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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

FOR THE QUARTERLY PERIOD ENDED June 30, 2015

OR

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

For the transition period from                      to                     

Commission File Number 001-33197

GUIDANCE SOFTWARE, INC.

(Exact name of registrant as specified in its charter)

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.

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 July 31, 2015, there were approximately 30,341,000 shares of the registrant’s Common Stock outstanding.

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GUIDANCE SOFTWARE, INC.

FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED June 30, 2015

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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)

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)

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)

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

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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:

EnCase® Enterprise, a comprehensive, network-enabled digital investigative solution that enables corporations and government agencies to search, collect, preserve and analyze data across all of the servers, desktops and laptops that comprise their entire network from a single location.  It also serves as a platform on which more powerful electronic discovery and cybersecurity products, as described below, are built;

EnCase® Cybersecurity, which provides the ability to identify and analyze undiscovered threats, such as polymorphic or metamorphic malware, and other advanced hacking techniques that evade traditional network or host-based defenses and includes investigative capabilities that target confidential or sensitive data and perform risk mitigation by wiping sensitive data from unauthorized locations;

EnCase® Analytics, a security intelligence product designed to derive insights from the data generated by endpoint activity.  EnCase Analytics leverages kernel-level access for endpoint data collection providing a repository of the most reliable data for insights into undetected risks and threats.  Through its interactive visual interface, EnCase Analytics exposes suspicious patterns, commonalities, and anomalies, to proactively identify threats and minimize damage;

EnCase® eDiscovery, which automates the search, collection, preservation and processing of electronically stored information for litigation and compliance purposes;

EnCase® eDiscovery Review, a cloud-based document review and production software-as-a-service (“SaaS”) for corporations and law firms;

EnCase® Forensic, a desktop-based product primarily used by law enforcement, government agencies and consultancies for collecting, preserving, analyzing and authenticating electronic computer forensic data for use in criminal and civil court proceedings;

EnCase® Portable, a triage and collection solution, delivered on a USB device, that allows forensic professionals and non-experts to quickly and easily triage and collect digital evidence in a forensically sound and court proven manner;

EnCase® App Central, an online marketplace that allows development and investigation professionals the opportunity to share and discover the latest apps that complement the Company’s EnCase solutions; and

Tableau ™, a family of data acquisition forensic hardware products, including forensic duplicators, multiple write blockers and other hardware.

In addition, we complement these offerings with a comprehensive array of professional 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 June 30, 2015 and the condensed consolidated statements of operations for the three and six months ended June 30, 2015 and 2014 and cash flows for the six months ended June 30, 2015 and 2014 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, 2014, filed with the U.S. Securities and Exchange Commission (the “SEC”) on February 24, 2015.

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, 2014 and include all normal and recurring adjustments necessary for the fair presentation of our financial position as of June 30, 2015, our results of operations for the three and six months ended June 30, 2015 and 2014 and our cash flows for the six months ended June 30, 2015 and 2014.  The condensed consolidated balance sheet as of December 31, 2014 has been derived from the December 31, 2014 audited financial statements.  The operating results for the three and six months period ended June 30, 2015 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 significant intercompany accounts and transactions have been eliminated.

Reclassification of Revenues and Expenses

We have reclassified certain revenues and expenses to conform to the current period’s presentation for all periods presented in our condensed consolidated statements of operations.  Services revenue now includes professional services, training, and subscription revenues.  Similarly, cost of services revenue includes cost of professional services revenue, cost of training revenue, and cost of subscription revenue.

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, contingent consideration, 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

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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.  Commencing on January 1, 2013, the Company adopted the ASU 2011-08 issued by the Financial Accounting Standards Board (“FASB”) for the revised guidance on “Testing of Goodwill for Impairment.”  Under this guidance, 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, 2014, 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 June 30, 2015, 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 $20.5 million as of June 30, 2015.  At June 30, 2015 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® Enterprise and EnCase® Forensic software products.  Our Enterprise products include perpetual licenses and are related to our EnCase® Enterprise, EnCase® Cybersecurity, and eDiscovery products.  Our Forensic products include revenues related to EnCase® Forensic, EnCase® Portable, and forensic hardware sales.  Revenue associated with the sale of software licenses and revenue associated with forensic hardware sales are referred to as product revenue.  Revenues are 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 software-as-a-service, which we collectively refer to as services revenues.  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 Accounting Standards Update (“ASU”) 2009-13, Multiple-Deliverable Revenue Arrangements, (amendment to Accounting Standards Codification (“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, subscription, services and maintenance revenues, as well as the amount of deferred revenue to be recognized in each accounting period.

