hopTo Inc. - Quarter Report: 2014 March (Form 10-Q)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended March 31, 2014

Commission File Number: 0-21683

HOPTO INC.

(Exact name of registrant as specified in its charter)

1919 S. Bascom Avenue, Suite 600

Campbell, CA 95008
(Address of principal executive offices)

Registrant’s telephone number:

(800) 472-7466

(408) 688-2674

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

Yes ☒ No [  ]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulations S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes ☒ No [  ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

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

As of May 8, 2014, there were issued and outstanding 114,032,303 shares of the registrant’s common stock, par value $0.0001.

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.

PART I. FINANCIAL INFORMATION

ITEM 1. Financial Statements

HOPTO INC.

Condensed Consolidated Balance Sheets

See accompanying notes to unaudited condensed consolidated financial statements

HOPTO INC.

Condensed Consolidated Statements of Operations

See accompanying notes to unaudited condensed consolidated financial statements

HOPTO INC. 

Condensed Consolidated Statements of Cash Flows

See accompanying notes to unaudited condensed consolidated financial statements

HOPTO INC.

Notes to Unaudited Condensed Consolidated Financial Statements

1. Basis of Presentation

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

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

2. Significant Accounting Policies

Use of Estimates

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

Revenue Recognition

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

Software license revenues are recognized when:

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

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

Postemployment Benefits (Severance Liability)

Nonretirement postemployment benefits, including salary continuation, supplemental unemployment benefits, severance benefits, disability-related benefits and continuation of benefits such as health care benefits, are recognized as a liability and a loss when it is probable that the employee(s) will be entitled to such benefits and the amount can be reasonably estimated. The cost of termination benefits recognized as a liability and an expense includes the amount of any lump-sum payments and the present value of any expected future payments. During 2012, we recorded $721,800 of severance expense, including stock compensation expense. Such expense was recorded as a result of a separation agreement and a release with Robert Dilworth in connection with Mr. Dilworth’s resignation as our Chief Executive Officer and as a member of our board of directors. In addition, during 2013 we recorded an additional $75,700 of severance expense as a result of a separation and release agreement we entered into with a former vice president-level employee (as further discussed in Note 5 to Unaudited Condensed Consolidated Financial Statements). An aggregate of $16,700 and $62,900 is reported as a severance liability, at March 31, 2014 and December 31, 2013, respectively.

Software Development Costs

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

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

Long-Lived Assets

Long-lived assets are assessed for possible impairment whenever events or changes in circumstances indicate that the carrying amounts may not be recoverable, whenever we have committed to a plan to dispose of the assets or, at a minimum, annually. Typically, for long-lived assets to be held and used, measurement of an impairment loss is based on the fair value of such assets, with fair value being determined based on appraisals, current market value, comparable sales value, and discounted future cash flows, among other variables, as appropriate. Assets to be held and used (which assets are affected by an impairment loss) are depreciated or amortized at their new carrying amount over their remaining estimated life; assets to be sold or otherwise disposed of are not subject to further depreciation or amortization. No such impairment charge was recorded during either of the three-month periods ended March 31, 2014 or 2013.

Allowance for Doubtful Accounts

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

The following table sets forth the details of the Allowance for Doubtful Accounts for the three-month periods ended March 31, 2014 and 2013:

Concentration of Credit Risk

For the three-month periods ended March 31, 2014 and 2013, respectively, we considered the customers listed in the following table to be our most significant customers. The table sets forth the percentage of sales attributable to each customer during the periods presented, and the respective customer’s ending accounts receivable balance as a percentage of reported accounts receivable, net, as of March 31, 2014 and 2013.

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 Accounting 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 March 31, 2014, all of our $1,152,300 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, adoption of ASU 2013-11, which became effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2013, did not have a material impact on our results of operations, cash flows or financial position.

Reclassifications

As a result of internal cost restructurings, certain amounts previously allocated to our GO-Global segment prior to 2014 are now allocated to our hopTo segment, including costs associated with being a publicly-held entity and other corporate-level expense. The presentation of 2013 segment income (loss) from operations in Note 15 has been conformed to be consistent with the current year’s presentation.

