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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, 2003
Commission File Number: 0-21683
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GraphOn Corporation
(Exact name of Registrant as specified in its charter)
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Delaware 13-3899021
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
105 Cochrane Circle, Suite L
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 October 22, 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 9
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 20
Item 4. Controls and Procedures 20
PART II.
Item 6. Exhibits and Reports on Form 8-K 21
Signatures 22
PART I--FINANCIAL INFORMATION
ITEM I Financial Statements
GRAPHON CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
September 30, December 31,
2003 2002
ASSETS ------------ -----------
------------ (Unaudited)
Current Assets:
Cash and cash equivalents $ 730,900 $ 1,958,200
Accounts receivable, net of allowance for
doubtful accounts of $46,800 and $50,300 809,300 337,900
Prepaid expenses and other current assets 19,700 192,000
------------ -----------
Total Current Assets 1,559,900 2,488,100
------------ -----------
Property and equipment, net 185,800 421,900
Purchased technology, net 542,000 1,163,100
Capitalized software, net 557,500 406,500
Other assets 11,900 70,000
------------ -----------
TOTAL ASSETS $ 2,857,100 $ 4,549,600
============ ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current Liabilities:
Accounts payable $ 168,900 $ 228,700
Accrued expenses 344,700 795,100
Deferred revenue 920,800 796,100
------------ -----------
Total Current Liabilities 1,434,400 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, 16,618,459 and 16,580,719
shares issued and outstanding 1,700 1,700
Additional paid in capital 45,987,000 45,982,500
Notes receivable (52,000) (50,300)
Accumulated other comprehensive loss (3,000) (2,400)
Accumulated deficit (44,511,000) (43,201,800)
------------ -----------
Total Stockholders' Equity 1,422,700 2,729,700
------------ -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 2,857,100 $ 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 Nine Months Ended
September 30, September 30,
------------------- ----------------
2003 2002 2003 2002
----------- ----------- ----------- ----------
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
Revenue $1,086,500 $ 836,500 $ 3,305,600 $ 1,947,600
Cost of revenue 313,100 454,700 980,600 1,371,200
----------- ----------- ----------- -----------
Gross Profit 773,400 381,800 2,325,000 576,400
----------- ----------- ----------- -----------
Operating Expenses:
Selling and marketing 420,500 387,500 1,289,700 1,712,900
General and administrative 300,000 837,800 1,137,900 2,295,300
Research and development 486,800 782,700 1,133,600 2,502,100
Fixed assets impairment - 914,000 - 914,000
Restructuring charge 80,100 452,400 80,100 1,942,800
----------- ----------- ----------- -----------
Total Operating Expenses 1,287,400 3,374,400 3,641,300 9,367,100
----------- ----------- ----------- -----------
Loss From Operations (514,000) (2,992,600) (1,316,300) (8,790,700)
----------- ----------- ----------- -----------
Other Income (Expense):
Interest and other income 2,600 27,300 11,400 143,100
Interest and other expense - (15,800) (4,300) (71,900)
----------- ----------- ----------- -----------
Total Other Income (Expense) 2,600 11,500 7,100 71,200
----------- ----------- ----------- -----------
Net Loss $ (511,400) $(2,981,100) $(1,309,200)$(8,719,500)
Other Comprehensive Loss, net of tax
Unrealized holding loss on investment - (1,300) - (3,800)
Foreign currency translation gain (loss) - 2,100 (600) 1,000
----------- ----------- ----------- -----------
Comprehensive Loss $ (511,400) $(2,980,300) $(1,309,800)$(8,722,300)
=========== =========== =========== ===========
Basic and Diluted Loss per Common Share $ (0.03) $ (0.17) $ (0.08)$ (0.50)
=========== =========== =========== ===========
Weighted Average Common Shares Outstanding 16,613,155 17,508,574 16,603,577 17,455,439
=========== =========== =========== ===========
See accompanying notes to condensed consolidated financial statements.
