10-Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

FOR THE QUARTERLY PERIOD ENDED September 30, 2016

OR

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

For the transition period from                            to                            

Commission File Number 001-33197

GUIDANCE SOFTWARE, INC.

(Exact name of registrant as specified in its charter)

Delaware	95-4661210
(State or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification No.)
1055 E. Colorado Blvd.
Pasadena, California 91106	(626) 229-9191
(Address of principal executive offices)	Registrant’s telephone number, including area code

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

Common Stock, $0.001 par value per share.

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

None.

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No o

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

Large accelerated filer o	Accelerated filer x
Non- accelerated filer o	Smaller reporting company o

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

As of November 4, 2016, there were approximately 32,149,000 shares of the registrant’s Common Stock outstanding.

GUIDANCE SOFTWARE, INC.

FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED September 30, 2016

Table of Contents

		Page
PART I - FINANCIAL INFORMATION
Item 1.	Financial Statements (Unaudited)	3
	Condensed Consolidated Balance Sheets at September 30, 2016 and December 31, 2015	3
	Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2016 and 2015	4
	Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2016 and 2015	5
	Notes to the Condensed Consolidated Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	19
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	26
Item 4.	Controls and Procedures	26
PART II - OTHER INFORMATION
Item 1.	Legal Proceedings	27
Item 1A.	Risk Factors	27
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	27
Item 3.	Defaults upon Senior Securities	27
Item 4.	Removed and Reserved	27
Item 5.	Other Information	27
Item 6.	Exhibits	27
Signatures		28

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PART I. FINANCIAL INFORMATION

Item 1.Financial Statements

GUIDANCE SOFTWARE, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except per share data)

(Unaudited)

	September 30, 2016			December 31, 2015
ASSETS
Current assets:
Cash and cash equivalents	$	11,654		$	18,967
Trade receivables, net of allowance for doubtful accounts of $293 and $376, respectively	21,555			21,434
Inventory	2,283			2,543
Prepaid expenses and other current assets	4,959			3,335
Total current assets	40,451			46,279
Long-term assets:
Property and equipment, net	12,353			13,513
Intangible assets, net	5,017			6,157
Goodwill	14,632			14,632
Other assets	2,394			1,709
Total long-term assets	34,396			36,011
Total assets	$	74,847		$	82,290
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	6,255		$	3,335
Accrued liabilities	10,854			9,884
Bank line of credit	4,500			—
Deferred revenues	39,716			41,553
Total current liabilities	61,325			54,772
Long-term liabilities:
Deferred rent and other long-term liabilities	7,379			7,527
Deferred revenues	6,643			8,242
Deferred tax liabilities	579			511
Total long-term liabilities	14,601			16,280
Commitments and contingencies (Note 10)
Stockholders’ equity:
Preferred stock, $0.001 par value: 10,000,000 shares authorized; no shares issued or outstanding	—			—
Common stock, $0.001 par value; 100,000,000 shares authorized; 33,989,000 and 32,306,000 shares issued, respectively; and 32,210,000 and 30,526,000 shares outstanding, respectively	26			25
Additional paid-in capital	125,526			118,714
Treasury stock, at cost, 1,779,000 and 1,779,000 shares, respectively	(11,479		)	(11,479		)
Accumulated deficit	(115,152		)	(96,022		)
Total stockholders’ (deficit) equity	(1,079		)	11,238
Total liabilities and stockholders’ equity	$	74,847		$	82,290

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

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GUIDANCE SOFTWARE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(Unaudited)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2016			2015			2016			2015
Revenues:
Product revenue	$	9,600		$	7,759		$	26,693		$	23,093
Services revenue	7,806			9,041			24,492			26,487
Maintenance revenue	10,299			10,023			29,875			29,796
Total revenues	27,705			26,823			81,060			79,376
Cost of revenues (excluding amortization and depreciation, shown below):
Cost of product revenue	2,574			2,520			6,945			6,556
Cost of services revenue	5,191			6,011			16,476			18,512
Cost of maintenance revenue	573			601			1,815			1,781
Total cost of revenues (excluding amortization and depreciation, shown below)	8,338			9,132			25,236			26,849
Operating expenses:
Selling and marketing	10,984			9,156			33,098			28,357
Research and development	6,069			5,281			18,811			15,690
General and administrative	3,743			5,078			19,066			14,262
Depreciation and amortization	1,188			1,574			3,910			4,811
Total operating expenses	21,984			21,089			74,885			63,120
Operating loss	(2,617		)	(3,398		)	(19,061		)	(10,593		)
Other income and expense:
Interest income	—			3			8			8
Interest expense	(10		)	(3		)	(14		)	(7		)
Other income, net	5			4			14			21
Total other income and expense	(5		)	4			8			22
Loss before income taxes	(2,622		)	(3,394		)	(19,053		)	(10,571		)
Income tax (benefit) provision	(14		)	77			77			244
Net loss	$	(2,608	)	$	(3,471	)	$	(19,130	)	$	(10,815	)
Net loss per share:
Basic	$	(0.09	)	$	(0.12	)	$	(0.67	)	$	(0.39	)
Diluted	$	(0.09	)	$	(0.12	)	$	(0.67	)	$	(0.39	)
Weighted average number of shares used in per share calculation:
Basic	29,020			28,197			28,743			27,864
Diluted	29,020			28,197			28,743			27,864

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

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GUIDANCE SOFTWARE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)

	Nine Months Ended September 30,
	2016			2015
Operating Activities:
Net loss	$	(19,130	)	$	(10,815	)
Adjustments to reconcile net loss to net cash (used in) provided by operating activities:
Depreciation and amortization	3,910			4,811
Recovery of bad debt	—			(200		)
Share-based compensation	6,814			5,109
Deferred taxes	68			69
Loss on disposal of assets	126			14
Changes in operating assets and liabilities:
Restricted cash	—			153
Trade receivables	(121		)	379
Inventory	260			199
Prepaid expenses and other assets	(2,310		)	905
Accounts payable	3,098			(2,417		)
Accrued liabilities	836			1,752
Deferred revenues	(3,436		)	1,492
Net cash (used in) provided by operating activities	(9,885		)	1,451
Investing Activities:
Purchase of property and equipment	(1,869		)	(3,429		)
Net cash used in investing activities	(1,869		)	(3,429		)
Financing Activities:
Proceeds from the exercise of stock options	—			1,687
Borrowings on bank line of credit	4,500			—
Principal payments on capital lease obligations and other obligations	(59		)	(63		)
Net cash provided by financing activities	4,441			1,624
Net decrease in cash and cash equivalents	(7,313		)	(354		)
Cash and cash equivalents, beginning of period	18,967			18,355
Cash and cash equivalents, end of period	$	11,654		$	18,001
Non-cash investing and financing activities:
Purchase of equipment included in accounts payable and accrued expenses	$	32		$	98

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

5

GUIDANCE SOFTWARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1. Description of the Business

General

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

Our main products and services are:

Our security suite of products:

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

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

·EnForce Risk Manager is a new data risk and privacy solution.  It allows organizations to implement a proactive approach to information governance, ensuring that sensitive data is identified, classified and remediated allowing organizations to reduce their cyber attack surface area, significantly mitigating potential damage from breaches and improving their ability to comply with global data protection mandates.

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

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

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

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

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

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Note 2. Summary of Significant Accounting Policies

Basis of Presentation

The accompanying condensed consolidated balance sheets as of September 30, 2016 and the condensed consolidated statements of operations for the three and nine months ended September 30, 2016 and 2015 and cash flows for the nine months ended September 30, 2016 and 2015 are unaudited.  These statements should be read in conjunction with the audited consolidated financial statements and related notes, together with management’s discussion and analysis of financial position and results of operations, contained in our Annual Report on Form 10-K for the year ended December 31, 2015, filed with the U.S. Securities and Exchange Commission (the “SEC”) on February 25, 2016.

The accompanying condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States, or (“GAAP”), and pursuant to the rules and regulations of the SEC for interim financial reporting.  In the opinion of our management, the unaudited condensed consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2015 and include all normal and recurring adjustments necessary for the fair presentation of our financial position as of September 30, 2016 and our results of operations for the three and nine months ended September 30, 2016 and 2015 and our cash flows for the nine months ended September 30, 2016 and 2015.  The condensed consolidated balance sheet as of December 31, 2015 has been derived from the December 31, 2015 audited financial statements.  The operating results for the three and nine month periods ended September 30, 2016 are not necessarily indicative of the results that will be achieved for the full fiscal year or for future periods.

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

Reclassification of Liabilities

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

Use of Estimates and Assumptions

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

Cash and Cash Equivalents

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

Fair Value of Financial Instruments

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

Trade Receivables

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

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Inventory

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

Amortization of Intangible Assets with Finite Lives

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

Goodwill and Indefinite-Lived Intangibles

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

Concentrations of Credit Risk

Financial instruments that potentially subject us to significant concentrations of credit risk consist primarily of cash and cash equivalents and accounts receivable.  We restrict our investments in cash and cash equivalents to financial institutions, US government or federal agency instruments and obligations of corporations with high credit ratings.  At September 30, 2016, the majority of our cash balances were held at financial institutions located in California in accounts that are insured by the Federal Deposit Insurance Corporation for up to $250,000. Uninsured balances aggregate approximately $11.3 million as of September 30, 2016.  At September 30, 2016 all of our cash equivalents consisted of financial institution obligations.  We periodically perform credit evaluations of our customers and maintain reserves for potential losses on our accounts receivable.  We do not believe we are subject to concentrations of credit risk with respect to such receivables.

Revenue Recognition

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Revenue Recognition for Hardware and Subscription Revenues (Nonsoftware Elements)

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

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

9

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

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

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

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

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

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

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

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

Recently Issued Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (“FASB”) and International Accounting Standards Board (“IASB”) jointly issued ASU No. 2014-09, Revenue from Contracts with Customers, which supercedes the revenue recognition requirements in ASC 605 Revenue Recognition.  ASU 2014-09 is a comprehensive new revenue recognition standard that will supercede nearly all existing revenue recognition guidance under US GAAP.  The standard’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services.  In doing so, companies will need to use more judgment and make more estimates than under current authoritative guidance.  These may include identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation.  The standard is effective beginning after December 15, 2016, and early adoption is not permitted under US GAAP.  On April 1, 2015, the FASB voted to propose to defer the effective date of ASU 2014-09 by one year.  The standard is effective for fiscal years beginning after December 15, 2017, and early adoption is not permitted under US GAAP.  We are currently evaluating the financial statement impact of the new revenue recognition standard, as well as its impact on our accounting policies, business processes, systems and controls.

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

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

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

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

Realignment Expense

As a result of reducing headcount and the closing of our Orlando and Houston offices, we incurred approximately $0.4 million and $3.5 million during the three and nine months ended September 30, 2016, respectively, in rent expense, severance and related expenses in cost of services revenues, selling and marketing, research and development and general administrative expenses.

Note 3. Net Loss Per Share

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

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

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

	Three Months Ended September 30,						Nine Months Ended September 30,
	2016			2015			2016			2015
Basic loss per common share:
Numerator:
Net loss	$	(2,608	)	$	(3,471	)	$	(19,130	)	$	(10,815	)
Net loss allocated to common stockholders	$	(2,608	)	$	(3,471	)	$	(19,130	)	$	(10,815	)
Denominator:
Basic weighted average shares outstanding	29,020			28,197			28,743			27,864
Net loss per basic common share	$	(0.09	)	$	(0.12	)	$	(0.67	)	$	(0.39	)
Diluted loss per common share:
Numerator:
Net loss	$	(2,608	)	$	(3,471	)	$	(19,130	)	$	(10,815	)
Net loss allocated to common stockholders	$	(2,608	)	$	(3,471	)	$	(19,130	)	$	(10,815	)
Denominator:
Basic weighted average shares outstanding	29,020			28,197			28,743			27,864
Effect of dilutive share-based awards	—			—			—			—
Diluted weighted average shares outstanding	29,020			28,197			28,743			27,864
Net loss per diluted common share	$	(0.09	)	$	(0.12	)	$	(0.67	)	$	(0.39	)

Antidilutive securities, which consist of stock options and restricted stock awards that are not included in the diluted net loss per share calculation, consisted of an aggregate of approximately 1,732,000 and 2,338,000 shares for the three and nine months ended September 30, 2016, respectively, and 918,000 and 1,920,000 shares for the three and nine months ended September 30, 2015, respectively.

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Note 4. Inventory

Inventory is comprised of hardware components, packaged software components and finished goods and is valued at the lower of cost or market, using the weighted average cost method.  The following table sets forth, by major classes, inventory as of September 30, 2016 and December 31, 2015 (in thousands):

	September 30, 2016		December 31, 2015
Inventory:
Components	$	1,167	$	1,082
Finished goods	1,116		1,461
Total inventory	$	2,283	$	2,543

Note 5. Goodwill and Other Intangibles

We evaluate goodwill and indefinite-lived intangible assets for impairment on an annual basis, or more frequently if circumstances indicate impairment may have occurred, and there have been no impairment charges related to such assets through September 30, 2016.  We expect the balance of goodwill assigned to our products segment to be deductible for tax purposes while the balance of goodwill assigned to our subscription and professional services segments will not be deductible for tax purposes.

