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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 June 30, 2003
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
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Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Exchange Act Rule 12b-2). Yes [ ] No [X]
As of August 7, 2003 there were issued and outstanding 16,618,459 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
Condensed Consolidated Balance Sheets 2
Condensed Consolidated Statements of Operations
and Comprehensive Loss 3
Condensed Consolidated Statements of Cash Flows 4
Notes to Condensed Consolidated Financial
Statements 5
Item 2.Management's Discussion and Analysis of Financial
Condition and Results of Operations 8
Item 3.Quantitative and Qualitative Disclosures About
Market Risk 19
Item 4.Controls and Procedures 19
PART II.
Item 6.Exhibits and Reports on Form 8-K 20
Signatures 21
PART I--FINANCIAL INFORMATION
ITEM I Financial Statements
GRAPHON CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
June 30, December 31,
2003 2002
ASSETS ------------- -----------
------------ (Unaudited)
Current Assets:
Cash and cash equivalents $1,155,900 $1,958,200
Accounts receivable, net of allowance for
doubtful accounts of $55,500 and $50,300 562,700 337,900
Prepaid expenses and other current assets 16,600 192,000
---------- ----------
Total Current Assets 1,735,200 2,488,100
---------- ----------
Property and equipment, net 286,000 421,900
Purchased technology, net 749,100 1,163,100
Capitalized software, net 603,900 406,500
Other assets 29,600 70,000
---------- ----------
TOTAL ASSETS $3,403,800 $4,549,600
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current Liabilities:
Accounts payable $ 162,700 $ 228,700
Accrued expenses 467,300 795,100
Deferred revenue 841,500 796,100
---------- ----------
Total Current Liabilities 1,471,500 1,819,900
---------- ----------
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, 16,16,602,719 and 16,580,719
shares issued and outstanding 1,700 1,700
Additional paid in capital 45,984,500 45,982,500
Notes receivable (51,300) (50,300)
Accumulated other comprehensive loss (3,000) (2,400)
Accumulated deficit (43,999,600) (43,201,800)
------------ ------------
Total Stockholders' Equity 1,932,300 2,729,700
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 3,403,800 $ 4,549,600
============ ============
See accompanying notes to condensed consolidated financial statements.
2
GRAPHON CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
Three Months Ended Six Months Ended
June 30, June 30,
------------------------ ------------------------
2003 2002 2003 2002
----------- ----------- ----------- -----------
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
Revenue $ 1,175,300 $ 525,400 $ 2,219,100 $ 1,111,100
Cost of revenue 343,000 461,900 667,500 916,500
----------- ----------- ----------- -----------
Gross Profit 832,300 63,500 1,551,600 194,600
----------- ----------- ----------- -----------
Operating Expenses:
Selling and marketing 448,300 516,700 869,200 1,325,500
General and administrative 481,700 835,800 838,000 1,479,400
Research and development 318,800 884,600 646,800 1,697,400
Restructuring charge - - - 1,490,400
----------- ----------- ----------- -----------
Total Operating Expenses 1,248,800 2,237,100 2,354,000 5,992,700
----------- ----------- ----------- -----------
Loss From Operations (416,500) (2,173,600) (802,400) (5,798,100)
----------- ----------- ----------- -----------
Other Income (Expense):
Interest and other income 3,100 53,100 8,900 115,800
Interest and other expense (4,300) (27,500) (4,300) (56,100)
----------- ----------- ----------- -----------
Total Other Income (Expense) (1,200) 25,600 4,600 59,700
----------- ----------- ----------- -----------
Net Loss $ (417,700) $(2,148,000) $ (797,800) $(5,738,400)
=========== =========== =========== ===========
Other Comprehensive Loss, net of tax
Unrealized holding gain (loss) on investment - (2,500) - 4,900
Foreign currency translation loss - (1,100) - (600)
----------- ----------- ----------- -----------
Comprehensive Loss $ (417,700) $(2,151,600) $ (797,800) $(5,734,100)
=========== =========== =========== ===========
Basic and Diluted Loss per Common Share $ (0.03) $ (0.12) (0.05) (0.33)
=========== =========== =========== ===========
Weighted Average Common Shares Outstanding 16,602,719 17,353,663 16,598,708 17,428,431
=========== =========== =========== ===========
See accompanying notes to condensed consolidated financial statements.
