Anixa Biosciences Inc - Quarter Report: 2014 April (Form 10-Q)

Funding and Management’s Plans

In January 2013, we received aggregate gross proceeds of $1,765,000 from the issuance of 8% convertible debentures due January 25, 2015 in a private placement.  During the third quarter of fiscal 2013, $325,000 of the principal amount of these debentures were converted into 2,166,775 shares of our common stock.  During the second quarter of fiscal 2014,  $1,440,000 of the principal amount of the convertible debentures were converted into 8,267,080 of shares of our common stock, and the remaining $200,000 of convertible debt was repaid in cash. 

On November 11, 2013, the Company completed a private placement with a single institutional investor, pursuant to which the Company issued a $3,500,000 principal amount 6% convertible debenture due November 11, 2016.  For details on this debenture, please see Note 2, “Convertible Debentures” herein.

During the six months ended April 30, 2014, cash used in operating activities was approximately $1,680,000.  Cash used in investing activities during the six months ended April 30, 2014 was $2,051,000, which resulted from the purchase of certificates of deposit totaling $2,700,000 which was partially offset by the sale of certificates of deposit totaling $650,000.  Our cash provided by financing activities during the six months ended April 30, 2014 was approximately $3,451,000, which resulted from the sale of convertible debentures in a private placement for $3,500,000 and the proceeds from exercise of warrants to purchase common stock of approximately $150,000, offset by the payment to redeem convertible debentures of $200,000.   As a result, our cash, cash equivalents, and short-term investments at April 30, 2014 increased approximately $1,770,000 to approximately $2,668,000 from approximately $898,000 at the end of fiscal year 2013.

Based on currently available information, the Company believes that its existing cash, cash equivalents, short-term investments and accounts receivable, and expected cash flows from patent licensing and enforcement, and other potential sources of cash flows will be sufficient to enable it to continue our patent licensing and enforcement activities for at least 12 months.  However, our projections of future cash needs and cash flows may differ from actual results. If current cash on hand and cash that may be generated from the Stock Purchase Agreement and from patent licensing and enforcement activities are insufficient to satisfy our liquidity requirements, we may seek to sell equity securities or obtain loans from various financial institutions where possible.  The sale of additional equity securities or convertible debt could result in dilution to our shareholders. We can give no assurance that we will generate sufficient cash flows in the future (through licensing and enforcement of patents, or otherwise) to satisfy our liquidity requirements or sustain future operations, or that other sources of funding, such as sales of equity or debt, would be available, if needed, on favorable terms or at all.  We can also give no assurance that we will have sufficient funds to repay our outstanding indebtedness.  If we cannot obtain such funding if needed or if we cannot sufficiently reduce operating expenses, we would need to curtail or cease some or all of our operations. 

10

Table of Contents

Table of Contents

In connection with the issuance of the Convertible Debenture due November 2016, the Company incurred legal costs which were allocated as provided below:

We recorded stock-based compensation expense, related to stock options granted to employees and directors, of approximately $989,000 and $1,028,000, during the six months ended April 30, 2014 and 2013, respectively, and approximately $524,000 and $555,000 during the three months ended April 30, 2014 and 2013, respectively. Stock-based compensation expense for the six months ended April 30, 2014 and 2013 includes approximately $747,000 and $803,000, respectively, and during the three months ended April 30, 2014 and 2013 approximately $364,000 and $402,000, respectively, related to the amortization of compensation cost for stock options granted in prior periods but not yet vested. As of April 30, 2014, there was unrecognized compensation cost related to non-vested stock options granted to employees and directors, related to service based options of approximately $2,846,000, which will be recognized over a weighted-average period of 1.8 years.  

          We account for stock options granted to consultants using the accounting guidance included in ASC 505-50 “Equity-Based Payments to Non-Employees” (“ASC 505-50”).  In accordance with ASC 505-50, we estimate the fair value of service based stock options and performance based options at each reporting period, using the Black-Scholes pricing model.  For options vesting if the trading price of the Company’s common stock exceeds price targets we estimate the fair value at each reporting period using a Monte Carlo Simulation.  We recognize compensation expense for service based stock options and options subject to market conditions over the requisite or implied service period of the grant.  For performance based awards, compensation expense is recognized when the performance target is achieved.