3. Property and Equipment

Property and equipment was:

Aggregate property and equipment depreciation and amortization expense was $53,300 and $25,200 during the three-month periods ended March 31, 2014 and 2013, respectively.

4. Liability Attributable to Warrants

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

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

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

On June 17, 2013, we entered into, and subsequently consummated, an Exercise Agreement (the “Exercise Agreement”) with five of the largest investors in our September 1, 2011 private placement of common stock and warrants (the “2011 Transaction”), providing for the exercise for cash by such investors of warrants to purchase an aggregate of 9 million shares of our common stock, out of the approximately 17 million shares of common stock subject to warrants issued to the investors in the 2011 Transaction that remained outstanding as of such date. The approximately 5 million shares of common stock subject to warrants issued to the placement agent in the 2011 Transaction that remained outstanding as of such date were not part of the Exercise Agreement. We 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.

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

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

The fair market value of our common stock was $0.20 and $0.37 per share as of March 31, 2014 and 2013, respectively. We used a binomial pricing model to determine the fair value of our warrants liability as of March 31, 2014 and December 31, 2013, the balance sheet dates, using the following assumptions:

The following table is a reconciliation of the warrants liability measured at fair value using significant unobservable inputs (Level 3) for the three months ended March 31, 2014:

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

5. Severance Liability

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

The following table summarizes the salary continuation and medical coverage payments during the three-month period ended March 31, 2014.

6. Deferred Rent

We amended our office lease during 2013. On February 1, 2014, we moved our corporate offices to a different building within the same office complex owned and operated by our landlord in Campbell, California, where our corporate offices had been located prior to February 1, 2014. Since the new space is controlled by the same landlord, we considered the lease amendment to be a modification to our preexisting lease; accordingly, we are amortizing the remaining balance in deferred rent immediately prior to February 1, 2014 over the remaining term of the modified amended lease. Additionally, our landlord provided us with $103,400 of leasehold improvements on the new space that we are amortizing over the reaming term of the amended lease. All of the prior leasehold improvements that had not been previously amortized were accelerated and recognized in their entirety from the time of the amendment through January 2014, prior to the move.

As of March 31, 2014 deferred rent was:

As of December 31, 2013 deferred rent was:

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-month periods ended March 31, 2014 and 2013, respectively, by classification:

The following table presents summaries of the status and activity of our stock option awards for the three-month period ended March 31, 2014.

Of the options outstanding as of March 31, 2014, 8,752,638 were vested, 2,696,533 were estimated to vest in future periods and 112,884 were estimated to be forfeited prior to their vesting. As of March 31, 2014, there was approximately $255,100 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 ten months.

All options are exercisable immediately upon grant. Options vest ratably, generally 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 March 31, 2014. We include the common stock underlying the restricted stock award in shares outstanding once such common stock has vested and the restriction has been removed (“releases” or “released”). The common stock vests ratably, generally over a 33-month period commencing in the fourth month after the award date. 

As of March 31, 2014, there was approximately $674,400 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 March 31, 2014 and 2013 was:

9. Cost of Revenue

Cost of revenue for the three-month periods ended March 31, 2014 and 2013 was:

10. Capitalized Software Development Costs

Capitalized software development costs consisted of the following:

Amortization of capitalized software development costs is a component of costs of revenue. Capitalized software development costs amortization aggregated $68,000 and $41,500 during the three-month periods ended March 31, 2014, and 2013, respectively.

We recorded $0 and $464,500 of capitalized software development costs during the three-month periods ended March 31, 2014 and 2013, respectively. Such costs capitalized during the three-month period ended March 31, 2013 were associated with the development of hopTo. Had these costs not met the criteria for capitalization, they would have been expensed.

