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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the quarterly period ended September 30, 2002
Commission File Number: 0-21683
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GraphOn Corporation
(Exact name of Registrant as specified in its charter)
-------------------------------
Delaware 13-3899021
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
400 Cochrane Circle
Morgan Hill, CA 95037
(Address of principal executive offices)
Registrant's telephone number: (800) 472-7466
---------------------------------------------
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 [ ]
As of November 12, 2002 there were issued and outstanding 17,540,720
shares of the Registrant's Common Stock, par value $0.0001.
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GRAPHON CORPORATION
FORM 10-Q
Table of Contents
Page
PART I.
Item 1.Financial Statements
Consolidated Balance Sheets 2
Consolidated Statements of Operations 3
Consolidated Statements of Cash Flows 4
Notes to Consolidated Financial Statements 5
Item 2.Management's Discussion and Analysis of Financial
Condition and Results of Operations 10
Item 3.Quantitative and Qualitative Disclosures About
Market Risk 24
Item 4.Controls and Procedures 24
PART II.
Item 6.Exhibits and Reports on Form 8-K 25
Signatures 26
Certifications 26
PART I--FINANCIAL INFORMATION
ITEM I Financial Statements
GRAPHON CORPORATION
CONSOLIDATED BALANCE SHEETS
September 30, December 31,
2002 2001
ASSETS ------------ ------------
------------ (Unaudited)
Current Assets:
Cash and cash equivalents ..................... $ 1,406,800 $ 3,952,600
Available-for-sale securities ................. 252,300 3,008,000
Accounts receivable, net of allowance for
doubtful accounts of $56,600 and $350,000 .... 325,400 620,400
Prepaid expenses and other current assets ..... 172,000 251,300
------------ ------------
Total Current Assets .......................... 2,156,500 7,832,300
------------ ------------
Property and equipment, net ...................... 507,200 1,436,100
Purchased technology, net ........................ 1,370,100 3,132,400
Capitalized software, net ........................ 138,900 513,400
Other assets ..................................... 72,600 71,600
------------ ------------
TOTAL ASSETS ................................ $ 4,245,300 $ 12,985,800
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current Liabilities:
Accounts payable .............................. $ 242,300 $ 319,900
Accrued expenses .............................. 822,100 735,500
Notes payable ................................. - 26,600
Deferred revenue .............................. 396,100 577,800
------------ ------------
Total Current Liabilities ..................... 1,460,500 1,659,800
------------ ------------
Commitments and contingencies .................... - -
Stockholders' Equity
Preferred stock, $0.01 par value, 5,000,000 shares
authorized, no shares issued and outstanding .... - -
Common stock, $0.0001 par value, 45,000,000
shares authorized, 17,514,052 and 17,226,004
shares issued and outstanding ................... 1,900 1,700
Additional paid in capital ....................... 45,982,300 45,925,900
Deferred compensation ............................ (19,000) (193,800)
Notes receivable ................................. (50,300) -
Accumulated other comprehensive income ........... (1,300) 1,500
Accumulated deficit .............................. (43,128,800) (34,409,300)
------------ ------------
Total Stockholders' Equity ....................... 2,784,800 11,326,000
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY .. $ 4,245,300 $ 12,985,800
============ ============
See accompanying notes to consolidated financial statements.
2
GRAPHON CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ ------------------
2002 2001 2002 2001
------------ ------------ ------------ ------------
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
Revenue .................................. $ 836,500 $ 1,018,300 $ 1,947,600 $ 5,274,500
Cost of revenue .......................... 454,700 933,700 1,371,200 1,683,600
------------ ------------ ------------ ------------
Gross Profit .......................... 381,800 84,600 576,400 3,590,900
------------ ------------ ------------ ------------
Operating Expenses:
Selling and marketing .................... 387,500 2,141,700 1,712,900 5,110,200
General and administrative ............... 837,800 1,264,500 2,295,300 4,119,900
Research and development ................. 782,700 1,090,000 2,502,100 3,559,300
Asset impairment ......................... 914,000 - 914,000 -
Restructuring charge ..................... 452,400 - 1,942,800 -
------------ ------------ ------------ ------------
Total Operating Expenses ................. 3,374,400 4,496,200 9,367,100 12,789,400
------------ ------------ ------------ ------------
Loss From Operations ..................... (2,992,600) (4,411,600) (8,790,700) (9,198,500)
Other Income (Expense):
Interest and other income ............. 27,300 106,700 143,100 446,800
Interest and other expense ............ (15,800) (38,800) (71,900) (49,300)
Loss on joint venture ................. - (400) - (41,100)
------------ ------------ ------------ ------------
Total Other Income .................... 11,500 67,500 71,200 356,400
------------ ------------ ------------ ------------
Loss Before Provision for Income Taxes ... (2,981,100) (4,344,100) (8,719,500) (8,842,100)
Provision for Income Taxes ............... - - - -
------------ ------------ ------------ ------------
Net Loss ................................. $ (2,981,100) $ (4,344,100) $ (8,719,500) $ (8,842,100)
------------ ------------ ------------ ------------
Basic and Diluted Loss per Common Share .. $ (0.17) $ (0.25) $ (0.50) $ (0.57)
============ ============ ============ ============
Weighted Average Common Shares Outstanding 17,508,574 17,225,996 17,455,439 15,579,701
============ ============ ============ ============
See accompanying notes to consolidated financial statements.
3
GRAPHON CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended
September 31,
2002 2001
----------- ------------
(Unaudited) (Unaudited)
Cash Flows From Operating Activities:
Net loss ............................................. $(8,719,500) $(8,842,100)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization ..................... 1,572,400 2,017,800
Restructuring charge .............................. 657,800 -
Asset impairment loss ............................. 914,000 -
Loss on disposal of fixed assets .................. - 28,200
Amortization of deferred compensation ............. 174,800 957,700
Provision for doubtful accounts ................... (293,400) 150,000
Loss on joint venture - related party ............. - 41,100
Changes in operating assets and liabilities:
Accounts receivable ............................... 588,400 (419,000)
Prepaid expenses and other assets ................. 79,300 78,500
Accounts payable .................................. (77,600) (54,400)
Accrued expenses .................................. 86,600 885,000
Deferred revenue .................................. (181,700) 127,700
----------- -----------
Net Cash Used In Operating Activities ................ (5,198,900) (5,029,500)
----------- -----------
Cash Flows From Investing Activities:
Purchase of available-for-sale securities ............ (768,300) (2,734,000)
Proceeds from sale of available-for-sale securities .. 3,525,200 5,910,400
Capitalization of software development costs ......... - (324,800)
Capital expenditures ................................. (82,900) (422,300)
Other assets ......................................... (1,000) (37,200)
Proceeds from dissolution of joint
venture - related party ............................. - 954,500
Investment in joint venture - related party .......... - (103,700)
----------- -----------
Net Cash Provided By Investing Activities ......... 2,673,000 3,242,900
----------- -----------
Cash Flows From Financing Activities:
Repayment of note payable ............................ (26,600) (90,300)
Proceeds from note payable ........................... - 131,200
Net proceeds from issuance of common stock ........... 6,400 118,600
----------- -----------
Net Cash (Used In) Provided By Financing Activities (20,200) 159,500
----------- -----------
Effect of exchange rate fluctuations on cash and
cash equivalents .................................. 300 (400)
----------- -----------
Net Decrease in Cash and Cash Equivalents ............ (2,545,800) (1,627,500)
Cash and Cash Equivalents, beginning of period ....... 3,952,600 8,200,100
----------- -----------
Cash and Cash Equivalents, end of period ............. $ 1,406,800 $ 6,572,600
=========== ===========
Supplemental Disclosure of Cash Flow Information:
Cash paid for interest expense $ 200 $ 3,200
Noncash Investing and Financing Activities:
Notes receivable issued for purchase of common stock $ 50,000 $ -
See accompanying notes to consolidated financial statements.
