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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
)
Accumulated other comprehensive loss:
                                                             
Foreign currency adjustment
   
(23
)
   
-
     
(23
)
   
-
   
-
     
-
     
-
     
(23
)
Stockholders' equity
   
1,244
     
-
     
1,244
     
12,168
   
-
     
807
     
4,478
     
6,529
 
                                                               
Non-controlling interest in subsidiary
   
(3
)
   
-
     
(3
)
   
-
   
-
     
-
     
-
     
(3
)
Non-controlling interest in equity of affiliate
   
221
     
221
     
-
     
-
   
-
     
-
     
-
     
-
 
(River Valley Business Center, LLC)
                                                             
Total equity
   
1,462
     
221
     
1,241
     
12,168
   
-
     
807
     
4,478
     
6,526
 
                                                               
Total liabilities and stockholders' equity
 
$
8,535
   
$
2,826
   
$
5,709
   
$
13,120
 
$
(5,100
)
 
$
61
   
$
6,494
   
$
12,264
 

Sajan, Inc., subsidiaries and affiliate (River Valley Business Center, LLC)
Common stock, $.01 par value, 18,000 shares authorized, 9,181 (pre merger) and 16,009 (pro forma) issued and outstanding at December 31, 2009
Preferred stock, $.01 par value, 10,000 shares authorized, no shares issued and outstanding at December 31, 2009

SEE NOTES TO UNAUDITED PRO FORMA FINANCIAL STATEMENTS

 
15

 

SAJAN, INC., SUBSIDIARIES AND AFFILIATE
(RIVER VALLEY BUSINESS CENTER, LLC)
UNAUDITED PRO FORMA COMBINED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
For the year ended December 31, 2009
 


  
  
Sajan, Inc.,
Subsidiaries, and
Affiliate
  
  
Deconsolidation
of River Valley
Business Center,
LLC
  
  
Adjustments
  
  
Sajan, Inc.
and
Subsidiaries
  
  
MathStar,
Inc.
  
  
Pro Forma
Adjustments
  
  
Unaudited
Pro
Forma Total
  
Revenues:
                                         
Translation and consulting income
 
$
11,640
   
$
-
   
$
-
   
$
11,640
   
$
-
   
$
-
   
$
11,640
 
Technology income
   
1,019
     
-
     
-
     
1,019
     
-
     
-
     
1,019
 
Rental income
   
67
     
406
     
339
G
   
-
     
-
     
-
     
-
 
Other revenue
   
-
     
-
     
-
     
-
     
95
     
-
     
95
 
Total revenues
   
12,726
     
406
     
339
     
12,659
     
95
     
-
     
12,754
 
                                                         
Operating expenses:
                                                       
Cost of revenues (exclusive of amortization and depreciation included in general and administrative below)
   
7,002
     
-
     
-
     
7,002
     
105
     
-
     
7,107
 
Sales and marketing
   
3,414
     
-
     
-
     
3,414
     
-
     
158
I
   
3,572
 
Research and development
   
596
     
-
     
-
     
596
     
36
     
3
I
   
635
 
General and administrative
   
2,875
     
246
     
339
G
   
2,968
     
2,200
     
(705
)H
   
4,463
 
Restructuring and impairment charges
   
-
     
-
     
-
     
-
     
593
     
-
     
593
 
Total operating expenses
   
13,887
     
246
     
339
     
13,980
     
2,934
     
(544
)
   
16,370
 
                                                         
Income (loss) from operations
   
(1,161
)
   
160
     
-
     
(1,321
)
   
(2,839
)
   
544
     
(3,616
)
                                                         
Other income (expense):
                                                       
Interest expense
   
(209
)
   
(165
)
   
-
     
(44
)
   
-
     
-
     
(44
)
Interest and other income
   
4
     
-
     
-
     
4
     
88
     
-
     
92
 
Other expense
   
(38
)
   
-
     
-
     
(38
)
   
-
     
-
     
(38
)
Total other income (expense)
   
(243
)
   
(165
)
   
-
     
(78
)
   
88
     
-
     
10
 
                                                         
Net loss before income taxes and non-controlling interests in subsidiary and affiliate
   
(1,404
)
   
(5
)
   
-
     
(1,399
)
   
(2,751
)
   
544
     
(3,606
)
                                                         
Income tax benefit
   
(308
)
   
-
     
-
     
(308
)
   
-
     
-
     
(308
)
                                                         
Net loss before non-controlling interest
   
(1,096
)
   
(5
)
   
-
     
(1,091
)
   
(2,751
)
   
544
     
(3,298
)
Less Non-controlling interest in subsidiary
   
(4
)
   
-
     
-
     
(4
)
   
-
     
-
     
(4
)
Less Non-controlling interest in affiliate (River Valley Business Center)
   
(5
)
   
(5
)
   
-
     
-
     
-
     
-
     
-
 
                                                         
Net loss attributable to Sajan, Inc. and subsidiaries
 
$
(1,087
)
 
$
-
   
$
-
   
$
(1,087
)
 
$
(2,751
)
 
$
544
   
$
(3,294
)
                                                         
Loss per common share - Basic and diluted
 
$
(0.19
)
                 
$
(0.19
)
 
$
(0.30
)
         
$
(0.21
)
                                                         
Weighted average shares outstanding - Basic and diluted
   
5,686
                     
5,686
     
9,181
             
16,009
   

SEE NOTES TO UNAUDITED PRO FORMA FINANCIAL STATEMENTS

 
16

 
 

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

 
A
Merger document notes cash of $5,100 paid at the time of closing to the stockholders of Sajan.

B     ·
Transaction costs of $261 related fees and expenses by MathStar.
  ·
Transaction costs of $85 related fees and expense by Sajan.

 
C
Payment of note payable – related party of $262 and accrued interest – related party of $23 as required by the Merger Agreement.
 
D      ·
Transaction costs accrued of $282 related fees and expenses by MathStar.
  ·
Transaction costs accrued of $179 related fees and expenses by Sajan.

E      ·
Merger agreement provides for a note payable for one year of $1,000 to the majority stockholders of Sajan.
 
  ·
Merger agreement provides for $1,000 to be placed in escrow for the indemnification obligations.

 
F
Record net monetary assets of MathStar of $4,842 for the issuance of 9,181 shares of common stock and the conversion of Sajan shares at 1.225 per share.

 
G
Rent expense paid by Sajan to River Valley Business Center, LLC which will no longer be accounted for as a variable interest entity.

H      ·
Transaction costs of $543 related fees and expenses by MathStar.
  ·
Transaction costs of $264 related fees and expenses by Sajan.
  ·
Stock options and warrants repriced based on terms of Merger document.  Expense of $102 for the modification for vested equity instruments.

Additional expense to be recorded for the modifications in the years ending December 31:

2010
 
$
17
 
2011
   
16
 
2012
   
16
 
2013
   
16
 
   
$
65
 

 
I
Stock options and warrants repriced based on terms of Merger document.  Expense of $161 for the modification for vested equity instruments.
Additional expense to be recorded for the modifications in the years ending December 31:
2010
 
$
156
 
2011
   
80
 
2012
   
77
 
   
$
313
 
 
 
17

 

 
J
Pay off of line of credit of $1,000.

 
K
Accrual for 113 dissenter’s common shares with a fair value of $364.

3.
Concentrations of Credit Risk –

Financial instruments which potentially subject the Company to concentrations of credit risk consist principally of cash and cash equivalents and accounts receivable.

Cash Concentration – Cash and cash equivalents include all highly liquid investment assets with a maturity of ninety days or less at the time of purchase. The Company places its cash at financial institutions with balances that, at times, may exceed federally insured limits. The Company evaluates the creditworthiness of these financial institutions in determining the risk associated with these deposits. The Company has not experienced any losses on such accounts.