Intangible assets are amortized on a straight-line basis over their estimated useful lives, with the exception of customer relationships, which are amortized on a double-declining basis.  Amortization expense for intangible assets with finite lives was $0.4 million and $1.1 million for the three and nine months ended September 30, 2016, respectively, and $0.4 million and $1.3 million for the three and nine months ended September 30, 2015, respectively. The following table summarizes cumulative amortization expense related to intangible assets subject to amortization as of September 30, 2016 and December 31, 2015 (in thousands):

	September 30, 2016							December 31, 2015
	Gross Costs		Accumulated Amortization			Net		Gross Costs		Accumulated Amortization			Net
Core technology	$	5,800	$	(3,797	)	$	2,003	$	5,800	$	(3,211	)	$	2,589
Customer relationships	6,475		(4,161		)	2,314		6,475		(3,779		)	2,696
Trade names	2,100		(1,452		)	648		2,100		(1,317		)	783
Covenant not-to-compete	200		(184		)	16		200		(154		)	46
Domain name	45		(9		)	36		45		(2		)	43
Total	$	14,620	$	(9,603	)	$	5,017	$	14,620	$	(8,463	)	$	6,157

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

Year ending	Amortization Expense
2016	$	368
2017	1,409
2018	1,401
2019	825
2020	539
Thereafter	475
Total amortization expense	$	5,017

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Note 6. Debt Obligations

On August 29, 2014, we entered into a three year, Senior Secured Revolving Line of Credit (“Revolver”) with a bank. We are obligated to pay a commitment fee of $0.2 million over the three year term of the Revolver.

The maximum principal amount that may be outstanding at any given time under the Revolver, which includes up to $3.0 million of standby letters of credit, is $10.0 million. Borrowing availability is calculated as 80% of eligible accounts receivable, with a maximum of $10.0 million.  Any borrowings under the Revolver would be collateralized by substantially all of our assets, as well as pledges of capital stock.

The Revolver requires that, if we suffer an event of default or have borrowed more than 75% of the maximum principal amount permitted to be outstanding, the Company maintains an adjusted quick ratio of at least 1.15:1.  The adjusted quick ratio is calculated by dividing quick assets (cash less restricted cash plus accounts receivable) by current liabilities (current liabilities plus outstanding standby letter of credit less the current portion of deferred revenue).  Borrowings under the Revolver bear interest at a floating rate ranging from 1.25% to 3.25% above the prime rate depending on the Company’s adjusted quick ratio.

As of September 30, 2016, the Company was in compliance with all the covenants of the Revolver.  The Company had letters of credit outstanding against the Revolver in the amount of $1.2 million, resulting in the maximum available borrowing under the Revolver to be $8.6 million.  As of September 30, 2016, the balance outstanding under the Revolver was $4.5 million, remaining borrowing availability was $4.1 million and the Company’s adjusted quick ratio was 1.46:1.  During periods when the adjusted quick ratio is below 1.5:1, any collections received by the bank on behalf of the Company will be applied to outstanding loan balances before being remitted to the Company’s operating account.

During October 2016, the $4.5 million outstanding balance was repaid in full. All principal, interest and any other fees will be due and payable in full on or prior to August 29, 2017.

Note 7. Employee Benefit Plans

At September 30, 2016, approximately 1,321,000 shares were available for grant as options or nonvested share awards under the Guidance Software, Inc. Second Amended and Restated 2004 Equity Incentive Plan (the “Plan”).

Stock Options

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

	Number of Options		Weighted Average Exercise Price		Weighted Average Remaining Contractual Term (in years)	Aggregate Intrinsic Value
Outstanding, December 31, 2015	1,675,000		$	7.63	6.6	$	239,000
Granted	689,000		$	4.03
Exercised	—		$	—
Forfeited or expired	(430,000	)	$	6.74
Outstanding, September 30, 2016	1,934,000		$	6.55	7.1	$	1,232,000
Exercisable, September 30, 2016	623,000		$	9.44	2.9	$	141,000

We define in-the-money options at September 30, 2016 as options that had exercise prices that were lower than the $5.96 fair market value of our common stock at that date.  The aggregate intrinsic value of options outstanding at September 30, 2016 is calculated as the difference between the exercise price of the underlying options and the fair market value of our common stock for the 1,340,000 shares that were in-the-money at that date, 203,000 of which were exercisable.

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Restricted Stock Awards

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

	Number of Shares		Weighted Average Fair Value
Outstanding, December 31, 2015	2,049,000		$	7.30
Granted	2,131,000		4.44
Vested	(455,000	)	7.90
Forfeited	(448,000	)	6.40
Outstanding, September 30, 2016	3,277,000		$	5.48

The total grant date fair value of shares vested under such grants during the nine months ended September 30, 2016 was $3,594,000.

On March 18, 2016, we granted approximately 586,000 performance-based restricted stock awards to certain members of our executive team, with a fair market value of $4.37 per share, which are included in our restricted stock awards outstanding.  The performance criteria are based on the achievement of certain revenue levels for the year ending December 31, 2016.  Depending on the revenue level achieved, the number of shares that will vest ranges from 10% to 200% of the 586,000 shares granted.  The performance criteria will be measured on a quarterly basis; and if any of the revenue levels are achieved during the calendar year ending December 31, 2016, 50% of the shares will vest upon the Board’s certification in February 2017, and the remaining 50% will vest on December 31, 2017.  As of September 30, 2016, the Company achieved 84% of the revenue level; as a result approximately 492,000 shares will vest in February 2017.  These performance-based restricted stock awards were considered for calculating the diluted shares outstanding balance at September 30. 2016.  However, as the Company is in a net loss position for both the three and nine months ended September 30, 2016, the performance-based restricted stock awards were considered anti-dilutive and therefore excluded from the calculation.

Share-Based Compensation

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

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

	Three Months Ended September 30,
	2016			2015
Risk-free interest rate	1.1		%	1.8		%
Dividend yield	—		%	—		%
Expected life (years)	5.71			5.65
Volatility	47.50		%	42.78		%
Weighted average grant date fair value	$	2.63		$	4.08

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

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

	Three Months Ended September 30,				Nine Months Ended September 30,
	2016		2015		2016		2015
Stock option awards	$	188	$	110	$	545	$	231
Restricted stock awards	3,029		1,604		6,269		4,878
Share-based compensation expense	$	3,217	$	1,714	$	6,814	$	5,109

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As of September 30, 2016, we estimated, with 70% or greater likelihood, that approximately 200% of the performance-based restricted stock awards would vest based on the forecasted achievement of certain revenue levels for the year ending December 31, 2016.  As a result, $1.6 million and $2.2 million of share-based compensation expense related to the performance-based restricted stock awards is included in our total restricted stock awards share-based compensation expense for the three and nine months ended, September 30, 2016, respectively.

As of September 30, 2016, approximately $2.5 million of total unrecognized share-based compensation expense related to stock options is expected to be recognized over a weighted-average period of 3.1 years.  Approximately $14.3 million of total unrecognized share-based compensation expense related to restricted stock awards is expected to be recognized over a weighted-average period of 2.6 years.  For awards outstanding at September 30, 2016, we expect to record approximately $0.2 million and $2.5 million in share-based compensation for the remainder of the fiscal year ending in 2016 related to stock options and restricted stock awards, respectively.

Note 8. Income Taxes

We account for income taxes in accordance with Income Taxes (ASC 740).  Deferred income taxes are recorded for the expected tax consequences of temporary differences between the tax bases of assets and liabilities for financial reporting purposes and amounts recognized for income tax purposes.  We record a valuation allowance to reduce our deferred tax assets to the amount of future tax benefit that is more likely than not to be realized.  As of September 30, 2016, we have recorded a valuation allowance against our net deferred tax assets resulting in a carrying value of zero.

We recorded an income tax (benefit) provision for the three and nine months ended September 30, 2016 of $(14,000) and $77,000 as compared to $77,000 and $244,000 for the same periods in 2015.  Our income tax (benefit) provision for the three and nine months ended September 30, 2016 differs from the U.S. statutory rate of 34% primarily due to the tax impact of certain share-based compensation, and the impact of providing a valuation allowance against research and development credits and deferred tax assets.  Our provision for the three and nine months ended September 2015 differs from the U.S. statutory rate of 34% primarily due to state taxes, foreign taxes, the tax impact of certain share-based compensation charges, and the impact of providing a valuation allowance against research and development credits and deferred tax assets.

Note 9. Fair Value Measurements

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

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

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

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

The following table sets forth, by level within the fair value hierarchy, financial assets and liabilities that are accounted for at fair value on a recurring basis as of September 30, 2016 and December 31, 2015 (in thousands):

	Fair Value Measurements at September 30, 2016
	Total		Level 1		Level 2		Level 3
Assets:
Money market accounts	205		205		—		—
Total assets	$	205	$	205	$	—	$	—

	Fair Value Measurements at December 31, 2015
	Total		Level 1		Level 2		Level 3
Assets:
U.S. Treasury Securities	$	2,008	$	2,008	$	—	$	—
Money market accounts	4,290		4,290		—		—
Total assets	$	6,298	$	6,298	$	—	$	—

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Note 10. Commitments and Contingencies

Third-party Software Licenses

In February 2016, the Company entered into a $1.7 million third-party software license agreement authorizing the Company to integrate software as a component of its products through February 2020.  The agreement also provides for payment by the Company of $0.3 million for two years of maintenance and support.  The $2.0 million is payable in five installments, $1.5 million is payable during the year ending December 31, 2016 and $0.5 million is payable during the first six months of 2017.  As of September 30, 2016, the outstanding balance was $1.4 million.

Letter of Credit

As of September 30, 2016 we had a $1.2 million letter of credit outstanding against our Senior Secured Revolving Line of Credit related to the lease of our corporate headquarters.

Legal Matters

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

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

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

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

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

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

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On June 16, 2016, MyKey and the Company agreed to a settlement agreement for $2.3 million, whereby in exchange for a payment by the Company, which the Company has paid, the Company received a full release of all claims for patent infringement against the Company.  The settlement payment was recorded to general and administrative expenses.

On July 29, 2016, the Company entered into a settlement agreement with TEFKAT LLC (formerly known as Tableau LLC) and its sole shareholder, Robert Botchek, related to a breach of contract stemming from the MyKey matter.  The agreement requires TEFKAT LLC to pay the Company a settlement amount of $1.2 million, which has been received by the Company.  The settlement received was recorded as an offset to the $2.3 million MyKey settlement payment, resulting in a net effect of $1.1 million recorded in general and administrative expenses.

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

Indemnifications

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

Note 11. Segment Information

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

·Products segment—Includes EnCase® Endpoint Investigator, EnCase® Endpoint Security, EnCase® eDiscovery, EnCase® Risk Manager, EnCase® Forensic and appliance sales.

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

·Professional services segment—Performs consulting services and implementations.

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

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

	Three Months Ended September 30, 2016
	Products		Subscription		Professional services		Training		Maintenance		Total
Revenues	$	9,600	$	1,543	$	4,169	$	2,094	$	10,299	$	27,705
Cost of revenues	2,574		631		3,449		1,111		573		8,338
Segment profit	$	7,026	$	912	$	720	$	983	$	9,726	19,367
Total operating expenses											21,984
Operating loss											$	(2,617	)

	Three Months Ended September 30, 2015
	Products		Subscription		Professional services		Training		Maintenance		Total
Revenues	$	7,759	$	1,790	$	5,259	$	1,992	$	10,023	$	26,823
Cost of revenues	2,520		952		3,644		1,415		601		9,132
Segment profit	$	5,239	$	838	$	1,615	$	577	$	9,422	17,691
Total operating expenses											21,089
Operating loss											$	(3,398	)

	Nine Months Ended September 30, 2016
	Products		Subscription		Professional services		Training		Maintenance		Total
Revenues	$	26,693	$	4,728	$	13,510	$	6,254	$	29,875	$	81,060
Cost of revenues	6,945		1,952		10,446		4,078		1,815		25,236
Segment profit	$	19,748	$	2,776	$	3,064	$	2,176	$	28,060	55,824
Total operating expenses											74,885
Operating loss											$	(19,061	)

	Nine Months Ended September 30, 2015
	Products		Subscription		Professional services		Training		Maintenance		Total
Revenues	$	23,093	$	4,894	$	15,052	$	6,541	$	29,796	$	79,376
Cost of revenues	6,556		2,902		11,334		4,276		1,781		26,849
Segment profit	$	16,537	$	1,992	$	3,718	$	2,265	$	28,015	52,527
Total operating expenses											63,120
Operating loss											$	(10,593	)

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

	Three Months Ended September 30,				Nine Months Ended September 30,
	2016		2015		2016		2015
Revenues
United States	$	21,483	$	20,919	$	61,642	$	60,876
Europe	3,492		3,700		11,645		10,875
Asia	1,633		1,153		4,018		4,004
Other	1,097		1,051		3,755		3,621
	$	27,705	$	26,823	$	81,060	$	79,376

Note 12. Subsequent Events

Reduction in Work Force

Subsequent to September 30, 2016, we incurred approximately $0.7 million in severance expense due to a reduction in work force.

