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UNITED STATES
SECURITIES AND
EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED March 31, 2016

OR

o  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from               to              

Commission File Number 001-33197

GUIDANCE SOFTWARE, INC.

(Exact name of registrant as specified in its charter)

Securities registered pursuant to Section 12(b) of the Act:

Common Stock, $0.001 par value per share.

Securities registered pursuant to Section 12(g) of the Act:

None.

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 x  No o

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 Regulation S-T (232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No o

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.

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

As of May 4, 2016, there were approximately 32,114,000 shares of the registrant’s Common Stock outstanding.

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GUIDANCE SOFTWARE, INC.

FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED March 31, 2016

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PART I. FINANCIAL INFORMATION

Item 1.                                  Financial Statements

GUIDANCE SOFTWARE, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share and per share data)

(Unaudited)

The accompanying notes are an integral part of these condensed consolidated financial statements

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GUIDANCE SOFTWARE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(Unaudited)

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GUIDANCE SOFTWARE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)

The accompanying notes are an integral part of these condensed consolidated financial statements

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GUIDANCE SOFTWARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1. Description of the Business

General

Guidance Software, Inc. was incorporated in the state of California in 1997 and reincorporated in Delaware on December 11, 2006.  Guidance and its subsidiaries are collectively referred to herein as “Guidance,” “we,” “our,” or the “Company.”  Headquartered in Pasadena, California, Guidance is the leading global provider of digital investigative solutions.  Our EnCase® platform provides an investigative infrastructure that enables our customers to search, collect and analyze electronically stored information in order to address human resources matters, litigation matters, allegations of fraud, suspicious network endpoint activity and to defend and secure their organization’s data assets.

Our main products and services are:

Our security suite of products:

·                  EnCase Endpoint Security provides crucial IT cybersecurity functionality to enterprises and government agencies through its incident response and sensitive data discovery capabilities. Integrated with leading security alerting tools from HP, Cisco, Blue Coat Systems, and FireEye, EnCase Endpoint Security helps automate the critical first steps in cybersecurity incident response from the moment of a first alert. It rapidly delivers forensic-level visibility of the relevant endpoint data, capturing a snapshot of valuable information from active memory that might otherwise expire which may serve as evidence for potential criminal prosecution.

·                  EnCase Endpoint Investigator provides an investigative platform that enables an organization to search, collect, preserve, and analyze data on the servers, desktops, and laptops across its network. EnCase Endpoint Investigator enables organizations to respond to electronic discovery requests and conduct internal investigations, including those related to human resources or those focused on compliance or fraud. Companies can also collect and preserve data in response to regulator requests or for civil litigation matters.

·                  EnForce Risk Manager, which we expect will be made available commercially in 2016, is a highly anticipated, new data risk and privacy solution.  It will allow organizations to implement a proactive approach to information governance, ensuring that sensitive data is identified, classified and remediated allowing organizations to reduce their cyber attack surface area, significantly mitigating potential damage from breaches and improving their ability to comply with global data protection mandates.

EnCase Forensic is the industry-standard digital investigation solution that enables forensic practitioners to conduct efficient, forensically sound digital data collection and investigations. The EnCase Forensic solution lets examiners acquire data from a wide variety of devices, unearth potential evidence with disk-level forensic analysis, and craft comprehensive reports on their findings, all while maintaining the integrity of the evidence in a forensically sound and court-proven manner.

EnCase eDiscovery is our enterprise-wide e-discovery solution addressing the end-to-end e-discovery needs of corporations and government agencies. The e-discovery product portfolio includes capabilities such as: legal hold, identification, collection, preservation, processing, first-pass review, and early case assessment (ECA) review.

EnCase eDiscovery Review is a powerful, highly secure, private cloud-hosted, multi-matter review platform with advanced analysis and technology assisted review (TAR) functionality, comprehensive production capabilities, and extensive project management and workflow features to enable efficient, effective, and defensible distributed review.

Tableau appliances include write blockers, forensic duplicators and storage devices. Write blockers and forensic duplicators are used to acquire forensically sound copies of digital storage devices such as hard disks and solid state drives.

In addition, we complement these offerings with a comprehensive array of professional and training services, including technical support and maintenance services to help our customers implement our solutions, conduct investigations and train their IT and legal professionals to effectively and efficiently use our products.

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Note 2. Summary of Significant Accounting Policies

Basis of Presentation

The accompanying condensed consolidated balance sheets as of March 31, 2016 and the condensed consolidated statements of operations for the three months ended March 31, 2016 and 2015 and cash flows for the three months ended March 31, 2016 and 2015 are unaudited.  These statements should be read in conjunction with the audited consolidated financial statements and related notes, together with management’s discussion and analysis of financial position and results of operations, contained in our Annual Report on Form 10-K for the year ended December 31, 2015, filed with the U.S. Securities and Exchange Commission (the “SEC”) on February 25, 2016.

The accompanying condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States, or (“GAAP”), and pursuant to the rules and regulations of the SEC for interim financial reporting.  In the opinion of our management, the unaudited condensed consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2015 and include all normal and recurring adjustments necessary for the fair presentation of our financial position as of March 31, 2016 and our results of operations for the three months ended March 31, 2016 and 2015 and our cash flows for the three months ended March 31, 2016 and 2015.  The condensed consolidated balance sheet as of December 31, 2015 has been derived from the December 31, 2015 audited financial statements.  The operating results for the three month period ended March 31, 2016 are not necessarily indicative of the results that will be achieved for the full fiscal year or for future periods.

The condensed consolidated financial statements include the accounts of Guidance and its wholly owned subsidiaries.  All intercompany accounts and transactions have been eliminated.

Reclassification of Liabilities

We have reclassified certain liabilities to conform to the current period’s presentation for all periods presented in our condensed consolidated balance sheets.  The reclassification includes capital lease obligations combined with accrued liabilities, and deferred rent combined with other long-term liabilities.

