Innovaro, Inc. 10-K

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Our shares of common stock trade on the NYSE Amex under the symbol “UTK” though March 15, 2010. As of March 16, 2010, we began doing business as Innovaro and changed our ticker symbol to NYSE Amex: “INV”. Computershare Trust Company, Inc., 350 Indiana Street, Suite 800, Golden, CO 80401; 303-262-0600, serves as transfer agent for our common stock. We had approximately 3,000 stockholders of record at March 15, 2010. Price Range of Common Stock and Dividends The following table reflects the high and low closing prices for our common stock as reported on the NYSE Amex and the cash dividends declared per common share for the periods indicated: High Low Dividends Fiscal year 2009 First quarter $ 8.90 $ 6.00 — Second quarter $ 6.65 $ 3.79 — Third quarter $ 5.15 $ 3.75 — Fourth quarter $ 4.55 $ 3.60 — Fiscal year 2008 First quarter $ 13.05 $ 9.95 — Second quarter $ 11.10 $ 9.98 — Third quarter $ 11.05 $ 9.50 — Fourth quarter $ 10.29 $ 8.65 — Our Board of Directors has sole discretion in determining whether to declare and pay cash dividends in the future. The declaration of cash dividends will depend on our profitability, financial condition, cash requirements, future prospects and other factors deemed relevant by our Board of Directors. Our ability to pay cash dividends in the future could be limited or prohibited by regulatory requirements and the terms of financing agreements that we may enter into or by the terms of any preferred stock that we may authorize and issue. Securities Authorized for Issuance under Equity Compensation Plans The information required by this item appears under “Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters” included elsewhere in this Annual Report on Form 10-K. 16 Table of Contents Performance Graph The following graph shows a comparison of the five-year cumulative total return, assuming the reinvestment of dividends, on our common stock with that of the Russell Microcap Index, our sale of technology rights peer group (“Peer Group Technology”) including British Technology Group plc, Competitive Technologies, Inc., IP Group plc, and Sagentia Group AG, and our innovation consulting services peer group (“Peer Group Consulting”) including Forrester Research, Inc., Gartner, Inc., Huron Consulting Group, Inc. and Diamond Management and Technology Consultants Inc. The graph assumes $100 was invested on December 31, 2004 in our common stock, the Russell Microcap Index companies, and the companies in both of the peer groups. Note that historical stock price performance is not necessarily indicative of future stock price performance. COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN AMONG UTEK, RUSSELL MICROCAP INDEX AND UTEK’S PEER GROUPS 17 Table of Contents Item 6. Selected Financial Data The following table presents our selected consolidated financial and other data and has been derived from our audited financial statements for the three months ended December 31, 2009, nine months ended September 30, 2009, and the years ended December 31, 2008, 2007, 2006 and 2005. The information below should be read in conjunction with “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the notes thereto, each of which is included in another section of this annual report on Form 10-K. Operating Company Accounting Investment Company Accounting Three Months Ended Dec 31, 2009(1) Nine Months Ended Sept 30, 2009(1) Year Ended December 31, 2008 2007 2006 2005 Consolidated Statement of Operations Data: Revenue / Income from operations $ 3,012,839 $ 7,764,664 $ 20,178,119 $ 20,300,949 $ 56,952,937 $ 22,743,823 Net (loss) income from operations (624,006 ) (9,340,651 ) (10,034,812 ) 3,776,742 19,944,207 5,887,830 Net (loss) income from operations per diluted common share $ (0.05 ) $ (0.83 ) $ (1.01 ) $ 0.42 $ 2.27 $ 0.80 Weighted average shares: Diluted 11,605,373 11,257,663 9,947,221 8,989,234 8,786,605 7,325,312 Cash dividends declared per common share — — — — $ 0.04 — Dec 31, 2009(2) Dec 31, 2008 Dec 31, 2007 Dec 31, 2006 Dec 31, 2005 Balance Sheet Data: Total assets $ 40,331,181 $ 45,886,209 $ 45,221,077 $ 53,040,810 $ 49,005,960 Long-term debt 6,329,252 839,765 — — — Net asset value per share n/a $ 3.42 $ 4.85 $ 5.71 $ 5.58 (1) Financial data for the year ended December 31, 2009 has been segregated into two sections to conform to the financial statement presentation in our consolidated financial statements, which is included in another section of this annual report on Form 10-K. Financial data for the nine months ended September 30, 2009 reflect our operations as an investment company and financial data for the three months ended December 31, 2009 reflect our operations as an operating company. See Note 1 to the consolidated financial statements, which are included in another section of this annual report on Form 10-K, for further discussion of UTEK’s change in status from an investment company to operating company. (2) Balance sheet data as of December 31, 2009 includes approximately $8.9 million in total assets and $4.2 million in long-term debt of our newly consolidated subsidiary, UTEK Real Estate Holdings, Inc. See Note 1 to the consolidated financial statements, which are included in another section of this annual report on Form 10-K, for further discussion of the circumstances relating to the consolidation of UTEK Real Estate Holdings, Inc. with those of UTEK. 18 Table of Contents Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations Special Note Regarding Forward-Looking Statements The following discussion should be read in conjunction with our consolidated financial statements and the notes thereto included elsewhere in this annual report on Form 10-K. This annual report on Form 10-K contains forward-looking statements regarding the plans and objectives of management for future operations. These forward-looking statements may involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements to be materially different from future results, performance or achievements expressed or implied by any forward-looking statements. Forward-looking statements, which involve assumptions and describe our future plans, strategies and expectations, are generally identifiable by use of the words “may,” “will,” “should,” “expect,” “anticipate,” “estimate,” “believe,” “intend” or “project” or the negative of these words or other variations on these words or comparable terminology. These forward-looking statements are based on assumptions that may be incorrect, and we cannot assure you that the projections included in these forward-looking statements will come to pass. Our actual results could differ materially from those expressed or implied by the forward-looking statements as a result of various factors. Overview For comparability purposes, the revenues and expenses for the nine months ended September 30, 2009 under Investment Company Accounting and for the three months ended December 31, 2009 under Operating Company Accounting are presented combined for the year ended December 31, 2009 throughout management’s discussion and analysis. Management believes this presentation to be more meaningful to the reader as there has been no significant change in our revenue streams as a result of our change in status. In addition, we refer to “income from operations,” which is revenue under investment company presentation, simply as “revenue” throughout this and certain other sections of this annual report on Form 10-K in order to eliminate confusion. Financial Condition Our total assets were $40.3 million at December 31, 2009, compared to $45.9 million at December 31, 2008. At the end of fiscal year 2009, we had $6.3 million in long-term debt outstanding, $2.1 million in cash and cash equivalents and $492,000 of investments in certificates of deposit. Revenue totaled approximately $10.8 million for fiscal year 2009 compared to $20.2 million for fiscal year 2008. Net loss from operations totaled approximately $10.0 million for both fiscal years ended 2009 and 2008. Net realized losses on investments, net of any related deferred tax effect, totaled approximately $49.6 million in 2009 as compared to $4.2 million in 2008. In this regard, we received gross proceeds of $3.1 million in 2009 and $2.3 million in 2008 in connection with the sale of the securities we received in connection with our global technology licensing agreements and technology transfers. Proceeds received in connection with the sale of our investments for the year ended December 31, 2009 included $1.1 million in cash, $218,000 in common stock, $201,000 in an additional investment in UTEK Real Estate Holdings, Inc., and $1.5 million in a note receivable. Net change in unrealized appreciation (depreciation) of investments, net of any related deferred tax benefit, was $44.3 million in 2009 as compared to $(12.2) million in 2008. The unrealized appreciation of $44.3 million in 2009 is related to the reversal of previously recorded unrealized depreciation upon the sale of certain investments for a realized loss of 49.6 million. Current Market Conditions Since mid-2007, global credit and other financial markets have suffered substantial stress, volatility, illiquidity and disruption. These forces reached unprecedented levels in late 2008, resulting in the bankruptcy or acquisition of, or government assistance to, several major domestic and international financial institutions. These 19 Table of Contents events have significantly diminished overall confidence in the financial markets and caused increasing global economic uncertainty. This reduced confidence and uncertainty could further exacerbate the overall market disruptions and risks to businesses in need of capital, including us. Moreover, the deterioration in the equity