hopTo Inc. - Quarter Report: 2013 September (Form 10-Q)

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SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

 

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

 SECURITIES EXCHANGE ACT OF 1934

 

 For the Quarterly Period Ended September 30, 2013

Commission File Number: 0-21683

HOPTO INC.

(Exact name of registrant as specified in its charter)

1901 S. Bascom Avenue, Suite 660

Campbell, CA 95008

(Address of principal executive offices)

Registrant’s telephone number:

(800) 472-7466

(408) 688-2674

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

 Yes 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 Regulations S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

 Yes 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 November 8, 2013, there were issued and outstanding 101,459,382 shares of the registrant’s common stock, par value $0.0001.

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HOPTO INC.

FORM 10-Q

Table of Contents

 

Forward-Looking Information

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

 

 

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

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ITEM 1. Financial Statements

 

HOPTO INC.

 

See accompanying notes to unaudited condensed consolidated financial statements

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 HOPTO INC.

See accompanying notes to unaudited condensed consolidated financial statements

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HOPTO INC.

See accompanying notes to unaudited condensed consolidated financial statements

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HOPTO INC.

 

See accompanying notes to unaudited condensed consolidated financial statements

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HOPTO INC.

Notes to Unaudited Condensed Consolidated Financial Statements

1.  Basis of Presentation

 

Our Board of Directors adopted an amendment to our Certificate of Incorporation changing our name from GraphOn Corporation to hopTo Inc. effective September 9, 2013. A Certificate of Amendment of Incorporation was filed with the Delaware Secretary of State implementing the name change. The amendment had been previously approved by our stockholders.

 

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

 

The unaudited condensed consolidated financial statements included herein reflect all adjustments, which include only normal, recurring adjustments, except for the effect of the amendment to warrants (Note 4), that are, in our opinion, necessary to state fairly the results for the periods presented. This Quarterly Report on Form 10-Q should be read in conjunction with our audited consolidated financial statements contained in our Annual Report, as amended, on Form 10-K/A for the year ended December 31, 2012, which was filed with the SEC on April 12, 2013 (“2012 10-K/A Report”). The interim results presented herein are not necessarily indicative of the results of operations that may be expected for the full fiscal year ending December 31, 2013 or any future period.

 

During September 2012, we reached settlement and licensing agreements that effectively ended all of our then on-going intellectual property litigation.  Having been approached by the respective counter-parties to each of our lawsuits, and in consultation with our board of directors, we determined that it was in our best long-term strategic interests to settle each lawsuit in order to move forward and shift our focus to our software products, including our new product initiatives.    We do not intend to pursue intellectual property litigation as an integral part of our strategy to fund our future operations.  Accordingly for all periods presented, the results of operations and cash flows related to our former intellectual property segment has been segregated and reported as “Discontinued Operations”.  See Note 17 to our Notes to Unaudited Condensed Consolidated Financial Statements.

2.  Significant Accounting Policies

 

Use of Estimates

 

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

 

Revenue Recognition

 

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

Software license revenues are recognized when:

 

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Persuasive evidence of an arrangement exists, (i.e., when we sign a non-cancellable license agreement wherein the customer acknowledges an unconditional obligation to pay, or upon receipt of the customer’s purchase order), and

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Delivery has occurred or services have been rendered and there are no uncertainties surrounding product acceptance (i.e., when title and risk of loss have been transferred to the customer, which occurs when the media containing the licensed program(s) is provided to a common carrier or, in the case of electronic delivery, when the customer is given access to the licensed program(s)), and

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The price to the customer is fixed or determinable, as typically evidenced in a signed non-cancellable contract, or a customer’s purchase order, and

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Collectability is probable.  If collectability is not considered probable, revenue is recognized when the fee is collected.

 

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

 

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

 

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

 

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

 

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

 

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

Deferred Rent

 

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

 

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

 

Postemployment Benefits (Severance Liability)

 

Nonretirement postemployment benefits, including salary continuation, supplemental unemployment benefits, severance benefits, disability-related benefits and continuation of benefits such as health care benefits, are recognized as a liability and a loss when it is probable that the employee(s) will be entitled to such benefits and the amount can be reasonably estimated. The cost of termination benefits recognized as a liability and an expense includes the amount of any lump-sum payments and the present value of any expected future payments. During 2012, we recorded $721,800 of severance expense, including stock compensation expense. Such expense was recorded as a result of a separation agreement and a release with Robert Dilworth in connection with Mr. Dilworth’s resignation as our Chief Executive Officer and as a member of our board of directors.  In addition, during 2013 we recorded an additional $75,700 of severance expense as a result of a separation and release agreement we entered into with a former vice president-level employee (as further discussed in Note 5 to Unaudited Condensed Consolidated Financial Statements).  An aggregate of $140,100 and $262,400 is reflected as a severance liability, at September 30, 2013 and December 31, 2012, respectively.

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Software Development Costs

 

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

 

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

 

Long-Lived Assets

 

Long-lived assets are assessed for possible impairment whenever events or changes in circumstances indicate that the carrying amounts may not be recoverable, whenever we have committed to a plan to dispose of the assets or, at a minimum, annually. Typically, for long-lived assets to be held and used, measurement of an impairment loss is based on the fair value of such assets, with fair value being determined based on appraisals, current market value, comparable sales value, and discounted future cash flows, among other variables, as appropriate. Assets to be held and used (which assets are affected by an impairment loss) are depreciated or amortized at their new carrying amount over their remaining estimated life; assets to be sold or otherwise disposed of are not subject to further depreciation or amortization. No such impairment charge was recorded during either of the three or nine-month periods ended September 30, 2013 or 2012.