4
GRAPHON CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation
The unaudited consolidated financial statements of GraphOn Corporation (the
Company) included herein have been prepared in accordance with the instructions
for Form 10-Q and, therefore, do not include all information and footnotes
necessary for a complete presentation of the Company's results of operations,
financial position and cash flows.
The unaudited condensed financial statements included herein reflect all
adjustments (which include only normal, recurring adjustments, except for the
restructuring and asset impairment charges, as described below) that are, in the
opinion of management, necessary to state fairly the results for the periods
presented. This Quarterly Report on Form 10-Q should be read in conjunction with
the Company's audited financial statements contained in the Company's Annual
Report on Form 10-K for the year ended December 31, 2001, which was filed with
the Securities and Exchange Commission (the Commission) on March 29, 2002. The
interim results presented herein are not necessarily indicative of the results
of operations that may be expected for the full fiscal year ending December 31,
2002, or any future period.
The Company's financial statements have been presented on a going concern
basis, which contemplates the realization of assets and the settlement of
liabilities in the normal course of business. The Company has suffered from
recurring losses and has absorbed significant cash in its operating activities.
Further, the Company's revenues have declined significantly during the
nine-month period ended September 30, 2002, compared to the similar period of
2001. These matters raise substantial doubt about the ability of the Company to
continue in existence as a going concern. Although there can be no assurances,
the Company believes that revenue for the second half of 2002 will be greater
than revenue for the first half of 2002.
The consolidated financial statements do not include any adjustments relating
to the recoverability and classification of assets or the amount and
classification of liabilities that might result should the Company be unable to
continue as a going concern. In order to realize assets and settle liabilities
within the normal course of business, the Company must continue to aggressively
adjust its current level of operations in order to match the Company's currently
available resources. Such adjustments will likely include further work force
reductions, exiting of facilities or the disposition of certain operations.
Management believes that the Company will be able to support its operational
needs with currently available resources for at least the next few quarterly
periods. Management has been successful in significantly reducing operating
costs through a series of strategic restructurings and work force reductions
that began in September of 2001. Throughout these strategic initiatives,
management has been able focus research and development efforts on the
completion of the GO-Global for Windows (the Windows enterprise edition of the
legacy Bridges product line) and it was released for sale at the end of
September 2002. During the three-month period ended September 30, 2002,
management conducted extensive market research, independently and through
several beta test sites, to gauge the potential market for GO-Global for
Windows. The results were encouraging. Management believes that a successful
5
roll out of the GO-Global for Windows product to those customers who expressed
an interest during its beta testing would generate sufficient revenue that, when
coupled with the cumulative operating benefits to be derived from the
significantly reduced operating costs structure now in place, would permit the
Company to continue as a going concern for at least the next few quarterly
periods. However, there can be no guarantees that the roll out of GO-Global for
Windows will be successful or that those customers who have expressed interest
in it will ultimately place orders.
The Company is exploring all options available to aggressively reduce costs,
to increase revenues and to find alternative sources of financing its
operations. Such options will likely include further work force reductions,
exiting of facilities, or the disposition of certain operations. If the Company
were unsuccessful in obtaining any of these strategic goals, it would face a
severe constraint on its ability to sustain operations in a manner that would
create future growth and viability, and the Company may need to cease operations
entirely.
The Company has announced that it has signed an agreement to acquire three
privately held affiliated entities in the telecommunications industry. The
Company believes that should the acquisition be successful, the newly acquired
entities would have available financial resources to provide for the Company's
operations. Consummation of the proposed acquisition is subject to a number of
conditions including the performance of customary due diligence investigations,
filing and clearance of proxy solicitation materials and receipt of shareholder
approval, among others. As of September 30, 2002 several of the conditions
necessary for the proposed acquisition to take place had not yet occurred. If
these conditions are not satisfied by December 31, 2002, the acquisition
agreement will expire unless it is extended by the parties.
2. Earnings Per Share
Basic earnings per share are calculated using the weighted average number of
shares outstanding during the period. Diluted earnings per share are calculated
using the weighted average number of shares outstanding during the period plus
the dilutive effect of outstanding stock options and warrants using the
"treasury stock" method and are not included since they are antidilutive.
3. Stockholders' Equity
During the nine-month period ended September 30, 2002, the Company issued
25,720 shares of common stock to employees pursuant to the purchase by those
employees of common stock under the Employee Stock Purchase Plan, resulting in
cash proceeds of $6,400. Also during the nine-month period ended September 30,
2002, the Company issued 200,000 shares of common stock to directors pursuant to
the exercise by those directors of stock options granted under the 1998 Stock
Option/Stock Issuance Plan. Each of the two directors exercising the options
issued a $25,000 promissory note to the Company to pay for the options. The
notes are for a term of three years, are due on or before March 5, 2005 and bear
semi-annual interest at 2.67% per annum, which is equal to the applicable
federal short-term interest rate in effect at the time the promissory notes were
signed.
During the three-month period ended September 30, 2002, the Company issued
14,000 shares of common stock to employees pursuant to the purchase by those
employees of common stock under the Employee Stock Purchase Plan, resulting in
6
cash proceeds of $1,000. This amount is included in the Consolidated Statements
of Cash Flows as a component of net proceeds from issuance of common stock.
4. Litigation
The Company is currently not involved in any litigation that it believes
would have a materially adverse affect upon its financial results.
5. Asset Impairment
During the three-month period ended September 30, 2002 the Company recorded
an impairment charge of $914,000 against several intangible assets, primarily
capitalized technology assets. Statement of Financial Accounting Standards
(SFAS) No. 121 - Accounting for the Impairment of Long-Lived Assets requires
that long-lived assets must be reviewed for impairment whenever events or
changes in circumstances indicate that the carrying amount of an asset may not
be recoverable. SFAS No. 121 sets forth examples of events or changes in
circumstances that indicate that the recoverability of the carrying amount of an
asset should be addressed, including the following:
o A significant decrease in the market value of an asset;
o A significant change in the extent or manner in which an asset
is used;
o A significant adverse change in the business climate that could
affect the value of an asset; and
o Current and historical operating or cash flow losses.
The Company believed that a review of the current carrying values to evaluate
whether the value of any of its long-lived technology assets had been impaired
was warranted, due to several factors, including:
o The challenges the Company faced in bringing the Windows
enterprise product to maturity;
o The continued pervasive weakness in the world-wide economy;
o How the Company was incorporating and planning to incorporate
each element of the purchased technologies into its
technology; and
o The Company's continued and historical operating and cash flow losses.