markets has had a significant impact on the cash proceeds that we have been able to obtain upon the sale of our investments. In addition, the deterioration in consumer confidence and a general reduction in spending by consumers and business have had an adverse effect on our innovation consulting services operations as businesses have delayed spending on these types of services. Although the market and economic conditions have recently improved, we can provide no assurance that we will not be negatively impacted by these market and economic conditions. Investment Portfolio Activity Until September 30, 2009, the Company was a non-diversified, closed-end management investment company that had elected to be treated as a business development company (“BDC”) under the Investment Company Act of 1940 (“1940 Act”). On October 1, 2009, because we no longer met the requirements, the Company filed a notification on Form N-54C with the SEC withdrawing its election to be regulated as a BDC under the 1940 Act. As such, the Company began reporting as an operating company as of October 1, 2009. In connection with our plan to de-elect BDC status, we liquidated a significant portion of our investment portfolio during 2009. We sold some or all of our shares in a significant number of our portfolio companies for $3.1 million in cash and other assets, which resulted in realized losses of $49.6 million and unrealized appreciation of $44.3 million, which is primarily related to the reversal of previously recorded unrealized depreciation upon the sale of these investments. Conversion from Investment Company Presentation to Operating Company Presentation The withdrawal of the Company’s election to be regulated as a BDC under the 1940 Act resulted in a significant change in the Company’s method of accounting. Investment company financial statement presentation and accounting utilizes the value method of accounting used by investment companies, which requires investment companies to value their investments at market value as opposed to historical cost, and recognize income related to unrealized gains and losses in the current period. As an operating company, the required financial statement presentation and accounting for investments held is either fair value or historical cost methods of accounting, depending on the classification of the investment and the Company’s intent with respect to the period of time it intends to hold the investment. In addition, the financial accounts of majority-owned entities were not consolidated with those of the Company under Investment Company Accounting; rather, investments in those entities were reflected in the Company’s balance sheet at fair value. As an operating company, the Company is required to consolidate the accounts of majority-owned entities in which we have a controlling financial interest with those of the Company. In this regard, the accounts of UTEK Real Estate Holdings, Inc., which was previously reflected as an investment in the Company’s balance sheet at fair value, have been consolidated with the accounts of the Company from October 1, 2009. The consolidation of UTEK Real Estate Holdings, Inc. had a significant effect on the Company’s balance sheet as of December 31, 2009, as it added approximately $500,000 in investments, $8.0 million in land and buildings and $4.2 million in related long-term debt. The consolidation did not have a material effect on the Company’s results of operations for the three months ended December 31, 2009. For a detailed discussion of the impact of the withdrawal of the Company’s election to be regulated as a BDC under the 1940 Act on its method of accounting and a discussion of how the Company accounts for investments as an operating company, see Notes 1 and 2 to the consolidated financial statements contained elsewhere in this annual report on Form 10-K. 20 Table of Contents Results of Operations Summary of Results for Years Ended December 31, 2009, 2008 and 2007 Revenue / Income from Operations (in thousands, except percentages) 2009 2008 2007 Percent Change 2009 versus 2008 Percent Change 2008 versus 2007 Innovation consulting services $ 7,491 $ 11,135 $ — (33 )% 100 % Sale of technology rights — 4,685 16,373 (100 )% (71 )% Subscription and other services 3,227 3,959 3,343 (18 )% 18 % Investment income, net 60 399 585 (85 )% (32 )% Revenue $ 10,778 $ 20,178 $ 20,301 (47 )% (1 )% Innovation Consulting Services Innovation consulting services revenue includes income from strategic innovation consulting and foresight and trend research. Innovation consulting services revenue decreased $3.6 million for the year ended December 31, 2009 compared to the year ended December 31, 2008. Throughout 2009, we had the innovation consulting income of three divisions, which were acquired intermittently during 2008. We recognized revenue for all three divisions for the entire year of 2009 versus having recognized revenue for these divisions for only a portion of 2008. However, the revenue of all of our acquired innovation consulting companies suffered significantly throughout 2009 due to the adverse economic conditions. During economic cycles in which companies are experiencing financial difficulties or uncertainty, companies generally cancel or delay spending on consulting type services. As a result of our acquisition of Strategos, Innovaro and Social Technologies in 2008, our innovation consulting revenue increased to $11.1 million for the year ended December 31, 2008, versus $-0- for the year ended December 31, 2007. Sale of Technology Rights Sale of technology rights income strictly relates to the revenue generated from completed technology transfers. Sale of technology rights revenue decreased during 2009 as a result of our not having completed any technology transfers during the year ended December 31, 2009 compared to having completed seven technology transfers during the year ended December 31, 2008. To mitigate the risk of declining stock prices with respect to the stock consideration we have historically received in connection with our technology transfers, we currently intend to complete all technology transfers for cash as opposed to stock. In addition, our client focus is now more heavily weighted towards larger capitalization companies, which has caused a significant slowdown in the process to complete a technology transfer given the more measured decision making process with respect to executing a technology transfer by these companies. Sale of technology rights revenue decreased during 2008 as a result of our having completed seven technology transfers during the year ended December 31, 2008 compared to having completed sixteen technology transfers during the year ended December 31, 2007. The technology transfers had an average value of $669,000 and $1.0 million for the years ended December 31, 2008 and 2007, respectively. With the exception of $125,000 in 2008 and $200,000 in 2007, all income from the sale of technology rights for the years ended December 31, 2008 and 2007 was received in the form of equity securities. Overall equity market conditions generally forced micro-capitalization stock prices down during 2008, making it more difficult for some of our clients to issue a reasonable amount of stock with sufficient value in exchange for these technologies. In addition, we were pursuing technology transfers on a more selective basis to mitigate the risk of declining stock prices with respect to the stock consideration we received in connection with our technology transfers. These circumstances resulted in a decrease in the number of executed technology transfers during 2008. 21 Table of Contents As a result of the change from completing technology transfers in exchange for cash as opposed to stock consideration, and the change in focus toward a large capitalization client, we expect our revenues from the sale of technology rights in the near-term will continue to be significantly lower than our historical revenues from such transactions. Subscription and Other Services Our subscription and other services revenue was $3.2 million for the year ended December 31, 2009 versus $4.0 million and $3.3 million for the years ended December 31, 2008 and 2007, respectively. Our subscription and other services revenue includes online licensing services income from our website subscriptions, global technology licensing income (including patent analytic fees), and income from various other services. Our online licensing services division had website subscription income of approximately $1.9 million for the year ended December 31, 2009 as compared to $2.1 million for the year ended December 31, 2008. We have been able to keep this income source relatively stable from 2008 to 2009 due to a new product sold through Pharmalicensing called Partnering Search. Through this program, we use our partnering experts to search for partners on behalf of the customers as well as to provide a fully qualified list of target companies, instruct customers on how to contact target companies, make introductions and coordinate initial contact/conference calls. Our online licensing services division had website subscription income of approximately $2.1 million for the year ended December 31, 2008 as compared to $1.3 million for the year ended December 31, 2007. The increase was attributable to the acquisition of Pharmalicensing in January 2008, which accounted for $760,000 in subscription revenues for the year ended December 31, 2008. Our global technology licensing income was approximately $800,000 for the year ended December 31, 2009 as compared to $1.3 million for the year ended December 31, 2008. The decrease in 2009 resulted primarily from a decrease in the number of global technology licensing agreements signed and the number of patent