3
GRAPHON CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months Ended
June 30,
2003 2002
----------- -----------
(Unaudited) (Unaudited)
Cash Flows From Operating Activities:
Net loss $ (797,800) $(5,738,400)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 632,000 1,076,000
Restructuring charge - 559,800
Amortization of deferred compensation - 141,400
Loss on disposal of fixed assets 4,300 -
Provision for doubtful accounts 5,200 (200,000)
Changes in operating assets and liabilities:
Accounts receivable (230,000) 433,500
Prepaid expenses and other assets 175,400 147,100
Accounts payable (66,000) 137,500
Accrued expenses (327,800) (6,200)
Deferred revenue 45,400 (74,500)
----------- -----------
Net Cash Used In Operating Activities (559,300) (3,523,800)
----------- -----------
Cash Flows From Investing Activities:
Purchase of available-for-sale securities - (768,300)
Proceeds from sale of available-for-sale securities - 1,256,000
Capitalization of software development costs (282,200) -
Capital expenditures (1,600) (82,900)
Other assets 40,000 -
Note receivable (1,000) -
----------- -----------
Net Cash Provided By (Used In) Investing Activities (244,400) 404,800
----------- -----------
Cash Flows From Financing Activities:
Repayment of note payable - (26,600)
Net proceeds from issuance of common stock 2,000 5,400
----------- -----------
Net Cash Provided (Used In) By Financing Activities 2,000 (21,200)
----------- -----------
Effect of exchange rate fluctuations on cash and
cash equivalents (600) (600)
----------- -----------
Net Decrease in Cash and Cash Equivalents (802,300) (3,140,800)
Cash and Cash Equivalents, beginning of period 1,958,200 3,952,600
----------- -----------
Cash and Cash Equivalents, end of period $ 1,155,900 $ 811,800
=========== ===========
Supplemental Disclosure of Cash Flow Information:
Cash paid for interest expense $ - $ 200
Noncash Investing and Financing Activities:
Notes receivable issued for purchase of common stock $ - $ 50,000
See accompanying notes to condensed consolidated financial statements.
4
GRAPHON CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation
The unaudited condensed 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 consolidated financial statements included herein
reflect all adjustments (which include only normal, recurring adjustments in the
quarterly period ended June 30, 2003) 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, 2002, which was filed with the Securities and
Exchange Commission (the Commission) on March 31, 2003. 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, 2003, or any
future period.
The Company's condensed consolidated 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 cash balances, including both cash
and cash equivalents and available-for-sale securities, have declined
significantly as of June 30, 2003 compared to December 31, 2002. These matters
raise substantial doubt about the ability of the Company to continue in
existence as a going concern. The condensed 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.
Revenues as reported for the current period are significantly higher than the
same period in the prior year and management believes that revenue for the
second half of 2003 will be greater than revenue for the first half of 2003.
Although there can be no assurances that these revenues will materialize,
management has been encouraged by the performance of GO-Global for Windows since
its December 2002 commercial rollout as well as the growth in revenue being
generated by the Unix product line.
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. The Company has been successful in significantly reducing operating
costs through a series of strategic restructurings and work force reductions
that began in September of 2001, and will potentially further reduce operating
costs as needed in order to match operating costs with available resources as
2003 progresses.
The Company is exploring all options available to aggressively reduce costs,
to increase revenues and to find alternative sources of financing its
5
operations. Such options will likely include the exiting of facilities and could
possibly include further work force reductions or the disposition of certain
operations if management were unable to match its operations to currently
available resources. 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.
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 three-month period ended March 31, 2003, the Company issued 22,000
shares of common stock to employees pursuant to the purchase by those employees
of common stock under the Employee Stock Purchase Plan, resulting in cash
proceeds of $2,000. This amount is included in the Consolidated Statements of
Cash Flows as a component of net proceeds from issuance of common stock. The
Company did not enter into any transactions that affected Stockholder's Equity
during the three-month period ended June 30, 2003.
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. Stock-Based Incentive Programs
The following table summarizes relevant information as the Company's reported
results of operations under the intrinsic value method of accounting for stock
awards, with supplemental information, as if the fair value recognition
provisions of Statement of Financial Accounting Standards Number 123, "Stock
Based Compensation," as amended by Statement of Financial Accounting Standards
Number 148, "Accounting for Stock Based Compensation - Transition and
Disclosure," (collectively SFAS 123) had been applied to each of the three-month
and six-month periods ended June 30, 2003 and 2002, respectively.
