hopTo Inc. - FORM 10-Q - November 14, 2014

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EX-31 - EXHIBIT 31.2 - hopTo Inc.	ex31-2.htm
EX-32 - EXHIBIT 32.2 - hopTo Inc.	ex32-2.htm
EX-32 - EXHIBIT 32.1 - hopTo Inc.	ex32-1.htm
EX-31 - EXHIBIT 31.1 - hopTo Inc.	ex31-1.htm
EXCEL - IDEA: XBRL DOCUMENT - hopTo Inc.	Financial_Report.xls

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended September 30, 2014

Commission File Number: 0-21683

hopTo Inc.

(Exact name of registrant as specified in its charter)

Delaware	13-3899021
(State of incorporation)	(IRS Employer
	Identification No.)

1919 S. Bascom Avenue, Suite 600

Campbell, CA 95008
(Address of principal executive offices)

Registrant’s telephone number:

(800) 472-7466

(408) 688-2674

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 such filing requirements for the past 90 days.

Yes ☒ No [ ]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulations S-T 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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

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 Exchange Act). Yes [ ] No ☒

As of November 7, 2014, there were issued and outstanding 114,862,793 shares of the registrant’s common stock, par value $0.0001.

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HOPTO INC.

FORM 10-Q

Table of Contents

		PAGE
PART I.	FINANCIAL INFORMATION
Item 1.	Financial Statements	2
	Condensed Consolidated Balance Sheets as of September 30, 2014 (unaudited) and December 31, 2013	2
	Unaudited Condensed Consolidated Statements of Operations for the Three and Nine-Month Periods Ended September 30, 2014 and 2013	3
	Unaudited Condensed Consolidated Statements of Stockholders’ Deficit for the Nine-Month Periods Ended September 30, 2014 and 2013	4
	Unaudited Condensed Consolidated Statements of Cash Flows for the Nine-Month Periods Ended September 30, 2014 and 2013	5
	Notes to Unaudited Condensed Consolidated Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	23
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	33
Item 4.	Controls and Procedures	33

PART II.	OTHER INFORMATION
Item 1.	Legal Proceedings	34
Item 1A.	Risk Factors	34
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	34
Item 3.	Defaults Upon Senior Securities	34
Item 4.	Mine Safety Disclosures	34
Item 5.	Other Information	34
Item 6.	Exhibits	34
	Signatures	35

Forward-Looking Information

This report includes, in addition to historical information, "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. This act provides a "safe harbor" for forward-looking statements to encourage companies to provide prospective information about themselves so long as they identify these statements as forward-looking and provide meaningful cautionary statements identifying important factors that could cause actual results to differ from the projected results. All statements other than statements of historical fact we make in this report are forward-looking statements. In particular, the statements regarding industry prospects and our future results of operations or financial position are forward-looking statements. Such statements are based on management's current expectations and are subject to a number of uncertainties and risks that could cause actual results to differ significantly from those described in the forward looking statements. Factors that may cause such a difference include the following:

●	the success of our new products depends on a number of factors including market acceptance and our ability to manage the risks associated with product introduction;
●	local, regional, national and international economic conditions and events, and the impact they may have on us and our customers;
●	our revenue could be adversely impacted if any of our significant customers reduces its order levels or fails to order during a reporting period; and
●	other factors, including, but not limited to, those set forth under Item 1A, “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2013, which was filed with the Securities and Exchange Commission (the “SEC”) on March 31, 2014, and in other documents we have filed with the SEC.

Statements included in this report are based upon information known to us as of the date that this report is filed with the SEC, and we assume no obligation to update or alter our forward-looking statements made in this report, whether as a result of new information, future events or otherwise, except as otherwise required by applicable federal securities laws.

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PART I. FINANCIAL INFORMATION

ITEM 1. Financial Statements

HOPTO INC.
Condensed Consolidated Balance Sheets

	(Unaudited)
	September 30, 2014			December 31, 2013
Assets
Current Assets:
Cash	$	2,003,900		$	2,430,700
Accounts receivable, net		457,900			811,700
Prepaid expenses		96,200			43,100
Total Current Assets		2,558,000			3,285,500

Capitalized software development costs, net		446,100			619,400
Property and equipment, net		394,400			302,100
Other assets		140,000			139,900
Total Assets	$	3,538,500		$	4,346,900

Liabilities and Stockholders’ Deficit
Current Liabilities:
Accounts payable and accrued expenses	$	676,300		$	844,100
Deferred revenue		2,433,500			2,772,900
Deferred rent		41,200			31,200
Severance liability		7,900			62,900
Total Current Liabilities		3,158,900			3,711,100

Warrants liability		602,900			979,800
Deferred revenue		379,700			476,200
Deferred rent		171,900			84,600
Total Liabilities		4,313,400			5,251,700

Commitments and contingencies

Stockholders' Deficit:
Preferred stock, $0.01 par value, 5,000,000 shares authorized, no shares issued and outstanding		—			—
Common stock, $0.0001 par value, 195,000,000 shares authorized, 112,199,221 and 98,510,622 shares issued and outstanding at September 30, 2014 and December 31, 2013, respectively		11,200			9,800
Additional paid-in capital		74,429,300			71,697,300
Accumulated deficit		(75,215,400	)		(72,611,900	)
Total Stockholders' Deficit		(774,900	)		(904,800	)
Total Liabilities and Stockholders' Deficit	$	3,538,500		$	4,346,900

See accompanying notes to unaudited condensed consolidated financial statements

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HOPTO INC.
Condensed Consolidated Statements of Operations

	Three Months Ended September 30,						Nine Months Ended September 30,
	2014			2013			2014			2013
	(Unaudited)			(Unaudited)			(Unaudited)			(Unaudited)
Revenue	$	1,289,200		$	1,534,700		$	4,036,100		$	4,545,500
Costs of revenue		100,100			100,500			348,800			349,600
Gross profit		1,189,100			1,434,200			3,687,300			4,195,900

Operating expenses:
Selling and marketing		343,300			683,300			1,576,900			1,743,500
General and administrative		655,700			914,900			2,505,400			2,441,600
Research and development		1,195,300			1,444,500			3,873,100			3,533,300
Total operating expenses		2,194,300			3,042,700			7,955,400			7,718,400

Loss from operations		(1,005,200	)		(1,608,500	)		(4,268,100	)		(3,522,500	)

Other income (expense):
Change in fair value of warrants liability		54,700			(639,100	)		1,665,900			680,100
Other, net		(200	)		(200	)		1,000			(500	)
Loss from operations before provision for income tax		(950,700	)		(2,247,800	)		(2,601,200	)		(2,842,900	)
Provision for income tax		200			4,600			2,300			7,300
Net Loss	$	(950,900	)	$	(2,252,400	)	$	(2,603,500	)	$	(2,850,200	)
Basic and diluted loss per share	$	(0.01	)	$	(0.02	)	$	(0.02	)	$	(0.03	)
Average weighted common shares outstanding – basic and diluted		112,058,708			94,836,777			111,397,562			87,992,742

See accompanying notes to unaudited condensed consolidated financial statements

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HOPTO INC.
Condensed Consolidated Statements of Stockholders’ Deficit

	Nine Months Ended September 30,
	2014			2013
	(Unaudited)			(Unaudited)
Preferred stock – shares outstanding
Beginning balance		—			—
Ending balance		—			—
		—			—
Common stock – shares outstanding
Beginning balance		98,510,622			82,616,750
Private placement of stock and warrants		11,299,999			—
Employee stock option issuances		256,818			1,459,972
Exercise of warrants		1,000,000			10,222,500
Vesting of restricted stock awards		1,131,782			1,208,412
Ending balance		112,199,221			95,507,634

Common stock – amount
Beginning balance	$	9,800		$	8,300
Par value of shares issued in private placement		1,200			—
Exercise of employee stock options		—			100
Exercise of warrants		100			900
Vesting of restricted stock awards		100			200
Ending balance	$	11,200		$	9,500

Additional paid-in capital
Beginning balance	$	71,697,300		$	62,425,400
Stock-based compensation expense		417,000			617,000
Company payment of employee taxes for stock-based compensation		(1,800	)		—
Proceeds from exercise of employee stock options		47,800			302,600
Proceeds from exercise of warrants		259,800			2,614,400
Proceeds from private placement of common stock and warrants, net of par value of shares issued		3,388,800			—
Cost of private placement of common stock and warrants		(20,000	)		—
Allocation of proceeds from common stock and warrants to warrants liability		(1,356,000	)		—
Accretion of compensation expense, net of forfeitures – consultant warrants		(3,600	)		11,800
Issuance of new warrants, per exercise agreement		—			514,800
New warrants recorded as cost of exercise agreement		—			(514,800	)
Reclassification of warrants liability to equity from exercise of warrants		—			385,900
Issuance of new warrants, per offer to exercise		—			45,600
New warrants recorded as cost of offer to exercise		—			(45,600	)
Reclassification of warrants liability to equity from amendment of warrants		—			4,391,000
Ending balance	$	74,429,300		$	70,748,100

Accumulated deficit
Beginning balance	$	(72,611,900	)	$	(68,865,900	)
Net loss		(2,603,500	)		(2,850,200	)
Ending balance	$	(75,215,400	)	$	(71,716,100	)
Total Stockholders’ Deficit	$	(774,900	)	$	(958,500	)

See accompanying notes to unaudited condensed consolidated financial statements

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HOPTO INC.
Condensed Consolidated Statements of Cash Flows

	Nine Months Ended September 30,
	2014			2013
	(Unaudited)			(Unaudited)
Cash Flows Provided By (Used In) Operating Activities:
Net Loss	$	(2,603,500	)	$	(2,850,200	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		296,900			187,700
Stock-based compensation expense		417,000			580,500
Company payment of employee taxes for stock-based compensation		(1,800	)		—
Change in fair value of derivative instruments – warrants		(1,665,900	)		(680,100	)
Accretion of warrants liability for consulting services		(67,000	)		35,700
Accretion of equity warrants for consulting services		(3,600	)		11,800
Revenue deferred to future periods		(2,756,500	)		2,725,500
Recognition of deferred revenue		2,320,600			(3,102,600	)
Changes in severance liability		(55,000	)		(122,300	)
Changes in deferred rent		(9,300	)		(19,900	)
Changes to allowance for doubtful accounts		(23,800	)		(4,300	)
Changes in operating assets and liabilities:
Accounts receivable		377,600			169,800
Prepaid expenses		(53,100	)		87,800
Accounts payable and accrued expenses		(231,800	)		226,600
Other assets		(100	)		15,200
Net Cash Used in Operating Activities		(4,059,300	)		(2,738,800	)

Cash Flows Used In Investing Activities:
Capital expenditures		(45,300	)		(75,800	)
Capitalized software development costs		—			(506,900	)
Net Cash Used In Investing Activities		(45,300	)		(582,700	)

Cash Flows Provided By (Used In) Financing Activities:
Proceeds from exercise of warrants		260,000			2,615,300
Proceeds from exercise of employee stock options		47,800			302,700
Cost associated with private placement of common stock and warrants		(20,000	)		—
Proceeds from private placement of common stock and warrants		3,390,000			—
Net Cash Provided By Financing Activities		3,677,800			2,918,000

Net Decrease in Cash		(426,800	)		(403,500	)
Cash - Beginning of Period		2,430,700			3,960,600
Cash - End of Period	$	2,003,900		$	3,557,100

See accompanying notes to unaudited condensed consolidated financial statements

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HOPTO INC.