 

Allowance for Doubtful Accounts

 

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

 

The following table sets forth the details of the Allowance for Doubtful Accounts for the three and nine-month periods ended September 30, 2013 and 2012:

 

		Beginning Balance				Charge Offs				Recoveries				Provision				Ending Balance
		Three Months Ended September 30,
2013		$	24,600			$	—			$	—			$	5,000			$	29,600
2012			37,900				—				—				(7,700	)			30,200
			Nine Months Ended September 30,
2013		$	33,900			$	—			$	—			$	(4,300	)		$	29,600
2012			25,000				—				—				5,200				30,200

Concentration of Credit Risk

 

For the three and nine-month periods ended September 30, 2013 and 2012 respectively, we considered the customers listed in the following tables to be our most significant customers. The tables set forth the percentage of sales attributable to each customer for the three and nine-month periods ended September 30, 2013 and 2012, and the respective customer’s ending accounts receivable balance as a percentage of reported accounts receivable, net, as of September 30, 2013 and 2012.

 

		Three Months Ended September 30, 2013								Three Months Ended September 30, 2012
Customer		Sales				Accounts Receivable				Sales				Accounts Receivable
Elosoft			10.4	%			15.1	%			7.2	%			10.7	%
IDS			9.9	%			4.5	%			8.7	%			1.2	%
GE			9.7	%			16.5	%			10.1	%			19.8	%
Alcatel-Lucent			8.4	%			16.2	%			7.2	%			14.3	%
GAD			6.4	%			—				5.5	%			—
Total			44.8	%			52.3	%			38.7	%			46.0	%

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		Nine Months Ended September 30, 2013								Nine Months Ended September 30, 2012
Customer		Sales				Accounts Receivable				Sales				Accounts Receivable
Elosoft			6.3	%			15.1	%			5.5	%			10.7	%
IDS			6.6	%			4.5	%			5.4	%			1.2	%
GE			6.8	%			16.5	%			8.1	%			19.8	%
Alcatel-Lucent			7.5	%			16.2	%			4.8	%			14.3	%
GAD			4.7	%			—				10.5	%			—
Total			31.9	%			52.3	%			34.3	%			46.0	%

Derivative Financial Instruments

 

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

 

Fair Value of Financial Instruments

 

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

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

 

As of September 30, 2013, all of our $1,968,800 Warrants Liability reported at fair value was categorized as Level 3 inputs (See Note 4).

 

Recent Accounting Pronouncements

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

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In February 2013, FASB issued ASU No. 2013-02 “Other Comprehensive Income” (ASU 2013-02). The objective of ASU 2013-02 is to improve the reporting of reclassifications out of other comprehensive income.  This objective is reached by requiring an entity to report the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in net income if the amount being reclassified is required under GAAP to be reclassified in its entirety to net income.  ASU 2013-02 is effective and is to be applied prospectively to reporting periods beginning after December 15, 2012. We currently have no amounts that would meet the criteria to be reclassified; accordingly, the adoption of ASU 2013-02 did not have a material impact on our results of operations, cash flows or financial position.  Comprehensive loss equals net loss for the each of the three and nine-month periods ended September 30, 2013 and 2012, respectively.

 

In July 2012, FASB issued ASU No. 2012-02 “Intangibles – Goodwill and Other” (ASU 2012-02). The objective of ASU 2012-02 is to reduce the cost and complexity of performing an impairment test for indefinite-lived intangible assets by simplifying how an entity tests those assets for impairment and to improve consistency in impairment testing guidance among long-lived asset categories. ASU 2012-02 is effective for fiscal years beginning after September 15, 2012. Early adoption is permitted. We currently have no goodwill or material indefinite-lived intangible assets; accordingly, the adoption of ASU 2012-02 did not have a material impact on our results of operations, cash flows or financial position.

 

3.  Property and Equipment

Property and equipment was:

		September 30, 2013				December 31, 2012
Equipment		$	1,238,800			$	1,171,900
Furniture			392,800				380,200
Leasehold improvements			147,500				147,500
			1,779,100				1,699,600
Less: accumulated depreciation and amortization			1,421,300				1,340,700
		$	357,800			$	358,900

 

Aggregate property and equipment depreciation and amortization expense was $28,200 during the three-month period ended September 30, 2013 and $80,600 during the nine-month period ended September 30, 2013. During the nine-month period ended September 30, 2013, we capitalized the following costs: equipment; $64,900, furniture; $14,600.

 

4.  Liability Attributable to Warrants

 

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

 

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

 

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

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

 

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

On August 9, 2013, we consummated an offer to exercise warrants (the “Offer to Exercise”) made to holders of warrants in the 2011 Transaction who were not parties to the Exercise Agreement.  We were obligated to conduct the Offer to Exercise under the terms of the Exercise Agreement entered into in connection with the June 17, 2013 transaction.  In connection with the Offer to Exercise, warrants to purchase an aggregate of 305,000 shares of our common stock were exercised for which we received cash proceeds of $64,000.  In consideration for the early exercise of these warrants, we issued an aggregate of 152,500 New Warrants at an exercise price of $1.00 per warrant, with a term of five years from issuance.