Three months ended June 30,
--------------------------------
2003 2002
--------------- --------------
Net loss:
As reported: $ (417,700) $ (2,148,000)
Add: stock-based compensation expense
included in net loss, net of related
tax effects - 47,200
Deduct: total stock-based compensation
expense determined under fair-value
method for all awards, net of related
tax effects (56,800) (411,600)
-------------- --------------
Pro forma net loss $ (474,500) $ (2,512,400)
============== ==============
6
Basic and diluted loss per share:
As reported $ (0.03) $ (0.12)
Pro forma $ (0.03) $ (0.17)
Six months ended June 30,
--------------------------------
2003 2002
--------------- --------------
Net loss:
As reported: $ (797,800) $ (5,738,400)
Add: stock-based compensation expense
included in net loss, net of related
tax effects - 141,400
Deduct: total stock-based compensation
expense determined under fair-value
method for all awards, net of related
tax effects (190,200) (852,200)
-------------- --------------
Pro forma net loss $ (988,000) $ (6,449,200)
============== ==============
Basic and diluted loss per share:
As reported $ (0.05) $ (0.33)
Pro forma $ (0.06) $ (0.37)
6. Subsequent Event - Restructuring Charge
During August 2003, the Company negotiated a buy out of the lease for its
corporate offices in Morgan Hill, California. The total buy out price is
approximately $141,000 and will consist of approximately $125,000 cash and the
forfeiture of an approximate $16,000 security deposit. The buy out will save the
company approximately $270,000 over what would have been the remainder of the
lease term.
The Company has approximately $88,200 of the restructuring accrual that
was recorded when the Morgan Hill facilities were initially vacated during the
first quarter of 2002 remaining. Consequently, it is anticipated that a
restructuring charge of $52,800 will be recognized during the third quarter of
2003, calculated as follows:
Buy out price $ 141,000
Less: Amount charged to restructuring
accrual (88,200)
----------
Estimated restructuring charge $ 52,800
==========
The Company has already secured another location for its corporate
operations in Morgan Hill, California. The Company will vacate its current
premises and begin occupying the new location on or about September 1, 2003. The
new lease is month-to-month at an initial rate of approximately $1,000 per
month.
7
ITEM 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
Forward-Looking Statements
The following discussion of our financial condition and results of operations
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
our Annual Report on Form 10-K for the year ended December 31, 2002 and in other
documents we filed 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.
We are headquartered in Morgan Hill, California, with offices in Concord, New
Hampshire and Reading, United Kingdom.
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
consider several aggressive strategic initiatives including the exiting of
facilities, possible further work force reductions 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
8
to make judgments, assumptions and estimates that affect the amounts reported in
the Condensed Consolidated 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
Consolidated 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.
Software development costs incurred in the research and development of new
products are expensed as incurred until technological feasibility, in the form
of a working model, has been established, at which time such costs are
capitalized until the product is available for general release to customers.
Capitalized costs are amortized based on either estimated current and future
revenue for each product or straight-line amortization over the shorter of three
years or the remaining estimated life of the product, whichever produces the
higher expense for the period.
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 will perform impairment tests on our intangible assets on an annual basis
and between annual tests in certain circumstances. In response to changes in
industry and market conditions, we may strategically realign our resources,
dispose of, or otherwise exit businesses, and consider further restructurings,
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
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.
We apply Accounting Principles Board ("APB") Opinion Number 25, Accounting
for Stock Issued to Employees, and related interpretations when accounting for
9
our stock option and stock purchase plans. In accordance with APB No. 25, we
apply the intrinsic value method in accounting for employee stock options.
Accordingly, we generally recognize no compensation expense with respect to
stock-based awards to employees.