Notes to Unaudited Condensed Consolidated Financial Statements

1. Basis of Presentation

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

The unaudited condensed consolidated financial statements included herein reflect all adjustments, which include only normal, recurring adjustments that are, in our opinion, necessary to state fairly the results for the periods presented. This Quarterly Report on Form 10-Q should be read in conjunction with our audited consolidated financial statements contained in our Annual Report, as amended, on Form 10-K for the year ended December 31, 2013, which was filed with the SEC on March 31, 2014 (“2013 10-K Report”). The interim results presented herein are not necessarily indicative of the results of operations that may be expected for the full fiscal year ending December 31, 2014 or any future period.

2. Significant Accounting Policies

Use of Estimates

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

Revenue Recognition

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

Software license revenues are recognized when:

●	Persuasive evidence of an arrangement exists, (i.e., when we sign a non-cancellable license agreement wherein the customer acknowledges an unconditional obligation to pay, or upon receipt of the customer’s purchase order), and
●	Delivery has occurred or services have been rendered and there are no uncertainties surrounding product acceptance (i.e., when title and risk of loss have been transferred to the customer, which occurs when the media containing the licensed program(s) is provided to a common carrier or, in the case of electronic delivery, when the customer is given access to the licensed program(s)), and
●	The price to the customer is fixed or determinable, as typically evidenced in a signed non-cancellable contract, or a customer’s purchase order, and
●	Collectability is probable. If collectability is not considered probable, revenue is recognized when the fee is collected.

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

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

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

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

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

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

Deferred Rent

The lease for our office in Campbell, California, as amended, (See Note 6) contains free rent and predetermined fixed escalations in our minimum rent payments. We recognize rent expense related to this lease on a straight-line basis over the term of the lease. We record any difference between the straight-line rent amounts and amounts payable under the lease as part of deferred rent in current or long-term liabilities, as appropriate.

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

Postemployment Benefits (Severance Liability)

Nonretirement postemployment benefits, including salary continuation, supplemental unemployment benefits, severance benefits, disability-related benefits and continuation of benefits such as health care benefits, are recognized as a liability and a loss when it is probable that the employee(s) will be entitled to such benefits and the amount can be reasonably estimated. The cost of termination benefits recognized as a liability and an expense includes the amount of any lump-sum payments and the present value of any expected future payments. During 2012, we recorded $721,800 of severance expense, including stock compensation expense. Such expense was recorded as a result of a separation agreement and a release with Robert Dilworth in connection with Mr. Dilworth’s resignation as our Chief Executive Officer and as a member of our board of directors. In addition, during 2013 we recorded an additional $75,700 of severance expense as a result of a separation and release agreement we entered into with a former vice president-level employee (See Note 5). An aggregate of $7,900 and $62,900 is reported as a severance liability, at September 30, 2014 and December 31, 2013, respectively.

Software Development Costs

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

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

Long-Lived Assets

Long-lived assets are assessed for possible impairment whenever events or changes in circumstances indicate that the carrying amounts may not be recoverable, whenever we have committed to a plan to dispose of the assets or, at a minimum, annually. Typically, for long-lived assets to be held and used, measurement of an impairment loss is based on the fair value of such assets, with fair value being determined based on appraisals, current market value, comparable sales value, and discounted future cash flows, among other variables, as appropriate. Assets to be held and used (which assets are affected by an impairment loss) are depreciated or amortized at their new carrying amount over their remaining estimated life; assets to be sold or otherwise disposed of are not subject to further depreciation or amortization. No such impairment charge was recorded during either of the three or nine-month periods ended September 30, 2014 or 2013.

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Allowance for Doubtful Accounts

We maintain an allowance for doubtful accounts that reflects our best estimate of potentially uncollectible trade receivables. The allowance is based on assessments of the collectability of specific customer accounts and the general aging and size of the accounts receivable. We regularly review the adequacy of our allowance for doubtful accounts by considering such factors as historical experience, credit worthiness, and current economic conditions that may affect a customer’s ability to pay. We specifically reserve for those accounts deemed uncollectible. We also establish, and adjust, a general allowance for doubtful accounts based on our review of the aging and size of our accounts receivable.

The following table sets forth the details of the Allowance for Doubtful Accounts for the three-month periods ended September 30, 2014 and 2013:

	Beginning Balance		Charge Offs		Recoveries		Provision			Ending Balance
2014	$	20,400	$	—	$	—	$	(2,200	)	$	18,200
2013		24,600		—		—		5,000			29,600

The following table sets forth the details of the Allowance for Doubtful Accounts for the nine-month periods ended September 30, 2014 and 2013:

	Beginning Balance		Charge Offs		Recoveries		Provision			Ending Balance
2014	$	42,000	$	—	$	—	$	(23,800	)	$	18,200
2013		33,900		—		—		(4,300	)		29,600

Concentration of Credit Risk

For the three and nine-month periods ended September 30, 2014 and 2013 respectively, we considered the customers listed in the following tables to be our most significant customers. The tables set forth the percentage of sales attributable to each customer during the periods presented, and the respective customer’s ending accounts receivable balance as a percentage of reported accounts receivable, net, as of September 30, 2014 and 2013.

	Three Months Ended September 30, 2014			As of September 30, 2014			Three Months Ended September 30, 2013			As of September 30, 2013
Customer	Sales			Accounts Receivable			Sales			Accounts Receivable
Alcatel-Lucent		7.3	%		22.4	%		8.4	%		16.2	%
Centric		4.2	%		10.7	%		4.0	%		3.5	%
Elosoft		5.7	%		12.7	%		10.4	%		15.1	%
G E		17.8	%		4.1	%		9.7	%		16.5	%
IDS		9.3	%		0.0	%		9.9	%		4.5	%
Seagate Technology		7.4	%		2.2	%		1.4	%		2.3	%
Total		51.7	%		52.1	%		43.8	%		58.1	%

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	Nine Months Ended September 30, 2014			As of September 30, 2014			Nine Months Ended September 30, 2013			As of September 30, 2013
Customer	Sales			Accounts Receivable			Sales			Accounts Receivable
Alcatel-Lucent		5.3	%		22.4	%		7.5	%		16.2	%
Centric		6.0	%		10.7	%		3.2	%		3.5	%
Elosoft		6.4	%		12.7	%		6.3	%		15.1	%
G E		14.5	%		4.1	%		6.8	%		16.5	%
IDS		7.0	%		0.0	%		6.6	%		4.5	%
Total		39.2	%		49.9	%		30.4	%		55.8	%

Derivative Financial Instruments

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

Fair Value of Financial Instruments

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

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

●

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

●

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

●

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

As of September 30, 2014, all of our $602,900 Warrants Liability reported at fair value was categorized as Level 3 inputs (See Note 4).

Recent Accounting Pronouncements

In August 2014, FASB issued Accounting Standards Update (“ASU”) No. 2014-15 “Preparation of Financial Statements - Going Concern (Subtopic 205-40)”. Under U.S. GAAP, continuation of a reporting entity as a going concern is presumed as the basis for preparing financial statements unless and until the entity's liquidation becomes imminent. Preparation of financial statements under this presumption is commonly referred to as the going concern basis of accounting. If and when an entity's liquidation becomes imminent, financial statements should be prepared under the liquidation basis of accounting in accordance with Subtopic 205-30, Presentation of Financial Statements-Liquidation Basis of Accounting. Even when an entity's liquidation is not imminent, there may be conditions or events that raise substantial doubt about the entity's ability to continue as a going concern. In those situations, financial statements should continue to be prepared under the going concern basis of accounting, but the amendments in the update should be followed to determine whether to disclose information about the relevant conditions and events. The amendments in this ASU are effective for the annual period ending after December 15, 2016, and for annual periods and interim periods thereafter. Early application is permitted. We will evaluate the going concern considerations in this ASU, however, at the current period, we do not believe that the Company has met conditions which would subject its consolidated financial statements to additional disclosure.

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In June 2014, FASB issued ASU No. 2014-12 “Compensation – Stock Compensation (Topic 718)” (“ASU 2014-12”). The objective of ASU 2014-12 is to resolve the diverse accounting treatment being applied in practice by reporting entities in the accounting for share-based payment awards that require a specific performance target to be achieved in order for employees to become eligible to vest in the awards, particularly those awards whose terms may provide that the performance target could be achieved after the employee completes the requisite service period. That is, the employee would be eligible to vest in the award regardless of whether the employee is rendering service on the date the performance target is achieved. ASU 2014-12 is effective for annual periods and interim periods within those annual periods beginning after December 15, 2015, and earlier adoption is permitted. The share-based payment awards we currently have outstanding which have performance targets do not contain clauses wherein the performance target could be achieved after the employee completes the requisite service period; accordingly, adoption of ASU 2014-12 did not have a material impact on our results of operations, cash flows or financial position.

In May 2014, FASB issued ASU No. 2014-09 “Revenue from Contracts with Customers (Topic 606)” (“ASU 2014-09”). ASU 2014-09 is the end result of a joint project initiated by FASB and the International Accounting Standards Board (“IASB”). IASB is the body that sets International Financial Reporting Standards (“IFRS”). The goal of FASB’s and IASB’s joint project was to clarify the principles for recognizing revenue and to develop a common revenue standard for U.S. GAAP and under IFRS. Specifically, ASU 2014-09:

Removes inconsistencies and weaknesses in revenue requirements.

Provides a more robust framework for addressing revenue issues.

Improves comparability of revenue recognition practices across entities, industries, jurisdictions, and capital markets.

Provides more useful information to users of financial statements through improved disclosure requirements.

Simplifies the preparation of financial statements by reducing the number of requirements to which an entity must refer.

The core principle of ASU 2014-09 is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09 is effective for annual reporting periods beginning after December 15, 2016, including interim periods within such annual period. Early adoption is not permitted. We are currently evaluating this ASU in order to determine whether or not its adoption will have a material impact on our results of operations, cash flows or financial position.

In April 2014, FASB issued ASU No. 2014-08 “Presentation of Financial Statements (Topic 205) and Property, Plant and Equipment (Topic 360)” (“ASU 2014-08”). The objective of ASU 2014-08 is to address issues in Subtopic 205-20, “Presentation of Financial Statements – Discontinued Operations”, that give rise to complexity and difficulties in practice. Generally, ASU 2014-08 is effective for discontinued operations that occur within annual periods beginning on or after December 31, 2014, and interim periods within those years. Early adoption is permitted, but only for discontinued operations that have not been reported in financial statements previously issued or available for issuance. We currently have no discontinued operations to report; consequently, adoption of ASU 2014-08 did not have a material impact on our results of operations, cash flows or financial position.

