Supplemental disclosures of cash flow information and non-cash transactions:

In connection with its acquisition of Prism, IPC assumed liabilities and issued common stock as follows:

1. Business of Internet Patents Corporation

Internet Patents Corporation (“IPC”) was originally incorporated in California in February 1995 and re-incorporated in Delaware in October 1996, and is headquartered outside Sacramento, California. Our headquarters mailing address is 101 Parkshore Drive, Suite 100, Folsom, CA 95630, and the telephone number at that location is (916) 932-2860. Our principal website is www.internetpatentscorporation.net.

From our inception through December 21, 2011, we operated an online insurance marketplace that electronically matched consumers and providers of automobile, property, health, term life, and small business insurance. We discontinued this business in connection with the sale of substantially all of our assets (the “Disposition”) to Bankrate, Inc. (“Bankrate”) in a transaction that closed on December 21, 2011 (“Disposition Date”).

On the Disposition Date and in connection with the Disposition, we changed our name from InsWeb Corporation (“InsWeb”) to Internet Patents Corporation. Since the Disposition Date, our business has consisted of licensing and enforcing a portfolio of patents relating to technology that was developed by us. On March 26, 2015, we completed a merger with Prism Technologies, LLC (“Prism”), with Prism becoming a wholly-owned subsidiary of IPC (the “Merger”). Prism also operates a patent licensing and enforcement business. Prism and its subsidiaries own a portfolio of nine patent families with an aggregate of 51 issued patents and five pending patent applications in the areas of computer and network security, semiconductors and medical technology.

In the Merger, Prism’s former owners received an aggregate of $16.5 million in cash and 3.5 million shares of our common stock. Subject to certain conditions, we have also agreed to share future revenue related to Prism’s patents with Prism’s former security holders up to a maximum amount of approximately $49.5 million. Further details about the Merger can be found in Note 3 – Acquisition - to the Notes to Condensed Financial Statements.

INTERNET PATENTS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

The following chart describes the status of all patent infringement litigation involving IPC, Prism and Secure Axcess, a wholly owned subsidiary of Prism.

2. Basis of Presentation

The consolidated financial statements include the accounts of IPC and its wholly-owned subsidiaries, Goldrush Insurance Services, Inc. and Prism Technologies LLC. All significant inter-company accounts and transactions have been eliminated in the consolidated financial statements.

The accompanying unaudited interim condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 8-03 of Regulation S-X. Accordingly, they do not contain all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. In the opinion of management, the accompanying unaudited interim condensed consolidated financial statements reflect all adjustments, which include only normal recurring adjustments, necessary to present fairly our financial position as of June 30, 2015 and the results of operations for the three and six months ended June 30, 2015 and 2014 and of cash flows for the six months ended June 30, 2015 and 2014. The financial data and other information disclosed in these notes to the condensed consolidated financial statements related to these periods are unaudited. The results for the three and six months ended June 30, 2015 are not necessarily indicative of the results to be expected for any future period.

These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K and other information as filed with the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such rules and regulations. The December 31, 2014 condensed consolidated balance sheet was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States. We believe the disclosures in its notes to the condensed consolidated financial statements are adequate to make the information presented not misleading. We have evaluated subsequent events through the time of filing these financial statements. Based upon the evaluation, there was no material impact on the accompanying condensed consolidated financial statements.

Reclassifications

Certain reclassifications, which have no effect on previously reported net loss, have been made to the 2014 condensed consolidated statements of operations to conform to IPC’s 2014 financial statement presentation.

Summary of Significant Accounting Policies

Business Combination Accounting 

IPC accounts for acquisitions in accordance with ASC 805 “Business Combinations.” Accordingly, the net assets acquired were recorded at their estimated fair values and Prism’s operating results are included in the Company’s consolidated financial statements from the Closing Date. IPC recognizes, separately from goodwill, the identifiable assets acquired and liabilities assumed at their estimated acquisition date fair values. IPC measures and recognizes goodwill as of the acquisition date as the excess of: (a) the aggregate of the fair value of consideration transferred, the fair value of any noncontrolling interest in the acquiree (if any) and the acquisition date fair value of IPC’s previously held equity interest in the acquiree (if any), over (b) the fair value of net assets acquired and liabilities assumed. At the acquisition date, IPC measures the fair values of all assets acquired and liabilities assumed that arise from contractual contingencies.  IPC measures the fair values of all noncontractual contingencies if, as of the acquisition date, it is more likely than not that the contingency will give rise to an asset or liability. While IPC uses its best estimates and assumptions as a part of the purchase price allocation process to accurately value assets acquired and liabilities assumed at the acquisition date, IPC’s estimates are inherently uncertain and subject to refinement. As a result, during the measurement period, which may be up to one year from the acquisition date, IPC will record adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill. Upon the conclusion of the measurement period or final determination of the values of assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments are recorded to IPC’s consolidated statements of operations. Prism’s operations are included in IPC’s consolidated financial statements as of March 26, 2015. Acquisition related costs associated with a business combination are expensed as incurred.