We recorded consulting expense, related to stock options granted to consultants, during the six months ended April 30, 2014 and 2013 of approximately $888,000 and $427,000, respectively, and approximately $633,000 and $185,000 during the three months ended April 30, 2014 and 2013, respectively. Stock-based consulting expense for the six and three months ended April 30, 2014 includes approximately $843,000 and $606,000, respectively, related to the amortization of compensation cost for stock options granted in prior periods but not yet vested. As of April 30, 2014, there was unrecognized consulting expense related to non-vested stock options granted to consultants, related to service based options of approximately $2,067,000, which will be recognized over a weighted-average period of 1.6 years.  

Fair Value Determination  

We use the Black-Scholes pricing model in estimating the fair value of stock options which vest over a specific period of time or upon achieving performance targets. To determine the weighted average fair value of stock options on the date of grant, employees and directors are included in a single group. The fair value of stock options granted to consultants is determined on an individual basis. The stock options we granted during the six months ended April 30, 2014 consisted of awards with 10-year terms that vest over one year and options with 10-year terms that vest over 36 months. The stock options we granted during the six months ended April 30, 2013 consisted of awards of options with 5-year terms, which vest over one year and options with 10-year terms which vest in three annual installments commencing on the date of grant or over a nine month period.  

19

The following weighted average assumptions were used in estimating the fair value of stock options granted during the six and three months ended April 30, 2014 and 2013.

The expected term of stock options represents the weighted average period the stock options are expected to remain outstanding.We use the simplified method to determine expected term.The simplified method was adopted since we do not believe that historical experience is representative of future performance because of the impact of the changes in our operations and the change in terms from historical options which vested immediately to terms including vesting periods of up to three years. Under the Black-Scholes pricing model we estimated the expected volatility of our shares of common stock based upon the historical volatility of our share price over a period of time equal to the expected term of the options. We estimated the risk-free interest rate based on the implied yield available on the applicable grant date of a U.S. Treasury note with a term equal to the expected term of the underlying grants. We made the dividend yield assumption based on our history of not paying dividends and our expectation not to pay dividends in the future.  

Under ASC 718, the amount of stock-based compensation expense recognized is based on the portion of the awards that are ultimately expected to vest. Accordingly, if deemed necessary, we reduce the fair value of the stock option awards for expected forfeitures, which are forfeitures of the unvested portion of surrendered options. Based on our historical experience we have not reduced the amount of stock-based compensation expenses for anticipated forfeitures.

20

We will reconsider use of the Black-Scholes pricing model if additional information becomes available in the future that indicates another model would be more appropriate. If factors change and we employ different assumptions in the application of ASC 718 and ASC 505-50 in future periods, the compensation expense that we record may differ significantly from what we have recorded in the current period.

For options vesting if the trading price of the Company’s common stock exceeds price targets we used a Monte Carlo Simulation in estimating expected term and fair value.

Stock Option Activity

During the six months ended April 30, 2014 and 2013, we granted options to purchase 8,710,000 and 180,000 shares, respectively, of common stock at weighted average exercise prices of $0.21 and $0.20 per share, respectively, pursuant to the CopyTele, Inc. 2010 Share Incentive Plan (the "2010 Share Plan).   During the six-month period ended April 30, 2013, in addition to options granted under the 2010 Share Plan, we granted options to our outside directors to purchase 3,000,000 shares at weighted average excise prices of $0.21 per share.  During the six-month periods ended April 30, 2014 and 2013, stock options to purchase 5,000 shares and 90,000 shares, respectively, of common stock were exercised with aggregate proceeds of approximately $1,000 and $13,000, respectively.

Stock Option Plans

As of April 30, 2014, we have two stock option plans:  the CopyTele, Inc. 2003 Share Incentive Plan (the "2003 Share Plan") and the 2010 Share Plan, which were adopted by our Board of Directors on April 21, 2003 and July 14, 2010, respectively.  