Based on a study of the various factors affecting asset impairment, as
outlined above and in SFAS No. 121, the following asset impairment charges were
determined to be necessary in order to reduce the carrying value of these assets
to the Company's current estimate of the present value of the expected future
cash flows to be derived from these assets:
Net Book Value Impairment Net Book Value
Before Impairment Write Down After Impairment
Purchased Technology $ 2,145,200 $ 775,100 $ 1,370,100
Capitalized Software 277,800 138,900 138,900
--------------- ---------- --------------
Totals $ 2,423,000 $ 914,000 $ 1,509,000
=============== ========== ==============
7
6. Restructuring Charge
Effective August 30, 2002, the Company closed its Bellevue, Washington
engineering facility as part of its continued strategic initiative to reduce
operating costs. In conjunction with the closure, the Company reduced its
engineering headcount in both its Bellevue and Concord, New Hampshire offices
and reduced its headcount in the administrative and sales and marketing
departments. Additionally, the Company wrote off costs of leasehold improvements
that had been made to the Bellevue facility and the cost of various assets that
were abandoned with the office closure. A summary of the restructuring charges
that were recognized during the three-month period ended September 30, 2002 is
as follows:
Category Charge
Minimum lease payments $ 263,600
Employee severance 132,900
Fixed assets abandonment 99,700
Other 10,300
Reduction of March 31, 2002
restructuring charge (54,100)
---------
$ 452,400
=========
The minimum lease payments are an estimate of the cash the Company may need
to disburse in order to fulfill its obligations under the current Bellevue
office lease. The estimated payments are equal to one year's worth of aggregated
monthly lease payments plus 25% of the aggregated monthly lease payments through
the expiration of the lease in April 2006. Given current market conditions in
the corporate real estate rental market in the Bellevue, Washington area, the
Company anticipates that its search for a suitable sub lessee should take
approximately one year and that the sub lessee's rent would be lower than that
of the Company's, under the current terms of the rental agreement. The Company
estimates that it might have to agree to carry up to 25% of the current minimum
rental payments in order to attract a suitable sub lessee within the one-year
time frame.
The costs associated with fixed assets disposals are comprised of the
estimated net book value of the assets, including furniture and fixtures,
equipment and leasehold improvements, which were written off upon the closure of
the Bellevue office, as these assets will have no future utility. The Company
does not anticipate any material cash disposal costs to be incurred to dispose
of the fixed assets.
During the three-month period ended September 30, 2002 the Company revised
costs associated with the restructuring charge it had recorded during the
three-month period ended March 31, 2002. Based on final settlement of employee
severance payments, the Company reduced its previously estimated restructuring
severance costs by approximately $54,100.
7. Acquisition
On August 21, 2002, the Company announced that it had signed an agreement to
acquire three privately held, affiliated entities in the telecommunications
industry. The Company expects that these businesses will benefit from its
software development expertise and experience, while providing the Company with
a revenue stream and platform for potential future growth and profitability.
8
Consummation of the proposed acquisition is subject to a number of conditions
including the performance of customary due diligence investigations, filing and
clearance of proxy solicitation materials and receipt of shareholder approval,
among others. As of September 30, 2002, several of the conditions necessary for
the proposed acquisition to take place had not yet occurred. If these conditions
are not satisfied by December 31, 2002, the acquisition agreement will expire
unless it is extended by the parties.
9
ITEM 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
Forward-Looking Statements
The following discussion of the financial condition and results of operations
of the Company contains forward-looking statements within the meaning of Section
27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act
of 1934. Actual results and the timing of certain events could differ materially
from those anticipated in these forward-looking statements as a result of
certain factors, including, but not limited to, those set forth under "Risk
Factors" in the Company's Annual Report on Form 10-K for the year ended December
31, 2001 and in other documents filed by the Company with the Securities and
Exchange Commission.
Overview
We are developers of business connectivity software, including server-based
software, with an immediate focus on web-enabling applications for use by
various parties, including independent software vendors (ISVs), application
service providers (ASPs), corporate enterprises, governmental and educational
institutions, and others. Server-based computing, sometimes referred to as
thin-client computing, is a computing model where traditional desktop software
applications are relocated to run entirely on a server, or host computer. This
centralized deployment and management of applications is intended to reduce the
complexity and total costs associated with enterprise computing. Our software
architecture provides application developers with the ability to relocate
applications traditionally run on the desktop to a server, or host computer,
where they can be run over a variety of connections from remote locations to the
desktop. Our server-based technology works on today's most powerful personal
computer, or low-end network computer, without application rewrites or changes
to the corporate computing infrastructure.
With our software, applications can be web enabled, without any modification
to the original application software required, allowing the applications to be
run from browsers or portals. In addition, the ability to access such
applications over the Internet creates new operational models and sales
channels. We provide the technology to access applications over the Internet.
We entered both the UNIX and Linux server-based computing and web enabling
markets as early as 1996. We expanded our product offerings by shipping Windows
web-enabling software in early 2000.
Effective September 1, 2002, we are headquartered in Morgan Hill, California,
with offices in Concord, New Hampshire and Reading, United Kingdom.
On August 21, 2002, we announced that we had signed an agreement to acquire
three privately held, affiliated entities in the telecommunications industry. We
expect that these businesses will benefit from our software development
expertise and experience, while providing us with a revenue stream and platform
for potential future growth and profitability.
In order to ensure that we will be able to realize our assets and settle our
liabilities within the normal course of our business operations, we must
10
consider several aggressive strategic initiatives including future work force
reductions, the exiting of further facilities or the disposition of certain
operations.
Critical Accounting Policies
The preparation of financial statements and related disclosures in conformity
with accounting principles generally accepted in the United States requires us
to make judgments, assumptions and estimates that effect the amounts reported in
the Condensed Financial Statements and accompanying notes. Estimates are used
for, but not limited to, the accounting for the allowance for doubtful accounts,
the impairment of intangible assets, contingencies and other special charges and
taxes. Actual results could differ materially from these estimates. The
following critical accounting policies are impacted significantly by judgments,
assumptions and estimates used in the preparation of the Condensed Financial
Statements.
The recognition of revenue is based on our assessment of the facts and
circumstances of the sales transaction. We will recognize revenue only when all
four of the following conditions have been met:
o Persuasive evidence of an arrangement exists;
o Delivery has occurred or services have been rendered;
o Our price to the customer is fixed or determinable; and
o Collectibility is reasonably assured
The allowance for doubtful accounts is based on our assessment of the
collectibility of specific customer accounts and the aging of the accounts
receivable. If there is a deterioration of a major customer's credit worthiness
or actual defaults are higher than our historical experience, our estimates of
the recoverability of amounts due to us could be adversely affected.
We have experienced very little market volatility in the market prices of our
available-for-sale securities. These securities are recorded on the balance
sheet at fair value and we would recognize an impairment charge if a decline in
fair value below the cost basis were judged to be other than temporary. We
consider various factors in determining whether we should recognize an
impairment charge including, but not limited to the financial condition and the
near-term prospects of the issuer and our intent and ability to hold the
security until maturity. The ultimate market value realized on these securities
is subject to market volatility until they are sold.
We will perform impairment tests on our intangible assets on an annual basis
and between annual tests in certain circumstances. We performed a test on our
intangible assets during the three-month period ended September 30, 2002 that
resulted in the recording of a fixed asset impairment charge of approximately
$914,000 (See Note 5 to the Consolidated Financial Statements). In response to
changes in industry and market conditions, we may strategically realign our
resources and consider restructuring, disposing of, or otherwise exiting
businesses, which could result in an impairment of intangible assets in the
future.
