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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
Annual Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the fiscal year ended December 31, 2004 Commission file
number: 0-21683
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.)
3130 Winkle Avenue
Santa Cruz, California 95065
(Address of principal executive offices)
Registrant's telephone number: (800) 472-7466
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.0001 Par Value
(Title of class)
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 if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2)
Yes [ ] No [X]
The aggregate market value of the common equity of registrant held by
non-affiliates of the registrant as of June 30, 2004 was approximately
$8,676,600.
Number of shares of Common Stock outstanding as of March 30, 2005: 46,147,047
shares of Common Stock.
GRAPHON CORPORATION
FORM 10-K
Table of Contents
Page
PART I.
Item 1. Business 2
Item 2. Properties 9
Item 3. Legal Proceedings 9
Item 4. Submission of Matters to a Vote of Security Holders 10
PART II.
Item 5. Market for Registrant's Common Equity, Related
Stockholder Matters and Issuer Purchases of Equity Securities 10
Item 6. Selected Financial Data 10
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operation 11
Item 7A. Quantitative and Qualitative Disclosures About
Market Risk 24
Item 8. Financial Statements and Supplementary Data 25
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 47
Item 9A. Controls and Procedures 47
Item 9B. Other Information 47
PART III.
Item 10. Directors and Executive Officers of the Registrant 48
Item 11. Executive Compensation 49
Item 12. Security Ownership of Certain Beneficial Owners
and Management and Related Stockholder Matters 51
Item 13. Certain Relationships and Related Transactions 53
Item 14. Principal Accountant Fees and Services 54
PART IV.
Item 15. Exhibits, Financial Statement Schedules 55
SIGNATURES 56
FORWARD LOOKING INFORMATION
This report includes, in addition to historical information, "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995. This Act provides a "safe harbor" for forward-looking statements to
encourage companies to provide prospective information about themselves so long
as they identify these statements as forward-looking and provide meaningful
cautionary statements identifying important factors that could cause actual
results to differ from the projected results. All statements other than
statements of historical fact we make in this report or in any document
incorporated by reference are forward-looking statements. In particular, the
statements regarding industry prospects and our future results of operations or
financial position are forward-looking statements. Such statements are based on
management's current expectations and are subject to a number of uncertainties
and risks that could cause actual results to differ significantly from those
described in the forward looking statements. Factors that may cause such a
difference include, but are not limited to, those discussed in "Management's
Discussion and Analysis of Financial Condition and Results of Operation," as
well as those discussed elsewhere in this report.
PART I
ITEM 1. BUSINESS
General
We are a Delaware corporation, founded in May of 1996. We are developers of
business connectivity software, including Unix, Linux and Windows server-based
software, with an immediate focus on web-enabling applications for use by
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 reduces 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 a variety of display devices. With our
server-based 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. Our server-based technology can web-enable a
variety of Unix, Linux or Windows applications.
On January 31, 2005, we acquired Network Engineering Software, Inc. ("NES"),
which is engaged in the development and patenting of proprietary technologies
relating to the submission, storage, retrieval and security of information
remotely accessed by computers, typically through computer networks or the
Internet. In a contemporaneous transaction, we raised net proceeds of
approximately $2,000,000 in a private placement (the "2005 private placement")
of newly authorized Series A Preferred Stock and warrants to purchase newly
authorized Series B Preferred Stock. These transactions are described in our
Current Reports on Form 8-K, filed with the Securities and Exchange Commission
(SEC) on February 4, 2005.
Our headquarters are located at 3130 Winkle Avenue, California, 95065 and our
phone number is 1-800-GRAPHON (1-800-472-7466). Our Internet website is
http://www.graphon.com. The information on our website is not part of this
annual report. We also have offices in Concord, New Hampshire, Rolling Hills
Estates, California and Berkshire, England, United Kingdom.
You may read and copy any materials that we file with the SEC at the SEC's
Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549. You may
obtain information on the operation of the Public Reference Room by calling the
SEC at 1-800-SEC-0330. The SEC also maintains an Internet website
(http://www.sec.gov) that contains reports, proxy and information statements,
and other information that we file electronically with the SEC from time to
time. We have made available free of charge through our website (follow the
About Us link to the Investor tab to "SEC Filings") our annual report on Form
10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments
to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the
Securities Exchange Act of 1934 as soon as reasonably practicable after such
material was electronically filed with, or furnished to, the SEC.
Industry Background
History
In the 1970s, software applications were executed on central mainframes and
typically accessed by low-cost display terminals. Information technology
departments were responsible for deploying, managing and supporting the
applications to create a reliable environment for users. In the 1980s, the PC
became the desktop of choice: empowering the user with flexibility, a graphical
user interface, and a multitude of productive and inexpensive applications. In
the 1990s, the desktop provided access to mainframe applications and databases,
which run on large, server computers. Throughout the computing evolution, the
modern desktop has become increasingly complex and costly to administer and
maintain. This situation is further worsened as organizations become more
decentralized with remote employees, and as their desire increases to become
more closely connected with vendors and customers through the Internet.
Lowering Total Cost of Ownership
PC software in general has grown dramatically in size and complexity in recent
years. As a result, the cost of supporting and maintaining PC desktops has
increased substantially. Industry analysts and enterprise users alike have begun
to recognize that the total cost of PC ownership, taking into account the
recurring cost of technical support, administration, security and end-user down
time, has become high, both in absolute terms and relative to the initial
hardware purchase price.
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With increasing demands to control corporate computing costs, industry leaders
are developing technology to address total cost of ownership issues. One
approach, led by Sun Microsystems and IBM, utilizes Java-based network
computers, which operate by downloading small Java programs to the desktop,
which in turn are used for accessing server-based applications. Another approach
is Microsoft's Windows Terminal Services(TM), introduced in June 1998. It
permits server-based Windows applications to be accessed from Windows-based
network computers. Both initiatives are examples of server-based computing. They
simplify the desktop by moving the responsibility of running applications to a
central server, with the promise of lowering total cost of ownership.
Enterprise Cross-Platform Computing
Today's enterprises contain a diverse collection of end user devices, each with
its particular operating system, processing power and connection type.
Consequently, it is becoming increasingly difficult to provide universal access
to business-critical applications across the enterprise. As a result,
organizations resort to emulation software, new hardware or costly application
rewrites in order to provide universal application access.
A common cross-platform problem for the enterprise is the need to access Unix or
Linux applications from a PC desktop. While Unix-based computers dominate the
enterprise applications market, Microsoft Windows-based PCs dominate the
enterprise desktop market. Since the early 1990s, enterprises have been striving
to connect desktop PCs to Unix applications over all types of connections,
including networks and standard phone lines. This effort, however, is complex
and costly. The primary solution to date is known as PC X Server software. PC X
Server software is a large software program that requires substantial memory and
processing resources on the desktop. Typically, PC X Server software is
difficult to install, configure and maintain. Enterprises are looking for
effective Unix connectivity software for PCs and non-PC desktops that is easier
and less expensive to administer and maintain.
Today businesses are exploring alternatives to the Windows desktop. The Linux
desktop is a popular choice as it promises lower acquisition costs and avoids
"single vendor lock-in." The Linux desktop or the Unix desktop, popular in many
engineering organizations, both need to access the large number of applications
written for the Microsoft operating environment, such as Office 2003. Our
technology enables Windows applications to be published to any client device
running our GO-Global client software, including: Linux, Unix, Windows and
Macintosh desktops and devices.
Application Service Providers (ASPs)
With the ubiquitous nature of the Internet, new operational models and sales
channels are emerging. Traditional high-end software packages that were once too
expensive for many companies are now available for rent over the Internet. By
servicing customers through a centralized operation, rather than installing and
maintaining applications at each customer's site, ASPs play an important role in
addressing an enterprise's computing requirements. Today, ASPs are faced with
the difficult task of creating, or rewriting, applications to entertain the
broader market.
Remote Computing
The cost and complexity of contemporary enterprise computing has been further
complicated by the growth in remote access requirements. As business activities
become physically distributed, computer users have looked to portable computers
with remote access capabilities to stay connected in a highly dispersed work
environment. One problem facing remote computing over the Internet, or direct
telephone connections, is the slow speed of communication in contrast to the
high speed of internal corporate networks. Today, applications requiring remote
access must be tailored to the limited speed and lower reliability of remote
connections, further complicating the already significant challenge of
connecting desktop users to business-critical applications.
Our Approach
Our server-based software deploys, manages, supports and executes applications
entirely on the server computer and publishes their user interface efficiently
and instantaneously to desktop devices. The introduction of the Windows-based
version of our Bridges software, during 2000, enabled us to enter the Windows
application market. This allowed us to provide support for Windows applications
to both enterprise customers and to leverage independent software vendors (ISVs)
as a channel. During the fourth quarter of 2002 we introduced GO-Global for
Windows, a significant upgrade to our product offerings in the Windows market.
This new version has increased application compatibility, server scalability and
improved application performance over our previous version.
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Our technology consists of three key components:
o The server component runs alongside the server-based application and is
responsible for intercepting user-specific information for display at the
desktop.
o The desktop component is responsible only for sending keystrokes and mouse
motion to the server. It also presents the application interface to the
desktop user. This keeps the desktop simple, or thin, as well as
independent of application requirements for resources, processing power
and operating systems.
o Our protocol enables efficient communication over fast networks or slow
dial-up connections and allows applications to be accessed from remote
locations with network-like performance and responsiveness.
We believe that the major benefits of our technology are as follows:
o Lowers Total Cost of Ownership. Reducing information technology (IT)
costs is a primary goal of our products. Today, installing enterprise
applications is time-consuming, complex and expensive. It typically
requires administrators to manually install and support diverse desktop
configurations and interactions. Our server-based software simplifies
application management by enabling deployment, administration and
support from a central location. Installation and updates are made
only on the server, thereby avoiding desktop software and operating
system conflicts and minimizing at-the-desk support.
o Supports Strong Information Security Practices. The distributed nature of
most organizations' computing environments makes information security
difficult. Corporate assets in the form of data are often dispersed among
desktop systems. Our server-based approach places the application and data
on servers behind firewalls. This allows the corporation to centrally
manage their applications and data.
o Web Enables Existing Applications. The Internet represents a fundamental
change in distributed computing. Organizations now benefit from
ubiquitous access to corporate resources by both local and remote
users. However, to fully exploit this opportunity, organizations need
to find a way to publish existing applications to Internet enabled
devices. Our technology is specifically targeted at solving this
problem. With GO-Global, an organization can publish an existing
application to an Internet-enabled device without the need to rewrite
the application. This reduces application development costs while
preserving the rich user interface so difficult to replicate in a
native Web application.
o Connects Diverse Computing Platforms. Today's computing infrastructures
are a mix of computing devices, network connections and operating
systems. Enterprise-wide application deployment is problematic due to
this heterogeneity, often requiring costly and complex emulation
software or application rewrites. For example, Windows PCs typically
may not access a company's Unix applications without installing complex
PC X Server software on each PC. Typical PC X Servers are large and
require an information technology professional to properly install and
configure each desktop. For Macintosh, the choices are even fewer,
requiring the addition of yet another vendor product. For the newer
technologies, such as tablet PCs or handheld devices, application
access will be challenging.
To rewrite an application for each different display device (be that a
desktop PC or tablet PC) and their many diverse operating systems is often
a difficult and time-consuming task. In addition to the development
expense, issues of desktop performance, data compatibility and support
costs often make this option prohibitive. Our products provide
organizations the ability to access applications from virtually all
devices, utilizing their existing computing infrastructure, without
rewriting a single line of code or changing or reconfiguring hardware.
This means that enterprises can maximize their investment in existing
technology and allow users to work in their preferred environment.
o Leverages Existing PCs and Deploys New Desktop Hardware. Our software
brings the benefits of server-based computing to users of existing PC
hardware, while simultaneously enabling enterprises to begin to take
advantage of and deploy many of the new, less complex network
computers. This assists organizations in maximizing their current
investment in hardware and software while, at the same time,
facilitating a manageable and cost effective transition to newer
devices.
o Efficient Protocol. Applications typically are designed for
network-connected desktops, which can put tremendous strain on
congested networks and may yield poor, sometimes unacceptable,
performance over remote connections. For ASPs, bandwidth typically is
the top recurring expense when web-enabling, or renting, access to
applications over the Internet. In the wireless market, bandwidth
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constraints limit application deployment. Our protocol sends only
keystrokes, mouse clicks and display updates over the network,
resulting in minimal impact on bandwidth for application deployment,
thus lowering cost on a per user basis. Within the enterprise, our
protocol can extend the reach of business-critical applications to many
areas, including branch offices, telecommuters and remote users over
the Internet, phone lines or wireless connections. This concept may be
extended further to include vendors and customers for increased
flexibility, time-to-market and customer satisfaction.
We also intend to exploit the revenue potential of our NES patent portfolio,
summarized elsewhere herein, by:
o licensing such patents to companies that utilize the technology covered by
such patents in their products or services;
o initiating litigation against those companies who we believe are
infringing such patents and who are unwilling or who refuse to sign
license agreements which provide for royalty payments to us; and
o determining the extent to which the technology covered by the NES patents
has application to our current GO-Global product line and to the
development of new products.
Given our limited cash resources, we intend to prosecute any infringement
litigation that we initiate, as well as defend attempts to declare one or more
of our patents invalid, by engaging law firms on a contingency basis. If we are
able to engage one or more law firms in this manner, as to which we can offer no
assurance, this would reduce our net proceeds from successful litigation.
We anticipate that any cash flow that we are able to derive from our licensing
activities, if not used for working capital in the ordinary course of our
business, will be deployed to develop additional patentable technology.
Products
We are dedicated to creating business connectivity technology that brings
Windows, Unix, and Linux applications to the web without modification. Our
customers include ISVs, Value-Added Resellers (VARs), Application Service
Providers (ASPs) and small to medium-sized enterprises. By employing our
technology, customers benefit from a very quick time to market, overall cost
savings via centralized computing, a client neutral cross-platform solution, and
high performance remote access.
Our product offerings include GO-Global for Windows and GO-Global for Unix.
GO-Global for Windows allows access to Windows applications from remote
locations and a variety of connections, including the Internet and dial-up
connections. GO-Global for Windows allows Windows applications to be run via a
browser from Windows or non-Windows devices, over many types of data
connections, regardless of the bandwidth or operating system. With GO-Global for
Windows, web enabling is achieved without modifying the underlying Windows
applications' code or requiring costly add-ons.
GO-Global for Unix web-enables Unix and Linux applications allowing them to be
run via a browser from many different display devices, over various types of
data connections, regardless of the bandwidth or operating systems being used.
GO-Global for Unix web-enables individual Unix and Linux applications, or entire
desktops. When using Go-Global for Unix, Unix and Linux web enabling is achieved
without modifying the underlying applications' code or requiring costly add-ons.
Target Markets
The target market for our products comprises organizations that need to access
Windows, Unix and/or Linux applications from a wide variety of devices, from
remote locations, including over the Internet, dial-up lines, and wireless
connections. This includes organizations, such as small to medium-sized
companies, governmental and educational institutions, ISVs, VARs and ASPs. Our
software is designed to allow these enterprises to tailor the configuration of
the end user device for a particular purpose, rather than following a "one PC
fits all," high total cost of ownership model. Our opportunity within the
marketplace is more specifically broken down as follows:
o ISVs. By web-enabling their applications, software developers can
strengthen the value of their product offerings, opening up additional
revenue opportunities and securing greater satisfaction and loyalty from
their customers. We believe that ISVs who effectively address the web
computing needs of customers and the emerging ASP market will have a
competitive advantage in the marketplace.
By combining our products with desktop versions of their software
applications, our ISV customers have been able to accelerate the time to
5
market for web-enabled versions of their software applications without the
risks and delays associated with rewriting applications or using third
party solutions. Our technology quickly integrates with their existing
software applications without sacrificing the full-featured look and feel
of their original software application, thus providing ISVs with
out-of-the-box web-enabled versions of their software applications with
their own branding for licensed, volume distribution to their enterprise
customers.
o Enterprises Employing a Mix of Unix, Linux, Macintosh and Windows. Most
major enterprises employ a heterogeneous mix of computing
environments. Small to medium-sized companies that utilize a mixed
computing environment require cross-platform connectivity solutions,
like GO-Global, that will allow users to access applications from
different client devices. It has been estimated that PCs represent
over 90% of enterprise desktops. We believe that our products are well
positioned to exploit this opportunity and that our server-based
software products will significantly reduce the cost and complexity of
connecting PCs to various applications.
o Enterprises With Remote Computer Users. Remote computer users comprise one
of the fastest growing market segments in the computing industry.
Efficient remote access to applications has become an important part of
many enterprises' computing strategies. Our protocol is designed to enable
highly efficient low-bandwidth connections.
o ASPs. High-end software applications in the fields of human resources,
enterprise resource planning, enterprise relationship management and
others, historically have only been available to organizations able to
make large investments in capital and personnel. The Internet has
opened up global and mid-tier markets to vendors of this software who
may now offer it to a broader market on a rental basis. Our products
enable the vendors to provide Internet access to their applications
with minimal additional investment in development implementation.
o VARs. The VAR channel presents an additional sales force for our products
and services. In addition to creating broader awareness of GO-Global, the
VAR channel also provides integration and support services for our current
and potential customers. Our products allow software resellers to offer a
cost effective competitive alternative for Server-Base Thin Client
computing. In addition, reselling our GO-Global software creates new
revenue streams for our VARs through professional services and maintenance
renewals.
o Extended Enterprise Software Market. Extended enterprises allow access to
their computing resources to customers, suppliers, distributors and other
partners, thereby gaining flexibility in manufacturing and increasing
speed-to-market and customer satisfaction. For example, extended
enterprises may maintain decreased inventory via just-in-time,
vendor-managed inventory and related techniques.
The early adoption of extended enterprise solutions may be driven in part by
enterprises' need to exchange information over a wide variety of computing
platforms. We believe that our server-based software products, along with our
low-impact protocol, are well positioned to provide enabling solutions for
extended enterprise computing.
Strategic Relationships
We believe it is important to maintain our current strategic alliances and to
seek suitable new alliances in order to enhance shareholder value, improve our
technology and/or enhance our ability to penetrate relevant target markets. We
also are focusing on strategic relationships that have immediate revenue
generating potential, strengthen our position in the server-based software
market, add complementary capabilities and/or raise awareness of our products
and us.
In July 1999, we entered into a five-year, non-exclusive agreement with Alcatel
Italia, the Italian Division of Alcatel, the telecommunications, network systems
and services company. Pursuant to this agreement, Alcatel has licensed our
GoGlobal thin client PC X server software for inclusion with their Turn-key
Solution software, an optical networking system. Alcatel's customers are using
our server-based solution to access Alcatel's UNIX/X Network Management Systems
applications from T-based PCs. Alcatel has deployed GoGlobal internally to
provide their employees with high-speed network access to their own server-based
software over dial-up connections, local area networks (LANs) and wide area
networks (WANs). Although this agreement expired in July 2004, our relationship
with Alcatel continues as if the contract were still in effect. We anticipate
renewing this agreement during 2005.
In February 2002 we signed a three-year, non-exclusive agreement with Agilent
Technologies, an international provider of technologies, solutions and services
to the communications, electronics, life sciences and chemical analysis
industries. Pursuant to this agreement, we licensed our Unix-based web-enabling
products to Agilent for inclusion in their Agilent OSS Web Center, an operations
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support system that provides access to mission-critical applications remotely
via a secure Internet browser. This agreement was renewed during February 2005
for an additional one-year term.
In June 2002, we amended our distribution agreement with KitASP, a Japanese
application service provider, which was founded by companies within Japan's
electronics and infrastructure industries, including NTT DATA, Mitsubishi
Electric, Omron, RICS, Toyo Engineering and Hitachi, to extend its term through
June 2006 and to afford KitASP, should it achieve certain performance criteria,
an exclusive right, within Japan, to distribute our web-enabling technology,
bundled with their ASP services, and to resell our software.
In March 2004, we entered into our fifth consecutive one-year, non-exclusive
licensing agreement with FrontRange, an international software and services
company. Pursuant to our original agreement, we licensed our Bridges for Windows
server-based software for integration with FrontRange's HEAT help desk software
system. FrontRange has private labeled and completely integrated Bridges for
Windows into its HEAT help desk software as iHEAT. As part of our 2003 renewal
of this agreement, we licensed our GO-Global for Windows server-based software
to FrontRange for integration with both FrontRange's HEAT and its Client
Relationship Management software package Goldmine. We anticipate restructuring
our licensing agreement with FrontRange during 2005.