Use of Estimates and Assumptions

The preparation of financial statements in conformity with GAAP requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures.  On an ongoing basis, we evaluate these estimates, including those related to revenue recognition, share-based compensation, bad debts, income taxes, contingent consideration, commitments, impairment considerations, contingencies and litigation.  We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances.  Actual results may differ from these estimates.

Cash and Cash Equivalents

We invest excess cash in money market funds and highly liquid debt instruments of the US government and its agencies. Highly liquid investments with stated maturities of three months or less from the date of purchase are classified as cash and cash equivalents.

Fair Value of Financial Instruments

The carrying amounts of cash equivalents, accounts receivable and accounts payable approximate fair value because of the short-term maturities of these instruments.  Based on borrowing rates currently available to us for borrowings with similar terms, the carrying values of our capital lease obligations also approximate fair value.

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Trade Receivables

Trade receivables are carried at original invoice amount less an allowance for doubtful accounts.  The allowance is established through a provision for bad debt expense, which is included in general and administrative expenses.  We determine the adequacy of this allowance by evaluating individual customer accounts receivable, through consideration of the customer’s financial condition and credit history, and taking into account current economic conditions.  In addition, we analyze our historical credit loss history and apply these loss rates to our current accounts receivable balances to verify the reasonableness of our allowance.  Trade receivables are written off when deemed uncollectible.  A trade receivable is generally considered past due if any portion of the receivable balance is outstanding for more than 30 days unless alternate terms are provided.

Inventory

Inventory is comprised of hardware components, packaged software components and finished goods and is valued at the lower of cost or market, using the weighted average cost method.  We conduct quarterly inventory reviews for obsolescence, and inventory considered unlikely to be sold is adjusted to net realizable value.

Amortization of Intangible Assets with Finite Lives

Intangible assets with finite lives are recorded at their fair value at the time of acquisition.  With the exception of our customer relationships intangible asset, which is amortized on a double-declining basis, the acquisition date fair values of such assets are amortized on a straight-line basis over the estimated useful lives.

Goodwill and Indefinite-Lived Intangibles

We account for our goodwill and indefinite-lived intangible assets in accordance with Intangibles — Goodwill and Other (ASC 350).  Goodwill represents the excess of purchase price over fair value of net assets acquired and is assigned to a reporting unit at the date the goodwill is initially recorded.  Goodwill and indefinite-lived intangible assets are not amortized but evaluated for impairment annually, or whenever events or changes in circumstances indicate that the value may not be recoverable.  The Company has the option to choose whether it will apply the qualitative assessment first before the quantitative assessment.  We performed a quantitative assessment for our goodwill and indefinite-lived assets as of October 1, 2015, and determined they were not impaired.

Concentrations of Credit Risk

Financial instruments that potentially subject us to significant concentrations of credit risk consist primarily of cash and cash equivalents and accounts receivable.  We restrict our investments in cash and cash equivalents to financial institutions, US government or federal agency instruments and obligations of corporations with high credit ratings.  At March 31, 2016, the majority of our cash balances were held at financial institutions located in California in accounts that are insured by the Federal Deposit Insurance Corporation for up to $250,000. Uninsured balances aggregate approximately $19.9 million as of March 31, 2016.  At March 31, 2016 all of our cash equivalents consisted of financial institution obligations.  We periodically perform credit evaluations of our customers and maintain reserves for potential losses on our accounts receivable.  We do not believe we are subject to concentrations of credit risk with respect to such receivables.

Revenue Recognition

We generate revenues principally from the sale of our EnCase software products. Our software products include perpetual licenses and are related to our EnCase Endpoint Investigator, EnCase Endpoint Security, EnCase eDiscovery, EnCase Forensic, EnCase Portable, and forensic appliance sales. Revenue associated with the sale of software licenses and revenue associated with forensic appliance sales are referred to as product revenue. Revenues are also generated from training courses and consulting services in which we assist customers with the performance of digital investigations and train their IT and legal professionals in the use of our software products, as well as subscription revenues associated with cloud-based document review and production SaaS, which we collectively refer to as services revenue. Our proprietary products are generally sold with one to three years of maintenance, which can be renewed at a stated renewal rate and is referred to as maintenance revenues.

We recognize revenue in accordance with ASU 2009-13 , Multiple-Deliverable Revenue Arrangements , (amendment to ASC Topic 605, Revenue Recognition ), Revenue Recognition - Software topic (ASC 985-605) and Revenue Recognition (ASC 605). While the standards govern the basis for revenue recognition, significant judgment and the use of estimates are required in connection with the allocation of revenue between product, services and maintenance revenues, as well as the amount of deferred revenue to be recognized in each accounting period.

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Revenue Recognition Criteria: We recognize revenue when the following criteria have been met:

·           Persuasive evidence of an arrangement: When we either enter into contracts or receive written purchase orders issued by a customer that legally bind us and the customer.

·           Delivery : We deem delivery of products to have occurred when the title and risk of ownership have passed to the buyer. Services revenues are considered delivered as they are performed.

·           Fixed or determinable fee: We consider the fee to be fixed or determinable if the fee is not subject to refund or adjustment and the payment terms are within normal established practices. If the fee is not fixed or determinable, we recognize revenues as amounts become due and payable with respect to transactions with extended payment terms, or as refund rights lapse with respect to transactions containing such provisions, provided all other revenue recognition criteria have been met.

·           Collection is deemed probable: We conduct a credit review for all significant transactions at the time of the arrangement to determine the credit-worthiness of the customer. Collection is deemed probable if we have a reasonable basis to expect that the customer will pay amounts under the arrangement as payments become due.

We report our revenues in three categories: product revenue, services revenue, and maintenance revenue. Product revenue includes revenues from software products and hardware products. Services revenue includes revenue from professional services, training, and subscriptions. Maintenance revenue includes maintenance revenue associated with our hardware and software products. Accounting treatment for each category of revenue and our most significant contract structures is further described below.