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

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

Overview

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

Factors Affecting Our Results of Operations

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

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

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

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

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

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

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

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Critical Accounting Policies and Estimates

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

Results of Operations

The following table sets forth our results of operations for the three and nine months ended September 30, 2016 and 2015, respectively, expressed as a percentage of total revenues:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2016		2015		2016		2015
Revenues:
Product revenue	34.6	%	28.9	%	32.9	%	29.1	%
Services revenue	28.2		33.7		30.2		33.4
Maintenance revenue	37.2		37.4		36.9		37.5
Total revenues	100.0		100.0		100.0		100.0
Cost of revenues:
Cost of product revenue	9.3		9.4		8.6		8.3
Cost of services revenue	18.7		22.4		20.3		23.3
Cost of maintenance revenue	2.1		2.2		2.2		2.2
Total cost of revenues	30.1		34.0		31.1		33.8
Gross profit	69.9		66.0		68.9		66.2
Operating expenses:
Selling and marketing	39.7		34.1		40.9		35.7
Research and development	21.9		19.7		23.2		19.8
General and administrative	13.5		18.9		23.5		18.0
Depreciation and amortization	4.3		5.9		4.8		6.1
Total operating expenses	79.4		78.6		92.4		79.6
Operating loss	(9.5	)%	(12.6	)%	(23.5	)%	(13.4	)%
Other income and expense:
Interest income	—		—		—		—
Interest expense	—		—		—		—
Other income, net	—		—		—		—
Total other income and expense	—		—		—		—
Loss before income taxes	(9.5	)%	(12.6	)%	(23.5	)%	(13.4	)%
Income tax (benefit) provision	(0.1	)	0.3		0.1		0.3
Net loss	(9.4	)%	(12.9	)%	(23.6	)%	(13.7	)%

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

	Three Months Ended September 30,				Nine Months Ended September 30,
	2016		2015		2016		2015
Non-cash Share-based Compensation Data (1):
Cost of product revenue	$	14	$	26	$	43	$	87
Cost of services revenue	170		281		546		849
Cost of maintenance revenue	36		37		111		119
Selling and marketing	1,085		352		1,909		1,113
Research and development	950		397		2,078		1,211
General and administrative	962		621		2,127		1,730
Total non-cash share-based compensation	$	3,217	$	1,714	$	6,814	$	5,109

(1)Non-cash share-based compensation recorded in the three and nine month periods ended September 30, 2016 and 2015 relates to stock options and restricted share awards granted to employees measured under the fair value method.  See Note 7 to the condensed consolidated financial statements.

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Comparison of Results of Operations for the Three and Nine Months Ended September 30, 2016 and 2015

Sources of Revenue

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

	Three Months Ended September 30,					Nine Months Ended September 30,
(Dollars in thousands)	2016		Change %	2015		2016		Change %	2015
Product revenue	$	9,600	24%	$	7,759	$	26,693	16%	$	23,093
Services revenue	7,806		(14)%	9,041		24,492		(8)%	26,487
Maintenance revenue	10,299		3%	10,023		29,875		—%	29,796
Total revenues	$	27,705	3%	$	26,823	$	81,060	2%	$	79,376

Product Revenue

We generate product revenue principally from two product categories: Enterprise products and Forensic products.  Revenue from our Enterprise products includes sales related to licenses from our security suite of products which are comprised of: EnCase Endpoint Security, EnCase Endpoint Investigator, EnCase Risk Manager, as well as sales of our EnCase eDiscovery product.  Revenue of our Forensic products includes sales related to EnCase Forensic, EnCase Portable, and forensic appliance sales.  During the first two quarters of each fiscal year, we typically experience lower levels of product sales due to the seasonal budgetary cycles of our customers.  The third quarter is typically the strongest quarter for sales to our federal government customers. Typically, sales to our corporate customers are highest in the fourth quarter.

Product revenue increased by $1.8 million, or 24%, from $7.8 million to $9.6 million, and increased by $3.6 million, or 16%, from $23.1 million to $26.7 for the three and nine months ended September 30, 2016, respectively, as compared with the same periods in 2015.

The increase in product revenue for the three months ended September 30, 2016 as compared to the same period in 2015 was primarily due to a $1.8 million increase in Enterprise software revenue.

The increase in product revenue for the nine months ended September 30, 2016 as compared to the same period in 2015 was primarily due to a $2.1 million increase in Enterprise software revenue, $1.1 million increase in sales of our Forensic appliances, and a $0.4 million increase in our Forensic software sales.

For the three and nine months ended September 30, 2016, Enterprise and Forensic software sales increased primarily due to pricing increases on our Enterprise products and improved sales execution of our channel-focused sales model and, Forensic appliance sales increased due to new products released during 2015.

Services Revenue

We generate services revenue from professional services, training and subscriptions of our EnCase eDiscovery Review product.  Our professional services provides various consulting services to our clients, including network security incident response, e-discovery, civil/criminal digital investigation, implementation services, as well as a software advisory program. Our training services educate students in computer forensics principles and the use of our EnCase software products and methodology. Subscription service customers have the right to access our cloud-based document review and production software; however, they may not take possession of the software at any time during the term of the agreement. We generate subscription revenue principally from two types of customers: corporate or large enterprise customers who typically use our cloud-based software to host multiple legal cases on an ongoing basis, and law firm customers, who typically use our cloud-based software to host single cases.

Services revenue decreased $1.2 million, or 14%, from $9.0 million to $7.8 million, and decreased $2.0 million, or 8%, from $26.5 million to $24.5 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in 2015.

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The decrease in services revenue for the three months ended September 30, 2016 as compared to the same period in 2015 is primarily related to a $1.1 million decrease in our professional services revenue and a decrease of $0.2 million in our subscription revenue.  The decrease in professional services is primarily due to timing of large engagements with one of our large customers.  The decrease in subscription revenues is primarily related to $0.2 million revenue received due to the settlement of a dispute regarding data storage we received in the three months ended September 30, 2015 that did not reoccur in the same period during 2016.

The decrease in services revenue for the nine months ended September 30, 2016 as compared to the same period in 2015 is primarily related to a $1.5 million decrease in our professional services revenue, a decrease of $0.3 million in our training revenue, and a decrease of $0.2 million in subscription revenue.  The decrease in professional services is due to timing of large engagements with certain of our customers, as well as a decline in our billable headcount related to higher than usual turnover during the second quarter of 2016.  The decrease in training revenue is primarily due to lower number of students trained during the period.  The decrease in subscription revenue is primarily related to $0.2 million revenue received due to the settlement of a dispute regarding data storage we received in the three months ended September 30, 2015 that did not reoccur in the same period during 2016.

Maintenance Revenue

Maintenance revenue is generated from customers who purchase software maintenance services with new product licenses and maintenance renewals for on-premise products. Software maintenance includes software updates and upgrades, telephone and e-mail support, as well as self-service on our website.

Maintenance revenue increased by $0.3 million, or 3%, from $10.0 million to $10.3 million for the three months ended September 30, 2016, as compared to the same period in 2015, and remained flat for the nine months ended September 30, 2016, as compared to the same period in 2015.

The increase in maintenance revenue for the three month period ended September 30, 2016 as compared to the same period in 2015 was primarily due to renewals from non-current contracts being renewed during the third quarter of 2016.

Cost of Revenues

	Three Months Ended September 30,							Nine Months Ended September 30,
(Dollars in thousands)	2016			Change %	2015			2016			Change %	2015
Cost of product revenue	$	2,574		2%	$	2,520		$	6,945		6%	$	6,556
Cost of services revenue	5,191			(14)%	6,011			16,476			(11)%	18,512
Cost of maintenance revenue	573			(5)%	601			1,815			2%	1,781
Total cost of revenues	$	8,338		(9)%	$	9,132		$	25,236		(6)%	$	26,849
Share-based compensation included above:
Cost of product revenue	$	14			$	26		$	43			$	87
Cost of services revenue	$	170			$	281		$	546			$	849
Cost of maintenance revenue	$	36			$	37		$	111			$	119
Gross Margin Percentage
Products	73.2		%		67.5		%	74.0		%		71.6		%
Services	33.5		%		33.5		%	32.7		%		30.1		%
Maintenance	94.4		%		94.0		%	93.9		%		94.0		%
Total	69.9		%		66.0		%	68.9		%		66.2		%

Cost of Product Revenue

Cost of product revenue consists principally of the cost of producing our software products, including third party software royalties, the cost of manufacturing our hardware appliances and product distribution costs, including the cost of packaging, shipping, customs duties, and, to a lesser extent, compensation and related overhead expenses.  While these costs are primarily variable with respect to sales volumes, they remain low in relation to the revenues generated and result in higher gross margins than our services and training businesses.  Our gross margins can be affected by product mix, as our enterprise products are generally higher margin products than our forensic products, which include software and hardware.

Cost of product revenue increased $0.1 million, or 2%, from $2.5 million to $2.6 million, and $0.4 million, or 6%, from $6.6 million to $6.9 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in 2015.  The increase for the three and nine months ended September 30, 2016 as compared to the same periods in 2015, was primarily due to a $0.2 million and $0.7 million increase in certain appliance costs primarily related to increased sales of our appliance products, partially offset by a $0.1 million and $0.3 million reduction in employee-related costs due to a reduction in headcount, for the three and nine months ended September 30, 2016, respectively.

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Cost of Services Revenue

Cost of services revenue consists principally of employee compensation costs, including share-based compensation and related overhead, travel, facilities cost, software maintenance paid to third party vendors, and SaaS hosting infrastructure costs associated with professional services, training, and subscription services.

Cost of services revenue decreased $0.8 million, or 14%, from $6.0 million to $5.2 million, and $2.0 million, or 11%, from $18.5 million to $16.5 million, for the three and nine months ended September 30, 2016, respectively, as compared to the same periods in 2015.

The decrease in cost of services revenue for the three months ended September 30, 2016, as compared to the same period in 2015, was primarily due to a $0.8 million decrease in compensation and employee-related costs associated with a reduction in headcount.

The decrease in cost of services revenue for the nine months ended September 30, 2016, as compared to the same period in 2015, was primarily due to a $2.4 million decrease in compensation and employee-related costs, partially offset by $0.7 million in realignment expense associated with a reduction in headcount and the closure of our Orlando training center. Additionally, we had a decrease of $0.2 million in software maintenance costs primarily due to non-renewals of various third-party software maintenance contracts.

Cost of Maintenance Revenue

Cost of maintenance revenue includes third-party outsourcing fees, employee compensation costs for customer technical support and related overhead costs.

Total cost of maintenance revenue remained essentially flat at $0.6 million and $1.8 million for the three and nine months ended September 30, 2016, respectively, as compared to the same periods in 2015.

Operating Expenses

	Three Months Ended							Nine Months Ended
	September 30,							September 30,
(Dollars in thousands)	2016			Change %	2015			2016			Change %	2015
Selling and marketing expenses	$	10,984		20%	$	9,156		$	33,098		17%	$	28,357
Research and development expenses	$	6,069		15%	$	5,281		$	18,811		20%	$	15,690
General and administrative expenses	$	3,743		(26)%	$	5,078		$	19,066		34%	$	14,262
Depreciation and amortization expenses	$	1,188		(25)%	$	1,574		$	3,910		(19)%	$	4,811
Share-based compensation included above:
Selling and marketing expenses	$	1,085			$	352		$	1,909			$	1,113
Research and development expenses	$	950			$	397		$	2,078			$	1,211
General and administrative expenses	$	962			$	621		$	2,127			$	1,730
As a percentage of revenue:
Selling and marketing expenses	39.7		%		34.1		%	40.9		%		35.7		%
Research and development expenses	21.9		%		19.7		%	23.2		%		19.8		%
General and administrative expenses	13.5		%		18.9		%	23.5		%		18.0		%
Depreciation and amortization expenses	4.3		%		5.9		%	4.8		%		6.1		%

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Selling and Marketing Expenses

Selling and marketing expenses consist primarily of personnel costs and costs related to our sales force and marketing staff. Selling and marketing expenses also include expenses relating to advertising, brand building, marketing promotions and trade show events (net of amounts received from sponsors and participants), product management, and travel and allocated overhead.

Selling and marketing expenses increased $1.8 million, or 20%, from $9.2 million to $11.0 million, and increased $4.7 million, or 17%, from $28.4 million to $33.1 million for the three and nine months ended September 30, 2016, respectively, as compared to the same periods in 2015.

The increase in selling and marketing expenses for the three months ended September 30, 2016 was primarily due to a $1.8 increase in compensation and other employee-related costs due to the investment in our sales and channel-focused leadership, as compared to the same period in 2015.

The increase in selling and marketing expenses for the nine months ended September 30, 2016 was primarily due to an increase of $2.8 million of compensation and employee-related costs and $1.6 million of realignment expense due to the investment in our sales and channel-focused leadership, as well as a $0.4 million increase in marketing and promotional activities as compared to the same period in 2015.

Research and Development Expenses

Research and development expenses consist primarily of compensation, including share-based compensation and related overhead expenses.

Research and development expenses increased $0.8 million, or 15%, from $5.3 million to $6.1 million, and increased $3.1 million, or 20%, from $15.7 million to $18.8 million for the three and nine months ended September 30, 2016, respectively, as compared to the same periods in 2015.

The increase in research and development expenses for the three and nine months ended September 30, 2016, as compared to the same periods in 2015, was primarily related to a $0.8 million and a $2.8 million increase in compensation costs, respectively and other employee-related expenses primarily due to an increase in headcount.  Additionally, for the nine months ended September 30, 2016, there was a $0.4 million increase in realignment expense recorded during the first quarter of 2016 due to a leadership change in product development.

General and Administrative Expenses

General and administrative expenses consist of personnel and related costs for accounting, legal, information systems, human resources and other administrative functions.  In addition, general and administrative expenses include professional service fees, bad debt expense, and other corporate expenses and related overhead.

General and administrative expenses decreased $1.3 million, or 26%, from $5.1 million to $3.7 million, and increased $4.8 million, or 34%, from $14.3 million to $19.1 million for the three and nine months ended September 30, 2016, respectively, as compared to the same periods in 2015.

The decrease in general and administrative expenses for the three months ended September 30, 2016, as compared to the same period in 2015, was primarily due to a $1.2 million settlement received from an indemnity lawsuit related to the patent infringement lawsuit with MyKey Technology, LLC.

The increase in general and administrative expenses for the nine months ended September 30, 2016, as compared to the same period in 2015, was primarily due to $2.2 million in various consulting and legal fees related to the proxy contest with the Company’s founder, former Chief Technology Officer and former Chairman of the Board of Directors, a $1.1 million net expense related to our patent infringement litigation settlements, a $0.6 million increase in employee-related costs primarily due to an increase in share-based compensation expense related to our performance-based restricted stock awards, a $0.5 million increase in realignment expense primarily due to the closure of our Houston office, a $0.2 million reversal of bad debt expense that occurred during the third quarter of 2015 that did not reoccur in 2016, and $0.1 million increase in legal fees related to corporate governance matters.