In September 2003, we amended our non-exclusive licensing agreement with
Compuware, an international software and services company, to afford Compuware
the right to include, for a three year period, our GO-Global for Windows
server-based software with Compuware's UNIFACE software, a development and
deployment environment for enterprise customer-facing applications. Compuware's
customers are using our server-based solution to provide enterprise-level
UNIFACE applications over the Internet. Compuware has private labeled and
completely integrated GO-Global for Windows into its UNIFACE deployment
architecture as UNIFACE Jti.
Sales, Marketing and Support
Our customers, to date, have included small to medium-sized enterprises, ISVs,
VARs and large governmental organizations. Sales to Alcatel, KitASP and
FrontRange represented approximately 20.9%, 14.9% and 14.1%, respectively, of
our revenues in 2004. Sales to FrontRange and Alcatel represented approximately
27.4% and 18.4%, respectively, of our revenues in 2003. We consider KitASP,
Alcatel and FrontRange to be our most significant customers.
Our sales and marketing efforts will be focused on increasing product awareness
and demand among ISVs, ASPs, small to medium-sized enterprises, and VARs who
have a vertical orientation or are focused on Unix, Linux or Windows
environments. Current marketing activities include direct mail, targeted
advertising campaigns, tradeshows, production of promotional materials, public
relations and maintaining an Internet presence for marketing and sales purposes.
Research and Development
Our research and development efforts currently are focused on developing new
products and further enhancing the functionality, performance and reliability of
existing products. We invested $1,500,900, $1,797,200 and $3,129,800 in research
and development in 2004, 2003 and 2002, respectively, including capitalized
software development costs of $0, $282,200 and $298,500, respectively. We have
made significant investments in our protocol and in the performance and
development of our server-based software. We expect investments in research and
development during 2005 to approximate 2004 levels.
Competition
The server-based software market in which we participate is highly competitive.
We believe that we have significant advantages over our competitors, both in
product performance and market positioning. This market ranges from remote
access for a single PC user to server-based software for large numbers of users
over many different types of device and network connections. Our competitors
include manufacturers of conventional PC X server software. Competition is
expected from these and other companies in the server-based software market.
Competitive factors in our market space include; price, product quality,
functionality, product differentiation and breadth.
We believe our principal competitors for our current products include Citrix
Systems, Inc., Hummingbird Communications, Ltd., Tarantella, WRQ, Network
Computing Devices and NetManage. Citrix is the established leading vendor of
server-based computing software. Hummingbird is the established market leader in
PC X Servers. WRQ, Network Computing Devices, and NetManage also offer
traditional PC X Server software.
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Proprietary Technology
We rely primarily on trade secret protection, copyright law, confidentiality and
proprietary information agreements to protect our proprietary technology and
registered trademarks. The loss of any material trade secret, trademark, trade
name or copyright could have a material adverse effect on our results of
operations and financial condition. There can be no assurance that our efforts
to protect our proprietary technology rights will be successful.
Despite our precautions, it may be possible for unauthorized third parties to
copy portions of our products, or to obtain information we regard as
proprietary. We do not believe our products infringe on the rights of any third
parties, but there can be no assurance that third parties will not assert
infringement claims against us in the future, or that any such assertion will
not result in costly litigation or require us to obtain a license to proprietary
technology rights of such parties.
In November 1999, we acquired a U.S. patent for the remote display of Microsoft
Windows applications on Unix and Linux desktops with X Windows. As a result, we
believe that we have acquired patent protection and licensing rights for the
deployment of all Windows applications remoted, or displayed, over a network or
any other type of connection to any X Windows systems. This patent, which covers
our Bridges for Windows (formerly jBridge) technology, was originally developed
by a team of engineers formerly with Exodus Technology and hired by us in May
1998.
Upon our acquisition of NES on January 31, 2005, we acquired the right to 11
patents, all of which were either owned by, or exclusively licensed to NES.
These are primarily method patents that describe software and network
architectures to accomplish certain tasks. Generally, our patents describe:
o methods to collect, store and display information developed and accessed
by users and stored on host computer servers
o methods to provide multiple virtual websites on one computer
o methods to protect computers and computer networks from unauthorized
access
o methods to provide on-line information and directory service
The patents, summarized below, have applicability to computer networks, virtual
private networks and the Internet.
------------------ --------------------- ---------------------------------------------
Patent Date of Grant Scope of Coverage
Number
------------------ --------------------- ---------------------------------------------
5,778,367 July 7, 1998 Automated, network-accessible,
.................. ..................... user-populated database, particularly
6,324,538 November 27, 2001 for the World Wide Web.
.................. .....................
6,850,940 February 1, 2005 " "
(1) (1)
------------------ --------------------- ---------------------------------------------
5,870,550 February 9, 1999 Network-accessible server that hosts
.................. ..................... multiple websites
6,647,422 November 11, 2003 " "
------------------ --------------------- ---------------------------------------------
5,826,014 October 20, 1998 Internet firewall application in which
a "proxy agent" screens incoming
.................. ..................... request from network users and
6,061,798 May 9, 2000 verifies the authority of the incoming
request before permitting access to a
network element.
------------------ --------------------- ---------------------------------------------
5,898,830 April 27, 1999 Firewall computers that act as intermediaries
.................. ..................... between pairs of other computers including
6,052,788 April 18, 2000 control of access to a virtual private
.................. ..................... network.
8
6,751,738 June 15, 2004 " "
.................. .....................
6,804,783 October 12, 2004 " "
------------------ --------------------- ---------------------------------------------
5,790,664 August 4, 1998 Technology for monitoring the license
status of software application(s)
installed on a client computer
------------------ --------------------- ---------------------------------------------
(1) Patent granted on February 1, 2005, subsequent to the acquisition of NES,
thereby increasing the number of issued patents from 11 to 12.
As of February 21, 2005, we have 43 applications for patents filed in the US
Patent Office covering various aspects of methods relating to the submission,
storage, retrieval and security of information stored on computers accessed
remotely, typically through computer networks or the Internet. At that date, the
applications had been pending for various periods ranging from 7 to 55 months.
Of the 43 applications, 41 are continuations of previously issued patents and
two are continuations in part. No applications for patents have been filed in
any non-US jurisdiction.
Operations
Our current staff performs all purchasing, order processing and shipping of our
products and accounting functions related to our operations. Production of
software masters, development of documentation, packaging designs, quality
control and testing are also performed by us. When required by a customer,
CD-ROM and floppy disk duplication, printing of documentation and packaging are
also accomplished through in-house means. We generally ship products
electronically immediately upon receipt of order. As a result, we have
relatively little backlog at any given time, and do not consider backlog a
significant indicator of future performance. Additionally, since virtually all
of our orders are currently being fulfilled electronically, we do not maintain
any prepackaged inventory.
Employees
As of March 15, 2005, we had a total of 23 employees, including five in
marketing, sales and support, 12 in research and development, four in
administration and finance and two in our patent group. We believe our
relationship with our employees is good. No employees are covered by a
collective bargaining agreement.
ITEM 2. PROPERTIES
We currently occupy approximately 1,000 square feet of office space in Santa
Cruz, California. The office space is rented pursuant to a one-year operating
lease, which became effective August 1, 2004. Rent on the Santa Cruz facility is
approximately $1,400 per month.
During October 2004 we renewed our lease for approximately 3,300 square feet of
office space in Concord, New Hampshire, for a one-year term, which is cancelable
upon 30-days written notice by either our landlord or us. Rent on the Concord
facility is approximately $5,300 per month.
We have been occupying leased facilities in Rolling Hills Estates, California on
a month-to-month basis since October 2002. Rent on this office is approximately
$1,000 per month.
We also have been renting a small office in Berkshire, England, United Kingdom
since December 2002. Our current lease runs through December 2005. Rent on this
office, which can fluctuate depending on exchange rates, is approximately $400
per month.
We believe our current facilities will be adequate to accommodate our needs for
the foreseeable future.
ITEM 3. LEGAL PROCEEDINGS
We are currently not party to any legal proceedings that we believe will have a
material negative impact on our operations.
9
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Our 2004 Annual Meeting of Stockholders was held on December 30, 2004. At the
meeting, two directors were reelected to serve for a three-year term. The vote
was as follows:
For Withheld
---------- --------
Robert Dilworth 14,847,998 319,777
August Klein 15,032,643 135,132
The following individuals continue in their capacity as directors: Gordon
Watson and Michael Volker. Their current terms expire during 2005 and 2006,
respectively.
The shareholders also ratified the reappointment of BDO Seidman, LLP as our
independent auditors for fiscal 2004. The vote was as follows:
For Against Abstain
---------- ------- -------
15,075,513 59,902 32,360
Subsequently, in February 2005, the audit committee appointed Macias Gini &
Company LLP as the Company's Independent Registered Public Accounting firm.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS
AND ISSUER PURCHASES OF EQUITY SECURITIES
The following table sets forth, for the periods indicated, the high and low
reported sales price of our common stock. From May 28, 2002 to March 26, 2003,
our common stock was quoted on the Nasdaq SmallCap Market System. Since March
27, 2003 our common stock has been quoted on the Over-the-Counter Bulletin
Board. Our common stock is quoted under the symbol "GOJO."
Fiscal 2004 Fiscal 2003
------------------- -------------------
Quarter High Low High Low
-------- -------- -------- --------
1st $ 1.03 $ 0.20 $ 0.28 $ 0.13
2nd $ 0.93 $ 0.41 $ 0.34 $ 0.13
3rd $ 0.51 $ 0.25 $ 0.28 $ 0.18
4th $ 0.56 $ 0.25 $ 0.28 $ 0.15
On March 30, 2005, there were approximately 165 holders of record of our common
stock. On April 11, 2005, the last reported sales price was $0.36.
During the fourth quarter of 2004, we granted stock options to our two executive
officers to purchase an aggregate of 680,000 shares of common stock at an
exercise price of $0.34 per share. The grant of such stock options to the
executive officers was not registered under the Securities Act of 1933 because
the stock options either did not involve an offer or sale for purposes of
Section 2(a)(3) of the Securities Act, in reliance on the fact that the stock
options were granted for no consideration, or were offered and sold in
transactions not involving a public offering, exempt from registration under the
Securities Act pursuant to Section 4(2).
We have never declared or paid dividends on our common stock. We do not
anticipate paying any cash dividends for the foreseeable future. We currently
intend to retain future earnings, if any, to finance operations and the
expansion of our business. Any future determination to pay cash dividends will
be at the discretion of our Board of Directors and will be dependent upon the
earnings, financial condition, operating results, capital requirements and other
factors as deemed necessary by the Board of Directors.
Information regarding our equity compensation plans, including stockholder
approved plans and plans not approved by stockholders, is set forth in Item 12
of this Annual Report on Form 10-K.
ITEM 6. SELECTED FINANCIAL DATA
The following selected historical financial data should be read in conjunction
with "Management's Discussion and Analysis of Financial Condition and Results of
Operation" and our historical financial statements and the notes thereto
included elsewhere herein. BDO Seidman LLP, independent registered public
accounting firm, has audited our financial statements as of December 31, 2003,
2002, 2001 and 2000, and for the years then ended, from which our respective
10
historical financial data for those years has been derived. Macias Gini &
Company LLP independent registered public accounting firm, has audited our
financial statements as of December 31, 2004 and for the year then ended, from
which our respective historical financial data for that year has been derived.
Statement of Operations Data:
Year Ended December 31,
2004 2003 2002 2001 2000
------------ -------------- ------------- ------------- --------------
(Amounts in thousands, except share and per share data)
--------------------------------------------------------------------------
Revenue $ 3,530 $ 4,170 $ 3,535 $ 5,911 $ 7,567
Costs of revenue 904 1,371 1,680 2,613 1,044
------------ -------------- ------------- ------------- --------------
Gross profit 2,626 2,799 1,855 3,298 6,523
------------ -------------- ------------- ------------- --------------
Operating expenses:
Selling and marketing 1,384 1,680 2,235 5,989 5,750
General and administrative 1,183 1,419 2,801 4,561 4,653
Research and development 1,501 1,515 2,831 4,134 4,060
Asset impairment loss - - 914 4,501 -
Restructuring charge - 80 1,943 - -
------------ -------------- ------------- ------------- --------------
Total operating expenses 4,068 4,694 10,724 19,185 14,463
------------ -------------- ------------- ------------- --------------
Loss from operations (1,442) (1,895) (8,869) (15,887) (7,940)
Other income (expense) 15 8 77 410 (1,434)
------------ -------------- ------------- ------------- ---------------
Loss before provision
for income taxes (1,427) (1,887) (8,792) (15,477) (9,374)
Provision for income taxes - - - 1 1
------------ -------------- ------------- ------------- --------------
Net loss $ (1,427) $ (1,887) $ (8,792) $ (15,478) $ (9,375)
============ ============== ============= ============= ==============
Basic and diluted loss per
common share $ (0.07) $ (0.11) $ (0.50) $ (0.97) $ (0.65)
============ ============== ============= ============= ===============
Weighted average common
shares outstanding 21,307,966 16,607,328 17,465,099 16,007,763 14,396,435
============ ============== ============= ============= ==============
Balance Sheet Data:
As of December 31,
2004 2003 2002 2001 2000
------------ -------------- ------------- ------------- --------------
(Amounts in thousands)
--------------------------------------------------------------------------
Working capital $ (213) $ 284 $ 668 $ 6,173 $ 12,879
Total assets 2,224 2,562 4,550 12,986 21,040
Total liabilities 1,858 1,715 1,820 1,660 1,983
Shareholders' equity 366 847 2,730 11,326 19,057
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION
The following discussion should be read in conjunction with the consolidated
financial statements and related notes provided elsewhere in this Annual Report
on Form 10-K.
Critical Accounting Policies. The preparation of financial statements and
related disclosures in conformity with accounting principles generally accepted
in the United States requires management to make judgments, assumptions and
estimates that affect the amounts reported in the Consolidated Financial
Statements and accompanying notes. The Summary of Significant Accounting
Policies appears in Part II, Item 8 - Financial Statements and Supplementary
Data, of this Form 10-K, which describes the significant accounting polices and
methods used in the preparation of the Consolidated Financial Statements.
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
11
by judgments, assumptions and estimates used in the preparation of the
Consolidated Financial Statements.
Revenue Recognition
Generally, software license revenues are recognized when a non-cancelable
license agreement has been signed and the customer acknowledges an unconditional
obligation to pay, the software product has been delivered, there are no
uncertainties surrounding product acceptance, the fees are fixed or determinable
and collection is considered probable. Delivery is considered to have occurred
when title and risk of loss have been transferred to the customer, which
generally occurs when the media containing the licensed programs is provided to
a common carrier. In the case of electronic delivery, delivery occurs when the
customer is given access to the licensed programs. If collectibility is not
considered probable, revenue is recognized when the fee is collected.
Revenue earned on software arrangements involving multiple elements is allocated
to each element arrangement based on the relative fair values of the elements.
If there is no evidence of the fair value for all the elements in a multiple
element arrangement, all revenue from the arrangement is deferred until such
evidence exists or until all elements are delivered. We recognize revenue from
the sale of software licenses when all the following conditions are 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.
Revenues recognized from multiple-element software arrangements are allocated to
each element of the arrangement based on the fair values of the elements, such
as licenses for software products, maintenance, consulting services or customer
training. The determination of fair value is based on objective evidence. We
limit our assessment of objective evidence for each element to either the price
charged when the same element is sold separately or the price established by
management having the relevant authority to do so, for an element not yet sold
separately. If evidence of fair value of all undelivered elements exists but
evidence does not exist for one or more delivered elements, then revenue is
recognized using the residual method. Under the residual method, the fair value
of the undelivered elements is deferred and the remaining portion of the
arrangement fee is recognized as revenue.
Allowance for Doubtful Accounts
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 us could be adversely affected.
Capitalized Software Development Costs
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 typically
capitalized until the product is available for general release to customers.
Capitalized costs are amortized based on either estimated current and future
revenue for the 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.
Impairment of Intangible Assets
We 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 and
consider restructuring, disposing of, or otherwise exiting businesses, which
could result in an impairment of intangible assets. During 2002 we recorded
significant write-downs to the value of our intangible assets as a result of the
impairment tests performed. A significant consideration impacting the results of
the impairment tests was the substantial delay in getting our most recently
released Windows-based product upgrade, GO-Global for Windows, into marketable
condition. The engineering delays we encountered resulted in a substantial
decrease in our revenue in 2002, which ultimately caused us to consume almost
all of our cash balances in our day-to-day operations.
Loss Contingencies
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 when 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.
12
Stock Compensation
We apply Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock
Issued to Employees" and related interpretations thereof (hereinafter
collectively referred to as APB 25) when accounting for our employee and
directors stock options and employee 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 Statement of Financial Accounting Standards (SFAS) No.
123, "Accounting for Stock-Based Compensation" as amended by SFAS 148
(hereinafter collectively referred to as 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 our stock option plans and
employee stock purchase plan been determined consistent with SFAS 123, our
reported net loss and net loss common per share would have been changed to the
amounts discussed elsewhere in this Form 10-K. See New Accounting
Pronouncements, below, for further details on accounting for stock-based
compensation.
Results of Operations
The first table that follows sets forth our income statement data for the years
ended December 31, 2004 and 2003, respectively, and calculates the dollar change
and percentage change from 2003 to 2004 in the respective line items. The second
table that follows presents the same information for the years ended December
31, 2003 and 2002.
Year Ended
December 31,
------------------- Dollars Percentage
(Dollars in 000s) 2004 2003 Change Change
- ----------------- -------- -------- ------- -------
Revenue $ 3,530 $ 4,170 $ (640) (15.3)%
Cost of revenue 904 1,371 (467) (34.1)
-------- -------- -------
Gross profit 2,626 2,799 (173) (6.2)
-------- -------- -------
Operating expenses:
Selling and marketing 1,384 1,680 (296) (17.6)
General and administrative 1,183 1,419 (236) (16.6)
Research and development 1,501 1,515 (14) (0.9)
Restructuring charges - 80 (80) (100.0)
-------- -------- -------
Total operating expenses 4,068 4,694 (626) (13.3)
-------- -------- -------
Loss from operations (1,442) (1,895) 453 23.9
-------- -------- -------
Other income (expense):
Interest and other income 15 13 2 15.4
Interest and other expense - (5) 5 100.0
-------- -------- -------
Total other income (expense) 15 8 7 87.5
-------- -------- -------
Net loss $ (1,427) $ (1,887) $ 460 24.4%
======== ======== =======
Year Ended
December 31,
------------------- Dollars Percentage
(Dollars in 000s) 2003 2002 Change Change
- ----------------- -------- -------- -------- -------
Revenue $ 4,170 $ 3,535 $ 635 18.0
Cost of revenue 1,371 1,680 (309) (18.4)
-------- -------- --------
Gross profit 2,799 1,855 (944) (50.9)
-------- -------- --------
Operating expenses:
Selling and marketing 1,680 2,235 (555) (24.8)
General and administrative 1,419 2,801 (1,382) (49.3)
Research and development 1,515 2,831 (1,316) (46.5)
Asset impairment loss - 914 (914) (100.0)
Restructuring charges 80 1,943 (1,863) (95.9)
-------- -------- --------
Total operating expenses 4,694 10,724 (6,030) (56.2)
-------- -------- --------
Loss from operations (1,895) (8,869) 6,974 78.6
-------- -------- --------
13
Other income (expense):
Interest and other income 13 153 (140) (91.5)
Interest and other expense (5) (76) 71 (93.4)
-------- -------- --------
Total other income (expense) 8 77 (69) (89.6)
-------- -------- --------
Net loss $ (1,887) $ (8,792) $ 6,905 78.5%
======== ======== ========
Revenue. Our revenue is primarily derived from product licensing fees and
service fees from maintenance contracts. Other sources of revenue include
private labeling fees and sales of software development kits. Private labeling
fees are derived when we contractually agree to allow a customer to brand our
product with their name. We defer these fees upon contract signing and recognize
the revenue ratably over the initial term of the contract. Software development
kits are tools that allow end users to develop, interface and brand their own
applications for use in conjunction with either our Windows or Unix/Linux
products. Currently, we do not generate a significant amount of revenue from
private labeling transactions, nor do we anticipate generating a significant
amount of revenue from them or from the sale of software development kits during
2005.
The first table that follows summarizes product licensing fees for the years
ended December 31, 2004 and 2003, respectively and calculates the change in
dollars and percentage from 2003 to 2004 in the respective line item. The second
table that follows presents the same information for the years ended December
31, 2003 and 2002, respectively.
