iSign Solutions (ISGN) 10-Q 2012 Q1 Quarterly report

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:                                                      March 31, 2012

OR

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:                                                      000-19301                      

COMMUNICATION INTELLIGENCE CORPORATION

(Exact name of registrant as specified in its charter)

Delaware	94-2790442
(State or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification No.)

   275 Shoreline Drive, Suite 500, Redwood Shores, CA  94065-1413

          (Address of principal executive offices)                  (Zip Code)

(650) 802-7888

Registrant's telephone number, including area code

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes X No

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

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

large accelerated filer accelerated filer non-accelerated filer   X Smaller reporting Company

Indicate by check mark whether the registrant is a shell company (as defined in Section 12b-2 of the exchange Act)

Yes No X

Number of shares outstanding of the issuer's Common Stock, as of May 14, 2012: 222,585,576.

INDEX

	Page No.
PART I.  FINANCIAL INFORMATION
Item 1.  Financial Statements
Condensed Consolidated Balance Sheets at March 31, 2012 (unaudited) and December 31, 2011	3
Condensed Consolidated Statements of Operations for the Three-Month Periods Ended March 31, 2012 and 2011 (unaudited)	4
Condensed Consolidated Statements of Comprehensive Income for the Three Month Periods Ended March 31, 2012 and 2011 (unaudited)	5
Condensed Consolidated Statement of Changes in Stockholders’ Equity for the Three-Month Period Ended March 31, 2012 (unaudited)	6
Condensed Consolidated Statements of Cash Flows for the Three-Month Periods Ended March 31, 2012 and 2011 (unaudited)	7
Notes to Unaudited Condensed Consolidated Financial Statements	9
Item 2.  Management's Discussion and Analysis of Financial Condition and Results of Operations	22
Item 3.  Quantitative and Qualitative Disclosures About Market Risk	26
Item 4.  Controls and Procedures	26
PART II.  OTHER INFORMATION
Item 1.    Legal Proceedings	27
Item 1A. Risk Factors	27
Item 2.    Unregistered Sale of Securities and Use of Proceeds	27
Item 3.    Defaults Upon Senior Securities	27
Item 4.    Mine Safety Disclosures	27
Item 5.    Other Information	27
Item 6.    Exhibits
(a) Exhibits	27
Signatures	30

- 2 -

PART I–FINANCIAL INFORMATION

Item 1.  Financial Statements.

Communication Intelligence Corporation

Condensed Consolidated Balance Sheets

 (In thousands)

	March 31,			December 31,
	2012			2011
Assets	Unaudited
Current assets:
Cash and cash equivalents	$	322		$	307
Accounts receivable, net of allowance of $4 at March 31, 2012 and $3 at December 31, 2011		224			298
Prepaid expenses and other current assets		52			29
Total current assets		598			634
Property and equipment, net		27			32
Patents, net		1,929			2,020
Capitalized software development costs, net		13			78
Other assets		29			29
Total assets	$	2,596		$	2,793
Liabilities and Stockholders' Equity
Current liabilities:
Short-term notes payable(Note 4)	$	1,213		$	1,083
Accounts payable		326			261
Accrued compensation		257			221
Other accrued liabilities		148			243
Deferred revenue		587			517
Total current liabilities		2,531			2,325
Deferred revenue long-term		348			397
Deferred rent		141			147
Derivative liability		289			281
Total liabilities		3,309			3,150
Commitments and contingencies
Stockholders' equity:
Series A-1 Preferred Stock, $.01 par value; 2,000 shares authorized; 898 and 880 shares issued and outstanding at March 31, 2012 and December 31, 2011, respectively, ($898 liquidation preference at March 31, 2012)		898			880
Series B Preferred Stock, $.01 par value; 14,000 shares authorized; 9,337 and 9,250 shares issued and outstanding at March 31, 2012 and December 31, 2011, respectively, ($14,006 liquidation preference at March 31, 2012)		7,466			7,380
Series C Preferred Stock, $.01 par value; 4,100 shares authorized; 3,914 and 3,547 shares issued and outstanding at March 31, 2012 and December 31, 2011, respectively, ($5,871 liquidation preference at March  31, 2012)		4,492			3,569
Common stock, $.01 par value; 1,050,000 shares authorized; 229,178 issued, 222,677 outstanding at March 31, 2012 and 198,188 shares issued and outstanding at December 31, 2011		2,291			1,981
Treasury shares, 6,500 and 0 shares at March 31, 2012 and December 31, 2011, respectively		(325	)		−
Additional paid-in capital		97,168			97,715
Accumulated deficit		(112,658	)		(111,839	)
Accumulated other comprehensive loss		(45	)		(43	)
Total stockholders' (deficit)		(713	)		(357	)
Total liabilities and stockholders' equity	$	2,596		$	2,793

See accompanying notes to these Condensed Consolidated Financial Statements

3 

Communication Intelligence Corporation

Condensed Consolidated Statements of Operations

Unaudited

(In thousands, except per share amounts)

	Three Months Ended
	March 31,
	2012			2011
Revenue:
Product	$	513		$	121
Maintenance		154			156
Total Revenue		667			277
Operating costs and expenses:
Cost of sales:
Product		67			168
Maintenance		22			106
Research and development		472			296
Sales and marketing		387			396
General and administrative		491			565
Total operating costs and expenses		1,439			1,531
Loss from operations		(772	)		(1,254	)
Interest and other expense, net		(4	)		(2	)
Interest expense:
Related party		(27	)		−
Other		(3	)		−
Amortization of loan discount:
Related party		(4	)		−
Other		(1	)		−
Loss on derivative liability		(8	)		(73	)
Net loss		(819	)		(1,329	)
Accretion of beneficial conversion feature, Preferred shares:
Related party (Note 6)		(578	)		(1,832	)
Other (Notes 6)		(81	)		(1,669	)
Preferred stock dividends:
Related party		(68	)		(202	)
Other		(23	)		(77	)
Net loss attributable to common stockholders	$	(1,569	)	$	(5,109	)
Basic and diluted net loss per common share	$	(0.01	)	$	(0.03	)
Weighted average common shares outstanding, basic and diluted		219,184			191,306

See accompanying notes to these Condensed Consolidated Financial Statements

4 

Communication Intelligence Corporation

Condensed Consolidated Statements of Comprehensive Loss

Unaudited

(In thousands, except per share amounts)

	Three Months Ended
	March 31,
	2012			2011
Net loss	$	(819	)	$	(1,329	)
Other comprehensive loss, net of tax:
Foreign currency translation adjustment		(2	)		−
Total comprehensive loss	$	821		$	(1,329	)

See accompanying notes to these Condensed Consolidated Financial Statements

5 

Communication Intelligence Corporation

Consolidated Statement of Changes in Stockholders' Equity

Three Months Ended March 31, 2012

Unaudited

(In thousands)

	Series A-1 Preferred Shares Outstanding		Series A-1Preferred Shares Amount		Series B Preferred Shares Outstanding			Series B Preferred Shares Amount			Series C Preferred Shares Outstanding			Series C Preferred Shares Amount		Common Shares Outstanding			Common Stock Amount		Treasury Stock			Additional Paid-In Capital			Accumulated Deficit			Accumulated Other Comprehensive Loss			Total
Balance as of December 31, 2011		880	$	880		9,250		$	7,380			3,547		$	3,569		198,188		$	1,981				$	97,715		$	(111,839	)	$	(43	)	$	(357	)
Receipt of 6.5M Common Shares in settlement of the 16b action																	(6,500	)				(325	)											(325	)
Series C Preferred Shares issued in settlement of an indemnification claim related to the 16b settlement												278			417																			417
Stock-based employee compensation																									151									151
Common shares issued in connection with the cashless exercise of warrants																	20,186			202					(202	)							─
Common shares issued in connection with the exercise of warrants for cash																	7,439			74					139									213
Common shares issued in connection with the exercise of stock options option for cash																	132			1					8									9
Common shares issued in connection with the conversion of Series B Preferred Shares						(140	)		(140	)							3,232			33					107									−
Accretion of Beneficial Conversion Feature on Series C Preferred Shares issued in settlement of the indemnification claim															418										(418	)								−
Accretion of Beneficial Conversion Feature on Preferred Shares dividends issued in kind									153						88										(241	)								−
Preferred share dividends, paid in kind		18		18		227			73			89													(91	)								−
Comprehensive loss:
Net loss													��															(819	)					(819	)
Foreign currency translation adjustment																															(2	)		(2	)
Total comprehensive loss																																		(821	)
Balances as of March 31, 2012		898	$	898		9,337		$	7,466			3,914		$	4,492		222,677		$	2,291		(325	)	$	97,168		$	(112,658	)	$	(45	)	$	(713	)

See accompanying notes to these Condensed Consolidated Financial Statements

6 

Communication Intelligence Corporation

Condensed Consolidated Statements of Cash Flows

Unaudited

(In thousands)