Accounts receivable concentration – Concentrations of credit risk with respect to trade accounts receivable are limited due to the dispersion of customers across different industries and geographic regions.  As of September 30, 2010, two customers accounted for 18.8% and 13.4% of the accounts receivable and as of December 31, 2009, one customer accounted for 37% of the accounts receivable.

4.
Segment Information and Major Customers –

The Company views its operations and manages its business as one reportable segment, providing language translation solutions to a variety of companies, primarily in its targeted vertical markets.  Factors used to identify the Company’s single operating segment include the financial information available for evaluation by the chief operating decision maker in making decisions about how to allocate resources and assess performance.  The Company markets its products and services through its headquarters in the United States and its wholly-owned subsidiaries operating in Ireland, Spain and India.

Net sales per geographic region, based on the billing location of end customer, are summarized below.  For comparative purposes, we have omitted the rental income of approximately $0 and $16,800 for the three months ended September 30, 2010 and 2009, respectively and $10,200 and $50,400 for the nine months ended September 30, 2010 and 2009, respectively, derived from the River Valley affiliate for income through the effective date of the Merger and $5,300 in other revenue generated from our MathStar subsidiary, for which operations were ceased prior to the Merger.  (See Note 1)

   
Three Months Ended September 30,
  
   
2010
  
  
2009
  
 
  
Sales
  
  
Percent
   
Sales
   
Percent
 
United States
 
$
3,310,510
     
78.65
%
 
$
2,511,477
     
81.36
%
International
   
898,735
     
21.35
%
   
575,219
     
18.64
%
Total Sales
 
$
4,209,245
     
100
%
 
$
3,086,696
     
100
%
 
   
Nine months Ended September 30,
 
   
2010
   
2009
 
   
Sales
   
Percent
   
Sales
   
Percent
 
United States
 
$
9,085,568
     
78.72
%
 
$
7,245,179
     
82.52
%
International
   
2,455,999
     
21.28
%
   
1,534,918
     
17.48
%
Total Sales
 
$
11,541,567
     
100
%
 
$
8,780,097
     
100
%
 
 
18

 

The Company’s largest two customers accounted for 16.4% and 12.8% of net revenues for the three months ended September 30, 2010 and one customer accounted for 13.3% of net revenues for the three months ended September 30, 2009.   Two customers accounted for 11.7% and 10.2% of net revenues for the nine months ended September 30, 2010 and two customers accounted for 15.1% and 10.2% of net revenues for the nine months ended September 30, 2009.
 
No individual foreign country accounted for 10% of consolidated revenue in any period presented.

5.
Related Party Transactions –

Notes Payable

Notes payable and accrued interest to related parties was approximately $1,048,000 and $316,000 at September 30, 2010 and December 31, 2009, respectively, related to two notes payable to officers and stockholders of the Company, Shannon and Angela Zimmerman.  The majority of the note payable as of December 31, 2009 was paid as of the date of the Merger.  On February 23, 2010, the Company issued a Promissory Note to Shannon and Angela Zimmerman as part of the Merger consideration.  The Promissory Note documents the Company’s obligation to pay $1 million of the pro rata amount of the cash Merger consideration to the Zimmermans. The Promissory Note has a term of one year and provides for an interest rate of 8% per year to be accrued until payment of the Promissory Note.  Accrued interest was approximately $48,000 as of September 30, 2010.  Upon the occurrence of an “event of default,” as defined in the Promissory Note, and at any time thereafter, the unpaid principal balance, plus accrued interest, plus all other amounts due under the Promissory Note will, at the option of the Zimmermans, be immediately due and payable, without notice or demand. The obligations of the Company under the Promissory Note are unsecured.  

Lease

Sajan leases its office space from River Valley under two non-cancelable operating leases. The first lease was entered into during 2005 and expires in January 2026. The second lease was entered into during 2008 and expires in January 2026. In February 2010, the lease terms were amended to expire on January 31, 2017 and reduce the monthly lease payments by $1,766 per month. These lease agreements require the Company to pay a minimum monthly rental plus certain operating expenses. Related party rental income and expense for the office leases of approximately $0 and $84,700 has been eliminated from the consolidated financial statements for the three months ended September 30, 2010 and 2009, respectively, and $51,400 and $253,980 has been eliminated from the consolidated financial statements for the nine months ended September 30, 2010 and 2009, respectively.  Payment of rent under these leases is secured by goods, chattels, fixtures and personal property of the Company.

6.
Debt –

Line of Credit

The Company had $0 and $650,000 outstanding at September 30, 2010 and December 31, 2009, respectively, under a $1,000,000 bank line of credit. The line of credit due in December 2009 was extended to mature in March 2010.   The line of credit was paid in full and closed on February 23, 2010.

 
19

 

7.
Other Accrued Liabilities –

Other accrued liabilities of the following at:
   
September 30, 2010
   
December   31,   2009
 
Legal and professional services
    24,750       184,497  
Professional translator services
    476,483       418,243  
Accrued lease obligations
    288,173       -  
Other
    43,513       144,931  
Total
  $ 832,919     $ 747,671  

8.
Non-controlling Interest –

In 2009 Sajan formed Sajan India, a software development subsidiary in Delhi, India.  To comply with local regulations, two individuals created the subsidiary and each held a 3% interest at time of formation.  During the third quarter of 2010, the Company acquired this 6% interest for $3,000 and the Indian operation is now a wholly owned subsidiary of Sajan.  All non-controlling interests have been eliminated as a result of the acquisition of the outstanding shares.  In view of the immaterial amount involved to reacquire the shares, no purchase accounting adjustments have been recorded.  The non-controlling interest at December 31, 2009 was $3,075.

9.
Options and Warrants –

Amended and Restated 2004 Long-Term Incentive Plan

In October 2004, MathStar adopted and in June 2005 its stockholders approved the Amended and Restated 2004 Long-Term Incentive Plan (the “Plan”). Under the Plan, 1,333,334 shares of the Company's common stock were reserved for the issuance of restricted stock and incentive and nonqualified stock options to directors, officers and employees of and advisors to the Company at exercise prices as determined by the Board of Directors on the dates of grants. With the approval of stockholders at the 2006 and 2007 annual meetings, 300,000 and 1,366,666 additional shares were reserved, respectively, under the Plan.  With the approval of stockholders at the 2008 annual meeting, 3,000,000 additional shares were reserved under the Plan and a one-for-five reverse stock split of its common stock was approved, which in effect, reduced the number of shares reserved under the Plan to 1,200,000.  On June 10, 2010, the stockholders of Sajan approved an amendment to increase the number of shares reserved for issuance by 1.0 million shares.  The total number of shares reserved under the Plan as of September 30, 2010 is 2,200,000.

As a result of the Merger, Sajan adopted the Plan and converted the options outstanding in their 2001 Stock Option Plan for 1.225 options of MathStar common stock.  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 (see Note 2).  

On September 30, 2010, 1,168,748 options in the Plan were outstanding with a weighted average exercise price of $1.79 per share.

 
20

 

10.
Income Taxes –

Our deferred income tax assets and liabilities are recognized for the differences between the financial statement and income tax reporting basis of assets and liabilities based on currently enacted rates and laws.  These differences include depreciation, net operating loss carryforwards, capital loss carryforwards, allowance for accounts receivable, stock options and warrants, prepaid expenses, unrealized loss on securities, capitalized software costs, cash  to accrual  conversion, and accrued liabilities.  Our current deferred tax asset as of September 30, 2010 and December 31, 2009, was approximately $680,000 and $660,000, respectively.   Our current deferred tax liability as of September 30, 2010 and December 31, 2009 was $564,000 and $605,000, respectively.
 
The cumulative net operating loss available to offset future income was $32.2 million as of September 30, 2010.  The Company's federal and state net operating loss carryforwards expire in various calendar years from 2015 through 2029.  (Available research and development credit carryforwards at September 30, 2010, represent federal and state amounts of $3.2 million with expiration dates in calendar years 2020 through 2028). Future utilization of available net operating loss carryforwards may be limited under Internal Revenue Code Section 382 as a result of significant changes in ownership. These limitations could result in reduction of these net operating loss carryforwards before they are utilized. Based upon the provisions of Section 382 of the Code, an amount of up to 4.14% of the available NOL is available on an annual basis.
 