The 2003 Share Plan provides for the grant of nonqualified stock options, stock appreciation rights, stock awards, performance awards and stock units to key employees and consultants.  The maximum number of shares of common stock available for issuance under the 2003 Share Plan is 70,000,000 shares. The 2003 Share Plan was administered by the Stock Option Committee through June 2004, from June 2004 through July 2010, by the Board of Directors, from July 2010 through August 2012, by the Stock Option Committee, from August 2012 through November 2012, by the Executive Committee of the Board of Directors and since November 2012, by the Board of Directors, which determines the option price, term and provisions of each option.  The exercise price with respect to all of the options granted under the 2003 Share Plan since its inception was equal to the fair market value of the underlying common stock at the grant date.  In accordance with the provisions of the 2003 Share Plan, the plan terminated with respect to the grant of future options on April 21, 2013.  Information regarding the 2003 Share Plan for the six months ended April 30, 2014 is as follows:

21

The remaining nonqualified stock options granted in September 2012 to purchase 1,500,000 shares consisted of grants of 750,000 stock options to our Chairman in compensation for his service as interim Chief Executive Officer of the Company and as compensation for his prior service as a director, and 750,000 stock options to a director in compensation for his service in recruiting the Company’s new management team.  These stock options have an exercise price of $0.2225 (the average of the high and low sales price on September 21, 2012) and an intrinsic value as of April 30, 2014 of approximately $176,000.  The options vest in 3 equal annual installments of 250,000 commencing on September 21, 2012 and have a term of ten years.   As of April 30, 2014, 1,000,000 options were exercisable with an aggregate intrinsic value of approximately $118,000.  These stock options otherwise have the same terms and conditions as options granted under the Company’s 2010 Share Incentive Plan.  

During the year ended October 31, 2013, nonqualified stock options to purchase 3,000,000 shares were granted to our outside directors for service rendered to our Company.  Of these options,

(a)  In November 2012, nonqualified stock options to purchase 1,000,000 shares were issued to one of our directors as additional compensation for service in recruiting the Company’s new management team. These options have an exercise price of $0.211 (the average of the high and low sales price on date of grant) and vest 333,334 shares upon grant and 333,333 shares in two annual installments commencing November 30, 2013.  

(b) In February 2013, nonqualified stock options to purchase 1,000,000 shares were issued to the Chairman of the Board.  These stock options have an exercise price of $0.235 (the average of the high and low sales price on date of grant) and vest 333,334 shares upon grant and 333,333 shares in two annual installments commencing February 15, 2014.  

(c) In March 2013, nonqualified stock options to purchase an aggregate of 1,000,000 shares were granted to the Company’s three outside directors.  Each of these stock options has an exercise price of $0.195 (the average of the high and low sales price on date of grant) and vest in four equal quarterly installments commencing March 31, 2013.

24

As of April 30, 2014, the options to purchase 3,000,000 shares had an intrinsic value of approximately $379,000 and the portion exercisable of 2,333,334 shares had an intrinsic value of approximately $301,000.  These options otherwise have the same terms and conditions as options granted under the Company’s 2010 Share Incentive Plan.

The following table summarizes information about the above stock options outstanding that were not granted under the 2003 Share Plan or the 2010 Share Plan as of April 30, 2014:

Stock Awards

We account for stock awards granted to employees and consultants based on their grant date fair value, in accordance with ASC 718 and ASC 505-50, respectively.  During the six months ended April 30, 2014 and 2013, we issued 110,000 shares and 250,000 shares, respectively, of common stock to consultants for services rendered pursuant to the 2010 Share Plan.  We recorded consulting expense for the six months ended April 30, 2014 and 2013 of approximately $35,000 and $52,000, respectively and for the three months ended April 30, 2014 of approximately $7,000 and $26,000, respectively, for the shares of common stock issued to consultants.  

4.  FAIR VALUE MEASUREMENTS

ASC 820 “Fair Value Measurements and Disclosures” (“ASC 820”) defines fair value, establishes a framework for measuring fair value under GAAP, and expands disclosures about fair value measurements.  In accordance with ASC 820, we have categorized our financial assets, based on the priority of the inputs to the valuation technique, into a three-level fair value hierarchy as set forth below.  If the inputs used to measure the financial instruments fall within different levels of the hierarchy, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument.