Intangible Assets

The fair value amount assigned to each acquired patent asset is being amortized on a straight-line basis, depending on the patent, over a period ranging from 1.5 to 4.5 years. The amortization period of the entire acquired patent portfolio is a weighted average of 3.7 years and was determined using the estimated life of each patent, which is represented by the period over which 100% of the expected discounted cash flows are received, and then using a weighted average approach based on the value of the patent and the estimated life.

The amortization period of the covenants not to compete with Prism’s officers is 3 years; the expected term of the agreements.

INTERNET PATENTS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

Goodwill

Goodwill represents the excess of:  (a) the aggregate of the fair value of consideration transferred, the fair value of any noncontrolling interest in the acquiree (if any) and the acquisition date fair value of IPC’s previously held equity interest in the acquiree (if any), over (b)  the fair value of assets acquired and liabilities assumed.  Goodwill and intangible assets, deemed to have indefinite lives, are subject to annual impairment testing as described below. 

Goodwill will be tested for impairment on at least an annual basis in the fourth quarter of the year.  In the first step of testing for goodwill impairment, IPC will estimate the fair value of the net assets associated with the goodwill.  If the fair value of these net assets is greater than the carrying value of the net assets, including goodwill, then there will be no impairment.  If the fair value is less than the carrying value, then IPC would perform a second step and determine the fair value of the goodwill. In this second step, the fair value of goodwill is determined by deducting the fair value of the identifiable assets and liabilities from the fair value of the reporting unit as a whole, as if that reporting unit had just been acquired and the purchase price were being initially allocated.  If the fair value of the goodwill is less than its carrying value for a reporting unit, an impairment charge would be recorded to earnings in the Company’s Consolidated Statements of Operations. 

In addition, IPC would evaluate goodwill for impairment if events or circumstances change between annual tests indicating a possible impairment.  Examples of such events or circumstances include the following:

Share-Based Payments

IPC accounts for share-based compensation in accordance with ASC 718 “Compensation – Stock Compensation.” Under the provisions of ASC 718, share-based compensation cost is generally estimated at the grant date based on the award’s fair value as calculated by the Black-Scholes-Merton (BSM) option-pricing model. The BSM option-pricing model requires various highly judgmental assumptions including expected option life, volatility, and forfeiture rates. If any of the assumptions used in the BSM option-pricing model change significantly, share-based compensation expense may differ materially in the future from that recorded in the current period. Generally, compensation cost is recognized over the requisite service period. However, to the extent performance conditions affect the vesting of an award, compensation cost will be recognized only if the performance condition is satisfied. Compensation cost will not be recognized, and any previously recognized compensation cost will be reversed, if the performance condition is not satisfied.

Recently Adopted Accounting Pronouncements

In May 2014, the FASB issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The ASU will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. The new standard is effective for annual reporting periods beginning after December 15, 2017. Early application is not permitted. The standard permits the use of either the retrospective or cumulative effect transition method. We are evaluating the effect that ASU 2014-09 will have on our Condensed Consolidated Financial Statements and related disclosures. We have not yet selected a transition method nor have we determined the effect of the standard on our ongoing financial reporting.

In August 2014, the FASB issued Accounting Standards Update (“ASU”) No. 2014-15, “Presentation of Financial Statements—Going Concern” (Subtopic 205-40) which amends the current guidance in ASC Topic 205 by adding Subtopic 40. Subtopic 40 requires management to evaluate whether there are conditions or events that in aggregate would raise substantial doubt about an entity’s ability to continue as a going concern for one year from the date the financial statements are issued or available to be issued. If substantial doubt existed, management would be required to make certain disclosures related to nature of the substantial doubt and, under certain circumstances, how that substantial doubt would be mitigated. This amendment is effective for annual periods ending after December 15, 2017 and for subsequent interim and annual periods thereafter. Early adoption is permitted. We are evaluating the effects, if any, adoption of this guidance will have on our consolidated financial statements.