	Three Months Ended March 31,
	2012			2011
Cash flows from operating activities:
Net loss	$	(819	)	$	(1,329	)
Adjustments to reconcile net loss to net cash used for operating activities:
Depreciation and amortization		162			283
Amortization of debt discount and deferred financing costs		5			−
Stock-based employee compensation		151			186
Restricted stock expense		−			1
Series C Preferred Shares issued for services		−			97
Series C Preferred Shares issued in settlement of indemnity claim		417
Common Stock received as settlement of 16b claim		(325	)
Loss on derivative liability		8			73
Forfeiture of restricted stock issued in lieu of salary		−			(16	)
Changes in operating assets and liabilities:
Accounts receivable		74			2
Prepaid expenses and other assets		(23	)		(6	)
Accounts payable		65			90
Accrued compensation		36			(159	)
Other accrued liabilities		(104	)		(24	)
Deferred revenue		20			(99	)
Net cash used for operating  activities		(333	)		(901	)
Cash flows from investing activities: Acquisition of property and equipment		−			(13	)
Capitalized software development costs		−			(12	)
Net cash used for investing activities		−			(25	)
Cash flows from financing activities:
Net proceeds from issuance of Series C preferred shares		−			690
Proceeds from issuance of short-term debt		125			−
Proceeds from exercise of warrants for cash		213			−
Proceeds from exercise of stock options		9			−
Net cash provided by financing activities		347			690
Effect of exchange rate changes on cash and cash equivalents		1			−
Net decrease in cash and cash equivalents		15			(236	)
Cash and cash equivalents at beginning of period		307			1,879
Cash and cash equivalents at end of period	$	322		$	1,643

See accompanying notes to these Condensed Consolidated Financial Statements

7 

Communication Intelligence Corporation

Condensed Consolidated Statements of Cash Flows (Continued)

Unaudited

(In thousands)

	Three Months Ended March 31,
	2012		2011
Supplementary disclosure of cash flow information
Interest paid	$	−	$	−
Income taxes paid	$	−	$	−
Non-cash financing and investing transactions:
Dividends on Preferred Shares	$	91	$	−
Accretion of beneficial conversion feature on convertiblepreferred shares	$	659	$	3,501
Issuance of preferred shares by payment of dividends in kind	$	−	$	279
Fee warrants issued in connection with the March 31, 2011 issuance of the Series C Preferred shares	$	−	$	4
Cashless exercise of warrants	$	202	$	−
Conversion of Series B Preferred Stock into Common Stock	$	140	$	−

See accompanying notes to these Condensed Consolidated Financial Statements

8 

Communication Intelligence Corporation

 (In thousands, except per share amounts)

FORM 10-Q

1.   Nature of business and summary of significant accounting policies

Basis of Presentation

The financial information contained herein should be read in conjunction with the Company's consolidated audited financial statements and notes thereto included in its Annual Report on Form 10-K for the year ended December 31, 2011.

The accompanying unaudited condensed consolidated financial statements of Communication Intelligence Corporation and its subsidiary (the “Company” or “CIC”) have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America (“GAAP”) for complete consolidated financial statements. In the opinion of management, the unaudited condensed consolidated financial statements included in this quarterly report reflect all adjustments (consisting only of normal recurring adjustments) that the Company considers necessary for a fair presentation of its financial position at the dates presented and the Company’s results of operations and cash flows for the periods presented.  The Company’s interim results are not necessarily indicative of the results to be expected for the entire year.

The Company is a leading supplier of electronic signature products and the recognized leader in biometric signature verification. CIC enables companies to achieve truly paperless workflow in their electronic business processes by providing multiple signature technologies across virtually all applications. CIC’s solutions are available both in software as a service (“SaaS”) and on-premise delivery models and afford “straight-through-processing,” which can increase customer revenue by enhancing user experience and can also reduce costs through paperless and virtually error-free electronic transactions that can be completed significantly quicker than paper-based procedures. To date, the Company primarily has delivered biometric and electronic signature solutions to channel partners and end-user customers in the financial services industry.

The Company's research and development activities have given rise to numerous technologies and products. The Company's core technologies can be referred to as "transaction-enabling” technologies. These technologies include various forms of electronic signatures, such as handwritten biometric, click-to-sign and others, as well as signature verification, cryptography and the logging of audit trails to show signers’ intent. These technologies can enable secure, legal and regulatory compliant electronic transactions that can enhance customer experience at a fraction of the time and cost required by traditional, paper-based processes. The Company’s products include SignatureOne® Ceremony® Server™, SignatureOne® Console, Sign-it® and the iSign® suite of products.

Going Concern

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As of March 31, 2012, the Company’s accumulated deficit was approximately $112,658, and the Company has incurred losses in 2011 and the three months ended March 31, 2012. The Company also has a working capital deficit at March 31, 2012. The Company has primarily met its working capital needs through the sale of debt and equity securities. As of March 31, 2012, the Company’s cash balance was approximately $322. These factors raise substantial doubt about the Company’s ability to continue as a going concern. Historically the Company raised needed capital through debt and equity financings and converted short-term notes payable to equity. In addition the Company sold, for cash in a private placement, 1,440 additional shares of Series B Preferred Stock at a purchase price of $1.00 per share (Note 6 to the Condensed Consolidated Financial Statements).  In December 2010 the stockholders approved the issuance of a Series C Participating Convertible Preferred Stock and the Company sold, for cash in a private placement, 2,211

9 

Communication Intelligence Corporation

 (In thousands, except per share amounts)

FORM 10-Q

1.   Nature of business and summary of significant accounting policies (continued)

shares of Series C Preferred Stock at a purchase price of $1.00 per share (Note 6 to the Condensed Consolidated Financial Statements). In March 2011, the Company sold for cash in a private placement an additional 800 shares of Series C Preferred Stock at a purchase price of $1.00.

In September 2011, the Company borrowed $100 at 10% per annum in the form of two demand notes, and borrowed an additional $500 at 10% per annum in the form of an unsecured convertible promissory note due September 20, 2012. In December 2011, the Company borrowed $500 at 10% per annum in the form of unsecured convertible promissory notes due December 2, 2012. (Note 4 to the Condensed Consolidated Financial Statements). In February 2012, the Company borrowed $25 at 10% per annum in the form of a demand note, and in March 2012, the Company borrowed an additional $100 at 10% per annum in the form of a demand note.

There can be no assurance that the Company will be successful in securing adequate capital resources to fund planned operations or that any additional funds will be available to the Company when needed, or if available, will be available on favorable terms or in amounts required by the Company. If the Company is unable to obtain adequate capital resources to fund operations, it may be required to delay, scale back or eliminate some or all of its operations, which may have a material adverse effect on the Company's business, results of operations and ability to operate as a going concern. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

The Company adopted the following new accounting standards on January 1, 2012:

Comprehensive Income

On January 1, 2012, the Company adopted an accounting standard that modifies the presentation of comprehensive income in the financial statements. The standard requires an entity to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The Company elected the latter presentation option upon adopting this accounting standard. The adoption of this guidance did not have a significant effect on the consolidated financial statements.

In the first quarter of 2012, the adoption of other accounting standards had no material impact on the Company’s financial position, results of operations or cash flows.

Revenue recognition

For Products sold under perpetual license, the Company recognizes revenue upon shipment, provided that persuasive evidence of an arrangement exists, collection is determined to be probable, all non-recurring engineering work necessary to enable the Company's product to function within the customer's application has been completed and the Company's product has been delivered according to specifications. For software sold under a term license, the Company recognizes revenue over the term of the license granted. Revenue from customization of software is recognized when all engineering work necessary to enable the Company's products to function within the customer's application has been completed, and the Company has delivered its product according to specifications.

Software license agreements may contain multiple elements, including upgrades and enhancements, products deliverable on a when and if available basis and post contract support.

For arrangements with multiple deliverables the Company allocates consideration at the inception of an arrangement to all of its deliverables based on their relative selling prices. In the absence of the vendor-specific objective evidence or third-party evidence of the selling prices, Management’s best estimate of the

10

Communication Intelligence Corporation

 (In thousands, except per share amounts)

FORM 10-Q

1.   Nature of business and summary of significant accounting policies (continued)

selling prices is use. For the Company’s tangible products containing software and hardware elements that function together and deliver the tangible products’ essential functionality is accounted for under the multiple-element arrangements revenue recognition guidance discussed above.

Maintenance revenue is recorded for post-contract support and upgrades or enhancements, which is paid for in addition to license fees, and is recognized as costs are incurred or over the support period whichever is longer. For undelivered elements where objective and reliable evidence of fair value does not exist, revenue is deferred and subsequently recognized when delivery has occurred and when fair value has been determined.

Treasury Stock

Shares of common stock returned to, or repurchased by the Company are recorded at cost and are included as a separate component of stockholders’ equity. The Company received 6,500 shares of its Common Stock having a fair value under the cost method of $325 in January 2012, in settlement of a 16b suit brought by a shareholder against Phoenix Venture Fund, LLC. At March 31, 2012, the total value of treasury stock was $325.

