XOTC:CICN Cicero Inc Quarterly Report 10-Q Filing - 3/31/2012

Effective Date 3/31/2012

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549

FORM 10-Q
 
(Mark one)
þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended March 31, 2012.

o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from_________to_________

Commission File Number 0-26392
 
CICERO INC.
(Exact name of registrant as specified in its charter)
 
Delaware
 
11-2920559
(State or other jurisdiction of incorporation or organization)
 
(I.R.S Employer Identification Number)


8000 Regency Parkway, Suite 542, Cary, North Carolina
 
27518
(Address of principal executive offices)
 
(Zip Code)

(919) 380-5000
(Registrant's telephone number, including area code)

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  þ    NO  o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non accelerated filer, or smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer   o       Accelerated Filer   o       Non accelerated filer   o       Smaller reporting company   þ
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   Yes þ   No o

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

73,094,286 shares of common stock, $.001 par value, were outstanding as of May 12, 2012.
 


 
 

 
 
Cicero Inc.
Index
 
 
Page
Number
PART I.     Financial Information  
     
Item 1.
Condensed  Consolidated Financial Statements
 
     
 
Condensed Consolidated Balance Sheets as of March 31, 2012 (unaudited) and December 31, 2011
3
     
 
Condensed Consolidated Statements of Operations for the three months ended March 31, 2012 and 2011 (unaudited)
4
     
 
Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2012 and 2011 (unaudited)
5
     
 
Condensed Consolidated Statements of Stockholder’s Deficit for the three months ended March 31, 2012 and December 31, 2011 (unaudited)
6
     
 
Notes to Condensed Consolidated Financial Statements (unaudited)
7
     
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
17
     
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
23
     
Item 4.
Controls and Procedures
23
     
PART II.    Other Information
25
     
Item 1.
Legal Proceedings
25
     
Item 1A.
Risk Factors
25
     
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
25
     
Item 3.
Defaults Upon Senior Securities
25
     
Item 4.
Mine Safety Disclosures
25
     
Item 5.
Other Information
25
     
Item 6.
Exhibits
26
     
SIGNATURE
27

 
2

 

PART I.    FINANCIAL INFORMATION
ITEM 1.  FINANCIAL STATEMENTS

CICERO INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)

 
 
March 31,
2012
   
December 31,
2011
 
 ASSETS
 
(unaudited)
       
Current assets:
           
Cash and cash equivalents
  $ 20     $ 184  
Trade accounts receivable, net
    3,023       861  
Prepaid expenses and other current assets
    362       404  
Total current assets
    3,405       1,449  
Property and equipment, net
    30       32  
Intangible asset, net (Note 3)
    554       729  
Goodwill (Note 3)
    2,832       2,832  
Total assets
  $ 6,821     $ 5,042  
 LIABILITIES AND STOCKHOLDERS' DEFICIT
               
Current liabilities:
               
Short-term debt (Note 4)
  $ 3,484     $ 6,137  
Accounts payable
    3,267       3,170  
Accrued expenses:
               
Salaries, wages, and related items
    1,025       1,407  
Other
    182       424  
Deferred revenue
    1,796       1,611  
Total current liabilities
    9,754       12,749  
Long-term debt (Note 5)
    700       1,916  
Total liabilities
    10,454       14,665  
                 
Commitment and Contingencies (Note 10)
               
                 
Stockholders' deficit:                
Convertible preferred stock, $0.001 par value, 10,000,000 shares authorized                
Series A-1 – 1,541.6 shares issued and outstanding at March 31, 2012 and
1,542.6 shares issued and outstanding at December 31, 2011
    --       --  
Series B -  10,400 shares issued and outstanding at March 31, 2012 and at December 31, 2011
    --       --  
Common stock, $0.001 par value, 215,000,000 shares authorized at March 31, 2012
73,054,286 issued and outstanding at March 31, 2012and 47,444,524 issued and
            outstanding at December 31, 2011
    73       47  
Additional paid-in capital
    236,345       232,506  
Accumulated deficit
    (240,051 )     (242,176 )
Total stockholders' deficit
    (3,633 )     (9,623 )
Total liabilities and stockholders' deficit
  $ 6,821     $ 5,042  

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

 
3

 
 
CICERO INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(unaudited)

 
 
Three Months Ended
March 31,
 
   
2012
   
2011
 
Revenue:
           
Software
  $ 3,238     $ 164  
Maintenance
    356       383  
Services
    75       182  
Total operating revenue
    3,669       729  
                 
Cost of revenue
               
Software
    175       175  
Maintenance
    36       38  
Services
    270       274  
Total cost of revenue
    481       487  
                 
Gross margin
    3,188       242  
                 
Operating expenses:
               
Sales and marketing
    512       428  
Research and product development
    375       275  
General and administrative
    349       316  
Total operating expenses
    1,236       1,019  
Income/(loss) from operations
    1,952       (777 )
                 
Other income/(expense):
               
Interest expense
    (210 )     (175 )
   Other income/(expense)
    --       --  
   Gain on forgiveness of debt
    414       --  
Gain on reversal of earn-out accrual
    --       517  
                 
Income taxes
    --       --  
Net income/(loss)
  $ 2,156     $ (435 )
   8% preferred stock Series B dividend and deemed dividend on preferred stock
    32       32  
Net income/(loss) applicable to common stockholders
  $ 2,124     $ (467 )
Income/(loss) per share applicable to common stockholders:
               
     Basic
  $ 0.04     $ (0.01 )
     Diluted
  $ 0.03     $ (0.01 )
Weighted average shares outstanding:
               
     Basic
    48,008       47,114  
     Diluted
    73,283       47,114  
 
The accompanying notes are an integral part of the condensed consolidated financial statements.
 
 
4

 
 
CICERO INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)

   
Three Months Ended
March 31,
 
   
2012
   
2011
 
Cash flows from operating activities:
           
Net income/(loss)
  $ 2,156     $ (435 )
Adjustments to reconcile net loss to net cash used in operating activities:
               
Depreciation and amortization
    179       181  
Stock compensation expense     22       21  
Bad debt expense
    2       12  
Gain on reversal of earn out contingency
    --       (517 )
Gain on forgiveness of debt
    (414 )     --  
Changes in assets and liabilities:
               
Trade accounts receivable
    (2,164 )     (152 )
Prepaid expenses and other assets
    42       (37 )
Accounts payable and accrued expenses
    155       (22 )
Deferred revenue
    185       913  
Net cash generated/(used in) operating activities
    163       (36 )
                 
Cash flows from investing activities:
               
Purchases of equipment
    (2 )     (3 )
             Net cash used in investing activities
    (2 )     (3 )
                 
Cash flows from financing activities:
               
Borrowings under short and long-term debt
    525       300  
Repayments of short and long-term debt
    (850 )     (105 )
Net cash generated/(used by) financing activities
    (325 )     195  
Net increase/(decrease) in cash
    (164 )     156  
Cash:
               
Beginning of period
    184       43  
End of period
  $ 20     $ 199  

Non-Cash Investing and Financing Activities:

During March 2012, the Company converted $265 of accrued Series B Preferred Stock dividends by issuing 1,765,333 shares of its common stock.

During March 2012, the Company converted $3,544 of debt and $33 of interest payable to private lenders by issuing 23,843,429 shares of its common stock.
 
The accompanying notes are an integral part of the condensed consolidated financial statements.
 