3
GRAPHON CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended
September 30,
2003 2002
------------ ------------
(Unaudited) (Unaudited)
Cash Flows From Operating Activities:
Net loss $ (1,309,200) $(8,719,500)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 943,500 1,572,400
Restructuring charge 42,200 657,800
Asset impairment charge - 914,000
Amortization of deferred compensation - 174,800
Loss on disposal of fixed assets 4,300 -
Provision for doubtful accounts (3,500) (293,400)
Interest accrued on directors' notes receivable (1,700) -
Changes in operating assets and liabilities:
Accounts receivable (467,900) 588,400
Prepaid expenses and other assets 172,300 79,300
Accounts payable (59,800) (77,600)
Accrued expenses (450,400) 86,600
Deferred revenue 124,700 (181,700)
----------- -----------
Net Cash Used In Operating Activities (1,005,500) (5,198,900)
----------- -----------
Cash Flows From Investing Activities:
Purchase of available-for-sale securities - (768,300)
Proceeds from sale of available-for-sale securities - 3,525,200
Capitalization of software development costs (282,200) -
Capital expenditures (1,600) (82,900)
Other assets 58,100 (1,000)
----------- -----------
Net Cash Provided By (Used In) Investing Activities (225,700) 2,673,000
----------- -----------
Cash Flows From Financing Activities:
Repayment of note payable - (26,600)
Net proceeds from issuance of common stock 4,500 6,400
----------- -----------
Net Cash Provided (Used In) By Financing Activities 4,500 (20,200)
----------- -----------
Effect of exchange rate fluctuations on cash and
cash equivalents (600) 300
----------- -----------
Net Decrease in Cash and Cash Equivalents (1,227,300) (2,545,800)
Cash and Cash Equivalents, beginning of period 1,958,200 3,952,600
----------- -----------
Cash and Cash Equivalents, end of period $ 730,900 $ 1,406,800
=========== ===========
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 September 30, 2003, except for the restructuring charge,
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, 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 September 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.
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 for
the remaining quarter of 2003 and into 2004.
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 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.
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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 September 30, 2003, the Company issued
15,740 shares of common stock to employees pursuant to the purchase by those
employees of common stock under the Employee Stock Purchase Plan (the "ESPP"),
resulting in cash proceeds of $2,500. During the nine-month period ended
September 30, 2003, the Company issued 37,540 shares of common stock to
employees pursuant to the purchase by those employees of common stock under the
ESPP, resulting in cash proceeds of $4,500. These amounts are 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. Stock-Based Incentive Programs
The Company accounts for stock-based compensation under the intrinsic value
method of accounting for stock awards, in accordance with Accounting Principles
Board Opinion number 25, "Accounting for Stock Issued to Employees" (APB 25) as
permitted by Statement of Financial Accounting Standards number 123, Stock-Based
Compensation (collectively SFAS 123). The Company has not changed to the fair
value method of accounting for stock-based employee compensation. Accordingly,
the adoption of SFAS No. 148, "Accounting for Stock-Based Compensation -
Transition and Disclosure" (SFAS 148) did not affect the Company's financial
condition or results of operations. However, SFAS 123, as amended by SFAS 148,
requires that information be provided as if the Company had accounted for stock
options under the fair value method of this statement, including disclosing pro
forma information regarding net loss and loss per share beginning with the first
quarter of 2003. Had the Company applied the fair value recognition provisions
of SFAS 123 to stock-based compensation, the Company's net loss and basic and
diluted loss per share would have been changed from the "as reported" amounts to
the "pro forma" amounts as follows:
Three months ended September 30,
2003 2002
-------------- --------------
Net loss:
As reported: $ (511,400) $ (2,981,100)
Add: stock-based compensation expense
included in net loss, net of related
tax effects - 33,400
Deduct: total stock-based compensation
expense determined under fair-value
method for all awards, net of related
6
tax effects (42,400) (409,300)
-------------- --------------
Pro forma net loss $ (553,800) $ (3,357,000)