Under the cost method, the gross cost of the shares reacquired is charged to a contra equity account entitled treasury stock. The equity accounts that were credited for the original share issuance (common stock, paid-in capital in excess of par, etc.) remain intact. When the treasury shares are reissued, proceeds in excess of cost are credited to a paid-in capital account. Any deficiency is charged to retained earnings (unless paid-in capital from previous treasury share transactions exists, in which case the deficiency is charged to that account, with any excess charged to retained earnings).

Accounting Changes and Recent Accounting Pronouncements

Accounting Standards Issued But Not Yet Adopted

Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the Company’s financial position, results of operations and cash flows.

 2.   Accounts receivable and revenue concentrations

Four customers accounted for 91% of total accounts receivable a March 31, 2012. Customer one accounted for 10%, customer two accounted for 12%, customer three accounted for 14% and customer four accounted for 55% of total accounts receivable. Two customers accounted for 61% and 15%, respectively, of gross accounts receivable as of March 31, 2011.

One customer accounted for 64% of total revenue for the three months ended March 31, 2012. Two customers accounted for 24% and 13%, respectively, of total revenue for the three months ended March 31, 2011.

3.   Patents

The Company performs intangible asset impairment analysis at least annually in accordance with the relevant accounting guidance. The Company periodically reassesses the lives of its patents and tests for impairment in order to determine whether the book value of each patent exceeds the fair value of each patent. Fair value is determined by estimating future cash flows from the products that are and will be protected by the patents and taking into account the factors listed in Critical Accounting Policies in the Company’s Annual Report on Form 10-K.

11 

Communication Intelligence Corporation

 (In thousands, except per share amounts)

FORM 10-Q

3.   Patents (continued)

Management completed an analysis of the Company’s patents as of December 31, 2011. Based on that analysis, the Company concluded that no impairment of the carrying value of the patents existed. The Company believes that no events or circumstances occurred or changed during the three months ended March 31, 2012, and therefore concluded that no impairment in the carrying values of the patents existed at March 31, 2012.

Amortization of patent costs was $91 and $94 for the three months ended March 31, 2012 and 2011, respectively.

Intangible Assets

The following table summarizes intangible assets (in millions):

	March 31, 2012					December 31, 2011
	Carrying Amount		Accumulated Amortization			Carrying Amount		Accumulative Amortization
Amortizable intangible assets:
Patents	$	6,746	$	(4,817	)	$	6,746	$	(4,726	)
Other		4,112		(4,099	)		4,112		(4,034	)
Total	$	10,858	$	(8,916	)	$	10,858	$	(8,760	)

Amortization for intangible assets recorded as of March 31, 2012 is estimated to be (in thousands):

Remainder of 2012	$	287
2013		365
2014		357
2015		342
2016		322
Thereafter		269
Total	$	1,942

4.   Short-term notes payable

On February 17 and March 5, of 2011, the Company borrowed $25 and $100, respectively, from Phoenix, a related party, and issued unsecured demand notes. These notes are due on demand and bear interest at the rate of 10% per annum.

On December 2, 2011, the Company entered into a Note and Warrant Purchase Agreement (the “December 2011 Purchase Agreement”) with Philip Sassower, the Company’s Chairman and CEO, and other investors (the “December 2011 Investors”). Under the terms of the December 2011 Purchase Agreement, the Company issued unsecured convertible promissory notes in the aggregate amount of $500 (the “December 2011 Notes”) to the December 2011 Investors. The December 2011 Notes bear interest at the rate of 10% per annum, and have a maturity date of December 20, 2012.  The December 2011 Notes are also convertible at the option of the December 2011 Investors into securities sold in the Company’s next equity financing with gross proceeds to the Company in excess of $100.  In connection with the issuance of the December 2011 Notes, the Company also issued to the December 2011 Investors warrants to purchase an aggregate of 5,556 shares of the Company’s Common Stock at an exercise price of $0.0225 per share. The company ascribed a value of $13 to the warrants using a modified Black Scholes pricing model with the following assumptions;

12

Communication Intelligence Corporation

 (In thousands, except per share amounts)

FORM 10-Q

4.   Short-term notes payable (continued)

risk free interest rate of 0.39, expected life of three years, expected volatility of 202%, and a dividend yield of 0. The warrant value was recorded as a discount to notes payable and as a derivative liability. The discount will be amortized over the life of the note.The warrants are exercisable for a period of three years. In February 2012, warrants for 5,000 shares were exercised, 4,889 in a cashless exercise and 111 for cash. The Company issued 4,043 Shares of Common stock related to the exercise and received $2 in cash. As of March 31, 2012, the fair value of the remaining 556 warrants was $2.

On September 20, 2011, the Company entered into a Note and Warrant Purchase Agreement (the “September 2011 Purchase Agreement”) with Phoenix Banner Holdings, LLC (the “September 2011 Investor”), an entity affiliated with Phoenix, the Company’s largest stockholder.  Under the terms of the September 2011 Purchase Agreement, the Company issued an unsecured convertible promissory note in the amount of $500 (the “September 2011 Note”) to the September 2011 Investor.  The September 2011 Note bears interest at the rate of 10% per annum, and has a maturity date of September 20, 2012. The September 2011 Note is also convertible at the option of the September 2011 Investor into securities sold in the Company’s next equity financing with gross proceeds to the Company in excess of $100. In connection with the issuance of the September 2011 Note, the Company also issued to the September 2011 Investor a warrant to purchase 5,556 shares of the Company’s Common Stock at an exercise price of $0.0225 per share. On September 20, 2011 the company ascribed a value of $7 to the warrants using a modified Black Scholes pricing model with the following assumptions; risk free interest rate of 0.42, expected life of three years, expected volatility of 204%, and a dividend yield of 0. The warrant value was recorded as a discount to notes payable and as a derivative liability. The discount will be amortized over the life of the note. The warrant is exercisable for a period of three years. As of March 31, 2012, the fair value of the warrant was $19.

On September 2, 2011, the Company borrowed an aggregate of $100 from Phoenix and an employee of the Company and issued unsecured demand notes to each. These notes are due on demand and bear interest at the rate of 10% per annum.

The Company used the net proceeds from the transaction for working capital and general corporate purposes.

Interest expense associated with the Company’s debt for the three months ended March 31, 2012 and 2011, was $30 and $0, respectively, of which $27 and $0 was related party expense. Amortization of debt discount and deferred financing costs included in interest expense for the three months ended March 31, 2012, and 2011, was $5 and $0, respectively, of which $4 and $0 was related party expense.

Material commitments:

The Company had the following commitments at March 31, 2012:

	Payments due by period
Contractual obligations	Total		2012		2013		2014		2015		2016	Thereafter
Short-term note payable (1)		1,225		1,225		−		−		−	−		−

1.   The Company issued demand notes in September 2011 in the amount of $100, and in February and March 2012 in the amounts of $25 and $100, respectively. The Company issued convertible notes in September and December 2011 in the amount of $500 and $500, respectively. The notes bear interest at the rate of 10% per annum. The Convertible notes are due in September and December 2012.

5.   Derivative liability

The Company has determined that certain warrants related to the Company’s financings and the embedded conversion feature on the Series A-1 Preferred Stock require liability classification because of certain provisions that may result in an adjustment to the number of shares upon settlement and an adjustment to

13

Communication Intelligence Corporation

 (In thousands, except per share amounts)

FORM 10-Q

5.   Derivative liability (continued)

their exercise or conversion.  The fair value of the embedded conversion feature for the Series A-1 Preferred Stock at March 31, 2012 and December 31, 2011 was insignificant.

The Company has issued 8,380 shares of Series B Preferred Stock and 2,211 shares of Series C Preferred Stock, respectively. At December 31, 2010, the Company determined that the embedded conversion feature on these shares required liability classification due to the impact the anti-dilution provisions could have had on the number of shares issuable upon conversion. The fair value of the embedded conversion feature on the Series B Preferred Stock at December 31, 2010, was approximately $136, and the fair value of the embedded conversion feature on the Series C Preferred Stock was approximately $179. On March 31, 2011, the Company amended its Amended and Restated Certificate of Designation for its Series B Preferred Stock and its Certificate of Designation for its Series C Preferred Stock by amending the anti-dilution provisions (See Note 7 to the Condensed Consolidated Financial Statements). As a result of these amendments, the Series B Preferred Stock and Series C Preferred Stock no longer require liability classification.  On the date of these amendments, the Company revalued the conversion features on these shares, resulting in a loss of $47, and reclassified the derivative value to equity, resulting in a decrease in the derivative liability of $362.

In March 2011, the Company issued fee warrants to related parties to purchase 1,778 shares of common stock in connection with a private placement sale of 800 shares of Series C Preferred Stock and recorded a derivative liability of $4 as of March 31, 2011. The fair market value of the derivative liability at March 31, 2012 was $6 (Note 7 to the Condensed Consolidated Financial Statements).

In August 2011, the Company issued 1,000 warrants as part of consulting agreements. The Company ascribed a value of $1 to the warrants using a modified Black Scholes pricing model with the following assumptions; risk free interest rate of 0.07, expected life of three years, expected volatility of 190%, and a dividend yield of 0. The warrants have a three year life and expire on August 11, 2014. As of March 31, 2012, the fair value of the warrants was $1.