Year Ended December 31, Increase/(Decrease)
------------------------ -----------------------
Product licensing fees 2004 2003 Dollars Percentage
- ---------------------- ----------- ----------- ---------- ----------
Windows $ 1,361,600 $ 1,649,000 $ (287,400) (17.4%)
Unix/Linux 1,033,600 1,523,100 (489,600) (32.1)
----------- ----------- ----------
Total $ 2,395,200 $ 3,172,100 $ (777,000) (24.5%)
=========== =========== ==========
2003 2002 Dollars Percentage
----------- ----------- ---------- ----------
Windows $ 1,649,000 $ 1,394,200 $ 254,800 18.3%
Unix/Linux 1,523,100 1,547,800 (24,700) (1.6)
----------- ----------- ----------
Total $ 3,172,100 $ 2,942,000 $ 230,100 7.8%
=========== =========== ==========
The majority of our product licensing fees has been realized from a limited
number of customers. As such, product licensing fees revenue has varied,
sometimes substantially, from quarter to quarter and year to year. We expect our
quarterly product licensing fees revenue to continue to vary during 2005.
During 2004, one of our significant ISV customers informed us that they would
begin selling our Windows-based products as an add-on to their software
applications products, instead of bundling our products with theirs, as had been
done previously. Sales to this customer declined by approximately $419,000 in
2004 from 2003, and were the primary contributing factor to our overall decline
in Windows product licensing fees. Partially offsetting this decrease was the
recognition of approximately $188,000 of revenue from a Windows product
licensing sale that we had originally recorded as a deferred item during
December of 2003 because not all of the criteria for revenue recognition had
been met. Once all the criteria were met, in early 2004, we recognized this
revenue.
Approximately $302,800 of the decrease in 2004 Unix/Linux product licensing fee
revenue was due to a one-time sale to a governmental end-user, which occurred
during 2003. The majority of the remaining 2004 decrease was due to the
aggregate variations in our other customers' sales orders.
Our customers' response to the release of the significantly upgraded version of
our Windows product, GO-Global for Windows, during the fourth quarter of 2002
was a significant contributing factor to the increase in 2003 of Windows product
licensing fees from 2002.
During the fourth quarter of 2002, we entered into a significant one-time
transaction with a customer that generated approximately $552,500 of Unix
product licensing fee revenue. Net of this transaction, 2003 revenue from Unix
product licensing fees increased by approximately $527,800, or 53.0%, from 2002
levels. Approximately $300,000 of this increase came from one long-standing Unix
ISV customer.
During 2004, we recognized approximately $1,015,000 of revenue from service
fees, an increase of $184,100, or approximately 22.2% from the approximately
$830,900 recognized during 2003. This increase has primarily resulted from
continued increases in sales of maintenance contracts to our Windows customers
resulting from the release of GO-Global for Windows during the fourth quarter of
2002.
14
During 2004, we recognized approximately $119,600 of revenue from other items, a
decrease of $47,700, or approximately 28.5%, from the approximately $167,300
recognized during 2003. The decrease was primarily due to a $150,000 decrease in
distributor fee revenue, which was partially offset by $100,000 of revenue
recognized from the sale of a software development kit. We had signed a $300,000
two-year distribution agreement with our distributor in Japan and had been
ratably recognizing the distributor fee as revenue over the underlying initial
two-year term, which expired on December 31, 2003. The sale of the software
development kit was a one-time transaction and we do not currently anticipate
selling another kit during 2005.
During 2003, we recognized approximately $830,900 of revenue from service fees,
an increase of $388,700, or 87.9%, from the approximately $442,200 recognized
during 2002. The increase was primarily attributable to an increased level of
sales of maintenance contracts, which began when we introduced our GO-Global for
Windows product during the fourth quarter of 2002. Additionally, we sold
approximately $300,000 worth of maintenance contracts as part of the large Unix
transaction that we entered into during the fourth quarter of 2002, (discussed
above), that are being amortized over a three-year period. A negligible amount
of service fees from this transaction was recognized as revenue during 2002 as
compared with approximately $100,000, or one full-year's worth, during 2003.
During 2003, we recognized approximately $167,300 of revenue from other items,
an increase of $16,500, or approximately 10.9%, from the approximately $150,800
recognized during 2002. The increase was primarily due to the recognition of
private labeling revenue derived from two customers. If customers, typically
ISVs, wish to brand our product with their name, we charge them a private
labeling fee, which we recognize as revenue, ratably, over a three-year period.
We anticipate that many of our customers will enter into, and periodically
renew, maintenance contracts to ensure continued product updates and support.
Revenue from maintenance contracts was approximately 28.8%, 19.9% and 12.5% of
revenue in 2004, 2003 and 2002, respectively. We expect revenue from maintenance
contracts in 2005 to approximate 2004 levels.
Sales to our three largest customers for 2004 represented approximately 20.9%,
14.9% and 14.1%, respectively, of total revenue. These three customers' December
31, 2004 year-end accounts receivable balances represented approximately 30.9%,
2.9% and 0.0% of reported net accounts receivable. By March 16, 2005, we had
collected the majority of these outstanding balances.
Sales to our three largest customers for 2003 represented approximately 27.4%,
18.4% and 9.2%, respectively, of total revenue. These three customers' December
31, 2003 year-end accounts receivable balances represented approximately 0.0%,
28.0%, and 44.1% of reported net accounts receivable. By March 18, 2004, we had
collected the majority of these outstanding balances.
Cost of Revenue. Cost of revenue consists primarily of the amortization of
acquired technology and the amortization of capitalized technology developed
in-house. Also included in cost of revenue are the costs of servicing
maintenance contracts. Research and development costs for new product
development, after technological feasibility is established, are recorded as
"capitalized software" on our balance sheet and subsequently amortized as cost
of revenue over the shorter of three years or the remaining estimated life of
the products.
The decreases in cost of revenues in 2004 from 2003 and in 2003 from 2002 were
due primarily to certain elements of our acquired technology becoming fully
amortized during 2003, additional elements becoming fully amortized during 2004
and the write-downs of the estimated remaining carrying values of our intangible
assets that were recorded during the third quarter of 2002.
As more fully explained below under Asset Impairment Loss, during September 2002
we wrote down the historical cost of various components of our purchased
technology assets as part of our periodic assessments of asset impairment. The
amortization of our technology assets, as explained above, is recorded as a
component of Cost of Revenue.
Based on our current product development plan and as a result of our intangible
assets becoming fully amortized during 2004, we expect that our cost of revenue
will be significantly lower in 2005 as compared with 2004. Cost of revenue was
approximately 25.6%, 32.9% and 47.5% of total revenues for the years 2004, 2003
and 2002, respectively.
Sales and Marketing Expenses. Sales and marketing expenses primarily consist of
salaries and related benefits, sales commissions, outside consultants, travel
expenses, trade show related activities and promotional costs.
The decrease in sales and marketing expenses in 2004 from 2003 was primarily
caused by decreased salaries, benefits and commissions ($240,600) and facilities
allocations ($170,200), which were partially offset by an increase in outside
consultants ($123,300). The reasons for these changes were as follows:
15
o The decrease in salaries, benefits and commissions was the result of
terminating two people during late 2003 and two during 2004.
o The decrease in facilities allocation was the result of the 2003
terminations. All of the sales and marketing employees who had been
sharing space with general and administrative employees at our
corporate headquarters location were terminated during 2003.
Accordingly, the allocation of overhead costs to sales and marketing
ceased.
o The increase in outside consultants was a result of outsourcing
marketing work upon the 2003 terminations.
The decrease in sales and marketing expenses in 2003 from 2002 was primarily
caused by decreased human resources costs ($392,900), trade show activities and
promotional costs ($134,300) and travel and entertainment ($62,600). Partially
offsetting these decreases was an increase in outside consulting services
($115,800). The reasons for these changes were as follows:
o The decrease in human resources costs was the result of the
restructurings made during 2002 and was reflected for a full year in
2003.
o The decrease in trade shows activities and promotional costs was part
of our decision made in 2002 to cut these costs to a minimal level
while using our remaining cash on strategic engineering initiatives.
o The decrease in travel and entertainment was due to the reductions in
head count made in 2002 as well as prioritizing the engineering
initiatives over sales and marketing activities.
o The increase in outside consulting services reflected the hiring of a
marketing firm to assist with marketing efforts during 2003, once
various elements of the engineering initiatives reached completion.
We expect that cumulative sales and marketing expenses in 2005 will approximate
those incurred during 2004. Sales and marketing expenses were approximately
39.2%, 40.3% and 63.2% of total revenues for the years 2004, 2003 and 2002,
respectively.
General and Administrative Expenses. General and administrative expenses
primarily consist of salaries and related benefits, legal and professional
services, insurance, costs associated with being a publicly held company and bad
debts expense.
General and administrative expense decreased in 2004 from 2003 primarily because
of decreased facilities allocations ($152,900) and decreased directors and
officers insurance ($103,100). The reasons for these decreases were as follows:
o Our overhead structure was greatly reduced when we consummated a
buy-out of our former lease for our corporate headquarters facilities
at 400 Cochrane Circle, Morgan Hill, CA. This facility had been
approximately 14,000 square feet. Since October 2003, we have
maintained our corporate offices in approximately 1,000 square feet of
space.
o Our directors and officers insurance expense was lower in 2004 than
2003 because we did not renew our policy upon its expiration in 2003.
The decrease in general and administrative expenses in 2003 from 2002 was
primarily caused by decreased outside services ($446,000), legal fees
($324,800), deferred compensation ($187,400), directors and officers insurance
($158,600), travel and entertainment ($141,000) and human resources costs
($173,100). The reasons for these decreases were as follows:
o We abandoned the merger talks we had conducted throughout 2002 with
three related entities in the telecommunications industry, thus
reducing our needs for general and administrative outside services
during 2003. Also contributing to lower outside consulting fees during
2003 were lower fees charged by our Interim Chief Executive Officer.
o As a result of the abandonment of the merger talks, we also reduced the
need for legal services.
o The decrease in deferred compensation expense was because the amounts
previously deferred became fully amortized during 2002.
o In addition to our 2002 restructurings, we also aggressively reduced
costs during 2002, including the costs of our directors and officers
insurance. Upon its renewal for the 2002/2003 policy year, we reduced
the policy's coverage by approximately 40% and then discontinued it
entirely upon its expiration in June 2003.
o Travel and entertainment and human resource costs were lower in 2003 as
a result of the reduction in headcount experienced as part of the
restructurings that occurred in 2002.
The ending balance of our allowance for doubtful accounts as of December 31,
2004, 2003 and 2002, was $46,800, $46,800 and $50,300, respectively. Bad debts
expense was $0, $16,300 and $31,600 for the years ended December 31, 2004, 2003
and 2002, respectively.
16
We anticipate that cumulative general and administrative expense in 2005 will
exceed those incurred during 2004 primarily due to the costs we expect our newly
initiated patent group to incur as they begin exploring viable means of
commercially exploiting the NES patent portfolio. General and administrative
expenses were approximately 33.5%, 34.0% and 79.2% of 2004, 2003 and 2002 total
revenues, respectively.
Research and Development Expenses. Research and development expenses consist
primarily of salaries and related benefits paid to software engineers, payments
to contract programmers, and facility expenses related to our remotely located
engineering offices.
Research and development expense for 2004 approximated 2003 levels, as reported.
Research and development expense for 2003 does not include approximately
$149,100 of wages and related costs and $133,100 of outside consulting services
related to software development costs that were capitalized during 2003. No such
costs were capitalized during 2004.
The decrease in research and development expense in 2003 from 2002 was primarily
caused by decreased human resources costs ($693,500), depreciation of fixed
assets ($130,100), rent ($113,000), the allocation of corporate overheads
($78,000), outside consultants ($38,100) and an increase in customer service
costs ($144,600). The reasons for these changes were as follows:
o Human resources costs were decreased as a result of the 2002
restructuring. We began 2002 with 28 research and development employees
and ended the year with 15. No changes were made to research and
development headcount during 2003.
o The decrease in depreciation expense was due to the timing of various
assets reaching the end of their estimated useful lives, as well as an
overall decrease in the asset base that resulted from the 2002 and 2001
restructuring charges.
o The decrease in rent was primarily due to the negotiated settlement of
the lease on our former Bellevue, Washington engineering offices.
o The allocation of corporate overheads decreased as a result of the
headcount reductions as well as the overall lowered cost structure
resulting from the 2002 and 2001 restructurings.
o The reduction in outside consultants was primarily due to the
non-renewal of an engineering consultant's contract as the requested
work had been completed.
o Customer service costs consist primarily of wages and benefits paid to
various engineers and are charged to cost of sales instead of being
charged to research and development. More engineering time was spent
providing customer service during 2003, as compared to 2002,
consequently, more costs were charged to cost of sales than to research
and development.
We believe that a significant level of investment for research and development
is required to remain competitive. Accordingly, during 2005 we will continue
working towards our goal of full maturity for our products through a combination
of in-house and contracted research and development efforts. We anticipate that
these efforts will include a combination of enhancing the functionality of our
current product offerings and adding additional features to them. We expect
research and development expenditures in 2005 to approximate 2004 levels.
Research and development expense was approximately 42.5%, 36.3% and 80.1% of
total revenues for the years 2004, 2003 and 2002, respectively.
Asset Impairment Loss. During 2002 we recorded an asset impairment charge of
$914,000 against several of our intangible assets, primarily capitalized
technology assets. We review our long-lived assets for impairment whenever
events or changes in circumstances indicate that the carrying amount of an asset
may not be recoverable. Examples of events or changes in circumstances that
indicate that the recoverability of the carrying amount of an asset should be
addressed, including the following:
o A significant decrease in the market value of an asset;
o A significant change in the extent or manner in which an asset is used;
o A significant adverse change in the business climate that could affect the
value of an asset; and
o Current and historical operating or cash flow losses.
We believed that a review of our carrying values in 2002 to evaluate whether the
value of any of our long-lived technology assets had been impaired was
warranted, due to several factors, including:
o The challenges we faced in bringing our GO-Global for Windows and
GO-Global:XP products to maturity;
o The continued pervasive weakness in the world-wide economy;
o How we were incorporating and planning to incorporate each element of the
purchased technologies into our legacy technology;
o Our continued and historical operating and cash flow losses.
17
Based on studies of the various factors affecting asset impairment, as outlined
above, the following asset impairment charges were determined to be necessary in
order to reduce the carrying value of certain of these assets to our current
estimate of the present value of the expected future cash flows to be derived
from these assets:
Net Book Value Impairment Net Book Value
Before Impairment Write Down After Impairment
------------------ -------------- ------------------
Purchased Technology $ 2,145,200 $ 775,100 $ 1,370,100
Capitalized Software 277,800 138,900 138,900
------------------ -------------- ------------------
Totals $ 2,423,000 $ 914,000 $ 1,509,000
================== ============== ==================
The asset impairment charges were approximately 0.0%, 0.0% and 25.9% of total
revenues for the years 2004, 2003 and 2002, respectively. We do not anticipate
recording an asset impairment charge during 2005.
Restructuring charges. During 2002 we closed our Morgan Hill, California and
Bellevue, Washington office locations as part of our strategic initiatives to
reduce operating costs. In conjunction with these closures, we reduced headcount
in all of our operating departments and wrote off the costs of leasehold
improvements and other assets that were abandoned. A summary of the
restructuring charge recorded during 2002 is as follows:
December 31, 2002
Ending Balance
Restructuring Cash Non-cash Restructuring
Category Charge Payments Charges Accrual
- -------- ------------- -------------- ------------ ---------------
Year ended December 31, 2002:
Employee severance $ 831,000 $ (831,000) $ - $ -
Fixed assets abandonment 657,800 - (657,800) -
Minimum lease payments 443,800 (161,600) - 282,200
Other 10,200 (10,200) - -
------------- -------------- ------------ ---------------
Totals $ 1,942,800 $ (1,002,800) $ (657,800) $ 282,200
============= ============== ============ ===============
During 2003 we negotiated settlements of the leases for our former offices in
Bellevue, Washington and Morgan Hill, California, which completed the
restructuring activities that had been approved under Emerging Issues Task Force
(EITF) 94-3, "Liability Recognition for Certain Employee Termination Benefits
and Other Costs to Exit an Activity (Including Certain Costs Incurred in a
Restructuring)," during 2002 and had begun in 2002, as explained above.
Additionally, we relocated our Morgan Hill, California offices from 400 Cochrane
Circle to 105 Cochrane Circle and further disposed of certain assets that were
no longer in service. To the extent that the December 31, 2002 ending
restructuring charge accrual balance was less than the costs incurred for these
activities, we recorded an additional restructuring charge during 2003. A
summary of the restructuring charge recorded during 2003 is as follows:
December 31, 2003
Ending Balance
Restructuring Cash Non-cash Restructuring
Category Charge Payments Charges Accrual
- -------- ------------- ------------- ------------- --------------
Year ended December 31, 2003:
Opening accrual balance $ - $ - $ - $ 282,200
Fixed assets abandonment 42,200 - (42,200) -
Leases settlements - rent 36,800 (269,000) - (232,200)
Deposits forfeited 16,000 - (56,000) (40,000)
Commissions 12,000 (22,000) - (10,000)
Other (1) (26,900) - 26,900 -
-------------- ------------- ------------- --------------
Totals $ 80,100 $ (291,000) $ (71,300) $ -
============= ============= ============= ==============
(1) Includes the write-off of deferred rent associated with the Morgan Hill
lease and other miscellaneous items.
During June 2003, we negotiated a buy out of the lease for our former
engineering offices in Bellevue, Washington. The total buy out price was
approximately $184,000 and consisted of a lump-sum cash payment of $144,000, the
forfeiture of an approximate $40,000 security deposit and a $10,000 commission
to the real estate broker who was involved in the transaction. It is estimated
that the buy out saved approximately $355,800 over the contractually scheduled
lease term.
18
During August 2003, we negotiated a buy out of the lease for our former
corporate offices in Morgan Hill, California. 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. It is estimated
that the buy out saved approximately $270,000 over the contractually scheduled
lease term.
The net aggregate amount of the annual lease payments made under all of our
leases in the years 2004, 2003 and 2002, excluding lease buyout payments, was
approximately $95,700, $295,400 and $525,700, respectively.
Interest and Other Income. During 2004, 2003 and 2002, the primary component of
interest and other income was interest income derived on excess cash. Our excess
cash was held in relatively low-risk, highly liquid investments, such as U.S.
Government obligations, bank and/or corporate obligations rated "A" or higher by
independent rating agencies, such as Standard and Poors, or interest bearing
money market accounts with minimum net assets greater than or equal to one
billion U.S. dollars.
The increase in interest income in 2004 from 2003 was primarily due to interest
income accrued on our note receivable ($3,000), which was partially offset by
lower interest income on excess cash due to lower amounts of excess cash in 2004
as compared with 2003. The decrease in interest income in 2003 from 2002 was due
to lower average cash and cash equivalents, and available-for-sale securities
balances in 2003 as compared with 2002. Additionally, the decrease was
reflective of a decrease in our portfolio's average yield rate, which reflected
the market's response to the cuts and subsequent stabilization made in interest
rates by the Federal Reserve during these time periods.
The lower cash and cash equivalents balance at year end 2004, as compared with
year end 2003, is primarily due to the outflow of approximately $620,000
resulting from operating activities. As more fully explained under Liquidity and
Capital Resources, we have been consuming cash in our operations and have seen
our cash reserves continually decline for the past several years. Interest and
other income was approximately 0.4%, 0.3% and 4.3% of total revenues for the
years 2004, 2003 and 2002, respectively.
Interest and Other Expense. Interest and other expense has historically
consisted primarily of the cost of accrued interest on bonds and other
investments that we purchased with our excess cash. However we incurred no such
interest and other expense during 2004 as all of our excess cash was maintained
in a highly-liquid money market account and we purchased no bonds. The decrease
in 2003 from 2002 was primarily due to our discontinuance of purchasing bonds
with our excess cash.
Interest and other expense was approximately 0.0%, 0.1% and 2.2% of total
revenues for the years 2004, 2003 and 2002, respectively.
Provision for Income Taxes. At December 31, 2004, we had approximately
$41,464,000 in federal net operating loss carryforwards. The federal net
operating loss carryforwards will expire at various times from 2007 through
2020, if not utilized. In addition, the Tax Reform Act of 1986 contains
provisions that may limit the net operating loss carryforwards available for use
in any given period upon the occurrence of various events, including a
significant change in ownership interests. In 1998, we experienced a "change of
ownership" as defined by the provisions of the Tax Reform Act of 1986. As such,
our utilization of our net operating loss carryforwards through 1998 will be
limited to approximately $400,000 per year until such carryforwards are fully
utilized or expire.