Revenue Recognition for Software Products and Software-Related Services (Software Elements)

Software product revenue. The timing of software product revenue recognition is dependent on the nature of the product sold or the structure of the license.

EnCase Software Products: Revenue associated with these arrangements, exclusive of amounts allocated to maintenance and other undelivered elements, for which we have vendor-specific objective evidence of fair value (“VSOE”), is recognized upon delivery, provided that all other criteria for revenue recognition have been met. Revenue associated with term licenses are recognized ratably over the term of the license because we have not established VSOE for post-contract customer support in term license arrangements.

Services revenue. The majority of our consulting and implementation services are performed under per hour or fixed fee arrangements. Revenue from such services is recognized as the services are provided or upon expiration of the contractual service period.

Training revenue is either recognized on a per-class basis upon a participant’s attendance or, for those customers who have subscribed to our Annual Training Passport program, revenue is recognized ratably over the annual period.

Maintenance revenue. Maintenance revenue includes technical support and software updates on a when-and-if-available basis. We recognize maintenance revenue ratably over the applicable maintenance period. We determine the amount of maintenance revenue to be allocated through reference to substantive maintenance renewal provisions contained in multiple element arrangements. We consider substantive maintenance provisions to be provisions where the cost of the maintenance renewal is stated in the contract with our customer as a percentage of the net license fee, provided the rate is substantive.

Revenue Recognition for Multiple-Element Arrangements — Software Products and Software-Related Services (Software Arrangements)

We often enter into arrangements with customers that purchase both software products and software-related services from us at the same time, or within close proximity of one another (referred to as software-related multiple-element arrangements). Such software-related multiple-element arrangements may include the sale of our software products, software maintenance services, which include license updates and product support, consulting/implementation services and training whereby the software license delivery is followed by the subsequent delivery of the other elements. For those software-related multiple-element arrangements, we have applied the residual method to determine the amount of software license revenues to be recognized pursuant to ASC 985-605. Under the residual method, if VSOE exists for the undelivered elements, this amount is deferred with the remaining, or residual, portion of the arrangement consideration recognized upon delivery of the software license, provided all other revenue recognition criteria are met.

Revenue Recognition for Hardware and Subscription Revenues (Nonsoftware Elements)

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Hardware product revenue. Revenue associated with the sale of forensic appliances is recognized upon shipment to the customers, which include certain resellers, provided that all other criteria for revenue recognition have been met.

Subscription services revenue. Customers pay subscription fees to access our cloud-based document review and production software; however, they may not take possession of the software at any time during the term of the agreement. In general, we recognize revenue for subscription fees on a straight-line basis over the contract period commencing on the date the subscription is made available to the customer. Usage-based fees, which are determined monthly, are recognized when incurred.

Revenue Recognition for Multiple-Element Arrangements — Hardware, Subscription, and Nonsoftware-Related Services (Nonsoftware Arrangements)

We enter into arrangements with customers that purchase both nonsoftware-related subscription services and nonsoftware-related services, such as consulting services, at the same time or within close proximity of one another (referred to as nonsoftware multiple-element arrangements). Each element within a nonsoftware multiple-element arrangement is accounted for as a separate unit of accounting provided the following criteria are met: the delivered products or services have value to the customer on a standalone basis; and for an arrangement that includes a general right of return relative to the delivered products or services, delivery or performance of the undelivered product or service is considered probable and is substantially controlled by us. We consider a deliverable to have standalone value if the product or service is sold separately by us or another vendor, or could be resold by the customer. Further, our revenue arrangements generally do not include a general right of return relative to the delivered products. Where the aforementioned criteria for a separate unit of accounting are not met, the deliverable is combined with the undelivered element and treated as a single unit of accounting for the purposes of allocation of the arrangement consideration and revenue recognition. For those units of accounting that include more than one deliverable but are treated as a single unit of accounting, we generally recognize revenues ratably over the delivery period. For the purposes of revenue classification of the elements that are accounted for as a single unit of accounting, we allocate revenue to the respective revenue line items within our consolidated statements of operations based on a rational and consistent methodology utilizing our best estimate of relative selling prices of such elements.

For our nonsoftware multiple-element arrangements, we allocate revenue to each element based on a selling price hierarchy at the arrangement’s inception. The selling price for each element is based upon the following selling price hierarchy: VSOE, if available; third party evidence (“TPE”) if VSOE is not available; or best estimate of selling price (“BESP”) if neither VSOE nor TPE are available. A description as to how we determine VSOE, TPE and BESP is provided below:

· VSOE . VSOE is determined based on its historical pricing and discounting practices for the specific product or service when sold separately. In determining VSOE, we require that a substantial majority of the selling prices for these services fall within a reasonably narrow pricing range.

· TPE . When VSOE cannot be established for deliverables in a multiple element arrangement, judgment is applied with respect to whether we can establish a selling price based on TPE. TPE is determined based on competitor prices for similar deliverables when sold separately. Generally, our go-to-market strategy differs from that of our peers, and our offerings contain a significant level of differentiation such that comparable pricing of services with similar functionality has not been obtained. Furthermore, we have been unable to reliably determine selling prices of similar competitive services on a stand-alone basis. As a result, we have not been able to establish selling prices based on TPE.

· BESP . When VSOE or TPE cannot be established, we use BESP in our allocation of arrangement consideration. The objective of BESP is to determine the price at which we would transact a sale if the service were sold on a stand-alone basis. We determine BESP for deliverables by considering multiple factors including but not limited to prices we charge for similar offerings, market conditions, competitive landscape and pricing practices.

Revenue Recognition for Multiple-Element Arrangements — Arrangements with Software and Nonsoftware Elements

We also enter into multiple-element arrangements that may include a combination of our various software-related and nonsoftware-related products and services. In such arrangements, we first allocate the total arrangement consideration based on the relative selling prices to the software group of elements as a whole and to the nonsoftware group of elements. We then further allocate consideration allocated to the software group and nonsoftware group to the respective elements within that group following the guidance in ASC 985-605, ASC 605-25, and our policies described above. After the arrangement consideration has been allocated to the elements, we recognize revenue for each respective element in the arrangement as described above.