In September 2011, the Company issued 5,556 warrants in connection with the September 2011 Purchase Agreement. The Company ascribed a value of $7 to the warrants using a modified Black Scholes pricing model with the following assumptions; risk free interest rate of 0.42, expected life of three years, expected volatility of 204%, and a dividend yield of 0. The warrants have a three year life and expire on August 11, 2014. As of March 31, 2012, the fair value of the warrants was $19.

In December 2011, the Company issued 5,556 warrants in connection with the December 2011 Purchase Agreement. The Company ascribed a value of $13 to the warrants using a modified Black Scholes pricing model with the following assumptions; risk free interest rate of 0.39%, expected life of three years, expected volatility of 202%, and a dividend yield of 0. The warrants have a three year life and expire on August 11, 2014. In February 2012, 5,000 of the warrants were exercised, 4,889 in a cashless exercise and 111 for cash. The Company issued 4,043 Shares of Common stock related to the exercise and received $2 in cash. As of March 31, 2012, the fair value of the warrants was $2.

The fair value of the outstanding derivative liabilities at March 31, 2012, and December 31, 2011, was $289 and $281, respectively.

The Company uses the Black-Scholes pricing model to calculate fair value of its warrant derivative liabilities. Key assumptions used to apply these models are as follows:

	March 31, 2012	December 31, 2011
Expected term	0.3 to 2.60 years	0.5 to 2.90 years
Volatility	206.7% – 279.1%	204.7% - 315.2%
Risk-free interest rate	0.07% – 0.51%	0.06% – 0.36%
Dividend yield	0%	0%

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Communication Intelligence Corporation

 (In thousands, except per share amounts)

FORM 10-Q

 5.  Derivative liability (continued)

Fair value measurements:

Assets and liabilities measured at fair value as of March 31, 2012, are as follows:

	Value at		Quoted prices in active markets		Significant other observable inputs		Significant unobservable inputs
	March 31, 2012		(Level 1)		(Level 2)		(Level 3)
Derivative liability	$	289	$	−	$	−	$	289

The fair value framework requires a categorization of assets and liabilities into three levels based upon the assumptions (inputs) used to price the assets and liabilities. Level 1 provides the most reliable measure of fair value, whereas Level 3 generally requires significant management judgment. The three levels are defined as follows:

Level 1: Unadjusted quoted prices in active markets for identical assets and liabilities.

Level 2: Observable inputs other than those included in Level 1. For example, quoted prices for similar assets or liabilities in active markets or quoted prices for identical assets or liabilities in inactive markets.

Level 3: Unobservable inputs reflecting management’s own assumptions about the inputs used in pricing the asset or liability.

There were no financial assets or liabilities measured at fair value, with the exception of cash and cash equivalents (level 1) and the above mentioned derivative liability (level 3) as of March 31, 2012 and December 31, 2011, respectively.

Changes in the fair market value of the level 3 derivative liability for the nine month period ended March 31, 2012 are as follows:

	Derivative Liability
Balance at January 1, 2012	$	281
Additional liabilities recorded related to warrants issued for services		−
Loss on derivative liability		8
Balance at September 30, 2011	$	289

6.   Net loss per share

The Company calculates net loss per share of both basic net loss per share, which is based on the weighted average number of shares outstanding, and when applicable, diluted income per share, which is based on the weighted average number of shares and dilutive potential shares outstanding.

For the three months ended March 31, 2012, 50,238 shares of common stock issuable upon the exercise of outstanding options, 147,482 shares issuable upon the exercise of warrants and 396,006 shares of common stock issuable upon the conversion of the convertible preferred stock were excluded from the calculation of dilutive earnings per share because the exercise of such options and warrants and the conversion of the preferred stock would be anti-dilutive.

For the three months ended March 31, 2011, 33,032 shares of common stock issuable upon the exercise of outstanding options, 176,798 shares issuable upon the exercise of warrants and 344,825 shares of common stock issuable upon the conversion of the convertible preferred stock were excluded from the calculation of dilutive earnings per share because the exercise of such options and warrants and the conversion of the preferred stock would be anti-dilutive.

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Communication Intelligence Corporation

 (In thousands, except per share amounts)

FORM 10-Q

6. Net loss per share (continued)

The following table is a reconciliation of the numerator (net loss) and the denominator (number of shares) used in the basic and diluted EPS calculations and sets forth potential shares of common stock that are not included in the diluted net loss per share calculation as the effect is antidilutive:

	Three Months Ended
	March 31,			March 31,
	2012			2011
Numerator-basic and diluted net loss	$	(1,558	)	$	(5,109	)
Denominator-basic or diluted weighted average number of common shares outstanding		219,184			191,306
Net loss per share – basic and diluted	$	(0.01	)	$	(0.03	)

7.   Equity

The Company has granted stock options under its 1999 Option Plan which expired in April of 2009 (options outstanding under that plan are not effected by its expiration) and has also granted options to employees, directors and consultants pursuant to individual plans.

The Company's Board of Directors adopted the 2009 Stock Compensation Plan on July 1, 2009, reserving 7,000 shares of Common Stock of the Company for issuance thereunder. As of March 31, 2012, there are 2,218 options outstanding pursuant to this plan.

The Company's Board of Directors adopted the 2011 Stock Compensation Plan on January 28, 2011, reserving 50,000 shares of Common Stock of the Company for issuance thereunder. As of March 31, 2012, there are 43,617 options outstanding pursuant to this plan.

Share-based compensation expense is based on the estimated grant date fair value of the portion of share-based payment awards that are ultimately expected to vest during the period.  The grant date fair value of stock-based awards to employees and directors is calculated using the Black-Scholes option pricing model. Forfeitures of share-based payment awards are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The estimated average forfeiture rate for the three months ended March 31, 2012 and 2011, was approximately 9.59% and 24%, respectively, based on historical data.

Valuation and Expense Information:

The weighted-average fair value of stock-based compensation is based on the single option valuation approach. Forfeitures are estimated and it is assumed no dividends will be declared.  The estimated fair value of stock-based compensation awards to employees is amortized using the accrual method over the vesting period of the options. The fair value calculations are based on the following assumptions:

Valuation and Expense Information (continued):

	Three Months Ended March 31, 2012	Three Months Ended March 31, 2011
Risk free interest rate	0.62% – 5.11%	1.12% – 5.11%
Expected term (years)	2.82 – 7.00	2.82 – 7.00
Expected volatility	93.63% – 147.4%	91.99% – 147.41%
Expected dividends	None	None

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Communication Intelligence Corporation

 (In thousands, except per share amounts)

FORM 10-Q

7.   Equity (continued)

The Company did not grant any stock options during the three months ended March 31, 2012. During the three months ended March 31, 2012, a total of 132,163 stock options were exercised for $9 in cash at a weighted average price of $0.06 per share. The Company granted 24,496 stock options during the three months ended March 31, 2011, and no stock options were exercised. The following table summarizes the allocation of stock-based compensation expense related to stock option grants for the three months ended March 31, 2012 and 2011.

	Three Months Ended March31,
	2012		2011
Research and development	$	70	$	90
Sales and marketing		21		44
General and administrative		51		52
Director		9		−
Stock-based compensation expense	$	151	$	186

A summary of option activity under the Company’s plans as of March 31, 2012 is as follows:

	March 31, 2012
Options	Shares			Weighted Average Exercise Price		Weighted Average Remaining Contractual Term		Aggregate Intrinsic Value
Outstanding at January 1,		51,353		$	0.09			$	4,450
Granted		−			−			$	−
Exercised		(132	)	$	0.07			$	2
Forfeited or expired		(983	)	$	0.06			$	64
Outstanding at March 31		50,238		$	0.09		5.47	$	4,377
Vested and expected to vest at March 31		50,238		$	0.09		5.47	$	4,377
Exercisable at March 31		18,510		$	0.16		4.31	$	2,942

The following tables summarize significant ranges of outstanding and exercisable options as of March 31, 2012:

		As of March 31, 2012
		Options Outstanding						Options Exercisable
Range of Exercise Prices		Number Outstanding		Weighted Average Remaining Contractual Term (in years)		Weighted Average Exercise Price		Number Outstanding		Weighted Average Exercise Price
$	0.07 – $0.50		48,275		5.67	$	0.06		16,547	$	0.08
	0.51 – 1.00		1,901		0.72	$	0.75		1,901	$	0.75
	1.01 – 2.00		62		0.19	$	1.75		62	$	1.75
			50,238		5.47	$	0.09		18,510	$	0.16

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Communication Intelligence Corporation

 (In thousands, except per share amounts)

FORM 10-Q

7.   Equity (continued)

A summary of the status of the Company’s non-vested shares as of March 31, 2012, is as follows:

Non-vested Shares	Shares			Weighted Average Grant-Date Fair Value
Non-vested at January 1, 2012		36,814		$	0.05
Granted		−		$	0.00
Exercised		(132	)	$	0.07
Forfeited		(983	)	$	0.06
Vested		(3,970	)	$	0.05
Non-vested at March 31, 2011		31,729		$	0.05

As of March 31, 2012, there was $401 of total unrecognized compensation expense related to non-vested share-based compensation arrangements granted under the plans.  The unrecognized compensation expense is expected to be realized over a weighted average period of 2.8 years.