analytics projects, which was driven by poor economic conditions. We have recently increased the price of our services and are concentrating on providing improved services to a few select clients. Our global technology licensing income was approximately $1.3 million for the year ended December 31, 2008 as compared to $1.9 million for the year ended December 31, 2007. The decrease in 2008 resulted primarily from a decrease in the number of global technology licensing agreements signed and the number of patent analytics projects, which was by driven poor economic conditions. The number of new agreements added in 2008 was thirty-two as compared to eighty new agreements in 2007. During 2008, we did implement a price increase, but due to the lowered number of alliances, the income was still lower than in 2007. Our other services generated $490,000 in income during 2009 compared to $533,000 in 2008 and $148,000 in 2007. The change from year to year is primarily related to Strategos software and licensing income, which became a new revenue stream during 2008. Investment Income, net Investment income decreased in 2009 and 2008 due to lower cash and cash equivalent balances and reduced market interest rates in the lower interest rate environment. Beginning on October 1, 2009, we changed from Investment Company Accounting to Operating Company Accounting, which resulted in investment income for the fourth quarter of 2009 being recorded as other income and expense in the statement of operations. This did not have a significant impact on the change in investment income from 2008 to 2009. 22 Table of Contents Expenses Direct Costs of Innovation Consulting Services (in thousands, except percentages) 2009 2008 2007 Percent Change 2009 versus 2008 Percent Change 2008 versus 2007 Direct costs of innovation consulting services $ 6,305 $ 10,124 $ — (38 )% 100 % As a percent of innovation consulting services 84 % 91 % — % (7 )ppt 91 ppt* * The abbreviation “ppt” throughout this section denotes percentage points. Direct costs of innovation consulting services are comprised of salaries and related taxes, bonuses, certain outside services and other direct project costs related to innovation consulting services revenue. This expense line item was created in 2008 as a result of the acquisitions of Strategos, Innovaro and Social Technologies and the addition of our innovation consulting services segment. The most significant portion of direct costs of innovation consulting services is comprised of consulting personnel compensation including bonuses. Direct costs decreased by $3.8 million from the year ended December 31, 2008 to the year ended December 31, 2009. This change is related to a decrease in bonuses of $5.3 million, partially offset by an increase in Strategos and Social Technologies division salaries of $690,000 and $782,000, respectively. Bonuses comprised $565,000 of direct costs of innovation consulting services for the year ended December 31, 2009 as compared to $5.9 million of for the year ended December 31, 2008. The decrease in bonuses paid is directly related to the significant decrease in revenue. We have a Strategos Bonus Plan for qualifying Strategos division employees. The award pool is determined from eligible earnings and aggregate revenues and is limited to the extent required to permit Strategos to maintain sufficient operating cash. Awards are to be paid out by December 15 th of each year and are accrued on a quarterly basis. Approximately 85% to 90% of Strategos net income will be paid out in connection with this bonus plan. We have an Innovaro Bonus Plan for qualifying Innovaro division employees. The award pool is determined from eligible earnings and aggregate revenues and is limited to the extent required to permit Innovaro to maintain sufficient operating cash. Awards are to be paid out by June 30 th of each year and are accrued on a quarterly basis. Approximately 75% to 85% of Innovaro net income will be paid out in connection with this bonus plan. We have a Social Technologies Bonus Plan for qualifying Social Technologies division employees. The award pool is determined from eligible earnings and aggregate revenues and is limited to the extent required to permit Social Technologies to maintain sufficient operating cash. Direct Costs of Subscription and Other Services The Company does not report direct costs associated with its subscription and other services revenue as these costs have not been quantified. Direct costs of subscription and other services are primarily related to salaries and related expenses of employees who have multiple roles within the organization. Acquisition of Technology Rights (in thousands, except percentages) 2009 2008 2007 Percent Change 2009 versus 2008 Percent Change 2008 versus 2007 Acquisition of technology rights $ — $ 1,780 $ 3,816 (100 )% (53 )% As a percent of sale of technology rights 0 % 38 % 23 % (38 )ppt 15 ppt 23 Table of Contents Acquisition of technology rights costs consist of the direct costs associated with our technology transfers, which include cash to further accelerate commercialization efforts, license fees to acquire new technologies, consulting fees with the inventor of the technologies, and sponsored research fees with the university or research facility transferring the technologies. The overall decrease in acquisition of technology rights from the year ended December 31, 2008 to the year ended December 31, 2009 was due to the Company not having completed any technology transfers during 2009 compared to having completed seven technology transfers during 2008. To mitigate the risk of declining stock prices with respect to the stock consideration we have historically received in connection with our technology transfers, we currently intend to complete all technology transfers for cash as opposed to stock. In addition, our client focus is now more heavily weighted towards larger capitalization companies, which has caused a significant slowdown in the process to complete a technology transfer given the more measured decision making process with respect to executing a technology transfer by these companies. The overall decrease in acquisition of technology rights from the year ended December 31, 2007 to the year ended December 31, 2008 was due to our having completed nine less technology transfers in 2008 than in 2007. The average cost per technology transfer remained fairly consistent from 2007 to 2008, but the percentage of sale of technology rights revenue increased to 38% in 2008 as a result of the lower average revenue per technology transfer. This is a result of the decrease in the average value of technology transfers from $1.0 million in 2007 to $669,000 in 2008. Acquisition of technology rights costs are directly related to sale of technology rights revenue. In the future, we plan to focus on completing technology transfers in exchange for cash remuneration. The following table provides certain information relating to the costs of the acquisition of technology rights we incurred in connection with our technology transfers during the year ended December 31, 2008: Date Client Acquiring Newly Formed Company Newly Formed Company Dollar Amount of Expenses January 28 Rim Semiconductor Company Broadband Distance Systems, Inc. $ 440,000 March 24 Rim Semiconductor Company Multi-Carrier Communications, Inc. 383,500 March 31 Platina Energy Group, Inc. Enhanced Oil Recovery, Inc. 360,500 June 10 World Energy Group, Inc. Advanced Alternative Energy, Inc. 236,000 June 26 CSMG Technologies, Inc. Carbon Capture Technologies, Inc. 60,000 September 26 World Energy Solutions, Inc. H-Hybrid Technologies, Inc. 300,000 $ 1,780,000 24 Table of Contents The following table provides certain information relating to costs of the acquisition of technology rights we incurred in connection with our technology transfers during the year ended December 31, 2007: Date Client Acquiring Newly Formed Company Newly Formed Company Dollar Amount of Expenses January 4 Manakoa Services Corporation Infinite Identification Technologies, Inc. $ 400,000 January 11 Cyberlux Corporation Hybrid Lighting Technologies, Inc. 192,455 January 30 CytoDyn, Inc. Advanced Genetic Technologies, Inc. 167,500 January 31 Material Technologies, Inc. Stress Analysis Technologies, Inc. 130,000 February 12 Liberty Diversified Holdings, Inc. Sero Tonin Solutions, Inc. 70,052 March 12 Metamorphix Global, Inc. Flex Crete Technologies, Inc. 52,884 March 12 Klegg Electronics, Inc. Tempo Control Technologies, Inc. 135,388 March 28 Avalon Oil & Gas, Inc. Leak Location Technologies, Inc. 155,000 April 30 Material Technologies, Inc. Damage Assessment Technologies, Inc. 300,000 May 30 Klegg Electronics, Inc. Klegg Network Storage Technologies, Inc. 450,000 June 28 Material Technologies, Inc. Non-Destructive Assessment Technologies, Inc. 280,000 July 12 Pathway One Plc WebMed Technologies, Inc. 305,215 July 20 MachineTalker, Inc. Wideband Detection Technologies, Inc. 40,000 Sept 28 World Energy Solutions, Inc. Hydrogen Safe Technologies, Inc. 492,350 November 12 NeoStem, Inc. Stem Cell Technologies, Inc. 300,000 December 28 MachineTalker, Inc. Micro Wireless Technologies, Inc. 345,000 $ 3,815,844 Salaries and Wages (in thousands, except percentages) 2009 2008 2007 Percent Change 2009 versus 2008 Percent Change 2008 versus 2007 Salaries and wages $ 5,295 $ 6,154 $ 3,519 (14 )% 75 % As a percent of revenue 49 % 30 % 17 % 19 ppt 13 ppt Salaries and wages include non-sales employee and officer salaries and related benefits including bonuses and stock-based compensation. Salaries and wages decreased by $859,000 for the year ended December 31, 2009 compared to the year ended December 31, 2008. During the year ended December 30, 2009, we had a $2.55 million charge to salaries and wages related to the modification of the acquisition and employment agreements with the manager of our Social Technologies division versus having had a $1.65 million charge for our CEO’s severance liability in the corresponding period of 2008. The offsetting decrease in salaries and wages of approximately $1.75 million in 2009 relates to the reduction in employees of $1,270,000, the retirement of our CEO of $284,000 and a decrease in stock compensation expense of $203,000 resulting primarily from significant option forfeitures. Salaries and wages increased $2.6 million during the year ended December 31, 2008 compared to the year ended December 31, 2007 as a result of the accrual of our former CEO’s severance liability of $1.65 million, the addition of Pharmalicensing employees to the payroll of $425,000, additional salaries related to new management for the TekScout website of $125,000, increased officer salaries of $293,000 and an increase in stock-based compensation expense of $167,000 resulting from additional option grants. We expect salaries and wages to increase for the year ending December 31, 2010 as a result of new hires. 