============== ==============
Basic and diluted loss per share:
As reported $ (0.03) $ (0.17)
Pro forma $ (0.03) $ (0.19)
Nine months ended September 30,
2003 2002
--------------- ---------------
Net loss:
As reported: $ (1,309,200) $ (8,719,500)
Add: stock-based compensation expense
included in net loss, net of related
tax effects - 174,800
Deduct: total stock-based compensation
expense determined under fair-value
method for all awards, net of related
tax effects (232,600) (1,261,500)
-------------- --------------
Pro forma net loss $ (1,541,800) $ (9,806,200)
============== ==============
Basic and diluted loss per share:
As reported $ (0.08) $ (0.50)
Pro forma $ (0.09) $ (0.56)
On June 24, 2003, the Company announced a voluntary stock option exchange
program for its employees who were not executive officers or members of its
Board of Directors. Under the terms of the exchange program, eligible employees
had the opportunity, if they so chose, to cancel any of their outstanding
unexercised options to purchase Company common stock that had an exercise price
greater than or equal to $0.50 in exchange for an equal number of new options to
be granted at a future date. The exchange program was open until 5:00 p.m.,
Eastern Time, on July 23, 2003. The exercise price of the new options will be
equal to the closing bid price per share of the Company's common stock on the
grant date of the new options, as reported by the OTC Bulletin Board, or its
successor market, if any. The grant date is currently estimated to be on, or
about January 26, 2004.
As of July 23, 2003, the closing date of the exchange program, 578,935
options were exchanged by eligible employees and cancelled. The cancellation of
these options did not have a material effect on the calculation of the deduction
for the total stock-based compensation expense determined under the fair-value
method for either the three or nine-month periods ended September 30, 2003 as
reported in the above tables contained within this footnote.
6. Restructuring Charge
Beginning in September of 2001, the Company has undertaken several
strategic restructurings in effort to reduce operating costs to sustainable
levels. One of these restructurings included the March 2002 closure of the
7
corporate facility in Morgan Hill, California and the relocation of the
corporate functions to the Company's former engineering facility in Bellevue,
Washington. During the quarter ended March 31, 2002, a $1,490,400 restructuring
charge was expensed that reflected the estimated total costs of the office
closure and relocation. Included in this amount was an accrual for the estimated
amount of rent that would be need to be paid while attempting to either sublease
the facility, or negotiate a lease settlement, totaling $180,100.
During August 2003, the Company negotiated a buy out of the lease for its
former corporate offices at 400 Cochrane Circle, Morgan Hill, California ("400
Cochrane"). The total buy out price was approximately $153,000 and consisted of
a lump-sum cash payment of $125,000, the forfeiture of an approximate $16,000
security deposit and a $12,000 commission to the real estate broker who was
involved in the transaction. Offsetting these amounts was $115,100 of the
estimated rent accrual that had been originally recorded during March 2002. It
is estimated that the buy out saved the Company approximately $270,000 over what
would have been the remainder of the lease term.
Effective September 1, 2003, the Company moved its corporate offices to
105 Cochrane Circle, Suite L, Morgan Hill, California ("105 Cochrane"). The new
lease is month-to-month at an initial rate of approximately $1,000 per month. In
conjunction with the 400 Cochrane buy out and the move to 105 Cochrane, certain
fixed assets, primarily furniture and equipment, were disposed of and written
off. No material disposal costs were incurred related to the disposal of these
assets.
A summary of these restructuring charges is as follows:
Item Cash Non Cash Total
---- ------------ ------------- -------------
Lump-sum lease settlement $ 125,000 $ - $ 125,000
Deposit forfeiture - 16,000 16,000
Real estate commissions 12,000 - 12,000
Disposal of fixed assets - 42,200 42,200
Accruals (115,100) - (115,100)
------------ ------------- -------------
Restructuring charge $ 21,900 $ 58,200 $ 80,100
============ ============= =============
7. Commitments and Contingencies
As of September 30, 2003, the Company had one payment remaining on the
lease for its New Hampshire facility, in the amount of $17,300. During October
2003, the Company entered into a one-year operating lease for a new facility in
New Hampshire, which is cancelable by either party with 30 days written notice.