In assessing the recovery of the deferred tax assets, management considers whether it is more likely than not that a portion or all of the deferred tax assets will not be realized.  The ultimate realization of deferred tax assets is dependent upon the generations of future taxable income in the periods in which those temporary differences become deductible.  Management considers the scheduled reversals of future deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment.   As such, the Company has recorded a valuation allowance to offset a portion of its deferred taxes.  The valuation allowance was $16.9 million and $0 as of September 30, 2010 and December 31, 2009, respectively.

On February 25, 2010, the Company entered into the Tax Benefit Preservation Plan and Rights Agreement (the “Preservation Plan”) with Wells Fargo Shareowner Services, a division of Wells Fargo Bank, National Association, as Rights Agent. The Company’s Board of Directors adopted the Preservation Plan in an effort to protect against a possible limitation on the ability to use its net operating losses under the Internal Revenue Code of 1986, as amended (the “Code”), and rules promulgated by the Internal Revenue Service.  Under the Preservation Plan, beginning March 12, 2010, for each share of the Company’s common stock held, the holder of the common stock has the right to purchase one one-millionth of a share of a new series of preferred stock of the Company.

We file a consolidated U.S. federal tax return.  As a result of the adoption of ASC 740 – Income Taxes, effective October 1, 2007, we applied the requirements of ASC 740 to all tax positions for which the statute of limitations remained open.  ASC 740 was issued to address the non-comparability in reporting tax assets and liabilities resulting from a lack of specific guidance in prior standards on consistent recognition threshold and a measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return.  ASC 740 also provides related guidance on derecognition, classification, interest and penalties, accounting interim periods, disclosures and transition.  To the extent interest and penalties would be assessed by taxing authorities on any underpayment of income taxes, such amounts would be accrued and classified as a component of income tax expenses on the consolidated statement of operations.

11.
Legal Proceedings –

In the ordinary course of business, the Company is subject to legal proceedings and claims. In the opinion of management, the amount of ultimate liability with respect to these actions may or may not materially affect the financial position of the Company nor can an estimate be made. The Company expenses legal costs during the period incurred.

Tiberius Litigation

As reported in our Annual Report on Form 10-K for the year ended December 31, 2009, filed with the SEC on March 31, 2010, on October 14, 2009, the Company filed a Complaint against Tiberius Capital, LLC (“Tiberius”) in the United States District Court for the District of Minnesota captioned “MathStar, Inc., Feltl and Company, Inc., Sajan, Inc., Perkins Capital Management, Inc., Richard C. Perkins, Merrill A. McPeak, Benno G. Sand, John C. Feltl and Joseph P. Sullivan, Plaintiffs, v. Tiberius Capital II, LLC, Defendant” charging Tiberius with threatening to bring a class action lawsuit against the Company and  tortious interference with prospective economic advantage.  On November 9, 2009, Tiberius served and filed its Answer and asserted certain counterclaims.

 
21

 

On April 26, 2010, the United States District Court, District of Minnesota granted the Company’s motion to dismiss all counterclaims asserted by Tiberius.  Tiberius retains certain rights to amend its counterclaims and to appeal this decision.  The Company believes that the Tiberius claims are without merit and that it is not liable for any of these claims.

Litigation by Sajan, Inc. Stockholder (Natzel)

On February 11, 2010, Mary Jo Natzel, a stockholder of Sajan, Inc., initiated a lawsuit against Shannon Zimmerman and Angel Zimmerman (the “Zimmermans”) and Sajan, Inc. in the Minnesota District Court, Hennepin County, Fourth Judicial District. Ms. Natzel seeks declaratory, injunctive and monetary relief in an amount in excess of $50,000 against Sajan, Inc. and the Zimmermans in connection with the alleged underpayment to Ms. Natzel of distributions made by Sajan, Inc. while it was a corporation taxed under Subchapter S of the Internal Revenue Code and representations by the Zimmermans with respect to the amount of money invested in Sajan, Inc.

On May 13, 2010, the Company tendered a check to the plaintiffs in the amount of $366,942 in payment of the fair value of the shares of Sajan tendered by the plaintiff in connection with the exercise of dissenters’ rights related to the Company’s merger effected in February 2010.  On June 8, 2010, the Company received a letter which asserted that the fair value was $495,372.  The Company disputes the value claimed by the plaintiff.  The Company was required to take action with respect to this supplemental claim by August 6, 2010.  On August 3, 2010, the parties agreed to suspend the August 6, 2010 deadline to take action indefinitely and agreed to mediate this claim on September 9, 2010, where the issues related to the fair value of the shares were discussed.  There was no agreement to settle as a result of the mediation process.  On November 1, 2010, the Company filed a petition requesting the court to determine the fair value of the shares.  The parties are proceeding with discovery.

We believe the claims are without merit and intend to vigorously defend this lawsuit.  A complete summary of the litigation is included in our Annual Report on Form 10-K for the year ended December 31, 2009, filed with the SEC on March 31, 2010.
 
22


Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements
 
This Quarterly Report on Form 10 - Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934 (“   Securities Exchange Act ”).   Forward-looking statements reflect the current view about future events.   When used in this Quarterly Report on Form 10 - Q the words “anticipate,” “will,” “believe,” “estimate,” “expect,” “future,” “intend,” “plan” and similar expressions or the negative of these terms as they relate to Sajan , Inc. (the “Company” or “Sajan”)  its subsidiaries or its management identify forward-looking statements.   Forward-looking statements are based on information available at the time the statements are made and involve known and unknown risks, uncertainties and other factors that may cause our results, levels of activity, performance or achievements to be materially different from the information expressed or implied by the forward-looking statements.   Such statements reflect the current view of our management with respect to future events and are subject to risks, uncertainties, assumptions and other factors (including the risks contained in the section of Annual Report on Form 10 -K entitled “Risk Factors” filed with the SEC on March 31, 2010) relating to the Company ’s industry, its operations and results of operations, and any businesses that may be acquired by it.   These factors include:

 
·
our rate of growth in the global multi-lingual content delivery industry, especially for software-as-a-service solutions within this industry;

 
·
changes in the utilization of our software and services by our customers;

 
·
lack of acceptance of any existing or new solutions we offer;

 
·
our ability to continue increasing the number of our customers or the revenues we derive from our recurring revenue customers;

 
·
continued economic weakness and constrained globalization spending by businesses operating in international markets;

 
·
our ability to effectively develop new solutions that compete effectively with the solutions that our current and future competitors offer;

 
·
risk of increased regulation of the Internet and business conducted via the Internet;

 
·
our ability to identify attractive acquisition opportunities, successfully negotiate acquisition terms and effectively integrate any acquired companies or businesses;

 
·
our ability to effectively manage our growth;

 
·
availability of capital on acceptable terms to finance our continued growth;

 
·
risks of conducting international commerce, including foreign currency exchange rate fluctuations, changes in government policies or regulations, longer payment cycles, trade restrictions, economic or political instability in foreign countries where we may increase our business and reduced protection of our intellectual property;

 
·
our ability to add sales and marketing, research and development or other key personnel who are able to successfully sell or develop our solutions;

 
23

 

 
·
our ability to operate as a public company and comply with applicable disclosure and other requirements and to hire additional personnel with public company compliance experience; and

 
·
other risk factors included under “Risk Factors” in our Annual Report on Form 10 -K filed with the SEC on March 31, 2010 .