We have determined pro forma information regarding net income and earnings
per share as if we had accounted for employee stock options under the fair value
method as required by SFAS Number 123, Accounting for Stock Compensation. The
fair value of these stock-based awards to employees was estimated using the
Black-Scholes option pricing model. Had compensation cost for the Company's
stock option plan and employee stock purchase plan been determined consistent
with SFAS No. 123, the Company's reported net income (loss) and net earnings
(loss) per share would have been changed to the amounts indicated below (in
thousands except per share data):
Three months ended June 30,
--------------------------------
2003 2002
--------------- --------------
Net loss:
As reported: $ (417,700) $ (2,148,000)
Add: stock-based compensation expense
included in net loss, net of related
tax effects - 47,200
Deduct: total stock-based compensation
expense determined under fair-value
method for all awards, net of related
tax effects (56,800) (411,600)
-------------- --------------
Pro forma net loss $ (474,500) $ (2,512,400)
============== ==============
Basic and diluted loss per share:
As reported $ (0.03) $ (0.12)
Pro forma $ (0.03) $ (0.17)
Six months ended June 30,
--------------------------------
2003 2002
--------------- --------------
Net loss:
As reported: $ (797,800) $ (5,738,400)
Add: stock-based compensation expense
included in net loss, net of related
tax effects - 141,400
Deduct: total stock-based compensation
expense determined under fair-value
method for all awards, net of related
tax effects (190,200) (852,200)
-------------- --------------
Pro forma net loss $ (988,000) $ (6,449,200)
============== ==============
Basic and diluted loss per share:
As reported $ (0.05) $ (0.33)
Pro forma $ (0.06) $ (0.37)
10
Results of Operations for the Three and Six-Month Periods Ended June 30, 2003
Versus the Three and Six-Month Periods Ended June 30, 2002.
Revenue
Our revenues are primarily derived from product licensing fees. Other sources
of revenue mainly include service fees from maintenance contracts. Total revenue
for the three-month period ended June 30, 2003 increased by $649,900, or 123.7%,
to $1,175,300 from $525,400 for the same period in 2002. Total revenue for the
six-month period ended June 30, 2003 increased by $1,108,000, or 99.7%, to
$2,219,100 from $1,111,100 for the same period in 2002.
Revenue derived from our Windows-based products during the three-month period
ended June 30, 2003 increased by $469,000, or 266.3%, to $645,100 from $176,100
for the same period in the prior year. Revenue derived from our Windows-based
products during the six-month period ended June 30, 2003 increased by $582,700,
or 122.7%, to $1,057,700 from $475,000 for the same period in 2002. The
increases were primarily due to sales of GO-Global for Windows, which was
introduced towards the end of 2002. Sales of our other Windows-based products
have virtually ceased as older customers upgrade to GO-Global for Windows and
discontinue use of our older Windows-based products.
Revenue derived from our UNIX-based products during the three-month period
ended June 30, 2003 increased by $63,800, or 28.7%, to $286,000 from $222,200 in
the same period of the prior year. Revenue derived from our UNIX-based products
during the six-month period ended June 30, 2003 increased by $304,600, or 78.9%,
to $690,600 from $386,000 for the same period in 2002. The increase in our
UNIX-based product revenue was primarily attributable to product licensing fees
that resulted from one-time transactions entered into with a limited number of
customers.
Revenue derived from the amortization of deferred maintenance fees during the
three-month period ended June 30, 2003 increased by $112,900, or 126.0%, to
$202,500 from $89,600 for the same period in the prior year. Revenue derived
from the amortization of deferred maintenance fees during the six-month period
ended June 30, 2003 increased by $216,600, or 123.7%, to $391,700 from $175,100
for the same period in 2002. Our customers typically purchase a maintenance
contract at the time they license our product. Fees associated with the
maintenance contracts are deferred and recognized as revenue ratably over the
underlying service period of the maintenance contract.
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 2003.
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
11
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 June 30, 2003 decreased by
$118,900, or 25.7%, to $343,000 from $461,900 for the same period in 2002. Cost
of revenue for the six-month period ended June 30, 2003 decreased by $249,000,
or 27.1%, to $667,500 from $916,500 for the same period in 2002. The carrying
value of certain elements of our purchased technologies was reduced to zero as
part of the fixed asset impairment charge we recorded as of September 30, 2002,
accordingly, no amortization expense related to these particular assets was
recorded during the current year.
We expect cost of revenue to remain at approximately the same dollar amount
during the third quarter of 2003. During the fourth quarter of 2003 we expect
the dollar amount of cost of revenue to slightly decline and during the first
quarter of 2004 we expect it to decline more significantly as the remaining
elements of our purchased technologies become fully amortized over these
reporting periods. Offsetting these declines will be the commencement of the
amortization of software development costs that we have capitalized, and expect
to capitalize, during 2003. We expect to begin amortizing some of these
development costs during the three-month period ended September 30, 2003 and the
balance during the quarter ended December 31, 2003.
Cost of revenue was approximately 29.2% and 87.9% of revenue for the
three-month periods ended June 30, 2003 and 2002, respectively, and
approximately 30.1% and 82.5% of revenue for the six-month periods then ended,
respectively.