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Revenue Recognition Criteria: In general, we recognize revenue when the following criteria have been met:

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

·                           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 subscription revenues. 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® Enterprise Solutions and EnCase® Forensic Solutions: 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, stated in the contract with our customer as a percentage of the product fee.

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.

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Revenue Recognition for Hardware and Subscription Revenues (Nonsoftware Elements)

Hardware product revenue. Revenue associated with the sale of forensic hardware 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.

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Recently Issued Accounting Pronouncements

In May 2014, the FASB and 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 was originally effective beginning after December 15, 2016, and early adoption was not permitted under US GAAP.  However, on July 9, 2015, the FASB approved to defer the effective date of ASU 2014-09 by one year, beginning after December 15, 2017, with an option to adopt as of the original effective date, beginning after December 15, 2016.  We are currently evaluating the financial statement impact of the new standard.

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.

Realignment Expense

As a result of reducing headcount during the three and six months ended June 30, 2014, we incurred approximately $0.4 million and $1.6 million, respectively, in 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

Basic net loss per common share is calculated by dividing the net loss by the weighted average number of common shares outstanding during the reporting period.  Diluted net loss 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 per share (in thousands, except per share amounts):

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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 1,969,000 and 1,934,000 shares for the three and six months ended June 30, 2015, respectively, and 2,062,000 and 1,838,000 shares for the three and six months ended June 30, 2014, respectively.

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 June 30, 2015 and December 31, 2014 (in thousands):

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 June 30, 2015.  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 $0.9 million, and $0.5 million and $1.1 million for the three and six months ended June 30, 2015, and 2014, respectively. The following table summarizes cumulative amortization expense related to intangible assets subject to amortization as of June 30, 2015 and December 31, 2014 (in thousands):

The following table summarizes the estimated remaining amortization expense through 2019 and thereafter (in thousands):

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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.  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.  Any borrowings under the Revolver would be secured 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, we maintain an Adjusted Quick Ratio of at least 1.15 to 1.0.  If the Adjusted Quick Ratio falls below 1.5 to 1.0, 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.  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.  We are obligated to pay a commitment fee of $0.2 million over the three year term of the Revolver. All principal, interest and any other fees will be due and payable in full on or prior to August 29, 2017.

On February 25, 2015, we entered into an amendment (“Amendment”) to the Revolver.  The Amendment allows for advances (each, an “Equipment Advance”) from the bank to be used solely for eligible equipment purchases.  Eligible equipment includes (a) general purpose equipment, computer equipment, office equipment, furnishings, subject to certain limitations, (b) computer software and transferable software licenses, and (c) other equipment.  The maximum advance (“Equipment Line”) equals $2.2 million and an Equipment Advance must be paid over a period of thirty-six months after it has been issued.  The principal amount outstanding for each Equipment Advance shall accrue interest at an annual rate, based on the Adjusted Quick Ratio, ranging from 1.25% - 3.25% above the Prime Rate, and shall be paid monthly. Amount drawn on the Equipment Line reduces the available amount under the Revolver. To date we have not drawn on the Equipment Line.

As of June 30, 2015, we were in compliance with all the covenants of the Revolver.  We had letters of credit outstanding against the Revolver in the amount of $1.3 million, resulting in the maximum available borrowing under the Revolver to be $8.5 million.  Availability is calculated as 80% of eligible accounts receivable, with a maximum of $10.0 million.  To date we have not borrowed under the Revolver.

Note 7. Employee Benefit Plans

At June 30, 2015, approximately 3,691,000 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”), which includes an additional 3,000,000 shares that were approved for issuance at our annual shareholders meeting on May 13, 2015.

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:

We define in-the-money options at June 30, 2015 as options that had exercise prices that were lower than the $8.47 fair market value of our common stock at that date.  The aggregate intrinsic value of options outstanding at June 30, 2015 is calculated as the difference between the exercise price of the underlying options and the fair market value of our common stock for the 854,000 shares that were in-the-money at that date, 176,000 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:

The total grant date fair value of shares vested under such grants during the six months ended June 30, 2015 was $4,249,000.

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:

There were no stock options granted during the three and six months ended, June 30, 2014.

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):

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As of June 30, 2015, approximately $1.6 million of total unrecognized share-based compensation related to stock options is expected to be recognized over a weighted-average period of 3.8 years.  Approximately $14.2 million of total unrecognized share-based compensation cost related to restricted stock awards is expected to be recognized over a weighted-average period of 2.6 years.  For awards outstanding at June 30, 2015, we expect to record approximately $0.2 million and $3.5 million in share-based compensation for the remainder of the fiscal year ending in 2015 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 June 30, 2015, we have recorded a valuation allowance against our net deferred tax assets resulting in a carrying value of zero.