Should one or more of these risks or uncertainties materialize, or should the underlying assumptions prove incorrect, actual results may differ significantly from those anticipated, believed, estimated, expected, intended or planned. Although our management believes that the expectations reflected in the forward-looking statements are reasonable, it cannot guarantee future results, levels of activity, performance or achievements. Except as required by applicable law, including the securities laws of the United States, Sajan does not intend to update any of the forward-looking statements to conform these statements to actual results. The following discussion should be read in conjunction with the financial statements and the related notes and the pro forma financial information included in our Annual Report Form on 10-K filed with the SEC on March 31, 2010.

 
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Recent Events

Merger Transaction

Pursuant to the Merger Agreement, by and among MathStar, a Delaware corporation, and Sajan, a privately held Minnesota corporation whose business is providing language translation technology and service; Garuda, 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.  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.

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 have a large minority interest in the combined entity, the governing board consists 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.

 
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General Overview

Sajan provides  on-demand language translation solutions to customers selling products into global markets. These customers use our solutions to translate product manuals, instructions, warnings, and other product information into numerous languages. We combine our internally developed proprietary technology and high quality translation services to provide language translation solutions that are fast, reliable, and user-friendly. By utilizing an integrated technology and a service-based approach to language translation, we offer comprehensive solutions that allow customers to rely upon a single provider to meet all of their language translation needs. Our hosted technology system delivers a secure online solution that can be offered on a modular basis, which makes it attractive in both small business settings and in large enterprise environments.

We offer our customers the ability to utilize our solutions under three different models:

 
·
Technology Enabled Service Model: we provide all of the customer’s language translation requirements;

 
·
Managed Service Model: customers use our technology and operations staff to manage translators; and

 
·
Licensed Software Model: a technology-only solution that is independently operated by our customers.

Our solutions are used to manage the end-to-end process of content globalization, which is the project, process and delivery management of content translated and localized into multiple languages across the enterprise. Content is localized across the enterprise for a wide variety of high value-added purposes and uses, most notably, product sales and marketing, packaging, user manuals, technical support and training, as well as internal requirements.

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 Ltd, the producer of Sajan’s technology tools. Sajan India Software Private Limited (“Sajan – India”), based in Delhi, India, houses one of our development center at which we conduct substantially all of our software development activities. Sajan-India is a wholly-owned subsidiary of Sajan.  In 2010, we also established a Global Language Service Center in Spain, Sajan Spain S.L., to serve the European market.  All of these operations are wholly-owned subsidiaries of Sajan.

Discussion of Critical Accounting Policies and Estimates
 
Discussion of the financial condition and results of our operations is based upon our consolidated financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of these consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, costs and expenses, and related disclosures. On an ongoing basis, we evaluate our estimates and judgments, including those discussed below. These estimates are based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. The results of our analysis form the basis for making assumptions about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions, and the impact of such differences may be material to the consolidated financial statements.

Management believes the following critical accounting policies involve significant judgments and estimates in the preparation of our consolidated financial statements:

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.

 
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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:  translation services, account management, graphic design services, technical, consulting and professional services as requested by our clients 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.

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.

 
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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.
 
Income Taxes

Income taxes are provided for tax effects of transactions reported in the consolidated financial statements and consist of income taxes currently due plus deferred income taxes related to timing differences between the basis of certain assets and liabilities for financial statements and income tax reporting. Deferred taxes are determined based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect in the years in which the differences are expected to reverse. A valuation allowance for the net deferred tax assets is provided if, based upon the weight of available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized.

On September 30, 2010, we have an accumulated NOL carryforward of approximately $32.2 million, which includes approximately $29.1 million as a result of the Merger.  The NOL carryforward may be used to offset future income tax liabilities, subject to limitations as provided in Section 382 of the Code, as amended, and will continue to be available provided there is no change of control, as defined in Section 382 of the Code. Based upon the provisions of Section 382 of the Code, an amount of up to 4.14% of the available NOL is available on an annual basis. The Company is allowed to issue shares in each year subsequent to the effective date of the Merger in an amount not to exceed 10% of the share count at the beginning of such year without violating the Section 382 of the Code change of control limitations, even if such issuance were to constitute a change of control as defined in Section 382 of the Code.

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.

 
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Stock-based Compensation

We measure and recognize compensation expense for all stock-based compensation at fair value. Our determination of fair value of share-based compensation awards on the date of grant using an option-pricing model is affected by our stock price as well as assumptions regarding a number of variables. These variables include, but are not limited to, 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. We do not have historical exercise data to develop such an assumption. In cases where companies do not have historical data and where the options meet certain criteria, SEC Staff Accounting Bulletin 107 (“SAB 107”) provides the use of a simplified expected-term calculation. Accordingly, Sajan calculated the expected terms using the SAB 107 simplified method.

Prior to the Merger, we calculated expected volatility for stock options and awards using an industry index and comparable companies, as we were recently a privately owned company and did not have sufficient information to utilize a historical volatility. We consider specific companies with comparable operations along with the Dow Jones software and computer services small cap technology index to be representative of our size and industry and have used the historical closing total return values of that index for the three years prior to the date of grant to estimate volatility. Management expects and estimates that substantially all employee stock options will vest, and therefore the forfeiture rate used was 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.

Source of Revenues
         
We generate revenues by providing language translation services to customers for which we are paid based upon the number of words translated and by the languages involved. The price charged per word per language varies depending upon the language, the availability of translator resources and the extent to which our proprietary TMate search algorithm has been applied to reuse prior translation work. We break out for financial reporting purposes revenues for which we incurred direct cost of revenues with linguists versus revenues where the translation is machine-based from Translation Memory. In late 2010, we expect that we will begin generating revenue on a product only basis, for which we will also receive revenue on a per word basis similar to our services business model based upon the number of words processed through our GCMS software platform by our product customers.

 Cost of Revenue

Cost of revenue is highly variable based upon the volume of translation services revenue. We work with freelance linguists who complete the actual language translation, and they are paid on a per word basis. The fixed component of cost of revenue is comprised of the global operations staff located principally in our River Falls, Wisconsin location and also in our Dublin, Ireland location, who are responsible for project and process management, quality control, operational integration, vendor management and production operations. In the near term, our cost of revenues may be affected by a number of factors including the mix of customers, the mix of services and the extent of new customer implementations in a given quarter.  Over the long term, we expect cost of revenue will grow in absolute dollars, as we expect to continue to grow our revenue, but decrease as a percentage of revenue due to economies of scale, more efficient sourcing and operational efficiencies from ongoing utilization of our GCMS platform.

 
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Sales and Marketing Expenses

Sales and marketing expense consists primarily of advertising and promotional costs, wages and benefits for sales and marketing personnel, sales commissions and partner referral fees. Advertising costs consist of pay-per-click payments to search engines and print advertisements in trade journals. Advertising costs are expensed as incurred. Promotional costs consist primarily of public relations, memberships and event costs. As we move to accelerate our sales activities both domestically and internationally, and launch sales and marketing initiatives for our product solutions, we expect sales, advertising and marketing expense to increase in dollar terms but to decrease slightly as a percentage of total sales.

Research and Development Expenses

Research and development expenses consist primarily of wages and benefits for product strategy and development personnel. We have focused our research and development efforts more recently on the industrialization of the GCMS platform and its component modules for general release and independent use by the various participants involved in the content globalization process and for the ability to host GCMS utilizing cloud computing methodologies. Functional development has continued in parallel on improving ease of use, functionality, scalability and efficiency of Translation Memory processing.

We capitalize certain software development costs and amortize such costs over 36 months, with such amortization included in depreciation and amortization expense as noted below. The research and development organization is located principally at Sajan India and at Sajan Software. We expect that on an annual basis, research and development expenses will increase in absolute dollars as we continue to enhance and expand our product offerings, but decrease as a percentage of revenues as we expect to continue to grow our revenues at a faster rate.

General and Administrative Expenses

General and administrative expenses consist primarily of wages and benefits for administrative, human resources, internal information technology support, finance and accounting personnel, professional fees, certain taxes and other corporate expenses.  We expect that our general and administrative expenses will increase in absolute dollars but will decrease on a percentage of revenue basis as we move into 2011,  as the costs associated with being a public company stabilize.