11. Stockholders’ Equity

2014 Private Placement

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

The 2014 private placement was recorded into the financial statements as follows:

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

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

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

Stock Repurchase Program

During each of the three-month periods ended March 31, 2014 and 2013, we did not repurchase any of our common stock under the terms of our Board-approved $1,000,000 stock repurchase program (“stock repurchase program”). As of March 31, 2014, approximately $782,600 remained available for future purchases under this program. We are not obligated to repurchase any specific number of shares and the stock repurchase program may be suspended or terminated at our discretion.

12. Commitments and Contingencies

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

13. Supplemental Disclosure of Cash Flow Information

We did not disburse any cash for the payment of interest expense during the three-month periods ended March 31, 2014 or 2013. We did not disburse any cash for the payment of income taxes during the three-month period ended March 31, 2014. We disbursed $1,100 for the payment of income taxes during the three-month period ended March 31, 2013. Such disbursement was made for the payment of foreign income taxes related to the operation of our Israeli subsidiary, GraphOn Research Labs, Ltd.

During the three-month period ended March 31, 2014 we reduced our warrants liability by $1,183,500, which was recorded in the Condensed Consolidated Statement of Operations. Such reduction reflected the aggregate fair value adjustments we recorded during such period, which was partially offset by the recording of the fair value of warrants issued in conjunction with the 2014 transaction. No cash was disbursed in conjunction with these items (See Note 4).

During the three-month period ended March 31, 2014, we capitalized $103,400 of leasehold improvements for which no cash was disbursed. We recorded $81,600 of such amount to long-term liabilities – deferred rent, and $21,800 to current liabilities – deferred rent.

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 March 31, 2014 and 2013, 35,557,372 and 40,421,088 shares of common stock equivalents, respectively, were excluded from the computation of dilutive loss per share since their effect would be anti-dilutive.

15. Segment Information

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

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

Segment revenue for the three-month periods ended March 31, 2014 and 2013 was as follows:

Segment income (loss) from operations for the three-month periods ended March 31, 2014 and 2013 was as follows:

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

As of March 31, 2014 segment long-lived assets were as follows:

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 commercial release of hopTo through Apple’s App Store in November 2013. The two segments do not engage in cross-segment transactions.

Go-Global software revenue by country for the three-month periods ended March 31, 2014 and 2013 was as follows:

16. Related Party Transactions

Tamalpais Partners LLC

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

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

ipCapital Group, Inc.

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

For the three-month periods ended March 31, 2014 and 2013, we paid ipCapital an aggregate of $0 and $5,000, respectively, for services performed under the engagement agreement, as amended. For the three-month periods ended March 31, 2014 and 2013, we had incurred additional charges from ipCaptial for work performed during such periods of $0 and $10,000, respectively. Such amounts were reported in accounts payable.

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 $49,800 and $73,500 as a component of general and administrative expense during the three-month periods ended March 31, 2014 and 2013, respectively, resulting from the change in fair value.

ipCapital Licensing Company I, LLC

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

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

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.

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

Introduction

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

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

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

Recent Developments

On May 5, 2014, we named Jean-Louis Casabonne as our Chief Financial Officer.

Corporate Background

We are a Delaware corporation, founded in May 1996. Our headquarters are located at 1919 S. Bascom Avenue, Suite 600, Campbell, California, 95008, our toll-free phone number is 1-800-472-7466, and our phone number for local and international calls is 408-688-2674. We have an office in Concord, New Hampshire, and we have remote employees located in various states, as well as internationally in the United Kingdom and Israel. Our corporate Internet Website is http://www.hopto.com. The information on our website is not part of this quarterly report.

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

The hopTo Opportunity

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

The current industry addresses this need using one of two approaches. Certain companies have developed new productivity tools that include apps for mobile devices, which attempt to reach a level of compatibility and feature set comparable to established productivity tools for the personal computer (“PC”), such as Microsoft® Office (which runs on Microsoft Windows® operating system and Mac OSX®). Although these tools are generally well-adapted to the unique constraints of mobile devices, they currently suffer from a limited feature set and from severe compatibility issues with PC-based tools, such as Microsoft Office. Microsoft’s recently announced Office for the iPad also provides great compatibility, but requires the use of Microsoft services such as OneDrive without the freedom and flexibility of hopTo to use many popular alternatives, as well as access remote Windows and Mac computers.