The lease period for this new facility is from November 1, 2003 through October
31, 2004 and commences upon the expiration of the Company's current New
Hampshire facility's lease, which expires, by its terms, on October 31, 2003.
Monthly rent payments for the new facility are approximately $5,000. The Company
does not anticipate any interruption of business with the move to the new
facility, nor does it anticipate any material costs of moving its operations.
Future minimum annual lease payments for the new lease are as follows:
Year ended December 31, 2003: $ 10,000
2004: $ 50,000
8
All other facilities currently occupied by the Company are being rented on
a month-to-month basis and have no future minimum annual lease payments
associated with them. The aggregate monthly rental payments for the
month-to-month facilities currently being occupied are approximately $3,000.
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.
9
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 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.
10
We apply APB 25 and related interpretations when accounting for our stock
option and stock purchase plans. In accordance with APB 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 123. 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 123, the Company's reported
net loss and net loss per share would have been changed to the amounts indicated
in Note 5.
Reclassifications. Certain amounts in the prior periods' financial statements
have been reclassified to conform to the current periods' presentation.
Results of Operations for the Three and Nine-Month Periods Ended September 30,
2003 Versus the Three and Nine-Month Periods Ended September 30, 2002.
Revenue
Our revenues are primarily derived from product licensing fees. Other sources
of revenue mainly consist of service fees from maintenance contracts. Total
revenue for the three-month period ended September 30, 2003 increased by
$250,000, or 29.9%, to $1,086,500 from $836,500 for the same period in 2002.
Total revenue for the nine-month period ended September 30, 2003 increased by
$1,358,000, or 69.7%, to $3,305,600 from $1,358,000 for the same period in 2002.
Revenue derived from our Windows-based products during the three-month period
ended September 30, 2003 increased by $26,600, or 6.9%, to $410,500 from
$383,900 for the same period in the prior year. Revenue derived from our
Windows-based products during the nine-month period ended September 30, 2003
increased by $597,400, or 69.6%, to $1,456,200 from $858,800 for the same period
in 2002. The increases primarily reflect continued growth in licensing fees
derived from our new GO-Global for Windows product. We believe it is a
technically superior product than our Bridges for Windows and legacy Go Global
products. As more customers demo GO-Global for Windows, more continue to buy new
licenses as well as upgrade their previously installed base of Bridges for
Windows and legacy Go Global products. Sales of these other Windows-based
products have ceased as upgrades to GO-Global for Windows are made.
Revenue derived from our UNIX-based products during the three-month period
ended September 30, 2003 increased by $127,000, or 54.7%, to $359,200 from
$232,200 in the same period of the prior year. Revenue derived from our
UNIX-based products during the nine-month period ended September 30, 2003
increased by $431,900, or 69.9%, to $1,049,800 from $617,900 for the same period
in 2002. Similar to the increases in our Windows-based products, the increases
in UNIX-based product revenue primarily reflects continued growth in licensing
fees for GO-Global for UNIX. We believe it is a technically superior product
than our Bridges for UNIX and legacy Go Global products. As more customers demo
GO-Global for UNIX, more continue to buy new licenses as well as upgrade their
previously installed base of Bridges for UNIX and legacy Go Global products.
Sales of these other UNIX-based products have declined as upgrades to GO-Global
for UNIX are made.
11
Revenue derived from the amortization of deferred maintenance fees during the
three-month period ended September 30, 2003 increased by $93,100, or 81.0%, to
$208,000 from $114,900 for the same period in the prior year. Revenue derived
from the amortization of deferred maintenance fees during the nine-month period
ended September 30, 2003 increased by $309,500, or 106.7%, to $599,600 from
$290,100 for the same period in 2002. Our customers typically purchase a
maintenance contract at the time they license our product. Our maintenance
contracts are primarily for a one-year time period and generally are renewed
upon expiration. 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.