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. Selling and
marketing expenses for the three-month period ended June 30, 2003 decreased by
$68,400, or 13.2%, to $448,300 from $516,700 for the same period in 2002.
Selling and marketing expenses for the six-month period ended June 30, 2003
decreased by $456,300, or 34.4%, to $869,200 from $1,325,500 for the same period
in 2002.
The decrease for the three-month period ended June 30, 2003 was primarily due
to the timing of marketing activities, including tradeshow participation,
creative advertising and other promotional activities. Cumulative expenses
incurred for these activities for the three-month period ended June 30, 2003
decreased by $57,500, or 93.5%, to $4,000 from $61,500 for the same period in
2002. The decrease for the six-month period ended June 30, 2003 was primarily
due to the headcount reduction that was part of our March 2002 restructuring.
Salaries and benefits expense, net of commissions, related to our sales and
marketing staff for the six-month period ended June 30, 2003 decreased by
$401,700, or 47.5%, to $443,300 from $845,000 for the same period in 2002.
We anticipate that selling and marketing expenses in future periods will be
higher than those incurred in the three-month period ended June 30, 2003 as we
implement various marketing strategies aimed at growing revenue. Sales and
marketing expenses were approximately 38.1% and 98.3% of revenue for the
three-month periods ended June 30, 2003 and 2002, respectively and approximately
39.2% and 119.3% of revenue for the six-month periods then ended, respectively.
General and Administrative Expenses
General and administrative expenses primarily consist of salaries and
associated benefits, legal, professional and other outside services, certain
12
costs associated with being a publicly held corporation, the allocation of
corporate overhead charges and bad debts expense. General and administrative
expenses for the three-month period ended June 30, 2003 decreased by $354,100,
or 42.4%, to $481,700 from $835,800 for the same period in 2002. General and
administrative expenses for the six-month period ended June 30, 2003 decreased
by $641,400, or 43.4%, to $838,000 from $1,479,400 for the same period in 2002.
The decreases were primarily due to a decrease in outside services, a
decrease in fees paid to The Nasdaq Stock Market related to our listing on The
Nasdaq SmallCap Market, a decrease in the amortization of deferred compensation
expense and a decrease in salaries and associated benefits.
The decrease in outside services was primarily due to one-time outside
consulting costs incurred during the prior year when various consultants
assisted us in the assessment of our products and their potential for future
enhancements and the development of short and long-term strategic initiatives to
increase revenues, reduce costs and enhance shareholder value, as well as
investment banking fees paid related to the potential merger we pursued during
2002 with three related firms in the telecommunications industry. For the
three-month period ended June 30, 2003, outside services decreased by $205,300,
or 79.1%, to $54,200 from $259,500 for the same period in the prior year. For
the six-month period ended June 30, 2003, outside services decreased by
$285,900, or 75.8%, to $91,500 from $377,400 for the same period in 2002.
The decrease in fees paid to The Nasdaq Stock Market was primarily related to
our phase down from The Nasdaq National Market to The Nasdaq SmallCap Market
that occurred during the prior year, as well as our delisting from The Nasdaq
SmallCap Market, which occurred during the current period. For the three-month
period ended June 30, 2003, fees paid to The Nasdaq Stock Market decreased by
$51,600, or 91.8%, to $4,600 from $56,200 for 2002. For the six-month period
ended June 30, 2003, fees paid to The Nasdaq Stock Market decreased by $58,800,
or 67.3%, to $28,600 from $87,400 for the same period in 2002.
For the three-month and six-month periods ended June 30, 2003, deferred
compensation amortization expense was $0 and $0, as compared with $45,700 and
$135,000 in the same periods of the prior year, respectively, due to the
expiration of certain third party consulting contracts, over whose lifetime
deferred compensation expense was being amortized. Under the terms of those
contracts, 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 the 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 the contracts were amortized over the respective contract's service period,
all of which expired by the end of December 2002.
Salaries and associated benefits decreased for the three-month period ended
June 30, 2003 by $26,200, or 18.2%, to $118,100 from $144,300 for the same
period in the prior year and by $81,200, or 24.2%, to $253,900 from $335,100 for
the six-month period ended June 30, 2003. The decreases were primarily due to
the restructuring that occurred during September 2002.
We anticipate that general and administrative expense in future periods will
approximate those incurred during the three-month period ended June 30, 2003.