Depreciation and Amortization
 
Depreciation and amortization consist of the expense related to property and equipment, capitalized software development costs and software license costs that are being depreciated or amortized over the estimated useful lives of the assets using the straight-line method.
 
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 or 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.

 
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Results of Operations - Three Months Ended September 30, 2010 Compared to Three Months Ended September 30, 2009

For the three months ended September 30, 2010, net loss attributable to stockholders was $.57 million compared to net loss of $.30 million for the three months ended September 30, 2009. Operating results for the quarter reflect increased revenues and cost of revenues from additional translation services which resulted in an increase in gross margin of $.16 million.  This was offset by an increase in operating expenses related to increased sales and marketing costs related to higher commissions and costs related to our Ireland office, increased investment in research and development associated with our TMS system and increased general and administrative expenses associated with improving internal processes and associated with public company requirements.

Net loss related to our non-controlling interest in our Sajan   India subsidiary was $0 for the three months ended September 30, 2010 compared to $8,000 for the three months ended September 30, 2009.  Our investment in Sajan – India occurred in June 2009. The Company acquired the non-controlling interest of Sajan India in the quarter ended September 30, 2010.   Net loss related to our non-controlling interest in our affiliate was $0 for the three months ended September 30, 2010 and approximately $9,000 for the three months ended September 30, 2009 related to River Valley’s operations through the date of the Merger.  The Merger is a reconsideration event between Sajan and River Valley, thus financial results for River Valley were deconsolidated on the date of the Merger and will not be presented in future periods.
 
The major components of revenues, cost of revenue, operating expenses, other income (expense), and income tax benefit are discussed below.
 
   
Three Months Ended
       
Item
 
September 30,
2010
   
September 30,
2009
   
% Change
(Year Over Year)
 
Revenues
  $ 4,209,245     $ 3,103,482       35.6 %
Cost of Revenues
    2,563,706       1,613,422       58.9 %
Operating Expenses:
                       
Sales and Marketing
    838,906       748,835       12.0 %
Research and Development
    327,184       175,179       86.8 %
General and Administrative
    816,533       600,312       36.0 %
Depreciation and Amortization
    217,009       252,145       (13.9 )%
Other Income (Expense):
                       
Interest expense
    (21,843 )     (52,563 )     (58.4 )%
Interest and other income
    8,866       -       100.0 %
Other expense
    (883 )     (23,132 )     (96.2 )%
Income tax benefit
    -       79,663       (100.0 )%
Net loss before non-controlling interest
    (567,953 )     (282,443 )     101.0 %
Less non-controlling interest in subsidiary
    -       (7,869 )     (100.0 )%
Less non-controlling interest in affiliate
    -       (8,722 )     (100.0 )%
Net loss attributable to Sajan, Inc. and subsidiaries
  $  (567,953 )   $  (299,034 )     89.9 %

 
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Revenues

Revenues totaled $4.2 million for the three months ended September 30, 2010 compared to $3.1 million for the three months ended September 30, 2009. This $1.1 million or 35.6% increase resulted from an increase in the number of customers, the growth of business with existing customers, and the introduction of new products and services.

The following table summarizes our revenues for the three months ended September 30, 2010 and 2009, respectively:
 
 
Three Months Ended
 
Three Months Ended
 
 
September 30,
 
September 30,
 
 
2010
 
2009
 
2010
 
2009
 
         
(percentage of revenues)
 
Translation and consulting income
$ 3,809,968   $ 2,790,848     90.5 %   89.9 %
Technology income
  314,696     276,559     7.5 %   8.9 %
Product income
  50,506     19,289     1.2 %   0.6 %
Other income
  34,075     16,786     0.8 %   0.5 %
Total
$ 4,209,245   $ 3,103,482     100.0 %   100.0 %

Cost of Revenues

Cost of revenues increased $.95 million, or 58.9% for the three months ended September 30, 2010 compared to the three months ended September 30, 2009.   As a percentage of revenue, cost of revenues was 60.9% for the three months ended September 30, 2010 compared to 52% for the same interim period in 2009. The increase in dollar terms resulted from additional costs to process the additional words translated, as well as additional costs associated with an increase in the operations staff in River Falls in support of anticipated growth. The cost of revenues as a percentage of revenue increased as a result of a shift in the mix of business between customers, the addition of new customers that required incremental implementation costs, and a sizable non-recurring special project for a customer which we agreed to perform at very low gross profit.

Cost of revenue excludes depreciation and amortization of $.22 million and $.25 million for the three months ended September 30, 2010 and September 30, 2009, respectively, which are included in operating expenses.

Operating Expenses

Total operating costs for the three months ended September 30, 2010 were $2.2 million compared to $1.8 million for the three months ended September 30, 2009. For the three months ended September 30, 2010, the major components of these costs were sales and marketing, research and development, general and administrative expenses and depreciation and amortization expense. A discussion of the various components of our operating costs for the three months ended September 30, 2010 and 2009 appears below:

Sales and Marketing. Sales and marketing expense of approximately $.84 million for the three months ended September 30, 2010 increased 12% from sales and marketing expense of approximately $.75 million for the three months ended September 30, 2009. The increase in our expenses between the interim periods is the result of an increase in compensation expense related to the addition of sales and marketing staff in our Ireland and Spain offices and higher stock based compensation expense related to sales and marketing personnel.  As a percentage of revenue, sales and marketing expense was approximately 20% for the three months ended September 30, 2010, a decrease from approximately 24.1% for the same interim period in 2009, reflecting the economies of scale that result from an increase in revenues and management’s intentional restraint on discretionary marketing spending.

 
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Research and Development.  Research and development expense of approximately $.33 million grew $.15 million or 87% for the three months ended September 30, 2010 over research and development expense of $.18 million for the three months ended September 30, 2009.  The increase for the three months ended September 30, 2010 is comprised of additional investments in our software development activities related to our enterprise technology product, Global Communication Management System (“GCMS”).  This increased investment primarily was seen through an increase in salaries and benefits expense from the addition of staff  in both the United States and India and an increase in R&D related travel costs.  These increases were offset by lower stock based compensation expense as compared to the prior year.  As a percentage of revenue, research and development expense increased to 7.8% for the three months ended September 30, 2010 compared to 5.6% for the three months ended September 30, 2009.

General and Administrative.  General and administrative expense was $.82 million and $.60 million for the three months ended September 30, 2010 and 2009, respectively, an increase of approximately $.22 million, or 36%.  As a percentage of revenue, general and administrative expense was 19.4% for the three months ended September 30, 2010 as compared with 19.3% for the three months ended September 30, 2009.  The increase in dollar terms reflects additional staff and costs associated with additional business activities including complying with public company requirements, increased insurance and rent expense and additional stock based compensation expense as compared to prior year levels. These increases were offset by lower professional fees incurred in the quarter versus year ago levels which included activity associated with the merger transaction that was completed in the first quarter of 2010.     
 
Depreciation and Amortization.  Depreciation and amortization expense was $.22 million and $.25 million for the three months ended September 30, 2010 and 2009, respectively, a decrease of $35,000.  As a percentage of revenue, depreciation and amortization expense was 5.2% for the three months ended September 30, 2010 as compared to 8.1% for the three months ended September 30, 2009.
 
Other Income (Expense).   Interest expense for three months ended September 30, 2010 of approximately $22,000 decreased from $53,000 for the three months ended September 30, 2009 as a result of the elimination of the mortgage interest expense that related to the buildings owned by River Valley Business Center, LLC and leased by Sajan.  The interest expense was discontinued as a result of the deconsolidation on February 23, 2010.  Interest and other income for the three months ended September 30, 2010 was approximately $9,000 compared to $0 for the three months ended September 30, 2009.  The increase in interest income is a result of increased cash and cash equivalents. 

Income Tax Benefit

Income tax benefit for the three months ended September 30, 2010 was zero compared to income tax benefit of $.08 million for the three months ended September 30, 2009.