 
5

 
 
CICERO INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT
(in thousands)
 
     
Common Stock
     
Preferred Stock
Shares Amount
     
Additional
Paid-in
     
Accumulated
     
Total
 
Balance at December 31, 2011
    47,444     $ 47       12       --     $ 232,506     $ (242,176 )   $ (9,623 )
Dividend for preferred B stock
                                            (31 )     (31 )
Beneficial conversion of preferred A stock
    1               (1 )                             --  
Issuance of stock for payment of debt and interest
    23,844       24                       3,554               3,578  
Issuance of stock for payment of accrued dividends
    1,765       2                       263               265  
Options issued as compensation
                                    13               13  
Restricted shares issued as compensation
                                    9               9  
Net income
                                            2,156       2,156  
Balance at March 31, 2012
    73,054     $ 73       11       --     $ 236,345     $ (240,051 )   $ (3,633 )
 
 
6

 
 
CICERO INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (unaudited)

NOTE 1.   INTERIM FINANCIAL STATEMENTS

The accompanying financial statements for the three months ended March 31, 2012 and 2011 are unaudited, and have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC").  Certain information and note disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to those rules and regulations.  Accordingly, these interim financial statements should be read in conjunction with the audited financial statements and notes thereto contained in Cicero Inc.'s (the "Company") Annual Report on Form 10-K for the year ended December 31, 2011, filed with the SEC on April 16, 2012.  The results of operations for the interim periods shown in this report are not necessarily indicative of results to be expected for other interim periods or for the full fiscal year.  In the opinion of management, the information contained herein reflects all adjustments necessary for a fair presentation of the interim results of operations.  All such adjustments are of a normal, recurring nature.

The year-end condensed balance sheet data was derived from audited financial statements in accordance with the rules and regulations of the SEC, but does not include all disclosures required for financial statements prepared in accordance with accounting principles generally accepted in the United States of America.

The accompanying condensed consolidated financial statements include the accounts of the Company and its subsidiaries.  All of the Company's subsidiaries are wholly owned for the periods presented.

Liquidity

The accompanying financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business.  Although the Company has incurred an operating loss of approximately $2,970,000 for the year ended December 31, 2011, and has a history of operating losses, management feels that the Company has repositioned itself in the marketplace. Its products have already contracted several new and significant customers in 2011 and 2012 which the Company believes should generate significant cash flows to sustain operations in the forthcoming year. For the three months ended March 31, 2012, the Company has generated net income of $2,156,000.  In addition, during 2012, the Company has already retired $1,900,000 of assorted notes and interest payable, has converted over $3,800,000 of other short term debt, interest payable and accrued Series B preferred stock dividend into common stock and has received notification of debt forgiveness of approximately $414,000.  The Company has extended the maturity dates of several other debt obligations that were due in 2012 to 2013, to assist with liquidity.

Use of Accounting Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management 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.  Actual amounts could differ from these estimates.  Significant estimates include the recoverability of long-lived assets, valuation and recoverability of goodwill, stock based compensation, deferred taxes and related valuation allowances and valuation of equity instruments.

Financial Instruments:

The carrying amount of the Company’s financial instruments, representing accounts receivable, accounts payable and short-term debt approximate their fair value due to their short term nature.
 
 
7

 

The fair value and carrying amount of long-term debt were as follows:

   
March 31,
2012
   
December 31,
2011
 
Fair Value
  $ 635,326     $ 1,887,709  
Carrying Value
    700,000       1,916,000  

Valuations for long-term debt are determined based on borrowing rates currently available to the Company for loans with similar terms and maturities.

Stock-Based Compensation

The Company adopted Financial Accounting Standards Board (“FASB”) guidance now codified as ASC 718 “Compensation – Stock Compensation” which addresses the accounting for stock-based payment transactions in which an enterprise receives employee services in exchange for (a) equity instruments of the enterprise or (b) liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of such equity instruments.  The Company uses the Black-Scholes option-pricing model to determine the fair-value of stock-based awards under ASC 718.  The Company did not issue any options in the first three months of 2012.  The Company recognized stock-based compensation expense of $22,000 for the three months ended March 31, 2012.  This is comprised of $13,000 in connection with outstanding options and $9,000 for the 549,360 shares of restricted stock reserved for Mr. John Broderick, the Company’s CEO, in accordance with his 2007 employment agreement.
 
 
The following table sets forth certain information as of March 31, 2012 about shares of the Company’s common stock, par value $.001 (the “Common Stock”), outstanding and available for issuance under the Company’s existing equity compensation plans: the Cicero Inc. 2007 Employee Stock Option Plan, the Cicero Inc. 1997 Stock Option Incentive Plan and the Outside Director Stock Option Plan.  The Company’s stockholders approved all of the Company’s stock-based compensation plans.

   
Shares
 
Outstanding on January 1, 2012
    4,296,193  
Granted
    --  
Exercised
    --  
Forfeited
    --  
Outstanding on March 31, 2012
    4,296,193  
         
Weighted average exercise price of outstanding options   $ 0.39  
         
Aggregate Intrinsic Value
  $ 251,256  
         
Shares available for future grants on March 31, 2012
    224,857  

Recently Adopted Accounting Pronouncements

In September 2011, the FASB issued Accounting Standards Update (“ASU”) No. 2011-08, Intangibles—Goodwill and Other (Topic 350)—Testing Goodwill for Impairment (ASU 2011-08), to simplify how entities test goodwill for impairment. ASU 2011-08 allows entities to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If greater than 50 percent likelihood exists that the fair value is less than the carrying amount then a two-step goodwill impairment test as described in Topic 350 must be performed. The guidance provided by this update becomes effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011 with early adoption permitted. The Company adopted this standard during the year ended December 31, 2011, and it did not have material impact on the Company’s consolidated financial position and results of operations.
 
 
8

 

Reclassification

Certain accounts in the prior annual year-end income statement have been reclassified for comparative purposes to conform with the presentation in the current interim financial statements. These reclassifications have no effect on previously reported loss.
 
NOTE 2.   SOAdesk ACQUISITION

On January 15, 2010, the Company entered into an Asset Purchase Agreement with SOAdesk, LLC (“SOAdesk”) and Vertical Thought, Inc. (“VTI” and, together with SOAdesk, the “Sellers”), pursuant to which the Company acquired the Sellers’ “United Desktop” and “United Data Model” software technology, as well as substantially all of the other assets owned by the Sellers directly or indirectly used (or intended to be used) in or related to Sellers’ business of providing customer interaction consulting and technology services for organizations and contact centers throughout the world (the “Business”). The Company also assumed certain liabilities of the Sellers related to the Business, as described in the Asset Purchase Agreement.

The aggregate consideration payable by the Company to the Sellers consists of the following:
 
  $300,000 paid in cash to the Sellers on the closing date;

an unsecured convertible note in the aggregate principal amount of $700,000, payable to SOAdesk, with an annual interest rate of 5% and an original maturity date of March 31, 2010.  On March 31, 2010, the maturity date of the unsecured Convertible Note was extended from March 31, 2010 to September 30, 2010 and was secured by shares of the Company’s Series B Preferred Stock (the “Convertible Note”).  At September 30, 2010 the maturity date was extended from September 30, 2010 to March 31, 2011.  In March 2011, the maturity date was extended to March 31, 2012.  In March 2012, the maturity date was extended to December 31, 2012;

  $525,000, payable in cash to SOAdesk on March 31, 2010 (subsequently converted into a convertible promissory note as stated below);

an unsecured convertible note in the aggregate principal amount of $1,000,000, payable to SOAdesk on November 14, 2015 and convertible into shares of the Company’s Common Stock; and

certain earn-out contingencies of $2,410,000 based on product and enterprise revenue performance targets being met.