13
General and administrative expenses were approximately 41.0% and 159.1% of
revenues for the three-month periods ended June 30, 2003 and 2002, respectively,
and approximately 37.8% and 133.1% of revenues for the six-month periods ended
June 30, 2003 and 2002, 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 June 30, 2003 decreased by
$565,800, or 64.0%, to $318,800 from $884,600 for the same period in 2002.
Research and development expenses for the six-month period ended June 30, 2003
decreased by $1,050,600, or 61.9%, to $646,800 from $1,697,400 for the same
period in 2002.
The decreases were primarily due to decreases in headcount, resulting from
our September 30, 2002 restructuring, the reassignment of certain engineers from
production to customer service, a decrease in depreciation expense, and a
decrease in the allocation of corporate overhead charges.
The headcount reductions led to decreases in salaries and fringe benefits.
For the three-month period ended June 30, 2003, salaries and fringe decreased by
$412,900, or 73.5%, to $149,000 from $561,900 for the same period in 2002. For
the six-month period ended June 30, 2003, salaries and fringe benefits decreased
by $731,600, or 65.5%, to $385,900 from $1,117,500 for the same period in 2002.
As a result of the September 30, 2002 restructuring, certain engineers who
had been principally involved in development, particularly related to our Unix
products, were reassigned to customer service. Customer service salaries and
fringe benefits are reported as a component of cost of sales. During the
three-month and six-month periods ended June 30, 2003, $94,500 and $166,800,
respectively, of salaries and fringe benefits were reported as a component of
cost of sales as compared with only $53,000 and $98,500 in the respective
periods of 2002. Consequently, salaries and fringe benefits were $41,500 and
$68,300, or 78.3% and 69.3%, lower during the three-month and six-month periods
ended June 30, 2003, respectively, than the same periods in 2002 due to the
reassigned engineers.
Depreciation expense decreased as a result of the fixed assets that were
abandoned or taken out of service as part of the September 30, 2002
restructuring as well as other assets reaching the end of their useful lives and
becoming fully depreciated since the three and six-month periods ended June 30,
2002. For the three-month period ended June 30, 2003, depreciation expense
decreased by $53,000, or 49.3%, to $54,600 from $107,600 for the same period in
2002. For the six-month period ended June 30, 2003, depreciation expense
decreased by $83,600, or 49.1%, to $86,500 from $170,100 for the same period in
2002.
The allocation of corporate overhead charges was $0 and $0 during the three
and six-month periods ended June 30, 2003, respectively, as compared with
$45,800 and $45,800 during the same periods in 2002. We had relocated our
corporate offices to our Bellevue, Washington engineering facility during March
2002 until the facility's closure in September 2002. Since then, our corporate
offices have been in Morgan Hill, California.
Under accounting principles generally accepted in the United States, all
costs of product development incurred once technological feasibility has been
14
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. Approximately
$169,400 and $0 of product development costs were capitalized during the
three-month periods ended June 30, 2003 and 2002, respectively. Approximately
$282,200 and $0 of product development costs were capitalized during the
six-month periods ended June 30, 2003 and 2002, respectively. Of the cost
capitalized, approximately $115,200 and $149,100 was related to engineering
performed in-house during the three and six-month periods ended June 30, 2003,
respectively, and consists of the salaries and related benefits paid to the
development engineers. The remaining $54,200 and $133,100 that was capitalized
during the three and six-month periods ended June 30, 2003, respectively,
related to fees paid to outside consultants. The majority of these costs were
incurred in the development of Go-Global for Windows version 3.0, which we
estimate will be available for release during December 2003.
We anticipate that research and development expense in future periods,
inclusive of capitalized software development costs, will approximate those
incurred during the three-month period ended June 30, 2003. Research and
development expenses were approximately 27.1% and 168.4% of revenues for the
three-month periods ended June 30, 2003 and 2002, respectively, and
approximately 29.1% and 152.8% of revenues for the six-month periods ended June
30, 2003 and 2002, respectively.
Other Income (Expense)
Other income (expense) consists primarily of interest income on excess cash
and losses on fixed assets taken out of service. Our excess cash is held in
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 June 30, 2003
decreased by $26,800, or 104.7%, to ($1,200) from $25,600 for the same period in
2002. Other income (expense) for the six-month period ended June 30, 2003
decreased by $55,100, or 92.3%, to $4,600 from $59,700 for the same period in
2002. The decreases were primarily due to lower amounts of excess cash on-hand
throughout the current year as compared with the prior year. All of our excess
cash is invested and the interest rates being paid on our invested cash during
the current year were lower than those in the prior year.