Preferred Shares

Series A-1

In May 2008, the Company issued an aggregate of 1,040 shares of the Company’s Series A Cumulative Convertible Preferred Stock in exchange for certain debt. The Series A Cumulative Convertible Preferred Stock was subsequently exchanged in October 2008 for an equivalent number of shares of Series A-1 Cumulative Convertible Preferred Stock (the “Series A-1 Preferred Stock”).  During 2009, 146 Series A-1 Preferred Shares were converted into 1,005 shares of the Company’s Common Stock. As of March 31, 2012, there are 898 shares of Series A-1 Preferred Stock outstanding.  The shares of Series A-1 Preferred Stock carry an eight percent (8%) annual dividend, payable quarterly in arrears in cash or in additional shares of Series A-1 Preferred Stock, have a liquidation preference over Common Stock of one dollar ($1.00) per share and are convertible into shares of Common Stock at the conversion price of fourteen cents ($0.14) per share. The shares of Series A-1 Preferred Stock are convertible any time. The Company issued 18 shares of Series A-1 Preferred Stock in payment of dividends for the three months ended March 31, 2012. If the outstanding shares of Series A-1 Preferred Stock were converted in their entirety as of March 31, 2012, the Company would issue 6,412 shares of Common Stock.

Series B

On August 5, 2010, the Company completed the conversion of all of the Company’s outstanding indebtedness and issued 6,608 shares of Series B Participating Convertible Preferred Stock (the “Series B Preferred Stock”) in accordance with an executed Exchange Agreement entered into with Phoenix Venture Fund LLC and certain other holders of the Company’s indebtedness (the “Recapitalization”). In accordance with the executed Series B Preferred Stock Purchase Agreement the Company issued 1,440 shares of Series B Preferred Stock for proceeds of $1,440, net of expenses of $437 (the “Series B Financing”). In addition, the Company paid approximately $143 in expenses to a third party in connection with the financing. The expenses were recorded as a charge to additional paid in capital. The proceeds were used for working capital and general corporate purposes, in each case in the ordinary course of business, and to pay fees and expenses associated with the Recapitalization and Series B Financing.

The shares of Series B Preferred Stock carry a ten percent (10%) annual dividend, payable quarterly in arrears in cash or in additional shares of Series B Preferred Stock, and have a liquidation preference over shares of

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Communication Intelligence Corporation

 (In thousands, except per share amounts)

FORM 10-Q

7.   Equity (continued)

Series A-1 Preferred Stock and Common Stock of $1.50 per share. The shares of Series B Preferred Stock were initially convertible into shares of Common Stock at an initial conversion price of six cents ($0.06) per

share. However, the Company issued additional preferred stock, the Series C Participating Convertible Preferred Stock (the “Series C Preferred Stock”), at a price less than the current conversion price of $0.06, which resulted in a downward adjustment in the conversion price of the Series B Preferred Stock to $0.0433 per share and an increase in the number of shares of Common Stock that would be issued upon conversion of the outstanding shares of Series B Preferred Stock. The shares of Series B Preferred Stock are convertible at any time.

The conversion feature was determined to be a derivative liability in the amount of $2,000 of which $1,498 was attributable to related parties and $502 to the other creditors. Due to the decline in the price of the Company’s Common Stock and the issuance of the Series C Preferred Stock, the fair value of the embedded conversion feature on the Series B Preferred Stock was reduced to approximately $130 at December 31, 2010. In March 2011, the Company amended its Amended and Restated Certificate of Designation for its Series B Preferred Stock, revising among other things the terms of conversion, thereby eliminating the accounting requirement to classify the conversion feature on the Series B Preferred Stock as a derivative liability. In January and March 2012, a total of 140 shares of Series B Preferred Stock were converted into 3,232 shares of the Company’s Common Stock. The Company issued 227 shares of Series B Preferred Stock in payment of dividends for the three months ended March 31, 2012. As of March 31, 2012, there are 9,337 shares of Series B Preferred Stock outstanding. If the outstanding Series B Preferred Stock is converted in its entirety at March 31, 2012, the Company would issue 215,642 shares of Common Stock.

Series C

On December 31, 2010, the Company completed the sale of 2,211 shares of Series C Preferred Stock through a Securities Purchase Agreement with Phoenix Venture Fund LLC and certain other investors, which sale provided proceeds to the Company of $2,211 net of approximately $422 in expenses to third parties in connection with the financing. The expenses were recorded as a charge to additional paid-in capital. The proceeds are being used for working capital and general corporate purposes, in each case in the ordinary course of business, and to pay fees and expenses associated with the sale of the Series C Preferred Stock.

The shares of Series C Preferred Stock carry a ten percent (10%) annual dividend, payable quarterly in arrears in cash or in additional Series C Preferred Stock, and have liquidation preference that is senior to all other shares of the Company’s capital stock, pursuant to which holders of shares of Series C Preferred Stock will receive liquidating distributions in the amount of $1.50 per share plus any accrued dividends. The shares of Series C Preferred Stock are convertible into Common Stock at any time at an initial conversion price of $0.0225 per share, subject to adjustment for stock dividends, splits, combinations and similar events and, with certain exceptions, the issuance of additional securities at a purchase price less than the then current conversion price of the Series C Preferred Stock. On December 31, 2010, the Series C Preferred Stock’s conversion feature was determined to be a derivative liability in the amount of $179, of which $113 was attributable to related parties and $66 to the other holders. In March 2011, the Company amended the Certificate of Designation for its Series C Preferred Stock, revising among other things the terms of conversion, eliminating the accounting requirement to classify the conversion feature on Series C Preferred Stock as a derivative liability.

After receipt of the liquidation preference, the shares of Series C Preferred Stock and Series B Preferred Stock will participate pro rata on an as-converted basis with the shares of Common Stock in any remaining liquidation proceeds (after payment of the liquidation preference on the Series C Preferred Stock, Series B Preferred Stock and Series A-1 Preferred Stock).

On March 31, 2011, the Company amended its Amended and Restated Certificate of Designation for its Series B Preferred Stock and its Certificate of Designation for its Series C Preferred Stock to modify the anti-dilution provisions. Under the amendments, in the event additional stock is issued at a price lower than the conversion price then in effect, the new conversion price of the Series B Preferred Stock or Series C Preferred

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Communication Intelligence Corporation

 (In thousands, except per share amounts)

FORM 10-Q

7. Equity (continued)

Stock cannot be (A) lower than the average closing market price for the Common Stock for the twenty (20) trading

days prior to the closing date of a transaction requiring an adjustment in the conversion price (the “Market Price”) or (B) greater than the conversion price then in effect. The amendments were approved by the Company’s Board of Directors and the necessary majorities of the Company’s Series A-1 Preferred Stock, Series B Preferred Stock and Series C Preferred Stock, and were filed with the Delaware Secretary of State on March 31, 2011. As a result of the amendments, the Company reclassified $362 from derivative liabilities to equity on March 31, 2011 (Note 4) and recorded a beneficial conversion feature of $3,501 related to the intrinsic value of the conversion feature on March 31, 2011.

On March 6, 2011, the Company issued 97 shares of its Series C Preferred Stock and warrants to purchase 4,311 shares of Common Stock to its Acting President as part of a professional service agreement.  The shares of Series C Preferred Stock and warrants are convertible into Common Stock under the same terms discussed above.

On March 31, 2011, the Company sold an additional 800 shares of Series C Preferred Stock for proceeds of $800, net of approximately $110 in expenses to third parties in connection with the financing.

On March 9, 2012, the Company issue 278 shares of Series C Preferred Stock valued at $417 in settlement of the indemnification claim brought by Phoenix Venture Fund LLC, resulting from the settlement of a 16b claim in January 2012 brought by a Company shareholder against Phoenix Venture Fund LLC, certain affiliates and the Company as a nominal defendant. The Company booked a $418 accretion amount for the beneficial conversion feature on the 278 shares of Series C Preferred Stock at March 31, 2012.

The Company issued 89 shares of Series C Preferred Stock in payment of dividends for the three months ended March 31, 2012. As of March 31, 2012, there are 3,914 shares of Series C Preferred Stock outstanding.  If the outstanding shares of Series C Preferred Stock were converted in their entirety, the Company would issue 173,952 shares of Common Stock.

Warrants

Series C Warrants

Each investor who purchased shares of Series C Preferred Stock in the financing transactions which closed on December 31, 2010 and March 31, 2011 received a warrant to purchase a number of shares of Common Stock equal to the aggregate number of shares of Series C Preferred Stock purchased by the investor divided by 0.0225. Each warrant issued in connection with the Series C Financing has an exercise price of $0.0225 per share and is exercisable in whole or in part, including by means of cashless exercise, for a period of three years from the date of issuance. In February and March 2012, 28,678 warrants were exercised by holders of the Series C Preferred Stock warrants. Of these shares exercised, 6,222 were exercised for cash for which the Company received $140 and 22,456 were exercised on a cashless basis. The Company issued 23,928 Shares of Common Stock related to these exercises. If the remaining outstanding Series C Warrants are exercised for cash in their entirety, the Company would issue 122,060 shares of Common Stock.