We are subject to the possibility of various loss contingencies arising in
the ordinary course of business. We consider the likelihood of the loss or
impairment of an asset or the incurrence of a liability as well as our ability
11
to reasonably estimate the amount of loss in determining loss contingencies. An
estimated loss contingency is accrued if it is probable that a liability has
been incurred or an asset has been impaired and the amount of the loss can be
reasonably estimated. We regularly evaluate current information available to us
to determine whether such accruals should be adjusted.
Results of Operations for the Three and Nine-Month Periods Ended September 30,
2002 Versus the Three and Nine-Month Periods Ended September 30, 2001.
Revenue
Our revenues are primarily derived from product and patent technology
licensing fees. Other sources of revenue include service fees from maintenance
contracts and training fees. Total revenue for the three-month period ended
September 30, 2002 decreased by $181,800, or 17.9%, to $836,500 from $1,018,300
for the same period in 2001. Total revenue for the nine-month period ended
September 30, 2002 decreased by $3,326,900, or 63.1%, to $1,947,600 from
$5,274,500 for the same period in 2001.
Revenue derived from our Windows-based products during the three-month period
ended September 30, 2002 decreased by $209,400, or 32.7%, to $430,200 from
$639,600 for the same period in the prior year. Revenue derived from our
Windows-based products during the nine-month period ended September 30, 2002
decreased by $947,100, or 49.7% to $958,100 from $1,905,200 for the same period
in the prior year. The decreases in our Windows-based product revenue for both
the three and nine-month periods ended September 30, 2002 were primarily due to
product licensing fees, which were recorded during the three and nine-month
periods ended September 30, 2001, that resulted from one-time transactions
entered into with a limited number of customers.
Revenue derived from our UNIX-based products during the three-month period
ended September 30, 2002 decreased by $77,800, or 20.5%, to $300,800 from
$378,600 for the same period in the prior year. Revenue derived from our
UNIX-based products during the nine-month period ended September 30, 2002
decreased by $359,600, or 30.8%, to $809,000 from $1,168,600 for the same period
in the prior year. The decreases in our UNIX-based product revenue for both the
three and nine-month periods ended September 30, 2002 was primarily attributable
to product licensing fees made during the three and nine-month periods ended
September 30, 2001, that resulted from one-time transactions entered into with a
limited number of customers.
Also during the nine-month period ended September 30, 2002, revenue derived
from licensing our patented technology decreased by $2,200,000, or 100%, to $0
from $2,200,000 for the same period in the prior year. We derived no revenue
from licensing our patented technology during either of the three-month periods
ended September 30, 2002 or 2001, respectively. We do not anticipate licensing
our patented technology during the remainder of 2002. The market for licensing
our patented technology is very limited; accordingly, we reduced the carrying
value of our patented technology to zero as part of our fixed asset impairment
charge recorded at year-end 2001.
Currently, a significant portion of our licensing fees is derived from a
limited number of customers, which vary, sometimes significantly, from quarter
to quarter. We expect this trend to continue throughout 2002.
12
Cost of Revenue
Cost of revenue consists primarily of the amortization of acquired technology
or capitalized technology developed in-house. Under accounting principles
generally accepted in the United States, research and development costs for new
product development, after technological feasibility is established, are
recorded as "capitalized software" on our balance sheet and are subsequently
amortized as cost of revenue over the shorter of three years or the remaining
estimated life of the products. Other items included in cost of revenue are
customer service costs and shipping and packaging materials.
Cost of revenue for the three-month period ended September 30, 2002 decreased
by $479,000, or 51.3%, to $454,700 from $933,700 for the same period in 2001.
Cost of revenue for the nine-month period ended September 30, 2002 decreased by
$312,400, or 18.6%, to $1,371,200 from $1,683,600 for the same period in 2001.
The decreases for the three-month and nine-month periods ended September 30,
2002 are the result of the fixed asset impairment charge we recorded at year-end
2001. The carrying value of various elements of our acquired technologies was
reduced to zero as part of the year-end 2001 fixed asset impairment charge.
Accordingly, no amortization expense related to these acquired technology assets
was recorded during the current year.
During the three-month period ended September 30, 2002, we have again
recorded an asset impairment charge in order to reduce the carrying value of our
long-lived intangible assets to estimated net realizable value. We expect cost
of revenue related to the amortization of these intangible assets to be
approximately 10% lower than that recorded during the three-month period ended
September 30, 2002, for the next several quarterly reporting periods.
Selling and Marketing Expenses
Selling and marketing expenses primarily consist of salaries, sales
commissions, travel expenses, trade show related activities, promotional, and
advertising costs and the allocation of corporate overhead charges. Also
included in selling and marketing expenses is amortization of non-cash
compensation resulting from the issuance of stock options and warrants to
various outside sales and marketing consultants. Selling and marketing expenses
for the three-month period ended September 30, 2002 decreased by $1,754,200, or
81.9%, to $387,500 from $2,141,700 for the same period in 2001. For the
nine-month period ended September 30, 2002, selling and marketing expenses
decreased by $3,397,300, or 66.5%, to $1,712,900 from $5,110,200 for the same
period in 2001.
The decreases for the three and nine-month periods ended September 30, 2002,
as compared to the same time periods in the prior year, were primarily due to
decreases in headcount, resulting from our September 2001 workforce reduction as
well as our March 31, 2002 restructuring. These reductions led to decreases in
human resources costs, including salaries, fringe benefits and commissions.
These reductions also led to decreases in costs that typically fluctuate in
direct relation to head count level, such as travel expenses and the allocation
of corporate overhead charges. For the three-month period ended September 30,
2002, human resources costs decreased by $1,112,100, or 79.7%, to $282,400 from
$1,394,500 for the same period in the prior year. For the nine-month period
ended September 30, 2002, human resources costs decreased by $2,040,700, or
63.6%, to $1,167,000 from $3,207,700 for the same period in the prior year. For
the three-month period ended September 30, 2002, travel expenses decreased by
13
$67,300, or 69.3%, to $29,800 from $97,100 for the same period in the prior
year. For the nine-month period ended September 30, 2002, travel expenses
decreased by $238,400, or 67.9%, to $112,700 from $351,100 for the same period
in the prior year. For the three-month period ended September 30, 2002,
corporate overhead charges allocated to the sales and marketing department
decreased by $160,500, or 96.1%, to $6,500 from $167,000 for the same period in
the prior period. For the nine-month period ended September 30, 2002, corporate
overhead charges allocated to the sales and marketing department decreased by
$297,000, or 69.4%, to $131,300 from $428,300 for the same period in the prior
year.
We determined during February 2002 that we would temporarily shift our sales
and marketing concentration for the balance of 2002 towards our UNIX products
and away from our Windows products. The purpose of this shift was two-fold.
First, this would free up our Windows-based engineers' time to allow them to
continue their efforts to refine our Windows-based product line, particularly
our Windows enterprise edition, GG:XP, so that those products could compete more
effectively in the market place. Second, since our sales and marketing resources
were very limited, allocating a higher percentage of those resources to the more
stable and competitive UNIX products would be a more efficient use of those
resources.