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Recently Issued Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (“FASB”) and International Accounting Standards Board (“IASB”) jointly issued ASU No. 2014-09, Revenue from Contracts with Customers, which supercedes the revenue recognition requirements in ASC 605 Revenue Recognition.  ASU 2014-09 is a comprehensive new revenue recognition standard that will supercede nearly all existing revenue recognition guidance under US GAAP.  The standard’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services.  In doing so, companies will need to use more judgment and make more estimates than under current authoritative guidance.  These may include identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation.  The standard is effective beginning after December 15, 2016, and early adoption is not permitted under US GAAP.  On April 1, 2015, the FASB voted to propose to defer the effective date of ASU 2014-09 by one year.  We are currently evaluating the financial statement impact of the new revenue recognition standard.

In August 2014, the FASB issued ASU No. 2014-15, Presentation of Financial Statements-Going Concern (Subtopic 205-40), Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern. This standard sets forth management’s responsibility to evaluate, each reporting period, whether there is substantial doubt about our ability to continue as a going concern, and if so, to provide related footnote disclosures. The standard is effective for annual and interim reporting periods ending after December 15, 2016.  We are currently evaluating this new standard and expect it to have no impact on our financial position and results of operations.

In November 2015, the FASB issued ASU No. 2015-17, Balance Sheet Classification of Deferred Taxes, to simplify the presentation of deferred income taxes.  The amendments require that deferred tax liabilities and assets be classified as noncurrent in a classified statement of financial position. The amendments apply to all entities that present a classified statement of financial position.  The current requirement that deferred tax liabilities and assets of a tax-paying component of an entity be offset and presented as a single amount is not affected by the amendments.  The new guidance has been adopted on a prospective basis for the year ended December 31, 2015.  The adoption resulted in the reclassification of an immaterial deferred tax asset and noncurrent deferred tax liability of $0.5 million as of December 31, 2015.

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), which requires lessees to recognize on the balance sheet a right-of-use asset, representing their right to use the underlying asset for the lease term, and a lease liability for all leases with terms greater than 12 months. The guidance also requires qualitative and quantitative disclosures designed to assess the amount, timing and uncertainty of cash flows arising from leases. The standard requires the use of a modified retrospective transition approach, which includes a number of optional practical expedients that entities may elect to apply. ASU 2016-02 is effective for the Company beginning January 1, 2019 and we are currently evaluating the impact that ASU 2016-02 will have on our consolidated financial statements.

In March 2016, the FASB issued ASU No. 2016-09, Compensation - Stock Compensation (Topic 718), Improvements to the Employee Share-Based Payment Accounting.  The standard is intended to simplify several areas of accounting for share-based compensation arrangements, including the income tax impact, classification on the statement of cash flows and forfeitures. ASU 2016-09 is effective for the Company on January 1, 2017 and we are currently evaluating the impact that ASU 2016-09 will have on our consolidated financial statements.

Note 3. Net Loss Per Share

Earnings Per Share (ASC 260) defines unvested share-based payment awards that contain non-forfeitable rights to dividends as participating securities that should be included in computing EPS using the two-class method.  The Company’s unvested restricted stock awards qualify as participating securities.

Basic net loss per common share is calculated by dividing net loss allocated to common stockholders by the weighted average number of common shares outstanding during the reporting period. Diluted net loss allocated to common stockholders per share is calculated based on the weighted average number of common shares and dilutive potential common shares outstanding during the period. Dilutive potential common shares consist of the shares issuable upon the exercise of stock options and upon the vesting of restricted stock awards under the treasury stock method. In net loss periods, basic net loss per share and diluted net loss per share are identical since the effect of potential common shares is anti-dilutive and therefore excluded.

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The following table sets forth the computation of basic and diluted net loss allocated to common stockholders per share (in thousands, except per share amounts):

Antidilutive securities, which consist of stock options and restricted stock awards that are not included in the diluted net loss per share calculation, consisted of an aggregate of approximately 3,133,000 shares for the three months ended March 31, 2016 and 2,398,000 shares for the three months ended March 31, 2015.

For the three months ended March 31, 2016, 586,000 performance-based restricted awards were excluded from the computation of Diluted EPS as the performance metric had yet to be achieved or their inclusion would have been antidilutive.

Note 4. Inventory

Inventory is comprised of hardware components, packaged software components and finished goods and is valued at the lower of cost or market, using the weighted average cost method.  The following table sets forth, by major classes, inventory as of March 31, 2016 and December 31, 2015 (in thousands):

Note 5. Goodwill and Other Intangibles

We evaluate goodwill and indefinite-lived intangible assets for impairment on an annual basis, or more frequently if circumstances indicate impairment may have occurred, and there have been no impairment charges related to such assets through March 31, 2016.  We expect the balance of goodwill assigned to our products segment to be deductible for tax purposes while the balance of goodwill assigned to our subscription and services segments will not be deductible for tax purposes.