Depreciation and Amortization Expenses

Depreciation and amortization expenses consist of depreciation and amortization of our leasehold improvements, furniture, computer hardware and software, and intangible assets.  Depreciation and amortization expenses decreased $0.4 million, or 25%, from $1.6 million to $1.2 million, and decreased $0.9 million, or 19%, from $4.8 million to $3.9 million for the three and nine months ended September 30, 2016, respectively, as compared to the same periods in 2015.  The decrease is primarily due to certain assets being fully depreciated.

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Other Income and Expense

Total other income and expense consists of interest earned on cash balances, interest expense paid and other miscellaneous income and expense items. Other income and expense decreased $10,000, or 200%, from income of $5,000 to expense of $5,000, and decreased $14,000, or 64%, from $22,000 to $8,000 for the three and nine months ended September 30, 2016, respectively, as compared to the same periods in 2015.

Income Tax (Benefit) Provision

We recorded an income tax (benefit) provision of $(14,000) and $77,000, for the three and nine months ended September 30, 2016,  respectively, as compared to $77,000 and $244,000, for the same periods in 2015.  The income tax (benefit) provision is based on our estimated effective annual tax rate and taxable income (loss) for the respective years.  Our income tax (benefit) provision for the three and nine months ended September 30, 2016 differs from the U.S. statutory rate of 34% primarily due to the tax impact of certain share-based compensation charges, and the impact of providing a valuation allowance against research and development credits and deferred tax assets. Our income tax provision for the three and nine months ended September 2015 differs from the U.S. statutory rate of 34% primarily due to state taxes, foreign taxes, the tax impact of certain share-based compensation charges, and the impact of providing a valuation allowance against research and development credits and deferred tax assets.

Liquidity and Capital Resources

Since inception, we have largely financed our operations from the cash flow generated from the sale of our products and services, as well as proceeds from our initial public offering.  As of September 30, 2016, we had $11.7 million in cash and cash equivalents.  We believe that our cash flow from operations and our cash and cash equivalents are sufficient to fund our working capital and capital expenditure requirements for at least the next twelve months.

Changes in Cash Flow

We generate cash from operating activities from cash collections related to the sale of our products and services. Net cash used in operating activities was $9.9 million for the nine months ended September 30, 2016 as compared to net cash provided by operating activities of $1.5 million for the same period in 2015.  The change in cash was primarily a result of the net loss of $19.1 million for the nine months ended September 30, 2016 as compared to the net loss of $10.8 million for the same period in 2015, a decrease of $3.4 million in deferred revenues during the nine months ended September 30, 2016 as compared to an increase of $1.5 million for the same period in 2015, an increase of $6.8 million in share-based compensation during the nine months ended September 30, 2016 as compared to an increase of $5.1 million for the same period in 2015, partially offset by an increase in accounts payable of $3.1 million during the nine months ended September 30, 2016 as compared to a decrease of $2.4 million for the same period in 2015 and a decrease in prepaid expenses and other assets of $2.3 million during the nine months ended September 30, 2016 as compared to an increase of $0.9 million for the same period in 2015.

Net cash used in investing activities was $1.9 million for the nine months ended September 30, 2016, as compared to $3.4 million for the same period in 2015.  The decrease in cash used in investing activities was primarily due to the purchase of property and equipment related to new servers and technology equipment during the nine months ended September 30, 2015, that did not reoccur during the same period in 2016.

Net cash provided by financing activities was $4.4 million for the nine months ended September 30, 2016, as compared to $1.6 million for the same period in 2015.  The increase in cash provided by financing activities was primarily due to a $4.5 million drawing on our line of credit during the nine months ended September 30, 2016, partially offset by a decrease of $59,000 in principal payments made on capital leases and other obligations during the nine months ended September 30, 2016, as compared to $63,000 in principal payments on capital leases for the same period in 2015.  In addition, during the nine months ended September 30, 2015, cash provided by financing activities included $1.7 million in proceeds related to the exercise of stock options which did not reoccur during the same period in 2016.

On August 29, 2014, we entered into a three year, Senior Secured Revolving Line of Credit (“Revolver”) with a bank. We are obligated to pay a commitment fee of $0.2 million over the three year term of the Revolver.

The maximum principal amount that may be outstanding at any given time under the Revolver, which includes up to $3.0 million of standby letters of credit, is $10.0 million. Borrowing availability is calculated as 80% of eligible accounts receivable, with a maximum of $10.0 million.  Any borrowings under the Revolver would be collateralized by substantially all of our assets, as well as pledges of capital stock.

The Revolver requires that, if we suffer an event of default or have borrowed more than 75% of the maximum principal amount permitted to be outstanding, the Company maintains an adjusted quick ratio of at least 1.15:1.  The adjusted quick ratio is calculated by dividing quick assets (cash less restricted cash plus accounts receivable) by current liabilities (current liabilities plus outstanding standby letter of credit less the current portion of deferred revenue).  Borrowings under the Revolver bear interest at a floating rate ranging from 1.25% to 3.25% above the prime rate depending on the Company’s adjusted quick ratio.

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As of September 30, 2016, the Company was in compliance with all the covenants of the Revolver.  The Company had letters of credit outstanding against the Revolver in the amount of $1.2 million, resulting in the maximum available borrowing under the Revolver to be $8.6 million.  As of September 30, 2016, the balance outstanding under the Revolver was $4.5 million, remaining borrowing availability was $4.1 million and the Company’s adjusted quick ratio was 1.46:1.  During periods when the adjusted quick ratio is below 1.5:1, any collections received by the bank on behalf of the Company will be applied to outstanding loan balances before being remitted to the Company’s operating account.

During October 2016, the $4.5 million outstanding balance was repaid in full. All principal, interest and any other fees will be due and payable in full on or prior to August 29, 2017.

Contractual Obligations and Commitments

In February 2016, the Company entered into a $1.7 million third-party software license agreement authorizing the Company to integrate third-party software as a component of its products through February 2020.  The agreement also required payment of $0.3 million by the Company for two years of maintenance and support.  The $2.0 million is payable in five installments, of which $1.5 million is payable during the year ending December 31, 2016 and $0.5 million is payable during the first six months of 2017.  As of September 30, 2016, the outstanding balance was $1.4 million.

Off-Balance Sheet Arrangements

At September 30, 2016, we had no off-balance sheet arrangements as defined in Item 303(a)(4) of the SEC’s Regulation S-K.  We do not have material relationships or transactions with persons or entities that derive benefits from their non-independent relationship with us or our related parties except as disclosed in this report.

Item 3.Quantitative and Qualitative Disclosure about Market Risk

Market Risk. Market risk represents the risk of loss that may impact our financial position due to adverse changes in financial market prices and rates.  Our market risk exposure is primarily a result of fluctuations in foreign exchange rates, interest rates and credit risk.  We do not hold or issue financial instruments for trading purposes.

Foreign Currency Risk. To date, substantially all of our international sales have been denominated in US dollars, and therefore, the majority of our revenues are not subject to foreign currency risk.  Our operating expenses and cash flows are subject to fluctuations due to changes in foreign currency exchange rates, but such changes have historically had relatively little impact on our operating results and cash flows.  A strengthening of the dollar could make our products and services less competitive in foreign markets and therefore could reduce our revenues. In the future, an increased portion of our revenues and costs may be denominated in foreign currencies.  We do not enter into derivative instrument transactions for trading or speculative purposes.

Interest Rate Risk.  Our investment portfolio, consisting of highly liquid debt instruments of the US government at September 30, 2016, is subject to interest rate risk.  The fair value of our investment portfolio would not be significantly impacted by either a 100 basis point increase or decrease in interest rates due mainly to the short-term nature of our investment portfolio.

Item 4.Controls and Procedures

Management, with the participation of the President and Chief Executive Officer and Chief Financial Officer, has performed an evaluation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934).  This evaluation includes consideration of the controls, processes and procedures that are designed to ensure that information required to be disclosed by us in the reports we file under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to our management, including our President and Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. Based on such evaluation, our President and Chief Executive Officer and Chief Financial Officer concluded that, as of September 30, 2016, our disclosure controls and procedures were effective.

Changes in Internal Control Over Financial Reporting

There have been no changes in our internal control over financial reporting during the nine months ended September 30, 2016 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

26

PART II. OTHER INFORMATION

Item 1.Legal Proceedings

The information contained in Note 10 to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q is incorporated by reference herein.

Item 1A.Risk Factors

There have been no material changes to the risk factors as presented in our Annual Report on Form 10-K for the year ended December 31, 2015, filed with the U.S. Securities and Exchange Commission on February 25, 2016.

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

There have been no material changes to the Unregistered Sales of Equity Securities and Use of Processed as presented in our Annual Report on Form 10-K for the year ended December 31, 2015, filed with the U.S. Securities and Exchange Commission on February 25, 2016.

Item 3.Defaults upon Senior Securities

No information is required in response to this item.

Item 4.[Removed and Reserved]

No information is required in response to this item.

Item 5.Other Information

No information is required in response to this item.

Item 6.Exhibits

Exhibit Number	Description of Documents
31.1	Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2	Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1†	Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2†	Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS	XBRL Instance Document
101.SCH	XBRL Taxonomy Extension Schema Document
101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF	XBRL Taxonomy Extension Definition Linkbase Document
101.LAB	XBRL Taxonomy Extension Label Linkbase Document
101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document

†These certifications are being furnished solely to accompany this Quarterly Report pursuant to 18 U.S.C. Section 1350, and are not being filed for purposes of Section 18 of the Securities Exchange Act of 1934 and are not to be incorporated by reference into any filing of Guidance Software, Inc., whether made before or after the date hereof, regardless of any general incorporation language in such filing.

27

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.

Guidance Software, Inc.
By:	/s/ Barry J. Plaga
	Barry J. Plaga
	Chief Financial and Operating Officer
	(Principal Financial Officer)

Dated: November 8, 2016

28

EX-31.1

Exhibit 31.1

CERTIFICATION OF CHIEF EXECUTIVE OFFICER

PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

I, Patrick Dennis, certify that:

1.I have reviewed this quarterly report on Form 10-Q of Guidance Software, Inc.;

2.Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a)Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b)Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c)Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d)Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a)All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b)Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: November 8, 2016	/s/ Patrick Dennis
	Patrick Dennis
	President and Chief Executive Officer

EX-31.2

Exhibit 31.2

CERTIFICATION OF CHIEF FINANCIAL OFFICER

PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

I, Barry J. Plaga, certify that:

1.I have reviewed this quarterly report on Form 10-Q of Guidance Software, Inc.;

2.Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a)Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b)Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c)Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d)Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a)All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b)Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: November 8, 2016	/s/ Barry J. Plaga
	Barry J. Plaga
	Chief Financial and Operating Officer

EX-32.1

Exhibit 32.1

CERTIFICATION OF CHIEF EXECUTIVE OFFICER

PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

Pursuant to 18 U.S.C. § 1350, as created by Section 906 of the Sarbanes-Oxley Act of 2002, the undersigned officer of Guidance Software, Inc. (the “Company”) hereby certifies that:

(i)the accompanying Quarterly Report on Form 10-Q of the Company for the quarter ended September 30, 2016 (the “Report”) fully complies with the requirements of Section 13(a) or Section 15(d), as applicable, of the Securities Exchange Act of 1934, as amended; and

(ii)the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: November 8, 2016	/s/ Patrick Dennis
	Patrick Dennis
	President and Chief Executive Officer

A signed original of this written statement required by Section 906 of the Sarbanes-Oxley Act of 2002 (“Section 906”), or other document authenticating, acknowledging, or otherwise adopting the signature that appears in typed form within the electronic version of this written statement required by Section 906, has been provided to Guidance Software, Inc. and will be retained by Guidance Software, Inc. and furnished to the Securities and Exchange Commission or its staff upon request.

EX-32.2

Exhibit 32.2

CERTIFICATION OF CHIEF FINANCIAL OFFICER

PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

Pursuant to 18 U.S.C. § 1350, as created by Section 906 of the Sarbanes-Oxley Act of 2002, the undersigned officer of Guidance Software, Inc. (the “Company”) hereby certifies that:

(i)the accompanying Quarterly Report on Form 10-Q of the Company for the quarter ended September 30, 2016 (the “Report”) fully complies with the requirements of Section 13(a) or Section 15(d), as applicable, of the Securities Exchange Act of 1934, as amended; and

(ii)the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: November 8, 2016	/s/ Barry J. Plaga
	Barry J. Plaga
	Chief Financial and Operating Officer

A signed original of this written statement required by Section 906 of the Sarbanes-Oxley Act of 2002 (“Section 906”), or other document authenticating, acknowledging, or otherwise adopting the signature that appears in typed form within the electronic version of this written statement required by Section 906, has been provided to Guidance Software, Inc. and will be retained by Guidance Software, Inc. and furnished to the Securities and Exchange Commission or its staff upon request.

