1. INTERIM FINANCIAL STATEMENTS

9 Months Ended

Sep. 30, 2013

Notes to Financial Statements

INTERIM FINANCIAL STATEMENTS

The accompanying financial statements for the three and nine months ended September 30, 2013 and 2012 are unaudited, and have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC").  Certain information and note disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to those rules and regulations.  Accordingly, these interim financial statements should be read in conjunction with the audited financial statements and notes thereto contained in Cicero Inc.'s (the "Company") Annual Report on Form 10-K for the year ended December 31, 2012, filed with the SEC on April 15, 2013.  The results of operations for the interim periods shown in this report are not necessarily indicative of results to be expected for other interim periods or for the full fiscal year.  In the opinion of management, the information contained herein reflects all adjustments necessary for a fair presentation of the interim results of operations.  All such adjustments are of a normal, recurring nature.

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

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

Liquidity

The accompanying financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business.  The Company has incurred an operating loss of approximately $188,000 for the year ended December 31, 2012, and has a history of operating losses. For the nine months ended September 30, 2013, the Company incurred losses of $2,542,000 and had a working capital deficiency of $10,094,000 as of September 30, 2013. The Company retired approximately $1,900,000 and $416,000 of debt in 2012 and 2013, respectively. Additionally, the Company converted $3,800,000 of debt into common stock and received notification of additional forgiveness of liabilities of $598,000 during 2012.  Management feels that the Company has repositioned itself in the marketplace. The creation of Cicero Edge as a product in the enterprise mobility space has opened new opportunities in the financial services, insurance, healthcare and government industries where workers are becoming un-tethered from their desktops. Enterprise software sales are typically the result of a long sales cycle. In an effort to shorten that sales cycle, the Company has promoted its Discovery product which is a lightweight tool for both business and IT to use to determine how work happens at the desktop.  Discovery can capture data and generate reports that will point out bottlenecks in processes where automations or composites are called for.  Those actions would involve the use of the Company’s XM Product.   The Company anticipates an improvement in this regard based upon current discussions with active customers and prospects.  However, should the Company be unable to secure customer contracts that will drive sufficient cash flow to sustain operations, the Company will be forced to seek additional capital in the form of debt or equity financing; however, there can be no assurance that such debt or equity financing will be available on terms acceptable to the Company or at all. These factors raise substantial doubt about the Company’s ability to continue as a going concern. The financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern.

Use of Accounting Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual amounts could differ from these estimates.  Significant estimates include the recoverability of long-lived assets, valuation and recoverability of goodwill, stock based compensation, deferred taxes and related valuation allowances and valuation of equity instruments.

Financial Instruments:

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

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

	September 30, 2013		December 31, 2012
Fair Value	$	670,830	$	3,420,397
Carrying Value		700,000		3,509,000

Valuations for long-term debt are determined based on borrowing rates currently available to the Company for loans with similar terms and maturities. These loans have been determined to be Level 3 within the fair value hierarchy and use a discounted cash flow model to determine its valuation. There have been no changes to the valuation technique.

Stock-Based Compensation

The Company accounts for stock-based compensation in accordance with Accounting Standards Codification (“ASC”) 718 “Compensation – Stock Compensation” which addresses the accounting for stock-based payment transactions in which an enterprise receives employee services in exchange for (a) equity instruments of the enterprise or (b) liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of such equity instruments.  The Company uses the Black-Scholes option-pricing model to determine the fair-value of stock-based awards under ASC 718.  The Company issued 25,000 options at an exercise price of $0.05 in the first nine months of 2013.  The Company recognized stock-based compensation expense of $23,000 and $69,000 for the three and nine months ended September 30, 2013, respectively.  This is comprised of the following amounts for the three and nine months, respectively, as of September 30, 2013; $2,000 and $6,000, in connection with outstanding options, $9,000 and $27,000, for the 549,360 shares of restricted stock reserved for Mr. John Broderick, the Company’s CEO, in accordance with his 2007 employment agreement, and $12,000 and $36,000 for the 1,500,000 shares of restricted stock reserved for Mr. Broderick, in accordance with his 2012 employment agreement.

At September 30, 2013, there was unrecognized compensation cost of $3,000 related to stock options which is expected to be recognized over a weighted-average amortization period of less than 1 year.  In addition, at September 30, 2013, there was $36,000 of unrecognized expense compensation cost related to Mr. Broderick’s 549,360 shares of unvested restricted stock that is expected to be recognized over a weighted-average period of 1 year and $56,000 of unrecognized expense compensation cost related to Mr. Broderick’s 1,500,000 shares of unvested restricted stock that is expected to be recognized over a weighted-average period of 1 year.

The following table sets forth certain information as of September 30, 2013 about shares of the Company’s common stock, par value $.001 (the “Common Stock”), outstanding and available for issuance under the Company’s existing equity compensation plans: the Cicero Inc. 2007 Employee Stock Option Plan, the Cicero Inc. 1997 Stock Option Incentive Plan and the Outside Director Stock Option Plan.  The Company’s stockholders approved all of the Company’s stock-based compensation plans.

	Shares
Outstanding on December 31, 2012		3,921,493
Granted		25,000
Exercised		--
Forfeited		(533,283	)
Outstanding on September 30, 2013		3,413,210
Weighted average exercise price of outstanding options	$	0.31
Aggregate Intrinsic Value	$	--
Shares available for future grants on September 30, 2013		1,094,090