During the three-month period ended September 30, 2003, one of our largest
customers informed us that they would no longer be bundling GO-Global for
Windows with every product they ship. Beginning in the three-month period ended
December 31, 2003, they will begin offering GO-Global for Windows as an optional
feature, rather than as a standard item that had previously been shipped to all
customers. Although we are unable to forecast the actual amount of revenue we
may derive under this new distribution model, we anticipate that revenue from
this customer will be lower in future periods as compared with the current
reporting period.
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, 2003 decreased
by $141,600, or 31.1%, to $313,100 from $454,700 for the same period in 2002.
Cost of revenue for the nine-month period ended September 30, 2003 decreased by
$390,600, or 28.5%, to $980,600 from $1,371,200 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.
During the third quarter of 2004 we expect the dollar amount of cost of
revenue to decline significantly as the remaining elements of our purchased
technologies become fully amortized during the first and second quarters of the
year ended December 31, 2004. Offsetting these declines will be the commencement
of the amortization of software development costs that we have capitalized
during 2003. We began amortizing some of these development costs during the
three-month period ended September 30, 2003 and expect to begin amortizing the
remaining amounts during the quarter ended December 31, 2003.
12
Cost of revenue was approximately 28.8% and 54.4% of revenue for the
three-month periods ended September 30, 2003 and 2002, respectively, and
approximately 29.7% and 70.4% of revenue for the nine-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, public
relations and advertising costs and the allocation of corporate overhead
charges. Selling and marketing expenses for the three-month period ended
September 30, 2003 increased by $33,000, or 8.5%, to $420,500 from $387,500 for
the same period in 2002. Selling and marketing expenses for the nine-month
period ended September 30, 2003 decreased by $423,200, or 24.7%, to $1,289,700
from $1,712,900 for the same period in 2002.
The increase for the three-month period ended September 30, 2003 was
primarily due to an increase in marketing activities, including advertising and
other promotional activities. The decrease for the nine-month period ended
September 30, 2003 was primarily due to the headcount reductions that were part
of our 2002 restructurings. Salaries and benefits expense, net of commissions,
related to our sales and marketing staff for the nine-month period ended
September 30, 2003 decreased by $430,300, or 40.2%, to $641,400 from $1,071,700
for the same period in 2002.
We anticipate that selling and marketing expenses in future periods will
approximate those incurred in the three-month period ended September 30, 2003 as
we continue implementing various marketing strategies aimed at growing revenue.
Sales and marketing expenses were approximately 38.7% and 46.3% of revenue for
the three-month periods ended September 30, 2003 and 2002, respectively and
approximately 39.0% and 87.9% of revenue for the nine-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
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 September 30, 2003 decreased by
$537,800, or 64.2%, to $300,000 from $837,800 for the same period in 2002.
General and administrative expenses for the nine-month period ended September
30, 2003 decreased by $1,157,400, or 50.4%, to $1,137,900 from $2,295,300 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, 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 performing strategic assessments of the Company. Included were
assessments 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. Also included were
investment-banking fees paid related to the potential merger we pursued during
2002 with three related firms in the telecommunications industry. For the
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three-month period ended September 30, 2003, outside services decreased by
$153,300, or 72.9%, to $57,100 from $210,400 for the same period in the prior
year. For the nine-month period ended September 30, 2003, outside services
decreased by $417,200, or 73.7%, to $148,600 from $565,800 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 year. For the three-month
period ended September 30, 2003, no fees were paid to The Nasdaq Stock Market.