 

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

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

 

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

 

We used the exercise price of the warrants, as well as the fair market value of our common stock, to determine the fair value of our warrants.  The exercise price for warrants issued in conjunction with the 2011 Transaction, including those issued to the placement agent, was either $0.20 or $0.26 per share, and was $0.26 per share for the warrants issued to ipCapital. The fair market value of our common stock was $0.54 and $0.30 per share as of September 30, 2013 and 2012, respectively.

 

We used a binomial pricing model to determine the fair value of our warrants liability as of September 30, 2013 and December 31, 2012, the balance sheet dates, using the following assumptions:

 

		2011 Transaction								ipCapital
		September 30, 2013				December 31, 2012				September 30, 2013				December 31, 2012
Estimated volatility			120	%			159	%			125	%			163	%
Annualized forfeiture rate			—				—				—				—
Expected option term (years)			2.92				3.67				3.04				3.79
Estimated exercise factor			4				10				4				10
Risk-free interest rate			0.50	%			0.45	%			0.64	%			0.65	%
Dividends			—				—				—				—

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The following table is a reconciliation of the warrants liability measured at fair value using significant unobservable inputs (Level 3) for the nine months ended September 30, 2013:

 

Warrants liability – December 31, 2012 fair value		$	7,390,100
Change in fair value of warrant liability recorded in other income			(680,100	)
Change in fair value of warrant liability recorded in general and administrative expense			35,700
Reclassification of warrants liability to equity from exercise of warrants (1)			(385,900	)
Reclassification of warrants liability to equity from amendment to warrants  (1)			(4,391,000	)
Warrants liability – September 30, 2013 fair value		$	1,968,800

 

(1)

During the nine-month period ended September 30, 2013, our warrants liability was reduced as a result of the warrants amendment, as discussed above. Additionally, our warrants liability was further reduced by $385,900 as a result of the exercise of 1,072,500 warrants during such period, whose terms were not affected by the changes made under the warrants amendment. The aggregate reduction in the liability, combining the warrant amendment and this exercise, was $4,776,900. See Note 13.

 

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

 

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

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

For the Three and Nine-Month Period Ended September 30, 2012
		Beginning Outstanding				Issued				Exercised				Ending Outstanding
2011 Transaction			23,075,000				—				—				23,075,000
ipCapital			400,000				—				—				400,000
Total			23,475,000				—				—				23,475,000

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(1) Effective September 18, 2013, we entered into a consulting agreement with Genesis Select to provide us with a variety of investor relations services. As part of their compensation, we issued to them a warrant to purchase 312,500 shares of our common stock at an exercise price of $0.50 per share. The warrant will vest, monthly, over the initial twelve-month service period of the contract, assuming that the agreement remains in-force, with the first vesting having occured on October 18, 2013. The warrant is substantially similar in nature to those issued in the warrant amendment, discussed above, thus; the warrant is accounted in equity and is not included as a component of our warrants liability as of September 30, 2013. We used the following assumptions in a binomial pricing model to calculate the fair value of the warrant issued to Genesis: estimated volatility – 181%; expected term – 4.96 years; estimated exercise factor – 4, risk free interest rate – 1.41%; and dividends – 0. Expense associated with this warrant is recognized as a component of general and administrative expense over the one-year vesting term of the warrant.

5.  Severance Liability

On April 12, 2012, we entered into a separation agreement and a release with Robert Dilworth in connection with Mr. Dilworth’s resignation as our Chief Executive Officer and as a member of our board of directors. Subject to the terms of the separation agreement, effective April 20, 2012 (the “Release Effective Date”) we paid or provided Mr. Dilworth the following:

 

·

On the Release Effective Date, Mr. Dilworth’s outstanding unvested options became fully vested and exercisable, and his outstanding vested options were modified to extend the exercise period. All options will remain exercisable until the earlier of (i) the expiration dates of each of such options or (ii) the date that is 30 months after the Release Effective Date. The number of shares of common stock issuable upon exercise of such outstanding options is 2,000,000. We recognized $172,700 of non-cash stock-based compensation expense during 2012, as a result of the modification of Mr. Dilworth’s outstanding stock options.  No expense was recognized during the nine-month period ended September 30, 2013 as a result of the modifications.

 

·

On the Release Effective Date, Mr. Dilworth was granted an option to purchase 500,000 shares of common stock at an exercise price of $0.20 per share. Such option has a term of 30 months from the date of grant and will vest and become exercisable at a rate of 62,500 shares per quarter commencing on July 1, 2012. We recognized $64,700 of non-cash stock-based compensation expense during 2012 as a result of the issuance of this stock option to Mr. Dilworth.  No expense was recognized during the nine-month period ended September 30, 2013 as a result of the issuance.

 

·

From May 2012 through April 2013, Mr. Dilworth was paid $27,300 per month. From May 2013 through April 2014, Mr. Dilworth will be paid $13,600 per month.  During the three-month period ended June 30, 2012, we recognized $433,700 compensation expense related to Mr. Dilworth’s separation agreement, which we recorded as a liability.  Such amount represented the present value of the future salary and medical insurance (discussed below) continuation payments due Mr. Dilworth under the terms of the separation agreement.  During the three and nine-month periods ended September 30, 2013, we made salary continuation payments aggregating $36,600 and $172,900, respectively, to Mr. Dilworth.  As of September 30, 2013, the aggregate present value of the remaining future salary and medical insurance coverage continuation payments due Mr. Dilworth was $92,300, which was reported as a current liability.  All interest expense associated with the salary and medical insurance continuation payments made are charged to general and administrative expenses as incurred.  During the three and nine-month periods ended June 30, 2013, we incurred interest charges of $4,200 and $18,100 respectively.