The terms of the Asset Purchase Agreement were amended on March 31, 2010, and the Company issued a $525,000 convertible promissory note to SOAdesk in lieu of the $525,000 payment. This note, which carries an annual interest rate of 5%, is convertible into shares of the Company’s Series B Preferred Stock (Note 4) at the holder’s option and originally matured on June 30, 2010.  The Company paid principal in the amount of $100,000 in April 2010.  On June 30, 2010, the convertible note was amended to extend the maturity date from June 30, 2010 to September 30, 2010.  As of September 30, 2010, the convertible note was further amended to extend the maturity date from September 30, 2010 to March 31, 2011.  The total outstanding debt as of March 31, 2012 and December 31, 2011 is $421,000.  In March 2011, the Company and SOAdesk LLC agreed to extend the maturity date until March 31, 2012.  In accordance with ASC 470-20 “Debt with Conversion and Other Options”, the Company has determined the embedded conversion option is beneficial and has intrinsic value to the holder.  The total debt discount to be recognized was $175,000 and the Company had reduced the note by that amount and increased Additional Paid in Capital by the same amount. As of December 31, 2010, the Company has fully amortized the debt discount of $175,000 in the statement of operations.  In April 2012, the Company paid this note in full.
 
 
9

 
 
The Company was obligated to make additional payments of up to $2,410,000 over an 18 month period from January 15, 2010 through July 31, 2011, based upon the achievement of certain revenue performance targets. Such payments are payable quarterly during the 18 month period over which the performance targets are being measured. The earn-out award is to be calculated, subject to adjustment, based upon the cumulative effect of achieved revenue performance targets during the applicable earn-out period.  The obligation was determined by management after consultation with an independent appraiser using the income approach methodology analyzing the Company’s discounted cash flow and management’s input on probability of attaining the different revenue performance targets.  As of March 31, 2011, the Company had determined that the earn-out targets originally recorded as part of the acquisition will not be completely met.  The Company therefore recorded a gain of $517,000 in the first quarter of 2011, in addition to the $1,050,000 gain recorded in the fourth quarter of 2010, in the statement of operations from the reversal of part of the earn-out accrual.  At December 31, 2011 the Company has recorded $843,000 in accounts payable for the earn-out earned through July 31, 2011.

We account for contingent consideration payable to sellers of the acquired assets in accordance with the provisions of ASC Topic 805 “Business Combinations” to ensure that we account for any post combination payments made to sellers of acquired businesses as either additional purchase consideration or compensation based upon the (i) economic form of the transaction and (ii) subsequent involvement (if any) of the sellers in the business on a post combined basis.

Consideration:
     
    Cash paid
  $ 300,000  
    Convertible notes payable
    2,225,000  
    Earn-out contingency
    2,410,000  
         Total Consideration
  $ 4,935,000  
Allocated to:
       
    Software
  $ 2,103,000  
      Goodwill ($141,000 is expected to be deductible for tax purposes)
  $ 2,832,000  
    $ 4,935,000  
 
Simultaneously with the acquisition of the assets of SOAdesk LLC, the Company also closed an initial round of Series B Convertible Preferred Stock, of approximately $1,560,000 including $700,000 in cash, the cancellation of $710,000 of existing indebtedness and the cancellation of a note of $150,000 to memorialize an advance of payment for Series B Stock prior to issuance.  The Series B Convertible Preferred Stock bears an annual dividend of 8% and provides warrants to purchase common stock of the Company at a strike price of $0.25 per share.  The Series B stock may convert into common stock at a conversion rate of $0.15 per share.  Of the $1,560,000 raised, the Company’s Chairman, Mr. John Steffens invested $910,000 through a combination of cash and debt retirement.  Dividends accrued at March 31, 2012 amounted to $11,000.  In March 2012, the Company converted approximately $265,000 of accrued dividends into 1,626,667 shares of common stock of the Company.

NOTE 3.   GOODWILL AND OTHER INTANGIBLE ASSETS

The Company accounts for goodwill in accordance ASC Topic 350 “Intangibles – Goodwill and Other” which requires that goodwill and intangible assets with indefinite lives be tested for impairment annually or on an interim basis if events or circumstances indicate that the fair value of an asset has decreased below its carrying value.
 
Goodwill includes the excess of the purchase price over the fair value of net assets acquired of $2,832,000 in connection with the SOAdesk LLC acquisition in Note 2.  The Codification requires that goodwill be tested for impairment at the reporting unit level. Application of the goodwill impairment test requires judgment, including the identification of reporting units, assigning assets and liabilities to reporting units, assigning goodwill to reporting units, and determining the fair value.
 
 
10

 
 
Pursuant to recent authoritative accounting guidance, the Company elects to assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test. The Company is not required to calculate the fair value of a reporting unit unless the Company determines that it is more likely than not that its fair value is less than its carrying amount. If the Company determines that it is more likely than not that its fair value is less than its carrying amount, then the two-step goodwill impairment test is performed. The first step, identifying a potential impairment, compares the fair value of the reporting unit with its carrying amount. If the carrying value exceeds its fair value, the second step would need to be conducted; otherwise, no further steps are necessary as no potential impairment exists. The second step, measuring the fair value of assets and liabilities of the reporting unit to determine the  implied fair value of goodwill, which is compared with the carrying amount of that goodwill. Any excess of the goodwill carrying value over the respective implied fair value is recognized as an impairment loss, and the carrying value of goodwill is written down to fair value. Through December 31, 2011, no impairment of goodwill has been identified.
 
The Company’s intangible asset with a finite life in the amount of $2,103,000 is being amortized over its estimated useful life of 3 years for software acquired from SOAdesk LLC. Amortization expense for the three ended March 31, 2012 was $175,000, resulting in a net intangible asset of $554,000 at March 31, 2012. At March 31, 2012, the estimated future amortization expense for each of the succeeding years is as follows: $525,000 for the remaining nine months of 2012, and $28,000 for fiscal year 2013. Actual amortization expense to be reported in future periods could differ from these estimates as a result of new intangible asset acquisitions, changes in useful lives or other relevant factors.
 