In July 2013, FASB issued ASU No. 2013-11 “Income Taxes (Topic 740)” (“ASU 2013-11”). The objective of ASU 2013-11 is to provide explicit guidance on the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. FASB recognized that there was inconsistency in how previous guidance in this topic was applied in practice; thus, the objective of ASU 2013-11 is to eliminate the diversity of how previous guidance was applied. ASU 2013-11 became effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. As the amendments in ASU 2013-11 do not require new recurring disclosures, rather, they are aimed at creating consistency in how previous guidance is applied, we do not believe that adoption of ASU 2013-11 will have a material impact on our results of operations, cash flows or financial position.

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3. Property and Equipment

Property and equipment was:

	September 30, 2014			December 31, 2013
Equipment	$	306,400		$	1,243,500
Furniture		231,600			432,400
Leasehold improvements		167,600			147,500
		705,600			1,823,400
Less: accumulated depreciation and amortization		(311,200	)		(1,521,300	)
	$	394,400		$	302,100

Aggregate property and equipment depreciation and amortization expense was $34,600 during the three-month period ended September 30, 2014 and $123,600 during the nine-month period ended September 30, 2014. During the nine-month period ended September 30, 2014, we capitalized the following costs: equipment; $35,700, furniture; $12,600, and leasehold improvements; $167,600. During the nine-month period ended September 30, 2014, we retired the following asset costs related to assets that were no longer in service as of September 30, 2014: equipment; $972,900, furniture; $213,400, and leasehold improvements; $147,500. All of the assets so retired were fully depreciated or amortized at the time of their respective retirement.

4. Liability Attributable to Warrants

On January 7, 2014, we entered into a securities purchase agreement (the “SPA”) with a limited number of institutional investors, pursuant to which we issued and sold for cash an aggregate 11,299,999 shares of our common stock at a purchase price of $0.30 per share (See Note 11) (the “2014 Transaction”). We also issued warrants to the investors for no additional consideration to purchase an aggregate 5,650,001 shares of our common stock at an exercise price of $0.40 per share from January 7, 2014 through January 7, 2019.

Under certain conditions of the SPA that will expire no later than January 7, 2015, we could be required to issue a variable number of additional warrants to the investors at a below-market value exercise price. Accordingly, we have concluded that the warrants issued to the investors are not indexed to our common stock; therefore, the fair value of these warrants has been recorded as a liability.

Using a binomial pricing model, we calculated the fair value of the warrants issued to the investors on January 7, 2014 to be $1,356,000. We used the following assumptions in the binomial pricing model to derive the fair value: estimated volatility 158%; annualized forfeiture rate 0%; expected term 5 years; estimated exercise factor 3.5; risk free interest rate 1.71; and dividends 0.

On June 17, 2013, we entered into, and subsequently consummated, an Exercise Agreement (the “Exercise Agreement”) with five of the largest investors in our September 1, 2011 private placement of common stock and warrants (the “2011 Transaction”), providing for the exercise for cash by such investors of warrants to purchase an aggregate of 9 million shares of our common stock, out of the approximately 17 million shares of common stock subject to warrants issued to the investors in the 2011 Transaction that remained outstanding as of such date. The approximately 5 million shares of common stock subject to warrants issued to the placement agent in the 2011 Transaction that remained outstanding as of such date were not part of the Exercise Agreement. The Company agreed under the Exercise Agreement to subsequently commence a tender offer (the “Offer to Exercise”) to provide these holders of other warrants that remained outstanding from the 2011 Transaction with the same opportunity to exercise as provided under the Exercise Agreement.

The warrants exercised had a remaining term of approximately 38 months, and had an exercise price of $0.26 per warrant, which was the original exercise price. We received cash proceeds of $2.34 million as a result of the warrants exercised. In consideration for the early exercise of these warrants, we issued to the five investors an aggregate of 4.5 million warrants to purchase common stock at an exercise price of $1.00 per warrant, with a term of five years from issuance (the “New Warrants”). The New Warrants that were issued on June 18, 2013, were substantially similar to the investor warrants that were exercised, and, after giving effect to the amendments to such warrants described below, such warrants have been recorded as a component of equity (additional paid-in capital “APIC”) at Level 3 fair value.

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Using a binomial pricing model, we calculated the fair value of the New Warrants issued at the time of the Exercise Agreement to be $514,800. We used the following assumptions in the binomial pricing model: estimated volatility 185%; annualized forfeiture rate 0%; expected term 5 years; estimated exercise factor 1.5, risk free interest rate 1.07%; and dividends 0. The New Warrants were accounted for as a cost of the exercise of the warrants issued pursuant to the Exercise Agreement; as a result, a $514,800 reduction of APIC was also recorded. Accordingly, there was no net effect on equity because of the issuance of the new warrants.

Immediately prior to the exercise for cash, the five investors, who held a majority of the outstanding warrants issued in the 2011 Transaction to investors (“Investor Warrants”), agreed to amend the entire series of such warrants to delete the following provisions: (1) the price-based anti-dilution clause; (2) our right to lower the exercise price at our discretion; and (3) a clause that mandated that we buy the warrants for cash at their Black-Scholes value in the event of certain extraordinary transactions. By virtue of a majority-rule clause in the warrants, the elimination of these provisions from the Investor Warrants issued in the 2011 Transaction eliminated the warrant derivative liability classification related to all of the Investor Warrants issued in the 2011 Transaction, including those held by investors who did not exercise their warrants at the date of the amendment.

The warrants issued to the placement agent and to an intellectual property consulting firm (ipCapital Group, Inc.) were not included in the Exercise Agreement or affected by the amendment described above. The exercise price of such warrants could, in certain circumstances, be reset to below-market value. Accordingly, unlike the amended investor warrants, we have concluded that the warrants issued to the placement agent and ipCapital Group, Inc. are not indexed to our common stock; therefore, the fair value of these warrants were, and continue to be, recorded as a liability.

On August 9, 2013, we conducted the Offer to Exercise under the terms of the Exercise Agreement entered into and in connection with the June 17, 2013 transaction. In connection with the Offer to Exercise, warrants to purchase an aggregate of 305,000 shares of our common stock were exercised for which we received cash proceeds of $64,000. In consideration for the early exercise of these warrants, we issued an aggregate of 152,500 New Warrants at an exercise price of $1.00 per warrant, with a term of five years from issuance.

Using a binomial pricing model, we calculated the fair value of the New Warrants issued at the end of the Offer to Exercise to be $45,600. We used the following assumptions in the binomial pricing model: estimated volatility 171%; annualized forfeiture rate 0%; expected term 4.875 years; estimated exercise factor 4, risk free interest rate 1.31%; and dividends 0. The New Warrants were accounted for as a cost of the exercise of the warrants issued pursuant to the Exercise Agreement; as a result, a $45,600 reduction of APIC was also recorded. Accordingly, there was no net effect on equity because of the issuance of the new warrants.

Under ASC 820, “Fair Value Measurement,” we re-measure the fair value of the warrants classified as a liability at every balance sheet date. As an integral part of the re-measurement process, we reevaluate each of the assumptions used, and when circumstances change or we become aware of new information affecting any of our assumptions, we adjust those assumptions accordingly. During the three months ended March 31, 2013, two investors in the 2011 private placement exercised an aggregate of 462,500 warrants. While closing our books for the three months ended March 31, 2013, we reevaluated our internal assumptions based on historic and recent exercise patterns and analysis of our stock performance. Based on the work performed, we concluded that a lowering of our estimated exercise factor for the warrants issued in conjunction with the 2011 transaction from 10 to 4 was appropriate (see the assumptions used, as set forth in the tables, below).

Changes in fair value of the warrants liability are recognized in other income (expense), except for changes in the fair value of the warrants issued to ipCapital which are recognized as a component of general and administrative expense in the condensed consolidated statement of operations.

We used the exercise price of the warrants, as well as the fair market value of our common stock, to determine the fair value of our warrants. The exercise price for warrants issued in conjunction with the 2011 Transaction, including those issued to the placement agent, was either $0.20 or $0.26 per share, and was $0.26 per share for the warrants issued to ipCapital.

The fair market value of our common stock was $0.12 and $0.54 per share as of September 30, 2014 and 2013, respectively.

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We used a binomial pricing model to determine the fair value of our warrants liability at September 30, 2014 and December 31, 2013, using the following assumptions:

	Estimated Volatility			Annualized Forfeiture Rate		Expected Term (Years)		Estimated Exercise Factor		Risk-Free Interest Rate			Dividends
2011 Transaction
September 30, 2014		102	%		—		1.95		3.5		0.56	%		—
December 31, 2013		102	%		—		2.67		3.5		0.51	%		—
2014 Transaction
September 30, 2014		126	%		—		4.33		3.5		1.54	%		—
December 31, 2013		—			—		—		—		—			—
ipCapital
September 30, 2014		101	%		—		2.06		4.0		0.60	%		—
December 31, 2013		108	%		—		3.79		4.0		0.53	%		—

The following table is a reconciliation of the warrants liability measured at fair value using significant unobservable inputs (Level 3) for the nine months ended September 30, 2014:

Warrants liability – December 31, 2013 fair value	$	979,800
Change in fair value of warrant liability recorded in other income		(1,665,900	)
Change in fair value of warrant liability recorded in general and administrative expense		(67,000	)
Aggregate fair value of the warrants liability associated with the 2014 Transaction warrants at issuance		1,356,000
Warrants liability – September 30, 2014 fair value	$	602,900

The following tables reconcile the number of warrants outstanding for the periods indicated:

	For the Three-Month Period Ended September 30, 2014
	Beginning Outstanding		Issued		Exercised		Cancelled / Forfeited		Ending Outstanding
2011 Transaction		10,302,500		—		—		—		10,302,500
2014 Transaction		5,650,001		—		—		—		5,650,001
ipCapital		400,000		—		—		—		400,000
Exercise Agreement		4,500,000		—		—		—		4,500,000
Consultant Warrant (1)		169,273		—		—		—		169,273
Offer to Exercise		152,500		—		—		—		152,500
		21,174,274		—		—		—		21,174,274

	For the Nine-Month Period Ended September 30, 2014
	Beginning Outstanding		Issued		Exercised			Cancelled / Forfeited			Ending Outstanding
2011 Transaction		11,302,500		—		(1,000,000	)		—			10,302,500
2014 Transaction		—		5,650,001		—			—			5,650,001
ipCapital		400,000		—		—			—			400,000
Exercise Agreement		4,500,000		—		—			—			4,500,000
Consultant Warrant (1)		312,500		—		—			(143,227	)		169,273
Offer to Exercise		152,500		—		—			—			152,500
		16,667,500		5,650,001		(1,000,000	)		(143,227	)		21,174,274

(1)	Effective April 11, 2014, we cancelled our consulting agreement with a former investor relations firm. Under the terms of the agreement, 169,273 of the warrants that had been issued to such firm had vested as of the effective cancellation date.