Liquidity and Capital Resources
We are continuing to operate the business on a cash basis by striving to bring
our cash expenditures in line with our revenues. We are simultaneously looking
at ways to improve or maintain our revenue stream. Additionally, we continue to
review potential merger opportunities as they present themselves to us and at
such time as a merger might make financial sense and add value for our
shareholders, we will pursue that merger opportunity. We believe that improving
or maintaining our current revenue stream, coupled with our cash on hand,
including the cash raised in the 2005 private placement will sufficiently
support our operations during 2005.
On January 29, 2004, we completed a private placement, which raised a total of
$1,150,000 through the sale of 5,000,000 shares of common stock and five-year
warrants to purchase 2,500,000 shares of common stock (the "2004 private
placement"). Net proceeds of approximately $930,000, as well as other working
capital items, were used to fund our operations during 2004.
On February 2, 2005, we completed a private placement, which raised a total of
$4,000,000 (inclusive of a $665,000 credit as described below) through the sale
of 148,148 shares of Series A preferred stock and five-year warrants to purchase
74,070 shares of Series B preferred stock (the "2005 private placement"). In a
contemporaneous transaction, we acquired NES for 9,600,000 shares of common
stock, the assumption of approximately $235,000 of NES' indebtedness and the
reimbursement to AIGH Investment Partners, LLC ("AIGH"), an affiliate of a
principal stockholder (Orin Hirschman), of $665,000 for its advance on our
19
behalf of a like sum in December 2004 to settle certain third party litigation
against NES. We reimbursed the advance through a partial credit against the
price of our securities acquired by Mr. Hirschman in the 2005 private placement.
Our net proceeds from the 2005 private placement were approximately $2,000,000,
after giving effect to:
o our issuance of a $665,000 partial credit against the price of our
securities acquired by Mr. Hirschman in the 2005 private placement;
o our assumption of approximately $235,000 of NES' indebtedness;
o our payment of NES' legal fees and expenses of approximately $108,000;
o our payment of professional fees and expenses of approximately $692,000,
which we incurred in the NES acquisition;
o our payment of Mr. Hirschman's legal fees and expenses of approximately
$108,000;
o a fee paid to Griffin Securities Inc. in the amount of $50,000 in
connection with the 2005 private placement; and
o our payment of professional fees and expenses of approximately $142,000,
which we incurred in the 2005 private placement.
Pursuant to the terms of an agreement with the purchasers of the securities in
the 2005 private placement, we have agreed to prepare and file with the SEC a
registration statement covering the resale of shares of our common stock
underlying the Series A preferred stock and the Series B preferred stock. In
addition, under the terms of an agreement entered into in connection with the
NES acquisition, we agreed to register the shares of common stock issued in the
NES acquisition.
During 2004 we consumed $863,000 of cash in our operating activities. This
consumption of cash related primarily to our net loss of $1,427,500, which
included non-cash charges, primarily depreciation and amortization of $664,700,
interest accrued on our directors' notes of $1,400 and an aggregate decrease in
cash flow from our operating assets and liabilities of $98,800. We consumed
$435,500 of cash in our investing activities, primarily resulting from a
$350,000 increase in note receivable - related party, a $59,200 increase in
deferred acquisition costs, (both of which were related to our acquisition of
NES), the purchase of approximately $33,400 of fixed assets and a $7,100
reduction in other assets. We generated positive financing cash flows of
$947,300. These cash flows primarily related to net proceeds from the 2004
private placement of $931,400, proceeds from the exercise of warrants issued as
part of the 2004 private placement of $6,900 and the proceeds of sales of common
stock to our employees under the provisions of our employee stock purchase plan
of $9,000.
During 2003 we consumed $710,800 of cash in our operating activities. This
consumption of cash related primarily to our net loss of $1,886,600, which
included non-cash charges, primarily depreciation and amortization of
$1,248,400, the write-off of fixed assets abandoned as part of our 2003
restructuring of $42,200, the loss on assets disposed in our normal operations
of $4,300, which were partially offset by a decrease in our provision for
doubtful accounts of $3,500, and an aggregate decrease in cash flow from our
operating assets and liabilities of $115,600. We consumed $225,700 of cash in
our investing activities, resulting primarily from the capitalization of
software development costs of $282,200 and the purchase of fixed assets of
$1,600, which were partially offset by a $58,100 decrease in other assets. We
generated positive financing cash flows of $2,800, resulting from the proceeds
of the sale of common stock to our employees under the provisions of our
employee stock purchase plan.
Cash and cash equivalents
As of December 31, 2004, cash and cash equivalents were approximately $675,300
as compared with $1,025,500 at December 31, 2003. The $350,200 decrease was
primarily due to the cash consumed by our operations, partially offset by the
net proceeds of the 2004 private placement. We anticipate that our cash and cash
equivalents as of December 31, 2004, and the net proceeds from the 2005 private
placement, together with revenue from operations will be sufficient to fund our
anticipated expenses, inclusive of those that will be attributable to taking
steps to realize the maximum value of the patents we acquired from NES, during
the next twelve months. However, due to the inherent uncertainties associated
with predicting future operations, there can be no assurances that these
resources will be sufficient to fund our anticipated expenses during the next
twelve months.
Accounts receivable, net
At December 31, 2004, we had approximately $518,900 in accounts receivable, net
of allowances totaling $46,800. The net accounts receivable were virtually the
same as the approximately $521,000, net of the $46,800 allowance we reported at
December 31, 2003. We did not write off any receivables during 2004. From time
to time, we could maintain individually significant accounts receivable balances
from one or more of our significant customers. If the financial condition of any
of these significant customers should deteriorate, our operating results could
be materially adversely affected.
20
Commitments and contingencies
On December 10, 2004 we entered into an agreement (the "Reimbursement
Agreement") with AIGH pursuant to which we agreed to reimburse AIGH $665,000, as
well as its legal fees and expenses, relating to its successful efforts to
settle certain third party litigation against NES and certain affiliates of NES.
The third party litigation was brought against NES by one of its creditors.
Our obligation to reimburse AIGH was contingent upon several conditions,
including the consummation of the NES acquisition, the completion of the 2005
private placement, and our receipt of an assignment of the rights to NES'
intellectual property, which were held by AIGH, and was to be satisfied within
five business days of the occurrence of the contingencies. Since these events
had not occurred as of December 31, 2004 we did not recognize a liability on our
balance sheet for the Reimbursement Agreement. In January 2005, upon the
consummation of these contingencies, we credited the $665,000 owed to AIGH
against Mr. Hirschman's approximate $820,000 investment in the 2005 private
placement.
We have no material capital expenditure commitments for the next twelve months.
The following table discloses our contractual commitments for future periods,
which consist entirely of leases for office space, as previously discussed and
assumes that we will occupy all current leased facilities for the full term of
the underlying leases:
Year ending December 31,
------------------------
2005 $ 62,600
2006 and thereafter $ -
Rent expense aggregated approximately $95,700, $295,400 and $525,700 in fiscal
2004, 2003 and 2002, respectively.
New Accounting Pronouncements
In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS
No. 123R, "Share-Based Payment," which requires companies to expense the value
of employee stock options and similar awards. SFAS No. 123R is effective as of
the beginning of the first annual reporting period that begins after June 15,
2005. As of the effective date, we will be required to expense all awards
granted, modified, cancelled or repurchased as well as the portion of prior
awards for which requisite service has not yet been rendered, based on the
grant-date fair value of those awards as calculated for pro forma disclosures
under SFAS No. 123 "Stock-Based Compensation." We will apply SFAS No. 123R using
a modified version of prospective application. Under this method, compensation
cost is recognized on or after the required effective date for the portion of
outstanding awards for which the requisite service has not yet been rendered,
based on the grant-date fair value of those awards calculated under SFAS No. 123
for either recognition or pro forma disclosures.
Benefits of tax deductions in excess of recognized compensation cost are
required by SFAS 123R to be reported as a financing cash flow, rather than as an
operating cash flow as required under current literature. This requirement will
reduce net cash flows from operations and increase cash flows from financing in
periods after adoption. The adoption of SFAS 123R will have an impact on our
results of operations; however, we cannot currently estimate what the impact
will be because, among other things, it will depend on the levels of share-based
payments granted in the future. We are currently in the process of determining
the effects on our financial position, results of operations and cash flows that
will result from the adoption of SFAS 123R.
Risk Factors
The risks and uncertainties described below are not the only ones facing our
company. Additional risks and uncertainties not presently known to us, or risks
that we do not consider significant, may also impair our business. This document
also contains forward-looking statements that involve risks and uncertainties,
and actual results may differ materially from the results we discuss in the
forward-looking statements. If any of the following risks actually occur, they
could have a severe negative impact on our financial results and stock price.
We Have A History Of Operating Losses And Expect These Losses To Continue, At
Least For The Near Future.
We have experienced significant losses since we began operations. We expect to
continue to incur losses at least for the near future. We incurred net losses of
approximately $1,427,500, $1,886,600 and $8,792,500 for the years ended December
31, 2004, 2003 and 2002, respectively. Our expenses will increase as we begin
our efforts to commercially exploit the patents we acquired in the NES
acquisition; however, we cannot give assurance that revenues will increase
sufficiently to exceed costs. We do not expect to be profitable in 2005. In
future reporting periods, if revenues grow more slowly than anticipated, or if
operating expenses exceed expectations, we may not become profitable. Even if we
become profitable, we may be unable to sustain profitability.
21
If We Are Unable To Generate A Positive Cash Flow From Operations, Or Are
Unsuccessful In Securing External Means of Financing, We May Not Be Able
To Continue Our Operations.
We have not been able to generate positive cash flow from our operations and
have been financing our operations primarily from the cash raised when we called
various warrants in 1999 and 2000, and from selling common and preferred stock
in private placements. We believe that we have sufficient cash to meet our
operating needs throughout 2005 and the first few reporting periods of 2006 with
the cash we raised in the 2005 private placement and the cash we had on hand as
of December 31, 2004. However, if we were unable to generate positive cash flow
from our operations in future periods or were unable to raise external sources
of financing, we might need to discontinue our operations entirely.
We May Not Realize the Anticipated Benefits of Acquiring NES.
We acquired NES in January 2005 with the anticipation that we would realize
various benefits, including, among other things, expansion of our product
offerings, enhancement of our current product line, ownership of 11 issued
patents and another 43 patent applications in process. We may not fully realize
some or all of these benefits and the acquisition may result in the diversion of
management time and cash resources to the detriment of our core software
business. Costs incurred and liabilities assumed in connection with this
acquisition could also have an adversely impact our future operating results.
Our Revenue Is Typically Generated From A Very Limited Number Of
Significant Customers.
A material portion of our revenue during any reporting period is typically
generated from a very limited number of customers. Consequently, if any of these
significant customers reduce their order level or fail to order during a
reporting period, our revenue could be materially adversely impacted.
Several of our significant customers are ISVs who have bundled our products with
theirs to sell as web-enabled versions of their products. Other significant
customers include distributors who sell our products directly. We do not control
our significant customers. Some of our significant customers maintain
inventories of our products for resale to smaller end-users. If they reduce
their inventory of our products, our revenue and business could be materially
adversely impacted.
If We Are Unable To Develop New Products And Enhancements To Our Existing
Products, Our Business, Results Of Operations And Financial Condition
Could Be Materially Adversely Impacted.
Our future success depends on our ability to continually enhance our current
products and develop and introduce new products that our customers choose to
buy. If we are unable to satisfy our customers' demands and remain competitive
with other products that could satisfy their needs by introducing new products
and enhancements, our business, results of operations and financial condition
could be materially adversely impacted.
Our Stock Price Has Historically Been Volatile And You Could Lose The
Value Of Your Investment.
Our stock price has historically been volatile; it has fluctuated significantly
to date. The trading price of our stock is likely to continue to be highly
volatile and subject to wide fluctuations. Your investment in our stock could
lose value.
Our Operating Results In One Or More Future Periods Are Likely To
Fluctuate Significantly And May Fail To Meet Or Exceed The Expectations Of
Securities Analysts Or Investors.
Our operating results are likely to fluctuate significantly in the future on a
quarterly and on an annual basis due to a number of factors, many of which are
outside our control. Factors that could cause our revenues to fluctuate include
the following:
o The degree of success of our commercial exploitation of the NES patents;
o The degree of success of our recently introduced products;
o Variations in the timing of and shipments of our products;
o Variations in the size of orders by our customers;
o Increased competition;
o The proportion of overall revenues derived from different sales channels
such as distributors, original equipment manufacturers (OEMs) and others;
o Changes in our pricing policies or those of our competitors;
o The financial stability of major customers;
22
o New product introductions or enhancements by us or by competitors;
o Delays in the introduction of products or product enhancements by us or by
competitors;
o The degree of success of new products;
o Any changes in operating expenses; and
o General economic conditions and economic conditions specific to the
software industry.
In addition, our royalty and license revenues are impacted by fluctuations in
OEM licensing activity from quarter to quarter, which may involve one-time
royalty payments and license fees. Our expense levels are based, in part, on
expected future orders and sales; therefore, if orders and sales levels are
below expectations, our operating results are likely to be materially adversely
affected. Additionally, because significant portions of our expenses are fixed,
a reduction in sales levels may disproportionately affect our net income. Also,
we may reduce prices or increase spending in response to competition or to
pursue new market opportunities. Because of these factors, our operating results
in one or more future periods may fail to meet or exceed the expectations of
securities analysts or investors. In that event, the trading price of our common
stock would likely be affected.
We May Not Be Successful In Attracting And Retaining Key Management Or
Other Personnel.
Our success and business strategy is also dependent in large part on our ability
to attract and retain key management and other personnel. The loss of the
services of one or more members of our management group and other key personnel,
including our interim Chief Executive Officer, may have a material adverse
effect on our business.
Our Failure To Adequately Protect Our Proprietary Rights May Adversely
Affect Us.
Our commercial success is dependent, in large part, upon our ability to protect
our proprietary rights. We rely on a combination of patent, copyright and
trademark laws, and on trade secrets and confidentiality provisions and other
contractual provisions to protect our proprietary rights. These measures afford
only limited protection. We cannot assure you that measures we have taken will
be adequate to protect us from misappropriation or infringement of our
intellectual property. Despite our efforts to protect proprietary rights, it may
be possible for unauthorized third parties to copy aspects of our products or
obtain and use information that we regard as proprietary. In addition, the laws
of some foreign countries do not protect our intellectual property rights as
fully as do the laws of the United States. Furthermore, we cannot assure you
that the existence of any proprietary rights will prevent the development of
competitive products. The infringement upon, or loss of any proprietary rights,
or the development of competitive products despite such proprietary rights,
could have a material adverse effect on our business.
As regards our intention to exploit the portfolio of patents that we acquired
from NES:
o Although we believe the NES patents to be strong, there can be no
assurance that they will not be found invalid either in whole or in part
if challenged.
o Invalidation of their broadest claims could result in very narrow claims
that do not have the potential to produce meaningful license revenues.
o Many of the companies that we intend to seek licenses from are very large
with significant financial resources. We currently lack the ability to
initiate infringement litigation or to defend our patents against claims
of invalidity if such litigation is heavily contested over an extended
period of months or even years.
o We may not be able to engage attorneys that will work on our behalf on a
contingent fee basis or that will pursue litigation until a resolution is
achieved that is favorable to us. Such attorneys may seek to limit their
exposure either by advocating licensing settlements that are not favorable
to us or may abandon their efforts on our behalf.
o Because NES obtained no foreign patents or filed any foreign patent
applications, infringing companies may seek to avoid our demand for
licenses by moving the infringing activities offshore where US patents
cannot be enforced.
We Face Risks Of Claims From Third Parties For Intellectual Property
Infringement That Could Adversely Affect Our Business.
At any time, we may receive communications from third parties asserting that
features or content of our products may infringe upon their intellectual
property rights. Any such claims, with or without merit, and regardless of their
outcome, may be time consuming and costly to defend. We may not have sufficient
resources to defend such claims and they could divert management's attention and
resources, cause product shipment delays or require us to enter into new royalty
or licensing agreements. New royalty or licensing agreements may not be
available on beneficial terms, and may not be available at all. If a successful
infringement claim is brought against us and we fail to license the infringed or
similar technology, our business could be materially adversely affected.
23
Our Business Significantly Benefits From Strategic Relationships And There
Can Be No Assurance That Such Relationships Will Continue In The Future.
Our business and strategy relies to a significant extent on our strategic
relationships with other companies. There is no assurance that we will be able
to maintain or develop any of these relationships or to replace them in the
event any of these relationships are terminated. In addition, any failure to
renew or extend any licenses between any third party and us may adversely affect
our business.
We Rely On Indirect Distribution Channels For Our Products And May Not Be
Able To Retain Existing Reseller Relationships Or To Develop New Reseller
Relationships.
Our products primarily are sold through several distribution channels. An
integral part of our strategy is to strengthen our relationships with resellers
such as OEMs, systems integrators, value-added resellers, distributors and other
vendors to encourage these parties to recommend or distribute our products and
to add resellers both domestically and internationally. We currently invest, and
intend to continue to invest, significant resources to expand our sales and
marketing capabilities. We cannot assure you that we will be able to attract
and/or retain resellers to market our products effectively. Our inability to
attract resellers and the loss of any current reseller relationships could have
a material adverse effect on our business, results of operations and financial
condition. Additionally, we cannot assure you that resellers will devote enough
resources to provide effective sales and marketing support to our products.
The Market In Which We Participate Is Highly Competitive And Has More
Established Competitors.
The market we participate in is intensely competitive, rapidly evolving and
subject to technological changes. We expect competition to increase as other
companies introduce additional competitive products. In order to compete
effectively, we must continually develop and market new and enhanced products
and market those products at competitive prices. As markets for our products
continue to develop, additional companies, including companies in the computer
hardware, software and networking industries with significant market presence,
may enter the markets in which we compete and further intensify competition. A
number of our current and potential competitors have longer operating histories,
greater name recognition and significantly greater financial, sales, technical,
marketing and other resources than we do. We cannot assure you that our
competitors will not develop and market competitive products that will offer
superior price or performance features or that new competitors will not enter
our markets and offer such products. We believe that we will need to invest
increasing financial resources in research and development to remain competitive
in the future. Such financial resources may not be available to us at the time
or times that we need them, or upon terms acceptable to us. We cannot assure you
that we will be able to establish and maintain a significant market position in
the face of our competition and our failure to do so would adversely affect our
business.
ITEM 7A. 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. Substantially all 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.
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24
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Index to Consolidated Financial Statements
------------------------------------------
Page
Report of Independent Registered Public Accounting Firm (Macias Gini & Company LLP) 26
Report of Independent Registered Public Accounting Firm (BDO Seidman, LLP) 27
Consolidated Balance Sheets as of December 31, 2004 and 2003 28
Consolidated Statements of Operations and Comprehensive Loss for
the Years Ended December 31, 2004, 2003, and 2002 29
Consolidated Statements of Shareholders' Equity for the Years Ended
December 31, 2004, 2003 and 2002 30
Consolidated Statements of Cash Flows for the Years Ended
December 31, 2004, 2003 and 2002 31
Summary of Significant Accounting Policies 32
Notes to Consolidated Financial Statements 35
Report of Independent Registered Public Accounting Firm on
Supplemental Schedule (BDO Seidman, LLP) 45
Supplemental Schedule II 46
(Remainder of page intentionally left blank)
25
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders of GraphOn Corporation
We have audited the accompanying consolidated balance sheet of GraphOn
Corporation and subsidiary (the "Company") as of December 31, 2004 and the
related statements of operations and comprehensive loss, shareholders' equity
and cash flows for the year then ended. We have also audited the financial
statement schedule listed in the Index at Item 8. These financial statements and
schedule are the responsibility of the Company's management. Our responsibility
is to express an opinion on these financial statements and schedule based on our
audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements and schedule are free of material misstatement. The Company is not
required to have, nor were we engaged to perform, an audit of its internal
control over financial reporting. Our audit included consideration of internal
control over financial reporting as a basis for designing audit procedures that
are appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements and schedule, assessing the accounting principles used
and significant estimates made by management, as well as evaluating the overall
financial statement and schedule presentation. We believe that our audit
provides a reasonable basis for our opinion.
In our opinion, the 2004 consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
GraphOn Corporation and subsidiary as of December 31, 2004, and the consolidated
results of its operations and its cash flows for the year then ended in
conformity with accounting principles generally accepted in the United States of
America. Also, in our opinion, the related financial statement schedule presents
fairly in all material respects the information set forth therein.