 

·

From May 2012 through October 2013, we paid the premium costs to continue medical coverage for Mr. Dilworth and his spouse under the Employment Retirement Income Security Act of 1974. Such premiums aggregated $5,800 for May 2012 and June 2012, and will approximate $1,300 per month thereafter. During the three and nine-month periods ended September 30, 2013 we made medical insurance coverage continuation payments of $3,800 and $11,000 respectively.  During the three and nine-month periods ended September 30, 2013, we incurred interest charges of $100 and $700, respectively.

 

·	We paid Mr. Dilworth $15,000 as reimbursement for a portion of his legal fees in connection with negotiation of the separation agreement and the release.

 

Mr. Dilworth’s participation in the Key Employee Severance Plan and the Director Severance Plan was automatically terminated on the Release Effective Date. In addition, the separation agreement contains confidentiality and non-disparagement provisions subject to the terms set forth therein. Pursuant to the terms of the release, Mr. Dilworth provided as of the Release Effective Date a release of claims in connection with his employment and resignation. As a result of the separation agreement, we recognized an aggregate $721,800 of additional operating expenses, as summarized above of which all such expense was recognized contemporaneously with the consummation of Mr. Dilworth’s separation agreement during the second quarter of 2012.

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We estimated the fair value of each stock-based award set forth above, which were included as part of Mr. Dilworth’s separation agreement during 2012, using a binomial model with the assumptions set forth in the following table:

 

		Estimated Volatility				Annualized Forfeiture Rate				Expected Option Term (Years)				Estimated Exercise Factor				Risk-Free Interest Rate				Dividends
Modified options			70% - 157	%			0.00	%			0.25 – 2.5				10				0.08% - 0.29	%			—
New option			157	%			0.00	%			2.5				10				0.29	%			—

Expected volatility is based on the historical volatility of our common stock over the expected option term period ended on the last business day of each respective quarterly reporting period. The estimated forfeiture rate was set to zero as Mr. Dilworth is not obligated to perform any services for us under the terms of the separation agreement. The expected term was based on the actual expiration date of each of the options in the separation agreement. The estimated exercise factor was based on an analysis of historical data; historical exercise patterns; and a comparison of historical and current share prices. The approximate risk free interest rate was based on the implied yield available on U.S. Treasury issues with remaining terms equivalent to our expected term on our stock-based awards. We do not anticipate paying dividends on our common stock for the foreseeable future.

We discounted the initial aggregate remaining cash salary continuation payments due Mr. Dilworth and medical premiums to be paid on his behalf of $458,600 under the terms of the separation agreement using a 14.3% discount factor, with such factor representing our average cost of capital, which we derived by analyzing the costs we incurred in the various private placement transactions we have closed since 2004.

 

On July 17, 2013 we entered into a separation agreement and release with a former vice president-level employee who left the Company on June 7, 2013.  Subject to the terms of the separation agreement, which became effective on July 17, 2013 (the “Effective Date”), we accrued $75,700 of severance liability at June 30, 2013, of which, $47,800 remained outstanding as of September 30, 2013.

 

The following table summarizes the salary continuation and medical coverage payments during the nine-month period ended September 30, 2013.

		Compensation				Medical Coverage				Total
Balance at December 31, 2012		$	250,100			$	12,300			$	262,400
Separation agreement entered into in 2013			60,000				15,700				75,700
Accrued interest			18,100				700				18,800
Payments			(197,200	)			(19,600	)			(216,800	)
Balance at September 30, 2013		$	131,000			$	9,100			$	140,100

 

6. Deferred Rent

 

As of September 30, 2013 deferred rent was:

Component		Current Liabilities				Long-Term Liabilities				Total
Deferred rent expense		$	5,800			$	38,500			$	44,300
Deferred rent benefit			24,000				66,000				90,000
		$	29,800			$	104,500			$	134,300

As of December 31, 2012 deferred rent was:

Component		Current Liabilities				Long-Term Liabilities				Total
Deferred rent expense		$	2,700			$	43,500			$	46,200
Deferred rent benefit			24,000				84,000				108,000
		$	26,700			$	127,500			$	154,200

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

7.  Stock-Based Compensation

 

The following table summarizes the stock-based compensation expense, net of amounts capitalized, we recorded in our Unaudited Condensed Consolidated Statements of Operations for the three and nine-month periods ended September 30, 2013 and 2012, respectively, by classification:

 

		Three Months Ended September 30,								Nine Months Ended September 30,
Statement of Operations Classification		2013				2012				2013				2012
Costs of revenue		$	(500	)		$	6,700			$	3,300			$	17,100
Selling and marketing expense			39,800				33,200				118,700				84,800
General and administrative expense			76,300				71,000				255,800				404,700
Research and development expense			74,400				82,600				202,700				252,400
		$	190,000			$	193,500			$	580,500			$	759,000

The following table presents summaries of the status and activity of our stock option awards for the three-month period ended September 30, 2013.

		Number of Shares				Weighted Average Exercise Price				Weighted Average Remaining Contractual Terms (Years)				Aggregate Intrinsic Value
Outstanding – June 30, 2013			13,134,398			$	0.20
Granted			23,000				0.44
Exercised			(708,594	)			0.18
Forfeited or expired			(77,745	)			0.20
Outstanding – September 30, 2013			12,371,059			$	0.20				6.12			$	4,161,600

The following table presents summaries of the status and activity of our stock option awards for the nine-month period ended September 30, 2013.