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For the Three-Month Period Ended September 30, 2013
	Beginning Outstanding		Issued		Exercised		Ending Outstanding
2011 Transaction		13,157,500		—		305,000		12,852,500
Exercise Agreement		4,500,000		—		—		4,500,000
ipCapital		400,000		—		—		400,000
Consultant Warrant (1)		—		312,500		—		312,500
Offer to Exercise		—		152,500		—		152,500
Total		18,057,500		465,000		305,000		18,217,500

For the Nine-Month Period Ended September 30, 2013
	Beginning Outstanding		Issued		Exercised		Ending Outstanding
2011 Transaction		23,075,000		—		10,222,500		12,852,500
Exercise Agreement		—		4,500,000		—		4,500,000
ipCapital		400,000		—		—		400,000
Consulting Warrant (1)		—		312,500		—		312,500
Offer to Exercise		—		152,500		—		152,500
Total		23,475,000		4,965,000		10,222,500		18,217,500

5. Severance Liability

During 2012, we entered into a separation agreement and a release with our former Chief Executive Officer and member of our board of directors, and in 2013 we entered into a separation agreement and a release with a former vice president level employee. Under the terms of these agreements and releases, we agreed to provide each individual with salary continuation and medical coverage payments for predetermined lengths of time. In addition, we agreed to provide the former Chief Executive Officer with certain stock option benefits including the grant of an additional stock option, accelerated vesting of all then-outstanding options previously granted to him, and an extension of the post-employment exercise period for all of his options, including the newly granted one. All costs associated with the modification of his options and the costs of the new option grant were immediately recognized upon his separation.

During the three-month period ended September 30, 2014, we agreed to provide a terminated employee a lump sum salary payment and 4 months of medical coverage payments which will end December 31, 2014.

The following table summarizes the salary continuation and medical coverage payments during the three-month period ended September 30, 2014.

	Compensation			Medical Coverage			Total
Balance at June 30, 2014	$	—		$	—		$	—
Accrued interest		—			—			—
Separation agreement August 2014		37,500			10,500			48,000
Payments		(37,500	)		(2,600	)		(40,100	)
Balance at September 30, 2014	$	—		$	7,900		$	7,900

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The following table summarizes the salary continuation and medical coverage payments during the nine-month period ended September 30, 2014.

	Compensation			Medical Coverage			Total
Balance at December 31, 2013	$	62,900		$	—		$	62,900
Accrued interest		1,700			—			1,700
Separation Agreement August 2014		37,500			10,500			48,000
Payments		(102,100	)		(2,600	)		(104,700	)
Balance at September 30, 2014	$	—		$	7,900		$	7,900

6. Deferred Rent

We amended our office lease during 2013. On February 1, 2014, we moved our corporate offices to a different building within the same office complex owned and operated by our landlord in Campbell, California, where our corporate offices had been located prior to February 1, 2014. Since the new space is controlled by the same landlord, we considered the lease amendment to be a modification to our preexisting lease; accordingly, we are amortizing the remaining balance in deferred rent immediately prior to February 1, 2014 over the remaining term of the modified amended lease. Additionally, our landlord provided us with $106,600 of leasehold improvements on the new space that we are amortizing over the remaining term of the amended lease. All of the prior leasehold improvements that had not been previously amortized were accelerated and recognized in their entirety from the time of the amendment through January 2014, prior to the move.

As of September 30, 2014 deferred rent was:

Component	Current Liabilities		Long-Term Liabilities		Total
Deferred rent expense	$	1,500	$	49,500	$	51,000
Deferred rent benefit		39,700		122,400		162,100
	$	41,200	$	171,900	$	213,100

As of December 31, 2013 deferred rent was:

Component	Current Liabilities		Long-Term Liabilities		Total
Deferred rent expense	$	7,200	$	24,600	$	31,800
Deferred rent benefit		24,000		60,000		84,000
	$	31,200	$	84,600	$	115,800

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

7. Stock-Based Compensation

The following table summarizes the stock-based compensation expense, net of amounts capitalized, we recorded in our Unaudited Condensed Consolidated Statements of Operations for the three and nine-month periods ended September 30, 2014 and 2013, respectively, by classification:

	Three Months Ended September 30,					Nine Months Ended September 30,
Statement of Operations Classification	2014		2013			2014		2013
Costs of revenue	$	1,700	$	(500	)	$	4,800	$	3,300
Selling and marketing expense		20,900		39,800			47,800		118,700
General and administrative expense		58,100		76,300			304,500		255,800
Research and development expense		6,100		74,400			59,900		202,700
	$	86,800	$	190,000		$	417,000	$	580,500

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The following table presents summaries of the status and activity of our stock option awards for the three-month period ended September 30, 2014.

	Number of Shares			Weighted Average Exercise Price		Weighted Average Remaining Contractual Terms (Years)		Aggregate Intrinsic Value
Outstanding – June 30, 2014		11,105,267		$	0.21
Granted		-			-
Exercised		-			-
Forfeited or expired		(1,445,985	)		0.16
Outstanding – September 30, 2014		9,659,282		$	0.22		5.44	$	55,400

The following table presents summaries of the status and activity of our stock option awards for the nine-month period ended September 30, 2014.

	Number of Shares			Weighted Average Exercise Price		Weighted Average Remaining Contractual Terms (Years)		Aggregate Intrinsic Value
Outstanding – December 31, 2013		12,019,328		$	0.21
Granted		-			-
Exercised		(256,818	)		0.19
Forfeited or expired		(2,103,228	)		0.19
Outstanding – September 30, 2014		9,659,282		$	.22		5.44	$	55,400

Of the options outstanding as of September 30, 2014, 8,156,814 were vested, 1,448,682 were estimated to vest in future periods and 53,786 were estimated to be forfeited prior to their vesting. As of September 30, 2014, there was approximately $127,300 of total unrecognized compensation cost, net of estimated forfeitures, related to unvested stock options. Such cost is expected to be recognized over a weighted-average period of approximately nine months.

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

The following table presents summaries of the status and activity of our restricted stock awards for the three-month period ended September 30, 2014. We include the common stock underlying the restricted stock award in shares outstanding once such common stock has vested and the restriction has been removed (“releases” or “released”). The common stock vests ratably, over a 33-month period commencing in the fourth month after the award date.

	Number of Shares			Weighted Average Grant Date Fair Value		Weighted Average Remaining Recognition Period (Years)		Unrecognized Compensation Cost Remaining
Unreleased – June 30, 2014		3,625,457		$	0.24
Awarded		-			-
Released		(313,388	)		0.24
Forfeited		(635,202	)		0.32
Outstanding – September 30, 2014		2,676,867		$	0.22		2.09	$	679,600

The following table presents summaries of the status and activity of our restricted stock awards for the nine-month period ended September 30, 2014.

	Number of Shares			Weighted Average Grant Date Fair Value		Weighted Average Remaining Recognition Period (Years)		Unrecognized Compensation Cost Remaining
Unreleased – December 31, 2013		3,938,426		$	0.24
Awarded		2,152,000			0.19
Released		(1,131,782	)		0.26
Forfeited		(2,281,777	)		0.27
Outstanding – September 30, 2014		2,676,867		$	0.22		2.09	$	679,600

As of September 30, 2014, there was approximately $679,600 of total unrecognized compensation cost, net of estimated forfeitures, related to unreleased restricted stock awards. That cost is expected to be recognized over a weighted-average period of approximately 24 months.

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8. Revenue

Revenue for the three-month periods ended September 30, 2014 and 2013 was:

					2014 Over (Under) 2013
Revenue	2014		2013		Dollars			Percent
Software Licenses
Windows	$	425,600	$	559,600	$	(134,000	)		-23.9	%
UNIX/Linux		186,200		219,900		(33,700	)		-15.3	%
		611,800		779,500		(167,700	)		-21.5	%
Software Service Fees
Windows		460,100		511,300		(51,200	)		-10.0	%
UNIX/Linux		197,300		226,500		(29,200	)		-12.9	%
		657,400		737,800		(80,400	)		-10.9	%
Other		20,000		17,400		2,600			14.4	%
Total Revenue	$	1,289,200	$	1,534,700	$	(245,600	)		-16.0	%

Revenue for the nine-month periods ended September 30, 2014 and 2013 was:

					2014 Over (Under) 2013
Revenue	2014		2013		Dollars			Percent
Software Licenses
Windows	$	1,531,600	$	1,673,400	$	(141,800	)		-8.5	%
UNIX/Linux		429,600		670,100		(240,500	)		-35.9	%
		1,961,200		2,343,500		(382,300	)		-16.3	%
Software Service Fees
Windows		1,440,000		1,471,700		(31,700	)		-2.2	%
UNIX/Linux		588,800		686,300		(97,500	)		-14.2	%
		2,028,800		2,158,000		(129,200	)		-6.0	%
Other		46,100		44,000		2,100			4.8	%
Total Revenue	$	4,036,100	$	4,545,500	$	(509,400	)		-11.2	%

9. Cost of Revenue

Cost of revenue for the three-month periods ended September 30, 2014 and 2013 was:

					2014 Over (Under) 2013
	2014		2013		Dollars			Percent
Software service costs	$	26,300	$	64,100	$	(37,800	)		-59.0	%
Software product costs		73,800		36,400		37,400			102.7	%
	$	100,100	$	100,500	$	(400	)		-0.4	%

Cost of revenue for the nine-month periods ended September 30, 2014 and 2013 was:

	Nine Months Ended September 30,				2014 Over (Under) 2013
	2014		2013		Dollars			Percent
Software service costs	$	136,400	$	191,900	$	(55,500	)		-28.9	%
Software product costs		212,400		157,700		54,700			34.7	%
	$	348,800	$	349,600	$	(800	)		-0.2	%

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10. Capitalized Software Development Costs

Capitalized software development costs consisted of the following:

	September 30, 2014			December 31, 2013
Software development costs	$	1,119,400			1,119,400
Accumulated amortization		(673,300	)		(500,000	)
	$	446,100		$	619,400

Amortization of capitalized software development costs is a component of costs of revenue. Capitalized software development costs amortization aggregated $52,700 and $173,300 during the three and nine-month periods ended September 30, 2014, respectively, and $24,000 and $107,100 during the three and nine-month periods ended September 30, 2013, respectively.

We did not record any capitalized software development costs during the nine-month period ended September 30, 2014. We recorded $79,100 and $543,600 of capitalized software development costs during the three and nine-month periods ended September 30, 2013, respectively. Such costs capitalized during 2013 were associated with the development of hopTo. Had these costs not met the criteria for capitalization, they would have been expensed.