Intangible assets are amortized on a straight-line basis over their estimated useful lives, with the exception of customer relationships, which are amortized on a double-declining basis. Amortization expense for intangible assets with finite lives was $0.4 million for both the three months ended March 31, 2016, and 2015, respectively. The following table summarizes cumulative amortization expense related to intangible assets subject to amortization as of March 31, 2016 and December 31, 2015 (in thousands):

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The following table summarizes the estimated remaining amortization expense through 2020 and thereafter (in thousands):

Note 6. Debt Obligations

On August 29, 2014, we entered into a three year, Senior Secured Revolving Line of Credit (“Revolver”) with a bank.  The maximum principal amount that may be outstanding at any given time under the Revolver, which includes up to $3.0 million of standby letters of credit, is $10.0 million.  Any borrowings under the Revolver would be secured by substantially all of our assets, as well as pledges of capital stock.  The Revolver requires that, if we suffer an event of default or have borrowed more than 75% of the maximum principal amount permitted to be outstanding, we maintain an Adjusted Quick Ratio of at least 1.15 to 1.0.  If the Adjusted Quick Ratio falls below 1.5 to 1.0, any collections received by the bank on behalf of the Company will be applied to outstanding loan balances before being remitted to the Company’s operating account.  The Adjusted Quick Ratio is calculated by dividing Quick Assets (cash less restricted cash plus accounts receivable) by current liabilities (current liabilities plus outstanding standby letter of credit less the current portion of deferred revenue).  Borrowings under the Revolver bear interest at a floating rate ranging from 1.25% to 3.25% above the Prime Rate depending on the Company’s Adjusted Quick Ratio.  We are obligated to pay a commitment fee of $0.2 million over the three year term of the Revolver. All principal, interest and any other fees will be due and payable in full on or prior to August 29, 2017.

As of March 31, 2016, we were in compliance with all the covenants of the Revolver.  We had letters of credit outstanding against the Revolver in the amount of $1.2 million, resulting in the maximum available borrowing under the Revolver to be $8.2 million.  Availability is calculated as 80% of eligible accounts receivable, with a maximum of $10.0 million.  To date we have not borrowed under the Revolver.

Note 7. Employee Benefit Plans

At March 31, 2016, approximately 1,278,000 shares were available for grant as options or nonvested share awards under the Guidance Software, Inc. Second Amended and Restated 2004 Equity Incentive Plan (the “Plan”).

Stock Options

The terms of the options granted under the Plan are determined at the time of grant, and generally vest 25% annually over a four-year service period and typically must be exercised within 10 years from the date of grant.  A summary of stock option activity follows:

We define in-the-money options at March 31, 2016 as options that had exercise prices that were lower than the $4.30 fair market value of our common stock at that date.  The aggregate intrinsic value of options outstanding at March 31, 2016 is calculated as the difference between the exercise price of the underlying options and the fair market value of our common stock for the 511,000 shares that were in-the-money at that date, 34,000 of which were exercisable.

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Restricted Stock Awards

We issue restricted stock awards to certain directors, officers and employees. Compensation expense for such awards, based on the fair market value of the awards on the grant date, is recorded during the vesting period. Restricted stock awards generally vest 25% annually over a four-year service period. A summary of restricted stock awards activity follows:

The total grant date fair value of shares vested under such grants during the three months ended March 31, 2016 was $1,468,000.

On March 18, 2016, we granted approximately 586,000 performance-based restricted stock awards to certain members of our executive team, with a fair market value of $4.37 per share.  The performance criteria are based on certain revenue levels for the year ending December 31, 2016, ranging from a vesting percentage of 10% to 200% of the 586,000 shares granted.  The performance criteria will be measured on a quarterly basis; and if any of the levels are achieved during the calendar year ending December 31, 2016, 50% of the shares will vest on December 31, 2016 and the remaining 50% will vest on December 31, 2017.  For the three months ending March 31, 2016, none of the thresholds were achieved and therefore no performance-based restricted stock awards were included in our shares outstanding for the purpose of calculating our loss per share.

Share-Based Compensation

We account for share-based compensation in accordance with Compensation-Stock Compensation (ASC 718).   Compensation expense for stock options is recognized using the Black-Scholes option pricing model to determine the grant date fair value of share-based payments and recognize that cost, net of an estimated forfeiture rate, as compensation expense on a straight-line basis over the vesting period. Stock awards generally vest 25% annually over a four-year service period.  The determination of the grant date fair value of share-based awards using that model is affected by our stock price as well as assumptions regarding a number of complex and subjective variables. These variables include the estimated number of years that we expect employees to hold their stock options (the option “expected term”) and our expected stock price volatility, risk-free interest rates and dividends to be paid on our stock over that term.

The fair values of stock options granted under the Second Amended and Restated Plan were estimated at the date of grant using the Black-Scholes option pricing model and the following weighted average assumptions:

When historical data is available and relevant, the expected term of options granted is determined by calculating the average term from historical stock option exercise experience.  The volatility of our common stock is estimated at the date of grant based on the volatility of our publicly traded common stock over the prior 24 months.  The volatility is calculated based on the adjusted close price each day from a composite index. The risk-free interest rate used in option valuation is based on the implied yield in effect at the time of each option grant, based on US Treasury zero-coupon issues with equivalent expected terms. We use a dividend yield of zero in the Black-Scholes model, as we have no expectation we will pay any cash dividends on our common stock in the foreseeable future. Compensation-Stock Compensation (ASC 718) also requires that we estimate forfeitures at the time of grant and revise those estimates in subsequent periods if actual forfeitures differ from those estimates. We use historical data to estimate pre-vesting option forfeitures and record share-based compensation expense only for those awards that are expected to vest. Quarterly changes in the estimated forfeiture rate can potentially have a significant effect on reported share-based compensation, as the cumulative effect of adjusting the forfeiture rate for all expense amortization after the grant date is recognized in the period the forfeiture estimate is changed.

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The following table summarizes the share-based compensation expense we recorded (in thousands):

As of March 31, 2016, approximately $2.8 million of total unrecognized share-based compensation related to stock options is expected to be recognized over a weighted-average period of 3.5 years.  Approximately $14.1 million of total unrecognized share-based compensation cost related to restricted stock awards is expected to be recognized over a weighted-average period of 3.0 years.  For awards outstanding at March 31, 2016, we expect to record approximately $0.6 million and $4.6 million in share-based compensation for the remainder of fiscal year 2016 related to stock options and restricted stock awards, respectively.