/s/ Macias Gini & Company LLP
Macias Gini & Company LLP
Sacramento, California
March 29, 2005
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26
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders of GraphOn Corporation
We have audited the accompanying consolidated balance sheet of GraphOn
Corporation and Subsidiary (the Company) as of December 31, 2003 and the related
consolidated statements of operations and comprehensive loss, shareholders'
equity, and cash flows for each of the two years in the period ended December
31, 2003. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company is not required to
have, nor were we engaged to perform, an audit of its internal control over
financial reporting. Our audits included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of GraphOn Corporation
and Subsidiary as of December 31, 2003, and the results of their operations and
their cash flows for each of the two years in the period ended December 31, 2003
in conformity with accounting principles generally accepted in the United States
of America.
The accompanying financial statements have been prepared on a going concern
basis, which contemplates the realization of assets and the settlement of
liabilities in the normal course of business. As discussed in Note 1 to the
financial statements, the Company has suffered recurring losses and has absorbed
significant cash in its operating activities. Further, the Company has limited
alternative sources of financing available to fund any additional cash required
for its operations or otherwise. These matters raise substantial doubt about the
ability of the Company to continue as a going concern. Management's plan in
regard to these matters is also described in Note 1. The accompanying financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
/s/ BDO Seidman, LLP
BDO Seidman, LLP
San Jose, California
February 23, 2004
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27
GraphOn Corporation
Consolidated Balance Sheets
---------------------------
December 31, 2004 2003
- ----------------------------------------------------------- ------------ ------------
CURRENT ASSETS
Cash and cash equivalents ................................. $ 675,300 $ 1,025,500
Accounts receivable, net of allowance for doubtful accounts
of $46,800 and $46,800 .................................. 518,900 521,100
Prepaid expenses and other current assets ................. 24,100 23,100
------------ ------------
TOTAL CURRENT ASSETS ...................................... 1,218,300 1,569,700
------------ ------------
Property and equipment, net ............................... 75,400 144,800
Purchased technology, net ................................. - 335,000
Capitalized software, net ................................. 273,700 500,600
Note Receivable - related party ........................... 350,000 -
Deferred acquisition costs ................................ 269,700 -
Other assets .............................................. 37,300 11,900
------------ ------------
TOTAL ASSETS .............................................. $ 2,224,400 $ 2,562,000
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable .......................................... $ 250,200 $ 52,300
Accrued liabilities ....................................... 231,400 470,800
Accrued wages ............................................. 260,100 305,200
Deferred revenue .......................................... 689,800 763,000
------------ ------------
TOTAL CURRENT LIABILITIES ................................. 1,431,500 1,286,100
------------ ------------
LONG TERM LIABILITIES
Deferred revenue .......................................... 426,600 429,000
------------ ------------
TOTAL LIABILITIES ......................................... 1,858,100 1,715,100
------------ ------------
Commitments and contingencies (Note 13)
SHAREHOLDERS' 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, 21,716,765 and 16,618,459 shares
issued and outstanding ................................... 2,200 1,700
Additional paid-in capital ................................ 46,930,700 45,985,300
Notes receivable .......................................... (50,300) (50,300)
Accumulated other comprehensive loss ...................... (400) (1,400)
Accumulated deficit ....................................... (46,515,900) (45,088,400)
------------ ------------
TOTAL SHAREHOLDERS' EQUITY ................................ 366,300 846,900
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY ................ $ 2,224,400 $ 2,562,000
============ ============
See accompanying summary of significant accounting policies
and notes to consolidated financial statements
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28
GraphOn Corporation
Consolidated Statements of Operations and Comprehensive Loss
------------------------------------------------------------
Years Ended December 31, 2004 2003 2002
- --------------------------------------------- ------------ ------------ ------------
Revenue:
Product licenses ............................ $ 2,395,200 $ 3,172,100 $ 2,942,000
Service fees ................................ 1,015,000 830,900 442,200
Other ....................................... 119,600 167,300 150,800
------------ ------------ ------------
Total Revenue ............................... 3,529,800 4,170,300 3,535,000
------------ ------------ ------------
Cost of Revenue:
Product costs ............................... 572,100 1,017,300 1,470,200
Service costs ............................... 331,700 354,300 209,700
------------ ------------ ------------
Total Cost of Revenue ....................... 903,800 1,371,600 1,679,900
------------ ------------ ------------
Gross Profit ................................ 2,626,000 2,798,700 1,855,100
------------ ------------ ------------
Operating Expenses
Selling and marketing ....................... 1,383,700 1,679,800 2,235,100
General and administrative .................. 1,183,600 1,419,100 2,801,000
Research and development .................... 1,500,900 1,515,000 2,831,300
Asset impairment loss ....................... - - 914,000
Restructuring charges ....................... - 80,100 1,942,800
------------ ------------ ------------
Total Operating Expenses .................... 4,068,200 4,694,000 10,724,200
------------ ------------ ------------
Loss From Operations ........................ (1,442,200) (1,895,300) (8,869,100)
------------ ------------ ------------
Other Income (Expense)
Interest and other income ................... 14,700 13,000 152,500
Interest and other expense .................. - (4,300) (75,900)
------------ ------------ ------------
Total Other Income (Expense) ................ 14,700 8,700 76,600
------------ ------------ ------------
Net Loss .................................... (1,427,500) (1,886,600) (8,792,500)
Other Comprehensive Income (Loss), net of tax
Unrealized holding gain (loss)
on investment .............................. - - (7,500)
Foreign currency translation adjustment ..... 1000 1,000 3,600
------------ ------------ ------------
Comprehensive Loss .......................... $ (1,426,500) $ (1,885,600) $ (8,796,400)
============ ============ ============
Basic and Diluted Loss per Common Share ..... $ (0.07) $ (0.11) $ (0.50)
============ ============ ============
Weighted Average Common Shares Outstanding .. 21,307,966 16,607,328 17,465,099
============ ============ ============
See accompanying summary of significant accounting policies
and notes to consolidated financial statements
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29
GraphOn Corporation
Consolidated Statements of Shareholders' Equity
-----------------------------------------------
Accum-
ulated
Other
Compre-
Additional Deferred Notes hensive
Common Stock Paid-in Compen- Receiv- Income Accumulated
Shares Amount Capital sation able (Loss) Deficit Totals
---------- ------- ------------ ---------- --------- ------- ------------- ------------
Balances, December 31, 2001 17,288,332 $ 1,700 $ 45,925,900 $ (193,800) $ - $ 1,500 $ (34,409,300) $ 11,326,000
Issuance of common stock due to
exercise of options 200,000 200 50,000 - (50,000) - - 200
Employee stock purchases 25,720 - 6,400 - - - - 6,400
Noncash redemption of common
stock (933,333) (200) 200 - - - - -
Amortization of deferred
compensation - - - 193,800 - - - 193,800
Accrued interest receivable - - - - (300) - - (300)
Change in market value of
available-for-sale securities - - - - - (7,500) - (7,500)
Foreign currency translation - - - - - 3,600 - 3,600
Net Loss - - - - - - (8,792,500) (8,792,500)
---------- ------ ----------- --------- --------- ------- ------------- ------------
Balances, December 31, 2002 16,580,719 1,700 45,982,500 - (50,300) (2,400) (43,201,800) 2,729,700
Employee stock purchases 37,740 - 2,800 - - - - 2,800
Foreign currency translation - - - - - 1,000 - 1,000
Net Loss - - - - - - (1,886,600) (1,886,600)
---------- ------ ----------- --------- --------- ------- ------------- ------------
Balances, December 31, 2003 16,618,459 1,700 45,985,300 - (50,300) (1,400) (45,088,400) 846,900
Proceeds from private placement
of common stock 5,000,000 500 1,149,500 - - - - 1,150,000
Costs of private placement of
common stock - - (218,600) - - - - (218,600)
Employee stock purchases 37,638 - 9,000 - - - - 9,000
Accrued interest receivable - - (1,400) - - - - (1,400)
Issuance of common stock due to
exercise of warrants 30,000 - 6,900 - - - - 6,900
Restricted stock repurchase -
certificate not surrendered 30,668 - - - - - - -
Foreign currency translation - - - - - 1,000 - 1,000
Net Loss - - - - - - (1,427,500) (1,427,500)
---------- ------- ------------ --------- --------- ------- ------------- ------------
Balances, December 31, 2004 21,716,765 $ 2,200 $ 46,930,700 $ - $ (50,300) $ (400) $ (46,515,900) $ 366,300
========== ======= ============ ========= ========= ======= ============= ============
See accompanying summary of significant accounting policies and notes to consolidated financial statements
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30
GraphOn Corporation
Consolidated Statements of Cash Flows
-------------------------------------
Years ended December 31, 2004 2003 2002
- ---------------------------------------------------- ----------- ----------- -----------
Cash Flows From Operating Activities:
Net loss ........................................... $(1,427,500) $(1,886,600) $(8,792,500)
Adjustments to reconcile net loss to
net cash used in operating activities:
Depreciation and amortization ...................... 664,700 1,248,400 1,892,000
Non-cash restructuring charges ..................... - 42,200 657,800
Asset impairment loss .............................. - - 914,000
Loss on disposal of fixed assets ................... - 4,300 400
Amortization of deferred compensation .............. - - 193,800
Charges to provision for doubtful accounts ......... - 16,300 31,600
Reductions to provision for doubtful accounts ...... - (19,800) (331,300)
Accrued interest on directors notes receivables .... (1,400) - -
Changes in operating assets and liabilities:
Accounts receivable ............................. 2,200 (179,700) 582,200
Prepaid expenses and other assets ............... (1,000) 168,900 59,300
Accounts payable ................................ 18,400 (176,400) (91,200)
Accrued liabilities.............................. 3,300 (366,700) 188,100
Accrued wages ................................... (46,100) 42,400 (128,500)
Deferred revenue ................................ (75,600) 395,900 218,300
----------- ----------- -----------
Net cash used in operating activities: ............. (863,000) (710,800) (4,606,000)
----------- ----------- -----------
Cash Flows From Investing Activities:
Capitalization of software
development costs ................................. - (282,200) (298,500)
Capital expenditures ............................... (33,400) (1,600) (82,900)
Other assets ....................................... 7,100 58,100 1,600
Note receivable - related party .................... (350,000) - -
Deferred acquisition costs ......................... (59,200) - -
Purchase of available-for-sale securities .......... - - (768,300)
Proceeds from sale of available-
for-sale securities ............................... - - 3,776,300
----------- ----------- -----------
Net cash provided by (used in) investing
activities: ....................................... (435,500) (225,700) 2,628,200
----------- ----------- -----------
Cash Flows From Financing Activities:
Employee stock purchases ........................... 9,000 2,800 6,400
Proceeds from exercise of warrants ................. 6,900 - -
Proceeds from private placement of common stock .... 1,150,000 - -
Costs of private placement of common stock ......... (218,600) - -
Repayment of note payable .......................... - - (26,600)
----------- ----------- -----------
Net cash provided by (used in) financing activities: 947,300 2,800 (20,200)
----------- ----------- -----------
Effect of exchange rate fluctuations on
cash and cash equivalents ......................... 1,000 1,000 3,600
Net Decrease in Cash
and Cash Equivalents .............................. (350,200) (932,700) (1,994,400)
Cash and Cash Equivalents:
Beginning of year .................................. 1,025,500 1,958,200 3,952,600
----------- ----------- -----------
End of year ........................................ $ 675,300 $ 1,025,500 $ 1,958,200
=========== =========== ===========
See accompanying summary of significant accounting policies
and notes to consolidated financial statements
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31
GraphOn Corporation
Summary of Significant Accounting Policies
- ------------------------------------------
The Company. GraphOn Corporation (the Company) was founded in May 1996 and is
incorporated in the state of Delaware. The Company's headquarters are currently
in Santa Cruz, California. The Company develops, markets, sells and supports
business connectivity software, including Unix, Linux and Windows server-based
software, with an immediate focus on web-enabling applications for use by
Independent Software Vendors (ISVs), Application Service Providers (ASPs),
corporate enterprises, governmental and educational institutions, and others,
primarily in the United States, Asia and Europe.
Basis of Presentation and Use of Estimates. The consolidated financial
statements include the accounts of the Company and its subsidiaries
(collectively, the "Company"), significant intercompany accounts and
transactions are eliminated upon consolidation. In the Company's opinion, the
consolidated financial statements presented herein include all necessary
adjustments, consisting of only normal recurring adjustments, except for the
restructuring and asset impairment charges, as discussed below, to fairly state
the Company's financial position, results of operations and cash flows for the
periods indicated. The preparation of financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. These estimates include the allowance for
doubtful accounts, the estimated lives of intangible assets, depreciation of
fixed assets and accrued liabilities, among others. Actual results could differ
materially from those estimates.
Cash and Cash Equivalents. The Company considers all highly liquid investments
purchased with original maturities of three months or less to be cash
equivalents.
Marketable Securities. Under Statement of Financial Accounting Standards
(SFAS) No. 115, "Accounting for Certain Investments in Debt and Equity
Securities," securities are classified and accounted for as follows:
o Debt securities that the enterprise has the positive intent and ability to
hold to maturity are classified as held-to-maturity securities and
reported at amortized cost.
o Debt and equity securities that are bought and held principally for the
purpose of selling them in the near term are classified as trading
securities and reported at fair value, with unrealized gains and losses
included in earnings.
o Debt and equity securities not classified as either held-to-maturity
securities or trading securities are classified as available-for-sale
securities and reported at fair value, with unrealized gains and losses
excluded from earnings and reported in other comprehensive income.
Property and Equipment. Property and equipment are stated at cost. Depreciation
is calculated using the straight-line method over the estimated useful lives of
the respective assets, generally three to seven years. Amortization of leasehold
improvements is calculated using the straight-line method over the lesser of the
lease term or useful lives of the respective assets, generally seven years.
Purchased Technology. Purchased technology is amortized on a straight-line basis
over the expected life of the related technology or five years, whichever is
less.
Shipping and Handling. Shipping and handling costs are included in cost of
revenue for all periods presented.
Capitalized Software Costs. Under the criteria set forth in SFAS No. 86,
"Accounting for the Cost of Computer Software to be Sold, Leased or Otherwise
Marketed," development costs incurred in the research and development of new
software 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 to cost of sales 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.
Revenue. Software license revenues are recognized when a non-cancelable license
agreement has been signed and the customer acknowledges an unconditional
obligation to pay, the software product has been delivered, there are no
uncertainties surrounding product acceptance, the fees are fixed or determinable
and collection is considered probable. Delivery is considered to have occurred
when title and risk of loss have been transferred to the customer, which
generally occurs when the media containing the licensed programs is provided to
a common carrier. In the case of electronic delivery, delivery occurs when the
customer is given access to the licensed programs. If collectibility is not
considered probable, revenue is recognized when the fee is collected.
32
Revenue earned on software arrangements involving multiple elements is allocated
to each element arrangement based on the relative fair values of the elements.
If there is no evidence of the fair value for all the elements in a
multiple-element arrangement, all revenue from the arrangement is deferred until
such evidence exists or until all elements are delivered. The Company recognizes
revenue from the sale of software licenses when all the following conditions are
met:
o Persuasive evidence of an arrangement exists;
o Delivery has occurred or services have been rendered;
o The price to the customer is fixed or determinable; and
o Collectibility is reasonably assured.
Revenues recognized from multiple-element software arrangements are allocated to
each element of the arrangement based on the fair values of the elements, such
as licenses for software products, maintenance, consulting services or customer
training. The determination of fair value is based on objective evidence. The
Company limits its assessment of objective evidence for each element to either
the price charged when the same element is sold separately or the price
established by management having the relevant authority to do so, for an element
not yet sold separately. If evidence of fair value of all undelivered elements
exists but evidence does not exist for one or more delivered elements, then
revenue is recognized using the residual method. Under the residual method, the
fair value of the undelivered elements is deferred and the remaining portion of
the arrangement fee is recognized as revenue.
The Company recognizes revenue from service contracts ratably over the related
contract period, which generally ranges from 1-5 years.
Segment information. The Company operates in one business segment.
Allowance for Doubtful Accounts. The allowance for doubtful accounts is based on
assessments 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 historical experience, the
allowance for doubtful accounts is increased.
Advertising Costs. The cost of advertising is expensed as incurred. Advertising
costs for the years ended December 31, 2004, 2003 and 2002, were approximately
$3,000, $4,000 and $114,300, respectively. Advertising consists primarily of
various printed material.
Income Taxes. Under SFAS No. 109, "Accounting for Income Taxes," deferred income
taxes are recognized for the tax consequences of temporary differences between
the financial statement and income tax bases of assets, liabilities and
carryforwards using enacted tax rates. Valuation allowances are established when
necessary, to reduce deferred tax assets to the amount expected to be realized.
Realization is dependent upon future pre-tax earnings, the reversal of temporary
differences between book and tax income, and the expected tax rates in effect in
future periods.
Fair Value of Financial Instruments. The Company used the following methods and
assumptions in estimating the fair value disclosures for financial instruments:
Cash and cash equivalents: The carrying amount reported on the balance
sheet for cash and cash equivalents approximates fair value.
Notes receivable: The carrying amounts reported on the balance sheet for
the note receivable - related party and the note receivable reflect the
current principal balances remaining to be repaid to the Company. The
estimated fair values are based on the Company's estimates of interest
rates on similar instruments.
As of December 31, 2004 and 2003, the fair values of the Company's financial
instruments approximate their historical carrying amounts.
Long-Lived Assets. Long-lived assets are assessed for possible impairment
whenever events or changes in circumstances indicate that the carrying amounts
may not be recoverable, or whenever the Company has committed to a plan to
dispose of the assets. Measurement of the impairment loss is based on the fair
value of the assets. Generally, the Company determines fair value based on
appraisals, current market value, comparable sales value, and undiscounted
future cash flows as appropriate. Assets to be held and used affected by such
impairment loss are depreciated or amortized at their new carrying amount over
the remaining estimated life; assets to be sold or otherwise disposed of are not
subject to further depreciation or amortization.
33
Restructuring Charges. Charges related to the restructuring of the Company's
operations are estimated, accrued and expensed in the period in which the Board
of Directors has committed to and approved a restructuring plan. The
restructuring accrual is reduced in any period in which one or more of the
planned restructuring activities occur. The restructuring accrual is adjusted
for material differences between the actual cost of a restructuring activity and
the estimated cost of the restructuring activity in the period the actual cost
becomes known. The Company followed Emerging Issues Task Force (EITF) 94-3,
"Liability Recognition for Certain Employee Termination Benefits and Other Costs
to Exit an Activity (Including Certain Costs Incurred in a Restructuring)" for
restructuring plans entered into prior to January 1, 2003. The Company currently
follows SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal
Activities," for restructuring plans entered into on, or after, January 1, 2003.
Stock-Based Incentive Programs. The Company accounts for its stock-based
incentive programs using the intrinsic value method, as prescribed by Accounting
Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to
Employees" and interpretations thereof (collectively APB 25). Accordingly, the
Company records deferred compensation expense costs related to its employee
stock options when the market price of the underlying stock exceeds the exercise
price of each option on the date of grant. The Company records and measures
deferred compensation for stock options granted to non-employees, other than
members of the board, at their fair value. Deferred compensation is expensed on
a straight-line basis over the vesting period of the related stock option for
options issued to employees. Deferred compensation is expensed on a
straight-line basis over the shorter of the vesting period of the related stock
option or the contractual period of service for option grants to non-employees.
The Company did not grant any stock options at exercise prices below the fair
market value of the Company's common stock on the grant date during the years
ended December 31, 2004, 2003 and 2002.
As of December 31, 2004, the Company's deferred compensation balance was $0. The
accompanying statement of operations reflects stock-based compensation expense
of $0, $0 and $193,800 for the years ended December 31, 2004, 2003 and 2002,
respectively.
An alternative to the intrinsic value method of accounting for stock-based
compensation is the fair value approach prescribed by SFAS No. 123, "Accounting
for Stock-Based Compensation" as amended by SFAS 148 (hereinafter collectively
referred to as SFAS 123). If the Company followed the fair value approach, the
Company would be required to record deferred compensation based on the fair
value of the stock option at the date of grant. The fair value of the stock
option must be computed using an option-pricing model, such as the Black-Scholes
option valuation method, at the date of grant. The deferred compensation
calculated under the fair value method would then be amortized over the
respective vesting period of the stock option. See New Accounting
Pronouncements.
SFAS 123 requires the Company to provide pro forma information regarding net
income (loss) and earnings (loss) per share as if compensation cost for the
stock option plan had been determined in accordance with the fair value-based
method prescribed in SFAS 123 throughout the year. The Company estimated the
fair value of stock options at the grant date by using the Black-Scholes option
pricing-model with the following weighted average assumptions used for grants in
2004, 2003 and 2002, respectively: dividend yield (all years) of 0; expected
volatility (all years) of 60%; risk-free interest rate of 1.5%, 2.5% and 2.5%;
and expected lives (approximately, for all years) of five years, for all plan
options.