11. Stockholders’ Equity

2014 Transaction

During the three-month period ended March 31, 2014, we issued and sold for cash an aggregate 11,299,999 shares of our common stock at a purchase price of $0.30 per share in the 2014 Transaction that resulted in gross proceeds of $3,390,000 (See Note 4).

The 2014 Transaction was recorded into the financial statements as follows:

Gross cash proceeds	$	3,390,000
Less: gross proceeds allocated to warrants liability – investors		(1,356,000	)
Gross proceeds allocated to additional paid-in capital and common stock		2,034,000
Less: cash issuance costs – legal fees		(20,000	)
Recorded in additional paid-in capital and common stock	$	2,014,000

In conjunction with the 2014 Transaction, we recorded a warrants liability of $1,356,000 as of January 7, 2014 on our Balance Sheet (See Note 4).

Prior to the consummation of the 2014 Transaction, we had entered into negotiations with potential investors in which we had discussed various investment scenarios that ultimately were not pursued. We incurred an aggregate $41,200 of legal fees associated with these plans that we charged to operating expense during 2013.

Accounting fees associated with the 2014 Transaction, which aggregated approximately $9,600, were deemed immaterial and were charged to operating expense during the three-month period ended March 31, 2014.

Stock Repurchase Program

During each of the three and nine-month periods ended September 30, 2014 and 2013, we did not repurchase any of our common stock under the terms of our Board-approved $1,000,000 stock repurchase program (“stock repurchase program”). As of September 30, 2014, approximately $782,600 remained available for future purchases under this program. We are not obligated to repurchase any specific number of shares and the stock repurchase program may be suspended or terminated at our discretion.

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12. Commitments and Contingencies

On February 1, 2014, we relocated our corporate offices to a larger suite within our landlord’s office complex in Campbell, California. We are currently leasing 10,659 square feet under a five-year lease that, unless renewed, will expire in October 2018. The following table sets forth the minimum lease payments we will be required to make throughout the remainder of the lease:

Year	Amount
Remainder of 2014	$	111,800
2015		450,600
2016		464,200
2017		478,100
2018		366,600
	$	1,871,300

13. Supplemental Disclosure of Cash Flow Information

We did not disburse any cash for the payment of interest expense during the nine-month periods ended September 30, 2014 or 2013.

We disbursed $2,000 and $1,800 for the payment of income taxes during the nine-month periods ended September 30, 2014 and 2013, respectively. Such disbursement was made for the payment of foreign income taxes related to the operation of our Israeli subsidiary, GraphOn Research Labs Ltd.

During the nine-month period ended September 30, 2014, we reduced our warrants liability by $1,732,900, which was recorded in the Condensed Consolidated Statement of Operations. Such reduction reflected the aggregate fair value adjustments we recorded during such period, which was partially offset by the recording of the $1,356,000 fair value of warrants issued in conjunction with the 2014 Transaction. No cash was disbursed in conjunction with these items (see Note 4).

During the nine-month period ended September 30, 2014, we capitalized $106,600 of leasehold improvements for which no cash was disbursed. We recorded $81,600 of such amount to long-term liabilities – deferred rent, and $25,000 to current liabilities – deferred rent.

During the nine-month period ended September 30, 2014, we capitalized $64,000 of fixed assets for which no cash was disbursed. All of the amounts so capitalized were reported within accounts payable and accrued expenses.

During the nine-month period ended September 30, 2014, we retired $1,333,800 of fixed assets that were no longer in service as of September 30, 2014. All of the assets retired were fully depreciated or amortized at the time of their respective retirement (See Note 3).

14. Earnings (Loss) Per Share

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

For the three and nine-month periods ended September 30, 2014 and for the three and nine-month periods ended September 30, 2013, 33,510,414 and 33,707,201 shares of common stock equivalents, respectively, were excluded from the computation of dilutive loss per share since their effect would be antidilutive.

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15. Segment Information

FASB has established guidance for reporting information about operating segments that require segmentation based on our internal organization and reporting of revenue and operating income, based on internal accounting methods. Our financial reporting systems present various data for management to operate the business prepared in methods consistent with such guidance.

We currently operate our business in two segments; namely GO-Global and hopTo. Currently, GO-Global is the only segment that generates revenue.

Segment revenue for the three-month periods ended September 30, 2014 and 2013 was as follows:

					Increase (Decrease)
	2014		2013		Dollars			Percentage
GO-Global	$	1,289,200	$	1,534,700	$	(245,500	)		-16.0	%
hopTo		—		—		—			n/a
Consolidated Total	$	1,289,200	$	1,534,700	$	(245,500	)		-16.0	%

Segment revenue for the nine-month periods ended September 30, 2014 and 2013 was as follows:

					Increase (Decrease)
	2014		2013		Dollars			Percentage
GO-Global	$	4,036,100	$	4,545,500	$	(509,400	)		-11.2	%
hopTo		—		—		—			n/a
Consolidated Total	$	4,036,100	$	4,545,500	$	(509,400	)		-11.2	%

Segment income (loss) operations for the three and nine-month periods ended September 30, 3014 and 2013 was as follows:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2014			2013			2014			2013
GO-Global	$	677,000		$	800		$	2,108,700		$	(204,500	)
hopTo		(1,682,200	)		(1,609,300	)		(6,376,800	)		(3,318,000	)
Total	$	(1,005,200	)	$	(1,608,500	)	$	(4,268,100	)	$	(3,522,500	)

We do not allocate interest, other income, other expense, or income tax to our segments.

As of September 30, 2014 segment fixed assets (long-lived assets) were as follows:

			Accumulated
			Depreciation
	Cost Basis		/Amortization			Net
GO-Global	$	670,100	$	(634,600	)	$	35,500
hopTo		3,994,000		(3,189,000	)		805,000
Unallocated		140,000		—			140,000
Total	$	4,804,100	$	(3,823,600	)	$	980,500

We do not maintain any significant long-lived assets outside of the United States.

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Products and services provided by the GO-Global segment include all currently available versions of the GO-Global family of products, OEM private labeling kits, software developer’s kits, maintenance contracts, and product training and support. The hopTo segment, which is under development, will provide mobile end-users with a productivity workspace for their mobile devices that will allow users to manage, share, view, and edit their documents, regardless of where they are stored. We launched the commercial release of hopTo through Apple’s App Store in November 2013. The two segments do not engage in cross-segment transactions.

Go-Global software revenue by country for the three-and nine month periods ended September 30, 2014 and 2013 was as follows:

	Three Months Ended September 30,				Nine Months Ended September 30,
Revenue by Country	2014		2013		2014		2013
United States	$	631,600	$	677,600	$	1,778,100	$	1,886,000
Brazil		108,300		161,000		463,700		415,100
Germany		61,200		84,600		222,900		354,200
Other Countries		488,100		611,500		1,571,400		1,890,200
Total	$	1,289,200	$	1,534,700	$	4,036,100	$	4,545,500

16. Related Party Transactions

Tamalpais Partners LLC

Steven Ledger, former Chairman of our Board of Directors, is the founder and managing partner of Tamalpais Partners LLC, (“Tamalpais”) a business consulting firm. On March 17, 2014, contemporaneous with Mr. Ledger’s resignation from our board, we mutually agreed with Mr. Ledger to terminate our consulting agreement with Tamalpais. We paid Tamalpais $12,000 and $18,000 for the three-month periods ended March 31, 2014 and 2013, respectively, for services rendered to us under the terms of this consulting agreement. No amounts were due Tamalpais at either September 30, 2014 or 2013.

When Mr. Ledger resigned as our Chairman, we entered into a short-term consulting agreement with Mr. Ledger that was separate from the terminated agreement with Tamalpais. Under that exclusive consulting agreement, Mr. Ledger began providing consulting services to our Board of Directors for a term that commenced upon his resignation, and ended on August 15, 2014. The consulting agreement also provided that Mr. Ledger’s then currently unvested options to purchase our common stock granted during his term as a director will continue to vest during the term of the consulting agreement in accordance with their original terms. In addition, the agreement provides that the period in which to exercise such options will be extended through the end of 2014. Mr. Ledger will also be reimbursed for his reasonable expenses incurred in connection with rendering services to our Board of Directors in accordance with our expense reimbursement policies. The consulting agreement also contains confidentiality, mutual non-disparagement and independent contractor-related provisions.

ipCapital Group, Inc.

On October 11, 2011, we engaged ipCapital Group, Inc. (“ipCapital”), an affiliate of John Cronin, who is one of our directors, to assist us in the execution of our strategic decision to significantly strengthen, grow and commercially exploit our intellectual property assets. Our engagement agreement with ipCapital, which has been amended three times, affords us the right to request ipCapital to perform a number of diverse services, employing its proprietary processes and methodologies, to facilitate our ability to identify and extract from our current intellectual property base new inventions, potential patent applications, and marketing and licensing opportunities.

For the three and nine-month periods ended September 30, 2014 and 2013 we paid ipCapital an aggregate of $0 and $31,200, respectively, for services performed under the engagement agreement, as amended. No amounts were due ipCapital at September 30, 2014 and 2013.

In addition to the fees we agreed to pay ipCapital for its services, we issued ipCapital a five-year warrant to purchase up to 400,000 shares of our common stock at an initial price of $0.26 per share. Half of the warrant (200,000 shares) has a time-based vesting condition, with such vesting to occur in three equal annual installments. The first two vesting installments occurred on October 11, 2012 and October 11, 2013, respectively, with the remaining vesting installment to occur on October 11, 2014. The remaining 200,000 shares became fully vested upon the completion to our satisfaction of all services that we requested from ipCapital under the engagement agreement, prior to the signing of the amendments. Such performance was deemed satisfactory during 2012. We believe that these fees, together with the issuance of the warrant, constitute no greater compensation than we would be required to pay an unaffiliated person for performing substantially similar services.

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The exercise price of the warrant issued to ipCapital could be reset to below-market value. Consequently, we have concluded that such warrant is not indexed to our common stock and should be recorded as a liability. We recognize the warrants liability over their vesting period, and in accordance with the liability method of accounting, we re-measure the fair value of the accrued warrants at each balance sheet date and recognize the change in fair value as general and administrative compensation expense (See Note 4). We recognized $1,000 and $49,500 as a component of general and administrative expense during the three-month periods ended September 30, 2014 and 2013, respectively, and $67,000 and $35,700 during the nine-month periods ended September 30, 2014 and 2013, respectively, resulting from the change in fair value.

ipCapital Licensing Company I, LLC

On February 4, 2013, we entered into an IP Brokerage agreement with ipCapital Licensing Company I, LLC (“ipCLC”). John Cronin is a partner at ipCLC. Pursuant to the agreement, we have engaged ipCLC, on a no-retainer basis, to identify and present us with candidates who may be seeking to acquire a certain limited group of our patents unrelated to our current business strategy. If during the applicable term we enter into an agreement with any candidate presented by ipCLC to acquire or otherwise exploit the covered patents, we will pay ipCLC a fee of ten percent (10%) of the royalties, fees, and other consideration paid over the life of the agreement.