For the nine-month period ended September 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 nine-month periods ended September 30, 2003, deferred
compensation amortization expense was $0 and $0, as compared with $33,400 and
$168,300 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
September 30, 2003 by $61,000, or 33.4%, to $121,800 from $182,800 for the same
period in the prior year and by $139,300, or 27.8%, to $362,600 from $501,900
for the nine-month period ended September 30, 2003 from the same period in the
prior year. 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 September 30,
2003, except for the three-month period ended December 31, 2003. We anticipate
higher general and administrative expenses during the three-month period ended
December 31, 2003, primarily reflecting the costs associated with our annual
shareholders meeting, scheduled for December 30, 2003. General and
administrative expenses were approximately 27.2% and 100.2% of revenues for the
three-month periods ended September 30, 2003 and 2002, respectively, and
approximately 34.4% and 117.9% of revenues for the nine-month periods ended
September 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 September 30, 2003
decreased by $295,900, or 37.8%, to $486,800 from $782,700 for the same period
in 2002. Research and development expenses for the nine-month period ended
September 30, 2003 decreased by $1,368,500, or 54.7%, to $1,133,600 from
$2,502,100 for the same period in 2002.
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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 September 30, 2003, salaries and fringe
decreased by $197,000, or 36.5%, to $342,000 from $539,000 for the same period
in 2002. For the nine-month period ended September 30, 2003, salaries and fringe
benefits decreased by $711,200, or 40.5%, to $1,043,900 from $1,755,100 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 nine-month periods ended September 30, 2003, $59,700 and
$226,500, respectively, of salaries and fringe benefits were reported as a
component of cost of sales as compared with only $45,500 and $144,000 in the
respective periods of 2002. Consequently, salaries and fringe benefits were
$14,200 and $82,500, or 2.6% and 4.7%, lower during the three-month and
nine-month periods ended September 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 nine-month periods ended
September 30, 2002. For the three-month period ended September 30, 2003,
depreciation expense decreased by $19,700, or 34.0%, to $38,200 from $57,900 for
the same period in 2002. For the nine-month period ended September 30, 2003,
depreciation expense decreased by $103,400, or 45.4%, to $124,600 from $228,000
for the same period in 2002.
The allocation of corporate overhead charges was $0 and $0 during the three
and nine-month periods ended September 30, 2003, respectively, as compared with
$32,200 and $78,000 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
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 costs were capitalized during the three-month periods ended
September 30, 2003 and 2002, or during the nine-month period ended September 30,
2002. Approximately $282,200 of product development costs were capitalized
during the nine-month period ended September 30, 2003. Of the costs capitalized
during 2003, approximately $149,100 was related to engineering performed
in-house and consists of the salaries and related benefits paid to the
development engineers. The remaining $133,100 that was capitalized in 2003
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.
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We anticipate that research and development expense for the next few
quarterly reporting periods, inclusive of capitalized software development
costs, will approximate those incurred during the three-month period ended
September 30, 2003. Research and development expenses were approximately 44.8%
and 93.6% of revenues for the three-month periods ended September 30, 2003 and
2002, respectively, and approximately 34.3% and 128.5% of revenues for the
nine-month periods ended September 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 September 30, 2003
decreased by $8,900, or 77.4%, to $2,600 from $11,500 for the same period in
2002. Other income (expense) for the nine-month period ended September 30, 2003
decreased by $64,100, or 90.0%, to $7,100 from $71,200 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
interest rates to remain 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, 2003 was $511,400, a decrease of $2,469,700 or 82.9%, from a net
loss of $2,981,100 for the same period during 2002. Net loss for the nine-month
period ended September 30, 2003 was $1,309,200, a decrease of $7,410,300, or
85.0%, from a net loss of $8,719,500 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.
Liquidity and Capital Resources
As of September 30, 2003, cash and cash equivalents totaled $730,900, a
decrease of $1,227,300, or 62.8%, 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 $1,309,200. Operating activities that increased cash flow included: a
decrease in prepaid expenses and other current assets totaling $172,300, and an
increase in deferred revenue of $124,700. Offsetting these amounts were
decreases in accounts payable and accrued expenses, totaling $59,800 and
$450,400, respectively, and an increase in accounts receivable, net of the
allowance for doubtful accounts of $471,400.