Note 8. Income Taxes

We account for income taxes in accordance with Income Taxes (ASC 740).  Deferred income taxes are recorded for the expected tax consequences of temporary differences between the tax bases of assets and liabilities for financial reporting purposes and amounts recognized for income tax purposes.  We record a valuation allowance to reduce our deferred tax assets to the amount of future tax benefit that is more likely than not to be realized.  As of March 31, 2016, we have recorded a valuation allowance against our net deferred tax assets resulting in a carrying value of zero.

We recorded an income tax provision for the three months ended March 31, 2016 of $53,000 as compared to $71,000 for the same period in 2015.  Our income tax provision for the three months ended March 31, 2016 and 2015 differs from the U.S. statutory rate of 34% primarily due to state taxes, foreign taxes, the tax impact of certain share-based compensation charges, and the impact of providing a valuation allowance against research and development credits and deferred tax assets. During the quarter, we received a closing agreement on final determination from the Internal Revenue Service relating to our research and development credits carryforward for tax years 2010, 2011, and 2012. There is no impact to our income tax provision given our full valuation of deferred tax assets.

Note 9. Fair Value Measurements

In accordance with Fair Value Measurements and Disclosures (ASC 820), we measure our financial assets and liabilities at fair value on a recurring basis.  ASC 820 requires disclosure that establishes a framework for measuring fair value and expands disclosure about fair value measurements.  Under this standard, fair value is defined as the price that would be received in exchange for selling an asset or paid to transfer a liability (i.e., the “exit price”) in an orderly transaction between market participants at the measurement date.  ASC 820 establishes a hierarchy for inputs used in measuring fair value that minimizes the use of unobservable inputs by requiring the use of observable market data when available.  Observable inputs are inputs that market participants would use in pricing the asset or liability based on active market data.  Unobservable inputs would be inputs that reflect our assumptions about the assumptions market participants would use in pricing the asset or liability based on the best information available in the circumstances.  The statement requires fair value measurements be classified and disclosed in one of the following three categories:

Level 1:                                 Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets and liabilities.

Level 2:                                 Quoted prices in markets that are not active or financial instruments for which all significant inputs are observable, either directly or indirectly, and corroborated by market data.

Level 3:                                 Prices or valuations that require inputs that are both significant to the fair value measurement and unobservable.

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The following table sets forth, by level within the fair value hierarchy, financial assets and liabilities that are accounted for at fair value on a recurring basis as of March 31, 2016 and December 31, 2015 (in thousands):

Note 10. Commitments and Contingencies

Third-party Software Licenses

In February 2016, the Company entered into a $1.7 million third-party software license agreement authorizing the Company to integrate software as a component of its products through February 2020.  The agreement also provides for payment by the Company of $0.3 million for two years of maintenance and support.  The $2.0 million is payable in five installments, $1.5 million is payable during the year ending December 31, 2016 and $0.5 million is payable during the first six months of 2017.

Letter of Credit

As of March 31, 2016 we had a $1.2 million letter of credit outstanding against our Senior Secured Revolving Line of Credit related to the lease of our corporate headquarters.

Legal Matters

On May 20, 2011, MyKey Technology Inc. (“MyKey”) filed a complaint against us and certain other parties for patent infringement in the United States District Court for the District of Delaware.  With respect to the Company, the complaint alleged that certain of our data acquisition forensic hardware products that we acquired as a result of our acquisition of certain assets of Tableau, LLC (“Tableau”) infringe three of MyKey’s patents relating to write blocking, duplication and data removal technologies, respectively.  The complaint sought a declaration of infringement, a finding of willful infringement, compensatory damages, treble damages, injunctive relief, interest, expenses, costs and attorneys’ fees.

On July 22, 2011, MyKey also filed a complaint with the United States International Trade Commission (the “ITC”), alleging infringement by the Company and certain other parties of the three patents discussed in the preceding paragraph and requesting that the ITC commence an investigation pursuant to Section 337 of the Tariff Act of 1930.  The complaint sought injunctive relief barring the Company from the importation of products that allegedly infringed the three patents of MyKey.  On August 24, 2011, the ITC commenced an investigation of the Company and certain other parties related to the complaint by MyKey.  On August 31, 2011 the proceeding in the District Court was stayed pending the resolution of the ITC matter.  On August 1, 2012, MyKey amended its ITC complaint to remove allegations that its duplication patent had been infringed by the Company and to reduce the number of claims it alleged the Company had infringed related to MyKey’s data removal patent.  In August 2012, the parties completed a trial on the remaining patent claims at issue.

On December 28, 2012, the ITC released a final determination and Order holding that no violation of Section 337 of the Tariff Act of 1930 occurred as a result of the Company’s importation into the United States and sale of the products at issue.  This Order effectively ended the ITC proceeding in the Company’s favor.

On February 20, 2013, the U.S. District Court of Delaware lifted the stay of the proceedings in the MyKey matter.  Effective April 8, 2013, the parties stipulated to a transfer of the matter to the U.S. District Court for the Central District of California.  On April 16, 2013, the Company filed its Answer and Counterclaim.  MyKey filed a petition to consolidate a number of related cases, including the case against the Company in the Central District of California, into a Multi-District Litigation (“MDL”) proceeding.  On August 16, 2013, the MDL panel approved the petition and assigned the MDL consolidated cases to the judge who is also presiding over the individual case against the Company.  The MDL case will dispose of certain issues common to the consolidated cases, such as the validity of patents being asserted against the joint defendants.  On May 23, 2014, the parties completed a Markman hearing related to claim construction of the patents at issue.

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On March 26, 2014, MyKey also filed a complaint against the United States of America alleging that the United States had infringed U.S. Patents No. 6,813,682, 7,159,086 and 7,228,379 by or through its acceptance, receipt and/or use of write blocker products, data duplication products and data removal products.  The complaint alleges that such products were supplied to the government by the Company and certain of its co-defendants in the MDL proceeding.  No damages amount is stated in the complaint.  The government could assert a claim for indemnification against the Company but has not done so yet.  Although a financial loss is reasonably possible, the Company is unable to estimate the range of potential loss at this time.