25 Table of Contents Professional Fees (in thousands, except percentages) 2009 2008 2007 Percent Change 2009 versus 2008 Percent Change 2008 versus 2007 Professional fees $ 814 $ 1,257 $ 1,359 (35 )% (7 )% As a percent of revenue 8 % 6 % 7 % 2 ppt (1 )ppt Professional fees include accounting fees, legal fees and valuation expenses for our investments. Professional fees decreased by $443,000 for the year ended December 31, 2009 compared to the year ended December 31, 2008. We incurred legal fees related to specific projects in 2008 that were not incurred in 2009, which resulted in a decrease in legal fees of $198,000. Our valuation expenses decreased $124,000 due to a reduced number of investment holdings in 2009. Our accounting fees decreased $120,000 related to having four acquisition audits in 2008 that we did not have in 2009. The decrease in professional fees of $102,000 for the year ended December 31, 2008 compared to the year ended December 31, 2007 relates to a significant decrease in legal fees, partially offset by an increase in the accounting fees. We incurred legal fees related to our registration statement filing and responses to SEC comment letters in 2007, which were not incurred in 2008. This resulted in a decrease in legal fees of $316,000 in 2008. Our accounting fees increased $206,000 during 2008 related to acquisition audits performed due to filing requirements. We expect to have a decrease in professional fees for the year ending December 31, 2010 from an anticipated reduction in the number of investments requiring quarterly valuations and a reduction in legal fees related to the change from a BDC to an operating company. Sales and Marketing in thousands, except percentages) 2009 2008 2007 Percent Change 2009 versus 2008 Percent Change 2008 versus 2007 Sales and marketing $ 1,707 $ 2,322 $ 2,036 (26 )% 14 % As a percent of revenue 16 % 12 % 10 % 4 ppt 2 ppt Sales and marketing expenses include advertising, marketing, salaries and commissions paid to sales personnel, commissions paid to outside service providers, travel and other selling expenses. Sales and marketing expenses decreased by $615,000 for the year ended December 31, 2009 compared to the year ended December 31, 2008. Sales salaries decreased $81,000 as a result of downsizing the number of employees in all areas of the company, including sales staff. Commissions decreased $376,000 as a result of reduced sales and reduced sales staff. Sales related travel and entertainment costs decreased $42,000 and marketing costs decreased $109,000 in connection with management’s effort to curb costs. Sales and marketing expenses increased by $286,000 for the year ended December 31, 2008 compared to the year ended December 31, 2007. Commissions decreased $103,000 primarily as a result of reduced technology transfer sales. Sales related travel and entertainment costs increased $194,000 as a result of increased travel to clients in an attempt to boost sales and the addition of sales travel costs of our acquired companies. Marketing costs increased $81,000 due to the addition of marketing costs of our acquired companies and $19,000 for marketing our new TekScout website. Sales salaries increased $62,000 related to new employees from our acquired companies. We expect sales and marketing expenses to increase for the year ending December 31, 2010 as a result of a push in our marketing efforts. 26 Table of Contents General and Administrative (in thousands, except percentages) 2009 2008 2007 Percent Change 2009 versus 2008 Percent Change 2008 versus 2007 General and administrative $ 2,756 $ 3,781 $ 2,626 (27 )% 44 % As a percent of revenue 26 % 19 % 13 % 7 ppt 6 ppt General and administrative expenses decreased by $1.0 million for the year ended December 31, 2009 compared to the year ended December 31, 2008. We experienced a $297,000 reduction in investor relations, investment banking and public relations fees by eliminating our outside providers, a $156,000 reduction in payroll taxes and insurance and other payroll related expenses due to a decrease in payroll, and a $198,000 reduction in outside consulting costs related to four acquisitions during 2008, in addition to other reductions resulting from an overall plan to reduce all aspects of overhead. General and administrative expenses increased by $1.1 million for the year ended December 31, 2008 compared to the year ended December 31, 2007 as a direct result of the four acquisitions made in 2008. We had significant increases in insurance of $255,000, rent of $179,000, outside services of $180,000 and investment banking of $61,000, all of which were directly related to the acquisitions. The remainder of the increase primarily relates to employee costs as a result of these acquisitions. The increase was partially offset by a decrease in bad debt expense of $128,000 and a decrease in public relations costs of $54,000 because we stopped using an outside firm for this service. We expect general and administrative expenses for the year ending December 31, 2010 to remain flat to 2009. Amortization and Depreciation (in thousands, except percentages) 2009 2008 2007 Percent Change 2009 versus 2008 Percent Change 2008 versus 2007 Amortization and depreciation $ 1,616 $ 1,096 $ 212 47 % 416 % As a percent of revenue 15 % 5 % 1 % 10 ppt 4 ppt The increase in amortization and depreciation expense for the years ended December 31, 2009 and 2008 was a direct result of four business acquisitions we made in 2008. We acquired $12.4 million in intangible assets and $350,000 in fixed assets during 2008 in connection with these acquisitions, which significantly increased our annual amortization and depreciation expense. We expect amortization and depreciation for the year ending December 31, 2010 to increase in relation to that of 2009 as a result of the addition $4.0 million in depreciable assets from the consolidation of UTEK Real Estate, partially offset by a decrease of $700,000 in definite-lived intangible asset as a result of impairment. Impairment Loss (in thousands, except percentages) 2009 2008 2007 Percent Change 2009 versus 2008 Percent Change 2008 versus 2007 Impairment loss $ 2,368 $ — $ 210 100 % — % As a percent of revenue 22 % — % 1 % 22 ppt (1 )ppt 27 Table of Contents Our long-lived assets are tested for impairment on at least an annual basis. Impairment testing is required more often than annually if an event or circumstance indicates that an impairment, or decline in value, may have occurred. No impairments were incurred in 2008, but we incurred impairments during both 2009 and 2007 as discussed below. In 2009, our Social Technologies division had significant declines in revenues related to their futures and foresight projects. The state of the economy during 2009 contributed to potential Social Technologies’ clients focusing on short-term survival rather than long-term foresight planning. As a result, management terminated the majority of the division’s employees in favor of an independent, network-based approach in an effort to reduce overhead. Management concluded that this division suffered a significant adverse change in the business, which includes a projection of continuing operating and cash flow losses. We determined that there was impairment of the division’s purchased intangible assets of $1.0 million and impairment of the division’s goodwill of $1.3 million during 2009. In connection with our annual impairment analysis in 2007, we determined there was impairment of the goodwill related to the Pharma Transfer, Ltd. and Knowledge Express acquisitions. As a result, we recorded a partial impairment of the related goodwill during 2007. These write-downs resulted in an impairment charge of approximately $159,000 ($99,000 after tax) for the United Kingdom segment and $51,000 ($32,000 after tax) for the United States segment during 2007. Other (income) expense Other (income) expense is a new line item in our statement of operations beginning on October 1, 2009 in connection with our conversion to Operating Company Accounting. The net expense of $69,731 for the three months ended December 31, 2009 is primarily comprised of $110,000 loss on derivative liability relating to revaluing certain of our outstanding warrants to purchase UTEK common stock. This loss is partially offset by rental income of $40,000 and capital gains from the sale of marketable securities of $20,000. Interest Expense Interest expense, net is a new line item in our statement of operations beginning on October 1, 2009 in connection with our conversion to Operating Company Accounting. The net expense of $85,467 for the three months ended December 31, 2009 is primarily comprised of interest expense on long-term debt, primarily related to mortgages held by UTEK Real Estate, partially offset by interest income on our note receivable. Net Realized Gains or Losses on Investments (from investment company activity) (in thousands, except percentages) 2009 2008 2007 Percent Change 2009 versus 2008 Percent Change 2008 versus 2007 Realized gains/ (losses) $ (49,591 ) $ (4,232 ) $ (1,447 ) 1072 % 192 % In connection with our plan to de-elect BDC status, we liquidated a significant portion of our investment portfolio during 2009. We sold some or all of our shares in a significant number of our portfolio companies for $3.1 million in cash and other assets, which resulted in realized losses of $49.6 million and unrealized appreciation of $44.3 million, which is primarily related to the reversal of previously recorded unrealized depreciation upon the sale of these investments. 