INTERNET PATENTS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

3.  Acquisition and Preliminary Purchase Accounting

On March 26, 2015 (the “Closing Date”), IPC completed its acquisition of Prism Technologies, LLC (“Prism”) pursuant to the terms of the Agreement and Plan of Merger (the “Merger Agreement”) dated November 12, 2014. Prism was acquired for a purchase price of $58.3 million paid in a combination of cash, stock and potential contingent earn-out payments as discussed further below. IPC accounts for acquisitions in accordance with ASC 805 “Business Combinations.” Accordingly, the net assets acquired were recorded at their estimated fair values and Prism’s operating results are included in the Company’s consolidated financial statements from the Closing Date.

The maximum purchase price, exclusive of the discounting or probability reductions associated with the contingent consideration, is $75.4 million as of the Closing Date. The $75.4 million maximum purchase price is comprised of: (a) $16.5 million in cash ($1.3 million paid at Closing and $15.2 million paid in April, 2015); (b) $9.4 million associated with the issuance of 3.5 million shares of IPC common stock at Closing; and (c) a total of up to $49.5 million in cash in future contingent consideration.

Contingent Consideration

The contingent consideration payable to Prism’s former security holders consists of a share of future revenues related to lawsuits filed by Prism prior to March 26, 2015 (“Open Suits”). Under the terms of the Merger Agreement, IPC will retain the first $16.5 million in litigation or settlement proceeds received from Open Suits after closing (the “Sharing Threshold”), less any cash remaining in Prism at the time of closing. Prism’s former security holders will receive 70% of the litigation and settlement proceeds related to Open Suits in excess of the Sharing Threshold, up to $49.5 million. The contingent consideration is calculated quarterly and payable in the quarter following the period in which it is earned. Payments due for the quarters ended March 31, June 30, and September 30, are subject to a 20% retention. The retention payments are due in conjunction with the earn-out payment for December 31.

The preliminary estimated fair values of the Prism purchase price is comprised of the following (in thousands):

A portion of the consideration at closing was the issuance of 3,500,000 new shares of IPC’s common stock. The closing price-per-share of IPC’s common stock on the acquisition date was $2.68.

The fair value of contingent consideration to be paid as of the date of acquisition is calculated based upon the time value of money and the probability assessment in achieving patent proceeds.

Preliminary Purchase Price Allocation

IPC recognized of $0.1 million in goodwill, representing the excess purchase consideration over acquired tangible and intangible assets and liabilities assumed. The goodwill relates to expected synergies and the assembled workforce of Prism.

The acquired intangible assets included a patent portfolio valued, for purchase price allocation purposes, at $58.9 million with a weighted average useful life of 3.7 years and $2.5 million of non-compete agreements with a weighted average useful life of 3 years.

Management determined the fair value of intangible assets based on a number of factors, including a third-party valuation, utilizing the income approach in conjunction with discussions with Prism’s management and certain forecasts prepared by Prism. The rate utilized to discount net cash flows to their present values was approximately 32% for the non-compete agreements and a range of 34-35% for the patent portfolio. The discount rates were determined using a weighted-average cost of capital which incorporated a number of factors which included the risk-free rate, the market premium, a company size premium and a company-specific premium for the non-compete agreements. In addition, for the patent portfolio, there was an additional premium applied.

INTERNET PATENTS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

3.  Acquisition and Preliminary Purchase Accounting (continued)

The following table summarizes the preliminary estimated fair values of the assets acquired and liabilities assumed at the Closing Date. The purchase price allocations are based upon preliminary valuations, and our estimates and assumptions are subject to change within the measurement period as valuations are finalized. Any change in the estimated assets, prior to the finalization of the more detailed analyses, which must occur within one year from the Merger Date, may change the amount of the purchase price allocations.

Based upon refinements to our accounting estimates, the total purchase price, net of liabilities assumed, was reduced from $60.2 million at March 31, 2015 to $58.3 million at June 30, 2015. The refinements consisted of a decrease in goodwill from $5.1 million to $0.1 million, offset by an increase in intangible assets from $58.3 million to $61.4 million. The decrease in goodwill resulted from a revision to the revenue base used to calculate the contributory asset charges from a specific year to a range of years, pre and post-merger. In addition, the discount rates for the non-compete agreements and intangible assets were revised. The discount rate for the non-compete agreements increased from 27% to 32% to reflect the three year term of these agreements. The discount rate for the intangible assets decreased from 37% to a range of 34-35% as a result of evaluating the projected cash flows from individual patents rather than the entire portfolio. The refinements were made based on information available as of the transaction date.

The fair value of the notes payable was determined, using an annual discount rate of 12.0% to discount the notes payable’s payment stream based on management’s assumptions about the risk associated with satisfying the payment obligations, including the fact that certain patents serve as security for the notes.