We expect other income (expense) to be lower throughout the remainder of
2003, as compared with 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
June 30, 2003 was $417,700, a decrease of $1,730,300 or 80.6%, from a net loss
of $2,148,000 for the same period during 2002. Net loss for the six-month period
ended June 30, 2003 was $797,800, a decrease of $4,940,600, or 86.1%, from a net
loss of $5,738,400 for the same period in 2002. As a result of our continued
operating loss we intend to continue to aggressively reduce our operating costs
during 2003 and to pursue financing opportunities through all available means.
15
Liquidity and Capital Resources
As of June 30, 2003, cash and cash equivalents totaled $1,155,900, a decrease
of $802,300, or 41.0%, from $1,958,200 as of December 31, 2002.
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 $797,800. Operating activities that increased cash flow included: a
decrease in prepaid expenses and other current assets totaling $175,400, and an
increase in deferred revenue of $45,400. Offsetting these amounts were decreases
in accounts payable and accrued expenses, totaling $66,000 and $327,800,
respectively, and an increase in accounts receivable, net of the allowance for
doubtful accounts of $230,000.
Our condensed consolidated 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 cash balances, including both cash and cash equivalents
and available-for-sale securities have declined significantly as of June 30,
2003 as compared to December 31, 2002. These matters raise substantial doubt
about our ability to continue in existence as a going concern. The condensed
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.
Revenues as reported for both the three and six-month periods ended June 30,
2003 are significantly higher than the same periods in 2002 and management
believes that revenue for the second half of 2003 will be greater than revenue
for the first half of 2003. Although there can be no assurances that these
revenues will materialize, management has been encouraged by the performance of
GO-Global for Windows since its December 2002 commercial rollout as well as the
growth in revenue being generated by the Unix product line.
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 the exiting of facilities and could possibly
include further work force reductions or the disposition of certain operations
if we were unable to match our operations to currently available resources. 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 $559,300 net cash in operating activities for the
six-month period ended June 30, 2003. Of this amount, $144,000 was a one-time
disbursement made during June 2003 as settlement of the lease on our former
engineering facility in Bellevue, Washington, which we had vacated as part of
our September 30, 2002 restructuring.
The net cash used in investing activities of $244,400 decreased cash and cash
equivalents. The only significant investing activities during the current period
were the capitalization of $282,200 of software development costs, primarily
16
incurred in the development of the next release of our Windows-based product,
and the forfeiture of the approximately $40,000 deposit we had had on our former
engineering facility in Bellevue, Washington that was made as part of the
settlement of the lease. The 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 June 30, 2003 increased by $230,000, or
59.2%, to $618,200, from $388,200 as of December 31, 2002. The primary reason
for the increase was the timing of sales transactions during the current period
when several sales transactions occurred within the last few weeks of June 2003.
As of June 30, 2003, the cost basis of purchased technology, as adjusted by
the impact of the asset impairment charge recorded during 2002, was $1,370,100.
There has been no asset impairment charge recorded during 2003. 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 six-month period ended June 30, 2003 decreased by
$122,000, or 37.1%, to $207,000 from $329,000 for the same period in the prior
year. The decrease was due primarily to the asset impairment charges we recorded
during the year ended December 31, 2002 against various components of the
purchased technology.
Accounts payable as of June 30, 2003 decreased by $66,000, or 28.9%, to
$162,700 from $228,700 as of December 31, 2002. Accounts payable are comprised
of our various operating expenses and decreased due to the timing of the payment
of various invoices as well as our efforts to reduce our cash expenditures as
much as possible.
Accrued expenses as of June 30, 2003 decreased by $327,800, or 41.2%, to
$467,300 from $795,100 as of December 31, 2002. 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. Also included in
accrued expenses are the unpaid portions of the restructuring charges that we
expensed during 2002.
The decrease in accrued expenses is primarily due to the payment of the
former Bellevue, Washington office's lease settlement charges of $144,000, and
the payment of approximately $103,800 of consulting and accounting fees during
2003, which had been accrued as of December 31, 2002. As of June 30, 2003,
accrued expenses includes restructuring charges of $88,200 that will be applied
toward the settlement of the lease on our corporate office in Morgan Hill,
California during August 2003, as more fully explained in Note 6 to the
Condensed Consolidated Financial Statements.