The agreement is effective as of February 4, 2013, and will end 18 months after we or ipCLC serve 60 days written notice of termination to the other party (with earlier termination possible in the event of a material breach). The agreement provides for customary confidentiality undertakings, limitations on ipCLC’s total liability and mutual indemnification provisions. For both the three and nine-months ended September 30, 2014 and 2013, we have incurred zero costs.

We believe the terms of the agreement are fair and reasonable to us and are at least as favorable as those that could be obtained on an arms’ length basis.

17. Subsequent Events

On November 6, 2014, one of our larger ISV stocking resellers placed a stocking order for $1.5 million worth of GO-Global products and services. Per the standard payment terms of our arrangement with this reseller, we expect to receive the $1.5 million in January 2015. As with all stocking orders, revenue for this order will be recognized as the products and services are delivered to the reseller’s end users.

On November 10, 2014, we launched the first commercial version of HopTo Work, our mobile productivity workspace platform which includes an app available in Apple’s App Store and a server component which is sold through resellers and downloaded directly from hopTo’s website.

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

Introduction

We are developers of software productivity products for mobile devices such as tablets and smartphones, and application publishing software solutions. Our newest product, which is called hopTo, will be marketed to both consumers and businesses. hopTo provides mobile end users with a productivity workspace for their mobile devices that allows them to manage, share, view, and edit their documents, regardless of where they are stored. We launched the first commercial version of hopTo through Apple’s App Store on November 14, 2013. This version was targeted at Apple’s tablet devices, the iPad and the iPad Mini. Future releases will be targeted at other devices such as Apple’s iPhone, as well as competing devices such as those based on Google’s Android platform.

In addition to hopTo, we also sell a family of products under the brand name GO-Global, which is a software application publishing business and is our sole revenue source at this time. GO-Global is an application access solution for use and/or resale by independent software vendors (ISVs), corporate enterprises, governmental and educational institutions, and others, who wish to take advantage of cross-platform remote access and Web-enabled access to their existing software applications, as well as those who are deploying secure, private cloud environments.

Over the years, we have also made significant investments in intellectual property (IP). We have filed many patents designed to protect the new technologies embedded in hopTo, and we plan to continue to aggressively invest in the creation and protection of new IP as we continue to develop hopTo and other products.

Recent Developments

On October 30, 2014, we announced that Barry Flanagan would be joining hopTo as our Vice President of Sales effective November 3, 2014.

Corporate Background

We are a Delaware corporation, founded in May 1996. Our headquarters are located at 1919 S. Bascom Avenue, Suite 600, Campbell, California, 95008 and our phone number is 1-800-472-7466. We also have an office in Concord, New Hampshire. Additionally, we have remote employees located in various states, as well as internationally in the United Kingdom and Israel. Our corporate Internet Website is http://www.hopto.com. The information on our website is not part of this quarterly report.

Our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and any amendments to such reports filed with or furnished to the SEC under sections 13(a) or 15(d) of the Securities Exchange Act of 1934 are made available free of charge on our corporate Internet Website (click the “Investors” on our home page and then click “SEC Filings”) as soon as reasonably practicable after such reports are electronically filed with or furnished to the SEC.

The hopTo Opportunity

The adoption of mobile devices, such as smartphones and tablets, in the workplace has revealed the need for a mobile application and content access platform that addresses a range of mobile productivity challenges for professional/consumer users (“prosumers”), small and home offices (“SOHO”), small- to medium-sized businesses (“SMB” or “SMBs”), and Enterprise organizations. We believe a mobile platform that addresses this need will become a critical asset for any size organization, IT department, and for the most productive end user experience.

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The current industry addresses this need using one of two approaches. Certain companies have developed new productivity tools that include apps for mobile devices, which attempt to reach a level of compatibility and feature set comparable to established productivity tools for the personal computer (“PC”), such as Microsoft® Office (which runs on Microsoft Windows® operating system and Mac OSX®). Although these tools are generally well-adapted to the unique constraints of mobile devices, they currently suffer from a limited feature set and from severe compatibility issues with PC-based tools, such as Microsoft Office. Microsoft’s recently announced Office for the iPad does provide significant compatibility, but requires the use of Microsoft services such as OneDrive. We believe hopTo, unlike Office for the iPad, provides freedom and flexibility to use many popular alternatives, as well as remote access to Windows and Mac computers.

The second approach is a remote desktop access product, which connects the mobile device to an existing remote computer, such as a Mac or a PC (collectively “PCs”), or a remote “virtual machine” running on a server and appearing as a remote computer. This approach allows mobile users to leverage the capabilities of the remote computer to access the files and applications stored on those PCs, which are not typically available natively on the mobile device. We believe such an approach is limited because of the inherent user interface differences between applications designed for the large screen, mouse and keyboard typically associated with PCs, and applications designed for the smaller screens and touch-based input functionality of mobile devices.

Focusing more specifically on the larger SMB/Enterprise business markets, adoption of mobile devices is reshaping how organizations deliver, secure, and manage applications and content on these devices. This has also introduced challenges for organizations to integrate the devices into daily workflows and manage security on both company-owned and employee-owned devices.

From a workflow standpoint, we believe business users want mobile solutions that enable them to replace or extend their traditional desktop PC environment with mobile devices, which is often easier said than done. PC users have enjoyed a rich ecosystem of applications and technologies that has been growing for over 30 years, and have come to expect an exceptional level of power and flexibility to get their work done. Many solutions have been developed to meet this challenge but generally have failed, in particular for the iOS and Android devices that dominate both the consumer and business markets.

The hopTo Product

hopTo addresses these issues with a comprehensive productivity workspace for mobile devices (currently for the Apple iPad) that empowers mobile users by offering them functionalities similar to what they have come to expect from their PCs. For example, hopTo aggregates files and documents from multiple storage silos (such as Box, Dropbox, Google Drive, Microsoft OneDrive, or the user’s PC) into a single touch-friendly workspace. From within this workspace, users are able to search for documents in the workspace (which includes their cloud storage silos and their PC), view, edit, and share their documents, and import photos from their iPad camera roll or Google Image from the Web.

hopTo provides powerful document editing capabilities that leverage legacy Windows applications, such as Microsoft Office, to give users a rich, native editing feature set. Its high degree of compatibility with Microsoft Office enables easy collaboration with other users running Microsoft Office on Mac or Windows PCs. We believe hopTo is unique in that it both leverages legacy applications for document editing and provides a touch-friendly user experience that, in our view, none of our competitors have achieved, and which mobile users will view as highly desirable.

The first commercially available version of hopTo was released on November 14, 2013, through the Apple App Store. hopTo currently runs on the Apple iPad family of devices, and we plan to make it available for other devices, such as the Apple iPhone and for devices based on the Google Android platform. This product is targeted at users who are transitioning from PC to mobile—to provide access to their content regardless of where it’s stored, along with rich document editing capabilities, multitasking, file management, and more. The hopTo product is currently offered free of charge as we gradually grow our user-base and increase market share and brand awareness.

In March 2014, we announced our hopTo Work product. hopTo Work builds upon the hopTo product, bringing its core mobile productivity features to SMB/Enterprise users, with additional security and manageability functions. It targets Information Technology (“IT”) departments that are concerned with protecting and managing access to sensitive data, controlling access to business applications, compliance with internal policies and, in some cases, government regulations.

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With hopTo Work, IT departments will be able to more easily and safely address these concerns while integrating mobile technology into their networks and user workflows. It will further enable business users to make a smooth and simple transition from PCs to mobile devices for all or part of their work. As with the current prosumer/SOHO version of hopTo, the premise of hopTo Work is that mobile users in SMB/Enterprise businesses using devices such as the Apple iPad would like to travel with just their tablets but still have the benefits of secure access and editing capabilities for documents in their personal cloud storage, corporate cloud or network storage, and on their Mac or Windows computers.

hopTo Work is designed not only to assist users in performing operations on their iPads that typically require a Mac or Windows PC, but to do so within the data protection and access control policies of their IT organizations. Our view is that current solutions are limited because of the need to install special applications and procedures that are a hindrance to user productivity. We address these issues with the following features:

●

The ability to access and manage all of the user’s files and documents, no matter where they are stored. This includes consumer/prosumer-focused cloud storage services, the user’s home or work PC, or enterprise-class network servers and cloud storage services.

●

The ability to view, create, edit, manage, and share files through a native touch-screen mobile device interface rather than apps designed for legacy PC desktops with keyboards and mice.

●

The ability to multitask, which means working with multiple documents at the same time, side-by-side. The iPad is inherently a single document environment, which we believe is a major shortcoming for most users.

●

The ability to view, create, and edit Microsoft Office documents that are 100% compatible with Microsoft Office, thus allowing users to collaborate with other users who are using Microsoft Office on a Mac or a Windows PC.

●

The ability to address the problems of document sprawl, giving users easy access to manage, search, and browse the data they need across storage devices and cloud services, but without allowing sensitive documents to leave the corporate network undetected.

●

The ability for IT departments to implement a “bring-your-own-device” (BYOD) solution that integrates mobile device use into daily workflows and enhances user productivity without compromising security or putting an additional burden on the user experience.

●

The ability for IT departments to grant and revoke access to anyone for any data anywhere. Employees must have the ability to access corporate internal data (documents, file and applications) efficiently but without jeopardizing security.

hopTo Target Markets

Since its launch in November 2013, hopTo has proven, albeit on a free of charge basis to date, to be an appealing product to both the prosumer and SOHO markets based on downloads, user feedback, and third party reviews. For the remainder of 2014, we will continue to focus on these markets. We currently market and distribute hopTo through the Apple App Store, and over time may expand availability to other “app stores”, such as the Google Play Store. We currently offer hopTo free of charge, but we reserve the right to begin charging for it at any point, depending on user acceptance, our competitors’ pricing strategies, and other market conditions.

We view hopTo Work, with its additional security and manageability features, as a product that will appeal to the SMB and Enterprise markets. We expect sales strategies for the hopTo Work versions of the product to involve a combination of strategic partnerships with various relevant enterprise software companies, a sales partner channel, and a direct sales team, just to name a few. hopTo Work will be a predominantly paid offering with pricing options that may vary based on selected applications, advanced feature sets, file storage options, or other functionality and services, depending on user and company acceptance, our competitors’ pricing strategies, and other market conditions.

Our Intellectual Property

We believe that intellectual property (IP) is a business tool that potentially maximizes our competitive advantages and product differentiation, grows revenue opportunities, encourages collaboration with key business partners, and protects our long-term growth opportunities. Strategic IP development is therefore a critical component of our overall business strategy. It is a business function that consistently interacts with our research and development, product development, and marketing initiatives to generate further value from those operations.