NOTE 4.   SHORT TERM DEBT

Short-term debt, and notes payable to related party consist of the following (in thousands):

   
March 31, 
2012
   
December 31,
2011
 
Term loan (a)
  $ 553     $ 753  
Note payable – asset purchase agreement (b)
    1,121       1,121  
Note payable – related party (c)
    1,008       2,959  
Other short-term debt (d)
    802       1,304  
    $ 3,484     $ 6,137  

a)  
In October 2007, the Company agreed to restructure the note payable to Bank Hapoalim and guaranty by BluePhoenix Solutions. Under a new agreement with BluePhoenix, the Company made a principal reduction payment to Bank Hapoalim in the amount of $300,000. Simultaneously, BluePhoenix paid $1,671,000 to Bank Hapoalim, thereby discharging that indebtedness. The Company and BluePhoenix entered into a new note in the amount of $1,021,000, bearing interest at LIBOR plus 1.0% and maturing on December 31, 2011. In addition, BluePhoenix acquired 2,546,149 shares of the Company’s common stock in exchange for $650,000 paid to Bank Hapoalim to retire that indebtedness.  Of the new note payable to BluePhoenix, approximately $350,000 was due on January 31, 2009 and the balance was due on December 31, 2011.  During 2008, the Company paid $200,000 against the principal and BluePhoenix converted $50,000 of principal into 195,848 shares of Cicero common stock. In January 2009, the Company paid $100,000 against the principal. In January 2012, the Company entered into an addendum to the original note to extend the maturity of all outstanding principal and interest of $752,594 to December 31, 2012.  At the time of the extension, the Company paid $150,000 towards principal and interest on this note.  The unpaid principal and accumulated interest shall bear interest at a rate of LIBOR (3 months $ LIBOR, 0.518%) plus 6.7% per annum calculated quarterly.  In March 2012, the Company made a $50,000 principal reduction payment.  In April 2012, the Company paid off the note at a discount in the amount of $380,000 and recognized approximately $172,000 as a gain.
 
(b)
In January 2010, per the Asset Purchase Agreement, the Company entered into an unsecured convertible promissory note with SOAdesk for $700,000 with an annual interest rate of 5%.  The note was originally scheduled to mature on March 31, 2010 but was subsequently amended to extend the maturity date to September 30, 2010 and was secured with shares of the Company’s Series B Preferred Stock.  As of September 30, 2010, the maturity date was extended to March 31, 2011. In March 2011, the Company and SOAdesk LLC agreed to extend the maturity on the note to March 31, 2012.  In March 2012, the Company and SOAdesk LLC agreed to extend the maturity on the note to December 31, 2012.  At March 31, 2012 and December 31, 2011, the Company was indebted to SOAdesk in the amount of $700,000.
 
 
11

 
 
 
The note is convertible into shares of Series B Convertible Preferred Stock at the rate of one share per every $150 of principal and interest due under the note.  The Company is obligated to repay any principal of the loan with fifty percent of any gross proceeds of any Series B Preferred capital raise through maturity of the note.  The note is convertible at the holder’s option at any time or at maturity.
 
Also, as part of the Asset Purchase Agreement, the Company was to pay to the shareholders of SOAdesk LLC the sum of $525,000 on March 31, 2010.  In March 2010, the terms of the Asset Purchase Agreement were amended and the Company issued a $525,000 convertible promissory note to SOAdesk in lieu of the $525,000 payment originally due on March 31, 2010.  This note, which carries an annual interest rate of 5%, is secured by shares of the Company’s Series B Preferred Stock.  The note was to mature on June 30, 2010 but was subsequently amended to extend the maturity date to September 30, 2010.  As of September 30, 2010, the maturity date was further extended to March 31, 2011.  In March 2011, the Company and SOAdesk LLC agreed to extend the maturity on the note until March 31, 2012.  In March 2012, the Company and SOAdesk LLC agreed to extend the maturity on the note until December 31, 2012.  In April 2010 and May 2011, the Company paid $100,000 and $4,000, respectively, against the principal. At March 31, 2012 and December 31, 2011, the Company was indebted to SOAdesk in the amount of $421,000.  In April 2012, the note was paid in full.
 
(c)
From 2010 through first quarter 2012, the Company entered into several short term notes payable with John L. (Launny) Steffens, the Chairman of the Board of Directors, for various working capital needs. The notes bear interest at 12% per year and are unsecured. At December 31, 2011, the Company was indebted to Mr. Steffens in the amount of $3,065,000 of which $1,665,000 was reclassified from long term debt.  (See Note 5)  In March 2012, Mr. Steffens converted $3,000,000 of his debt, which included $350,000 which was lent to the Company in the first quarter of 2012, into 20,000,000 shares of common stock of the Company at a price of $0.15 per share.  In March 2012, Mr. Steffens agreed to refinance $465,000 of debt, of which only $115,000 was outstanding as of December 31, 2011, and $417,000 of accrued interest at an interest rate of 12% and a maturity date of March 31, 2013.  As such this amount has been reclassified to long term debt as of December 31, 2011. The amount has been reclassified as short term debt as of March 31, 2012.
 
From time to time the Company entered into promissory notes with one of the Company’s former directors and the former Chief Information Officer, Anthony Pizi.  The notes bear interest at 12% per annum. As of December 31, 2011, the Company was indebted to Anthony Pizi in the amount of $8,502. In March 2012, Mr. Pizi converted his indebtedness of $8,502 in debt and $17,222 of interest into 171,487 shares of common stock of the Company.
 
(d)
In March 2009, the Company entered into several secured Promissory Notes with certain investors in the aggregate amount of $750,000. The notes bear interest at 15% and mature on January 31, 2012. The notes were secured by the amount due under the Company’s support contract with Merrill Lynch. In addition, each investor was issued a warrant to purchase common stock of the Company. Under the terms of the warrant, which expires in five years, each note holder is entitled to purchase 1,000 shares of Cicero common stock for every $1,000 of principal due under the note. The exercise price on the warrant is $0.20 per share. The shares of common stock underlying the warrants have registration rights and a cashless exercise provision in the event no registration statement is effective for resale, if required.  The Company has allocated the proceeds received from the Note and Warrant Offering based on relative fair value and is amortizing such amount under the terms of the notes as additional interest expense in the amount of $50,349.  In February 2010, the Company reduced the principal indebtedness by $100,000.  At December 31, 2011, the Company was indebted to these investors in the amount of $650,000.  In March 2012, these notes were paid in full.
 
The Company does not have a revolving credit facility and from time to time has issued a series of short term promissory notes with private lenders and employees, which provide for short term borrowings, both secured by accounts receivable and unsecured.  The notes in the amount of $802,000 bear interest between 10% and 36% per annum and are payable on demand.

A note for $300,000 in principal, which is included in the $802,000 above, was due and outstanding under the Note agreement. The Company has contacted the lender to discuss a payment plan regarding the accrued interest payable under the Note or possible termination of the Note.  The Company paid $200,000 against the principal of this note in May 2012.

 
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NOTE 5.  LONG-TERM DEBT

Long-term loan and notes payable to related party consist of the following (in thousands):

   
March 31, 
2012
   
December 31,
2011
 
Note payable – related party (a)
  $ --     $ 532  
Other long-term debt (b)
    700       1,384  
    $ 700     $ 1,916  
 
a)  
From time to time during 2010 and 2011, the Company entered into several short term notes payable with John L. (Launny) Steffens, the Chairman of the Board of Directors, for various working capital needs. The notes bear interest at 12% per year and are unsecured. At December 31, 2011, the Company was indebted to Mr. Steffens in the amount of $3,065,000 of which $1,665,000 was reclassified from long term debt.  (See Note 4)  In March 2012, Mr. Steffens converted $3,000,000 of his debt, which included $50,000 which was lent to the Company in the first quarter of 2012, into 20,000,000 shares of common stock of the Company at a price of $0.15 per share.  In March 2012, Mr. Steffens agreed to refinance $465,000 of debt, of which only $115,000 was outstanding as of December 31, 2011, and $417,000 of accrued interest at an interest rate of 12% and a maturity date of March 31, 2013.  As such this amount has been reclassified to long term debt as of December 31, 2011. The amount has been reclassified as short term debt as of March 31, 2012.

b)  
In January 2010, as part of the Asset Purchase Agreement, the Company entered into an unsecured Convertible Promissory Note with SOAdesk in the amount of $1,000,000.  The note bears interest at 5% and is due November 14, 2015.  The note is convertible into shares of the Company’s common stock at the rate of one share for every $0.15 of principal and interest due under the note.  The note is convertible at the option of the holder with one-third convertible in January 2011, two-thirds convertible in January 2012, and the entire note convertible in January 2013 or at maturity.  In March 2012, SOAdesk elected to convert $300,000 of the outstanding note balance into 2,000,000 shares of the Company’s Common Stock.
 