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

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

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

The hopTo Product

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

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

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

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

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

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

hopTo Target Markets

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

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

Our Intellectual Property

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

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., (“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.

As a result of ipCapital’s work under the engagement agreement, as amended, as of May 8, 2014, we have 164 patent applications pending in the United States Patent Office (“USPTO”). We have received notice that 12 of such pending patents have been allowed by the USPTO, and that the process of issuing the final patent (converting the allowed “pending” patent into an actual patent) for the allowed patents has begun. Additionally, the issuance process has been completed for one patent application, which is not included in the preceding totals, and it has been issued as a United States Patent. We expect to file more applications throughout 2014.

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.

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:

Critical Accounting Policies

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

Results of Operations for the Three-Month Periods Ended March 31, 2014 and 2013

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

Revenue

Revenue for the three-month periods ended March 31, 2014 and 2013 was:

Revenue

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

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

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

Software Licenses

The decrease in Windows software licenses revenue was primarily due to an internal realignment of our resources in support of the development of our hopTo product.

Software licenses revenue from our UNIX/Linux products decreased primarily due to lower aggregate revenue from our resellers and end users, particularly our European telecommunications customers. During 2013, we learned that one of our significant European telecommunications customers, Ericsson, would no longer be ordering product licenses from us as their technology no longer utilized our GO-Global product.

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

We anticipate generating revenue from hopTo during 2014.

Software Service Fees

The increase in software service fees revenue attributable to our Windows products during the three-month period ended March 31, 2014, as compared to the same period of the prior year, was the result of the continued growth of the number of Windows maintenance contracts purchased by our end user customers on new license installations and the renewal of maintenance contracts on currently installed software licenses.

The decrease in service fees revenue attributable to our UNIX products for the three-month period ended March 31, 2014, as compared with the same period of the prior year, was primarily the result of the low level of our UNIX product sales throughout the current and prior year and a decrease in maintenance contract renewals. The majority of this decrease was attributable to our European telecommunications customers, including Ericsson, as discussed above.

We expect that software service fees for 2014 will approximate those for 2013, as we expect that increases in revenue from Windows maintenance contracts will be offset by the decline in revenue from UNIX maintenance contracts.

Other

The decrease in other revenue was primarily due to a decrease in private labeling fees, which was partially offset by an increase in professional services. We typically recognize private labeling fees revenue only when such services are requested by a new stocking reseller; they sign a contract with us, simultaneously place their first stocking order and ultimately, when they sell through their entire first stocking order, we recognize the private labeling fees revenue. Private labeling fees and professional services fees do not comprise a material portion of our revenue streams, nor do we anticipate that they will, and they can vary from period to period.

Costs of Revenue

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

Under accounting principles generally accepted in the United States (“GAAP”), development costs for new product development, after technological feasibility is established, are recorded as ìcapitalized softwareî on our Condensed Consolidated Balance Sheet. Such capitalized costs are subsequently amortized as cost of revenue (software product costs) over the shorter of three years or the remaining estimated life of the product. We recorded $0 and $464,500 of capitalized software development costs during the three-month periods ended March 31, 2014 and 2013, respectively. All of such capitalized costs were incurred in the development of hopTo.

Amortization of capitalized software development costs was $68,000 and $41,500 during the three-month periods ended March 31, 2014 and 2013, respectively.

Cost of revenue was 14.5% and 6.9% of total revenue for the three-month periods ended March 31, 2014 and 2013, respectively.

Cost of revenue for the three-month periods ended March 31, 2014 and 2013 was:

The increase in software service costs was primarily due to increased costs associated with hopTo, which were partially offset by decreased GO-Global costs. Upon release of the commercial version of hopTo, we began charging costs associated with supporting the product to costs of revenue. We expect software service costs for 2014 to be higher than those for 2013 as we expect to increase our hopTo customer service team in anticipation of meeting our hopTo customers’ needs as we transition the product from a freemium product into a product with a fee later in 2014.