Other Warrants

In February and March 2012, 6,484 warrants were exercised by the holders of the warrants other than those described above. Of these shares exercised, 1,217 were exercised for cash for which the Company received $73 and 5,267 were exercised on a cashless basis. The Company issued 3,696 Shares of Common Stock related to these exercises. At March 31, 2012, 25,421 shares of Common Stock were reserved for issuance upon exercise of outstanding warrants, excluding the 122,060 shares of Common Stock issuable upon exercise of the Series C Warrants described above.

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Communication Intelligence Corporation

 (In thousands, except per share amounts)

FORM 10-Q

7.   Equity (continued)

A summary of the warrants issued are as follows:

	March 31, 2012					December 31, 2011
	Warrants			Weighted Average Exercise Price		Warrants			Weighted Average Exercise Price
Outstanding at beginning of period		182,644		$	0.0261		135,131		$	0.0274
Issued							59,735		$	0.0064
Exercised		(35,162	)	$	.0067		(12,222	)	$	0.0225
Forfeited		−			−		−			−
Expired		−			−		−			−
Outstanding at end of period		147,482		$	0.0263		182,644		$	0.0261
Exercisable at end of period		147,482		$	0.0263		182,644		$	0.0261

A summary of the status of the warrants outstanding as of March 31, 2012 is as follows:

		March 31, 2012
Number of Warrants		Weighted Average Remaining Life		Weighted Average Exercise Price per share		Shares Exercisable		Weighted Average Exercise price
	17,073		1.03	$	0.0433		17,073
	130,408		1.78	$	0.0225		130,408
	147,482		1.74	$	0.0263		147,482	$       0.0249

Restricted Share Grants

In connection with the Recapitalization, the Company issued restricted shares to employees in exchange for reductions in their respective salaries. The number of shares issued was calculated based on the amount of the annual salary reduction divided by $0.06 per share. Fifty percent of the shares vested on December 31, 2010, and the remaining 50% are vested on June 30, 2011, subject to continued employment through such vesting dates. The Company has recognized $43 in expense associated with 452 restricted shares granted. As of March 31, 2012, the Company has issued 360 of the restricted shares granted.

8.   Subsequent event

On April 23, 2012, the Company entered into a Note and Warrant Purchase Agreement (the “Purchase Agreement”) with certain investors (each an “Investor,” and, collectively, the “Investors”). Under the terms of the Purchase Agreement, the Company received loans in the aggregate amount of $1,000,000 from the Investors in exchange for the Company’s issuance to each of the Investors an unsecured convertible promissory note equal to the principal amount of such Investor’s loan to the Company (each a “Note,” and, collectively, the “Notes”). The Notes bear interest at the rate of 10% per annum, and have a maturity date of April 22, 2013. The Notes automatically convert into securities sold in the Company’s next equity financing. In connection with the issuance of the Notes to the Investors, the Company also issued to the Investors warrants to purchase an aggregate of 5,000,000 shares of the Company’s Common Stock at an exercise price of $0.05 per share. The warrants are exercisable for a period of three years. The Company may use any funds received from the Investors to make payments on the Company’s existing indebtedness and accrued interest on that indebtedness, for working capital and general corporate purposes, in each case in the ordinary course of business, and to pay fees and expenses in connection with the Company’s entry into the Purchase Agreement.

21

Communication Intelligence Corporation

 (In thousands, except per share amounts)

FORM 10-Q

Forward Looking Statements

Certain statements contained in this quarterly report on Form 10-Q, including, without limitation, statements containing the words “believes”, “anticipates”, “hopes”, “intends”, “expects”, and other words of similar import, constitute “forward looking” statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements involve known and unknown risks, uncertainties and other factors which may cause actual events to differ materially from expectations.  Such factors include those set forth in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011, including the following:

·   Technological, engineering, manufacturing, quality control or other circumstances that could delay the sale or shipment of products;

·   Economic, business, market and competitive conditions in the software industry and technological innovations that could affect the Company’s business;

·   The Company’s inability to protect its trade secrets or other proprietary rights, operate without infringing upon the proprietary rights of others and prevent others from infringing on the proprietary rights of the Company; and

·   General economic and business conditions and the availability of sufficient financing.

Except as otherwise required by applicable laws, the Company undertakes no obligation to publicly update or revise any forward-looking statements, as a result of new information, future events or otherwise.

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

The following discussion and analysis should be read in conjunction with the Company’s unaudited condensed consolidated financial statements and notes thereto included in Part 1, Item 1 of this quarterly report on Form 10-Q and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” set forth in the Company’s Annual report on Form 10-K for the fiscal year ended December 31, 2011.

Overview

The Company is a leading supplier of electronic signature products and the recognized leader in biometric signature verification. CIC enables companies to achieve truly paperless workflow in their electronic business processes by providing multiple signature technologies across virtually all applications. CIC’s solutions are available both in SaaS and on-premise delivery models and afford “straight-through-processing,” which can increase customer revenue by enhancing user experience and can also reduce costs through paperless and virtually error-free electronic transactions that can be completed significantly faster than paper-based procedures. To date, the Company primarily has delivered biometric and electronic signature solutions to channel partners and end-user customers in the financial services industry.

The Company was incorporated in Delaware in October 1986. Except for the year ended December 31, 2004, in each year since its inception the Company has incurred losses. For the two-year period ended December 31, 2011, net losses attributable to common stockholders aggregated approximately $11,217, and, at March 31, 2012, the Company's accumulated deficit was approximately $112,658.

For the three months ended March 31, 2012, total revenue was $667, an increase of $390, or 141%, compared to total revenue of $277 in the prior year period. The increase in revenue is primarily attributable to the closing of a large upgrade order from a long time customer compared to the prior year period.

For the three months ended March 31, 2012, the loss from operations was $772, a decrease of $482, or 38%, compared with a loss from operations of $1,254 in the prior year period. The decrease in the loss from operations is primarily attributable to an increase of $390, or 141% in revenues and a $92, or 6% decrease in operating expenses including cost of sales compared to the prior year period.  Non-operating expense, including the beneficial conversion feature on the Company’s Series B and Series C Preferred Stock, for the three months ended March 31, 2012, was $804, a decrease of $3,051, or 79%, compared to $3,855 in the prior year.

22

Communication Intelligence Corporation

 (In thousands, except per share amounts)

FORM 10-Q

In February and March 2012, the Company borrowed $25 and $100, respectively, in the form of two demand notes from its largest investor.

Critical Accounting Policies and Estimates

Refer to Item 7, “Management Discussion and Analysis of Financial Condition and Results of Operations” in the Company’s 2011 Form 10-K.

Effect of Recent Accounting Pronouncement

In the first quarter of 2012, the adoption of accounting standards had no material impact on our financial position, results of operations or cash flows.

Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on our financial position, results of operations and cash flows.

Results of Operations

Revenue

For the three months ended March 31, 2012, product revenue was $513, an increase of $392, or 324%, compared to product revenue of $121 in the prior year period. The increase in product revenue is primarily due to a large upgrade order from a long time customer compared to the prior year period. For the three months ended March 31, 2012, maintenance revenue was $154, a negligible decrease of $2, or 1%, compared to maintenance revenue of $156 in the prior year period.

Cost of Sales

For the three months ended March 31, 2012, cost of sales was $89, a decrease of $185, or 68%, compared to cost of sales of $274 in the prior year period. The decrease in cost of sales is primarily attributable to a $65, or 25% reduction in direct engineering costs associated with revenue that was generated in connection with customer specific requirements and a $117, or 64% reduction in capital software amortization, compared to the prior year period.

Operating expenses

Research and Development Expenses

For the three months ended March 31, 2012, research and development expense was $472, an increase of $176, or 59%, compared to research and development expense of $296 in the prior year period. Research and development expenses consist primarily of salaries and related costs, outside engineering, maintenance items, and allocated facilities expenses.  The most significant factor in the $176 increase in research and development expense was an increase in certain salary levels, outside engineering development costs and a reduction in direct engineering cost allocated to cost of sales. For the three months ended March 31, 2012, research and development expense before capitalization of software development costs and other allocations was $558, an increase of $68, or 14%, compared to research and development expense before capitalization of software development costs and other allocations of $490 in the prior year period. The increase is due to increases in salary and related expenses and outside engineering costs.

Sales and Marketing Expenses

For the three months ended March 31, 2012, sales and marketing expense was $387, a decrease of $9, or 2%, compared to sales and marketing expense of $396 in the prior year period. The increase in commissions on the higher sales were offset by reduction in stock option expense and to decreases in other general marketing expenses.

23

Communication Intelligence Corporation

 (In thousands, except per share amounts)

FORM 10-Q

General and Administrative Expenses

For the three months ended March 31, 2012, general and administrative expense was $491, a decrease of $74, or 13%, compared to general and administrative expense of $565 in the prior year period.  The decrease is primarily attributable to decreases in professional services, travel and related expenses and other general administrative expenses.