In March 2012, certain private lenders agreed to refinance $83,000 of debt and $301,000 of accrued interest at an interest rate of 12% and a maturity date of March 31, 2013.  As such this amount had been classified as long term debt as of December 31, 2011.  The amount has been reclassified as short term debt as of March 31, 2012.

 
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NOTE 6.   CONVERSION OF DEBT TO EQUITY

On March 30, 2012, the Company entered into agreements with private lenders, including John L. Steffens, the Chairman of the Board of Directors, to convert $3,243,502 of debt and $33,013 of interest into 21,843,429 common share of the Company’s stock. (See Note 4)  The Company accounted for the transaction pursuant to Topic ASC 470-50, Modification and Extinguishment of Debt. Pursuant to ASC 470-50, when debt is extinguished by delivering noncash assets owned by the debtor, the gain or loss on the extinguishment should be measured by the difference between the net carrying amount of the debt and the fair value of the noncash assets. Any difference between the fair value and the carrying amount of the noncash assets should be recognized as a gain or loss on transfer. As part of management’s analysis in determining the fair market value, the Company engaged an independent expert to help determine the fair market value of the Company stock and whether a discount to the price of the stock needed to be applied.  In analysis of historical studies of discounts attributable to trading restrictions as well as analysis from an option pricing model of protective puts of the Company’s stock, the Company determined that a 25% discount to the closing stock price on the day of the transaction would be necessitated to establish fair market value.  The Company calculated an approximately $246,000 gain on the extinguishment of the debt, however, due to the fact that 20,000,000 shares of the transaction were being issued to Mr. Steffens, the Company determined that this was not an arm’s length agreement and as such has recorded the gain through additional paid in capital.

NOTE 7.   STOCKHOLDER’S EQUITY

During March 2012, the Company converted approximately $265,000 of accrued Series B Preferred Stock dividends by issuing 1,765,333 shares of its common stock.

During March 2012, the Company converted approximately $3,544,000 of debt and $33,000 of interest payable to certain directors and significant shareholders of the Company and other private lenders by issuing 23,843,429 unregistered shares of its common stock that are restricted subject to Rule 144 with the Securities and Exchange Commission.

NOTE 8.   INCOME TAXES

The Company accounts for income taxes in accordance with FASB guidance now codified as ASC 740 “Income Taxes”. The Company's effective tax rate differs from the statutory rate primarily due to the fact that no income tax benefit was recorded as a result of the net loss for the first three months of fiscal year 2012 or 2011.  Because of the Company's recurring losses, the deferred tax assets have been fully offset by a valuation allowance.

NOTE 9.   EARNINGS/LOSS PER SHARE

Basic loss per share is computed based upon the weighted average number of common shares outstanding.  Diluted loss per share is computed based upon the weighted average number of common shares outstanding and any potentially dilutive securities.  Potentially dilutive securities outstanding during the periods presented include stock options, warrants, restricted stock, preferred stock and convertible debt.
 
 
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The following table sets forth the components of basic and diluted earnings/loss per share calculation for the quarter ending March 31, 2012 (in thousands, except per share amount):



   
For the three months ended
March 31, 2012
 
   
Income
   
Shares
   
Per-Share
Amount
 
Net income
  $ 2,156              
Less: Preferred stock dividends
    (32 )            
Basic EPS
                   
Net income applicable to common stockholders
    2,124       48,008     $ 0.04  
Effect of Dilutive Securities
                       
Stock based compensation
    40       616          
Warrants
    --       27          
Restricted stock
    --       549          
Convertible preferred stock
    32       11,942          
5% Convertible debentures
    26       12,140          
Diluted EPS
                       
Net Income available to common stockholders + assumed conversions
  $ 2,222       73,283     $ 0.03  

Options and warrants to purchase shares of  common  stock  are  excluded  from  the calculation  of diluted  earnings per share when their  inclusion  would have an anti-dilutive effect on the calculation.  No options and warrants were included for the three months ended March 31, 2011, respectively.  The weighted average number of common shares is increased by the number of dilutive potential common shares issuable on the exercise of options less the number of common shares assumed to have been purchased with the proceeds from the exercise of the options pursuant to the treasury stock method; those purchases are assumed to have been made at the average price of the common stock during the respective period.

NOTE 10.   CONTINGENCIES

The Company, from time to time, is involved in legal matters arising in the ordinary course of its business including matters involving proprietary technology. While management believes that such matters are currently not material, there can be no assurance that matters arising in the ordinary course of business for which the Company is or could become involved in litigation, will not have a material adverse effect on its business, financial condition or results of operations.

In October 2003, we were served with a summons and complaint in Superior Court of North Carolina regarding unpaid invoices for services rendered by one of our subcontractors.  The amount in dispute was approximately $200,000 and is included in accounts payable. Subsequent to March 31, 2004, we settled this litigation.  Under the terms of the settlement agreement, we agreed to pay a total of $189,000 plus interest over a 19-month period ending November 15, 2005. The Company has not made any additional payments and has a remaining liability of approximately $88,000.
 
 
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During fiscal 2011, the Company was served with a writ of summons by a creditor who holds a revolving note agreement.  The Company has offered a repayment arrangement to the creditor but has received no response to date.  No formal complaint was filed and the Company intends to seek a dismissal of the writ of summons.

Under the indemnification clause of the Company’s standard reseller agreements and software license agreements, the Company agrees to defend the reseller/licensee against third party claims asserting infringement by the Company’s products of certain intellectual property rights, which may include patents, copyrights, trademarks or trade secrets, and to pay any judgments entered on such claims against the reseller/licensee. There were no claims against the Company as of March 31, 2012.
 
 
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ITEM 2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

Cicero, Inc. (the “Company”) provides businesses the ability to maximize every interaction from intra-company back office applications to those that take place between employees, customers and vendors while extending the value of the best of breed applications in which businesses have already invested. The Company provides an innovative and unique combination of application and process integration, automation, presentation and real-time analysis, all without changes to the underlying applications or requiring costly development expenditures. The Company’s business integration software addresses the emerging need for companies information systems to deliver enterprise-wide views of their business information processes. In addition to software solutions, the Company also provides technical support, training and consulting services as part of its commitment to providing customers with industry-leading solutions. The Company’s consulting team has in-depth experience in developing successful enterprise-class solutions as well as valuable insight into the business information needs of customers in the largest Fortune 500 corporations worldwide.

The Company focuses on the customer experience management market with emphasis on desktop integration and business process automation with its Cicero XM™ products. Cicero XM enables businesses to transform human interaction across the enterprise. Cicero XM enables the flow of data between different applications, regardless of the type and source of the application, eliminating redundant entry and costly mistakes. Cicero XM automates up and down-stream process flows, enforcing compliance and optimizing handle time and provides a task-oriented desktop, reducing training time and enabling delivery of best in class service. Cicero XM captures real-time information about each interaction, guiding the business user through an activity and capturing usage data to spot trends and forecast problems before they occur.