25

Table of Contents

Financial assets and liabilities recorded in the accompanying condensed consolidated balance sheets are categorized based on the inputs to the valuation techniques as follows:

Level 1 - Financial assets and liabilities whose values are based on unadjusted quoted prices for identical assets or liabilities in an active market which we have the ability to access at the measurement date.

Level 2 - Financial assets and liabilities whose values are based on quoted market prices in markets where trading occurs infrequently or whose values are based on quoted prices of instruments with similar attributes in active markets.  

Level 3 – Financial assets and liabilities whose values are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. These inputs reflect management’s own assumptions about the assumptions a market participant would use in pricing the asset and liabilities. We do not currently have any Level 3 financial assets.

The following table presents the hierarchy for our financial assets measured at fair value on a recurring basis as of April 30, 2014:

The following table presents the hierarchy for our financial assets measured at fair value on a recurring basis as of October 31, 2013:

The following table presents the hierarchy for our financial liabilities measured at fair value on a recurring basis as of April 30, 2014:

The following table presents the hierarchy for our financial liabilities measured at fair value on a recurring basis as of October 31, 2013:

26

Table of Contents

5.  INVESTMENTS

At April 30, 2014, we had marketable securities consisting of certificates of deposit of $2,050,000, which were classified as "available-for-sale securities" and reported at fair value.  

The fair value of investment in Videocon Industries Limited (“Videocon”) global depository receipts (‘Videocon GDRs”) as of April 30, 2014 and October 31, 2013, and the unrealized loss for the six months ended April 30, 2014, are as follows:

6.  ACCOUNTS PAYABLE AND ACCRUED EXPENSES

Accounts payable and accrued expense consist of the following as of:

7.    NET LOSS PER SHARE OF COMMON STOCK

In accordance with ASC 260, “Earnings Per Share”, basic net loss per common share (“Basic EPS”) is computed by dividing net loss by the weighted average number of common shares outstanding.  Diluted net loss per common share (“Diluted EPS”) is computed by dividing net loss by the weighted average number of common shares and dilutive common share equivalents and convertible securities then outstanding.  Diluted EPS for all periods presented is the same as Basic EPS, as the inclusion of the effect of common share equivalents then outstanding would be anti-dilutive.  For this reason, excluded from the calculation of Diluted EPS for the six and three months ended April 30, 2014 and 2013, were stock options to purchase 71,327,845 and 63,318,845 shares respectively, and warrants to purchase 18,628,281 and 13,658,759 shares, respectively and debentures convertible into 18,498,943 shares and 11,767,255 shares respectively.

28

8.  EFFECT OF RECENTLY ADOPTED AND ISSUED PRONOUNCEMENTS

In July 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update 2013-11 (“ASU 2013-11”) which requires the netting of unrecognized tax benefits against a deferred tax asset for a loss or other carry forward that would apply in settlement of the uncertain tax positions. Under the new standard, unrecognized tax benefits will be netted against all available same-jurisdiction loss or other tax carry forwards that would be utilized, rather than only against carry forwards that are created by the unrecognized tax benefits. ASC 2013-11 is effective for fiscal years and interim periods within those fiscal years beginning on or after December 15, 2013.  The adoption of ASC 213-11 on November 1, 2014 is not expected to have a material effect on our consolidated financial statements.

In May 2014, the FASB issued Accounting Standards Update 2014-09 (“ASU 2014-09”), “Revenue from Contracts with Customers”.  The amendments in ASU 2014-9 create Topic 606, Revenue from Contracts with Customers, and supersede the revenue recognition requirements in Topic 605, Revenue Recognition, including most industry-specific revenue recognition guidance.  In addition, the amendments supersede the cost guidance in Subtopic 605-35, Revenue Recognition—Construction-Type and Production-Type Contracts, and create new Subtopic 340-40, Other Assets and Deferred Costs—Contracts with Customers.  In summary, the core principle of Topic 606 is that an entity recognizes 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.  ASC 2014-09 is effective for fiscal years and interim periods within those fiscal years beginning on or after December 15, 2016.  The adoption of ASC 213-11 on November 1, 2017 is not expected to have a material effect on our consolidated financial statements.