During the three-month period ended September 2002 we conducted and completed
the beta testing of our Windows enterprise edition, GG:XP. We released the final
version of GG:XP during the last week of September. We have decided to rename
this product as GO-Global for Windows and to rename the latest release of our
Unix-based product GO-Global for Unix. We expect that there will be
approximately a three to four month time lag before we begin to receive orders
from our current customers for GO-Global for Windows as they strategize and
coordinate the rollout of this new technology with their own product upgrade
release schedules.
We anticipate that selling and marketing expenses in future periods will be
lower than those incurred in the three-month period ended September 30, 2002 as
a result the restructuring we made during the period and as we continue to
aggressively reduce our operating costs going forward. Sales and marketing
expenses were approximately 46.3% and 210.3% of revenue for the three-month
periods ended September 30, 2002 and 2001, respectively. Sales and marketing
expenses were approximately 87.9% and 96.9% of revenue for the nine-month
periods ended September 30, 2002 and 2001, respectively.
General and Administrative Expenses
General and administrative expenses primarily consist of salaries and
associated benefits, legal and professional services, amortization of non-cash
compensation resulting from the issuance of stock options and warrants to
various financial consultants and bad debts expense and the allocation of
corporate overhead charges. General and administrative expenses for the
three-month period ended September 30, 2002 decreased by $426,700, or 33.7%, to
$837,800 from $1,264,500 for the same period in 2001. For the nine-month period
ended September 30, 2002, general and administrative expenses decreased by
$1,824,600, or 44.3%, to $2,295,300 from $4,119,900 for the same period in the
prior year.
The decreases for the three and nine-month periods ended September 30, 2002
as compared to the same periods in the prior year were primarily due to
decreases in headcount, resulting from our September 2001 workforce reduction as
14
well as our March 31, 2002 restructuring. These reductions led to decreases in
human resources costs, including salaries and fringe benefits. These reductions
also led to decreases in costs that typically fluctuate in direct relation to
head count level, such as travel expenses and the allocation of corporate
overhead charges. For the three-month period ended September 30, 2002, human
resource costs decreased by $275,900, or 60.1%, to $182,800 from $458,700 for
the same period in the prior year. For the nine-month period ended September 30,
2002, human resource costs decreased by $831,200, or 61.8%, to $513,000 from
$1,344,200 for the same period in the prior year. For the three-month period
ended September 30, 2002, travel expenses decreased by $70,400, or 64.0%, to
$39,600 from $110,000 for the same period in the prior year. For the nine-month
period ended September 30, 2002, travel expenses decreased by $34,400, or 16.9%,
to $169,700 from $204,100 for the same period in the prior year. For the
three-month period ended September 30, 2002, corporate overhead charges
allocated to the general and administrative department decreased by $73,800, or
82.1%, to $16,100 from $89,900 for the same period in the prior year. For the
nine-month period ended September 30, 2002, corporate overhead charges allocated
to the general and administrative department decreased by $134,800, or 58.5%, to
$95,800 from $230,600 for the same period in the prior year.
Also contributing to the decreases in general and administrative expenses for
the three and nine-month periods ended September 30, 2002, as compared with the
same periods in the prior year were decreases in deferred compensation
amortization expense. For the three-month period ended September 30, 2002,
deferred compensation amortization expense decreased by $173,300, or 83.8%, to
$33,400 from $206,700 for the same period in the prior year. For the nine-month
period ended September 30, 2002, deferred compensation amortization expense
decreased by $701,000, or 80.0%, to $174,800 from $875,800 for the same period
in the prior year. The decrease was due to the expiration of certain third party
consulting contracts, over whose lifetime deferred compensation expense was
being amortized. Under the terms of these contracts, the consultants had been
issued stock options, in lieu of cash, for the performance of their respective
services to us. Using the Black-Scholes pricing model, a cost was calculated and
assigned to each of these contracts, and capitalized as a component of equity on
our balance sheet in accordance with accounting principles generally accepted in
the United States. The total costs of such contracts were amortized over the
respective contract's service period.
We anticipate that general and administrative expense in future periods will
be lower than those incurred during the three-month period ended September 30,
2002 as we continue to aggressively reduce our operating costs. General and
administrative expenses were approximately 100.1% and 117.9% of revenues for the
three and nine-month periods ended September 30, 2002 as compared with 124.2%
and 78.1% for the same periods in the prior year, respectively.
Research and Development Expenses
Research and development expenses consist primarily of salaries and benefits
to software engineers, payments to contract programmers, allocation of corporate
overhead charges, depreciation and computer related supplies. Research and
development expenses for the three-month period ended September 30, 2002
decreased by $307,300, or 28.2%, to $782,700 from $1,090,000 for the same period
in the prior year. For the nine-month period ended September 30, 2002, research
15
and development expense decreased by $1,057,200, or 29.7%, to $2,502,100 from
$3,559,300 for the same period in the prior year.
The decreases in research and development expenses for the three and
nine-month periods ended September 30, 2002, as compared with the same periods
in the prior year, were primarily due to a decrease in headcount, resulting from
our September 2001 workforce reduction and our March 31, 2002 restructuring.
These reductions led to decreased human resources expenses. Also causing a
decrease to research and development expenses was decreased engineering
consulting fees. For the three-month period ended September 30, 2002, human
resources expenses decreased by $227,700, or 31.6%, to $493,600 from $721,300
for the same period in the prior year. For the nine-month period ended September
30, 2002, human resources expenses decreased by $605,000, or 27.3%, to
$1,611,100 from $2,216,100 for the same period in the prior year. For the
three-month period ended September 30, 2002, engineering consulting fees
decreased by $58,500, or 40.2% to $87,100 from $145,600 for the same period in
the prior year. For the nine-month period ended September 30, 2002, engineering
consulting fees decreased by $456,700, or 68.9%, to $206,500 from $663,200 for
the same period in the prior year.
As we continued working towards our goal of full maturity for our products
during 2002, we closely monitored our research and development expenditures,
striving to reduce our expenses to levels sustainable by our current and
anticipated revenue levels. During the three-month period ended September 30,
2002, we completed the beta testing of our GO-Global for Windows product and
released it for sale to customers. We must continue to aggressively reduce our
operating costs in order to maintain our operations on a going concern basis. We
may consider further reducing our research and development efforts in order to
achieve this strategic goal.
Under accounting principles generally accepted in the United States, all
costs of product development incurred once technological feasibility has been
established, but prior to general release of the product, are to be capitalized
and amortized to expense over the estimated life of the underlying product,
rather than being charged to expense in the period incurred. No product
development amounts were capitalized during the three or nine-month periods
ended September 30, 2002. Approximately $192,300 and $324,800 of product
development costs were capitalized during the three and nine-month periods ended
September 30, 2001, respectively.
We anticipate that research and development expense in future periods will be
lower than those incurred during the three-month period ended September 30, 2002
as we continue to aggressively reduce our operating costs. Research and
development expenses were approximately 93.6% and 107.0% of revenues for the
three-month periods ended September 30, 2002 and 2001, respectively, and
approximately 128.5% and 67.5% of revenues for the nine-month periods ended
September 30, 2002 and 2001, respectively.