Management’s judgment is required in assessing the realizability of future deferred tax assets.  We consider all available evidence, both positive and negative, including historical levels of income, expectations and risks associated with estimates of future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for a valuation allowance.  If we later determine that it is more likely than not that the net deferred tax assets would be realized, we would reverse the applicable portion of the previously provided valuation allowance.  Likewise, in the event we were to determine that we would not be able to realize all or part of our net deferred tax assets in the future, an adjustment to the deferred tax assets would be charged to earnings in the period in which we make such a determination.

We file income tax returns with the Internal Revenue Service and the taxing authorities of various state and foreign jurisdictions.  We periodically perform a review of our uncertain tax positions.  An uncertain tax position represents our expected treatment of a tax position taken in a filed tax return, or planned to be taken in a future tax return, that has not been reflected in measuring income tax expense for financial reporting purposes.  At June 30, 2015, our liability for uncertain tax positions was $1.0 million.  We do not expect there to be any material changes to the estimated amount of liability associated with our uncertain tax positions over the next twelve months.  Due to the net operating loss carryforwards, the Company’s U.S. federal and state returns are generally open to examination by the Internal Revenue Service and state jurisdictions when such net operating losses are utilized.  Most foreign jurisdictions have statute of limitations that range from three to six years.

We recorded an income tax provision for the three and six months ended June 30, 2015 of $96,000 and $167,000 as compared to $82,000 and $160,000 for the same periods in 2014.  Our income tax provision for the three and six months ended June 30, 2015 and 2014 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 June 30, 2015 and December 31, 2014 (in thousands):

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Note 10. Commitments and Contingencies

Office Leases

On March 31, 2015, we amended our Office Lease Agreement (the “Pasadena Lease”) dated July 26, 2012 to expand our headquarters by approximately 3,600 rentable square feet.  The amendment commences on June 1, 2016 and the Pasadena Lease expires on May 31, 2024.  The expansion increases the base rent by a range of approximately $110,000 for the first year to approximately $140,000 for the final year.

On July 3, 2014, we entered into an Office Lease Agreement (the “San Francisco Lease”) to lease approximately 6,000 rentable square feet of an office building located in San Francisco, California.  The office building is the new location of our San Francisco office.  The San Francisco Lease commenced on December 1, 2014 and expires in December 31, 2019.  The total annual rent under the San Francisco Lease ranges from approximately $295,000 for the first year to approximately $332,000 for the final year.

Data Center Lease

Effective April 1, 2014, we entered into a Colocation Lease Agreement (the “Colocation Lease”) to rent space in a building located in Chandler, Arizona.  The Colocation Lease expires on June 30, 2018.  The Colocation Lease will serve as our new data center, replacing our former San Francisco location obtained in the Case Central acquisition.  Rent is based on power allocation and ranges from approximately $236,000 for the first year to approximately $265,000 for the final year.

Third-party Software Licenses

During the year ended December 31, 2014, the Company entered into a $1.5 million third-party software license agreement authorizing the Company to integrate software as a component of its products through March 2018.  The agreement also provides for maintenance and support over a three-year period, which may be renewed by the Company at the expiration of the three-year period ending March 2018.  The $1.5 million is payable in three annual installments of $492,000, with the final installment being paid in November 2016.  The license, maintenance and remaining liability have been recorded on the accompanying Condensed Consolidated Balance Sheets.

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.

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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.  Although a financial loss is reasonably possible, the Company is unable to estimate the range of potential loss at this time.

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.

We intend to defend the remaining MyKey matters vigorously and, at this time, are unable to estimate what, if any, liability we may have in connection with these matters.  We are unable to estimate a range of reasonably possible financial losses due to various reasons, including, among others, that (1) certain of the proceedings are at an early stage; (2) there is uncertainty as to the outcome of pending appeals, motions, or settlements; (3) there are significant factual issues to be resolved; (4) there are unresolved negotiations with certain indemnitors or indemnitees of the Company, related to the actions; and (5) we have meritorious defenses that we intend to assert.

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:

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·                  Products segment—Includes EnCase® Enterprise, EnCase® Cybersecurity, EnCase® Analytics, EnCase® eDiscovery, EnCase® Forensic, EnCase® Portable, Premium License Support Program and hardware 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):