9.  INCOME TAXES

We file Federal, New York State and California State income tax returns.  Due to net operating losses, the statute of limitations remains open since the fiscal year ended October 31, 1997. We account for interest and penalties related to income tax matters in marketing, general and administrative expenses. There are no unrecognized income tax benefits as of April 30, 2014 and October 31, 2013.

10.  COMMITMENT AND CONTINGENCES

Patent Acquisition Obligations

As of April 30, 2014, we have incurred obligations due no later than November 2017 related to the acquisition of patents, which have a discounted present value of approximately $ 3,037,000, and which amount will be reduced by royalties paid during the period.  The payment due in November 2017 is payable at the option of the Company in cash or common stock.

29

Litigation Matters

On January 28, 2013, we filed a lawsuit in the United States Federal District Court for the Northern District of California against AUO and E Ink in connection with the AUO License Agreements, alleging breach of contract and other charges, and are seeking compensatory, punitive, and treble damages (the “AUO/E Ink Lawsuit”).  In addition to numerous material breaches by AUO of the AUO License Agreements, the Complaint alleges that AUO and E Ink conspired to obtain rights to CopyTele’s ePaper® Electrophoretic Display technology, and CopyTele’s Nano Field Emission Display technology.  CopyTele alleges that such activities violated several State and Federal anti-trust and unfair competition statutes for which punitive and/or treble damages are applicable.  We can give no assurance as to the potential outcome of this litigation.  However, it is reasonably possible that the Company will not prevail on its damages claims in arbitration.  Pursuant to the terms of the related arbitration agreement, the Company may be liable for AUO’s attorney’s fees, which may exceed $1 million, if the Company does not prevail.

The operations of the Company involved patent licensing and enforcement in connection with the unauthorized use of patented technologies.   In connection with any of our patent enforcement actions, it is possible that a defendant may request and/or a court may rule that we have violated statutory authority, regulatory authority, federal rules, local court rules, or governing standards relating to the substantive or procedural aspects of such enforcement actions.  In such event, a court may issue monetary sanctions against us or award attorney's fees and/or expenses to a defendant(s), which could be material.

Other than the foregoing, we are not a party to any material pending legal proceedings.We are party to claims and complaints that arise in the ordinary course of business.  We believe that any liability that may ultimately result from the resolution of these matters will not, individually or in the aggregate, have a material adverse effect on our financial position or results of operations.

30

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

Due to arrangements previously entered into by the Company, certain of our patents contain encumbrances which may negatively impact our patent monetization and patent assertion activities.  Where we are able, we will take the steps necessary to remove any encumbrances that may inhibit our patent monetization and patent assertion activities.

Patent Monetization and Patent Assertion

Patent monetization is the generation of revenue and proceeds from patents and patented technologies (“Patent Monetization”).  Patent assertion is a specialized type of Patent Monetization where a patent owner, or a representative of the patent owner, seeks to prohibit or collect royalties from the unauthorized manufacture, sale, and use of the owner’s patented invention (“Patent Assertion”).  CTI’s business model is Patent Monetization and Patent Assertion.

CTI’s Patent Portfolios

Encrypted Mobile Communications

The Encrypted Mobile Communications patent portfolio covers hardware and software used to encrypt cellular phone calls and other mobile communications.  With the increased use of mobile devices, and the increased concerns regarding privacy and the protection of personal information, we believe the demand for secure mobile communications is increasing for both businesses and consumers.

ePaper® Electrophoretic Display

The ePaper® Electrophoretic Display patent portfolio covers core electrophoretic technology that is used in the world’s most popular eReader devices such as the Nook^® and the Kindle. The ePaper patents cover the underlying chemistry that is used to manufacture both the particles and the suspension, two of the key elements that are fundamental to the generation of the black and white eReader display.  CTI’s ePaper patents also cover the manufacturing, assembly, and physical structure of the display unit itself, as well as the electronics and internal operation of the device.  