28 Table of Contents Net realized losses on investments amounted to $49,591,193 for the nine months ended September 30, 2009 and were related to sales as follows: Portfolio Company Number of Shares Realized Gain (Loss) Advanced Medical Isotope Corporation—preferred shares 95,000 $ (1,387,427 ) Advanced Refractive Technologies, Inc.—common and preferred shares various (3,369,544 ) American Soil Technologies, Inc. 6,498,845 (1,010,585 ) Avalon Oil and Gas, Inc. 3,373,107 (1,595,566 ) Cyberlux Corporation—common and preferred shares various (2,133,210 ) CytoDyn, Inc. 2,768,000 (2,622,757 ) Eclips Energy Technologies, Inc. 9,790,530 (1,906,981 ) Island Gas Resources Plc 2,500 (4,478,732 ) Stealth MediaLabs, Inc. 4,221,165 (1,192,848 ) Klegg Electronics, Inc. 15,009,402 (4,543,913 ) Rim Semiconductor Company 210,000,000 (1,251,861 ) MATECH Corporation 17,823 (2,872,617 ) NutriPure Beverages, Inc.—common shares 69,237 (1,137,017 ) Tesla Vision Corporation—common and preferred shares various (3,074,753 ) The Renewable Corporation 2,971 (2,413,005 ) Trio Industries Group, Inc. 7,787,565 (8,611,409 ) UBA Technology, Inc.—common and preferred shares various (2,285,649 ) All other investments sold (3,703,319 ) Total $ (49,591,193 ) Net realized losses on investments, net of income tax effect, amounted to $4,232,138 for the year ended December 31, 2008 and were related to sales as follows: Company Name Number of Shares Realized Gain (Loss) Advanced Medical Isotope Corporation 600,000 $ 203,950 Avalon Oil and Gas, Inc. 247,200 (235,050 ) Broadcast International, Inc. 478,562 479,441 EcoSystem Corporation 922,446 (1,513,603 ) eLinear, Inc. 261,234 (118,963 ) The Renewable Corporation 2,491 (1,805,369 ) MATECH Corporation 2,728,243 (323,273 ) Pathway One PLC 3,000,000 (265,790 ) All other investments sold 20,434,345 (653,481 ) Total ($ 4,232,138 ) 29 Table of Contents Net realized losses on investments, net of income tax effect, amounted to $1,447,380 for the year ended December 31, 2007 and were related to sales as follows: Portfolio Company Number of Shares Realized Gain (Loss) Shumate Industries, Inc. 171,432 $ 127,234 Health Sciences Group, Inc. 3,023,703 (974,894 ) Swiss Medica, Inc. 1,735,000 (181,851 ) Xethanol Corporation 136,838 (378,936 ) Broadcast International, Inc. 505,798 222,543 Power3 Medical Products, Inc. 221,033 (106,931 ) All other investments sold 3,557,785 (154,545 ) Total ($ 1,447,380 ) Net realized gains and losses can vary substantially due to a variety of factors and may not be indicative of future performance. As a result of the uncertainty surrounding the future values of our investments, we are unable to make any projections or estimates regarding realized gains or losses expected in 2010. Net Changes in Unrealized Appreciation or Depreciation on Investments (from investment company activity) As a BDC, we were required to determine the value of each investment in our portfolio on a quarterly basis and changes in value result in unrealized appreciation or depreciation being recognized. Value, as defined in Section 2(a)(41) of the 1940 Act, is (i) the market price for those securities for which a market quotation is readily available and (ii) for all other securities and assets, fair value is as determined in good faith by the Board of Directors. Because there is typically no readily available market value for the investments in our portfolio, we valued substantially all of our investments at fair value as determined in good faith by the Board of Directors. In making its determination, our Board of Directors considered valuation appraisals provided by independent valuation service providers. Because of the inherent uncertainty of determining the fair value of investments that do not have a readily available market value, the fair value of our investments determined in good faith by the Board of Directors may differ significantly from the values that would have been used had a ready market existed for the investments, and the differences could be material. (in thousands, except percentages) Nine Months Ended Sept 30, 2009 Year Ended Dec 31, 2008 Year Ended Dec 31, 2007 Percent Change 2009 versus 2008 Percent Change 2008 versus 2007 Unrealized appreciation/ (depreciation) $ 44,292 $ (12,218 ) $ (10,806 ) (463 )% 13 % Overall negative equity market conditions and a weakened U.S. economy have resulted in significant decreases in market prices for a significant portion of our portfolio companies. This resulted in significant unrealized depreciation on many of our investments during 2008 and 2007. A significant amount of the accumulation of these losses has been realized during 2009 in connection with the sale or exchange of the majority of these investments. In addition, we recorded a valuation allowance against our deferred tax asset during 2008. A portion of the valuation allowance ($5.7 million) was charged as an expense against the change in unrealized depreciation of investments for the year ended December 31, 2008. The valuation allowance was recorded as a result of management’s determination that it was more likely than not that our net operating loss carryforwards would not be utilized in the future. In connection with our plan to de-elect BDC status, we liquidated a significant portion of our investment portfolio during 2009. We sold some or all of our shares in a significant number of our portfolio companies for $3.1 million in cash and other assets, which resulted in realized losses of $49.6 million and unrealized appreciation of $44.3 million, which is primarily related to the reversal of previously recorded unrealized depreciation upon the sale of these investments. 30 Table of Contents Net change in unrealized appreciation (depreciation) on investments amounted to $44,292,068 for the nine months ended September 30, 2009 and was related to our investments as follows: Portfolio Company Net Unrealized Appreciation (Depreciation) Effect of recognition of realized gains (losses) $ 42,937,888 Eclips Energy Technologies, Inc. 685,848 Websky, Inc. 294,262 All other investments 374,070 Total $ 44,292,068 Net change in unrealized appreciation (depreciation) on investments, net of income tax effect, amounted to $(12,217,977) for the year ended December 31, 2008 and was related to our investments as follows: Portfolio Company Net Unrealized Appreciation (Depreciation) Effect of recognition of realized gains (losses) $ 2,580,081 Advanced Refractive Technologies, Inc. (648,249 ) Cyberlux Corporation (710,231 ) Emission & Power Supply, Inc. (813,678 ) Tesla Vision Corporation (510,498 ) MachineTalker, Inc. (333,430 ) MATECH Corporation (2,439,129 ) MiMedx Group, Inc. 705,529 Platina Energy Group, Inc. (454,478 ) RIM Semiconductor Company (1,117,982 ) World Energy Solutions, Inc. (1,229,624 ) All other investments (1,556,095 ) Deferred tax valuation allowance (5,690,193 ) $ (12,217,977 ) Net unrealized appreciation (depreciation) on investments, net of income tax effect, amounted to $(10,806,048) for the year ended December 31, 2007 and was related to our investments as follows: Portfolio Company Net Unrealized Appreciation (Depreciation) Effect of recognition of realized gains (losses) $ 1,852,136 Advanced Refractive Technologies, Inc. (1,261,124 ) American Soil Technologies, Inc. (720,328 ) CytoDyn, Inc. (825,467 ) Industrial Biotechnology Corporation (1,243,595 ) Emission & Power Supply, Inc. (766,590 ) Klegg Electronics, Inc. (3,489,976 ) Manakoa Services Corporation (1,055,455 ) vidShadow, Inc. (703,548 ) World Energy Solutions, Inc. (1,436,653 ) All other investments (1,155,448 ) $ (10,806,048 ) 31 Table of Contents While these unrealized losses were significant, reduction in values and failures among small cap companies is not unexpected and may occur in the future. Changes in unrealized appreciation or depreciation can vary substantially due to a variety of factors and may not be indicative of future performance. Other Matters Income Tax Deferred taxes are provided on the asset and liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carry forwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Future tax benefits for net operating loss carryforwards are recognized to the extent that realization of these benefits is considered more likely than not. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. For federal and state income tax purposes, we are taxed at regular corporate rates on ordinary income and recognize gains on distributions of appreciated property. As an investment company, we were not entitled to the special tax treatment available to BDCs that elect to be treated as regulated investment companies under the Internal Revenue Code because, among other reasons, we did not distribute at least 90% of “investment company taxable income” as required by the Internal Revenue Code for such treatment. We do not have any income tax benefit related to the net loss from operations in 2009, nor do we have a deferred tax asset related to our net operating loss carryforward, because of a 100% valuation allowance. We do have an income tax benefit from the reversal of a deferred tax liability related to the impairment of an indefinite-lived intangible asset and from foreign tax for the year ended December 31, 2009. Liquidity and Capital Resources Cash Flows Cash used in operating activities of $3.7 million in 2009 increased $1.4 million from $2.3 million in 2008. This total cash used in operations of $3.7 million is primarily attributable to: • $9.96 million net operating loss; • $944,000 related to severance compensation paid to our former CEO in cash; and • $1.55 million decrease in deferred revenue related to recognition of certain jobs coupled with a lower overall revenue level. Partially offset by: • $682,000 in cash proceeds received from the sale of investments from investment company activity; • $1.6 million in non-cash depreciation and amortization related to the intangible assets and fixed assets acquired in 2008; • $2.4 million in non-cash goodwill and intangible asset impairment related to the Social Technologies division that was purchased in 2008; • $2.5 million in non-cash severance compensation paid for in escrowed shares of our common stock; • $577,000 in non-cash stock compensation expense related to the options issued; and • $1.2 million decrease in accounts receivable related to reduced revenue levels as a result of the economic downturn coupled with increased collection efforts. 32 Table of Contents Cash provided by investing activities of $169,000 in 2009 decreased $620,000 from $789,000 in 2008. This total cash provided by investing of $169,000 is primarily attributable to: • $453,000 in cash proceeds received from the sale of investments from operating company activity, Partially offset by: • $292,000 in cash paid out in connection with Strategos’ 2008 tax liability resulting from the acquisition. Cash provided by financing activities of $1.7 million in 2009 increased $1.55 million from $178,000 in 2008. This total cash provided by financing of $1.7 million is primarily attributable to: • $1.75 million in cash received from debt financing. Borrowings As of October 1, 2009, the financial results of UTEK Real Estate have been consolidated with those of UTEK. UTEK Real Estate has a $3 million bank note payable due in monthly installments of $20,436 including principal and interest at 6.50% through April 1, 2013 with a balloon payment due on May 1, 2013. In addition, UTEK Real Estate has a $1.5 million note payable due in monthly installments of interest at 5.25% with principal due in full on October 1, 2015. These loans were entered into in connection with the purchases of land and building that serves as our company headquarters and certain other undeveloped land located in Hillsborough County, Florida. These loans are collateralized by the property related to the purchases. On October 22, 2009, we entered into a Promissory Note (the “Note”) with Gators Lender, LLC (the “Lender”), pursuant to which we borrowed $1,750,000 from the Lender. Interest is payable at an annual rate of 8% on a quarterly basis, in arrears, beginning April 15, 2010. The entire principal amount outstanding and all accrued interest is payable in full no later than October 22, 2012. UTEK Real Estate is a co-borrower under the Note and the loan is guaranteed by all subsidiaries. In addition, the guaranty was secured pursuant to a security agreement encumbering vacant real property located in Hernando County, Florida (the “Collateral”), which is owned by Cortez 114, LLC (“Cortez”), a subsidiary of UTEK Real Estate. On February 26, 2010, we entered into a Substitution of Collateral Agreement and a Membership Interest Pledge Agreement and Release of Mortgage (the “Modification Agreements”), pursuant to which the Lender’s security interest in the Collateral was released and replaced by a security interest in 68% of the outstanding membership interests of Cortez. The Note was amended and restated to provide that UTEK and UTEK Real Estate must pay down $500,000 of the indebtedness to the Lender within 60 days. As additional consideration for this loan, we also entered into a Warrant Agreement with the Lender to allow the Lender to purchase up to 437,500 shares of UTEK’s common stock at an exercise price of $4.48 until October 22, 2014. The exercise price is subject to certain conditions and adjustments that make the exercise price variable. Liquidity Our primary cash requirements include working capital, principal and interest payments on indebtedness, and funding bonuses and severance obligations. Our primary sources of funds are cash received from customers in connection with operations, proceeds from the sale of our investments, debt financing and availability under our $450,000 revolving line of credit. At December 31, 2009, we had cash and cash equivalents of $2.1 million and investments in certificates of deposit (“CDs”) of $492,000. The CDs are pledged to financial institutions as collateral to support the issuance of our line of credit. The Company had $200,000 of unused availability under its revolving line of credit at December 31, 2009. 33 Table of Contents Subsequent to December 31, 2009, we satisfied our remaining severance obligation to our former CEO through the conveyance of a 32% ownership interest in Cortez. Cortez owns vacant real property located in Hernando County, Florida that previously served as Collateral to the Note discussed in “Borrowings” above. The Modification Agreement was entered into in connection with our satisfaction of this severance obligation. In connection with this severance payment, we paid approximately $320,000 to satisfy the related payroll taxes. We currently intend to fund our capital expenditures and liquidity needs with existing cash and cash equivalent balances, our investments in certificates of deposit, as well as with cash generated by operations, the potential sales of our investments and unused availability under our revolving line of credit. As a result of our progress in significantly reducing our overhead expenses, we believe that these sources will be sufficient to fund our scheduled debt service, bonus and severance obligations, and provide required resources for working capital for the next twelve months. We may seek to raise additional funds through public or private debt or equity financing for long-term liquidity. Financing terms from our recent debt financing discussed under “Borrowings” represent what possible additional financing could look like in the near term. Off-Balance Sheet Arrangements We have no off-balance sheet arrangements that have or are materially likely to have a current or future material effect on our financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources. Contractual Obligations The following table reflects a summary of our significant contractual obligations and other commercial commitments as of December 31, 2009 and the effect such obligations are expected to have on our liquidity and cash flow in future periods: Contractual Obligations Payments due by Period Total Less than 1 year 1-3 years 3-5 years More than 5 years Lines of credit $ 250,000 $ 250,000 $ — $ — $ — Long-term debt 6,554,000 875,000 1,681,000 2,748,000 1,250,000 Estimated interest payments(1) 1,627,000 470,000 819,000 250,000 88,000 Capital lease obligations 45,000 35,000 10,000 — — Operating lease obligations 300,000 136,000 139,000 25,000 — Total $ 8,776,000 $ 1,766,000 $ 2,649,000 $ 3,023,000 $ 1,338,000 (1) Estimated interest payments for long-term debt were calculated based on applicable rates and payment dates. Management expects to settle such interest payments with cash flows from operating activities or short-term borrowings. 34 Table of Contents Critical Accounting Estimates The preparation of financial statements in conformity with US GAAP requires management to make assessments, estimates and assumptions that affect the amounts reported in the financial statements. Critical accounting estimates are those that require management’s most difficult, complex, or subjective judgments and have the most potential to impact our financial position and operating results. We consider the following accounting policies and related estimates to be critical with regard to our status as an investment company and as an operating company: Revenue Recognition—Applicable under Both Investment Company Accounting and Operating Company Accounting Innovation Consulting Services Related to the Company’s Strategos division, revenues on fixed fee contracts are recognized on a pro rata basis based upon costs incurred to date compared to total estimated contract costs. Prior to the commencement of a client engagement, the Company and the client agree on fees for services based upon the scope of the project, staffing requirements and the level of client involvement. Total revenues are comprised of professional fees for services rendered to clients plus reimbursement of out-of-pocket expenses and exclude applicable taxes. Service revenue recognition inherently involves a degree of estimation. Examples of important estimates in this area include determining the level of effort required to execute the project, calculating costs incurred and assessing our progress toward project completion on an ongoing basis. These estimates can materially affect our revenues and earnings and require us to make judgments about matters that are uncertain. We utilize a number of management processes to monitor project performance and revenue recognition including periodic reviews of the progress of each project against the budget and staff and resource usage. From time to time, as