IPC incurred approximately $127,000 and $219,000 in acquisition-related expenses for the three and six months ended June 30, 2015, respectively. For the three months ended June 30, 2015 $86,000 was related to legal expenses and $41,000 in accounting and valuation expenses. For the six months ended June 30, 2015, $107,000 was related to legal expenses, $83,000 in accounting and valuation expenses and $29,000 in special shareholder meeting expenses. These costs are included in the consolidated statement of operations in general and administrative operating expenses for the three and six months ended June 30, 2015. There were no acquisition-related expenses incurred during the comparable periods during 2014.

INTERNET PATENTS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

3.  Acquisition and Preliminary Purchase Accounting (continued)

Pro forma Results of Operations

The pro forma results of operations provided below for the three and six months ended June 30, 2015 and 2014 are presented as though the acquisition had occurred at the beginning of the period presented. The pro forma information presented below does not purport to indicate what the Company's results of operations would have been if the acquisition had in fact occurred at the beginning of the earliest period presented nor does it intend to be a projection of the impact on future results or trends.      

4.  Fair Value Measurements

The following table presents the assets measured at fair value on a recurring basis as of June 30, 2015 (in thousands):

The following table presents the financial assets measured at fair value on a recurring basis as of December 31, 2014 (in thousands):

Cash equivalents, short-term investments and restricted cash equivalents include certificates of deposit, money market deposit accounts and money market funds. The carrying value of these cash equivalents, short-term investments and restricted cash equivalents approximates fair value. These securities are considered Level 1 instruments, and we use quoted prices in active markets for identical assets to determine their fair value.

5. Restricted Cash Equivalents and Short-Term Investments

As of both June 30, 2015 and December 31, 2014, restricted cash equivalents consisted of $0.8 million. A portion of the cash equivalents is used as collateral for a letter of credit of the same amount which secures our remaining rent obligations under the office space lease for IPC’s former corporate headquarters.

INTERNET PATENTS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

6. Other Assets

Prism owns several life insurance policies (also referred to as “life settlement contracts”). These life settlement contracts were part of the assets acquired by IPC in the Merger. A life settlement contract is the payment of cash to an insured in return for an assignment of ownership or beneficial interest in, and the right to receive the value of, a life insurance policy upon the death of the insured.

Life settlement contracts are preliminarily recorded at cash surrender value, with premium payments expensed as incurred. The policies are not subject to amortization; however IPC analyzes the carrying value for the impairment annually. Based upon our analysis, no impairment was noted for the three and six months ended June 30, 2015.

Life settlement contracts consist of the following at June 30, 2015 (in thousands):

7. Intangible Assets

        Intangible assets, net, include the following amounts (in thousands):

        Goodwill, the excess of the purchase price paid to former security holders of Prism over the fair market value of the net assets acquired, in the amount of $0.1 million was recorded as of the Closing Date. We did not have goodwill prior to the acquisition of Prism.

8. Accrued Expenses

Accrued expenses and other current liabilities consist of the following (in thousands):

9. Notes payable

As part of the Merger, IPC assumed a $3.6 million discounted non-interest bearing notes payable to two affiliated companies, due in four semi-annual installments of $1,000,000 beginning in June 2015, including imputed interest of 12%, based on management’s assumptions about the risk associated with satisfying the payment obligations, including the fact that certain patents serve as security for the notes.

INTERNET PATENTS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

9. Notes payable (continued)  

The aggregate maturities of the notes payable as of June 30, 2015 are as follows (in thousands):

10. Net Loss Per Share

Basic net loss per share is computed using the weighted-average number of shares of common stock outstanding. Diluted income per share is a measure of the potential dilution that would occur if stock options had been exercised.

The following table reconciles the numerator and denominator used to calculate basic and diluted net loss per share of common stock:

Potentially dilutive securities are not included in the diluted net loss calculation, because we had a net loss from operations, net of tax. The antidilutive securities that are not included in the calculation above are employee stock options and non-employee directors to purchase shares totaling 38,646 and 20,562 for the three and six month periods ending June 30, 2015 and 0 for the comparable periods in 2014.

11. Commitments and Contingencies

Leases

We have a non-cancelable 24 month lease through May 15, 2017 for approximately 1,300 square feet of office space in Folsom, California, which is currently IPC’s corporate headquarters.

Prism leases approximately 2,200 square feet of office space in Omaha, Nebraska under a non-cancelable 60 month lease through August 31, 2017.