Internet Telephonic Gateway

The internet telephonic gateway patent portfolio covers the integration of telephonic participation in web-based audio/video conferences by creating a gateway between the Internet, and cellular or traditional landline telephones. The end result is that participants can join and participate in online, audio/video conferences via a cellular or conventional telephone. This internet telephonic gateway technology is commonly used for web based audio/video events with broad based audience participation such as earnings calls, webinars, and virtual town hall meetings.

32

J-Channel Window Frame Construction

The J-Channel Window Frame Construction patent portfolio covers vinyl windows with an integrated frame, known in the industry as a “J-Channel”. Such windows are commonly used in modular buildings, mobile homes, and conventional, new home construction, resulting in easier and faster window installation.

Key Based Web Conferencing Encryption

The Key Based Web Conferencing Encryption patent portfolio covers the generation and management of encryption keys.  This type of encryption technology is commonly used to encrypt web-based conferencing, email for regulatory compliance purposes, and personal information such as contracts.  

Loyalty Conversion Systems

The Loyalty Conversion System patent portfolio covers coalition loyalty awards programs commonly provided by airlines, credit card companies, hotels, retailers, casinos, and others.  The portfolio covers the electronic conversion of non-negotiable, loyalty awards points into negotiable funds used to purchase goods and services from third parties, as well as covering the electronic conversions of awards points into points and awards provided by other loyalty program providers.

Micro Electro Mechanical Systems Display

The Micro Electro Mechanical Systems Display patent portfolio covers vanadium dioxide coated pixels that electrically modulate light at extremely high speeds to form an image, as well as the use of electrostatic force to move pixel sized membranes that create a color image. These are emerging, low voltage, display technologies with numerous potential commercial applications.

Nano Field Emission Display

The Nano Field Emission Display patent portfolio covers a new type of flat panel display consisting of low voltage color phosphors, specially coated carbon nanotubes, nano materials to generate secondary electrons, and ionized noble gas, resulting in a bright, sharp, high contrast color image.  This emerging technology could result in a flat panel display utilizing less power, with better picture quality and lower manufacturing costs than is currently found in the flat panel display industry.

VPN Multicast Communications

The VPN Multicast Communications patent portfolio covers the multicast, internet delivery of streaming data, media, and other content to large numbers of recipients, within the confines of specialized virtual private networks (“VPN’s). Multicasting is a commonly used content delivery protocol that enables several recipients to simultaneous receive content from a single internet transmission, greatly reducing Internet bandwidth costs. When combined with specialized VPN’s, the content and communications are protected from unwanted disclosure and piracy. Applications for these live, VPN multicast communications include videoconferences, online training and e-learning classes, internet television, web-based corporate events and strategy sessions, and other live transmissions of sensitive or protected content.

RESULTS OF OPERATIONS

Six months ended April 30, 2014 compared to the six months ended April 30, 2013

34

For the six months ended April 30, 2014, we recorded revenue of $1,105,000, from 5 license agreements issued from our Key Based Web Conferencing Encryption and J-Channel Window Frame Construction patent portfolios.  The license agreements provided for one-time, non-recurring, lump sum payments in exchange for a non-exclusive retroactive and future license, or covenant not to sue.  Accordingly, the earning process from these licenses was complete and 100% of the revenue was recognized upon execution of the license agreements.  There was no revenue in the six months ended April 30, 2013.

The Company currently owns or controls 9 patent portfolios.  Since implementing our new business model in January of 2013, the Company has initiated 42 lawsuits in connection with 6 of our patent portfolios.  As of April 30, 2014, 9 license agreements have been issued and the Company has 33 active lawsuits over 6 patent portfolios.  Our primary source of revenue will come from licenses resulting from the unauthorized use of our patented technologies, including the settlement of patent infringement lawsuits

Inventor Royalties and Contingent Legal Fees

Inventor royalties and contingent legal fees of approximately $465,000 during the six months ended April 30, 2014 are attributable to our patent assertion activities initiated during fiscal 2013, and are expensed in the period that the related revenues are recognized.  Inventor royalties and contingent legal fees, as a percentage of revenue from patent assertion activities, will vary between fiscal periods since the economic terms of patent agreements and contingent legal fee arrangements vary across the patent portfolios owned or controlled by our operating subsidiaries.  We did not incur any inventor royalties or contingent legal fees during the six months ended April 30, 2013, as we recognized no revenues during this period.