On October 16, 2014, MyKey filed a Notice of Status on Claim Construction Issues in the MDL action in which it acknowledged that MyKey will not be able to prove that the Company’s data duplication products infringed U.S. Patent 7,159,086.  In the same filing, MyKey acknowledged that certain claims of United States Patent 6,813,682 are invalid and therefore cannot be infringed by any product. On July 8, 2015, the judge in the Central District Court of California denied the motions of the Company and other defendants for summary judgment on the validity of the patents remaining in the case. On April 25, 2016, the Company filed a memorandum in support of defendant’s motion to dismiss for failure to state a claim and a motion in limine to preclude certain damages.  This matter is ongoing, and we anticipate it will go to trial in 2017.

We intend to defend the remaining MyKey matters vigorously.  While a financial loss is reasonably possible, at this time we are unable to estimate what, if any, liability we may have in connection with these matters.  We are unable to estimate a range of reasonably possible financial losses for various reasons, including, among others, that (1) certain of the proceedings are at an early stage, (2) there is uncertainty as to the outcome of pending appeals, motions, or settlements, (3) there are significant factual issues to be resolved, (4) there are unresolved negotiations with certain indemnitors or indemnitees of the Company, related to the actions, and (5) we have meritorious defenses that we intend to assert.

From time to time, we may become involved in various other lawsuits and legal proceedings that arise in the ordinary course of business.  Litigation is subject to inherent uncertainties, and an adverse result in these or other matters may arise from time to time that may harm our business.  We are not currently aware of any such other legal proceedings or claims that are likely to have a material impact on our business.

Indemnifications

We have agreed to indemnify our directors and executive officers for costs associated with any fees, expenses, judgments, fines and settlement amounts incurred by them in any action or proceeding to which any of them is, or is threatened to be, made a party by reason of his or her services in their role as a director or officer.

Note 11. Segment Information

In accordance with ASC 280, Segment Reporting, our segmentation is based on our internal organization and reporting of revenue and other performance measures. Our segments are designed to allocate resources internally and provide a framework to determine management responsibility.  Operating segments are defined as components of an enterprise about which discrete financial information is available that is evaluated regularly by the chief operating decision maker, or decision making group, in deciding how to allocate resources and in assessing performance.  Our chief operating decision maker is our Chief Executive Officer.  We have five operating segments, as summarized below:

·   Products segment—Includes EnCase® Enterprise, EnCase® Cybersecurity, EnCase® Analytics, EnCase® eDiscovery, EnCase® Forensic, EnCase® Portable, Premium License Support Program and hardware sales.

·   Subscription segment—Includes subscription services for cloud-based document review and production software.

·   Professional services segment—Performs consulting services and implementations.

·   Training segment—Provides training classes by which we train our customers to effectively and efficiently use our software products.

·   Maintenance segment—Includes maintenance related services.

We present the revenues generated by our services and maintenance segments collectively.  Currently, we do not separately allocate operating expenses to these segments, nor do we allocate specific assets, with the exception of goodwill, to these segments. Therefore, the segment information reported includes only revenues, cost of revenues and segment profit.  The following tables present the results of operations for each operating segment (in thousands):

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Revenues, classified by the major geographic areas in which we operate, are as follows (in thousands):

Note 12. Subsequent Events

On April 22, 2016, the Company reached a mutual settlement with Mr. Shawn McCreight, a related party, its founder and former Chief Technology Officer and Chairman of the Board of Directors, to end the proxy contest related to the Company’s upcoming annual stockholders meeting scheduled for May 11, 2016.  Under the terms of the settlement agreement, Mr. McCreight resigned his board position effective April 22, 2016, and the Company appointed Mr. Michael McConnell and Mr. John Colbert to the Company’s Board of Directors, effective April 27, 2016.  In addition, Mr. Christopher Poole resigned from the Board of Directors effective April 22, 2016.  As part of the settlement agreement, Mr. McCreight has agreed to vote in favor of the Company’s slate of director nominees at the upcoming annual meeting of stockholders, and the litigation between the Company and Mr. McCreight will be dismissed.  Furthermore, the settlement includes a provision for the Company to reimburse Mr. McCreight’s expenses of approximately $0.7 million related to the proxy contest, which will be incurred in the second quarter of 2016.  As part of the settlement, both Mr. Colbert and Mr. McConnell have entered into the Company’s form of Indemnification Agreement.

Additionally, on April 22, 2016, the Company entered into a standstill agreement with both Mr. McConnell and Mr. McCreight including certain commitments extending through the director nominations for the 2018 Annual Meeting.

The foregoing agreements were disclosed in connection with the Company’s Current Report on 8-K filed with the SEC on April 22, 2016, and it is incorporated herein by reference.

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

The following discussion of our financial condition and results of operations should be read together with the financial statements and related notes that are included elsewhere in this Quarterly Report. This discussion may contain forward-looking statements based upon current expectations that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth in this Quarterly Report under “Risk Factors,” in our Annual Report on Form 10-K for the year ended December 31, 2015 under “Risk Factors” and in other parts of this Quarterly Report.

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Overview

We develop and provide leading software and hardware solutions for digital investigations, including EnCase Endpoint Security, EnCase eDiscovery, and EnCase Endpoint Investigator, which are network-enabled products primarily for corporations and government agencies, and EnCase Forensic, a desktop-based product primarily for law enforcement agencies and digital investigators.

Factors Affecting Our Results of Operations

There are a number of trends that may affect our business and our industry. Some of these trends or other factors include:

·           Legislative and regulatory developments. Our digital investigation solutions allow law enforcement agencies, government organizations and corporations to conduct investigations within the legal and regulatory framework.  Historically, the implementation of new laws and regulations surrounding digital investigations has helped create demand for our products. Future changes in applicable laws or regulations could enhance or detract from the desirability of our products.