 

		Number of Shares				Weighted Average Exercise Price				Weighted Average Remaining Contractual Terms (Years)				Aggregate Intrinsic Value
Outstanding – December 31, 2012			14,174,000			$	0.20
Granted			23,000				0.44
Exercised			(1,459,972	)			0.17
Forfeited or expired			(232,151	)			0.20
Cancellation of unearned performance option			(133,818	)			0.19
Outstanding – September 30, 2013			12,371,059			$	0.20				6.12			$	4,161,600

 

Of the options outstanding as of September 30, 2013, 8,332,644 were vested, 3,906,226 were estimated to vest in future periods and 132,189 were estimated to be forfeited prior to their vesting.  As of September 30, 2013, there was approximately $239,100 of total unrecognized compensation cost, net of estimated forfeitures, related to unvested stock options. Such cost is expected to be recognized over a weighted-average period of approximately nine months.

 

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

 

The following table presents summaries of the status and activity of our restricted stock awards for the three-month period ended September 30, 2013. We include the common stock underlying the restricted stock award in shares outstanding once such common stock has vested and the restriction has been removed (“releases” or “released”).The common stock vests ratably, over a 33-month period; however, no such shares vest until after three months from the date of the restricted stock award.

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		Number of Shares				Weighted Average Grant Date Fair Value				Weighted Average Remaining Recognition P eriod (Years)				Unrecognized Compensation Cost Remaining
Unreleased – June 30, 2013			3,796,324			$	0.22
Awarded			1,027,500				0.42
Released			(432,521	)			0.23
Forfeited			(265,157	)			0.27
Outstanding – September 30, 2013			4,126,146			$	0.26				2.15			$	918,400

 

The following table presents summaries of the status and activity of our restricted stock awards for the nine-month period ended September 30, 2013.

		Number of Shares				Weighted Average Grant Date Fair Value				Weighted Average Remaining Recognition Period (Years)				Unrecognized Compensation Cost Remaining
Unreleased – December 31, 2012			4,043,123			$	0.18
Awarded			1,607,500				0.42
Released			(1,208,412	)			0.21
Forfeited			(316,065	)			0.36
Outstanding – September 30, 2013			4,126,146			$	0.26				2.15			$	918,400

As of September 30, 2013, there was approximately $918,400 of total unrecognized compensation cost, net of estimated forfeitures, related to unreleased restricted stock awards. That cost is expected to be recognized over a weighted-average period of approximately twenty-six months.

 

8.  Revenue

 

Revenue for the three-month periods ended September 30, 2013 and 2012 was:

 

		Three Months Ended September 30,								2013 Over (Under) 2012
Revenue		2013				2012				Dollars				Percent
Software Licenses
Windows		$	559,600			$	775,600			$	(216,000	)			-27.8	%
UNIX/Linux			219,900				234,200				(14,300	)			-6.1	%
			779,500				1,009,800				(230,300	)			-22.8	%
Software Service Fees
Windows			511,300				469,200				42,100				9.0	%
UNIX/Linux			226,500				232,700				(6,200	)			-2.7	%
			737,800				701,900				35,900				5.1	%
Other			17,400				22,400				(5,000	)			-22.3	%
Total Revenue		$	1,534,700			$	1,734,100			$	(199,400	)			-11.5	%

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Revenue for the nine-month periods ended September 30, 2013 and 2012 was:

 

		Nine Months Ended September 30,								2013 Over (Under) 2012
Revenue		2013				2012				Dollars				Percent
Software Licenses
Windows		$	1,673,400			$	2,046,200			$	(372,800	)			-18.2	%
UNIX/Linux			670,100				724,300				(54,200	)			-7.5	%
			2,343,500				2,770,500				(427,000	)			-15.4	%
Software Service Fees
Windows			1,471,700				1,338,800				132,900				9.9	%
UNIX/Linux			686,300				705,000				(18,700	)			-2.7	%
			2,158,000				2,043,800				114,200				5.6	%
Other			44,000				101,300				(57,300	)			-56.6	%
Total Revenue		$	4,545,500			$	4,915,600			$	(370,100	)			-7.5	%

9.  Cost of Revenue

 

Cost of revenue for the three-month periods ended September 30, 2013 and 2012 was:

	Three Months Ended September 30,								2013 Over (Under) 2012
	2013				2012				Dollars				Percent
Software service costs		$	64,100			$	97,500			$	(33,400	)			-34.3	%
Software product costs			36,400				63,200				(26,800	)			-42.4	%
		$	100,500			$	160,700			$	(60,200	)			-37.5	%

Cost of revenue for the nine-month periods ended September 30, 2013 and 2012 was:

 

		Nine Months Ended September 30,								2013 Over (Under) 2012
		2013				2012				Dollars				Percent
Software service costs		$	191,900			$	233,000			$	(41,100	)			-17.6	%
Software product costs			157,700				198,600				(40,900	)			-20.6	%
		$	349,600			$	431,600			$	(82,000	)			-19.0	%

 

10.  Capitalized Software Development Costs

 

Capitalized software development costs consisted of the following:

 

		September 30, 2013				December 31, 2012
Software development costs		$	1,116,700			$	573,100
Accumulated amortization			(457,100	)			(350,000	)
		$	659,600			$	223,100

 

Amortization of capitalized software development costs is a component of costs of revenue. Capitalized software development costs amortization aggregated $24,000 and $107,100 during the three and nine-month periods ended September 30, 2013, respectively, and $41,500 and $124,600 during the three and nine-month periods ended September 30, 2012, respectively.