Litigation and Licensing Expenses

Litigation and licensing expenses increased by approximately $97,000 to approximately $104,000 in the six months ended April 30 2014, from approximately $7,000 in the comparable period year period.  Litigation and licensing expenses, which are attributable to our patent assertion activities initiated during fiscal 2013 and the AUO/E Ink Lawsuit, are expensed in the period incurred.  

Amortization of Patents

Amortization of patents of approximately $152,000 in the six months ended April 30, 2014 is related to patent portfolios acquired in the first quarter of fiscal 2014.  We did not incur any patent amortization expense during the six months ended April 30, 2013.  

Marketing, General and Administrative Expenses

Marketing, general and administrative expenses decreased by approximately $213,000 to approximately $3,704,000 in the six months ended April 30, 2014, from approximately $3,917,000 in the comparable prior-year period. The decrease in marketing, general and administrative expenses was principally due to a decrease in legal and accounting fees of approximately $458,000, a decrease in rent expense of approximately $242,000 and a decrease in shareholder relations expense of approximately $156,000, offset by an increase in employee compensation, excluding stock option expense, of approximately $271,000 which was primarily attributable to employee bonuses, a bonus paid to the Company’s strategic advisor and a director of the Company of $100,000 and an increase in stock option expense for this strategic advisor and director of the Company of approximately $461,000.

 Legal and accounting fees in 2013 included nonrecurring costs related to the Company’s restructuring, which commenced in the fourth quarter of the fiscal year 2012. The decrease in rent expenses reflects the reduction in facilities requirements as a result of the Company’s restructuring.  Marketing, general and administrative expense for the six months ended April 30, 2014 and 2013 includes approximately $1,877,000 and $1,455,000, respectively, of non-cash stock option compensation expense.

Change in Value of Derivative Liability

Change in value of derivative liability was a loss of approximately $2,311,000 in the six months ended April 30, 2014 compared to a gain of $210,000 in the comparable prior year period. The derivative liability represents the bifurcated conversion features of the January 2013 Convertible Debentures and the November 2013 Convertible Debenture.  An increase in the price of our common stock results in an increase in derivative liability and a loss from change in value of derivative liability. See Note 2 to the condensed consolidated financial statements for additional information.      

Loss on Extinguishment of Debt

During the six months ended April 30, 2014, holders of $1,240,000 of the Convertible Debentures due January 2015 converted their holdings into 8,267,080 shares of Common Stock and holders of $200,000 of principal of Convertible Debentures due January 2015 consented to prepayment of obligations to them. In connection with these conversions and prepayments, the Company recorded a loss on extinguishment of debt of approximately $483,000 in the six months ended April 30, 2014, compared to $-0- in the comparable prior year period.  See Note 2 to the condensed consolidated financial statements for additional information.

Interest Expense

Interest expense decreased by approximately $57,000 to approximately $801,000 in the six months ended April 30, 2014 from approximately $858,000 in the prior year period.  Interest expense in the six months ended April 30, 2014 and 2013 includes approximately $447,000 and $103,000, respectively, of amortization of debt discount on convertible debentures, approximately $186,000 and $-0-, respectively, of amortized interest on our patent acquisition obligation and approximately $99,000 and $-0-, respectively, of accrued interest on the November 2013 convertible debentures.  During the six months ended April 30, 2013, the convertible debentures due September 2016 were converted into shares of common stock. The conversion of these debentures resulted in a charge to interest expense of approximately $717,000 during the six months ended April 30, 2013.  There was no charge to interest expense related to the conversion of debentures in the current fiscal period.

36

Dividend Income

Dividend income of approximately $48,000 received in the six months ended April 30, 2014 was related to the Videocon GDR’s.  There was no dividend income received in the six months ended April 30, 2013.