part of our normal management process, circumstances are identified that require us to revise our estimates of the timing of revenues to be realized on a project. To the extent that a revised estimate affects revenue previously recognized, we record the full effect of the revision in the period when the underlying facts become known. Related to the Company’s Social Technologies division, the Company has certain other consulting revenue for which vendor specific objective evidence is not available to allocate among the respective deliverables. Accordingly, the Company recognizes consulting services revenue at the point when all the deliverables associated with the consulting contract have been provided to the customer. Before the Company recognizes revenue, we require evidence of an agreement with the customer, delivery of the product or services, a fixed fee arrangement, collectability must be reasonably assured and receipt is probable. Collectability is determined on a customer-by-customer basis. Time-and-expense billing arrangements generally require the client to pay based on the number of hours worked by our consulting professionals at agreed-upon rates. Time-and-expense revenues are billed and recognized as incurred. Sale of Technology Rights A sale of technology rights refers to the process by which externally developed technologies are licensed to client companies for potential development and use. Historically, we primarily received illiquid securities in our client companies in connection with the sale of technology rights. The securities received were generally subject to restrictions on resale and generally were thinly traded or had no established market. Revenue for the sale of technology rights was based on the fair value of the securities received on the date of completion of the sale contract. The valuation of these securities at fair value is further discussed in the following section “Valuation Methodology for Portfolio Investments—Applicable under Investment Company Accounting.” 35 Table of Contents Subscription and Other Services Revenue from the sale of subscriptions to the Company’s websites generally is received in the form of cash and initially is deferred and subsequently recognized ratably over the term of the subscription, which is typically one year. Valuation Methodology for Portfolio Investments—Applicable under Investment Company Accounting Historically, we primarily received illiquid securities in connection with both our global technology licensing agreements and technology transfers. The securities received were generally subject to restrictions on resale and generally are thinly traded or have no established market. We determine fair value to be the amount for which an investment could be exchanged in an orderly disposition over a reasonable period of time between willing parties other than in a forced or liquidation sale. Our valuation process is intended to provide a consistent basis for determining the fair value of our portfolio investments. We record unrealized depreciation on investments when we believe that an investment has become impaired, including where realization of an equity security is doubtful. We record unrealized appreciation if we believe that the underlying portfolio company has appreciated in value and, therefore, our equity security has also appreciated in value. Upon the sale of our investments, the values that are ultimately realized may be different from the presently determined fair values of such securities. This difference could be material. We adopted the standards in ASC Topic 820 Fair Value Measurements and Disclosures on a prospective basis in the first quarter of 2008. These standards require us to assume that the portfolio investment is to be sold in the principal market to market participants, or in the absence of a principal market, the most advantageous market, which may be a hypothetical market. Market participants are defined as buyers and sellers in the principal or most advantageous market that are independent, knowledgeable, and willing and able to transact. In accordance with the standards, we have considered our principal market, or the market in which we exit our portfolio investments with the greatest volume and level of activity. All portfolio investments recorded at fair value are categorized based upon the level of judgment associated with the inputs used to measure their fair value. Hierarchical levels related to the amount of subjectivity associated with the inputs to fair valuation of these assets, are as follows: • Level 1—Unadjusted quoted prices in active markets for identical assets or liabilities. • Level 2—Quoted prices in active markets for similar assets or liabilities, or quoted prices for identical or similar assets or liabilities in markets that are not active, or inputs other than quoted prices that are observable for the asset or liability. • Level 3—Unobservable inputs for the asset of liability. Investment in our portfolio companies are classified within Level 2 of the fair value hierarchy as of December 31, 2008. Our equity interests in portfolio companies for which there is no liquid public market are valued using quoted market prices for identical or similar instruments in markets that are not active. The determined values are generally discounted to account for the illiquid nature of the investment and minority ownership positions. The value of our equity interests in portfolio companies for which market quotations are readily available is based on quoted market prices for similar instruments in an active market. These securities are generally thinly traded and/or carry discounts from the public market value for certain restrictions on resale. The fair value of our investments at December 31, 2008 was determined by our Board of Directors. At December 31, 2008, we received valuation assistance from an independent valuation firm on our entire portfolio of investments. As an investment company, our Board of Directors is ultimately responsible for valuing our investments in good faith. 36 Table of Contents Net Realized Gains or Losses and Net Change in Unrealized Appreciation or Depreciation for Portfolio Investments—Applicable under Investment Company Accounting Realized gains or losses are measured by the difference between the net proceeds from the repayment or sale and the original cost basis of the investment without regard to unrealized appreciation or depreciation previously recognized. The original cost basis of the securities received in connection with our global technology licensing agreements and technology transfers is equal to the amount of revenue recognized upon the receipt of such securities. Net change in unrealized appreciation or depreciation of investments through September 30, 2009 reflects the change in portfolio investment values during the reporting period, including the reversal of previously recorded unrealized appreciation or depreciation when gains or losses are realized. Valuation Methodology for Available-for-Sale Securities—Applicable under Operating Company Accounting All investments recorded at fair value are categorized based upon the level of judgment associated with the inputs used to measure their fair value. Hierarchical levels related to the amount of subjectivity associated with the inputs to fair valuation of these assets, are as follows: • Level 1—Unadjusted quoted prices in active markets for identical assets or liabilities. • Level 2—Quoted prices in active markets for similar assets or liabilities, or quoted prices for identical or similar assets or liabilities in markets that are not active, or inputs other than quoted prices that are observable for the asset or liability. • Level 3—Unobservable inputs for the asset of liability. The Company’s investments are classified within Level 2 of the fair value hierarchy. Our equity interests in companies for which there is no liquid public market are valued using quoted market prices for identical or similar instruments in markets that are not active. The determined values are generally discounted to account for the illiquid nature of the investment and minority ownership positions. The value of our equity interests in public companies for which market quotations are readily available is based on quoted market prices for similar instruments in an active market. These securities are generally thinly traded and/or carry discounts from the public market value for certain restrictions on resale. The Company utilizes the assistance of a third-party valuation firm in determining these values. Stock-Based Compensation—Applicable under Both Investment Company Accounting and Operating Company Accounting We account for stock option grants in accordance with US GAAP. Stock-based compensation cost recognized during the years ended December 31, 2009, 2008 and 2007 includes compensation cost for all share-based payments granted prior to, but not yet vested as of January 1, 2006 and compensation cost for all share-based payments granted subsequent to January 1, 2006, based on their relative grant date fair values estimated in accordance with US GAAP. The Company recognizes compensation expense on a straight-line basis over the requisite service period. Determination of the fair values of stock option grants at the grant date requires judgment, including estimating the expected term of the relevant grants and the expected volatility of the Company’s stock. Additionally, management must estimate the amount of stock option grants that are expected to be forfeited. The expected term of options granted represents the period of time that the options are expected to be outstanding and is based on historical experience of similar grants, giving consideration to the contractual terms of the grants, vesting schedules and expectations of future employee behavior. The expected volatility is based upon our historical market price at consistent points in a period equal to the expected life of the options. Expected forfeitures are based on historical experience and expectations of future employee behavior. 