XML

Document and Entity Information - shares	9 Months Ended
	Sep. 30, 2016	Nov. 04, 2016
Document and Entity Information
Entity Registrant Name	Guidance Software, Inc.
Entity Central Index Key	0001375557
Document Type	10-Q
Document Period End Date	Sep. 30, 2016
Amendment Flag	false
Current Fiscal Year End Date	--12-31
Entity Current Reporting Status	Yes
Entity Filer Category	Accelerated Filer
Entity Common Stock, Shares Outstanding		32,149,000
Document Fiscal Year Focus	2016
Document Fiscal Period Focus	Q3

XML

CONDENSED CONSOLIDATED BALANCE SHEETS - USD ($) $ in Thousands	Sep. 30, 2016	Dec. 31, 2015
Current assets:
Cash and cash equivalents	$ 11,654	$ 18,967
Trade receivables, net of allowance for doubtful accounts of $293 and $376, respectively	21,555	21,434
Inventory	2,283	2,543
Prepaid expenses and other current assets	4,959	3,335
Total current assets	40,451	46,279
Long-term assets:
Property and equipment, net	12,353	13,513
Intangible assets, net	5,017	6,157
Goodwill	14,632	14,632
Other assets	2,394	1,709
Total long-term assets	34,396	36,011
Total assets	74,847	82,290
Current liabilities:
Accounts payable	6,255	3,335
Accrued liabilities	10,854	9,884
Bank line of credit	4,500
Deferred revenues	39,716	41,553
Total current liabilities	61,325	54,772
Long-term liabilities:
Deferred rent and other long-term liabilities	7,379	7,527
Deferred revenues	6,643	8,242
Deferred tax liabilities	579	511
Total long-term liabilities	14,601	16,280
Commitments and contingencies (Note 10)
Stockholders' equity:
Preferred stock, $0.001 par value: 10,000,000 shares authorized; no shares issued or outstanding
Common stock, $0.001 par value; 100,000,000 shares authorized; 33,989,000 and 32,306,000 shares issued, respectively; and 32,210,000 and 30,526,000 shares outstanding, respectively	26	25
Additional paid-in capital	125,526	118,714
Treasury stock, at cost, 1,779,000 and 1,779,000 shares, respectively	(11,479)	(11,479)
Accumulated deficit	(115,152)	(96,022)
Total stockholders' (deficit) equity	(1,079)	11,238
Total liabilities and stockholders' equity	$ 74,847	$ 82,290

XML

CONDENSED CONSOLIDATED BALANCE SHEETS (Parenthetical) - USD ($) $ in Thousands	Sep. 30, 2016	Dec. 31, 2015
CONDENSED CONSOLIDATED BALANCE SHEETS
Trade receivables, allowance for doubtful accounts (in dollars)	$ 293	$ 376
Preferred stock, par value (in dollars per share)	$ 0.001	$ 0.001
Preferred stock, shares authorized	10,000,000	10,000,000
Preferred stock, shares issued	0	0
Preferred stock, shares outstanding	0	0
Common stock, par value (in dollars per share)	$ 0.001	$ 0.001
Common stock, shares authorized	100,000,000	100,000,000
Common stock, shares issued	33,989,000	32,306,000
Common stock, shares outstanding	32,210,000	30,526,000
Treasury stock, shares	1,779,000	1,779,000

XML

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS - USD ($) shares in Thousands, $ in Thousands	3 Months Ended		9 Months Ended
	Sep. 30, 2016	Sep. 30, 2015	Sep. 30, 2016	Sep. 30, 2015
Revenues:
Product revenue	$ 9,600	$ 7,759	$ 26,693	$ 23,093
Services revenue	7,806	9,041	24,492	26,487
Maintenance revenue	10,299	10,023	29,875	29,796
Total revenues	27,705	26,823	81,060	79,376
Cost of revenues (excluding amortization and depreciation, shown below):
Cost of product revenue	2,574	2,520	6,945	6,556
Cost of services revenue	5,191	6,011	16,476	18,512
Cost of maintenance revenue	573	601	1,815	1,781
Total cost of revenues (excluding amortization and depreciation, shown below)	8,338	9,132	25,236	26,849
Operating expenses:
Selling and marketing	10,984	9,156	33,098	28,357
Research and development	6,069	5,281	18,811	15,690
General and administrative	3,743	5,078	19,066	14,262
Depreciation and amortization	1,188	1,574	3,910	4,811
Total operating expenses	21,984	21,089	74,885	63,120
Operating loss	(2,617)	(3,398)	(19,061)	(10,593)
Other income and expense:
Interest income		3	8	8
Interest expense	(10)	(3)	(14)	(7)
Other income, net	5	4	14	21
Total other income and expense	(5)	4	8	22
Loss before income taxes	(2,622)	(3,394)	(19,053)	(10,571)
Income tax (benefit) provision	(14)	77	77	244
Net loss	$ (2,608)	$ (3,471)	$ (19,130)	$ (10,815)
Net loss per share:
Basic (in dollars per share)	$ (0.09)	$ (0.12)	$ (0.67)	$ (0.39)
Diluted (in dollars per share)	$ (0.09)	$ (0.12)	$ (0.67)	$ (0.39)
Weighted average number of shares used in per share calculation:
Basic (in shares)	29,020	28,197	28,743	27,864
Diluted (in shares)	29,020	28,197	28,743	27,864

XML

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS - USD ($) $ in Thousands	9 Months Ended
	Sep. 30, 2016	Sep. 30, 2015
Operating Activities:
Net loss	$ (19,130)	$ (10,815)
Adjustments to reconcile net loss to net cash (used in) provided by operating activities:
Depreciation and amortization	3,910	4,811
Recovery of bad debt		(200)
Share-based compensation	6,814	5,109
Deferred taxes	68	69
Loss on disposal of assets	126	14
Changes in operating assets and liabilities:
Restricted cash		153
Trade receivables	(121)	379
Inventory	260	199
Prepaid expenses and other assets	(2,310)	905
Accounts payable	3,098	(2,417)
Accrued liabilities	836	1,752
Deferred revenues	(3,436)	1,492
Net cash (used in) provided by operating activities	(9,885)	1,451
Investing Activities:
Purchase of property and equipment	(1,869)	(3,429)
Net cash used in investing activities	(1,869)	(3,429)
Financing Activities:
Proceeds from the exercise of stock options		1,687
Borrowings on bank line of credit	4,500
Principal payments on capital lease obligations and other obligations	(59)	(63)
Net cash provided by financing activities	4,441	1,624
Net decrease in cash and cash equivalents	(7,313)	(354)
Cash and cash equivalents, beginning of period	18,967	18,355
Cash and cash equivalents, end of period	11,654	18,001
Non-cash investing and financing activities:
Purchase of equipment included in accounts payable and accrued expenses	$ 32	$ 98

XML

Description of the Business

9 Months Ended

Sep. 30, 2016

Description of the Business

Description of the Business

Note 1. Description of the Business

General

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

Our main products and services are:

Our security suite of products:

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

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

· EnForce Risk Manager is a new data risk and privacy solution.  It allows organizations to implement a proactive approach to information governance, ensuring that sensitive data is identified, classified and remediated allowing organizations to reduce their cyber attack surface area, significantly mitigating potential damage from breaches and improving their ability to comply with global data protection mandates.

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

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

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

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

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

XML

Summary of Significant Accounting Policies

9 Months Ended

Sep. 30, 2016

Summary of Significant Accounting Policies

Summary of Significant Accounting Policies

Note 2. Summary of Significant Accounting Policies

Basis of Presentation

The accompanying condensed consolidated balance sheets as of September 30, 2016 and the condensed consolidated statements of operations for the three and nine months ended September 30, 2016 and 2015 and cash flows for the nine months ended September 30, 2016 and 2015 are unaudited.  These statements should be read in conjunction with the audited consolidated financial statements and related notes, together with management’s discussion and analysis of financial position and results of operations, contained in our Annual Report on Form 10-K for the year ended December 31, 2015, filed with the U.S. Securities and Exchange Commission (the “SEC”) on February 25, 2016.

The accompanying condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States, or (“GAAP”), and pursuant to the rules and regulations of the SEC for interim financial reporting.  In the opinion of our management, the unaudited condensed consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2015 and include all normal and recurring adjustments necessary for the fair presentation of our financial position as of September 30, 2016 and our results of operations for the three and nine months ended September 30, 2016 and 2015 and our cash flows for the nine months ended September 30, 2016 and 2015.  The condensed consolidated balance sheet as of December 31, 2015 has been derived from the December 31, 2015 audited financial statements.  The operating results for the three and nine month periods ended September 30, 2016 are not necessarily indicative of the results that will be achieved for the full fiscal year or for future periods.

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

Reclassification of Liabilities

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

Use of Estimates and Assumptions

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

Cash and Cash Equivalents

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

Fair Value of Financial Instruments

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

Trade Receivables

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

Inventory

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

Amortization of Intangible Assets with Finite Lives

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

Goodwill and Indefinite-Lived Intangibles

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

Concentrations of Credit Risk

Financial instruments that potentially subject us to significant concentrations of credit risk consist primarily of cash and cash equivalents and accounts receivable.  We restrict our investments in cash and cash equivalents to financial institutions, US government or federal agency instruments and obligations of corporations with high credit ratings.  At September 30, 2016, the majority of our cash balances were held at financial institutions located in California in accounts that are insured by the Federal Deposit Insurance Corporation for up to $250,000. Uninsured balances aggregate approximately $11.3 million as of September 30, 2016.  At September 30, 2016 all of our cash equivalents consisted of financial institution obligations.  We periodically perform credit evaluations of our customers and maintain reserves for potential losses on our accounts receivable.  We do not believe we are subject to concentrations of credit risk with respect to such receivables.

Revenue Recognition

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Revenue Recognition for Hardware and Subscription Revenues (Nonsoftware Elements)

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

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

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

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

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

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

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

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

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

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

Recently Issued Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (“FASB”) and International Accounting Standards Board (“IASB”) jointly issued ASU No. 2014-09, Revenue from Contracts with Customers, which supercedes the revenue recognition requirements in ASC 605 Revenue Recognition.  ASU 2014-09 is a comprehensive new revenue recognition standard that will supercede nearly all existing revenue recognition guidance under US GAAP.  The standard’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services.  In doing so, companies will need to use more judgment and make more estimates than under current authoritative guidance.  These may include identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation.  The standard is effective beginning after December 15, 2016, and early adoption is not permitted under US GAAP.  On April 1, 2015, the FASB voted to propose to defer the effective date of ASU 2014-09 by one year.  The standard is effective for fiscal years beginning after December 15, 2017, and early adoption is not permitted under US GAAP.  We are currently evaluating the financial statement impact of the new revenue recognition standard, as well as its impact on our accounting policies, business processes, systems and controls.

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

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

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

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

Realignment Expense

As a result of reducing headcount and the closing of our Orlando and Houston offices, we incurred approximately $0.4 million and $3.5 million during the three and nine months ended September 30, 2016, respectively, in rent expense, severance and related expenses in cost of services revenues, selling and marketing, research and development and general administrative expenses.

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Net Loss Per Share

9 Months Ended

Sep. 30, 2016

Net Loss Per Share

Net Loss Per Share

Note 3. Net Loss Per Share

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

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

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

	Three Months Ended September 30,						Nine Months Ended September 30,
	2016			2015			2016			2015
Basic loss per common share:
Numerator:
Net loss	$	(2,608	)	$	(3,471	)	$	(19,130	)	$	(10,815	)
Net loss allocated to common stockholders	$	(2,608	)	$	(3,471	)	$	(19,130	)	$	(10,815	)
Denominator:
Basic weighted average shares outstanding	29,020			28,197			28,743			27,864
Net loss per basic common share	$	(0.09	)	$	(0.12	)	$	(0.67	)	$	(0.39	)
Diluted loss per common share:
Numerator:
Net loss	$	(2,608	)	$	(3,471	)	$	(19,130	)	$	(10,815	)
Net loss allocated to common stockholders	$	(2,608	)	$	(3,471	)	$	(19,130	)	$	(10,815	)
Denominator:
Basic weighted average shares outstanding	29,020			28,197			28,743			27,864
Effect of dilutive share-based awards	—			—			—			—
Diluted weighted average shares outstanding	29,020			28,197			28,743			27,864
Net loss per diluted common share	$	(0.09	)	$	(0.12	)	$	(0.67	)	$	(0.39	)

Antidilutive securities, which consist of stock options and restricted stock awards that are not included in the diluted net loss per share calculation, consisted of an aggregate of approximately 1,732,000 and 2,338,000 shares for the three and nine months ended September 30, 2016, respectively, and 918,000 and 1,920,000 shares for the three and nine months ended September 30, 2015, respectively.

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Inventory

9 Months Ended

Sep. 30, 2016

Inventory

Inventory

Note 4. Inventory

Inventory is comprised of hardware components, packaged software components and finished goods and is valued at the lower of cost or market, using the weighted average cost method.  The following table sets forth, by major classes, inventory as of September 30, 2016 and December 31, 2015 (in thousands):

	September 30, 2016		December 31, 2015
Inventory:
Components	$	1,167	$	1,082
Finished goods	1,116		1,461
Total inventory	$	2,283	$	2,543

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Goodwill and Other Intangibles

9 Months Ended

Sep. 30, 2016

Goodwill and Other Intangibles

Goodwill and Other Intangibles

Note 5. Goodwill and Other Intangibles

We evaluate goodwill and indefinite-lived intangible assets for impairment on an annual basis, or more frequently if circumstances indicate impairment may have occurred, and there have been no impairment charges related to such assets through September 30, 2016.  We expect the balance of goodwill assigned to our products segment to be deductible for tax purposes while the balance of goodwill assigned to our subscription and professional services segments will not be deductible for tax purposes.