Under SFAS 123, the Company's pro forma net loss and the basic and diluted net
loss per common share would have been adjusted to the pro forma amounts below.
2004 2003 2002
------------ ------------ ------------
Net loss:
As reported .......................... $ (1,427,500) $ (1,886,600) $ (8,792,500)
Add: stock-based compensation
expense included in reported net loss,
net of related tax effects: .......... - - -
Deduct: total stock-based compensation
determined under fair value-based
method for all accounts,
net of related tax effects: .......... (191,700) (265,300) (1,725,200)
------------ ------------ ------------
Pro forma ............................ $ (1,619,200) $ (2,151,900) $(10,323,900)
============ ============ ============
34
Basic and diluted loss per share
As reported $ (0.07) $ (0.11) $ (0.50)
Pro forma $ (0.08) $ (0.13) $ (0.59)
Earnings Per Share of Common Stock. SFAS No. 128, "Earnings Per Share," provides
for the calculation of basic and diluted earnings per share. Basic earnings per
share includes no dilution and is computed by dividing income available to
common shareholders by the weighted-average number of common shares outstanding
for the period. Diluted earnings per share reflects the potential dilution of
securities by adding other common stock equivalents, including common stock
options, warrants and redeemable convertible preferred stock, in the weighted
average number of common shares outstanding for a period, if dilutive.
Potentially dilutive securities have been excluded from the computation, as
their effect is antidilutive. For the years ended December 31, 2004, 2003 and
2002, 6,641,957, 2,104,483 and 2,584,307 shares, respectively, of common stock
equivalents were excluded from the computation of diluted earnings per share
since their effect would be antidilutive.
Comprehensive Income. SFAS No. 130, "Reporting Comprehensive Income,"
establishes standards for reporting comprehensive income and its components in a
financial statement that is displayed with the same prominence as other
financial statements. Comprehensive income, as defined, includes all changes in
equity (net assets) during the period from non-owner sources. Examples of items
to be included in comprehensive income, which are excluded from net income,
include foreign currency translation adjustments and unrealized gain/loss of
available-for-sale securities. The individual components of comprehensive income
(loss) are reflected in the statements of shareholders' equity. As of December
31, 2004, 2003 and 2002, accumulated other comprehensive income (loss) was
comprised of foreign currency translation gains and the cumulative change in the
market value of the available-for-sale securities.
New Accounting Pronouncements. In December 2004, the Financial Accounting
Standards Board (FASB) issued SFAS No. 123R, "Share-Based Payment," which
requires companies to expense the value of employee stock options and similar
awards. SFAS No. 123R is effective as of the beginning of the first annual
reporting period that begins after June 15, 2005. As of the effective date, the
Company will be required to expense all awards granted, modified, cancelled or
repurchased as well as the portion of prior awards for which the requisite
service has not yet been rendered, based on the grant-date fair value of those
awards as calculated for pro forma disclosures under SFAS No. 123. The Company
will apply SFAS No. 123R using a modified version of prospective application.
Under this method, compensation cost is recognized on or after the required
effective date for the portion of outstanding awards for which the requisite
service has not yet been rendered, based on the grant-date fair value of those
awards calculated under SFAS No. 123 for either recognition or pro forma
disclosures.
Benefits of tax deductions in excess of recognized compensation cost are
required by SFAS No. 123R to be reported as a financing cash flow, rather than
as an operating cash flow as required under current literature. This requirement
will reduce net cash flows from operations and increase cash flows from
financing in periods after adoption. The adoption of SFAS No. 123R will have an
impact on the Company's results of operations, however management cannot
currently estimate what the impact will be because, among other things, it will
depend on the levels of share-based payments granted in the future. The Company
is currently in the process of determining the effects on its financial
position, results of operations and cash flows that will result from the
adoption of SFAS No. 123R.
Reclassifications. Certain amounts in the prior years' financial statements have
been reclassified to conform to the current year's presentation.
Notes to Consolidated Financial Statements
1. Subsequent Events.
On February 2, 2005, the Company completed a private placement (the "2005
private placement"), which raised a total of $4,000,000 (inclusive of a $665,000
credit as described below) through the sale of 148,148 shares of Series A
preferred stock and five-year warrants to purchase 74,070 shares of Series B
preferred stock. In a contemporaneous transaction, the Company acquired Network
Engineering Software, Inc. ("NES"), for 9,600,000 shares of common stock, the
assumption of approximately $235,000 of NES' indebtedness and the reimbursement
to AIGH Investment Partners, LLC ("AIGH"), an affiliate of a principal
stockholder (Orin Hirschman), of $665,000 for its advance on the Company's
behalf of a like sum in December 2004 to settle certain third party litigation
against NES. This reimbursement was effected by a partial credit against the
price of the securities acquired by Mr. Hirschman in the 2005 private placement.
Net proceeds from the 2005 private placement were approximately $2,000,000,
after giving effect to:
35
o issuance of a $665,000 partial credit against the price of the Company's
securities acquired by Mr. Hirschman in the 2005 private placement;
o assumption of approximately $235,000 of NES' indebtedness;
o payment of NES' legal fees and expenses of approximately $108,000;
o payment of professional fees and expenses of approximately $692,000, which
were incurred in the NES acquisition;
o payment of Mr. Hirschman's legal fees and expenses of approximately
$108,000;
o payment of a fee to Griffin Securities Inc. in the amount of $50,000 in
connection with the 2005 private placement; and
o payment of professional fees and expenses of approximately $142,000, which
were incurred in the 2005 private placement.
The Company expects such net proceeds along with revenues derived from
operations and the cash and cash equivalents reported as of December 31, 2004 to
fund anticipated expenses, inclusive of those that will be attributable to
taking steps to realize the maximum value of the patents acquired from NES,
during the next 12 months.
The 52,039 shares of NES common stock collateralizing the note
receivable-related party (See Note 5) were replaced by 3,260,391 shares of the
Company's common stock upon the completion of the NES acquisition.
Under the terms of the 2005 private placement, upon the effectiveness of an
amendment to the Company's Certificate of Incorporation to increase the
authorized number of shares of Common Stock from, all shares of Series A Stock
and Series B Stock would automatically convert into shares of Common Stock at a
rate of 100 shares of Common Stock for each share of Preferred Stock, and all
Warrants issued in the 2005 private placement would automatically become
exercisable for shares of Common Stock at a rate of 100 shares of Common Stock
for each share of Preferred Stock underlying such Warrants.
At the special meeting of the Company's stockholders, held on March 29, 2005,
the stockholders approved the amendment to the Company's Certificate of
Incorporation to increase the authorized number of common shares from 45,000,000
to 195,000,000. Consequently, an aggregate of 148,148 shares of Series A Stock
were converted into 14,814,800 shares of common stock and warrants to purchase
an aggregate of 74,070 Series B Stock were converted into warrants to purchase
an aggregate 7,407,000 shares of common stock. In addition, the warrants issued
pursuant to the finder's agreement discussed above, converted as follows: the
warrants to purchase 14,815 shares of Series A Stock and the warrants to
purchase 7,407 shares of Series B Stock converted into warrants to purchase
1,481,500 and 740,700 shares of common stock, respectively.
2. Property and Equipment.
Property and equipment consisted of the following:
December 31, 2004 2003
- ------------------------------ ---------- ----------
Equipment $ 903,200 $ 875,000
Furniture and fixtures 236,700 231,500
Leasehold improvements 30,400 30,400
---------- ----------
1,170,300 1,136,900
Less: accumulated depreciation
and amortization 1,094,900 992,100
---------- ----------
$ 75,400 $ 144,800
========== ==========
3. Purchased Technology.
Purchased technology consisted of the following:
December 31, 2004 2003
- ------------------------------ ----------- -----------
Purchased technology $ 1,370,100 $ 1,370,100
Less: accumulated amortization 1,370,100 1,035,100
----------- -----------
$ - $ 335,000
=========== ===========
36
4. Capitalized Software.
Capitalized software consisted of the following:
December 31, 2004 2003
- -------------------------------------- --------- ---------
Capitalized software development costs $ 719,500 $ 719,500
Less: accumulated amortization 445,800 218,900
--------- ---------
$ 273,700 $ 500,600
========= =========
5. Note Receivable - Related Party.
On October 6, 2004, the Company entered into a letter of intent to acquire NES
(see Note 1). The Company contemporaneously loaned $350,000 to Ralph Wesinger,
NES' majority shareholder, to fund his purchase of all the NES common stock then
owned by another person. The Company received Mr. Wesinger's 5-year promissory
note, which bears interest at a rate of 3.62% per annum and which was secured by
his approximately 65% equity interest in NES, to evidence this loan. Mr.
Wesinger also agreed that the Company would receive 25% of the gross proceeds of
any sale or transfer of any of Mr. Wesinger's NES shares, which shall be applied
in reduction of the then outstanding balance of his note, until the note is paid
in full or becomes due, whichever occurs first. The Company has the option to
accelerate the maturity date of this note upon the occurrence of certain events.
Upon completion of the Company's acquisition of NES (see Note 1), the 52,039
shares of NES common stock collateralizing the note receivable were replaced by
3,260,391 shares of the Company's common stock.
6. Deferred Acquisition Costs.
At December 31, 2004, the Company had deferred acquisition costs of $269,700.
Deferred acquisition costs consisted of legal fees associated with the NES
acquisition that were incurred between October 6, 2004, the date the Company
entered into the letter of intent to acquire NES, and December 31, 2004. In
conjunction with the closing of the NES acquisition (See Note 1), these costs
were included in the acquisition costs and allocated to the fair values of the
assets and liabilities acquired.
7. Accrued Liabilities.
Accrued liabilities consisted of the following:
December 31, 2004 2003
- ------------ ------------ ------------
Professional fees $ 212,200 $ 118,300
Accrued taxes 4,600 24,400
Other 14,600 22,900
------------ ------------
$ 231,400 $ 165,600
============ ============
Accrued professional fees as of December 31, 2004 includes approximately $32,500
of deferred financing costs, related to the 2005 private placement, and
approximately $31,000 of deferred acquisition costs, related to the NES
acquisition (See Note 1). These amounts appear on the December 31, 2004 balance
sheet as components of other assets and deferred acquisition costs,
respectively.
8. Asset Impairment Charge.
During 2002 the Company recorded an impairment charge of $914,000 against
several intangible assets, primarily capitalized technology assets. The review
of long-lived assets for impairment occurs whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. Examples of events or changes in circumstances that indicate that
the recoverability of the carrying amount of an asset should be addressed
include the following:
o A significant decrease in the market value of an asset;
o A significant change in the extent or manner in which an asset is used;
o A significant adverse change in the business climate that could affect the
value of an asset; and
o Current and historical operating or cash flow losses.
37
The Company believed that a review of the current carrying values to evaluate
whether the value of any of its long-lived technology assets had been impaired
was warranted, due to several factors, including:
o The challenges faced in bringing the GO-Global for Windows and
Go-Global:XP products to maturity;
o The continued pervasive weakness in the world-wide economy;
o How the Company was incorporating and planning to incorporate each element
of the purchased technologies into its legacy technology; and
o The Company's continued and historical operating and cash flow losses.
Based on studies of the various factors affecting asset impairment, as outlined
above, the following asset impairment charges were determined to be necessary in
order to reduce the carrying value of certain of these assets to the Company's
current estimate of the present value of the expected future cash flows to be
derived from these assets:
Net Book Value Impairment Net Book Value
2002 Impairment Before Impairment Write Down After Impairment
-------------- ----------------- ---------- ----------------
Purchased Technology $ 2,145,200 $ 775,100 $ 1,370,100
Capitalized Software 277,800 138,900 138,900
-------------- ---------- -----------
Totals $ 2,423,000 $ 914,000 $ 1,509,000
============== ========== ===========
The Company reassessed the carrying values of its intangible assets as of
December 31, 2004 and 2003 and determined that no further impairment of those
assets had occurred. The asset impairment charges were approximately 0.0%, 0.0%
and 25.9% of total revenues for the years 2004, 2003 and 2002, respectively.
9. Restructuring Charge.
During 2002 the Company closed its Morgan Hill, California and Bellevue
Washington office locations as part of its strategic initiatives to reduce
operating costs. In conjunction with these closures, headcount was reduced in
all operating departments and the costs of leasehold improvements and other
assets that were abandoned were written off. A summary of the restructuring
charges recorded during 2002 is as follows:
December 31, 2002
Ending Balance
Restructuring Cash Non-cash Restructuring
Category Charge Payments Charges Accrual
- -------- --------------- ------------- ----------- --------------
Year ended December 31, 2002:
Employee severance $ 831,000 $ (831,000) $ - $ -
Fixed assets abandonment 657,800 - (657,800) -
Minimum lease payments 443,800 (161,600) - 282,200
Other 10,200 (10,200) - -
--------------- -------------- ----------- --------------
Totals $ 1,942,800 $ (1,002,800) $ (657,800) $ 282,200
=============== ============== =========== ==============
During 2003 the Company negotiated settlements of the leases for its former
offices in Bellevue, Washington and Morgan Hill, California, which completed the
restructuring activities that had been approved under EITF 94-3 during 2002 and
had begun in 2002, as explained above. Additionally, the Company relocated its
Morgan Hill, California offices from 400 Cochrane Circle to 105 Cochrane Circle
and further disposed of certain assets that were no longer in service. To the
extent that the December 31, 2002 ending restructuring charge accrual balance
was less than the costs incurred for these activities, an additional
restructuring charge was recorded during 2003. A summary of the restructuring
charges recorded during 2003 is as follows:
December 31, 2003
Ending Balance
Restructuring Cash Non-cash Restructuring
Category Charge Payments Charges Accrual
- -------- --------------- ---------- --------- ---------------
Year ended December 31, 2003:
Opening accrual balance $ - $ - $ - $ 282,200
Fixed assets abandonment 42,200 - (42,200) -
Leases settlements - rent 36,800 (269,000) - (232,200)
Deposits forfeited 16,000 - (56,000) (40,000)
38
Commissions 12,000 (22,000) - (10,000)
Other (1) (26,900) - 26,900 -
--------------- ---------- --------- ---------------
Totals $ 80,100 $ (291,000) $ (71,300) $ -
=============== ========== ========= ===============
(1) Includes the write-off of deferred rent associated with the Morgan Hill
lease and other miscellaneous items.
During June 2003, the Company negotiated a buy out of the lease for its former
engineering offices in Bellevue, Washington. The total buy out price was
approximately $184,000 and consisted of a lump-sum cash payment of $144,000, the
forfeiture of an approximate $40,000 security deposit and a $10,000 commission
to the real estate broker who was involved in the transaction. It is estimated
that the buy out saved approximately $355,800 over what would have been the
remainder of the lease term.
During August 2003, the Company negotiated a buy out of the lease for its former
corporate offices in Morgan Hill, California. 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. It is estimated
that the buy out saved approximately $270,000 over what would have been the
remainder of the lease term.
10. Stockholders' Equity.
Common Stock. During 2004 the Company issued 5,000,000 shares of common stock as
part of a private placement that resulted in gross proceeds of $1,150,000, which
were offset by costs associated with the private placement aggregating
approximately $218,600. The Company issued 30,000 shares of common stock upon
the exercise of warrants that had been issued in conjunction with the 2004
private placement, resulting in gross proceeds of $6,900.
During 2004, 2003 and 2002, the Company issued 37,638, 37,740 and 25,720 shares
of common stock to employees in connection with the Employee Stock Purchase
Plan, resulting in net cash proceeds of $9,000, $2,800 and $6,400, respectively.
The Company increased the number of its common shares outstanding during 2004 by
30,668 shares, related to restricted shares that had been repurchased for which
the shareholder has not yet surrendered the stock certificate to the Company's
transfer agent for cancellation. The Company believes the risk of these shares
being traded is negligible as the share certificate carries a restrictive legend
on its face and cannot be traded without prior consent of the Company's counsel.
The Company believed that a more conservative accounting treatment should be
afforded theses shares, after consultations with its transfer agent, and decided
to add back these shares to its issued and outstanding totals.
During 2002 the Company issued 100,000 shares of common stock to each of two
directors who exercised options granted under the Company's 1998 Stock
Option/Stock Issuance Plan. Each of the two directors exercising the options
issued a $25,000 promissory note to the Company to pay for the options. Each of
the promissory notes is for a term of three years, due on or before March 5,
2005 and bears semi-annual interest at 2.67% per annum, which is equal to the
applicable federal short-term interest rate in effect at the time the promissory
notes were signed. In the event of default, the Company has full recourse to the
assets of the directors and can take back all 100,000 of the shares of common
stock so issued. Accrued interest income recognized on the promissory notes was
$1,400, $0 and $300 for 2004, 2003 and 2002, respectively. Each of these notes
was repaid in full, plus accrued interest, to the Company, during March 2005.
During 2002 the Company accepted 933,333 shares of its common stock from Menta
Software in full settlement of the then outstanding $1,400,000 due the Company
from Menta Software under the terms of the June 2001 patented technology
licensing agreement.
During 2002 the Company recognized $193,800 of deferred compensation expense
related to options and warrants it had issued in previous years to various third
parties in exchange for services provided. The following assumptions were used
for pricing the options and warrants using the Black-Scholes option-pricing
model: dividend yield of 0, expected volatility of 60%, risk-free interest rate
of 5.25%, and expected life of one year.
Stock Purchase Warrants. As of December 31, 2004, the following common stock
warrants were issued and outstanding:
Shares subject Exercise Expiration
Issued with respect to: to Warrant Price Date
- ----------------------- -------------- ------- ----------
Private placement 2,750,000 $ 0.33 01/09
Private placement 470,000 $ 0.23 01/09
Convertible notes 83,640 $ 1.79 01/06
Private placement 373,049 $ 1.79 01/06
39
1996 Stock Option Plan. In May 1996 the Company's 1996 Stock Option Plan (the
"96 Plan") was adopted by the board and approved by the stockholders. The 96
Plan is restricted to employees, including officers, and to non-employee
directors. As of December 31, 2004, the Company is authorized to issue up to
187,500 shares of its common stock in accordance with the terms of the 96 Plan.
Under the 96 Plan the exercise price of options granted is either at least equal
to the fair market value of the Company's common stock on the date of the grant
or, in the case when the grant is to a holder of more than 10% of the Company's
common stock, at least 110% of the fair market value of the Company's common
stock on the date of the grant. As of December 31, 2004, options to purchase
24,625 shares of common stock were outstanding, 538 options had been exercised
and options to purchase 162,337 shares of common stock remained available for
further issuance under the 96 Plan.
1998 Stock Option/Stock Issuance Plan. In June 1998 the Company's 1998 Stock
Option/Stock Issuance Plan (the "98 Plan") was adopted by the board and approved
by the stockholders. Pursuant to the terms on the 98 Plan, options or stock may
be granted and issued, respectively, to officers and other employees,
non-employee board members and independent consultants who render services to
the Company. As of December 31, 2004 the Company is authorized to issue up to
4,455,400 options or stock in accordance with the terms of the 98 Plan, as
amended.
Under the 98 Plan the exercise price of options granted is to be not less than
85% of the fair market value of the Company's common stock on the date of the
grant. The purchase price of stock issued under the 98 Plan shall also not be
less than 85% of the fair market value of the Company's stock on the date of
issuance or as a bonus for past services rendered to the Company. As of December
31, 2004, options to purchase 2,940,643 shares of common stock were outstanding,
323,904 options had been exercised, 248,157 shares of common stock had been
issued directly under the 98 Plan and 942,696 shares remained available for
grant/issuance. The Company did not issue any direct shares under the 98 Plan in
2004, 2003 or 2002 and does not anticipate issuing shares in 2005.
Supplemental Stock Option Plan. In May 2000, the board approved a supplement
(the "Supplemental Plan") to the 98 Plan. Pursuant to the terms of the
Supplemental Plan, options are restricted to employees who are neither Officers
nor Directors at the grant date. As of December 31, 2004 the Company is
authorized to issue up to 400,000 shares in accordance with the terms of the
Supplemental Plan.
Under the Supplemental Plan the exercise price of options granted is to be not
less than 85% of the fair market value of the Company's common stock on the date
of the grant or, in the case when the grant is to a holder of more than 10% of
the Company's common stock, at least 110% of the fair market value of the
Company's common stock on the date of the grant. As of December 31, 2004,
options to purchase 400,000 shares of common stock remained available for
issuance under the Supplemental Plan.