Asset Impairment Loss. During the three-month period ended September 30, 2002 we
recorded an impairment charge of $914,000 against several of our intangible
assets, primarily capitalized technology assets. SFAS No. 121 - Accounting for
the Impairment of Long-Lived Assets requires that long-lived assets must be
reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable. SFAS No. 121 sets
forth examples of events or changes in circumstances that indicate that the
recoverability of the carrying amount of an asset should be addressed, including
the following:
o A significant decrease in the market value of an asset;
16
o A significant change in the extent or manner in which an asset
is used;
o A significant adverse change in the business climate that could
affect the value of an asset; and
o Current and historical operating or cash flow losses.
We believed that a review of our current carrying values to evaluate whether
the value of any of our long-lived technology assets had been impaired was
warranted, due to several factors, including:
o The challenges we faced in bringing our Windows enterprise product
to maturity;
o The continued pervasive weakness in the world-wide economy;
o How we were incorporating and planning to incorporate each element
of the purchased technologies into our technology; and
o Our continued and historical operating and cash flow losses.
Based on a study of the various factors affecting asset impairment, as
outlined above and in SFAS No. 121, the following asset impairment charges were
determined to be necessary in order to reduce the carrying value of these assets
to our current estimate of the present value of the expected future cash flows
to be derived from these assets:
Net Book Value Impairment Net Book Value
Before Impairment Write Down After Impairment
Purchased Technology $ 2,145,200 $ 775,100 $ 1,370,100
Capitalized Software 277,800 138,900 138,900
--------------- ---------- ------------
Totals $ 2,423,000 $ 914,000 $ 1,509,000
=============== ========== ============
Restructuring Charge
During the three-month period ended September 30, 2002, effective August 31
31, 2002, we closed our Bellevue, Washington engineering facility as part of our
continuing strategic initiative to reduce operating costs. In conjunction with
the closure, we reduced our engineering headcount in the Bellevue and Concord,
New Hampshire locations and further reduced our headcount in the administrative
and sales and marketing departments. Additionally, we wrote off the costs of
leasehold improvements that had been made to the Bellevue facility and the costs
of various assets that were abandoned with the office closure.
A summary of the restructuring charges that were recognized during the
three-month period ended September 30, 2002 is as follows:
Category Charge
Minimum lease payments $ 263,600
Employee severance 132,900
Fixed assets abandonment 99,700
Other 10,300
Reduction of March 31, 2002
restructuring charge (54,100)
---------
$ 452,400
=========
17
The minimum lease payments are an estimate of the cash we may need to
disburse in order to fulfill our obligations under the current Bellevue office
lease. The estimated payments are equal to one year's worth of aggregated
monthly lease payments plus 25% of the aggregated monthly lease payments through
the expiration of the lease in April 2006. Given current market conditions in
the corporate real estate rental market in the Bellevue, Washington area, we
anticipate that our search for a suitable sub lessee should take approximately
one year and that the sub lessee's rent would be lower than ours, under the
current terms of the rental agreement. We estimate that we might have to agree
to carry up to 25% of the current minimum rental payments in order to attract a
suitable sub lessee within the one-year time frame.
The costs associated with fixed assets disposals are comprised of the
estimated net book value of the assets, including furniture and fixtures,
equipment and leasehold improvements, which were written off upon the closure of
the Bellevue office, as these assets will have no future utility. We do not
anticipate any material cash disposal costs to be incurred to dispose of the
fixed assets.
During the three-month period ended September 30, 2002 we revised costs
associated with the restructuring charge we had recorded during the three-month
period ended March 31, 2002. Based on final settlement of employee severance
payments, we reduced our previously estimated restructuring severance costs by
approximately $54,100.
No such restructuring charges were recorded during the three or nine-month
periods ended September 30, 2001.
We have aggressively sought ways to reduce our operating costs throughout
2002 as our operating and cash flow losses have continued. We will continue to
aggressively seek out all opportunities to further reduce our operating costs if
effort to survive as a going concern.
Other Income (Expense)
Other income (expense) consists primarily of interest income on excess cash,
interest income on available-for-sale securities, interest expense on short-term
notes payable and interest accrued on the purchase of available-for-sale
securities. Our excess cash is held in relatively low-risk, highly liquid
investments, such as U.S. Government obligations, bank and/or corporate
obligations rated "A" or higher by independent rating agencies, such as Standard
and Poors, or interest bearing money market accounts with minimum net assets
greater than or equal to one billion U.S. dollars.
Other income (expense) for the three-month period ended September 30, 2002
decreased by $56,000, or 83.0%, to $11,500 from $67,500 for the same period in
the prior year. Other income (expense) for the nine-month period ended September
30, 2002 decreased by $285,200, or 80.0%, to $71,200 from $356,400 for the same
period in the prior year. The decreases for the three and nine-month periods
ended September 30, 2002 were primarily due to lower amounts of excess cash and
available-for-sale securities on-hand as compared with the respective periods in
2001. Also responsible for the decrease for the three and nine-month periods
ended September 30, 2002 was the decrease in interest rates being paid by our
investments as compared with the interest rates from the respective periods in
the prior year.
18
Offsetting the decrease in other income (expense) for both the three and
nine-month periods ended September 30, 2002 was the reduction in loss on joint
venture, from $400 and $41,100 for the three and nine-month periods in the prior
year, respectively, to $0 for each respective period ended September 30, 2002.
We liquidated our joint venture during August 2001.
We expect other income (expense) to be lower throughout the remainder of 2002
as we expect our cash balances to be significantly lower as compared with the
respective periods of the prior year, and we expect the Federal Reserve Bank to
keep interest rates low for the next several months.
Net Loss
As a result of the foregoing items, net loss for the three-month period ended
September 30, 2002 was $2,981,100, a decrease of $1,363,000 or 31.4%, from a net
loss of $4,344,100 for the same period during 2001. Additionally, net loss for
the nine-month period ended September 30, 2002 was $8,719,500, an increase of
$122,600, or 1.4%, from a net loss of $8,842,100 for the same period during
2001. As a result of our continued operating loss we intend to continue to
aggressively reduce our operating costs during 2002 and to pursue financing
opportunities through all available means.
Liquidity and Capital Resources
As of September 30, 2002, cash and cash equivalents and available-for-sale
securities totaled $1,659,100, a decrease of $5,301,500, or 76.2%, from
$6,960,600 as of December 31, 2001.
The decrease in cash and cash equivalents was primarily attributable to net
cash used in operating activities, which was substantially comprised of our net
loss of $8,719,500. Operating activities that increased cash flow included: a
decrease in accounts receivable, $588,400; a decrease in prepaid expenses and
other current assets totaling $79,300, and an increase in accrued expenses,
$86,600. Offsetting these amounts were decreases in the provision for doubtful
accounts, $293,400; accounts payable $77,600; and deferred revenue $181,700.
Our financial statements have been presented on a going concern basis, which
contemplates the realization of assets and the settlement of liabilities in the
normal course of business. We have suffered from recurring losses and have
absorbed significant cash in our operating activities. Further, our revenues
have declined significantly during the nine-month period ended September 30,
2002 compared to the same period of 2001. These matters raise substantial doubt
about our ability to continue in existence as a going concern. Although there
can be no assurances, we believe that revenue for the second half of 2002 will
be greater than revenue for the first half of 2002.
The consolidated financial statements do not include any adjustments relating
to the recoverability and classification of assets or the amount and
classification of liabilities that might result should we be unable to continue
as a going concern. In order to realize assets and settle liabilities within the
normal course of business, we must continue to aggressively adjust our current
level of operations in order to match our currently available resources. Such
adjustments will likely include further work force reductions, exiting of
facilities or the disposition of certain operations.