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We rely primarily on trade secret protection, copyright law, confidentiality, and proprietary information agreements to protect our proprietary technology and registered trademarks. Despite our precautions, it may be possible for unauthorized third parties to copy portions of our products, or to obtain information we regard as proprietary. The loss of any material trade secret, trademark, trade name or copyright could have a material adverse effect on our results of operations and financial condition. We intend to defend our proprietary technology rights; however, we cannot give any assurance that our efforts to protect our proprietary technology rights will be successful.

We do not believe our products infringe on the rights of any third parties, but we can give no assurance that third parties will not assert infringement claims against us in the future, or that any such assertion will not result in costly litigation or require us to obtain a license to proprietary technology rights of such parties.

ipCapital Group, Inc.

On October 11, 2011, we engaged ipCapital Group, Inc., an affiliate of John Cronin, who is one of our directors, to assist us in the execution of our strategic decision to significantly strengthen, grow and commercially exploit our intellectual property assets. Our engagement agreement with ipCapital, which has been amended three times, affords us the right to request ipCapital to perform a number of diverse services, employing its proprietary processes and methodologies, to facilitate our ability to identify and extract from our current intellectual property base new inventions, potential patent applications, and marketing and licensing opportunities.

As a result of ipCapital’s work under the engagement agreement, as amended, as of November 1, 2014, we have 170 patent applications pending in the United States Patent Office (“USPTO”). Of these 170 applications, 15 patents have been granted by the USPTO. We have also received notice from the USPTO that 3 additional patent applications have been allowed and will ultimately issue as US patents in the next 60-90 days. We expect to file more applications throughout the remainder of 2014.

ipCapital Licensing Company I, LLC

Our GO-Global Software Products

Our GO-Global product offerings, which currently are our only revenue source, can be categorized into product families as follows:

●	GO-Global for Windows: Allows access to Windows-based applications from remote locations and a variety of connections, including the Internet and dial-up connections. The Windows applications run on a central computer server along with GO-Global Windows Host software. This allows the applications to be accessed remotely via GO-Global Client software, or a Web browser, over many types of data connections, regardless of the bandwidth or operating system. Web-enabling is achieved without modifying the underlying application’s code or requiring costly add-ons.

●	GO-Global for UNIX: Allows access to UNIX and Linux-based applications from remote locations and a variety of connections, including the Internet and dial-up connections. The UNIX/Linux applications run on a central computer server along with the GO-Global for UNIX Host software. This allows the applications to be accessed and run remotely via GO-Global Client software or a Web browser without having to modify the application’s code or requiring costly add-ons.

●	GO-Global Client: We offer a range of GO-Global Client software that allows remote application access from a wide variety of local, remote and mobile platforms, including Windows, Linux, UNIX, Apple OS X and iOS, and Google Android. We plan to continue to develop GO-Global Client software for new portable and mobile devices.

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Critical Accounting Policies

We believe that several accounting policies are important to understanding our historical and future performance. We refer to these policies as “critical” because these specific areas require us to make judgments and estimates about matters that are uncertain at the time we make the estimates. Actual results may differ from these estimates. For a summary of our critical accounting policies, please refer to our 2013 10-K Report and Note 2 to our Notes to Unaudited Condensed Consolidated Financial Statements.

Results of Operations for the Three and Nine-Month Periods Ended September 30, 2014 and 2013

The following operating results should be read in conjunction with our critical accounting policies.

Revenue

Revenue for the three-month periods ended September 30, 2014 and 2013 was:

					2014 Over (Under) 2013
Revenue	2014		2013		Dollars			Percent
Software Licenses
Windows	$	425,600	$	559,600	$	(134,000	)		-23.9	%
UNIX/Linux		186,200		219,900		(33,700	)		-15.3	%
		611,800		779,500		(167,700	)		-21.5	%
Software Service Fees
Windows		460,100		511,300		(51,200	)		10.0	%
UNIX/Linux		197,300		226,500		(29,200	)		-12.9	%
		657,400		737,800		(80,400	)		-10.9	%
Other		20,000		17,400		2,600			14.9	%
Total Revenue	$	1,289,200	$	1,534,700	$	(245,500	)		-16.0	%

Revenue for the nine-month periods ended September 30, 2014 and 2013 was:

					2014 Over (Under) 2013
Revenue	2014		2013		Dollars			Percent
Software Licenses
Windows	$	1,531,600	$	1,673,400	$	(141,800	)		-8.5	%
UNIX/Linux		429,600		670,100		(240,500	)		-35.9	%
		1,961,200		2,343,500		(382,300	)		-16.3	%
Software Service Fees
Windows		1,440,000		1,471,700		(31,700	)		-2.2	%
UNIX/Linux		588,800		686,300		(97,500	)		-14.2	%
		2,028,800		2,158,000		(129,200	)		-6.0	%
Other		46,100		44,000		2,100			4.8	%
Total Revenue	$	4,036,100	$	4,545,500	$	(509,400	)		-11.2	%

Our software revenue is currently entirely related to our GO-Global product line, and historically has been primarily derived from product licensing fees and service fees from maintenance contracts. The majority of this revenue has been earned, and continues to be earned, from a limited number of significant customers, most of whom are resellers. Many of our resellers (a “stocking reseller”) purchase software licenses that they hold in inventory until they are resold to the ultimate end user. We defer recognition of revenue from these sales (on our Condensed Consolidated Balance Sheet under the caption “Deferred Revenue”) until the stocking reseller sells the underlying software licenses to the ultimate end user. Consequently, if any of our significant stocking resellers materially change the rate at which they resell our software licenses to the ultimate end user, our software licenses revenue could be materially impacted.

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When a software license is sold directly to an end user by us, or by one of our resellers who does not stock licenses into inventory, revenue is recognized immediately upon shipment, assuming all other criteria for revenue recognition are met. Consequently, if any significant end user customer substantially changes its order level, or fails to order during the reporting period, whether the order is placed directly with us or through one of our non-stocking resellers, our software licenses revenue could be materially impacted.

Almost all stocking resellers maintain inventories of our Windows products; few stocking resellers maintain inventories of our UNIX products.

Software Licenses

Software licenses revenue from our Windows products decreased for the three and nine-month periods ended September 30, 2014, as compared with the same periods of the prior year primarily due to lower aggregate revenue derived from our stocking resellers.

Software licenses revenue from our UNIX/Linux products decreased during the three and nine-month periods ended September 30, 2014, as compared with the same periods of the prior year, primarily due to lower aggregate revenue from our resellers and end users, particularly our European telecommunications customers. During the three-month period ended September 30, 2013, we learned that one of our significant European telecommunications customers, Ericsson, would no longer be ordering product or future maintenance contracts from us as their technology no longer utilized our GO-Global product.

Although we have developed a plan to stabilize our GO-Global revenue, we anticipate that revenue in 2014 from GO-Global product licenses will be lower than that from 2013 due to our strategic shift to the hopTo product.

We anticipate generating revenue from hopTo during 2014.

Software Service Fees

The decrease in software service fees revenue attributable to our Windows products during the three and nine-month periods ended September 30, 2014, as compared to the same periods of the prior year, is consistent with and primarily the result of the lower level of software licenses revenue and the commensurate decrease in maintenance contract renewals.

The decrease in service fees revenue attributable to our UNIX products for the three and nine-month periods ended September 30, 2014, as compared with the same periods of the prior year, was primarily the result of the low level of our UNIX product sales throughout the current and prior year and a decrease in maintenance contract renewals. The majority of this decrease was attributable to our European telecommunications customers, including Ericsson, as discussed above.

We expect that software service fees for 2014 will decrease slightly from 2013.

Other

The increase in other revenue for the three and nine -month periods ended September 30, 2014, as compared with the same period of the prior year was primarily due to an increase in private labeling fees. We typically recognize private labeling fees revenue only when such services are requested by a new stocking reseller; they sign a contract with us, simultaneously place their first stocking order and ultimately, when they sell through their entire first stocking order, we recognize the private labeling fees revenue. Private labeling fees do not comprise a material portion of our revenue streams, and they can vary from period to period.

Costs of Revenue

Costs of revenue are comprised primarily of software service costs, which represent the costs of customer service, and software product costs, which are primarily comprised of the amortization of capitalized software development costs, and costs associated with licenses for third party software included in our product offerings. We incur no shipping or packaging costs as all of our deliveries are made via electronic means over the Internet.

Under GAAP, development costs for new product development, after technological feasibility is established, are recorded as “capitalized software” on our Condensed Consolidated Balance Sheet. Such capitalized costs are subsequently amortized as cost of revenue (software product costs) over the shorter of three years or the remaining estimated life of the product. During the three-month periods ended September 30, 2014 and 2013, we capitalized $0 and $79,100 of software development costs, respectively. During the nine-month periods ended September 30, 2014 and 2013, we capitalized $0 and $543,600 of software development costs, respectively. All of such capitalized costs were incurred in the development of hopTo.

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Amortization of capitalized software development costs was $52,700 and $24,000 during the three-month periods ended September 30, 2014 and 2013, respectively, and $173,300 and $107,100 during the nine-month periods ended September 30, 2014 and 2013, respectively.

Cost of revenue was 7.8% and 6.5% of total revenue for the three months ended September 30, 2014 and 2013, respectively, and 8.6% and 7.7% of total revenue for the nine months ended September 30, 2014 and 2013, respectively.

Cost of revenue for the three-month periods ended September 30, 2014 and 2013 was:

					2014 Over (Under) 2013
	2014		2013		Dollars			Percent
Software service costs	$	26,300	$	64,100	$	(37,800	)		-59.0	%
Software product costs		73,800		36,400		37,400			102.7	%
	$	100,100	$	100,500	$	(400	)		-0.4	%

Cost of revenue for the nine-month periods ended September 30, 2014 and 2013 was:

					2013 Over (Under) 2012
	2014		2013		Dollars			Percent
Software service costs	$	136,400	$	191,900	$	(55,500	)		-28.9	%
Software product costs		212,400		157,700		54,700			34.7	%
	$	348,800	$	349,600	$	(800	)		-0.2	%

The decrease in software service costs for the three and nine-month periods ended September 30, 2014, as compared with the same periods of the prior year, was primarily due to lower customer demand for such services related to our GO-Global products. We expect aggregate software service costs for 2014 to be lower than such costs for 2013.

Software product costs increased in both the three and nine-month periods ended September 30, 2014 compared with the same periods in 2013 primarily due to amortization of hopTo development software costs which commenced in November of 2013.

We expect that software costs of revenue for 2014 will be lower than 2013 levels, due to these items.

Selling and Marketing Expenses

Selling and marketing expenses primarily consist of employee costs, outside services, advertising, public relations and travel and entertainment expense.

Selling and marketing expenses for the three-month periods ended September 30, 2014 decreased by $340,000, or 49.8%, to $343,300, from $683,300 for the same period of 2013, which represented approximately 26.6% and 44.5% of revenue during these periods, respectively. Selling and marketing expenses for the nine-month period ended September 30, 2014 decreased by $166,600 or 9.6% to $1,576,900 from $1,743,500 for the same period in 2013, which represented approximately 39.1% and 38.4% of revenue during those periods, respectively.