Employee Stock Purchase Plan. In February 2000, the Employee Stock Purchase Plan
(the "ESPP") was adopted by the board and approved by the stockholders in June
2000. The ESPP provides for the purchase of shares of the Company's common stock
by eligible employees, including officers, at semi-annual intervals through
payroll deductions. No participant may purchase more than $25,000 worth of
common stock under the ESPP in one calendar year or more than 2,000 shares on
any purchase date. Purchase rights may not be granted to an employee who
immediately after the grant would own or hold options or other rights to
purchase stock and cumulatively possess 5% or more of the total combined voting
power or value of common stock of the Company.
Pursuant to the terms of the ESPP, shares of common stock are offered through a
series of successive offering periods, each with a maximum duration of six
months beginning on the first business day of February and August each year. The
purchase price of the common stock purchased under the ESPP is equal to 85% of
the lower of the fair market value of such shares on the start date of an
offering period or the fair market value of such shares on the last day of such
offering period. As of December 31, 2004, the ESPP is authorized to offer for
sale to participating employees 300,000 shares of common stock, of which,
168,056 shares have been purchased and 131,944 are available for future
purchase.
Option Exchange Programs. On January 26, 2004, 578,935 options were granted to
employees who were not executive officers or directors and who chose to
participate in a voluntary stock option exchange program that closed on July 23,
2003. Employees could choose to cancel any of their outstanding unexercised
options to purchase Company common stock that had exercise prices greater than
or equal to $0.50 in exchange for an equal number to be granted at a future
date. All options so cancelled were considered forfeited as of December 31,
2003, as reported elsewhere in this footnote.
On May 14, 2004, the Company's Chief Executive Officer and Chairman of the Board
and Chief Financial Officer voluntarily cancelled 260,000 and 380,000
outstanding unexercised options to purchase Company common stock in accordance
40
with a voluntary stock option exchange program for the Company's executive
officers and directors. Options that had exercise prices greater than or equal
to $0.50 were eligible to be exchanged for an equal number to be granted at a
future date. New options grants equal to the number cancelled were made on
November 15, 2004.
A summary of the status of the Company's stock option plans as of December 31,
2004, 2003 and 2002, and changes during the years then ended is presented in the
following table:
Options Outstanding
--------------------------------------------------------------------------
December 31, 2004 December 31, 2003 December 31, 2002
---------------------- ----------------------- -----------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
--------- ---------- ---------- ---------- ---------- ----------
Beginning 2,104,483 $ 2.47 2,584,307 $ 3.05 2,541,200 $ 4.32
Granted 1,803,187 $ 0.45 207,500 $ 0.18 1,193,000 $ 0.17
Exercised - $ - - $ - (200,000) $ 0.25
Forfeited (942,402) $ 4.60 (687,324) $ 3.95 (949,893) $ 3.45
--------- ---------- ---------- ---------- --------- ----------
Ending 2,965,268 $ 0.56 2,104,483 $ 2.47 2,584,307 $ 3.05
========= ========== ========== ========== ========== ==========
Exercisable at
year-end 2,965,268 $ 0.56 2,104,483 $ 2.47 2,584,307 $ 3.05
========= ========== ========== ========== ========== ==========
Weighted-average fair value
of options granted during
the period: $ 0.56 $ 0.10 $ 0.09
========== ========== ==========
The following table summarizes information about stock options outstanding as of
December 31, 2004:
Options Outstanding
--------------------------------------------------------------------------------
Options Exercisable
Weighted -----------------------
Average Weighted Weighted
Range of No. Remaining Average Number Average
Exercise Outstanding Contractual Exercise Exercisable Exercise
Price at 12/31/04 Life Price at 12/31/04 Price
--------- ----------- ----------- ---------- ----------- ---------
$ 0.01 - 0.18 942,500 7.77 yrs. $ 0.13 942,500 $ 0.13
$ 0.19 - 0.34 860,000 9.31 yrs. $ 0.32 860,000 $ 0.32
$ 0.35 - 0.56 903,382 7.02 yrs. $ 0.48 903,382 $ 0.48
$ 0.57 - 7.31 259,386 5.55 yrs. $ 3.23 259,386 $ 3.23
----------- ---------- ----------- ---------
2,965,268 $ 0.56 2,965,268 $ 0.56
=========== ========== =========== =========
11. Income Taxes.
There is no provision for income taxes for any of the years ended December 31,
2004, 2003 or 2002. The following summarizes the differences between income tax
expense and the amount computed applying the federal income tax rate of 34%:
December 31, 2004 2003 2002
- ------------ ----------- ----------- -------------
Federal income tax at
statutory rate $ (485,200) $ (641,400) $ (2,989,400)
State income taxes, net
of federal benefit (83,300) (97,100) (556,200)
Tax benefit not
currently recognizable 560,600 706,300 3,475,800
Research and development
Credit - - (100,000)
Other 7,900 32,200 30,200
----------- ----------- -------------
Provision for income taxes $ - $ - $ -
=========== =========== =============
41
Deferred income taxes and benefits result from temporary timing differences in
the recognition of certain expense and income items for tax and financial
reporting purposes, as follows:
December 31, 2004 2003
- ------------ -------------- --------------
Net operating loss carryforwards $ 14,961,000 $ 15,402,700
Tax credit carryforwards 654,000 654,500
Capitalized software (261,000) (199,700)
Depreciation and amortization 760,000 593,200
Reserves not currently deductible 585,000 404,800
Deferred compensation - 1,202,700
-------------- --------------
Total deferred tax asset 16,700,000 18,058,200
Valuation allowance (16,700,000) (18,058,200)
-------------- --------------
Net deferred tax asset $ - $ -
============== ==============
The Company has net operating loss carryforwards available to reduce future
taxable income, if any, of approximately $41,464,000 and $14,795,000 for Federal
and California income tax purposes, respectively. The benefits from these
carryforwards expire at various times from 2005 through 2022. As of December 31,
2004, the Company cannot determine that it is more likely than not that these
carryforwards and other deferred tax assets will be realized, and accordingly,
the Company has fully reserved for these deferred tax assets. The change in
valuation allowance was $1,358,200, $(706,300) and $(3,475,000) for the years
ended December 31, 2004, 2003 and 2002, respectively.
In 1998 the Company experienced a "change of ownership" as defined by the
provisions of the Tax Reform Act of 1986. As such, utilization of the Company's
net operating loss carryforwards through 1998 will be limited to approximately
$400,000 per year until such carryforwards are fully utilized or expire.
12. Concentration of Credit Risk.
Financial instruments, which potentially subject the Company to concentration of
credit risk, consist principally of cash and cash equivalents, trade receivables
and note receivable-related party. The Company places cash and cash equivalents
with high quality financial institutions and, by policy, limits the amount of
credit exposure to any one financial institution. As of December 31, 2004, the
Company had approximately $575,300 of cash and cash equivalents with financial
institutions, in excess of FDIC insurance limits.
For the year ended December 31, 2004, sales to the Company's three largest
customers accounted for approximately 20.9%, 14.9% and 14.1% of total revenues,
respectively, with related accounts receivable as of December 31, 2004 of
$160,400, $15,000 and $0, respectively.
For the year ended December 31, 2003, sales to the Company's three largest
customers accounted for approximately 27.4%, 18.4% and 9.2% of total revenues,
respectively, with related accounts receivable as of December 31, 2003 of $0,
$145,900 and $230,000, respectively.
For the year ended December 31, 2002, sales to the Company's three largest
customers accounted for approximately 26.9%, 23.4% and 12.5% of total revenues,
respectively, with related accounts receivable as of December 31, 2002 of $0, $0
and $58,800, respectively.
The Company performs credit evaluations of customers' financial condition
whenever necessary, and generally does not require cash collateral or other
security to support customer receivables.
Approximately 52,039 shares of NES' common stock (See Note 5) collateralizes the
note receivable-related party, which bears interest at 3.62% per annum and
matures in 2009. The Company reviews the collectibility of the note on a regular
basis.
13. Commitments and Contingencies.
Operating Leases. In October 2004, the Company renewed its operating lease for
an approximate 3,300 square foot facility in New Hampshire. This lease is
cancelable by the landlord or the Company upon 30-days written notice. Monthly
rental payments for this facility are approximately $5,300.
42
The Company currently occupies approximately 1,000 square feet of office space
in Santa Cruz, California. The office space is rented pursuant to a one-year
operating lease, which became effective August 1, 2004. Rent on the Santa Cruz
facility is approximately $1,400 per month.
The Company has been occupying leased facilities in Rolling Hills Estates,
California on a month-to-month basis since October 2002. Rent on this office is
approximately $1,000 per month.
The Company has also been renting a small office in Berkshire, England, United
Kingdom since December 2002. This operating lease runs through December 2005.
Rent on this office, which can fluctuate depending on exchange rates, is
approximately $400 per month.
Future minimum lease payments under all leases in effect as of December 31,
2004, assuming that neither the landlord nor the Company cancels the lease on
the New Hampshire facility, are as follows:
Year Payments
---- --------
2005 $ 62,600
2006 and thereafter $ -
Rent expense for the years ended December 31, 2004, 2003 and 2002 aggregated
approximately $95,700, $295,400 and $525,700, respectively.
Commitments. On January 29, 2004, the Company completed a private placement of
common stock and common stock purchase warrants in which Mr. Orin Hirschman
purchased 3,043,478 shares of common stock and warrants to purchase 1,521,739
shares of common stock (representing in the aggregate 19.7% of the Company's
outstanding shares of common stock as of March 18, 2004). As a condition of the
sale, the Company entered into an Investment Advisory Agreement with Mr.
Hirschman, pursuant to which it was agreed that in the event the Company
completes a transaction with a third party introduced by Mr. Hirschman, the
Company shall pay to Mr. Hirschman 5% of the value of that transaction. The
agreement, as amended, expires on January 29, 2008.
Contingencies. Under its Amended and Restated Certificate of Incorporation and
Amended and Restated Bylaws and certain agreements with officers and directors,
the Company has agreed to indemnify its officers and directors for certain
events or occurrences arising as a result of the officer or director's serving
in such capacity. Generally, the term of the indemnification period is for the
officer's or director's lifetime. The maximum potential amount of future
payments the Company could be required to make under these indemnification
agreements is unlimited as the Company does not currently have a directors and
officers liability insurance policy that limits its exposure and enables it to
recover a portion of any future amounts paid. The Company believes the estimated
fair value of these indemnification agreements is minimal and has no liabilities
recorded for these agreements as of December 31, 2004.
The Company enters into indemnification provisions under (i) its agreements with
other companies in its ordinary course of business, including contractors and
customers and (ii) its agreements with investors. Under these provisions, the
Company generally indemnifies and holds harmless the indemnified party for
losses suffered or incurred by the indemnified party as a result of the
Company's activities or, in some cases, as a result of the indemnified party's
activities under the agreement. These indemnification provisions often include
indemnifications relating to representations made by the Company with regard to
intellectual property rights, and often survive termination of the underlying
agreement. The maximum potential amount of future payments the Company could be
required to make under these indemnification provisions is unlimited. The
Company has not incurred material costs to defend lawsuits or settle claims
related to these indemnification agreements. As a result, the Company believes
the estimated fair value of these agreements is minimal. Accordingly, the
Company has no liabilities recorded for these agreements as of December 31,
2004.
The Company's software license agreements also generally include a performance
guarantee that the Company's software products will substantially operate as
described in the applicable program documentation for a period of 90 days after
delivery. The Company also generally warrants that services that the Company
performs will be provided in a manner consistent with reasonably applicable
industry standards. To date, the Company has not incurred any material costs
associated with these warranties.
14. Employee 401(k) Plan.
In December 1998, the Company adopted a 401(k) Plan (the Plan) to provide
retirement benefits for employees. As allowed under Section 401(k) of the
Internal Revenue Code, the Plan provides tax-deferred salary deductions for
eligible employees. Employees may contribute up to 15% of their annual
compensation to the Plan, limited to a maximum annual amount as set periodically
by the Internal Revenue Service. In addition, the Company may make
discretionary/matching contributions. During 2004, 2003 and 2002, the Company
contributed a total of $23,000, $27,200 and $52,400 to the Plan, respectively.
43
15. Supplemental Disclosure of Cash Flow Information.
The following is supplemental disclosure for the statements of cash flows.
Years Ended December 31, 2004 2003 2002
- ------------------------ ----------- ----------- -----------
Cash Paid:
- ----------
Income Taxes $ - $ - $ -
Interest $ - $ - $ 200
During 2002, the Company accepted 933,333 shares of its common stock from Menta
Software as full settlement of the outstanding $1,400,000 due the Company under
the terms of the patent license agreement the Company entered into with Menta
Software in May 2001.
During 2004, the Company capitalized approximately $179,500 and $31,000 of
deferred acquisition costs, related to the NES acquisition, that were included
in accounts payable and accrued liabilities, respectively, as of December 31,
2004. Additionally, during 2004, the Company accrued approximately $32,500 of
deferred financing costs, related to the 2005 private placement, as other
assets, as of December 31, 2004.
16. Quarterly Information (Unaudited).
The summarized quarterly financial data presented below reflect all adjustments,
which, except for the restructuring charge recorded during the third quarter of
fiscal 2003, in the opinion of management, are of a normal and recurring nature
necessary to present fairly the results of operations for the periods presented.
In thousands, except per share data.
Year ended First Second Third Fourth Full
December 31, 2004 Quarter Quarter Quarter Quarter Year
- ------------------------------- ------- ------- ------- ------- -------
Total revenues $ 903 $ 677 $ 932 $ 1,018 $ 3,530
Gross profit 593 373 784 876 2,626
Operating income (loss) (435) (735) (295) 23 (1,442)
Net income (loss) (431) (732) (293) 29 (1,427)
Income (loss) per common share:
Basic (0.03) (0.03) (0.01) 0.00 (0.07)
Diluted na na na 0.00 na
Year ended First Second Third Fourth Full
December 31, 2003 Quarter Quarter Quarter Quarter Year
- ------------------------ ------- ------- ------- ------- -------
Total revenues $ 1,044 $ 1,175 $ 1,086 $ 865 $ 4,170
Gross profit 720 832 773 474 2,799
Restructuring charge - - (80) - (80)
Operating loss (386) (416) (514) (579) (1,895)
Net loss (380) (418) (511) (578) (1,887)
Basic and diluted
loss per common share (0.02) (0.03) (0.03) (0.03) (0.11)
(Remainder of page intentionally left blank)
44
Report of Independent Registered Public Accounting Firm on Supplemental
Schedule
To the Board of Directors and Shareholders of GraphOn Corporation
The audits referred to in our report dated February 23, 2004 (which report
contains an explanatory paragraph regarding the ability of GraphOn Corporation
and Subsidiary to continue as a going concern) relating to the consolidated
financial statements of GraphOn Corporation and Subsidiary, which is contained
in Item 8 of this Form 10-K, included the audit of the financial statement
schedule listed in the accompanying index. This financial statement schedule is
the responsibility of the Company's management. Our responsibility is to express
an opinion on this financial statement schedule based upon our audits.
In our opinion, the consolidated financial statement schedule as of December 31,
2003 and 2002 and for each of the two years in the period ended December 31,
2003, presents fairly, in all material respects, the information set forth
therein.
/s/ BDO Seidman, LLP
BDO Seidman, LLP
San Jose, California
February 23, 2004
(Remainder of page intentionally left blank)
45
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
Balance Charged
At to costs Balance
Beginning and at end of
Description of period expenses Deductions period
- ----------- ----------- ----------- ----------- -----------
Allowance for
Doubtful accounts:
2004 $ 46,800 $ - $ - $ 46,800
2003 $ 50,300 $ 16,300 $ 19,800 $ 46,800
2002 $ 350,000 $ 31,600 $ 331,300 $ 50,300
(Remainder of page intentionally left blank)
46
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
We have previously reported in our Current Report on Form 8-K, filed with the
SEC on February 14, 2005, that we dismissed BDO Seidman, LLP as our independent
auditor and had engaged the firm of Macias Gini & Company LLP as our
independent auditor for the fiscal year ended December 31, 2004.
ITEM 9A. 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 December 31, 2004. 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 December 31, 2004 that has materially
affected, or is reasonably likely to materially affect, our internal control
over financial reporting.
ITEM 9B. OTHER INFORMATION
Not Applicable.
(Remainder of page intentionally left blank)
47
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Executive Officers and Directors of the Registrant
Set forth below is information concerning each of our directors and
executive officers as of March 18, 2005.
Name Age Position
Robert Dilworth 63 Chairman of the Board of Directors and
Chief Executive Officer (Interim)
William Swain 64 Chief Financial Officer and Secretary
August P. Klein 68 Director
Michael Volker 56 Director
Gordon Watson 69 Director
Robert Dilworth has served as one of our directors since July 1998 and was
appointed Chairman in December 1999. In January 2002, Mr. Dilworth was appointed
Interim Chief Executive Officer upon the termination, by mutual agreement, of
our former Chief Executive Officer, Walter Keller. From 1987 to 1998 he served
as the Chief Executive Officer and Chairman of the Board of Metricom, Inc., a
leading provider of wireless data communication and network solutions. Prior to
joining Metricom, from 1985 to 1988, Mr. Dilworth served as President of Zenith
Data Systems Corporation, a microcomputer manufacturer. Earlier positions
included Chief Executive Officer and President of Morrow Designs, Chief
Executive Officer of Ultramagnetics, Group Marketing and Sales Director of
Varian Associates Instruments Group, Director of Minicomputer Systems at Sperry
Univac and Vice President of Finance and Administration at Varian Data Machines.
Mr. Dilworth is also a director of eOn Communications, Sky Pipeline and Yummy
Interactive. Mr. Dilworth previously served as director of Mobility Electronics
and Get2Chip.com, Inc.
William Swain has served as our Chief Financial Officer and Secretary since
March 2000. Mr. Swain was a consultant from August 1998 until February 2000,
working with entrepreneurs in the technology industry in connection with the
start-up and financing of new business opportunities. Mr. Swain was Chief
Financial Officer and Secretary of Metricom Inc., from January 1988 until June
1997, during which time he was instrumental in private financings as well as
Metricom's initial public offering and subsequent public financing activities.
He continued as Senior Vice President of Administration with Metricom from June
1997 until July 1998. Prior to joining Metricom, Mr. Swain held senior financial
positions with leading companies in the computer industry, including Morrow
Designs, Varian Associates and Univac. Mr. Swain holds a Bachelors degree in
Business Administration from California State University of Los Angeles and is a
Certified Public Accountant in the State of California.
August P. Klein has served as one of our directors since August 1998. Mr. Klein
has been, since 1995, the founder, Chief Executive Officer and Chairman of the
Board of JSK Corporation. From 1989 to 1993, Mr. Klein was founder and Chief
Executive Officer of Uniquest, Inc., an object-oriented application software
company. From 1984 to 1988, Mr. Klein served as Chief Executive Officer of
Masscomp, Inc., a developer of high performance real time mission critical
systems and Unix-based applications. Mr. Klein has served as Group Vice
President, Serial Printers at Data Products Corporation and President and Chief
Executive Officer at Integral Data Systems, a manufacturer of personal computer
printers. From 1957 to 1982, he was General Manager of the Retail Distribution
Business Unit and Director of Systems Marketing at IBM. Mr. Klein is a director
of QuickSite Corporation and has served as a trustee of the Computer Museum in
Boston, Massachusetts since 1988. Mr. Klein holds a B.S. in Mathematics from St.
Vincent College.
Michael Volker has served as one of our directors since July 2001. Mr. Volker
has been, since 1996, Director of Simon Fraser University's Industry Liaison
Office. From 1996 to 2001, Mr. Volker was Chairman of the Vancouver Enterprise
Forum, a non-profit organization dedicated to the development of British
Columbia's technology enterprises. From 1987 to 1996, Mr. Volker was Chief
Executive Officer and Chairman of the Board of Directors of RDM Corporation, a
publicly listed company. RDM is a developer of specialized hardware and software
products for both Internet electronic commerce and paper payment processing.
From 1988 to 1992, Mr. Volker was Executive Director of BC Advanced Systems
Institute, a hi-tech research institute. Since 1982, Mr. Volker had been active
in various early stage businesses as a founder, investor, director and officer.
Mr. Volker, a registered professional engineer in the Province of British
Columbia, holds a Bachelor's and Master's degree from the University of
Waterloo.
Gordon Watson has served as one of our directors since April 2002. In 1997, Mr.