 

We recorded $79,100 and $543,600 of capitalized software development costs during the three and nine-month periods ended September 30, 2013, respectively.  Such capitalized costs were incurred in the development of our new product hopTo, and are comprised primarily of employee costs and the cost of licenses to third party software that will be used by our hopTo product upon its commercial release.  We anticipate releasing the first commercial version of hopTo in the fourth quarter time frame and will begin amortizing its capitalized software development costs accordingly (See Note 18).  Had these costs not met the criteria for capitalization, they would have been expensed.  We did not record any capitalized software development costs during the nine-month period ended September 30, 2012.

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11.  Stockholders’ Equity

 

Stock Repurchase Program

 

During each of the three and nine-month periods ended September 30, 2013 and 2012, we did not repurchase any of our common stock under the terms of our Board-approved $1,000,000 stock repurchase program (“stock repurchase program”). As of September 30, 2013, approximately $782,600 remained available for future purchases under this program. We are not obligated to repurchase any specific number of shares and the stock repurchase program may be suspended or terminated at our discretion.

 

12.  Commitments and Contingencies

 

Our corporate headquarters currently occupies 4,413 square feet of office space in Campbell, California, under a five-year lease that expires June 30, 2017. During October 2013, we amended our lease in order to secure a larger facility from our landlord. See Note 18.

13.  Supplemental Disclosure of Cash Flow Information

 

We did not disburse any cash for the payment of interest expense during the nine-month periods ended September 30, 2013 or 2012.

 

We disbursed $1,800 and $3,100 for the payment of income taxes during the nine-month periods ended September 30, 2013 and 2012, respectively. All such disbursements were for the payment of foreign income taxes related to the operation of our Israeli subsidiary, GraphOn Research Labs Ltd.

 

During the nine-month period ended September 30, 2013, we capitalized $36,700 of stock-based compensation expense for which no cash was disbursed, as a component of capitalized software development costs. We did not capitalize any stock based compensation expense costs during the nine month period ended September 30, 2012.

 

During the nine-month period ended September 30, 2013, we reduced our warrants liability by $5,421,300, of which $680,100 was recorded in the Condensed Consolidated Statement of Operations. The amendment to the warrants resulted in $4,391,000 being reclassified to equity.  The remaining reduction amount was the result of the exercise of 1,072,500 warrants that were not part of the amendment.  No cash was disbursed in conjunction with these items (see Note 4).

 

During the nine-month period ended September 30, 2013, we capitalized $3,700 of property and equipment for which no cash was disbursed.

 

During the nine month period ended September 30, 2012, we incurred costs associated with discontinued intellectual property operations activities of $468,400, of which $432,800 was disbursed, and the balance reported as a component of accounts payable.

 

During the nine-month period ended September 30, 2012, we capitalized $130,900 of property and equipment for which no cash was disbursed. We recorded $104,100 of such amount to long term liabilities – deferred rent, $24,000 of such amount to current liabilities – deferred rent and the balance to accounts payable and accrued liabilities.

 

14.  Earnings (Loss) Per Share

 

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

 

For the three-month periods ended September 30, 2013 and 2012, 33,707,201 and 36,997,357 shares of common stock equivalents, respectively, were excluded from the computation of dilutive loss per share since their effect would be antidilutive.

 

For the nine-month periods ended September 30, 2013 and 2012, 33,707,201 and 36,997,357 shares of common stock equivalents, respectively, were excluded from the computation of dilutive loss per share since their effect would be antidilutive.

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15.  Segment Information

 

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

 

During 2012, we entered into settlement and licensing agreements that effectively ended all of our then ongoing intellectual property litigation activities (Note 17).  As a result of these agreements, we will no longer be pursuing patent litigation as an integral funding strategy for our operations.

We will continue to pursue the intellectual property initiatives we have undertaken in conjunction with our relationship with ipCapital, however we believe that these initiatives do not comprise a reporting segment as the intent of these initiatives is to support and leverage our current software products and those in development.

Also, effective for the quarter ended December 31, 2012, we added a new segment (hopTo) and identified that we currently operate our business in two segments; namely GO-Global and hopTo.  Currently, GO-Global is the only segment that generates revenue.

During the three-month period ended September 30, 2013, commensurate with the renaming of our company to hopTo Inc., we reclassified certain corporate-level expenses from the GO-Global segment to the hopTo segment, including those pertaining to our ipCapital initiatives. The impact of such reclassifications appears in the following segment tables for all periods presented.