Cicero XM software offers a proven, innovative departure from traditional, costly and labor-intensive enterprise application integration solutions. The Company provides non-invasive application integration, reduces enterprise integration implementation cost and time, and extends companies' Service-Oriented Architecture (“SOA”) to the desktop. Cicero XM also enables customers to transform applications, business processes and human expertise into a seamless, cost effective business solution that provides a cohesive, task-oriented and role-centric interface that works the way people think.

By using Cicero XM technology, companies can decrease their customer management costs, improve their customer service, maximize the lifetime value of existing customers, and more efficiently cross-sell the full range of their products and services resulting in an overall increase in return on their information technology investments. In addition, the Company’s software enables organizations to reduce the business risks inherent in replacement or re-engineering of mission-critical applications and extend the productive life and functional reach of their application portfolio.

The Company provides an integrated toolkit called Cicero XM Studio that provides an intuitive integration and development environment, which simplifies the integration of complex multi-platform applications. Cicero XM provides a unique approach that allows companies to organize components of their existing applications to better align them with tasks and operational processes. In addition, the Company’s software solutions can streamline end-user tasks by providing a single, seamless user interface for simple access to multiple systems or be configured to display one or more composite applications to enhance productivity. Our technology enables automatic information sharing among line-of-business applications and tools. It is ideal for deployment in contact centers where its highly productive, task-oriented user interface promotes business user efficiency. By integrating diverse applications across multiple operating systems, Cicero is ideal for the financial services, insurance, telecommunications, intelligence, security, law enforcement, governmental and other industries requiring a cost-effective, proven application integration solution.
 
 
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In addition to software products, the Company also provides technical support, training and consulting services as part of its commitment to providing its customers industry-leading integration solutions.  The Company’s consulting team has in-depth experience in developing successful enterprise-class solutions as well as valuable insight into the business information needs of customers in the Global 5000.  We offer services around our integration software products.

This Quarterly Report on Form 10-Q contains forward-looking statements relating to such matters as anticipated financial performance, business prospects, technological developments, new products, research and development activities, liquidity and capital resources and similar matters. The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements. In order to comply with the terms of the safe harbor, the Company notes that a variety of factors could cause its actual results to differ materially from the anticipated results or other expectations expressed in the Company's forward-looking statements.  These risk and uncertainties include, among others, the following:

  
We develop new and unproven technology and products;

  
We depend on an unproven strategy for ongoing revenue;

  
Economic conditions could adversely affect our revenue growth and cause us not to achieve desired revenue;

  
The so-called “penny stock rule” could make it cumbersome for brokers and dealers to trade in our common stock, making the market for our common stock less liquid which could cause the price of our stock to decline;

  
Because we cannot accurately predict the amount and timing of individual sales, our quarterly operating results may vary significantly, which could adversely impact our stock price;

  
Loss of key personnel associated with Cicero XM development could adversely affect our business;

  
Different competitive approaches or internally developed solutions to the same business problem could delay or prevent adoption of Cicero XM;

  
Our ability to compete may be subject to factors outside our control;

  
The markets for our products are characterized by rapidly changing technologies, evolving industry standards, and frequent new product introductions;

  
We may face damage to the reputation of our software and a loss of revenue if our software products fail to perform as intended or contain significant defects;

  
We may be unable to enforce or defend our ownership and use of proprietary and licensed technology; and

  
Our business may be adversely impacted if we do not provide professional services to implement our solutions.

 
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Reference should be made to such factors and all forward-looking statements are qualified in their entirety by the above cautionary statements.  Although we believe that these forward-looking statements are based upon reasonable assumptions, we can give no assurance that our goals will be achieved.  Given these uncertainties, readers of this Quarterly Report on Form 10-Q are cautioned not to place undue reliance on these forward-looking statements.  These forward-looking statements are made as of the date of this quarterly report.  We assume no obligation to update or revise them or provide reasons why actual results may differ.

RESULTS OF OPERATIONS

The table below presents information for the three months ended March 31, 2012 and 2011 (in thousands):

   
Three months ended March 31,
   
2012
   
2011
 
Total revenue
  $ 3,669     $ 729  
Total cost of revenue
    481       487  
Gross margin
    3,188       242  
Total operating expenses
    1,236       1,019  
Income/(Loss) from operations
  $ 1,952     $ (777 )

Revenue.  The Company has three categories of revenue: software products, maintenance, and services. Software products revenue is comprised primarily of fees from licensing the Company's proprietary software products. Maintenance revenue is comprised of fees for maintaining, supporting, and providing periodic upgrades to the Company's software products. Services revenue is comprised of fees for consulting and training services related to the Company's software products.

The Company's revenues vary from quarter to quarter, due to market conditions, the budgeting and purchasing cycles of customers and the effectiveness of the Company’s sales force.  The Company typically does not have any material backlog of unfilled software orders and product revenue in any quarter is substantially dependent upon orders received in that quarter. Because the Company's operating expenses are relatively fixed over the short term, variations in the timing of the recognition of revenue can cause significant variations in operating results from quarter to quarter.

We generally recognize revenue from software license fees when our obligations to the customer are fulfilled, which is typically upon delivery or installation.  Revenue related to software maintenance contracts is recognized ratably over the terms of the contracts.  Revenues from services are recognized on a time and materials basis as the services are performed and amounts due from customers are deemed collectible and non-refundable.  Within the revenue recognition rules pertaining to software arrangements, certain assumptions are made in determining whether the fee is fixed and determinable and whether collectability is probable.  Should our actual experience with respect to collections differ from our initial assessment, there could be adjustments to future results.

THREE MONTHS ENDED MARCH 31, 2012 COMPARED WITH THE THREE MONTHS ENDED MARCH 31, 2011.

Total Revenues.  Total revenues increased $2,940,000, or 403.3%, from $729,000 to $3,669,000, for the three months ended March 31, 2012 as compared with the three months ended March 31, 2011. The increase is due primarily to an increase in revenue in software sales due to an enterprise license sale with UBS AG partially offset by a decrease in maintenance and consulting revenue.

Total Cost of Revenue.  Total cost of revenue decreased $6,000, or 1.2%, from $487,000 to $481,000, for the three months ended March 31, 2012 as compared with the three months ended March 31, 2011.  The decrease is primarily attributable to a decrease in professional services travel expenses.

Total Gross Margin.  Gross margin was $3,188,000, or 86.9%, for the three months ended March 31, 2012 as compared to the gross margin of $242,000, or 33.2% for the three months ended March 31, 2011. The increase in gross margin is primarily due to the increase in total sales.

Total Operating Expenses.  Total operating expenses increased $217,000, or 21.3%, from $1,019,000 to $1,236,000 for the three months ended March 31, 2012, as compared with the three months ended March 31, 2011.  The increase in total operating expenses is primarily attributable to higher personnel costs and outside professional services in the first quarter of 2012.
 
 
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Software Products.
Software Product Revenue.  The Company earned $3,238,000 in software product revenue for the three months ended March 31, 2012 as compared to $164,000 in software revenue for the three months ended March 31, 2011, an increase of $3,074,000.  The increase is primarily due to an enterprise license sale with UBS AG.