Deferred revenue as of June 30, 2003 increased by $45,400, or 5.7%, to
$841,500 from $796,100 as of December 31, 2002. The increase is due to the terms
of the various licensing agreements and maintenance contracts we entered into
during the current period as compared with the prior year, 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 for current
recognition 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.
17
As of June 30, 2003, we had current assets of $1,735,200 and current
liabilities of $1,471,500, which netted to working capital of $263,700. Included
in current liabilities was deferred revenue of $841,500.
For the period August 1 through December 31, 2003 our future minimum lease
obligations, which are principally for office space, are $71,900. The lease on
our Concord, New Hampshire engineering facility calls for payments of
approximately $17,300 per month and, by its terms, expires on October 30, 2003.
We are actively negotiating a facility lease, to commence upon its expiration at
rates more in line with current market rates. We expect that the new lease will
have a significantly lower monthly rate.
As more fully explained in Note 6 to the Condensed Consolidated Financial
Statements, we negotiated a settlement on our Morgan Hill, California corporate
offices lease during August 2003. The monthly rent on these facilities was
approximately $20,000 and is reflected in the future lease obligations amount,
discussed in the preceding paragraph, for August 2003 only - the last month for
which we were required to make a rental payment, prior to settlement of the
lease. We expect to occupy a new facility on or about September 1, 2003 on a
month-to-month basis. During the six-month period ended June 30, 2003, we
negotiated a settlement of the lease on our former Bellevue, Washington
engineering office, which we vacated as part of our September 2002
restructuring. Our offices in the United Kingdom are leased on a month-to-month
basis.
New Accounting Pronouncements
In January 2003, the Financial Accounting Standards Board issued
Interpretation No. 46 (FIN 46), "Consolidation of Variable Interest Entities,"
which addresses consolidation by business enterprises of variable interest
entities that either: (1) do not have sufficient equity investment at risk to
permit the entity to finance its activities without additional subordinated
financial support, or (2) the equity investors lack an essential characteristic
of a controlling financial interest. FIN 46 requires disclosure of Variable
Interest Entities (VIEs) in financial statements issued after January 31, 2003,
if it is reasonably possible that as of the transition date: (1) we will be the
primary beneficiary of an existing VIE that will require consolidation or, (2)
we will hold a significant variable interest in, or have significant involvement
with, an existing VIE. We do not have any entities that will require disclosure
or new consolidation as a result of adopting the provisions of FIN 46.
18
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
Our management carried out an evaluation, with the participation of our
Chief Executive Officer and Chief Financial Officer, of the effectiveness of our
disclosure controls and procedures as of June 30, 2003. Based upon that
evaluation, our Chief Executive Officer and Chief Financial Officer concluded
that our disclosure controls and procedures were effective to ensure that
information required to be disclosed by us in reports that we file or submit
under the Securities Exchange Act of 1934 is recorded, processed, summarized and
reported, within the time periods specified in the rules and forms of the
Securities and Exchange Commission.
There has not been any change in our internal control over financial
reporting in connection with the evaluation required by Rule 13a-15(d) under the
Exchange Act that occurred during the quarter ended June 30, 2003 that has
materially affected, or is reasonably likely to materially affect, our internal
control over financial reporting.
19
PART II--OTHER INFORMATION
ITEM 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
Exhibit 31 - Rule 13a-14(a)/15d-14(a) Certifications
Exhibit 32 - Section 1350 Certifications
(b) Reports on Form 8-K
During the quarter ended June 30, 2003, we filed or furnished the following
current reports on Form 8-K with the Securities and Exchange Commission:
Current report on Form 8-K, dated May 15, 2003, was furnished on May 16,
2003. The items reported were:
o Item 7 - Financial Statements and Exhibits, which identified
the exhibit furnished with the Form 8-K; and
o Item 9 - Regulation FD Disclosure, which reported the issuance of a
press release announcing our financial results for the quarter ended
March 31, 2003.
Current report on Form 8-K, dated May 15, 2003, was furnished on May 15,
2003. The item reported was:
o Item 9 - Regulation FD Disclosure, which furnished the Section 906
certifications that accompanied our quarterly report on form 10-Q for
the quarter ended March 31, 2003.
20
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: August 14, 2003
By: /s/ Robert Dilworth
---------------------------------
Robert Dilworth,
Chief Executive Officer (Interim) and
Chairman of the Board
(Principal Executive Officer)
Date: August 14, 2003
By: /s/ William Swain
---------------------------------
William Swain,
Chief Financial Officer
(Principal Financial Officer and
Principal Accounting Officer)