Results of Operations - Nine months Ended September 30, 2010 Compared to Nine months Ended September 30, 2009

For the nine months ended September 30, 2010, net loss attributable to stockholders was $2.6 million compared to net loss of $.87 million for the nine months ended September 30, 2009. Operating results for the quarter reflect increased revenues and cost of revenues from additional translation services which resulted in an increase in gross margin of $.9 million.  This was offset by an increase in operating expenses related to  nonrecurring legal, accounting, tax and investment banking fees related to the Merger, increased stock compensation expenses, increased insurance expenses, increased sales and marketing costs related to our Ireland office, additional investment in software development activities and increase general and administrative expenses related to public company activities and requirements .

 
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Net loss related to our non-controlling interest in our Sajan  India subsidiary was approximately $7,000 for the nine months ended September 30, 2010 compared to $5,700 for the nine months ended September 30, 2009.  Our investment in Sajan  India occurred in September 2009.  Net loss related to our non-controlling interest in our affiliate of approximately $5,000 is related to River Valley’s operations through the date of the Merger.  The Merger is a reconsideration event between Sajan and River Valley, thus financial results for River Valley were deconsolidated on the date of the Merger and will not be presented in future periods.  The non-controlling interest in Sajan India was acquired by the Company in the quarter ended September 30, 2010 and will not be presented in future periods.
 
The major components of revenues, cost of revenue, operating expenses, other income (expense), and income tax benefit are discussed below.
 
   
Nine Months Ended
       
Item
 
September 30,
2010
   
September 30,
2009
   
% Change
(Year Over Year)
 
Revenues
  $ 11,551,767     $ 8,830,453       30.8 %
Cost of Revenues
    6,614,335       4,799,579       37.8 %
Operating Expenses:
                       
Sales and Marketing
    2,571,394       2,449,906       5.0 %
Research and Development
    1,288,376       511,606       151.8 %
General and Administrative
    2,994,117       1,354,546       120.9 %
Depreciation and Amortization
    682,748       675,978       1.1 %
Other Income (Expense):
                       
Interest expense
    (90,259 )     (155,638 )     (42.0 )%
Interest and other income
    36,422       20,140       117.5 %
Other expense
    (18,262 )     (33,150 )     (56.2 )%
Income tax benefit
    62,311       248,557       (74.9 )%
Net loss before non-controlling interest
    (2,608,991 )     (881,253 )     196.1 %
Less non-controlling interest in subsidiary
    7,284       (5,738 )     (226.9 )%
Less non-controlling interest in affiliate
    (4,565 )     21,752       (121.0 )%
Net loss attributable to Sajan, Inc. and subsidiaries
  $  (2,606,272 )   $  (865,239 )     201.2 %

Revenues

Revenues totaled $11.6 million for the nine months ended September 30, 2010 compared to $8.8 million for the nine months ended September 30, 2009. This $2.8 million or 31% increase resulted from an increase in the number of customers, the growth of business with existing customers, and the introduction of new products and services.

The following table summarizes our revenues for the nine months ended September 30, 2010 and 2009, respectively:

 
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Nine Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2010
 
2009
 
2010
 
2009
 
         
(percentage of revenues)
 
Translation and consulting income
$ 10,433,551   $ 8,029,772     90.3 %   90.9 %
Technology income
  943,697     715,218     8.2 %   8.1 %
Product income
  120,473     35,105     1.0 %   0.4 %
Other income
  54,046     50,358     0.5 %   0.6 %
Total
$ 11,551,767   $ 8,830,453     100.00 %   100.00 %

Cost of Revenues

Cost of revenues increased $1.81 million, or 37.8% for the nine months ended September 30, 2010 compared to the nine months ended September 30, 2009.   As a percentage of revenue, cost of revenues was 57.3% for the nine months ended September 30, 2010 compared to 54.4% for the same interim period in 2009.    The increase in costs of revenues as a percentage of revenue is the result of a shift in the mix of business between customers, the addition of new customers that required incremental implementation costs, and a sizable non-recurring special project for a customer which we agreed to perform at very low gross profit.  These items were somewhat offset by increased economies of scale associated with a larger revenue base and the growth of technology and product revenue.

Cost of revenue excludes depreciation and amortization of $.68 million for both the nine months ended September 30, 2010 and September 30, 2009 which are included in operating expenses.

Operating Expenses

Total operating costs for the nine months ended September 30, 2010 were $7.5 million compared to $5.0 million for the nine months ended September 30, 2009. For the nine months ended September 30, 2010 and 2009, the major components of these costs were sales and marketing, research and development, general and administrative and depreciation and amortization expenses. A discussion of the various components of our operating costs for the nine months ended September 30, 2010 and 2009 appears below:

Sales and Marketing. Sales and marketing expense of approximately $2.57 million for the nine months ended September 30, 2010 increased $.12 million, or 5%, over sales and marketing expense of approximately $2.45 million for the nine months ended September 30, 2009. The increase in expenses between the year to date interim periods primarily relates to an increase in sales commissions related to the higher revenue levels in 2010, increased salaries and benefits related to our sales and marketing staff in Ireland and Spain which were new in 2010 and an increase in stock based compensation expenses.  These cost increases were offset in part by a reduction in sales and marketing related travel costs.  As a percentage of revenue, sales and marketing expense was approximately 22.3% for the nine months ended September 30, 2010 as compare to approximately 27.7% for the same interim period in 2009, reflecting the economies of scale that result from an increase in revenues.

Research and Development.  Research and development expense of approximately $1.3 million grew $.78 million or 152% for the nine months ended September 30, 2010 over research and development expense of $.51 million for the nine months ended September 30, 2009.  The increase for the nine months ended September 30, 2010 is comprised of additional investments associated with the development of our enterprise technology product, Global Communication Management System (“GCMS”).  This additional investment resulted in increased salaries and benefits expense from the addition of staff in the United States and India and an increase in stock compensation expense for the nine months ended September 30, 2010.   As a percentage of revenue, research and development expense increased to 11.2% for the nine months ended September 30, 2010 compared to 5.8% for the nine months ended September 30, 2009.

 
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General and Administrative.  General and administrative expense was $3.0 million for the nine months ended September 30, 2010 as compared with $1.36 million for the nine months ended September 30, 2009, an increase of approximately $1.64 million, or 120.9%.  As a percentage of revenue, general and administrative expense was 25.9% for the nine months ended September 30, 2010, compared to 15.3% for the nine months ended September 30, 2009.  This increase principally reflects non-recurring legal, accounting  and other professional fees associated with the completion of the Merger transaction in the first quarter of 2010, additional salaries and benefits related to staff additions necessary to address increased business activities, increased general and administrative costs related to our offices in Ireland, India and Spain in 2010 and increased rent and insurance expense.   In addition, there was an increase in stock compensation expense as a result of the Merger.  
 
Depreciation and Amortization.  Depreciation and amortization expense was $.68 million for the nine months ended both September 30, 2010 and 2009.   As a percentage of revenue, depreciation and amortization expense was 5.9% for the three months ended September 30, 2010 as compared to 7.7% for the three months ended September 30, 2009.
 
Other Income (Expense).   Interest expenses for nine months ended September 30, 2010 and 2009 of approximately $90,000 and $156,000 were related to the mortgage on the buildings owned by River Valley Business Center, LLC and leased by Sajan.  The decrease is the result of the deconsolidation of this entity on February 23, 2010.  Interest and other income for the nine months ended September 30, 2010 was approximately $36,000 compared to $20,000 for the nine months ended September 30, 2009.  The increase in interest income is a result of increased cash and cash equivalents.  Other expenses for the nine months ended September 30, 2010 were approximately $18,000 compared to $33,000 for the nine months ended September 30, 2009.  The decrease in other expenses was related to fluctuations in foreign currency.