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
16
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 September
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.
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 $1,005,500 net cash in operating activities for
the nine-month period ended September 30, 2003. Of this amount, $154,000 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. Also included in this amount were
one-time disbursements totaling $137,000 made during August 2003 as settlement
of the lease on our former corporate offices in Morgan Hill, California.
Recurring operating activities have therefore consumed approximately $714,500
net cash for the nine-month period ended September 30, 2003.
The net cash used in investing activities of $225,700 decreased cash and cash
equivalents. The only significant investing activities during the current year
were the capitalization of $282,200 of software development costs, primarily
incurred in the development of the next release of our Windows-based product,
that were offset by the forfeiture of approximately $58,100 of deposits we had
had on our former facilities that were made part of the settlement of the
respective leases. 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 September 30, 2003 increased by $467,900, or
120.5%, to $856,100, 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 September
2003.
As of September 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 nine-month period ended September 30, 2003
decreased by $366,100, or 37.1%, to $621,100 from $987,200 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.
17
Accounts payable as of September 30, 2003 decreased by $59,800, or 26.2%, to
$168,900 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 September 30, 2003 decreased by $450,400, or 56.7%, to
$344,700 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 as of December 31, 2002 was approximately $212,200 of
restructuring expenses that were ultimately paid out during the nine months
ended September 30, 2003. Other items that were accrued as of December 31, 2002
that were paid out during the nine month period ended September 30, 2003
included approximately $150,600 of employee costs (primarily accrued salaries,
commissions and bonuses) and $100,500 of legal and accounting fees.
Deferred revenue as of September 30, 2003 increased by $124,700, or 15.7%, to
$920,800 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.
As of September 30, 2003, we had current assets of $1,559,900 and current
liabilities of $1,434,400, which netted to working capital of $125,500. Included
in current liabilities was deferred revenue of $920,800.
Stock Option Exchange Program
On June 24, 2003, we announced a voluntary stock option exchange program for
employees who were not executive officers or members of our Board of Directors.
Under the terms of the exchange program, eligible employees had the opportunity,
if they so chose, to cancel any of their outstanding unexercised options to
purchase our common stock that had an exercise price greater than or equal to
$0.50 in exchange for an equal number of new options to be granted at a future
date. The exchange program was open until 5:00 p.m., Eastern Time, on July 23,
2003. The exercise price of the new options will be equal to the closing bid
price per share of our common stock on the grant date of the new options, as
reported by the OTC Bulletin Board, or its successor market, if any. The grant
date is currently estimated to be on, or about January 26, 2004.
The following table sets forth details pertaining to the eligibility and
results of the exchange program as of the program's close on July 23, 2003:
Eligible to Elected to
Total Exchange Exchange
------------ -------------- ---------------
Employees 24 21 19
Percentage (1) 100.0% 87.5% 90.5%
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Outstanding options 2,776,161 677,917 578,935
Percentage (1) 100.0% 24.42% 85.4%
(1) Elected to exchange percentage calculated as a percentage of eligible to
exchange. Eligible to exchange percentage calculated as a percentage of
total.
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.
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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 September 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 September 30, 2003 that has
materially affected, or is reasonably likely to materially affect, our internal
control over financial reporting.
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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 September 30, 2003, we filed or furnished the
following current report on Form 8-K with the Securities and Exchange
Commission:
Current report on Form 8-K, dated August 20, 2003, was furnished on August
20, 2003. The item reported was:
o Item 12 - Results of Operations and Financial Condition, which reported
the issuance of a press release reconfirming our financial results for
the quarter ended June 30, 2003.
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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 14, 2003
By: /s/ Robert Dilworth
---------------------------------
Robert Dilworth,
Chief Executive Officer (Interim) and
Chairman of the Board
(Principal Executive Officer)
Date: November 14, 2003
By: /s/ William Swain
---------------------------------
William Swain,
Chief Financial Officer
(Principal Financial Officer and
Principal Accounting Officer)
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