We have a non-cancelable 5-year full-service lease through February 14, 2017 for approximately 16,000 square feet of office space in a building that housed our headquarters until May 2013. The facility is located in Rancho Cordova, California. The lease includes negotiated annual increases in the monthly rental payments. On April 16, 2013, we subleased this space for the remainder of our term. The monthly sublease rent is less than our rent obligation to the landlord. As of June 30, 2015, we are expected to receive $227,000 from the sub-lessee for the remainder of our lease.

Until the expiration of the lease in September 2014, we also leased approximately 10,000 square feet of office space in San Francisco, California. This facility was fully subleased to two tenants.

INTERNET PATENTS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

11. Commitments and Contingencies (continued)

Legal Proceedings

On March 19, 2015, Maxim Group LLC (“Maxim”) sent Prism a letter demanding payment of a fee under an Advisory Agreement dated September 19, 2013 (the “Advisory Agreement). Prism rejected the demand and on April 10, 2015, Maxim filed a Statement of Claim with the Financial Industry Regulatory Authority (“FINRA”) to initiate arbitration of the dispute. In the Statement of Claim, Maxim alleges that Prism is liable for payment of a percentage of the Merger consideration as an advisory fee under the Advisory Agreement. Prism has answered the Statement of Claim and contested FINRA’s jurisdiction. However, Prism also filed a declaratory judgment action in Nebraska state court seeking a declaration that the Advisory Agreement is void, no advisory fee is owed and staying the FINRA arbitration proceeding. In the state court action Prism argues: (i) Maxim did not introduce IPC to Prism and Prism did not seek Maxim’s assistance with the Merger; (ii) Maxim was not registered as an investment advisor and cannot charge an advisory fee; and (iii) the advisory fee demanded by Maxim is grossly excessive under applicable law. A hearing on Prism’s request for a stay was held on May 7, 2015 but the court has not yet ruled on the motion. If the stay is not granted, IPC and Prism intend to vigorously defend the FINRA arbitration. Although an arbitration award to Maxim would be paid by IPC, it relates to a pre-Merger dispute and would reduce the maximum earnout payable to Prism’s former security holders. As such, an adverse arbitration decision, if any, would have a near term impact on our cash flow but is not expected to have a significant impact on our long term financial condition.

12. Options and Equity

As of June 30, 2015, there was $211,000 in unrecognized compensation cost for all stock options outstanding. A portion of the unrecognized compensation cost relates to grants of options to purchase 500,000 shares of common stock to five Prism executive officers under employment agreements executed in connection with the Merger. The exercise price of all of the options granted to Prism executive officers is $2.68. One-half of the options granted to each employee is serviced based and vest as follows: (i) 33.33% will vest upon the first anniversary of the first date of employment, and (ii) 1/24 of the remaining 66.67% will vest at the end of each of the 24 months following such anniversary, so long as the individual remains employed pursuant to the terms of his or her employment agreement.

The remaining one-half of the options granted to the five Prism officers are performance based and vest as follows: (i) 33.33% will vest upon the first anniversary of the first date of employment based on achievements measured against financial targets for such period; (ii) 33.33% will vest upon the second anniversary of the first date of employment based on achievements measured against financial targets for the second year of employment; and (iii) 33.34% will vest upon the third anniversary of the first date of employment based on achievements measured against financial targets for the third year of employment. The employee must remain employed for the service based and performance based options to vest; however, all unvested options will immediately vest upon: (A) termination of such person’s employment without good cause; or (B) the occurrence of a change of control as defined in such person’s employment agreement.

On June 11, 2015, IPC granted 72,500 performance based stock options, 72,500 service based stock options and 70,000 stock options which vested immediately, to members of management. The service based stock options vest 33% after one year and ratably over the next two years. The performance based stock options vest annually, if financial targets are met.

For the performance based options noted above, in accordance with ASC 718 “Compensation – Stock Compensation.”, a performance condition must be met for the award to vest and compensation cost will be recognized only if the performance condition is satisfied. The performance based option vesting criteria uses a tiered vesting structure between 0% to 100% based upon a comparison of annual licensing and enforcement outcomes to an annual target approved by the Board. The 2016 and 2017 financial targets have not been set by the Board, therefore the fair value of the performance based options will be recognized as zero. When IPC is able to assess the probability of achieving target levels, the fair value will be calculated at that time. For the 2015 financial target, IPC has assessed that 60% of the financial target has been achieved in accordance with the tiered vesting structure and under the terms of the grant agreement and therefore 50% of the 2015 performance based options have been vested as of June 30, 2015.

During the three and six months ended June 30, 2015 and 2014 there were no common share issuances associated with the exercise of stock options.