Income Tax Benefit

Income tax benefit for the nine months ended September 30, 2010 was $.06 million compared to income tax benefit of $.25 million for the nine months ended September 30, 2009.

Liquidity and Capital Resources

Summary cash flow data is as follows:
 
  
 
Nine months Ended September 30,
 
  
 
2010
   
2009
 
Cash flows provided (used) by :
           
Operating activities
 
$
(1,753,108
)
 
$
842,136
 
Investing activities
   
4,769,673
     
(845,718
)
Financing activities
   
(962,317
)
   
34,979
 
Net increase in cash
   
2,054,248
     
31,397
 
Effect of exchange rate changes in cash
   
(4,570
)
   
-
 
Cash, beginning of period
   
120,493
     
381,501
 
Cash, end of period
 
$
2,170,171
   
$
412,898
 

Net Cash (Used in) Provided by Operating Activities

Net cash used in operating activities for the nine months ended September 30, 2010 was $1.75 million and was used to fund our operations and expand our operations internationally.  Net cash provided by operating activities for the nine months ended September 30, 2009 was a result of a significantly lower net loss, a decrease in accounts receivable and an increase in accrued liabilities, offset by a reduction in deferred revenues.

 
36

 

Net Cash (Used in) Provided by Investing Activities

Net cash of $4.8 million provided by investing activities for the nine months ended September 30, 2010 primarily related to cash acquired in the Merger transaction.  Net cash of $.85 million used in investing activities for the nine months ended September 30, 2009 related to purchases of property and equipment, acquisition of specialized software and capitalization of software development costs.

Net Cash Used in Financing Activities

Net cash of $.96 million used in financing activities for the nine months ended September 30, 2010 primarily related to payments for merger-related costs and short-term debt.  Net cash of $40,000 provided by financing activities for the nine months ended September 30, 2009 related to amounts advanced on short -term debt facilities.

Sources of Capital

For the nine months ended September 30, 2010, our principal source of liquidity was funds generated from operations and cash received as part of the Merger.

Uses of Capital

Sajan’s primary uses of capital resources for the nine months ended September 30, 2010 have been to fund operating activities, expand business operations internationally, and make nonrecurring payments for professional fees related to the Merger.  The capital obtained by way of the Merger will be used to grow and support the business in a variety of different ways, including increased investments in research and development.  This will help extend our differentiation and provide greater value to our global clients.  We have a product roadmap influenced heavily by voice of market and will seek to accelerate key feature releases.  We also intend to use this capital for purchasing strategic companies which add ongoing benefit to the Company’s operations and clients.  This may include both language translation service companies and technology companies.  Finally, we will invest in more aggressive sales and marketing initiatives to assist in overall business growth.

We anticipate that we will generate positive cash flow from operations in the next six months but we may require investment capital to fund monthly cash flow requirements, investments in our organizational infrastructure for the launch of our business products and, potentially, for acquisitions.

We believe that our cash, cash equivalents and marketable securities and operating cash flows will be sufficient to meet our working capital and capital expenditure requirements for at least the next 12 months. Thereafter, we may need to raise additional funds through public or private financings or borrowings to fund our operations, to develop or enhance products, to fund expansion, to respond to competitive pressures or to acquire complementary products, businesses or technologies. If required, additional financing may not be available on terms that are favorable to us, if at all. If we raise additional funds through the issuance of equity or convertible debt securities, the percentage ownership of our stockholders will be reduced and these securities might have rights, preferences and privileges senior to those of our current stockholders or we may be subject to covenants that restrict how we conduct our business. No assurance can be given that additional financing will be available or that, if available, such financing can be obtained on terms favorable to our stockholders and us.

Off-Balance Sheet Arrangements  
 
The Company had no off-balance sheet arrangements as of September 30, 2010.

 
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Item 3. Quantitative and Qualitative Disclosures About Market Risk

Not applicable.
 
 Item 4T. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

On September 30, 2010, our Chief Executive Officer and Chief Financial Officer carried out an evaluation of the effectiveness of the design and operation of its disclosure controls and procedures (as defined in Exchange Rule 13a-15(e)), and concluded that our disclosure controls and procedures were not effective and designed to ensure that material information relating to the Company and our consolidated subsidiaries would be made known to them by others within the Company.  This conclusion was based primarily on the facts identified in our Annual Report on Form 10-K for fiscal year ended December 31, 2009, filed with the SEC on March 31, 2010.

Changes in Internal Control over Financial Reporting
 
There were no changes in our internal controls over financial reporting that occurred during the fiscal quarter covered by this report that materially affected, or were reasonably likely to materially affect such controls, except as described below.

During the quarter ended September 30, 2010, the Company hired a Chief Financial Officer who has initiated an analysis of the internal accounting controls and procedures.  This process has resulted in a number of changes to processes and procedures which have served to strengthen the Company’s internal accounting and disclosure controls.  In addition, during the year, the Company has taken the following steps to remediate the material weaknesses noted in the Annual Report on Form 10-K for the year ended December 31, 2009:

 
·
increase the oversight performed by our Board of Directors through expansion of our Board of Directors to seven members and expansion of our Audit Committee to four members.
 
·
increase our Audit Committee’s oversight role, including providing  additional oversight of the Company’s internal controls, more formal review of our consolidated financial statements, reviewing management’s analysis of actual expenditures compared to its approved budget, reviewing expense reports and supporting documentation for reimbursements to our Chief Executive Officer, monitoring the interim management reports on the effectiveness of our internal controls, discussing complex or unusual accounting transactions with management and our independent registered public accounting firm, and reviewing the draft periodic reports we file with the SEC;
 
·
design and implement robust corporate governance including: (1) direct oversight of our internal controls by the Audit Committee of our Board of Directors; (2) review of our Annual Report on Form 10-K and Quarterly Reports on Form 10-Q by the Audit Committee of our Board of Directors prior to filing with the SEC; (3) adoption and communication of our Code of Business Conduct and Ethics to our employees and consultants; (4) adoption and communication of our Policy on Insider Trading to our employees and consultants; (5) revision of policies within our employee handbook to ensure that appropriate disciplinary actions may be taken in the event an employee fails to properly perform their responsible internal controls or intentionally overrides any internal control and completion of employee training on the policy revisions; (6) adoption of charters for our Audit, Compensation, Governance and Nominating Committees of our Board of Directors; (7) adoption and training for our employees on our Whistleblower Policy, which includes our anonymous reporting system; (8) adoption of our policy on reporting and investigating complaints regarding accounting, internal accounting controls or auditing matters and concerns regarding questionable accounting or auditing matters; (9) communication to our global workforce by our Chief Executive Officer and Interim Chief Financial Officer on the importance of internal control compliance and reporting of noncompliance; and (10) adoption of our operating budget and our strategic plan by our Board of Directors;
 
·
secure the administrator passwords for the financial application, the servers and other devices used to support and backup the financial application, and replicate backup files to our corporate location to complete a validation of their integrity;

 
38

 

 
·
complete documentation of our key accounting processes and internal controls and initiate the internal assessment of the design and operating effectiveness of our internal controls as well as design of remediation efforts as necessary for proper compliance;
 
·
design and implement a formalized financial reporting process that includes properly prepared, supported and reviewed balance sheet reconciliations; properly prepared, supported and reviewed journal entries; properly segregated duties, and properly completed and approved financial close checklist and financial reporting calendar;
 
·
design a mechanism to capture costs related to our internally developed software;
 
·
begin implementing an Enterprise Resource Planning (“ERP”) system to replace our current financial software application, including ensuring access rights within our new financial software application comply with designated roles and responsibilities and support the proper segregation of duties; and
 
·
begin implementing generation of consolidated financial statements directly from the new ERP financial application and eliminate our current manual consolidation process.