Segment revenue for the three-month periods ended September 30, 2013 and 2012 was as follows:

										Increase (Decrease)
		2013				2012				Dollars				Percentage
GO-Global		$	1,534,700			$	1,734,100			$	(199,400	)			-11.5	%
hopTo			—				—				—				n/	a
Consolidated Total		$	1,534,700			$	1,734,100			$	(199,400	)			-11.5	%

Segment revenue for the nine-month periods ended September 30, 2013 and 2012 was as follows:

										Increase (Decrease)
		2013				2012				Dollars				Percentage
GO-Global		$	4,545,500			$	4,915,600			$	(370,100	)			-7.5	%
hopTo			—				—				—				n/	a
Consolidated Total		$	4,545,500			$	4,915,600			$	(370,100	)			-7.5	%

Segment loss from continuing operations for the three and nine-month periods ended September 30, 3013 and 2012 was as follows:

		Three Months Ended September 30,								Nine Months Ended September 30,
		2013				2012				2013				2012
GO-Global		$	800			$	413,000			$	(204,500	)		$	(591,000	)
hopTo			(1,609,300	)			(1,067,800	)			(3,318,000	)			(2,835,200	)
Total		$	(1,608,500	)		$	(654,800	)		$	(3,522,500	)		$	(3,426,200	)

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

As of September 30, 2013 segment fixed assets (long-lived assets) were as follows:

						Accumulated
						Depreciation
		Cost Basis				/Amortization				Net
GO-Global		$	1,964,900			$	(1,799,100	)		$	165,800
hopTo			930,800				(79,200	)			851,600
Total from continuing operations			2,895,700				(1,878,300	)			1,017,400
Discontinued operations			2,839,000				(2,839,000	)			—
Unallocated			31,700				—				31,700
Total		$	5,766,400			$	(4,717,300	)		$	1,049,100

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

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

 

Go-Global software revenue by country for the three-and nine month periods ended September 30, 2013 and 2012 was as follows:

 

		Three Months Ended September 30,								Nine Months Ended September 30,
Revenue by Country		2013				2012				2013				2012
United States		$	677,600			$	668,800			$	1,886,000			$	1,980,100
Germany			84,600				181,000				354,200				533,300
Brazil			161,000				176,400				415,100				444,800
Other Countries			611,500				707,900				1,890,200				1,957,400
Total		$	1,534,700			$	1,734,100			$	4,545,500			$	4,915,600

 

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16.  Related Party Transactions

 

Tamalpais Partners LLC

 

Steven Ledger, the Chairman of our Board of Directors, is the founder and managing partner of Tamalpais Partners LLC, (“Tamalpais”) a business consulting firm. On August 1, 2013, we amended our consulting agreement with Tamalpais. Under the consulting agreement, as amended, Tamalpais will provide us with advisory services focused on capital and business issues, including assistance on raising capital, mergers, acquisitions, business development and investor relations/positioning. We paid Tamalpais $54,000 and $18,000 during the three-month periods ended September 30, 2013 and 2012, respectively, for services rendered to us under the terms of this consulting agreement.  We paid Tamalpais $92,000 and $48,000 during the nine-month periods ended September 30, 2013 and 2012, respectively, for services rendered to us under the terms of this consulting agreement.  No amounts were due to Tamalpais at September 30, 2013.

ipCapital Group, Inc.

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

 

For the three and nine-month periods ended September 30, 2013 we paid ipCapital an aggregate of $0 and $31,200, respectively, for services performed under the engagement agreement, as amended. No amounts were due ipCapital at September 30, 2013. For the three and nine-month periods ended September 30, 2012 we paid ipCapital an aggregate $30,000 and $130,000, respectively for services performed under the engagement agreement, as amended. As of September 30, 2012, we owed ipCapital $37,300.

 

Prior to entering into the engagement agreement with ipCapital in 2011, ipCapital performed an analysis of our intellectual property and the potential methods we could employ to strengthen our intellectual property on a consulting basis.  We paid ipCapital $50,000 for this analysis in the nine-month period ended September 30, 2012.  All amounts paid to ipCapital in 2013 and 2012 have been reported within general and administrative expense.

 

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

 

The exercise price of the warrant issued to ipCapital could be reset to below-market value. Consequently, we have concluded that such warrant is not indexed to our common stock and should be recorded as a liability. We recognize the warrants liability over their vesting period, and in accordance with the liability method of accounting, we re-measure the fair value of the accrued warrants at each balance sheet date and recognize the change in fair value as general and administrative compensation expense. (See Note 4) We recognized $49,500 and $38,200 as a component of general and administrative expense during the three-month periods ended September, 2013 and 2012, respectively, and $35,700 and $52,700 during the nine-month periods ended September 30, 2013 and 2012, respectively, resulting from the change in fair value.

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ipCapital Licensing Company I, LLC

 

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

 

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

 

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

17. Discontinued Operations

 

During 2012, we reached settlement agreements that effectively ended all of our then on-going intellectual property litigation.  With the settlement of such litigation activities we ceased actively pursuing intellectual property litigation as an integral part of our strategy to fund our operations.  Accordingly, for all periods presented, the results of operations and cash flows related to our former intellectual property segment has been segregated and reported as “Discontinued Operations”.  There was no revenue derived from our intellectual property litigation in either of the three or nine month periods ended September 30, 2013 or 2012.  During the three and nine-month periods ended September 30, 2012 we incurred costs of $347,100 and $468,400 related to our discontinued operations, respectively.

 

We will continue to make significant investments in our intellectual property during the remainder of 2013.  We believe such investments will be an asset that will leverage our product strategy and protect our long-term growth strategies.  We do not intend to pursue intellectual property litigation as an integral part of our strategy to fund our future operations.

 

As of September 30, 2013 and 2012, all of our patents were fully amortized.  Additionally, we have characterized the NES patents as “held for sale” and will be pursuing reasonable sales opportunities for such patents as they become known to us.