The increase in software product costs was primarily due to increased costs associated with hopTo. Upon release of the commercial version of hopTo in late 2013, we began charging certain costs associated with it, including amortization of capitalized software development costs, and the costs of third party software we have licensed into hopTo, to cost of revenue.

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

Selling and Marketing Expenses

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

Selling and marketing expenses for the three-month period ended March 31, 2014 increased by $151,500, or 30.4%, to $650,500, from $499,000 for the same period of 2013, and represented approximately 48.5% and 30.9% of revenue during these periods, respectively.

The increase in selling and marketing expenses was mainly due to advertising costs associated with our hopTo product, which was partially offset by a decrease of such costs associated with our GO-Global products.

We currently expect our full-year 2014 selling and marketing expenses to be higher than those for 2013 as we expect to continue to invest advertising and promotional resources into both our hopTo and GO-Global product lines.

General and Administrative Expenses

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

General and administrative expenses increased by $247,900, or 33.2%, to $993,900, for the three-month period ended March 31, 2014, from $746,000 for the same period of 2013, and represented approximately 74.2% and 46.1% of revenue during these periods, respectively.

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

Adding to the increase in general and administrative expense was increased employee costs attributable to an increase in headcount, certain salary adjustments and an increase in allocated executive employee costs, primarily those attributable to our Chief Executive Officer.

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

Research and Development Expenses

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

Research and development expenses increased by $592,700, or 83.1%, to $1,305,900, for the three-month period ended March 31, 2014, from $713,200 for the same period of 2013, and represented approximately 97.4% and 44.1% of revenue for these periods, respectively.

During the three-month periods ended March 31, 2014 and 2013, we capitalized $0 and $464,500, respectively, of software development costs. Such costs were incurred in the development of our hopTo product.

Net of the impact of the capitalized software development costs discussed above, the increase in research and development expense was primarily due to higher staffing levels and recruitment fees for the new product development team in Campbell, California. We anticipate adding additional staff to our new products development team throughout 2014 in order to fully execute our hopTo development plan, consequently, we expect 2014 research and development expenses to be significantly higher than those for 2013.

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

During the three-month period ended March 31, 2014 we reported non-cash income related to the change in fair value of our Warrants Liability of $1,133,700, and during the same period of the prior year, we reported non-cash expense of $3,448,700 related to the change in fair value of our Warrants Liability. Such changes result from price changes in the market value for our common stock and can vary from period to period due to the exercise and/or issuance of warrants accounted for under the liability method. For further information regarding our Warrants Liability, see Note 4 to the Notes to Unaudited Condensed Consolidated Financial Statements.

Net Loss

Based on the foregoing, we reported net losses of $672,500 and $3,902,900 for the three-month periods ended March 31, 2014 and 2013, respectively.

Liquidity and Capital Resources

Our reported net loss for the three-month period ended March 31, 2014 of $672,500 included three significant non-cash items: depreciation and amortization of $121,300, which was primarily related to amortization of our capitalized software development costs; stock-based compensation expense of $169,700; and a gain in the change in value of our warrants liability of $1,133,700.

We invested $23,700 in capital expenditures during the three-month period ended March 31, 2014, primarily related to our new products development team, located in our office in Campbell, California.

During the three-month period ended March 31, 2014, 1,000,000 warrants and 215,757 employee options were exercised, which provided cash flows from financing activities of $260,000 and $43,600, respectively. Additionally, in conjunction with a private placement of our common stock, we sold and issued to investors 11,299,999 shares of our common stock and warrants to purchase 5,650,001 shares of our common stock at an exercise price of $0.40, which provided cash flows from financing activities of $3,370,000 net of issuance costs.

We are aggressively looking at ways to improve our revenue stream through the development, marketing and sale of new products. We are also aggressively looking at ways to streamline our GO-Global operations in order to align its cost structure with its sales. Should business combination opportunities present themselves to us, and should such opportunities appear to make financial sense and add value for our shareholders, we will consider those opportunities.