Interest expense

For the three months ended March 31, 2012, interest expense was $30, an increase of $30, or 100%, compared to interest expense of $0 in the prior year period. The increase is the result of the issuance of demand and convertible notes in the second half of 2011 and first quarter of 2012 (See Note 4 to the Condensed Consolidated Financial Statements).

For the three months ended March 31, 2012, amortization of loan discount and deferred financing expense was $5, an increase of $5, or 100%, compared to amortization of loan discount and deferred financing expense of $0 in the prior year period. The increase is the result of the issuance of demand and convertible notes in the second half of 2011 and first quarter of 2012 (see Note 4 to the Condensed Consolidated Financial Statements).

For the three months ended March 31, 2012, the loss on derivative liability was $8, a decrease of $65, or 82%, compared to the loss on derivative liability of $73 in the prior year period. The decrease in the loss on derivative liability is primarily due to the decrease in the number of derivatives through the exercise of warrants during February and March 2012. The closing price of the Company’s stock at March 31, 2012, and December 31, 2011, was $0.06 (see Note 5 to the Condensed Consolidated Financial Statements).

For the three months ended March 31, 2012, accretion of the beneficial conversion feature on shares of the Company’s Series B and Series C Preferred Stock was $659 a decrease of $2,842, or 81%, compared to the prior year period. In 2011, the Company amended its Amended and Restated Certificate of Designation for its Series B Preferred Stock and its Certificate of Designation for its Series C Preferred Stock to modify the anti-dilution provisions. As a result of these amendments, the conversion feature of each of the Series B Preferred Stock and Series C Preferred Stock no longer need to be classified as a derivative liability. The Company recorded a beneficial conversion feature and a non-cash expense for the difference between the closing market price of the Company’s Common Stock on March 31, 2011, and the conversion prices of the shares of Series B and Series C Preferred Stock multiplied by the number of shares of Common Stock issuable upon conversion of such shares of Series B and Series C Preferred Stock. The related party expense at March 31, 2012, was $578 and the non-related party expense was $81, compare to related party expense of $1,832 and the non-related party expense was $1,669, in the prior year period (see Note 7 to the Condensed Consolidated Financial Statements).

Liquidity and Capital Resources

At March 31, 2012, cash and cash equivalents totaled $322 compared to cash and cash equivalents of $307 at December 31, 2011. The increase in cash was primarily due to cash provided by financing activities of $347 offset by cash used by operations of $333.  At March 31, 2012, total current assets were $598, compared to total current assets of $634 at December 31, 2011. At March 31, 2012, the Company's principal sources of funds included its cash and cash equivalents aggregated $322.

At March 31, 2012, accounts receivable net, was $224, a decrease of $74, or 25%, compared to accounts receivable net of $298 at December 31, 2011. The decrease is due primarily to the collection of accounts receivable from the current quarter billings and the December 31, 2011, accounts receivable balance. At March 31, 2012, billed but unpaid maintenance contracts, which are offset against accounts receivable and deferred revenue, was $17, compared to $42 at December 31, 2011.  These amounts are expected to be collected in the second quarter of 2012.

24

Communication Intelligence Corporation

 (In thousands, except per share amounts)

FORM 10-Q

At March 31, 2012, prepaid expenses and other current assets were $52, an increase of $23, or 79%, compared to prepaid expenses and other current assets of $29 at December 31, 2012. The increase is due primarily to prepaid insurance for the current year.

At March 31, 2012, accounts payable were $326, an increase of $65, or 25%, compared to accounts payable of $261 at December 31, 2011. The increase is due primarily to an increase in professional service fees.  At March 31, 2012, accrued compensation was $257, an increase of $36, or 16%, compared to accrued compensation of $221 at December 31, 2011.  The increase is due primarily to the increase in the commission accrual on sales during the month of March 2012, compared to December 31, 2011.

At March 31, 2012, total current liabilities were $2,531, an increase of $207, or 9%, compared to total current liabilities of $2,325 at December 31, 2011. At March 31, 2012, current deferred revenue was $587, an increase of $70, or 14%, compared to current deferred revenue of $517 at December 31, 2011. Deferred revenue primarily reflects advance payments for maintenance fees from the Company's licensees that are generally recognized as revenue by the Company when all obligations are met or over the term of the maintenance agreement, whichever is longer.  Deferred revenue is recorded when the Company receives advance payment from its customers.

In February 2012, the Company borrowed $25 in the form of a Demand note from Phoenix, it largest investor. The note bears interest at the rate of 10% per annum. In March 2012, the Company borrowed $100 in the form of a demand note from Phoenix under the same terms described above.

During the months of January, February and March 2011, six investors exercised 7,439 warrants for cash providing the Company $213 in cash. In addition two employees exercised 132 stock options providing an additional $9 in cash.

In December 2011, the Company entered into the December 2011 Purchase Agreement with the December 2011 Investors. Under the terms of the December 2011 Purchase Agreement, the Company issued the December 2011 Notes to the December 2011 Investors.  The December 2011 Notes bear interest at the rate of 10% per annum, and have a maturity date of December 20, 2012.  The December 2011 Notes are also convertible at the option of the December 2011 Investors into securities sold in the Company’s next equity financing with gross proceeds to the Company in excess of $100.  In connection with the issuance of the December 2011 Note, the Company also issued to the December 2011 Investors warrants to purchase an aggregate of 5,556 shares of the Company’s Common Stock at an exercise price of $0.0225 per share. The Company ascribed a value of $13 to the warrants, which was recorded as a discount to short-term debt in the balance sheet.

In September 2011, the Company borrowed an aggregate of $100 from Phoenix and an employee of the Company and issued unsecured demand notes to each. These notes are due on demand and bear interest at the rate of 10% per annum. In addition the Company entered into the September 2011 Purchase Agreement with the September 2011 Investor.  Under the terms of the September 2011 Purchase Agreement, the Company issued the September 2011 Note to the September 2011 Investor.  The September 2011 Note bears interest at the rate of 10% per annum, and has a maturity date of September 20, 2012.  The September 2011 Note is also convertible at the option of the September 2011 Investor into securities sold in the Company’s next equity financing with gross proceeds to the Company in excess of $100.  In connection with the issuance of the September 2011 Note, the Company also issued to the September 2011 Investor a warrant to purchase 5,556 shares of the Company’s Common Stock at an exercise price of $0.0225 per share. The Company ascribed a value of $7 to the warrants, which was recorded as a discount to short-term debt in the balance sheet.

In March 2011, the Company sold 800 shares of Series C Preferred Stock for proceeds of $800, net of approximately $121 in expenses, of which $50 went to SG Phoenix LLC in payment of an administrative fee and $71 in expenses to third parties in connection with the financing.  In connection with the sale of the shares of Series C Preferred Stock, the Company issued warrants to purchase an aggregate of 35,556 shares of Common Stock with an exercise price of $0.0225 per share, which warrants are exercisable for a period of three years from the date of issuance. The Company recorded a beneficial conversion feature of $800 related to the intrinsic value of the conversion feature of the shares of Series C Preferred Stock.  The Company issued 305 shares of Series C Preferred Stock in payment of dividends for the year ended December 31, 2011.

For the three months ended March 31, 2012, the Company exercised its option related to the terms of its classes of preferred stock and made dividend payments in kind. For the three months ended March 31, 2012, the Company issued an aggregate of 17 shares of Series A-1 Preferred Stock, 227 shares of Series B Preferred Stock and 89 shares of Series C Preferred Stock in payment of dividends.

25

Communication Intelligence Corporation

 (In thousands, except per share amounts)

FORM 10-Q

Interest expense associated with the Company’s indebtedness for the three months ended March 31, 2012 and 2011, was $30 and $0, respectively, of which $27 and $0, respectively, was related party expense. Amortization of debt discount and deferred financing costs included in interest expense for the three months ended March 31, 2012 and 2011 was $5 and $0, respectively, of which $4 and $0, respectively, was related party expense.

The Company had the following material commitments as of March 31, 2012:

	Payments due by period
Contractual obligations	Total		2012		2013		2014		2015		2016		Thereafter
Short-term note payable (1)		1,225		1,225		-		-		-		-		-
Operating lease commitments (2)		1,300		201		275		283		292		249		-
Total contractual cash obligations	$	2,525	$	1,426	$	275	$	283	$	292	$	249	$	-

1.   The Company extended the lease on its offices in April 2010.  The base rent decreased by approximately 6% in November 2011 and will increase by approximately 3% per annum over the term of the new lease, which expires on October 31, 2016.

The Company has experienced recurring losses from operations that raise a substantial doubt about its ability to continue as a going concern. There can be no assurance that the Company will have adequate capital resources to fund planned operations or that any additional funds will be available to it when needed, or if available, will be available on favorable terms or in amounts required by it. If the Company is unable to obtain adequate capital

Item 3.                      Quantitative and Qualitative Disclosures About Market Risk.

Interest Rate Risk

The Company did not enter into any short-term security investments during the three months ended March 31, 2012.