 

18. Subsequent Events

 

On October 7, 2013, we amended our office lease with our landlord. Under the terms of the amendment, we will move from our current location to another building within the same office complex, and increase the space we lease from 4,413 square feet to 10,659 square feet. We believe the move will be completed on or about December 31, 2013.

The amended lease becomes effective November 1, 2013 and will expire on October 31, 2018. The lease contains rent escalation clauses and four months of free rent. Additionally, we paid $18,100 to the landlord as a prepayment of the first month’s rent on the new space. The following table sets forth the minimum lease payments due over the life of the lease.

Year		Amount
Remainder of 2013		$	—
2014			346,000
2015			449,500
2016			463,000
2017			476,900
2018			407,300
		$	2,142,700

Under the terms of the lease, the landlord will provide us with various leasehold improvements totaling $106,600. Upon signing the amendment, we made a deposit of $109,000 to our landlord.

 

As of September 30, 2013, we reported $103,700 of unamortized leasehold improvements associated with our current lease. We expect to amortize this amount over the remaining three month life of our current lease. We believe we will be moving most of our current furniture and equipment to our new space.

 

On November 14, 2013, we launched the first commercial version of hopTo, our mobile productivity workspace product on Apple’s App Store.

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

Introduction

We are developers of software productivity products for mobile devices such as tablets and smartphones, and application publishing software solutions. Our newest product, which is called hopTo, will be marketed to both consumers and businesses. hopTo will provide mobile end-users with a productivity workspace for their mobile devices that will allow users to manage, share, view, and edit their documents, regardless of where they are stored. We launched the first public release of hopTo through Apple’s App Store on April 15, 2013. This release was targeted at Apple’s tablet devices, the iPad and the iPad Mini. Future releases will be targeted at other devices such as Apple’s iPhone, as well as competing devices such as those based on Google’s Android platform.

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

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

 

Recent Developments

 

On September 9, 2013, we changed the name of our company from GraphOn Corporation to hopTo Inc.

 

We launched the first commercial version of hopTo on November 14, 2013 on Apple’s App Store.

 

Corporate Background

We are a Delaware corporation, founded in May 1996.  Our headquarters are located at 1901 S. Bascom Avenue, Suite 660, Campbell, California, 95008 and our phone number is 1-800- 472-7466.   We also have an office in Concord, New Hampshire. Additionally, we have remote employees located in various states, as well as internationally in the United Kingdom and Israel.  Our corporate Internet Website is http://www.hopto.com.  The information on our website is not part of this quarterly report.

 

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

The hopTo Product

 

The premise of hopTo is that mobile users using devices such as Apple’s iPad are looking for ways to leave their Mac or Windows computer behind and travel with just their tablets. hopTo was designed to assist such users in performing operations on their iPads that would typically require a Mac or Windows PC. Our view is that devices such as the iPad lack a number of basic functionalities in order to serve as a suitable “PC replacement” for business users:

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Our Intellectual Property

 

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

 

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

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

 

ipCapital Group, Inc.

 

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

 

As a result of ipCapital’s work under the engagement agreement, as amended, as of November 12, 2013, 150 new patent applications have been filed, of which 140 pertain to our hopTo technology and 10 pertain to our NES patent portfolio. We expect to file more applications throughout the remainder of 2013.

ipCapital Licensing Company I, LLC

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

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Our GO-Global Software Products

 

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

 

·

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

Critical Accounting Policies

 

We believe that several accounting policies are important to understanding our historical and future performance.  We refer to these policies as “critical” because these specific areas require us to make judgments and estimates about matters that are uncertain at the time we make the estimates. Actual results may differ from these estimates. For a summary of our critical accounting policies, please refer to our 2012 10-K/A Report and Note 2 to our Notes to Unaudited Condensed Consolidated Financial Statements.

 

Results of Operations for the Three and Nine-Month Periods Ended September 30, 2013 and 2012

 

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

 

Revenue

Revenue for the three-month periods ended September 30, 2013 and 2012 was:

 

		Three Months Ended September 30,								2013 Over (Under) 2012
Revenue		2013				2012				Dollars				Percent
Software Licenses
Windows		$	559,600			$	775,600			$	(216,000	)			-27.8	%
UNIX/Linux			219,900				234,200				(14,300	)			-6.1	%
			779,500				1,009,800				(230,300	)			-22.8	%
Software Service Fees
Windows			511,300				469,200				42,100				9.0	%
UNIX/Linux			226,500				232,700				(6,200	)			-2.7	%
			737,800				701,900				35,900				5.1	%
Other			17,400				22,400				(5,000	)			-22.3	%
Total Revenue		$	1,534,700			$	1,734,100			$	(199,400	)			-11.5	%

Revenue for the nine-month periods ended September 30, 2013 and 2012 was:

 

		Nine Months Ended September 30,								2013 Over (Under) 2012
Revenue		2013				2012				Dollars				Percent
Software Licenses
Windows		$	1,673,400			$	2,046,200			$	(372,800	)			-18.2	%
UNIX/Linux			670,100				724,300				(54,200	)			-7.5	%
			2,343,500				2,770,500				(427,000	)			-15.4	%
Software Service Fees
Windows			1,471,700				1,338,800				132,900				9.9	%
UNIX/Linux			686,300				705,000				(18,700	)			-2.7	%
			2,158,000				2,043,800				114,200				5.6	%
Other			44,000				101,300				(57,300	)			-56.6	%
Total Revenue		$	4,545,500			$	4,915,600			$	(370,100	)			-7.5	%