Software Product Gross Margin/(Loss).  The gross margin on software products for the three months ended March 31, 2012 was 94.6% compared with a gross margin loss of (6.7%) for the three months ended March 31, 2011.  The increase in gross margin is primarily due to the increase in software revenue while the related cost remains consistent with the prior quarter due to the amortization of the acquired SOAdesk software.

Maintenance.
Maintenance Revenue.  Maintenance revenue for the three months ended March 31, 2012 decreased by approximately $27,000, or 7.0%, from $383,000 to $356,000 as compared to the three months ended March 31, 2011 due to the cancellation of one renewal contract partially offset  by additional software and maintenance sales in the last three quarters of fiscal 2011.

Maintenance Gross Margin.  Gross margin on maintenance products for the three months ended March 31, 2012 was 89.9% compared with 90.1% for the three months ended March 31, 2011.  Cost of maintenance is comprised of personnel costs and related overhead for the maintenance and support of the Company’s software products.  The decrease of gross margin is due to the decrease in maintenance revenue.

Services.
Services Revenue.  Services revenue decreased $107,000, or 58.8%, from $182,000 to $75,000 for the three months ended March 31, 2012 as compared with the three months ended March 31, 2011. The decrease in services revenues is primarily attributable to a decrease in paid consulting engagements in the first three months of 2012.

Services Gross Margin Loss.  Services gross margin loss was 260.0% for the three months ended March 31, 2012 compared with gross margin loss of 50.5% for the three months ended March 31, 2011.  The decrease in gross margin was primarily attributable to the decrease in consulting revenue partially offset by a decrease in consulting expenses from reduced travel expense.

Operating Expenses:
Sales and Marketing.  Sales and marketing expenses primarily include personnel costs for salespeople, marketing personnel, travel and related overhead, as well as trade show participation and promotional expenses. Sales and marketing expenses for the three months ended March 31, 2012 increased by approximately $84,000, or 19.6%, from $428,000 to $512,000 as compared with the three months ended March 31, 2011.  The increase is primarily attributable to increase in headcount in the second half of 2011 and an increase in marketing expenses.

Research and Development.  Research and product development expenses primarily include personnel costs for product developers and product documentation and related overhead. Research and development expense increased by approximately $100,000, or 36.4%, from $275,000 to $375,000 for the three months ended March 31, 2012 as compared to the three months ended March 31, 2011. The increase in costs for the quarter is primarily due to an increase in headcount in the second half of fiscal 2011.

General and Administrative. General and administrative expenses consist of personnel costs for the legal, financial, human resources, and administrative staff, related overhead, and all non-allocable corporate costs of operating the Company. General and administrative expenses for the three months ended March 31, 2012 increased by approximately $33,000, or 10.4%, from $316,000 to $349,000 as compared to the three months ended March 31, 2011.  The increase is primarily attributable to an increase in personnel expenses and an increase in professional service expenses.
 
 
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Provision for Taxes. The Company’s effective income tax rate differs from the statutory rate primarily because an income tax expense/benefit was not recorded as a result of the gain in the first quarter of 2012 and loss in the first quarter of 2011. Because of the Company’s recurring losses, the deferred tax assets have been fully offset by a valuation allowance.

Net Income (Loss).  The Company recorded net income of $2,156,000 for the three months ended March 31, 2012 as compared to a net loss of $435,000 for the three months ended March 31, 2011. The increase is primarily due to a $3,074,000 increase in software product revenue over the prior period as a result of an enterprise license with UBS AG.

Impact of Inflation.  Inflation has not had a significant effect on the Company’s operating results during the periods presented.

LIQUIDITY AND CAPITAL RESOURCES

Cash

Cash and cash equivalents decreased to $20,000 at March 31, 2012 from $184,000 at December 31, 2011, a decrease of $164,000.

Net cash generated/used in Operating Activities.  Cash generated from operations for the three months ended March 31, 2012 was $163,000 compared to cash used in operations of $36,000 for the three months ended March 31, 2011.  Cash generated from operations for the three months ended March 31, 2012 was primarily due to the income from operations, depreciation and amortization of $179,000, stock compensation of $22,000, bad debt write off of $2,000, a decrease in prepaid expenses of $42,000, an increase in accounts payable and accrued expenses of $155,000 and in increase in deferred revenue of $185,000 partially offset by a gain of $414,000 from the write off of certain accrued wages and an increase in accounts receivable of $2,164,000.

Net cash used in Investing Activities. The Company purchased $2,000 worth of equipment during the three months ended March 31, 2012 versus $3,000 during the three months ended March 31, 2011.

Net cash generated/used in Financing Activities.  Net cash used by financing activities for the three months ended March 31, 2012 was approximately $325,000 as compared with net cash generated by financing activities of approximately $195,000 for the three months ended March 31, 2011.  Cash used by financing activities for the three months ended March 31, 2012 was comprised primarily from the repayment of $850,000 of short term debt offset by cash received from short term borrowings of $525,000.

Liquidity

The Company funded its cash needs during the three months ended March 31, 2012 with cash on hand from December 31, 2011; the revenue generated in the first three months of 2012 and short term borrowings.

During 2010 and 2011, the Company entered into various short term notes payable with John L. (Launny) Steffens, the Chairman of the Board of Directors, for various working capital needs. The notes bear interest at 12% per year and are unsecured. At December 31, 2011, the Company was indebted to Mr. Steffens in the amount of $3,065,000.  In March 2012, Mr. Steffens converted $3,000,000 of his debt into 20,000,000 shares of common stock of the Company at a price of $0.15 per share. In March 2012, Mr. Steffens agreed to refinance $465,000 of debt and $417,000 of accrued interest at an interest rate of 12% and a maturity date of March 31, 2013.  At March 31, 2012, the Company was indebted to Mr. Steffens in the amount of $1,008,000.

During March 2012, the Company converted $3,576,515 in principal and interest of debt held by certain lenders of short and long term notes, including certain directors and significant shareholders of the Company, into 23,843,433 shares of the Company’s common stock at a price of $0.15 per share.
 
 
21

 

During March 2012, the Company converted $264,800 of accrued Series B dividends owed to certain holders of the Company’s Series B Preferred Stock, including certain directors and significant shareholders of the Company, into 1,765,329 shares of the Company’s common stock at a price of $0.15 per share.

In April 2010, the Company issued to a certain accredited investor 1,333 shares of Series B Convertible Preferred Stock at $150 per share for a total of $200,000.  The Series B Convertible Preferred Stock bears an annual dividend of 8%.  The Series B stock may convert into common stock at a conversion rate of $0.15 per share.  As part of the Series B stock offering, the Company also issued warrants to purchase common stock of the Company at a strike price of $0.25 per share.  The warrants expire in five years.  333,333 warrants were issued to this investor.

In January 2010, the Company issued to certain accredited investors 9,067 shares of Series B Convertible Preferred Stock at $150 per share for a total of $1,360,000 including $500,000 in cash, the cancellation of $710,000 of existing indebtedness and the cancellation of a note of $150,000 to memorialize an advance of payment for Series B Stock prior to issuance.  The Series B Convertible Preferred Stock bears an annual dividend of 8%.  The Series B stock may convert into common stock at a conversion rate of $0.15 per share.  As part of the Series B stock offering, the Company also issued warrants to purchase common stock of the Company at a strike price of $0.25 per share.  2,266,667 warrants were issued to these investors.  Of the $1,360,000 in Series B Convertible Preferred Stock issued, the Company’s Chairman, Mr. John Steffens invested $910,000 through a combination of $200,000 in cash and $710,000 in the conversion of debt.