We believe that as a result of the expected introduction of new products slated for 2014, our revenue will increase. During 2014, we expect to continue to prioritize the investment of our resources into the development of various new products, and we expect that certain of these investments will ultimately be capitalized as software development costs. Further, due to our expected investments in new products and continued investments in intellectual property, we expect our cash outflow from operations to increase. Based on our cash on hand as of March 31, 2014, and the anticipation of stabilized revenue from our legacy GO-Global business, we believe that we will have sufficient capital resources to support our operational plans for the next twelve months; however; full implementation of our business plans for the next twelve months will require capital from issuances of debt or equity, or new revenue from our recently launched hopTo product.

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

Cash

As of March 31, 2014, our cash balance was $4,288,000, as compared with $2,430,700 as of December 31, 2013, an increase of $1,857,300, or 76.4%. The increase primarily resulted from the cash provided by our financing activities, which was comprised of the net cash received from a private placement of our common stock and warrants to purchase our common stock, and cash received from the exercise of warrants and employee stock options. Such proceeds were partially offset by the cash we used in our operations and investing activities.

Accounts Receivable, net

At March 31, 2014 and December 31, 2013, we reported accounts receivable, net, of $617,300 and $811,700, respectively. Such amounts were reported net of the allowance for doubtful accounts, which allowances totaled $23,100 and $42,000 at March 31, 2014 and December 31, 2013, respectively. The decrease in accounts receivable, net, was mainly due to lower sales during the three-month period ended March 31, 2014, as compared with the three-month period ended December 31, 2013. We collect the significant majority of our quarter-end accounts receivable during the subsequent quarter; accordingly, increases or decreases in accounts receivable from one period to the next tends to be indicative of the trend in our sales from one period to the next. From time to time, we could have individually significant accounts receivable balances due us from one or more of our significant customers. If the financial condition of any of these significant customers should deteriorate, our operating results could be materially affected.

Stock Repurchase Program

As of March 31, 2014, we had purchased 1,424,000 shares of our common stock for $217,400 under terms of our Board-approved stock repurchase program, which was established on January 8, 2008. Under this program, the Board approved up to $1,000,000 to be used in repurchasing our stock; however, we are not obligated to repurchase any specific number of shares and the program may be suspended or terminated at our discretion. During each of the three-month periods ended March 31, 2014 and 2013, no repurchases were made. As of March 31, 2014, $782,600 remains available for stock purchases under this program.

Working Capital

As of March 31, 2014, we had current assets of $5,025,400 and current liabilities of $3,392,500, which netted to working capital of $1,632,900. Included in current liabilities was the current portion of deferred revenue of $2,544,200.

ITEM 3. Quantitative and Qualitative Disclosures About Market Risk

Not applicable.

ITEM 4. Controls and Procedures

Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this report. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of March 31, 2014.

There has not been any change in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) during the quarter ended March 31, 2014 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. Subsequent to March 31, 2014 we hired a Chief Financial Officer.

PART II. OTHER INFORMATION

ITEM 1. Legal Proceedings

Not Applicable 

ITEM 1A. Risk Factors

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

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

On January 7, 2014, we entered into a securities purchase agreement (the “Agreement”) with a limited number of “accredited investors” (within the meaning of Rule 501 promulgated under the Securities Act of 1933, as amended (the “Securities Act”)), pursuant to which we issued and sold for cash an aggregate of 11,299,999 shares of our common stock at a purchase price of $0.30 per share. We also issued warrants to the investors for no additional consideration to purchase an aggregate 5,650,001 shares of common stock at an exercise price of $0.40 per share from January 7, 2014 through January 7, 2019. We received cash proceeds of $3,390,000 from this placement. We offered and sold our shares and warrants without registration under the Securities Act pursuant to Section 4(2) of the Securities Act and in reliance on Rule 506 of Regulation D promulgated thereunder.

ITEM 3. Defaults Upon Senior Securities

Not applicable

ITEM 4. Mine Safety Disclosures

Not applicable

ITEM 5. Other Information

Not applicable

ITEM 6. Exhibits

* Furnished, not filed          

SIGNATURES

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

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