Intangible assets are amortized on a straight-line basis over their estimated useful lives, with the exception of customer relationships, which are amortized on a double-declining basis.  Amortization expense for intangible assets with finite lives was $0.4 million and $1.1 million for the three and nine months ended September 30, 2016, respectively, and $0.4 million and $1.3 million for the three and nine months ended September 30, 2015, respectively. The following table summarizes cumulative amortization expense related to intangible assets subject to amortization as of September 30, 2016 and December 31, 2015 (in thousands):

	September 30, 2016							December 31, 2015
	Gross Costs		Accumulated Amortization			Net		Gross Costs		Accumulated Amortization			Net
Core technology	$	5,800	$	(3,797	)	$	2,003	$	5,800	$	(3,211	)	$	2,589
Customer relationships	6,475		(4,161		)	2,314		6,475		(3,779		)	2,696
Trade names	2,100		(1,452		)	648		2,100		(1,317		)	783
Covenant not-to-compete	200		(184		)	16		200		(154		)	46
Domain name	45		(9		)	36		45		(2		)	43
Total	$	14,620	$	(9,603	)	$	5,017	$	14,620	$	(8,463	)	$	6,157

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

Year ending	Amortization Expense
2016	$	368
2017	1,409
2018	1,401
2019	825
2020	539
Thereafter	475
Total amortization expense	$	5,017

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Debt Obligations

9 Months Ended

Sep. 30, 2016

Debt Obligations

Debt Obligations

Note 6. Debt Obligations

On August 29, 2014, we entered into a three year, Senior Secured Revolving Line of Credit (“Revolver”) with a bank. We are obligated to pay a commitment fee of $0.2 million over the three year term of the Revolver.

The maximum principal amount that may be outstanding at any given time under the Revolver, which includes up to $3.0 million of standby letters of credit, is $10.0 million. Borrowing availability is calculated as 80% of eligible accounts receivable, with a maximum of $10.0 million.  Any borrowings under the Revolver would be collateralized by substantially all of our assets, as well as pledges of capital stock.

The Revolver requires that, if we suffer an event of default or have borrowed more than 75% of the maximum principal amount permitted to be outstanding, the Company maintains an adjusted quick ratio of at least 1.15:1.  The adjusted quick ratio is calculated by dividing quick assets (cash less restricted cash plus accounts receivable) by current liabilities (current liabilities plus outstanding standby letter of credit less the current portion of deferred revenue).  Borrowings under the Revolver bear interest at a floating rate ranging from 1.25% to 3.25% above the prime rate depending on the Company’s adjusted quick ratio.

As of September 30, 2016, the Company was in compliance with all the covenants of the Revolver.  The Company had letters of credit outstanding against the Revolver in the amount of $1.2 million, resulting in the maximum available borrowing under the Revolver to be $8.6 million.  As of September 30, 2016, the balance outstanding under the Revolver was $4.5 million, remaining borrowing availability was $4.1 million and the Company’s adjusted quick ratio was 1.46:1.  During periods when the adjusted quick ratio is below 1.5:1, any collections received by the bank on behalf of the Company will be applied to outstanding loan balances before being remitted to the Company’s operating account.

During October 2016, the $4.5 million outstanding balance was repaid in full. All principal, interest and any other fees will be due and payable in full on or prior to August 29, 2017.

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Employee Benefit Plans

9 Months Ended

Sep. 30, 2016

Employee Benefit Plans

Employee Benefit Plans

Note 7. Employee Benefit Plans

At September 30, 2016, approximately 1,321,000 shares were available for grant as options or nonvested share awards under the Guidance Software, Inc. Second Amended and Restated 2004 Equity Incentive Plan (the “Plan”).

Stock Options

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

	Number of Options		Weighted Average Exercise Price		Weighted Average Remaining Contractual Term (in years)	Aggregate Intrinsic Value
Outstanding, December 31, 2015	1,675,000		$	7.63	6.6	$	239,000
Granted	689,000		$	4.03
Exercised	—		$	—
Forfeited or expired	(430,000	)	$	6.74
Outstanding, September 30, 2016	1,934,000		$	6.55	7.1	$	1,232,000
Exercisable, September 30, 2016	623,000		$	9.44	2.9	$	141,000

We define in-the-money options at September 30, 2016 as options that had exercise prices that were lower than the $5.96 fair market value of our common stock at that date.  The aggregate intrinsic value of options outstanding at September 30, 2016 is calculated as the difference between the exercise price of the underlying options and the fair market value of our common stock for the 1,340,000 shares that were in-the-money at that date, 203,000 of which were exercisable.

Restricted Stock Awards

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

	Number of Shares		Weighted Average Fair Value
Outstanding, December 31, 2015	2,049,000		$	7.30
Granted	2,131,000		4.44
Vested	(455,000	)	7.90
Forfeited	(448,000	)	6.40
Outstanding, September 30, 2016	3,277,000		$	5.48

The total grant date fair value of shares vested under such grants during the nine months ended September 30, 2016 was $3,594,000.

On March 18, 2016, we granted approximately 586,000 performance-based restricted stock awards to certain members of our executive team, with a fair market value of $4.37 per share, which are included in our restricted stock awards outstanding.  The performance criteria are based on the achievement of certain revenue levels for the year ending December 31, 2016.  Depending on the revenue level achieved, the number of shares that will vest ranges from 10% to 200% of the 586,000 shares granted.  The performance criteria will be measured on a quarterly basis; and if any of the revenue levels are achieved during the calendar year ending December 31, 2016, 50% of the shares will vest upon the Board’s certification in February 2017, and the remaining 50% will vest on December 31, 2017.  As of September 30, 2016, the Company achieved 84% of the revenue level; as a result approximately 492,000 shares will vest in February 2017.  These performance-based restricted stock awards were considered for calculating the diluted shares outstanding balance at September 30. 2016.  However, as the Company is in a net loss position for both the three and nine months ended September 30, 2016, the performance-based restricted stock awards were considered anti-dilutive and therefore excluded from the calculation.

Share-Based Compensation

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

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

	Three Months Ended September 30,
	2016			2015
Risk-free interest rate	1.1		%	1.8		%
Dividend yield	—		%	—		%
Expected life (years)	5.71			5.65
Volatility	47.50		%	42.78		%
Weighted average grant date fair value	$	2.63		$	4.08

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

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

	Three Months Ended September 30,				Nine Months Ended September 30,
	2016		2015		2016		2015
Stock option awards	$	188	$	110	$	545	$	231
Restricted stock awards	3,029		1,604		6,269		4,878
Share-based compensation expense	$	3,217	$	1,714	$	6,814	$	5,109

As of September 30, 2016, we estimated, with 70% or greater likelihood, that approximately 200% of the performance-based restricted stock awards would vest based on the forecasted achievement of certain revenue levels for the year ending December 31, 2016.  As a result, $1.6 million and $2.2 million of share-based compensation expense related to the performance-based restricted stock awards is included in our total restricted stock awards share-based compensation expense for the three and nine months ended, September 30, 2016, respectively.

As of September 30, 2016, approximately $2.5 million of total unrecognized share-based compensation expense related to stock options is expected to be recognized over a weighted-average period of 3.1 years.  Approximately $14.3 million of total unrecognized share-based compensation expense related to restricted stock awards is expected to be recognized over a weighted-average period of 2.6 years.  For awards outstanding at September 30, 2016, we expect to record approximately $0.2 million and $2.5 million in share-based compensation for the remainder of the fiscal year ending in 2016 related to stock options and restricted stock awards, respectively.

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Income Taxes

9 Months Ended

Sep. 30, 2016

Income Taxes

Income Taxes

Note 8. Income Taxes

We account for income taxes in accordance with Income Taxes (ASC 740).  Deferred income taxes are recorded for the expected tax consequences of temporary differences between the tax bases of assets and liabilities for financial reporting purposes and amounts recognized for income tax purposes.  We record a valuation allowance to reduce our deferred tax assets to the amount of future tax benefit that is more likely than not to be realized.  As of September 30, 2016, we have recorded a valuation allowance against our net deferred tax assets resulting in a carrying value of zero.

We recorded an income tax (benefit) provision for the three and nine months ended September 30, 2016 of $(14,000) and $77,000 as compared to $77,000 and $244,000 for the same periods in 2015.  Our income tax (benefit) provision for the three and nine months ended September 30, 2016 differs from the U.S. statutory rate of 34% primarily due to the tax impact of certain share-based compensation, and the impact of providing a valuation allowance against research and development credits and deferred tax assets.  Our provision for the three and nine months ended September 2015 differs from the U.S. statutory rate of 34% primarily due to state taxes, foreign taxes, the tax impact of certain share-based compensation charges, and the impact of providing a valuation allowance against research and development credits and deferred tax assets.

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Fair Value Measurements

9 Months Ended

Sep. 30, 2016

Fair Value Measurements

Fair Value Measurements

Note 9. Fair Value Measurements

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

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

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

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

The following table sets forth, by level within the fair value hierarchy, financial assets and liabilities that are accounted for at fair value on a recurring basis as of September 30, 2016 and December 31, 2015 (in thousands):

	Fair Value Measurements at September 30, 2016
	Total		Level 1		Level 2		Level 3
Assets:
Money market accounts	205		205		—		—
Total assets	$	205	$	205	$	—	$	—

	Fair Value Measurements at December 31, 2015
	Total		Level 1		Level 2		Level 3
Assets:
U.S. Treasury Securities	$	2,008	$	2,008	$	—	$	—
Money market accounts	4,290		4,290		—		—
Total assets	$	6,298	$	6,298	$	—	$	—

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Commitments and Contingencies

9 Months Ended

Sep. 30, 2016

Commitments and Contingencies

Commitments and Contingencies

Note 10. Commitments and Contingencies

Third-party Software Licenses

In February 2016, the Company entered into a $1.7 million third-party software license agreement authorizing the Company to integrate software as a component of its products through February 2020.  The agreement also provides for payment by the Company of $0.3 million for two years of maintenance and support.  The $2.0 million is payable in five installments, $1.5 million is payable during the year ending December 31, 2016 and $0.5 million is payable during the first six months of 2017.  As of September 30, 2016, the outstanding balance was $1.4 million.

Letter of Credit

As of September 30, 2016 we had a $1.2 million letter of credit outstanding against our Senior Secured Revolving Line of Credit related to the lease of our corporate headquarters.

Legal Matters

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

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

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

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

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

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

On June 16, 2016, MyKey and the Company agreed to a settlement agreement for $2.3 million, whereby in exchange for a payment by the Company, which the Company has paid, the Company received a full release of all claims for patent infringement against the Company.  The settlement payment was recorded to general and administrative expenses.

On July 29, 2016, the Company entered into a settlement agreement with TEFKAT LLC (formerly known as Tableau LLC) and its sole shareholder, Robert Botchek, related to a breach of contract stemming from the MyKey matter.  The agreement requires TEFKAT LLC to pay the Company a settlement amount of $1.2 million, which has been received by the Company.  The settlement received was recorded as an offset to the $2.3 million MyKey settlement payment, resulting in a net effect of $1.1 million recorded in general and administrative expenses.

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

Indemnifications

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

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Segment Information

9 Months Ended

Sep. 30, 2016

Segment Information

Segment Information

Note 11. Segment Information

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

· Products segment—Includes EnCase® Endpoint Investigator, EnCase® Endpoint Security, EnCase® eDiscovery, EnCase® Risk Manager, EnCase® Forensic and appliance sales.

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

· Professional services segment—Performs consulting services and implementations.

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

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

	Three Months Ended September 30, 2016
	Products		Subscription		Professional services		Training		Maintenance		Total
Revenues	$	9,600	$	1,543	$	4,169	$	2,094	$	10,299	$	27,705
Cost of revenues	2,574		631		3,449		1,111		573		8,338
Segment profit	$	7,026	$	912	$	720	$	983	$	9,726	19,367
Total operating expenses											21,984
Operating loss											$	(2,617	)

	Three Months Ended September 30, 2015
	Products		Subscription		Professional services		Training		Maintenance		Total
Revenues	$	7,759	$	1,790	$	5,259	$	1,992	$	10,023	$	26,823
Cost of revenues	2,520		952		3,644		1,415		601		9,132
Segment profit	$	5,239	$	838	$	1,615	$	577	$	9,422	17,691
Total operating expenses											21,089
Operating loss											$	(3,398	)

	Nine Months Ended September 30, 2016
	Products		Subscription		Professional services		Training		Maintenance		Total
Revenues	$	26,693	$	4,728	$	13,510	$	6,254	$	29,875	$	81,060
Cost of revenues	6,945		1,952		10,446		4,078		1,815		25,236
Segment profit	$	19,748	$	2,776	$	3,064	$	2,176	$	28,060	55,824
Total operating expenses											74,885
Operating loss											$	(19,061	)

	Nine Months Ended September 30, 2015
	Products		Subscription		Professional services		Training		Maintenance		Total
Revenues	$	23,093	$	4,894	$	15,052	$	6,541	$	29,796	$	79,376
Cost of revenues	6,556		2,902		11,334		4,276		1,781		26,849
Segment profit	$	16,537	$	1,992	$	3,718	$	2,265	$	28,015	52,527
Total operating expenses											63,120
Operating loss											$	(10,593	)

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

	Three Months Ended September 30,				Nine Months Ended September 30,
	2016		2015		2016		2015
Revenues
United States	$	21,483	$	20,919	$	61,642	$	60,876
Europe	3,492		3,700		11,645		10,875
Asia	1,633		1,153		4,018		4,004
Other	1,097		1,051		3,755		3,621
	$	27,705	$	26,823	$	81,060	$	79,376

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Subsequent Events

9 Months Ended

Sep. 30, 2016

Subsequent Events

Subsequent Events

Note 12. Subsequent Events

Reduction in Work Force

Subsequent to September 30, 2016, we incurred approximately $0.7 million in severance expense due to a reduction in work force.

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Summary of Significant Accounting Policies (Policies)

9 Months Ended

Sep. 30, 2016

Summary of Significant Accounting Policies

Basis of Presentation

Basis of Presentation

The accompanying condensed consolidated balance sheets as of September 30, 2016 and the condensed consolidated statements of operations for the three and nine months ended September 30, 2016 and 2015 and cash flows for the nine months ended September 30, 2016 and 2015 are unaudited.  These statements should be read in conjunction with the audited consolidated financial statements and related notes, together with management’s discussion and analysis of financial position and results of operations, contained in our Annual Report on Form 10-K for the year ended December 31, 2015, filed with the U.S. Securities and Exchange Commission (the “SEC”) on February 25, 2016.