·           Information technology budgets. Deployment of our solutions may require substantial capital expenditures by our customers. Budgets for information technology-related capital expenditures at corporations and all levels of government organizations are typically cyclical in nature, with generally higher budgets in times of improving economic conditions and lower budgets in times of economic slowdowns.

·           Law enforcement agency budgets. We sell our EnCase® Forensic products and training services primarily to law enforcement agencies.  Because of the limited nature of law enforcement budgets, funds are typically initially allocated toward solving issues perceived to be the most pressing.  Sales of our products could be impacted by changes in the budgets of law enforcement agencies or in the relative priority assigned to digital law enforcement investigations.

·           Prevalence and impact of hacking incidents and spread of malicious software. The increasing sophistication of hacking attacks on government and private networks and the global spread of malicious software, such as viruses, worms and rootkits, have increased the focus of corporations and large government organizations on digital investigations and other aspects of network security, which has, in turn, increased demand for our products.  Future changes in the number and severity of such attacks or the spread of malicious software could have an effect on the demand for our products.

·           Unpredictability of revenues. We experience unpredictability in our revenues, primarily from our customers’ budgeting cycles. The federal government’s budget year ends in the third calendar quarter of the year and a majority of corporate budget years end in the fourth calendar quarter of the year.  In addition, our customers also tend to make software purchases near the end of a particular quarter, which tends to make our revenues for a particular quarter unpredictable for a significant portion of that quarter.  We expect that this unpredictability in our revenues within particular quarterly periods will continue for the foreseeable future.

·           Amount of commercial litigation. Because commercial litigation often involves eDiscovery, an increase in commercial litigation could increase demand for our products and services, while a decrease in commercial litigation could decrease demand.

Critical Accounting Policies and Estimates

In preparing our financial statements, we make estimates, assumptions and judgments that can have a significant impact on our net revenue, operating income or loss and net income or loss, as well as on the value of certain assets and liabilities on our balance sheet.  We believe that the estimates, assumptions and judgments involved in the accounting policies described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2015 have the greatest potential impact on our financial statements, so we consider them to be our critical accounting policies and estimates.

In May 2014, the FASB and IASB jointly issued ASU No. 2014-09, Revenue from Contracts with Customers, which supercedes the revenue recognition requirements in ASC 605 Revenue Recognition.  ASU 2014-09 is a comprehensive new revenue recognition standard that will supercede nearly all existing revenue recognition guidance under US GAAP.  The standard’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services.  In doing so, companies will need to use more judgment and make more estimates than under current authoritative guidance.  These may include identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation.  The standard is effective beginning after December 15, 2016, and early adoption is not permitted under US GAAP.  On April 1, 2015, the FASB voted to propose to defer the effective date of ASU 2014-09 by one year.  We are currently evaluating the financial statement impact of the new revenue recognition standard.

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In August 2014, the FASB issued ASU No. 2014-15, Presentation of Financial Statements-Going Concern (Subtopic 205-40), Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern. This standard sets forth management’s responsibility to evaluate, each reporting period, whether there is substantial doubt about our ability to continue as a going concern, and if so, to provide related footnote disclosures. The standard is effective for annual and interim reporting periods ending after December 15, 2016.  We are currently evaluating this new standard and expect it to have no impact on our financial position and results of operations.

In November 2015, the FASB issued ASU No. 2015-17, Balance Sheet Classification of Deferred Taxes, to simplify the presentation of deferred income taxes.  The amendments require that deferred tax liabilities and assets be classified as noncurrent in a classified statement of financial position. The amendments apply to all entities that present a classified statement of financial position.  The current requirement that deferred tax liabilities and assets of a tax-paying component of an entity be offset and presented as a single amount is not affected by the amendments.  The new guidance has been adopted on a prospective basis for the year ended December 31, 2015.  The adoption resulted in the reclassification of an immaterial deferred tax asset and noncurrent deferred tax liability of $0.5 million as of December 31, 2015.  Prior periods presentation of deferred tax assets has not been retrospectively adjusted.

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), which requires lessees to recognize on the balance sheet a right-of-use asset, representing their right to use the underlying asset for the lease term, and a lease liability for all leases with terms greater than 12 months. The guidance also requires qualitative and quantitative disclosures designed to assess the amount, timing and uncertainty of cash flows arising from leases. The standard requires the use of a modified retrospective transition approach, which includes a number of optional practical expedients that entities may elect to apply. ASU 2016-02 is effective for the Company beginning January 1, 2019 and we are currently evaluating the impact that ASU 2016-02 will have on our consolidated financial statements.

In March 2016, the FASB issued ASU No. 2016-09, Compensation - Stock Compensation (Topic 718), Improvements to the Employee Share-Based Payment Accounting. The standard is intended to simplify several areas of accounting for share-based compensation arrangements, including the income tax impact, classification on the statement of cash flows and forfeitures. ASU 2016-09 is effective for the Company on January 1, 2017 and we are currently evaluating the impact that ASU 2016-09 will have on our consolidated financial statements.

Results of Operations

The following table sets forth our results of operations for the three months ended March 31, 2016 and 2015, respectively, expressed as a percentage of total revenues:

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The following table sets forth share-based compensation expense recorded in each of the respective periods (in thousands):

(1)                  Non-cash share-based compensation recorded in the three month period ended March 31, 2016 and 2015 relates to stock options and restricted share awards granted to employees measured under the fair value method.  See Note 7 to the condensed consolidated financial statements.

Comparison of Results of Operations for the Three Months Ended March 31, 2016 and 2015

Sources of Revenues

Our software product sales transactions typically include the following elements: (i) a software license fee paid for the use of our products under a perpetual license term, or for a specific term; (ii) an arrangement for first-year support and maintenance, which includes unspecified software updates, upgrades and post-contract support; and (iii) professional services for installation, implementation, consulting and training.  We also generate revenues from cloud-based document review and production software sold as subscription services.  We sell our software products and services through a combination of our direct sales force and resellers.  We sell our hardware products primarily through resellers.