37 Table of Contents Purchase Price Allocation Process for Business Combinations—Applicable under Both Investment Company Accounting and Operating Company Accounting We determine and allocate the purchase price of an acquired company to the tangible and intangible assets acquired and liabilities assumed as of the business combination date in accordance with US GAAP for business combinations. The purchase price allocation process requires us to use significant estimates and assumptions, including fair value estimates, as of the business combination date. While we use our best estimates and assumptions as a part of the purchase price allocation process to accurately value assets acquired and liabilities assumed at the business combination date, our estimates and assumptions are inherently uncertain and subject to refinement. As a result, during the purchase price allocation period, which is generally one year from the business combination date, we record adjustments to the assets acquired and liabilities assumed based on additional information received, with the corresponding offset to goodwill. In addition, there are contingencies based on earnings (commonly referred to as earnouts) included in some of our purchase agreements entered into during 2008. The earnout is recorded as it is earned over the contingency period, which is generally one to three years from the business combination date. With the exception of unresolved income tax matters or the earnout of contingent consideration, subsequent to the purchase price allocation period any adjustment to assets acquired or liabilities assumed is included in our operating results in the period in which the adjustment is determined. In January 2009, the Company adopted new US GAAP for business combinations, which requires a number of changes, including changes in the way assets and liabilities are recognized as a result of business combinations. This new US GAAP requires that more assets and liabilities assumed be measured at fair value as of the acquisition date and that liabilities related to contingent consideration be re-measured at fair value in each subsequent reporting period. It also requires the capitalization of in-process research and development at fair value and requires the expensing of acquisition-related costs as incurred. The impact of the adoption of this new US GAAP for business combinations will depend on the nature of acquisitions completed after the date of adoption. Carrying Values of Goodwill and Intangible Assets—Applicable under Both Investment Company Accounting and Operating Company Accounting Goodwill represents the excess of the aggregate consideration paid for an acquisition over the fair value of the net tangible and intangible assets acquired. Intangible assets represent the cost of trade marks, trade names, websites, customer lists, non-compete agreements, and proprietary processes and software obtained in connection with certain of these acquisitions. Intangible assets with finite lives are amortized on a straight-line basis over their estimated useful lives, which range from 5 to 12 years. In accordance with US GAAP, goodwill and intangible assets determined to have indefinite lives are not subject to amortization but are tested for impairment annually, or more frequently if events or changes in circumstances indicate a potential impairment may have occurred. Circumstances that may indicate impairment include qualitative factors such as an adverse change in the business climate, loss of key personnel, and unanticipated competition. Additionally, management considers quantitative factors such as current estimates of the future profitability of the Company’s reporting units, the current stock price, and the Company’s market capitalization compared to its book value. In conducting its impairment test, the Company compares the fair value of each of its reporting units to the related book value. If the fair value of a reporting unit exceeds its net book value, long-lived assets are considered not to be impaired. If the net book value of a reporting unit exceeds it fair value, an impairment loss is measured and recognized. The Company conducts its impairment test using balances as of December 31. The Company accounts for long-lived assets, including intangibles that are amortized, in accordance with US GAAP, which requires that all long-lived assets be reviewed for impairment whenever events or circumstances indicate that the carrying amount of an asset may not be recoverable. If indicators of impairment are present, reviews are performed to determine whether the carrying value of an asset to be held and used is 38 Table of Contents impaired. Such reviews involve a comparison of the carrying amount of an asset to future net undiscounted cash flows expected to be generated by the asset over its remaining useful life. If the comparison indicates that there is impairment, the impaired asset is written down to its fair value. The impairment to be recognized as a non-cash charge to earnings is measured by the amount by which the carrying amount of the asset exceeds the fair value of the asset. Assets to be disposed are reported at the lower of the carrying amount or fair value, less cost to dispose. As a result of significant declines in revenues related to its futures and foresight projects, management determined that there was possible goodwill and intangible asset impairment for our Social Technologies reporting unit. Therefore, interim impairment testing was performed as of June 30, 2009. The state of the economy early in 2009 contributed to potential Social Technologies’ clients focusing on short-term survival rather than long-term foresight planning. As a result, management terminated the majority of this division’s employees in favor of an independent, network-based approach in an effort to reduce overhead. Management concluded that this division suffered a significant adverse change in the business, which included a projection of continuing operating and cash flow losses. The Company determined that there was impairment of this division’s purchased intangible assets of $1.0 million and impairment of the division’s goodwill of $1.3 million. This impairment loss is included in the Company’s consolidated statement of operations for the nine months ended September 30, 2009. Based on our annual impairment analysis completed with the assistance of our independent valuation firm, we determined that no additional impairment exists at December 31, 2009. Derivative Liability—Applicable under Operating Company Accounting US GAAP requires bifurcation of embedded derivative instruments and measure of their fair value for accounting purposes. In addition, freestanding derivative instruments such as certain warrants are also derivative liabilities. We estimate the fair value of these instruments using the Black-Scholes option pricing model, which takes into account a variety of factors that require judgment, including estimating the expected term of the warrants and the expected volatility of the Company’s stock price. The expected term of the warrants represents the period of time that they are expected to be outstanding and is based on the contractual term of the warrants and expectations of the warrants holders’ behavior. The expected volatility is based upon our historical market price at consistent points in a period equal to the expected life of the warrants. Derivative liabilities are recorded at fair value at inception and then are adjusted to reflect fair value at the end of each quarter, with any increase or decrease in the fair value being recorded in results of operations as a component of other (income) expense. At December 31, 2009, we had a derivative instrument related to our issuance of a Note and Warrant Purchase Agreement as further discussed in Note 7 to the consolidated financial statements contained elsewhere in this annual report on Form 10-K. The warrants have features that make their exercise price variable. We used the Black-Scholes model to determine the fair value of these warrants at inception, which resulted in a derivative liability of approximately $555,000. We used the Black-Scholes model to determine the fair value of the warrants again as of December 31, 2009, which resulted in a derivative liability of approximately $665,000. The increase in the fair value of the derivative liability from inception is primarily related to the increase in the market price of our stock during the period. Recently Issued Accounting Pronouncements In October 2009, the Financial Accounting Standards Board (“FASB”) issued an update to existing guidance on revenue recognition for arrangements with multiple deliverables. This update will allow companies to allocate consideration received for qualified separate deliverables using estimated selling price for both delivered and undelivered items when vendor-specific objective evidence or third-party evidence is unavailable. Additional disclosures discussing the nature of multiple element arrangements, the types of deliverables under the arrangements, the general timing of their delivery, and significant factors and estimates used to determine estimated selling prices are required. We will adopt this update for new revenue arrangements entered into or materially modified beginning January 1, 2011. The adoption of this update is not expected to have a material impact on our consolidated financial statements. 39 Table of Contents