The accompanying condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States, or (“GAAP”), and pursuant to the rules and regulations of the SEC for interim financial reporting.  In the opinion of our management, the unaudited condensed consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2015 and include all normal and recurring adjustments necessary for the fair presentation of our financial position as of September 30, 2016 and our results of operations for the three and nine months ended September 30, 2016 and 2015 and our cash flows for the nine months ended September 30, 2016 and 2015.  The condensed consolidated balance sheet as of December 31, 2015 has been derived from the December 31, 2015 audited financial statements.  The operating results for the three and nine month periods ended September 30, 2016 are not necessarily indicative of the results that will be achieved for the full fiscal year or for future periods.

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

Reclassification of Liabilities

Reclassification of Liabilities

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

Use of Estimates and Assumptions

Use of Estimates and Assumptions

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

Cash and Cash Equivalents

Cash and Cash Equivalents

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

Fair Value of Financial Instruments

Fair Value of Financial Instruments

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

Trade Receivables

Trade Receivables

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

Inventory

Inventory

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

Amortization of Intangible Assets with Finite Lives

Amortization of Intangible Assets with Finite Lives

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

Goodwill and Indefinite-Lived Intangibles

Goodwill and Indefinite-Lived Intangibles

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

Concentrations of Credit Risk

Concentrations of Credit Risk

Financial instruments that potentially subject us to significant concentrations of credit risk consist primarily of cash and cash equivalents and accounts receivable.  We restrict our investments in cash and cash equivalents to financial institutions, US government or federal agency instruments and obligations of corporations with high credit ratings.  At September 30, 2016, the majority of our cash balances were held at financial institutions located in California in accounts that are insured by the Federal Deposit Insurance Corporation for up to $250,000. Uninsured balances aggregate approximately $11.3 million as of September 30, 2016.  At September 30, 2016 all of our cash equivalents consisted of financial institution obligations.  We periodically perform credit evaluations of our customers and maintain reserves for potential losses on our accounts receivable.  We do not believe we are subject to concentrations of credit risk with respect to such receivables.

Revenue Recognition

Revenue Recognition

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Revenue Recognition for Hardware and Subscription Revenues (Nonsoftware Elements)

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

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

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

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

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

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

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

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

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

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

Recently Issued Accounting Pronouncements

Recently Issued Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (“FASB”) and International Accounting Standards Board (“IASB”) jointly issued ASU No. 2014-09, Revenue from Contracts with Customers, which supercedes the revenue recognition requirements in ASC 605 Revenue Recognition.  ASU 2014-09 is a comprehensive new revenue recognition standard that will supercede nearly all existing revenue recognition guidance under US GAAP.  The standard’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services.  In doing so, companies will need to use more judgment and make more estimates than under current authoritative guidance.  These may include identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation.  The standard is effective beginning after December 15, 2016, and early adoption is not permitted under US GAAP.  On April 1, 2015, the FASB voted to propose to defer the effective date of ASU 2014-09 by one year.  The standard is effective for fiscal years beginning after December 15, 2017, and early adoption is not permitted under US GAAP.  We are currently evaluating the financial statement impact of the new revenue recognition standard, as well as its impact on our accounting policies, business processes, systems and controls.

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

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

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

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

Realignment Expense

Realignment Expense

As a result of reducing headcount and the closing of our Orlando and Houston offices, we incurred approximately $0.4 million and $3.5 million during the three and nine months ended September 30, 2016, respectively, in rent expense, severance and related expenses in cost of services revenues, selling and marketing, research and development and general administrative expenses.

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Net Loss Per Share (Tables)

9 Months Ended

Sep. 30, 2016

Net Loss Per Share

Schedule of computation of basic and diluted net loss allocated to common stockholders per share

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

	Three Months Ended September 30,						Nine Months Ended September 30,
	2016			2015			2016			2015
Basic loss per common share:
Numerator:
Net loss	$	(2,608	)	$	(3,471	)	$	(19,130	)	$	(10,815	)
Net loss allocated to common stockholders	$	(2,608	)	$	(3,471	)	$	(19,130	)	$	(10,815	)
Denominator:
Basic weighted average shares outstanding	29,020			28,197			28,743			27,864
Net loss per basic common share	$	(0.09	)	$	(0.12	)	$	(0.67	)	$	(0.39	)
Diluted loss per common share:
Numerator:
Net loss	$	(2,608	)	$	(3,471	)	$	(19,130	)	$	(10,815	)
Net loss allocated to common stockholders	$	(2,608	)	$	(3,471	)	$	(19,130	)	$	(10,815	)
Denominator:
Basic weighted average shares outstanding	29,020			28,197			28,743			27,864
Effect of dilutive share-based awards	—			—			—			—
Diluted weighted average shares outstanding	29,020			28,197			28,743			27,864
Net loss per diluted common share	$	(0.09	)	$	(0.12	)	$	(0.67	)	$	(0.39	)

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Inventory (Tables)

9 Months Ended

Sep. 30, 2016

Inventory

Schedule of inventory by major classes

The following table sets forth, by major classes, inventory as of September 30, 2016 and December 31, 2015 (in thousands):

	September 30, 2016		December 31, 2015
Inventory:
Components	$	1,167	$	1,082
Finished goods	1,116		1,461
Total inventory	$	2,283	$	2,543

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Goodwill and Other Intangibles (Tables)

9 Months Ended

Sep. 30, 2016

Goodwill and Other Intangibles

Summary of cumulative amortization expense related to intangible assets subject to amortization

The following table summarizes cumulative amortization expense related to intangible assets subject to amortization as of September 30, 2016 and December 31, 2015 (in thousands):

	September 30, 2016							December 31, 2015
	Gross Costs		Accumulated Amortization			Net		Gross Costs		Accumulated Amortization			Net
Core technology	$	5,800	$	(3,797	)	$	2,003	$	5,800	$	(3,211	)	$	2,589
Customer relationships	6,475		(4,161		)	2,314		6,475		(3,779		)	2,696
Trade names	2,100		(1,452		)	648		2,100		(1,317		)	783
Covenant not-to-compete	200		(184		)	16		200		(154		)	46
Domain name	45		(9		)	36		45		(2		)	43
Total	$	14,620	$	(9,603	)	$	5,017	$	14,620	$	(8,463	)	$	6,157

Schedule of estimated remaining amortization expense

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

Year ending	Amortization Expense
2016	$	368
2017	1,409
2018	1,401
2019	825
2020	539
Thereafter	475
Total amortization expense	$	5,017

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Employee Benefit Plans (Tables)

9 Months Ended

Sep. 30, 2016

Employee Benefit Plans

Schedule of stock option activity

	Number of Options		Weighted Average Exercise Price		Weighted Average Remaining Contractual Term (in years)	Aggregate Intrinsic Value
Outstanding, December 31, 2015	1,675,000		$	7.63	6.6	$	239,000
Granted	689,000		$	4.03
Exercised	—		$	—
Forfeited or expired	(430,000	)	$	6.74
Outstanding, September 30, 2016	1,934,000		$	6.55	7.1	$	1,232,000
Exercisable, September 30, 2016	623,000		$	9.44	2.9	$	141,000

Schedule of restricted stock awards activity

	Number of Shares		Weighted Average Fair Value
Outstanding, December 31, 2015	2,049,000		$	7.30
Granted	2,131,000		4.44
Vested	(455,000	)	7.90
Forfeited	(448,000	)	6.40
Outstanding, September 30, 2016	3,277,000		$	5.48

Schedule of weighted average assumptions used in valuation of awards

	Three Months Ended September 30,
	2016			2015
Risk-free interest rate	1.1		%	1.8		%
Dividend yield	—		%	—		%
Expected life (years)	5.71			5.65
Volatility	47.50		%	42.78		%
Weighted average grant date fair value	$	2.63		$	4.08

Schedule of share-based compensation expense

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

	Three Months Ended September 30,				Nine Months Ended September 30,
	2016		2015		2016		2015
Stock option awards	$	188	$	110	$	545	$	231
Restricted stock awards	3,029		1,604		6,269		4,878
Share-based compensation expense	$	3,217	$	1,714	$	6,814	$	5,109

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Fair Value Measurements (Tables)

9 Months Ended

Sep. 30, 2016

Fair Value Measurements

Schedule of financial assets and liabilities accounted for at fair value on a recurring basis

The following table sets forth, by level within the fair value hierarchy, financial assets and liabilities that are accounted for at fair value on a recurring basis as of September 30, 2016 and December 31, 2015 (in thousands):

	Fair Value Measurements at September 30, 2016
	Total		Level 1		Level 2		Level 3
Assets:
Money market accounts	205		205		—		—
Total assets	$	205	$	205	$	—	$	—

	Fair Value Measurements at December 31, 2015
	Total		Level 1		Level 2		Level 3
Assets:
U.S. Treasury Securities	$	2,008	$	2,008	$	—	$	—
Money market accounts	4,290		4,290		—		—
Total assets	$	6,298	$	6,298	$	—	$	—

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Segment Information (Tables)

9 Months Ended

Sep. 30, 2016

Segment Information

Schedule of results of operations for each operating segment

The following tables present the results of operations for each operating segment (in thousands):

	Three Months Ended September 30, 2016
	Products		Subscription		Professional services		Training		Maintenance		Total
Revenues	$	9,600	$	1,543	$	4,169	$	2,094	$	10,299	$	27,705
Cost of revenues	2,574		631		3,449		1,111		573		8,338
Segment profit	$	7,026	$	912	$	720	$	983	$	9,726	19,367
Total operating expenses											21,984
Operating loss											$	(2,617	)

	Three Months Ended September 30, 2015
	Products		Subscription		Professional services		Training		Maintenance		Total
Revenues	$	7,759	$	1,790	$	5,259	$	1,992	$	10,023	$	26,823
Cost of revenues	2,520		952		3,644		1,415		601		9,132
Segment profit	$	5,239	$	838	$	1,615	$	577	$	9,422	17,691
Total operating expenses											21,089
Operating loss											$	(3,398	)

	Nine Months Ended September 30, 2016
	Products		Subscription		Professional services		Training		Maintenance		Total
Revenues	$	26,693	$	4,728	$	13,510	$	6,254	$	29,875	$	81,060
Cost of revenues	6,945		1,952		10,446		4,078		1,815		25,236
Segment profit	$	19,748	$	2,776	$	3,064	$	2,176	$	28,060	55,824
Total operating expenses											74,885
Operating loss											$	(19,061	)

	Nine Months Ended September 30, 2015
	Products		Subscription		Professional services		Training		Maintenance		Total
Revenues	$	23,093	$	4,894	$	15,052	$	6,541	$	29,796	$	79,376
Cost of revenues	6,556		2,902		11,334		4,276		1,781		26,849
Segment profit	$	16,537	$	1,992	$	3,718	$	2,265	$	28,015	52,527
Total operating expenses											63,120
Operating loss											$	(10,593	)

Schedule of revenues, classified by the major geographic areas

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

	Three Months Ended September 30,				Nine Months Ended September 30,
	2016		2015		2016		2015
Revenues
United States	$	21,483	$	20,919	$	61,642	$	60,876
Europe	3,492		3,700		11,645		10,875
Asia	1,633		1,153		4,018		4,004
Other	1,097		1,051		3,755		3,621
	$	27,705	$	26,823	$	81,060	$	79,376

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Summary of Significant Accounting Policies (Details)	9 Months Ended
	Sep. 30, 2016
Trade Receivables
Minimum number of days after which receivables are considered past due	30 days

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Summary of Significant Accounting Policies - Concentrations of Credit Risk (Details) - Cash and cash equivalents - Concentration of credit risk	Sep. 30, 2016 USD ($)
Concentrations of Credit Risk
Uninsured cash balances	$ 11,300,000
Maximum
Concentrations of Credit Risk
Cash balances insured by the Federal Deposit Insurance Corporation	$ 250,000

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Summary of Significant Accounting Policies - Revenue Recognition (Details)	9 Months Ended
	Sep. 30, 2016
Minimum
Summary of Significant Accounting Policies
Period of maintenance of proprietary products	1 year
Maximum
Summary of Significant Accounting Policies
Period of maintenance of proprietary products	3 years

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Summary of Significant Accounting Policies - Recently Issued Accounting Pronouncements (Details) - USD ($) $ in Thousands	3 Months Ended	9 Months Ended
	Sep. 30, 2016	Sep. 30, 2016	Dec. 31, 2015
New Accounting Pronouncements or Change in Accounting Principle
Noncurrent deferred tax liability	$ 579	$ 579	$ 511
Realignment Expense
Rent expense, severance and related expenses	$ 400	$ 3,500
Accounting Standards Update 2015-17 | Pro Forma Adjustment
New Accounting Pronouncements or Change in Accounting Principle
Deferred income tax assets, noncurrent			500
Noncurrent deferred tax liability			$ 500