Despite the significant progress we believe we have made, we were unable to conclude that the material weaknesses described in our Annual Report on Form 10-K for the year ended December 31, 2009 were effectively remediated as of September 30, 2010, due to the fact that (i) less than the entire remediation plan has been implemented and (ii) an insufficient period of time has passed for management to test and document the effectiveness of those controls which have been altered or newly created as part of the remediation plan (as summarized above).  For further information, please see our Annual Report on Form 10-K for fiscal year ended December 31, 2009.

PART II. OTHER INFORMATION
 
Item 1. Legal Proceedings

On April 26, 2010, the United States District Court for the District of Minnesota granted the Company’s motion to dismiss all counterclaims asserted by Tiberius Capital II, LLC (“Tiberius”) in the action captioned “MathStar, Inc., Feltl and Company, Inc., Sajan, Inc., Perkins Capital Management, Inc., Richard C. Perkins, Merrill A. McPeak, Benno G. Sand, John C. Feltl and Joseph P. Sullivan, Plaintiffs, v. Tiberius Capital II, LLC, Defendant”.  Tiberius retains certain rights to amend its counterclaim and to appeal this decision.  A complete summary of this litigation is included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009, filed with the SEC on March 31, 2010. 

On February 11, 2010, Mary Jo Natzel, a stockholder of Sajan, Inc., initiated a lawsuit against Shannon Zimmerman and Angel Zimmerman (the “Zimmermans”) and Sajan, Inc. in the Minnesota District Court, Hennepin County, Fourth Judicial District. Ms. Natzel seeks declaratory, injunctive and monetary relief in an amount in excess of $50,000 against Sajan, Inc. and the Zimmermans in connection with the alleged underpayment to Ms. Natzel of distributions made by Sajan, Inc. while it was a corporation taxed under Subchapter S of the Internal Revenue Code and representations by the Zimmermans with respect to the amount of money invested in Sajan, Inc. 

 On May 13, 2010, the Company tendered a check to the plaintiffs in the amount of $366,942 in payment of the fair value of the shares of Sajan tendered by the plaintiff in connection with the exercise of dissenters’ rights related to the Company’s merger effected in February 2010.  On June 8, 2010, the Company received a letter which asserted that the fair value was $495,372.  The Company disputes the value claimed by the Plaintiff.  The Company was required to take action with respect to this supplemental claim by August 6, 2010.  On August 3, 2010, the parties agreed to suspend the August 6, 2010 deadline to take action indefinitely and agreed to mediate this claim on September 9, 2010, where the issues related to the fair value of the shares were discussed.  There was no agreement to settle this matter during the mediation process.

On November 1, 2010, the Company filed a petition requesting the court to determine the fair value of the shares.  The parties are now involved in discovery activities.  The Company expects to incur legal fees in the fourth quarter of 2010 and the first quarter of 2011 to defend this action.

A complete summary of the litigation is included in our Annual Report on Form 10-K for the year ended December 31, 2009, filed with the SEC on March 31, 2010.
 
39

 
Item 1A. Risk Factors

There have been no material changes to the Company’s Risk Factors as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2009, as filed with the SEC on March 31, 2010.
 
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 3. Defaults upon Senior Securities

None.

Item 4.  Removed and Reserved

Removed and Reserved.

Item 5.  Other Matters

On November 8, 2010, Mr. Vern Hanzlik, Chief Marketing Officer and a member of the Board of Directors of the Company and President of Sajan Software, submitted his resignation from all of his positions with and as a director of the Company and its subsidiaries, effective the close of business on January 1, 2011.

On November 8, 2010, the Board of Directors of approved a form of indemnification agreement (the “Indemnification Agreement”) for each of the Company’s directors and executive officers. Effective November 8, 2010, the Company entered into a separate Indemnification Agreement with each of its directors except Mr. Hanzlik (Shannon Zimmerman, Angela (Angel) Zimmerman, Richard C. Perkins, Michael W. Rogers, Benno G. Sand and Kris Tufto) and with each of its executive officers who are not also directors (Timothy Clayton). The Company may from time to time enter into additional Indemnification Agreements with future directors and executive officers of the Company.
 
Each of the Indemnification Agreements provides, subject to certain exceptions, that the Company will indemnify and hold harmless the directors and executive officers subject to the Indemnification Agreements to the maximum extent then authorized or permitted by the Company’s Certificate of Incorporation, its By-laws and the Delaware General Corporation Law or any other applicable law in effect on the date of the Indemnification Agreement and to any greater extent such applicable law may in the future from time to time permit. The Company believes that the Indemnification Agreements are necessary to attract and retain qualified persons to serve as directors and executive officers and is not presently aware of any claims that might give rise to payments under the Indemnification Agreements other than as described in Item 1, Legal Proceedings, above. The description of the Indemnification Agreements set forth in this Item 5 is not complete and is qualified in its entirety by reference to the full text of the form of Indemnification Agreement filed as Exhibit 10.2 hereto.

 
40

 

Item 6. Exhibits  

Exhibit No.
  
Description
     
2.1
 
Agreement and Plan of Merger, dated January 8, 2010, among MathStar, Inc., Sajan, Inc., Garuda Acquisition, LLC, and Thomas Magne (incorporated by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K filed with the SEC on January 11, 2010).
     
3.1
 
Certificate of Incorporation of MathStar, Inc. (incorporated by reference to Exhibit 3.1 to the Company’s Registration Statement on Form S-1 filed by MathStar, Inc. with the SEC on August 3, 2005, Registration No. 333-127164 (“Registration Statement”)).
     
3.2
 
Certificate of Amendment of the Certificate of Incorporation of MathStar, Inc. filed with the Delaware Secretary of State on May 23, 2008 (incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed with the SEC on May 23, 2008).
     
3.3
 
Certificate of Designation of Series A Preferred Stock filed with the Secretary of State of the State of Delaware on February 25, 2010 (incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K dated February 25, 2010 filed with the SEC).
     
3.4
 
Certificate of Ownership and Merger merging Sajan, Inc. into MathStar, Inc. filed with the SEC on March 3, 2010 (incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed with the SEC on March 3, 2010).
     
3.5
 
Certificate of Amendment to Amended Certificate of Incorporation of Sajan, Inc. filed with the Secretary of State of the State of Delaware on June 15, 2010 (incorporated by reference to Exhibit 3.4 to the Company’s Form 8-A12G/A filed with the SEC on June 23, 2010).
     
3.6
 
Bylaws of MathStar, Inc. (incorporated by reference to Exhibit 3.2 to the Registration Statement).
     
4.1
 
Form of common stock certificate of Sajan, Inc. (incorporated by reference to Exhibit 4.2 to the Company’s Form 8-A/A filed with the SEC on June 23, 2010).
     
4.2
 
Tax Benefit Preservation Plan and Rights Agreement, dated as of February 25, 2010, between MathStar, Inc. and Wells Fargo Shareowner Services, a division of Wells Fargo Bank, National Association, as Rights Agent (incorporated by reference to Exhibit 4.1 of the Company’s Current Report on Form 8-K dated February 25, 2010 filed with the SEC).
     
10.1
 
 Employment Agreement, dated as of August 4, 2010, by and between the Company and Timothy Clayton (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on August 6, 2010.
     
10.2
 
Form of Indemnification Agreement between the Company and each of its directors and executive officers.
     
31.1
 
Certification of principal executive officer pursuant to Rule 13a-14(a)/15d-14(a) ( filed herewith).
     
31.2
 
Certification of principal financial officer pursuant to Rule 13a-14(a)/15d-14(a) ( filed herewith).
     
32.1
 
Certification of principal executive officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 ( filed herewith).
     
32.2
 
Certification of principal financial officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 ( filed herewith).

 
41

 
 
SIGNATURES
 
Pursuant to the requirements of the Securities and Exchange Act, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Dated: November 12, 2010
Sajan, Inc.
 
(Registrant)
   
 
By:
/s/ Shannon Zimmerman
   
Shannon Zimmerman
   
Chief Executive Officer and President
     
 
By:
/s/ Timothy Clayton
   
Timothy Clayton
   
Chief Financial Officer

 
42