We have announced that we have signed an agreement to acquire three privately
held affiliated entities in the telecommunications industry in a stock
19
transaction. We believe that should the acquisition be successful, the newly
acquired entities would have available financial resources to provide for our
operations. Currently, several of the conditions necessary for the acquisition
to take place have not yet occurred. If these conditions are not satisfied by
December 31, 2002, the acquisition agreement will expire unless it is extended
by the parties.
We are exploring all options available to aggressively reduce costs, to
increase revenues and to find alternative sources of financing our operations.
Such options will likely include further work force reductions, exiting of
facilities, or the disposition of certain operations. If we were unsuccessful in
obtaining any of these strategic goals, we would face a severe constraint on our
ability to sustain operations in a manner that would create future growth and
viability, and we may need to cease operations entirely.
We have used approximately $5,198,900 net cash in operating activities for
the nine-month period ended September 30, 2002, including cash payments
aggregating approximately $973,600 that were related to the restructuring
charges that we recorded during the period. Our recurring operations' net cash
requirements for the nine-month period ended September 30, 2002 averaged
approximately $469,500 per month.
The net cash provided by investing activities of $2,673,000 increased cash
and cash equivalents. Significant investing activities included: purchases of
available-for-sale securities, $768,300, which were offset by sales of
available-for-sale securities, $3,525,200; and the purchase of capital assets
including equipment, totaling $82,900. We purchase available-for-sale
securities, typically very highly rated corporate bonds or similar investments,
primarily when we have cash in excess of our short-term needs for operating
expenditures. Sales of available-for-sale securities represent the maturing of
investments previously made. Upon maturity, funds from the maturing investments
are deposited in our investment money market account awaiting our instructions
to reinvest or transfer to our operating accounts. As our available cash has
declined, we have curtailed future reinvestments and are now holding the
proceeds of maturing investments in our money market account for maximum
liquidity. Our purchasing of capital assets has been curtailed to a minimum
amount in order to preserve our cash balances as long as possible.
Gross accounts receivable as of September 30, 2002 decreased by $588,400, or
60.6%, to $382,000, from $970,400 as of December 31, 2001. The primary reason
for the decrease was the collection of a few large older receivables that had
been outstanding as of December 31, 2001 as well as the charge off of amounts
that have been deemed uncollectible. Because these older receivables had been
outstanding as of December 31, 2001 and were collected during the nine-month
period ended September 30, 2002, we were able to reduce our provision for
doubtful accounts while maintaining adequate reserves against our current
receivables.
As of September 30, 2002, gross purchased technology decreased by $775,100,
or 8.9%, to $7,915,700 from $8,690,800 as of December 31, 2001. This decrease
was part of the asset impairment charge recorded during the three-month period
ended September 30, 2002. Purchased technology is comprised of various acquired
technologies that have been incorporated into one or more of our products. These
amounts are amortized to cost of revenue, generally over a three-year period.
Purchased technology amortization expense for the nine-month period ended
September 30, 2002 decreased by $462,300, or 31.9%, to $987,100 from $1,449,400
20
for the same period in the prior year. The decrease was due primarily to the
asset impairment charge we recorded as of December 31, 2001 against various
components of our purchased technology. Amortization of our purchased technology
is recorded as a component of cost of revenue on our income statement.
Accounts payable as of September 30, 2002 decreased by $77,600, or 24.3%, to
$242,300 from $319,900 as of December 31, 2001. Accounts payable are comprised
of our various operating expenses and increased due to the timing of the payment
of various invoices.
Accrued expenses as of September 30, 2002 increased by $86,600, or 11.8%, to
$822,100 from $735,500 as of December 31, 2001. Accrued expenses are charges for
services rendered for which an invoice has not yet been received such as
consulting fees, legal and accounting fees, and utilities. The increase in
accrued expenses is primarily due to the restructuring charges we have recorded
during the nine-month period ended September. As of September 30, 2002, accrued
expenses includes approximately $399,700 primarily representing the aggregate
amount of remaining rent we believe that we may ultimately have to pay for the
two offices we closed during 2002.
Deferred revenue as of September 30, 2002 decreased by $181,700, or 31.4%, to
$396,100 from $577,800 as of December 31, 2001. The decrease is due to the terms
of the various licensing agreements and maintenance contracts we had entered
into during the nine-month period ended September 31, 2002, which were offset by
previously deferred items being recognized as revenue, or being written off as
uncollectible. Increases in deferred revenue reflect the application of
generally accepted accounting principles in the United States, which set forth
certain criteria for the current recognition of revenue in the financial
statements. Revenues which do not currently meet the criteria are charged to
deferred revenue and are recognized either ratably over the time period during
which purchased services are provided to the customer, such as maintenance
contracts, or at such time that all revenue recognition criteria have been met.
As of September 30, 2002, we had cash and cash equivalents of $1,406,800 as
well as $252,300 in available-for-sale securities compared to total liabilities
of $664,700. Total liabilities are exclusive of deferred revenue of $396,100 and
the accrued estimated minimum lease payments that we might have to make of
$399,700, resulting from the restructurings we recorded during 2002.
Throughout the nine-month period ended September 30, 2002, we have undertaken
several strategic initiatives intended to control operating expenses and capital
expenditures. We have redirected our sales and marketing focus to our UNIX-based
products in attempt to increase revenues while we continued to focus our
engineering efforts on our windows enterprise edition product. These initiatives
have been successful in reducing our operating expenses. As explained above, our
expenses for the three and nine-month periods ended September 30, 2002 are
significantly lower in virtually every expense category as compared with the
same periods in the prior year.
New Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board finalized SFAS No.
141, "Business Combinations", and SFAS No. 142, "Goodwill and Other Intangible
Assets". SFAS No. 141 requires the use of the purchase method of accounting and
prohibits the use of the pooling-of-interests method of accounting for business
combinations initiated after June 30, 2001. SFAS No. 141 also requires that we
recognize acquired intangible assets apart from goodwill if the acquired
21
intangible assets meet certain criteria. SFAS No. 141 applies to all business
combinations initiated after June 30, 2001 and for purchase business
combinations completed on or after July 1, 2001. It also requires, upon
adoption of SFAS No. 142 that we reclassify the carrying amounts of intangible
assets and goodwill based on the criteria in SFAS No. 141.
SFAS No. 142 requires, among other things, that we no longer amortize
goodwill, but instead test goodwill for impairment at least annually. In
addition, SFAS No. 142 requires that we identify reporting units for the
purposes of assessing potential future impairments of goodwill, reassess the
useful lives of other existing recognized intangible assets, and cease
amortization of intangible assets with an indefinite useful life. An intangible
asset with an indefinite useful life should be tested for impairment in
accordance with the guidance in SFAS No. 142. SFAS No. 142 is required to be
applied in fiscal years beginning after December 15, 2001 to all goodwill and
other intangible assets recognized at that date, regardless of when those assets
were initially recognized. SFAS No. 142 requires us to complete a transitional
goodwill impairment test six months from the date of adoption. We also are
required to reassess the useful lives of other intangible assets within the
first interim quarter after adoption of SFAS No. 142.