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Net Loss Per Share (Details) - USD ($) $ / shares in Units, $ in Thousands	3 Months Ended		9 Months Ended
	Sep. 30, 2016	Sep. 30, 2015	Sep. 30, 2016	Sep. 30, 2015
Numerator:
Net loss	$ (2,608)	$ (3,471)	$ (19,130)	$ (10,815)
Net loss allocated to common stockholders	$ (2,608)	$ (3,471)	$ (19,130)	$ (10,815)
Denominator:
Basic weighted average shares outstanding	29,020,000	28,197,000	28,743,000	27,864,000
Net loss per basic common share (in dollars per share)	$ (0.09)	$ (0.12)	$ (0.67)	$ (0.39)
Numerator:
Net loss	$ (2,608)	$ (3,471)	$ (19,130)	$ (10,815)
Net loss allocated to common stockholders	$ (2,608)	$ (3,471)	$ (19,130)	$ (10,815)
Denominator:
Basic weighted average shares outstanding	29,020,000	28,197,000	28,743,000	27,864,000
Diluted weighted average shares outstanding	29,020,000	28,197,000	28,743,000	27,864,000
Net loss per diluted common share (in dollars per share)	$ (0.09)	$ (0.12)	$ (0.67)	$ (0.39)
Number of stock options and restricted stock awards excluded from calculation of diluted net loss per share (in shares)	1,732,000	918,000	2,338,000	1,920,000

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Inventory (Details) - USD ($) $ in Thousands	Sep. 30, 2016	Dec. 31, 2015
Inventory
Components	$ 1,167	$ 1,082
Finished goods	1,116	1,461
Total inventory	$ 2,283	$ 2,543

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Goodwill and Other Intangibles (Details) - USD ($)	3 Months Ended		9 Months Ended
	Sep. 30, 2016	Sep. 30, 2015	Sep. 30, 2016	Sep. 30, 2015
Goodwill and Other Intangibles
Impairment charges related to goodwill and indefinite-lived intangible assets			$ 0
Amortization expense	$ 400,000	$ 400,000	$ 1,100,000	$ 1,300,000

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Goodwill and Other Intangibles - Cumulative amortization expense (Details) - USD ($) $ in Thousands	Sep. 30, 2016	Dec. 31, 2015
Goodwill and Other Intangibles
Gross Costs	$ 14,620	$ 14,620
Accumulated Amortization	(9,603)	(8,463)
Total amortization expense	5,017	6,157
Core technology
Goodwill and Other Intangibles
Gross Costs	5,800	5,800
Accumulated Amortization	(3,797)	(3,211)
Total amortization expense	2,003	2,589
Customer relationships
Goodwill and Other Intangibles
Gross Costs	6,475	6,475
Accumulated Amortization	(4,161)	(3,779)
Total amortization expense	2,314	2,696
Trade names
Goodwill and Other Intangibles
Gross Costs	2,100	2,100
Accumulated Amortization	(1,452)	(1,317)
Total amortization expense	648	783
Covenant not-to-compete
Goodwill and Other Intangibles
Gross Costs	200	200
Accumulated Amortization	(184)	(154)
Total amortization expense	16	46
Domain name
Goodwill and Other Intangibles
Gross Costs	45	45
Accumulated Amortization	(9)	(2)
Total amortization expense	$ 36	$ 43

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Goodwill and Other Intangibles - Remaining amortization expense (Details) - USD ($) $ in Thousands	Sep. 30, 2016	Dec. 31, 2015
Estimated remaining amortization expense
2016	$ 368
2017	1,409
2018	1,401
2019	825
2020	539
Thereafter	475
Total amortization expense	$ 5,017	$ 6,157

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Debt Obligations (Details) $ in Millions		1 Months Ended	9 Months Ended
	Aug. 29, 2014 USD ($)	Oct. 31, 2016 USD ($)	Sep. 30, 2016 USD ($)
Revolver
Debt Obligations
Term	3 years
Commitment fee	$ 0.2
Maximum borrowing capacity	$ 10.0
Percentage of eligible accounts receivable for calculation of availability of borrowings	80.00%
Maximum principal amount permitted to be outstanding that has been borrowed (as a percent)	75.00%
Required adjusted quick ratio	1.15		1.46
Current borrowing capacity			$ 8.6
Outstanding loan balance			4.5
Remaining borrowing capacity			$ 4.1
Adjusted quick ratio below which collections will be applied to outstanding loan			1.5
Repaid in full		$ 4.5
Revolver | Minimum
Debt Obligations
Basis spread on variable rate (as a percent)			1.25%
Revolver | Maximum
Debt Obligations
Basis spread on variable rate (as a percent)			3.25%
Letters of credit
Debt Obligations
Maximum borrowing capacity	$ 3.0
Letter of credit outstanding			$ 1.2

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Employee Benefit Plans (Details) - USD ($)		9 Months Ended	12 Months Ended
	Mar. 18, 2016	Sep. 30, 2016	Dec. 31, 2015
Stock options
Equity Incentive Plan
Annual vesting percentage of shares granted under the Plan		25.00%
Vesting period		4 years
Maximum period for exercise of shares		10 years
Number of Options
Outstanding at the beginning of the period (in shares)		1,675,000
Granted (in shares)		689,000
Forfeited or expired (in shares)		(430,000)
Outstanding at the end of the period (in shares)		1,934,000	1,675,000
Exercisable at the end of the period (in shares)		623,000
Weighted Average Exercise Price
Outstanding at the beginning of the period (in dollars per share)		$ 7.63
Granted (in dollars per share)		4.03
Forfeited or expired (in dollars per share)		6.74
Outstanding at the end of the period (in dollars per share)		6.55	$ 7.63
Exercisable at the end of the period (in dollars per share)		$ 9.44
Weighted Average Remaining Contractual Term (in years)
Outstanding in years		7 years 1 month 6 days	6 years 7 months 6 days
Exercisable at the end of the period (in years)		2 years 10 months 24 days
Aggregate Intrinsic Value
Outstanding at the beginning of the period		$ 239,000
Outstanding at the end of the period		1,232,000	$ 239,000
Exercisable at the end of the period		$ 141,000
Additional disclosures
Fair market value of common stock used to define in-the-money options (in dollars per share)		$ 5.96
Number of in-the-money options used to calculate the aggregate intrinsic value of options (in shares)		1,340,000
Number of in-the-money options exercisable (in shares)		203,000
Restricted stock awards
Equity Incentive Plan
Annual vesting percentage of shares granted under the Plan		25.00%
Vesting period		4 years
Number of Shares
Outstanding at the beginning of the period (in shares)		2,049,000
Granted (in shares)	586,000	2,131,000
Vested (in shares)		(455,000)
Forfeited (in shares)		(448,000)
Outstanding at the end of the period (in shares)		3,277,000	2,049,000
Weighted Average Fair Value
Outstanding at the beginning of the period (in dollars per share)		$ 7.30
Granted (in dollars per share)	$ 4.37	4.44
Vested (in dollars per share)		7.90
Forfeited (in dollars per share)		6.40
Outstanding at the end of the period (in dollars per share)		$ 5.48	$ 7.30
Total grant date fair value of shares vested		$ 3,594,000
Granted (in shares)	586,000	2,131,000
Fair value (in dollars per share)	$ 4.37	$ 4.44
Restricted stock awards | Minimum
Weighted Average Fair Value
Vest ranges of the shares granted	10.00%
Restricted stock awards | Maximum
Weighted Average Fair Value
Vest ranges of the shares granted	200.00%
Restricted stock awards | Vesting On December 31, 2017
Weighted Average Fair Value
Vest ranges of the shares granted	50.00%
Restricted stock awards | Vesting in February, 2017
Number of Shares
Vested (in shares)		(492,000)
Weighted Average Fair Value
Vest ranges of the shares granted	50.00%
Achievement of threshold		84.00%
Plan
Equity Incentive Plan
Number of shares available for grant		1,321,000

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Employee Benefit Plans - Share-Based Compensation (Details) - USD ($) $ / shares in Units, $ in Thousands	3 Months Ended		9 Months Ended
	Sep. 30, 2016	Sep. 30, 2015	Sep. 30, 2016	Sep. 30, 2015
Weighted average assumptions
Risk-free interest rate (as a percent)	1.10%	1.80%
Dividend yield (as a percent)			0.00%
Expected life (years)	5 years 8 months 16 days	5 years 7 months 24 days
Volatility (as a percent)	47.50%	42.78%
Weighted average grant date fair value (in dollars per share)	$ 2.63	$ 4.08
Additional disclosures
Share-based compensation expense	$ 3,217	$ 1,714	$ 6,814	$ 5,109
Stock options
Additional disclosures
Share-based compensation expense	188	110	545	231
Total unrecognized share-based compensation cost related to stock options	2,500		$ 2,500
Weighted-average period over which unrecognized compensation cost is expected to be recognized			3 years 1 month 6 days
Share-based compensation cost expected to be recorded for the remainder of the fiscal year	200		$ 200
Restricted stock awards
Additional disclosures
Share-based compensation expense	3,029	$ 1,604	6,269	$ 4,878
Total unrecognized share-based compensation cost related to stock awards	14,300		$ 14,300
Weighted-average period over which unrecognized compensation cost is expected to be recognized			2 years 7 months 6 days
Share-based compensation cost expected to be recorded for the remainder of the fiscal year	2,500		$ 2,500
Performance-based restricted stock awards
Additional disclosures
Minimum percentage of likelihood that approximately 100% of the performance-based restricted stock awards would vest			70.00%
Estimated percentage of the performance-based restricted stock awards would vest on a 70% or greater likelihood			200.00%
Share-based compensation expense	$ 1,600		$ 2,200

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Income Taxes (Details) - USD ($) $ in Thousands	3 Months Ended		9 Months Ended
	Sep. 30, 2016	Sep. 30, 2015	Sep. 30, 2016	Sep. 30, 2015
Income Taxes
Carrying value of net deferred tax assets	$ 0		$ 0
Income tax (benefit) provision	$ (14)	$ 77	$ 77	$ 244
U.S. statutory tax rate (as a percent)	34.00%	34.00%	34.00%	34.00%

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Fair Value Measurements (Details) - Recurring - USD ($) $ in Thousands	Sep. 30, 2016	Dec. 31, 2015
Total
Assets:
Total assets	$ 205	$ 6,298
Total | U.S. Treasury Securities
Assets:
Total assets		2,008
Total | Money market accounts
Assets:
Total assets	205	4,290
Level 1
Assets:
Total assets	205	6,298
Level 1 | U.S. Treasury Securities
Assets:
Total assets		2,008
Level 1 | Money market accounts
Assets:
Total assets	$ 205	$ 4,290

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Commitments and Contingencies (Details) $ in Millions			1 Months Ended	9 Months Ended
	Jul. 29, 2016 USD ($)	Jun. 16, 2016 USD ($)	Feb. 29, 2016 USD ($) installment	Sep. 30, 2016 USD ($)	May 20, 2011 patent
Letters of credit
Contractual Obligations, Commitments and Contingencies
Letter of credit outstanding				$ 1.2
General and administrative expenses
Contractual Obligations, Commitments and Contingencies
Settlement awarded to (against) the Company				1.1
Patent infringement complaint
Contractual Obligations, Commitments and Contingencies
Number of patents for which infringement is alleged | patent					3
Settlement awarded to (against) the Company		$ (2.3)
Breach of contract
Contractual Obligations, Commitments and Contingencies
Settlement awarded to (against) the Company	$ 1.2
Software license agreement and maintenance and support agreement
Contractual Obligations, Commitments and Contingencies
Amount of agreement			$ 2.0	$ 1.4
Number of installments | installment			5
Installment payable during the year			$ 1.5
Installment payable during the first six months of 2017			0.5
Software license agreement
Contractual Obligations, Commitments and Contingencies
Amount of agreement			1.7
Maintenance and support agreement
Contractual Obligations, Commitments and Contingencies
Amount of agreement			$ 0.3
Agreement term			2 years

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Segment Information (Details) $ in Thousands	3 Months Ended		9 Months Ended
	Sep. 30, 2016 USD ($)	Sep. 30, 2015 USD ($)	Sep. 30, 2016 USD ($) segment	Sep. 30, 2015 USD ($)
Segment Information
Number of operating segments | segment			5
Revenues	$ 27,705	$ 26,823	$ 81,060	$ 79,376
Cost of revenues	8,338	9,132	25,236	26,849
Segment profit	19,367	17,691	55,824	52,527
Total operating expenses	21,984	21,089	74,885	63,120
Operating loss	(2,617)	(3,398)	(19,061)	(10,593)
Products
Segment Information
Revenues	9,600	7,759	26,693	23,093
Cost of revenues	2,574	2,520	6,945	6,556
Segment profit	7,026	5,239	19,748	16,537
Subscription
Segment Information
Revenues	1,543	1,790	4,728	4,894
Cost of revenues	631	952	1,952	2,902
Segment profit	912	838	2,776	1,992
Professional services
Segment Information
Revenues	4,169	5,259	13,510	15,052
Cost of revenues	3,449	3,644	10,446	11,334
Segment profit	720	1,615	3,064	3,718
Training
Segment Information
Revenues	2,094	1,992	6,254	6,541
Cost of revenues	1,111	1,415	4,078	4,276
Segment profit	983	577	2,176	2,265
Maintenance
Segment Information
Revenues	10,299	10,023	29,875	29,796
Cost of revenues	573	601	1,815	1,781
Segment profit	$ 9,726	$ 9,422	$ 28,060	$ 28,015

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Segment Information - Major geographic areas (Details) - USD ($) $ in Thousands	3 Months Ended		9 Months Ended
	Sep. 30, 2016	Sep. 30, 2015	Sep. 30, 2016	Sep. 30, 2015
Segment Information
Revenues	$ 27,705	$ 26,823	$ 81,060	$ 79,376
United States
Segment Information
Revenues	21,483	20,919	61,642	60,876
Europe
Segment Information
Revenues	3,492	3,700	11,645	10,875
Asia
Segment Information
Revenues	1,633	1,153	4,018	4,004
Other
Segment Information
Revenues	$ 1,097	$ 1,051	$ 3,755	$ 3,621

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Subsequent Events (Details) $ in Millions	1 Months Ended
	Oct. 31, 2016 USD ($)
Subsequent Event
Reduction in Work Force
Severance expense	$ 0.7