Foreign Currency Risk

From time to time, the Company makes certain capital equipment or other purchases denominated in foreign currencies. As a result, the Company’s cash flows and earnings are exposed to fluctuations in interest rates and foreign currency exchange rates. The Company attempts to limit these exposures through operational strategies and generally has not hedged currency exposures. During the three months ended March 31, 2012 and 2011, foreign currency translation gains and losses were insignificant.

Item 4. Controls and Procedures.

Disclosure Controls and Procedures

We carried out an evaluation as of the end of period covered by this report, under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of our disclosure controls and procedures pursuant to paragraph (b) of Rule 13a-15 and 15d-15 under the Exchange Act.  Based on that review, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in the reports it files or submits under the Exchange Act (1) is recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and (2) is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

26

Communication Intelligence Corporation

 (In thousands, except per share amounts)

FORM 10-Q

Changes in Internal Control over Financial Reporting

There have been no changes in our internal control over financial reporting during the quarter ended March 31, 2012 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Part II-Other Information

Item 1.             Legal Proceedings.

None.

Item 1A.                      Risk Factors

Not applicable.

Item 2.             Unregistered Sale of Securities and Use of Proceeds.

None.

Item 3.             Defaults Upon Senior Securities.

None.

Item 4.             Mine Safety Disclosures

Not applicable

Item 5.             Other Information.

None.

Item 6.             Exhibits.

(a)             Exhibits.

Exhibit Number	Document
3.1	Certificate of Incorporation of the Company, as amended, incorporated herein by reference to Exhibits 3.1, 3.2, 3.3 and 3.4 to the Company's Registration Statement on Form 10 (File No. 0-19301).
3.2	Certificate of Amendment to the Company's Certificate of Incorporation (authorizing the reclassification of the Class A Common Stock and Class B Common Stock into one class of Common Stock) as filed with the Delaware Secretary of State's office on November 1, 1991, incorporated herein by reference to Exhibit 3 to Amendment 1 on Form 8 to the Company's Form 8-A (File No. 0-19301).
3.3	By-laws of the Company adopted on October 6, 1986, incorporated herein by reference to Exhibit 3.5 to the Company's Registration Statement on Form 10 (File No. 0-19301).
3.4	By-laws of the Company adopted on October 6, 1986, incorporated herein by reference to Exhibit 3.5 to the Company's Registration Statement on Form 10 (File No. 0-19301).
3.5	Certificate of Amendment to the Company’s Amended and Restated Certificate of Incorporation dated January 24, 2001, incorporated herein by reference to Exhibit 3.5 to the Company’s Registration Statement on Form S/1, filed December 28, 2007.

27

Communication Intelligence Corporation

 (In thousands, except per share amounts)

FORM 10-Q

Exhibit Number	Document
3.6	Certificate of Elimination of the Company’s Certificate of Designation of the Series A Preferred Stock dated August 17, 2001, incorporated herein by reference to Exhibit 3.6 to the Company’s Registration Statement on Form S/1, filed December 28, 2007.
3.7	Certificate of Amendment to the Company’s Amended and Restated Certificate of Incorporation filed with the Delaware Secretary of State August 17, 2007, incorporated herein by reference to Exhibit 3.7 to the Company’s Registration Statement on Form S/1 filed on December 28, 2007.
3.8	Amended and Restated Certificate of Incorporation of the Company filed with the Delaware Secretary of State on May 18, 1995, incorporated herein by reference to Exhibit 3.2 to the Company’s Quarterly Report on Form 10-Q filed on August 14, 2008.
3.9	Certificate of Designations, Powers, Preferences and Rights of the Series A Cumulative Convertible Preferred Stock filed with the Delaware Secretary of State on June 4, 2008, incorporated herein by reference to Exhibit 4.23 to the Company’s Quarterly Report on Form 10-Q filed on August 14, 2008.
3.10	Certificate of Amendment to the Company’s Amended and Restated Certificate of Incorporation filed with the Delaware Secretary of State on June 30, 2008, incorporated herein by reference to Exhibit 3.7 to the Company’s Quarterly Report on Form 10-Q filed on August 14, 2008.
3.11	Certificate of Designations, Powers, Preferences and Rights of the Series A-1 Cumulative Convertible Preferred Stock filed with the Delaware Secretary of State on October 30, 2008, incorporated herein by reference to Exhibit 3.11 to the Company’s Annual Report on Form 10-K filed on March 12, 2009.
3.12	Certificate of Elimination of the Company’s Series A Cumulative Convertible Preferred Stock filed with the Delaware Secretary of State on December 30, 2008, incorporated herein by reference to Exhibit 3.12 to the Company’s Annual Report on Form 10-K filed on March 12, 2009.
3.13	Certificate of Amendment to the Company’s Amended and Restated Certificate of Incorporation filed with the Delaware Secretary of State on June 30, 2009, incorporated herein by reference to Exhibit 3.13 to the Company’s Quarterly Report on Form 10-Q filed on August 14, 2009.
3.14	Amendment No. 1 to By-laws dated June 17, 2010, incorporated herein by reference to Exhibit 3.14 to the Company’s Quarterly Report on Form 10-Q filed on August 16, 2010.
3.15	Certificate of Amendment to the Company’s Amended and Restated Certificate of Incorporation filed with the Delaware Secretary of State on August 4, 2010, incorporated herein by reference to Exhibit 3.15 to the Company’s Quarterly Report on Form 10-Q filed on November 12, 2010.
3.16	Amended and Restated Certificate of Designation of Series A-1 Cumulative Convertible Preferred Stock filed with the Delaware Secretary of State on August 4, 2010, incorporated herein by reference to Exhibit 3.16 to the Company’s Quarterly Report on Form 10-Q filed on November 12, 2010.
3.17	Certificate of Designation of Series B Participating Convertible Preferred Stock filed with the Delaware Secretary of State on August 4, 2010, incorporated herein by reference to Exhibit 3.17 to the Company’s Quarterly Report on Form 10-Q filed on November 12, 2010.
3.18	Certificate of Amendment to Amended And Restated Certificate of Incorporation filed with the Delaware Secretary of State on December 31, 2010, incorporated herein by reference to Exhibit 3.18 to the Company’s Annual Report on Form 10-K filed on March 30, 2011.
3.19	Second Amended and Restated Certificate of Designation of Series A-1 Cumulative Convertible Preferred Stock filed with the Delaware Secretary of State on December 31, 2010, incorporated herein by reference to Exhibit 3.19 to the Company’s Annual Report on Form 10-K filed on March 30, 2011.
3.20	Second Amended and Restated Certificate of Designation of Series B Participating Convertible Preferred Stock filed with the Delaware Secretary of State on December 31, 2010, incorporated herein by reference to Exhibit 3.20 to the Company’s Annual Report on Form 10-K filed on March 30, 2011.

28

Communication Intelligence Corporation

 (In thousands, except per share amounts)

FORM 10-Q

Exhibit  Number	Document
3.21	Certificate of Designation of Series C Participating Convertible Preferred Stock filed with the Delaware Secretary of State on December 31, 2010, incorporated herein by reference to Exhibit 3.21 to the Company’s Annual Report on Form 10-K filed on March 30, 2011.
3.22	Amendment to the Amended And Restated Certificate of Designation of the Series B Participating Convertible Preferred Stock, incorporated herein by reference to Exhibit 10.59 to the Company’s Current Report on Form 8-K filed March 31, 2011.
3.23	Amendment to the Amended And Restated Certificate of Designation of the Series C Participating Convertible Preferred Stock, incorporated herein by reference to Exhibit 10.60 to the Company’s Current Report on Form 8-K filed March 31, 2011.
10.59	Amendment to the Amended And Restated Certificate of Designation of the Series B Participating Convertible Preferred Stock, incorporated herein by reference to Exhibit 10.59 to the Company’s Current Report on Form 8-K filed March 31, 2011.
10.60	Amendment to the Amended And Restated Certificate of Designation of the Series C Participating Convertible Preferred Stock, incorporated herein by reference to Exhibit 10.60 to the Company’s Current Report on Form 8-K filed March 31, 2011.
10.61	Form Of Subscription Agreement, incorporated herein by reference to Exhibit 10.61 to the Company’s Current Report on Form 8-K filed on April 4, 2011.
10.62	Amendment No. 1 to the Registration Rights Agreement dated March 31, 2011, incorporated herein by reference to Exhibit 10.62 to the Company’s Current Report on Form 8-K filed on April 4, 2011
*31.1	Certification of Company’s Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
*31.2	Certificate of Company’s Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
*32.1	Certification of Chief Executive Officer pursuant to 18 USC Section 1750, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
*32.2	Certification of Chief Financial Officer pursuant to 18 USC Section 1750, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

* Filed herewith.

29

Communication Intelligence Corporation

 (In thousands, except per share amounts)

FORM 10-Q

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

COMMUNICATION INTELLIGENCE CORPORATION

Registrant

May 15, 2012	/s/ Andrea Goren
Date	Andrea Goren
	(Principal Financial Officer and Officer Duly Authorized to Sign on Behalf of the Registrant)

30