Pursuant to SFAS No. 142, we have completed a test for asset impairment
during third quarter 2002 and have recorded an asset impairment charge
accordingly (See Note 5 to the Consolidated Financial Statements). As of
September 30, 2002 we do not have any intangible assets with indefinite useful
lives, nor do we have any goodwill on our balance sheet. Our intangible assets
are comprised of acquired technology and technology developed in-house, both of
which have been incorporated into one or more of our products. As such, all of
our intangible assets are being amortized to cost of revenue over the estimated
useful lives of the underlying products, or three years, whichever is shorter.
SFAS No. 143, "Accounting for Asset Retirement Obligations", addresses
financial accounting and reporting for obligations associated with the
retirement of tangible long-lived assets and the associated asset retirement
costs. SFAS No. 143 is effective for financial statements issued for fiscal
years beginning after June 15, 2002. It is anticipated that the financial impact
of SFAS No. 143 will not have a material effect on us.
SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets", addresses financial accounting and reporting for the impairment or
disposal of long-lived assets. SFAS No. 144 supersedes SFAS No. 121, "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
Of," and the accounting and reporting provisions of APB Opinion No. 30,
"Reporting the Results of Operations--Reporting the Effects of Disposal of a
Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions," for the disposal of a business segment. SFAS No. 144
also eliminates the exception to consolidation for a subsidiary for which
control is likely to be temporary. The provisions of SFAS No. 144 are effective
for financial statements issued for fiscal years beginning after December 15,
2001, and interim periods within those fiscal years. The provisions of SFAS No.
144 generally are to be applied prospectively. It is anticipated that the
financial impact of SFAS No. 144 will not have a material effect on us.
SFAS No. 145, "Rescission of SFAS Statements No. 4, 44, and 64, Amendment
of SFAS Statement No. 13, and Technical Corrections", updates, clarifies and
simplifies existing accounting pronouncements. SFAS No. 145 rescinds SFAS No. 4,
"Reporting Gains and Losses from Extinguishment of Debt." SFAS No. 145 amends
22
SFAS No. 13, "Accounting for Leases," to eliminate an inconsistency between the
required accounting for sale-leaseback transactions and the required accounting
for certain lease modifications that have economic effects that are similar to
sale-leaseback transactions. The provisions of SFAS No. 145 related to SFAS No.
4 and SFAS No. 13 are effective for fiscal years beginning and transactions
occurring after May 15, 2002, respectively. It is anticipated that the financial
impact of SFAS No. 145 will not have a material effect on us.
In November 2001, the staff of the FASB reached consensus on Topic No. D-103,
on the topic of "Income Statement Characterization of Reimbursements Received
for Out of Pocket Expenses Incurred." This topic addresses whether
reimbursements received for out of pocket expenses incurred should be
characterized in the income statement as revenue or as a reduction of expenses
incurred. The FASB staff concluded that reimbursements received for out of
pocket expenses incurred should be characterized as revenue in the income
statement. This announcement will be applied in financial reporting periods
beginning after December 15, 2001, and comparative financial statements for
prior periods will be reclassified to comply with the guidance in this
announcement. It is anticipated that the financial impact of Topic No. D-103
will not have a material effect on us.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit Activities", which addresses financial accounting and reporting for
costs associated with exit activities and supersedes EITF 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)." SFAS No. 146
requires that a liability for a cost associated with an exit or disposal
activity be recognized and measured initially at fair value only when the
liability is incurred. This differs from EITF 94-3, which required that a
liability for an exit cost be recognized at the date of an entity's commitment
to an exit plan. However, under SFAS No. 146, a liability for one-time
termination benefits is recognized when an entity has committed to a plan of
termination, provided certain other requirements have been met. In addition,
under SFAS No. 146, a liability for costs to terminate a contract is not
recognized until the contract has been terminated, and a liability for costs
that will continue to be incurred under a contract's remaining term without
economic benefit to the entity is recognized when the entity ceases to use the
right conveyed by the contract. SFAS No. 146 is effective for exit or disposal
activities initiated after December 31, 2002. We will adopt the provisions of
SFAS No. 146 for restructuring activities initiated after December 31, 2002. It
is expected that the adoption of SFAS No. 146 will not have a material impact on
our consolidated results of operations or financial position.
23
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
We are currently not exposed to any significant financial market risks from
changes in foreign currency exchange rates or changes in interest rates and do
not use derivative financial instruments. A substantial majority of our revenue
and capital spending is transacted in U.S. dollars. However, in the future, we
may enter into transactions in other currencies. An adverse change in exchange
rates would result in a decline in income before taxes, assuming that each
exchange rate would change in the same direction relative to the U.S. dollar. In
addition to the direct effects of changes in exchange rates, such changes
typically affect the volume of sales or foreign currency sales price as
competitors' products become more or less attractive.
ITEM 4. Controls and Procedures
Within the 90 days prior to the date of this report, under the supervision
and with the participation of management, including our Chief Executive Officer
and our Chief Financial Officer, we have evaluated the effectiveness of the
design and operation of our disclosure controls and procedures pursuant to
Exchange Act Rule 13a-14. Based upon that evaluation, our Chief Executive
Officer and our Chief Financial Officer have concluded that our disclosure
controls and procedures are effective in timely alerting them about material
information relating to us (including our consolidated subsidiaries) required to
be included in our periodic SEC filings. There have been no significant changes
in our internal controls or in other factors that could significantly affect
internal controls subsequent to the date of their evaluation.
24
PART II--OTHER INFORMATION
ITEM 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
None
(b) Reports of Form 8-K
On August 14, 2002 we filed a report on Form 8-K dated August 14, 2002 with
the Commission. We filed, under Item 9 (Regulation FD Disclosure) of the Form
8-K, the Certification of Quarterly Report by Chief Executive Officer and the
Certification of Quarterly Report by Chief Financial Officer.
On August 21, 2002 we filed a report on Form 8-K dated August 21, 2002 with
the Commission. We filed, under Item 5 (Other Events) of the Form 8-K, that we
had announced that we had entered into an agreement to acquire three
privately-held, affiliated entities in the telecommunications industry.
On September 4, 2002 we filed a report on Form 8-K dated August 21, 2002 with
the Commission. We filed, under Item 5 (Other Events) of the Form 8-K, a copy of
the Agreement and Plan of Merger and Reorganization related to the acquisition
of the three privately-held entities in the telecommunications industry that we
had previously announced.
25
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the Registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.
GraphOn Corporation
(Registrant)
Date: November 19, 2002
By: /s/ Robert Dilworth
---------------------------------
Robert Dilworth,
Chief Executive Officer (Interim) and
Chairman of the Board
(Principal Executive Officer)
Date: November 19, 2002
By: /s/ William Swain
---------------------------------
William Swain,
Chief Financial Officer
(Principal Financial Officer and
Principal Accounting Officer)
Certifications
I, Robert Dilworth, certify that:
1. I have reviewed this quarterly report on Form 10-Q of GraphOn Corporation
("registrant");
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
26
c) presented in this quarterly report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of
the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 19, 2002
/s/ Robert Dilworth
--------------------
Robert Dilworth
Chief Executive Officer (Interim) and
Chairman of the Board
I, William Swain, certify that:
1. I have reviewed this quarterly report on Form 10-Q of GraphOn Corporation
("registrant");
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
27
c) presented in this quarterly report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of
the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 19, 2002
/s/ William Swain
-----------------
William Swain
Chief Financial Officer