The decrease in selling and marketing expenses during the three and nine-month periods ended September 30, 2014, as compared with the same periods of the prior year, was primarily due to lower headcount and marketing services costs.

We currently expect our full-year 2014 selling and marketing expenses to be lower than those for 2013 as we have revised our level of investment to highly efficient and targeted programs in both our hopTo and Go-Global product lines.

General and Administrative Expenses

General and administrative expenses primarily consist of employee costs, depreciation and amortization, legal, accounting, other professional services (including those related to our patents), rent, travel and entertainment and insurance. Certain costs associated with being a publicly held corporation are also included in general and administrative expenses, as well as bad debts expense.

General and administrative expenses decreased by $259,200, or 28.3%, to $655,700, for the three-month period ended September 30, 2014, from $914,900 for the same period of 2013, which represented approximately 50.9% and 59.6% of revenue during these periods, respectively.

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General and administrative expenses increased by $63,800, or 2.6%, to $2,505,400 for the nine-month period ended September 30, 2014, from $2,441,600 for the same period of 2013, which represented approximately 62.1% and 53.7% of revenue during these periods, respectively.

The decrease in general and administrative expense in the three-month period ended September 30, 2014, as compared with the same period of the prior year, was primarily due to a decrease in employee costs related to lower headcount.

The increase in general and administrative expense during the nine-month period ended September 30, 2014 was primarily due to a high level of activity surrounding our intellectual property. We have filed a substantial number of patent applications that began to be actively examined by the United States Patent Office during the latter half of 2013, with such examinations requiring a significant amount of response work from our patent attorneys. Additionally, we incurred costs in converting a significant number of previously-filed provisional patents into regular utility patent applications before their respective conversion deadlines expired, and we began to actively protect our trademarks.

Based on these items, we expect that general and administrative expense for 2014 will be higher than 2013 levels.

Research and Development Expenses

Research and development expenses consist primarily of employee costs, payments to contract programmers, travel and entertainment for all our engineers, and all rent for our leased engineering facilities.

Research and development expenses decreased by $249,200, or 17.3%, to $1,195,300, for the three-month period ended September 30, 2014, from $1,444,500 for the same period of 2013, which represented approximately 92.7% and 94.1% of revenue for these periods, respectively.

Research and development expenses increased by $339,800, or 9.6%, to $3,873,100, for the nine-month period ended September 30, 2014, from $3,533,300, which represented approximately 96.0% and 77.7% of revenue for these periods, respectively.

During the nine-month periods ended September 30, 2014 and 2013, we capitalized $0 and $659,600, respectively, of software development costs. Such costs were incurred in the development of hopTo product.

The decrease in research and development expense for the three-month period ended September 30, 2014, as compared with the same periods of the prior year, resulted from establishing more cost effective engineering consulting contracts.

The increase in research and development expense during the nine-month period ended September 30, 2014 was due primarily to the net effect of capitalization of software development expense in the prior year period. Gross research and development during the nine-month period ended September 30, 2014 was actually lower than the prior year period by $319,800 or 7.6%. This lower expense is due to our efforts to effectively manage expenses through lower headcount and more cost effective engineering consulting contracts.

As part of our strategy to drive efficiencies throughout our operations, we have optimized our development capability by eliminating headcount while offsetting with outsourced development resources, and certain non-labor operating expense reductions. We expect that the savings resulting from these actions will result in lower aggregate research and development expenses for 2014, as compared with those for 2013.

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Other Income (Expense) - Change in Fair Value of Warrants Liability

During the three and nine-month periods ended September 30, 2014 we reported non-cash income related to the change in fair value of our Warrants Liability of $54,700 and $1,665,900, respectively. During the three month period ended September 30, 2013, we reported non-cash expense related to the change in fair value of our Warrants Liability of $639,100, and during the nine-month period ending September 30, 2013 we reported non-cash income of $680,100. Such amounts resulted from price changes in the market value for our common stock and can vary from period to period due to the exercise and/or issuance of warrants accounted for under the liability method. For further information regarding our Warrants Liability, see Note 4 to the Notes to Unaudited Condensed Consolidated Financial Statements.

Net Loss

Based on the foregoing, we reported net losses of $950,900 and $2,252,400 for the three-month periods ended September 30, 2014, and 2013, respectively. Additionally, we reported net losses of $2,603,500 and $2,850,200 for the nine-month periods ended September 30, 2014 and 2013, respectively.

Liquidity and Capital Resources

Our reported net loss for the nine-month period ended September 30, 2014 of $2,603,500 included three significant non-cash items: depreciation and amortization of $296,900, which were primarily related to amortization of capitalized software development costs, stock-based compensation expense of $417,000 and a gain in the change in value of our warrants liability of $1,665,900.

We invested $45,300 in capital expenditures during the nine-month period ended September 30, 2014, primarily related to our new products development team, located in our office in Campbell, California, as well as leasehold improvements made to such office.

During the nine-month period ended September 30, 2014, 1,000,000 warrants and 256,818 employee options were exercised, which provided cash flows from financing activities of $260,000 and $47,800, respectively. Additionally, in conjunction with a private placement of our common stock, we sold and issued to investors 11,299,999 shares of our common stock and warrants to purchase 5,650,001 shares of our common stock at an exercise price of $0.40, which provided cash flows from financing activities of $3,370,000, net of cash issuance costs.

We are aggressively looking at ways to improve our revenue stream through the development, marketing and sale of new products. We have reorganized our GO-Global operations in order to align its cost structure with its sales. We have reorganized our hopTo operations to increase efficiency, we have reduced its engineering and administrative workforce, reduced certain of its non-labor expenses, and as a result of these actions, we expect such reductions to result in a cash savings of approximately $375,000 in our operating expenses throughout the remainder of 2014. Should business combination opportunities present themselves to us, and should such opportunities appear to make financial sense and add value for our shareholders, we will consider those opportunities.

During the fourth quarter of 2014, we expect to continue to prioritize the investment of our resources into the development of various new products. Further, due to our expected investments in new products and continued investments in intellectual property, we expect our net cash outflow from operations to continue. Based on our cash on hand as of September 30, 2014, the aforementioned reductions in expenditures, and the anticipation of stabilized revenue from our legacy GO-Global business, we believe that we will have sufficient capital resources to support our basic operational plans for the next twelve months; however; full implementation of our business plans for the next twelve months will require capital from issuances of debt or equity, or other sources, or new revenue from our recently launched hopTo product.

There can be no assurance of new revenue from new or existing product lines or additional capital from debt or equity issuances, or from other sources. In addition, issuances of new capital stock would dilute existing stockholders and may give the purchasers of new capital stock additional rights, preferences and privileges relative to existing stockholders. There can be no assurance that additional capital necessary for full execution of our hopTo business strategy will be available on a timely basis, on reasonable terms or at all.

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Cash

As of September 30, 2014, our cash balance was $2,003,900, as compared with $2,430,700 as of December 31, 2013, a decrease of $426,800, or 17.6%. The decrease primarily resulted from the cash used in our operations, as well as the investments we made in fixed assets, partially offset by the cash provided our financing activities, which was comprised of the net cash received from a private placement of our common stock and warrants to purchase our common stock, and cash received from the exercise of warrants and employee stock options.

Accounts Receivable, net

At September 30, 2014 and December 31, 2013, we reported accounts receivable, net, of $457,900 and $811,700, respectively. Such amounts were reported net of the allowance for doubtful accounts, which allowances totaled $18,200 and $42,000 at September 30, 2014 and December 31, 2013, respectively. The decrease in accounts receivable, net, was mainly due to lower sales during the three-month period ended September 30, 2014, as compared with the three-month period ended December 31, 2013. We collect the significant majority of our quarter-end accounts receivable during the subsequent quarter; accordingly, increases or decreases in accounts receivable from one period to the next tends to be indicative of the trend in our sales from one period to the next. From time to time, we could have individually significant accounts receivable balances due us from one or more of our significant customers. If the financial condition of any of these significant customers should deteriorate, our operating results could be materially affected.

Stock Repurchase Program

As of September 30, 2014, we had purchased 1,424,000 shares of our common stock for $217,400 under terms of our Board-approved stock repurchase program, which was established on January 8, 2008. Under this program, the Board approved up to $1,000,000 to be used in repurchasing our stock; however, we are not obligated to repurchase any specific number of shares and the program may be suspended or terminated at our discretion. During each of the three and nine-month periods ended September 30, 2014 and 2013, no repurchases were made. As of September 30, 2014, $782,600 remains available for stock purchases under this program.

Working Capital

As of September 30, 2014, we had current assets of $2,558,000 and current liabilities of $3,158,900, which netted to working capital deficit of $600,900. Included in current liabilities was the current portion of deferred revenue of $2,433,500.

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ITEM 3. Quantitative and Qualitative Disclosures About Market Risk

Not applicable.

ITEM 4. Controls and Procedures

Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this report. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of September 30, 2014.

There has not been any change in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) during the quarter ended September 30, 2014 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II. OTHER INFORMATION

ITEM 1. Legal Proceedings

Not Applicable

ITEM 1A. Risk Factors

There have been no material changes in our risk factors from those set forth under Item 1A, “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2013, which was filed with the Securities and Exchange Commission on March 31, 2014.

ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds

We did not sell any unregistered securities during the quarter ended September 30, 2014.

ITEM 3. Defaults Upon Senior Securities

Not applicable

ITEM 4. Mine Safety Disclosures

Not applicable

ITEM 5. Other Information

Not applicable

ITEM 6. Exhibits

Exhibit Number	Exhibit Description
31.1	Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2	Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1	Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (furnished, not filed)
32.2	Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (furnished, not filed)
101*	The following financial information from hopTo Inc.’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2014, formatted in eXtensible Business Reporting Language (XBRL): (i) Condensed Consolidated Balance Sheets as of September 30, 2014 (unaudited) and December 31, 2013, (ii) Unaudited Condensed Consolidated Statements of Operations for the Three and Nine Months ended September 30, 2014 and 2013, (iii) Unaudited Condensed Consolidated Statements of Stockholders’ Deficit for the Nine Months ended September 30, 2014 and 2013, (iv) Unaudited Condensed Consolidated Statements of Cash Flows for the Nine Months ended September 30, 2014 and 2013, (v) Notes to Unaudited Condensed Consolidated Financial Statements.

* Furnished, not filed

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

		hopTo Inc.
		(Registrant)

Date:	November 14, 2014		Date:	November 14, 2014

By:	/s/ Eldad Eilam		By:	/s/ Jean-Louis Casabonne
	Eldad Eilam			Jean-Louis Casabonne
	Chief Executive Officer			Chief Financial Officer
	(Principal Executive Officer)			(Principal Financial Officer and
				Principal Accounting Officer)

Attached files

hopTo Inc. Reports

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