Interest Income

Interest income increased to approximately $3,000 in the six months ended April 30, 2014 compared to approximately $-0- in the six months ended April 30, 2013 due to the increased amount of short term investments during the current period.

Three months ended April 30, 2014 compared with three months ended April 30, 2013

Revenue from Patent Assertion Activities

For the three months ended April 30, 2014, we recorded revenue of $1,105,000, from 5 license agreements issued from our Key Based Web Conferencing Encryption and J-Channel Window Frame Construction patent portfolios. The license agreements provided for one-time, non-recurring, lump sum payments in exchange for a non-exclusive retroactive and future license, or covenant not to sue.  Accordingly, the earning process from these licenses was complete and 100% of the revenue was recognized upon execution of the license agreements.  There was no revenue in the three months ended April 30, 2013.

Inventor Royalties and Contingent Legal Fees

Inventor royalties and contingent legal fees of approximately $465,000 during the three months ended April 30, 2014 are attributable to our patent assertion activities initiated during fiscal 2013, and are expensed in the period that the related revenues are recognized.  Inventor royalties and contingent legal fees, as a percentage of revenue from patent assertion activities, will vary between fiscal periods since the economic terms of patent agreements and contingent legal fee arrangements vary across the patent portfolios owned or controlled by our operating subsidiaries. We did not incur any inventor royalties or contingent legal fees during the three months ended April 30, 2013, as we recognized no revenues during this period.

Litigation and Licensing Expenses

Litigation and licensing expenses increased by approximately $64,000 to approximately $71,000 in the three months ended April 30 2014, from approximately $7,000 in the comparable period year period.  Litigation and licensing expenses, which are attributable to our patent assertion activities initiated during fiscal 2013 and the AUO/E Ink Lawsuit, are expensed in the period incurred.

37

Interest Expense

Interest expense decreased by approximately $413,000 to approximately $422,000 in the three months ended April 30, 2014 from approximately $835,000 in the prior year period.  Interest expense in the three months ended April 30, 2014 and 2013 includes approximately $229,000 and $83,000, respectively, of amortization of debt discount on convertible debentures, approximately $100,000 and $-0-, respectively, of amortized interest on our patent acquisition obligation and approximately $53,000 and $-0-, respectively, of accrued interest on the November 2013 convertible debentures. During the three months ended April 30, 2013, the convertible debentures due September 2016 were converted into shares of common stock.The conversion of these debentures resulted in a charge to interest expense of approximately $717,000 during the three months ended April 30, 2013. There was no charge to interest expense related to the conversion of debentures in the current fiscal period.

Interest Income

Interest income increased to approximately $2,000 in the three months ended April 30, 2014 compared to approximately $-0- in the three months ended April 30, 2013 due to the increased amount of short term investments during the current period.

LIQUIDITY AND CAPITAL RESOURCES

Based on currently available information, the Company believes that its existing cash, cash equivalents, short-term investments and accounts receivable, and expected cash flows from patent licensing and enforcement, and other potential sources of cash flows will be sufficient to enable it to continue our patent licensing and enforcement activities for at least 12 months.  However, our projections of future cash needs and cash flows may differ from actual results. If current cash on hand and cash that may be generated from the Stock Purchase Agreement and from patent licensing and enforcement activities are insufficient to satisfy our liquidity requirements, we may seek to sell equity securities or obtain loans from various financial institutions where possible.  The sale of additional equity securities or convertible debt could result in dilution to our shareholders. We can give no assurance that we will generate sufficient cash flows in the future (through licensing and enforcement of patents, or otherwise) to satisfy our liquidity requirements or sustain future operations, or that other sources of funding, such as sales of equity or debt, would be available, if needed, on favorable terms or at all.  We can also give no assurance that we will have sufficient funds to repay our outstanding indebtedness.  If we cannot obtain such funding if needed or if we cannot sufficiently reduce operating expenses, we would need to curtail or cease some or all of our operations.  Curtailing or ceasing some of our operations could jeopardize our future strategic initiatives and business plans.