In March 2009, the Company entered into several secured Promissory Notes with certain investors in the aggregate amount of $750,000. The notes bear interest at 15% and matured on January 31, 2012. The notes are secured by the amount due the Company under its support agreement with Merrill Lynch. In addition, each investor was issued a warrant to purchase common stock of the Company. Under the terms of the warrant, which expires in five years, each note holder is entitled to purchase 1,000 shares of Cicero common stock for every $1,000 of principal due under the note. The exercise price on the warrant is $0.20 per share. The shares of common stock underlying the warrants have registration rights and a cashless exercise provision in the event no registration statement is effective for resale, if required.  In February 2010, the Company reduced the principal indebtedness by $100,000.  In March 2012, the Company paid these notes in their entirety of $650,000.

The Company maintains a Note Agreement with an Investor in which the Company may from time to time borrow up to $500,000. The borrowings are secured by any outstanding receivables at the time of the loans. The loans bear interest at 36% per annum. At March 31, 2012, $300,000 was due and outstanding under the note agreement. The Company and the lender are in discussions to establish a payment plan to retire the note and accrued interest.

In October 2007, the Company and BluePhoenix entered into a note payable in the amount of $1,021,000, bearing interest at LIBOR plus 1.0% and maturing on December 31, 2011. In addition, BluePhoenix acquired 2,546,149 shares of the Company’s common stock in exchange for $650,000 paid to Bank Hapoalim to retire that indebtedness.  Of the new note payable to BluePhoenix, $350,000 was due on January 31, 2009 and the balance is due on December 31, 2011.  In March 2008, the Company and BluePhoenix agreed to accelerate the principal reduction payment of $350,000 due on January 31, 2009 and $200,000 was paid in March 2008.  The Company paid $100,000 in January 2009.  BluePhoenix agreed to convert $50,000 of the repayment into 195,848 shares of the Company’s common stock in July 2008.  In January 2012, the Company entered into an addendum to the original note to extend the maturity of all outstanding principal and interest of $752,594 to December 31, 2012.  At the time of the extension, the Company paid $150,000 towards principal and interest on the note.  The unpaid principal and accumulated interest shall bear interest at a rate of LIBOR (3 months $ LIBOR) plus 6.7% per annum calculated quarterly.  In March 2012, the Company made a $50,000 principal reduction payment against this note.  In April 2012, the Company paid off the balance of this note at a discount and recognized a gain of approximately $172,000.
 
 
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The Company believes that its financing activities and capitalization structure will have a positive impact on the future operations of the Company and its ability to raise additional capital, however, there can be no assurance that management will be successful in executing as anticipated or in a timely manner, especially in light of the continued tightness in the global credit markets as a result of the recent economic crisis.  If these strategies are unsuccessful, the Company may have to pursue other means of financing that may not be on terms favorable to the Company or its stockholders.  The Company has repositioned itself in the marketplace as a result of the acquisition of the assets of SOAdesk along with its key personnel. By combining the SOAdesk products with the Cicero legacy products, the Company is able to offer a complete Customer Experience Management suite of products. The new products have already received awards from within the industry and new customers have contracted to use the products, thereby generating new revenues. The Company has entered into several significant contracts in 2011 and 2012 which are generating capital to sustain its operations.  The Company anticipates a continued success in this regard based upon current discussions with active customers and prospects.  The Company has also retired approximately $1,900,000 of debt in 2012, has converted $3,800,000 of debt into common stock and has received notification of debt forgiveness of $404,000.  The Company anticipates that it will generate sufficient cash to sustain operations for the forthcoming year.

OFF-BALANCE SHEET ARRANGEMENTS

The Company does not have any off balance sheet arrangements. We have no unconsolidated subsidiaries or other unconsolidated limited purpose entities, and we have not guaranteed or otherwise supported the obligations of any other entity.

RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS

In September 2011, the FASB issued Accounting Standards Update (“ASU”) No. 2011-08, Intangibles—Goodwill and Other (Topic 350)—Testing Goodwill for Impairment (ASU 2011-08), to simplify how entities test goodwill for impairment. ASU 2011-08 allows entities to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If greater than 50 percent likelihood exists that the fair value is less than the carrying amount then a two-step goodwill impairment test as described in Topic 350 must be performed. The guidance provided by this update becomes effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011 with early adoption permitted. The Company adopted this standard during the year ended December 31, 2011, and it did not have material impact on the Company’s consolidated financial position and results of operations.
 
ITEM 3.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable.

ITEM 4.   CONTROLS AND PROCEDURES
 
a) Evaluation of Disclosure Controls and Procedures.

We maintain “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, or the Exchange Act, that are designed to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. Our disclosure controls and procedures have been designed to meet reasonable assurance standards. Additionally, in designing disclosure controls and procedures, our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.
 
 
23

 
 
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our internal control over financial reporting as of period ending March 31, 2012.  In making this assessment, we utilized the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control – Integrated Framework.
 
A material weakness is a deficiency or a combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of our annual interim financial statement will not be prevented or detected on a timely basis.  As a result of this evaluation, we concluded that our internal control over financial reporting was not effective as of March 31, 2012 because of the material weakness set forth below.

Due to a lack of adequate resources we did not independently account for a significant, complex, and non-routine transaction as of March 31, 2012.  However, the transaction has been properly disclosed in the accompanying consolidated financial statements as of March 31, 2012.  Due to the actual and potential effect on financial statement balances and disclosures of the deficiency noted above, we concluded that, this deficiency in internal controls constituted a material weakness in internal control over financial reporting.
 
Accordingly, our Chief Executive Officer and Chief Financial Officer have concluded that as of March 31, 2012, our disclosure controls and procedures were not effective.
 
Our efforts to improve our internal controls are ongoing and focused on expanding our organizational capabilities to improve our control environment and on implementing process changes to strengthen our internal control and monitoring.

(b) Changes in Internal Controls.

There were no changes in our internal control over financial reporting that occurred during the fiscal quarter ended March 31, 2012 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
 
 
24

 
 
PART II.   OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS

Not Applicable.

ITEM 1A.  RISK FACTORS

Not Applicable.

ITEM 2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Not applicable.

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES

See Footnote 4 with regards to a $300,000 Note agreement.

ITEM 4.   MINE SAFETY DISCLOSURES

None.
 
ITEM 5.  OTHER INFORMATION

None

 
25

 

ITEM 6.  EXHIBITS

Exhibit No.
 
Description
     
 
Master Agreement between Cicero, Inc. and UBS AG. (filed herewith)
     
 
Certification of Chief Executive Officer/Chief Financial Officer pursuant to Rule 13a-14(a) (filed herewith).
     
 
Certification of John P. Broderick pursuant to 18 USC § 1350, as adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002 (filed herewith).

 
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SIGNATURE
 
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
 
  CICERO INC.  
       
Date: May 21, 2012
By:
/s/ John P. Broderick  
    John P. Broderick  
    Chief Executive Officer and Chief Financial Officer  
       

 
 
 27

XOTC:CICN Cicero Inc Quarterly Report 10-Q Filling

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XOTC:CICN Cicero Inc Quarterly Report 10-Q Filing - 3/31/2012
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