Watson founded Watson Consulting, LLC, a consulting company for early stage
technology companies, in 1997, and has served as its President since its
inception. From 1996 to 1997 he served as Western Regional Director, Lotus
Consulting of Lotus Development Corporation. From 1988 to 1996, Mr. Watson held
various positions with Platinum Technology, Incorporated, most recently serving
as Vice President Business Development, Distributed Solutions. Earlier positions
include Senior Vice President of Sales for Local Data, Incorporated, President,
Troy Division, Data Card Corporation, and Vice President and General Manager,
Minicomputer Division, Computer Automation, Incorporated. Mr. Watson also held
48
various executive and director level positions with TRW, Incorporated, Varian
Data Machines, and Computer Usage Company. Mr. Watson holds a Bachelors of
Science degree in electrical engineering from the University of California at
Los Angeles and has taught at the University of California at Irvine. Mr. Watson
is also a director of DPAC Technologies, PATH Communications and SoftwarePROSe,
Inc.
Our Board of Directors has an audit committee consisting of three directors, all
of whom are independent as defined by the listing standards of The Nasdaq Stock
Market. The current members of the audit committee are August P. Klein
(committee chairman), Michael Volker and Gordon Watson. Our Board of Directors
has determined that Mr. Klein meets the SEC's definition of an audit committee
financial expert.
Our Board of Directors has adopted a Code of Ethics applicable to all of our
employees, including our chief executive officer, chief financial officer and
controller. This code of ethics was filed as an exhibit to the annual report on
Form 10-K for the year ended December 31, 2003.
All executive officers serve at the discretion of the Board of Directors.
Compliance With Section 16(a) of the Securities Exchange Act
Section 16(a) of the Securities Exchange Act of 1934 requires our officers and
directors, as well as those persons who own more than 10% of our common stock,
to file reports of ownership and changes in ownership with the SEC. These
persons are required by SEC rule to furnish us with copies of all Section 16(a)
forms they file.
Based solely on our review of the copies of such forms, or written
representations from certain reporting persons that no such forms were required,
we believe that during the year ended December 31, 2004, all filing requirements
applicable to our officers, directors and greater than 10% owners of our common
stock were complied with.
ITEM 11. EXECUTIVE COMPENSATION
Summary Compensation Table. The following table sets forth information for the
fiscal years ended December 31, 2004, 2003 and 2002 concerning compensation we
paid to our Chief Executive Officer and our other executive officers whose total
annual salary and bonus exceeded $100,000 for the year ended December 31, 2004.
Restricted Securities
Other Annual Stock Underlying LTIP All Other
Name and Principal Position Year Salary Bonus Compensation Awards Options Payouts Compensation
- --------------------------- ------ ---------- ----- ------------ ---------- ------------ ------- ------------
Robert Dilworth 2004 $ 99,000 - - - 300,000 (2) - -
Chairman of the Board 2003 $ 129,000 - - - 40,000 - -
Chief Executive Officer 2002 $ 256,000 - - - 100,000 - -
(Interim) (1)
- --------------------------- ------ ---------- ----- ------------ ---------- ------------ ------- ------------
William Swain 2004 $ 123,100 - - - 380,000 (2) - $ 2,000 (3)
Chief Financial Officer 2003 $ 96,200 - - - 40,000 - $ 2,000 (3)
Secretary 2002 $ 147,700 - - - - - $ 2,000 (3)
- --------------------------- ------ ---------- ----- ------------ ---------- ------------ ------- ------------
(1) Mr. Dilworth began as Chief Executive Officer (Interim) during January
2002. As interim Chief Executive Officer, Mr. Dilworth is compensated as a
consultant and not an employee, consequently; he is eligible to receive
compensation for his services as a director. Mr. Dilworth has elected,
since assuming the interim Chief Executive Officer position, to forgo the
cash compensation we pay all directors for their attendance at board and
committee meetings as well as the quarterly retainer.
(2) During 2004, Mr. Dilworth and Mr. Swain voluntarily surrendered, on May 14,
2004, 260,000 and 380,000 out-of-the-money options, respectively, in
conjunction with participation in a voluntary stock option exchange
program. New option grants equal to the number cancelled were made on
49
November 15, 2004. All options granted to Mr. Dilworth during fiscal 2004
were granted in his capacity as one of our directors.
(3) Company contribution to the 401(k) Plan.
Option Grants in Last Fiscal Year. The following table shows the stock option
grants made to the executive officers named in the Summary Compensation Table
during the 2004 fiscal year:
Number of Potential Realziable Value
Shares of Percent of Total at Assumed Annual Rates
Common Stock Options Granted of Stock Appreciation
Underlying to Employees Exercise Expiration for Option Term
Name Options Granted In Fiscal Year Price (1) Date 5% 10%
- ------------------ ----------------- ---------------- ---------- ------------ ----------------------------
Robert Dilworth 300,000 (2) 22.2% $ 0.34 11/14/14 $ 1,457,100 $ 1,910,800
- ------------------ ----------------- ---------------- ---------- ------------ ----------------------------
William Swain 380,000 (2) 28.1% $ 0.34 11/14/14 $ 1,845,700 $ 2,420,300
- ------------------ ----------------- ---------------- ---------- ------------ ----------------------------
(1) Options were granted at an exercise price equal to the fair market value of
our common stock, as determined by the closing sales price reported on the
Over-the-Counter Bulletin Board on the date of grant.
(2) During 2004, Mr. Dilworth and Mr. Swain voluntarily surrendered, on May 14,
2004, 260,000 and 380,000 out-of-the-money options, respectively, in
conjunction with participation in a voluntary stock option exchange
program. New option grants equal to the number cancelled were made on
November 15, 2004. All options granted to Mr. Dilworth during fiscal 2004
were granted in his capacity as one of our directors.
Fiscal Year-End Option Values. The following table shows information with
respect to unexercised stock options held by the executive officers named in the
Summary Compensation Table as of December 31, 2004. No options held by such
individuals were exercised during 2004.
Number of Securities Underlying Value of Unexercised
Unexercised Options In-The-Money Options at
at Fiscal Year-End (1) Fiscal Year-End (2)
Name Exercisable Unexercisable Exercisable Unexercisable
- ------------------ ------------- ----------------- ------------- ---------------
Robert Dilworth 440,000 - $ 112,200 -
- ------------------ ------------- ----------------- ------------- ---------------
William Swain 420,000 - $ 98,800 -
- ------------------ ------------- ----------------- ------------- ---------------
(1) Options are generally immediately exercisable and vest in 33 equal monthly
installments beginning three months after the date of grant. Shares issued
upon the exercise of options are subject to our repurchase, which right
lapses as the shares vest.
(2) The value of the in-the-money options was calculated as the difference
between the exercise price of the options and $0.56, the fair market value
of our common stock as of December 31, 2004, multiplied by the number of
the in-the-money options outstanding.
Compensation of Directors. During the year ended December 31, 2004, directors
who were not otherwise our employees were compensated at the rate of $1,000 for
attendance at each meeting of our board, $500 if their attendance is via
telephone, $500 for attendance at each meeting of a board committee, and a
$1,500 quarterly retainer. Additionally, outside directors are granted stock
options periodically, typically on a yearly basis. In the aggregate, our outside
directors received options to purchase 112,500 shares of our common stock during
2004 at an average exercise price of $0.56 per share.
50
Compensation Committee Interlocks and Insider Participation. During the year
ended December 31, 2004, the Compensation Committee was comprised of Robert
Dilworth, our Interim Chief Executive Officer and Chairman of the Board, and
August Klein, a non-employee director.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information, as of March 30, 2005, with
respect to the beneficial ownership of shares of our common stock held by: (i)
each director; (ii) each person known by us to beneficially own 5% or more of
our common stock; (iii) each executive officer named in the summary compensation
table; and (iv) all directors and executive officers as a group. Unless
otherwise indicated, the address for each stockholder is c/o GraphOn
Corporation, 3130 Winkle Avenue, Santa Cruz, California 95065.
Number of Shares
of Common Stock Percent of
Name and Address of Beneficial Owner Beneficially Owned (1)(2) Class (%)
- ------------------------------------------------------------------------ ------------------------- -----------
Robert Dilworth (3)..................................................... 693,820 1.5
William Swain (4)....................................................... 599,000 1.3
August P. Klein (5)..................................................... 445,760 1.0
Michael Volker (6)...................................................... 318,200 *
Gordon Watson (7)....................................................... 280,000 *
Orin Hirschman (8)...................................................... 9,120,417 18.5
6006 Berkeley Avenue
Baltimore, MD 21209
Ralph Wesinger (9)...................................................... 5,046,491 10.9
IDT Capital, Inc. (10).................................................. 5,555,500 11.6
520 Broad Street
Newark, NJ 07102
Globis Capital Partners (11)............................................ 3,821,278 8.2
60 Broad Street, 38th Floor
New York, NY 10004
All current executive officers and directors as a group (5 persons)(12). 2,336,780 4.8
* Denotes less than 1%.
(1) As used in this table, beneficial ownership means the sole or shared power
to vote, or direct the voting of, a security, or the sole or shared power
to invest or dispose, or direct the investment or disposition, of a
security. Except as otherwise indicated, based on information provided by
the named individuals, all persons named herein have sole voting power and
investment power with respect to their respective shares of our common
stock, except to the extent that authority is shared by spouses under
applicable law, and record and beneficial ownership with respect to their
respective shares of our common stock. With respect to each stockholder,
any shares issuable upon exercise of options and warrants held by such
stockholder that are currently exercisable or will become exercisable
within 60 days of March 30, 2005 are deemed outstanding for computing the
percentage of the person holding such options, but are not deemed
outstanding for computing the percentage of any other person.
(2) Percentage ownership of our common stock is based on 46,147,047 shares of
common stock outstanding as of March 30, 2005 and reflects the
effectiveness of the Certificate of Amendment that was approved by our
shareholders at our Special Meeting of Shareholders on March 29, 2005.
Upon the effectiveness of the Certificate of Amendment each share of our
previously outstanding Series A preferred stock was automatically
converted into 100 shares of our common stock and each warrant that was
exercisable for shares of our Series A or Series B preferred stock was
automatically converted into a warrant exercisable for that number of
shares of our common stock equal to the number of shares of Series A or
Series B preferred stock subject to the warrant multiplied by 100.
(3) Includes 640,000 shares of common stock issuable upon the exercise of
outstanding options.
(4) Includes 580,000 shares of common stock issuable upon the exercise of
outstanding options.
(5) Includes 295,000 shares of common stock issuable upon the exercise of
outstanding options.
(6) Includes 260,000 shares of common stock issuable upon the exercise of
outstanding options.
51
(7) Includes 280,000 shares of common stock issuable upon the exercise of
outstanding options.
(8) Based on information contained in a Schedule 13D/A filed by Orin Hirschman
on February 17, 2005. Includes 3,040,139 shares of common stock issuable
upon the exercise of outstanding warrants. Mr. Hirschman is the managing
member of AIGH Investment Partners, LLC (AIGH) and has sole voting and
dispositive power with respect to 4,555,200 shares held by AIGH, which
shares are included in Mr. Hirschman's beneficial ownership total.
(9) Based on information contained in a Schedule 13G filed by Mr. Wesinger on
February 10, 2005. Includes 1,569,816 shares held in escrow pursuant to
the terms of an escrow agreement (the "NES Escrow Agreement") entered into
in connection with the acquisition by GraphOn of NES. For the duration of
the escrow, Mr. Wesinger has the right to vote, but not to dispose of,
such shares. Includes 83,333 shares of common stock issuable upon exercise
of outstanding options.
(10) Based on information contained in a Schedule 13D filed by IDT Capital,
Inc. on February 15, 2005. Includes 1,851,800 shares of common stock
issuable upon the exercise of warrants. Howard S. Jonas exercises sole
voting and dispositive power with respect to the listed shares.
(11) Based on information contained in a Schedule 13G filed by Paul Packer on
February 10, 2004Includes 881,687 shares held by Mr. Paul Packer and
555,600 shares held by Globis Overseas Fund Ltd. (Globis Overseas).
Includes 925,900 shares of common stock issuable upon the exercise of
warrants. Mr. Packer is the Managing Member of Globis Capital Partners
(Globis) and is the Managing Member of the general partner of the manager
of Globis Overseas. Mr. Packer exercises sole voting and dispositive power
with respect to the shares beneficially owned by Globis and Globis
Overseas.
(12) Includes 2,055,000 shares of common stock issuable upon the exercise of
outstanding options.
Equity Compensation Plan Information. The following table sets forth information
related to all of our equity compensation plans as of December 31, 2004; it does
not give effect to 1,250,000 shares of common stock issuable under options
granted in 2005 to two individuals under plans approved by our board of
directors during 2005:
Number of Securities to be Weighted Average
Issued Upon Exercise of Exercise Price Number of Securities
Outstanding Options, Warrants of Outstanding Options, Remaining Available
Plan Category and Rights Warrants and Rights for Future Issuance
- ------------------------------------ -------------------------------- ------------------------- ------------------------
Equity compensation plans approved
by security holders:
Stock option plans 2,965,268 $ 0.56 1,145,591
Employee stock purchase plan (1) (1) (1)
- ------------------------------------ -------------------------------- ------------------------- ------------------------
Equity compensation plans not
approved by security holders:
Stock option plan (2) - na 400,000
- ------------------------------------ -------------------------------- ------------------------- ------------------------
Total 2,965,268 $ 0.56 1,545,591
- ------------------------------------ -------------------------------- ------------------------- ------------------------
(1) Under terms of the employee stock purchase plan (ESPP), employees who
participate in the plan are eligible to purchase shares of common stock.
As of December 31, 2004, 168,056 shares had been purchased through the
ESPP, at an average cost of $1.02 per share and 131,944 shares are
available for future purchase.
(2) On April 30, 2000 our board approved a supplemental stock option plan.
Participation in the supplemental plan is limited to those employees who
are, at the time of the option grant, neither officers nor directors. The
supplemental plan was initially authorized to issue options for up to
400,000 shares of common stock. The exercise price per share is subject to
the following provisions:
o The exercise price per share shall not be less than 85% of the fair
market value per share of common stock on the option grant date.
o If the person to whom the option is granted is a 10% shareholder,
then the exercise price per share shall not be less than 110% of the
fair market value per share of common stock on the option grant
date.
52
All options granted are immediately exercisable by the optionee. The
options vest, ratably, over a 33-month period, however no options vest
until after three months from the date of the option grant. The exercise
price is immediately due upon exercise of the option. The supplemental
plan shall terminate no later than April 30, 2010.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
On January 29, 2004, we issued and sold to certain individuals and entities in a
private placement (the "2004 private placement") 5,000,000 shares of common
stock and five-year warrants to acquire 2,500,000 shares of common stock at an
exercise price of $0.33 per share. We derived net proceeds of approximately
$931,400 from the 2004 private placement. We also issued to Griffin Securities
Inc., as a placement agent fee in respect to the 2004 private placement,
warrants to acquire 500,000 shares of common stock at an exercise price of $0.23
per share and warrants to acquire 250,000 shares of our common stock at an
exercise price of $0.33 per share.
Orin Hirschman purchased 3,043,478 shares of common stock and warrants to
acquire 1,521,739 shares of common stock in the 2004 private placement for
approximately $700,000 in cash (representing in the aggregate 9.9% of our
outstanding shares of common stock as of March 30, 2005). As a condition of the
sale, we entered into an Investment Advisory Agreement, expiring on January 29,
2007, with Mr. Hirschman, which provides for our payment of 5% of the value of
any business transaction that he introduces to us and which we accept.
On October 6, 2004, we entered into a letter of intent to acquire NES. We
contemporaneously loaned $350,000 to Ralph Wesinger, NES' majority shareholder,
to fund his purchase of all the NES common stock then owned by another person.
We received Mr. Wesinger's 5-year promissory note, which bears interest at a
rate of 3.62% per annum and which was secured by his approximately 65% equity
interest in NES, to evidence this loan. Mr. Wesinger also agreed that we would
receive 25% of the gross proceeds of any sale or transfer of these shares, which
shall be applied in reduction of the then outstanding balance of his note. We
have the option to accelerate the maturity date of this note upon the occurrence
of certain events.
On December 10, 2004 we entered into an agreement with AIGH Investment Partners,
LLC ("AIGH"), an affiliate of Orin Hirschman, to reimburse AIGH $665,000, as
well as its legal fees and expenses, relating to its successful efforts to
settle certain third party litigation against NES and certain of its affiliates.
On January 31, 2005, we completed our acquisition of NES in exchange for
9,600,000 shares of common stock, the assumption of approximately $235,000 of
NES' indebtedness and the reimbursement to AIGH of $665,000 for its advance on
our behalf of a like sum in December 2004 to settle certain third party
litigation against NES. This reimbursement was effected (as discussed below) by
a partial credit against the purchase price of our securities acquired by Mr.
Hirschman in the 2005 private placement. Of such 9,600,000 shares, 4,963,158
were issued to Mr. Wesinger, an aggregate 2,439,342 shares were issued to NES'
other shareholders and an aggregate 2,197,500 shares to two of NES' remaining
creditors. Immediately thereafter, 3,260,391 of the shares issued to Mr.
Wesinger were substituted for the NES shares that he had previously pledged to
us to secure repayment of his $350,000 note. In accordance with the terms of the
acquisition, Mr. Wesinger became a non-executive employee of our company upon
consummation of the acquisition.
On February 2, 2005, we issued and sold to certain individuals and entities in
the 2005 private placement 148,148 shares of newly authorized Series A preferred
stock at a price of $27.00 per share and five-year warrants to acquire 74,070
shares of newly authorized Series B preferred stock at an exercise price of
$40.00 per share. We derived net proceeds of approximately $2,000,000 from the
2005 private placement.
Orin Hirschman purchased 30,368 shares of Series A preferred stock and warrants
to acquire 15,184 shares of Series B preferred stock in the 2005 private
placement for an aggregate purchase price of $820,000. We repaid the $665,000 we
owed AIGH by crediting Mr. Hirschman's purchase price of our securities with a
like sum. The balance of the purchase price ($155,000) was paid in cash. As an
inducement to his participation in the 2005 private placement, we extended the
expiration date of Mr. Hirschman's Investment Advisory Agreement to January 29,
2008. Pursuant to the agreement with AIGH as described above, we also paid Mr.
Hirschman's legal fees and expenses of approximately $108,000.
On March 29, 2005, our shareholders approved an amendment to our certificate of
incorporation increasing our authorized but unissued common stock from
45,000,000 to 195,000,000 shares. Upon the effectiveness of the certificate of
amendment to our certificate of incorporation implementing this increase, each
share of Series A preferred stock will automatically convert into 100 shares of
our common stock and each warrant will automatically convert into a warrant to
purchase that number of shares of common stock equal to the number of shares of
preferred stock subject to the warrant multiplied by 100. As a result, upon the
effectiveness of the certificate of amendment, all outstanding shares of Series
A Preferred Stock (148,148 shares) were converted into 14,814,800 shares of our
common stock. In addition, upon the effectiveness of the certificate of
amendment, all outstanding warrants to purchase shares of Series A preferred
stock (14,815 shares) and Series B preferred stock (81,477 shares) were
converted into five-year warrants to purchase 1,481,500 shares of our common
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stock at an exercise price of $0.27 per share and five-year warrants to purchase
8,147,700 shares of our common stock at an exercise price of $0.40 per share,
respectively.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
On February 9, 2005, our Audit Committee dismissed BDO Seidman, LLP as our
independent auditors. Fees for professional services provided by BDO Seidman,
LLP for the years ended December 31, 2004 and 2003 were as follows:
Category 2004 2003
-------- --------- ----------
Audit fees $ 44,600 $ 104,100
Audit - related fees - -
Tax fees 15,800 17,000
Other fees - -
--------- ----------
Totals $ 60,400 $ 121,100
========= ==========
Fees for audit services include fees associated with our annual audit, the
reviews of our quarterly reports on Form 10-Q, and assistance with and review of
documents filed with the Securities and Exchange Commission (the "SEC").
Audit-related fees include consultations regarding revenue recognition rules and
interpretations as they related to the financial reporting of certain
transactions. Tax fees included tax compliance and tax consultations. For 2004,
BDO Seidman, LLP's audit fees consisted of fees associated with the reviews of
our quarterly reports on Form 10-Q and assistance with and review of documents
filed with the SEC. Their tax fees consisted of tax compliance and tax
consultations. For 2003, their audit fees included fees associated with our 2003
annual audit, the reviews of our quarterly reports on Form 10-Q, and assistance
with and review of documents filed with the SEC. Their tax fees consisted of tax
compliance and tax consultations.
On February 9, 2005, our Audit Committee engaged the firm of Macias Gini &
Company LLP as our independent auditor for the fiscal year ending December 31,
2004. Estimated fees, payable in 2005, for the audit of our 2004 financial
statements and the preparation of our 2004 federal, state and local tax returns
are $75,000 and $12,000, respectively. We had accrued these amounts as of
December 31, 2004.
The audit committee has adopted a policy that requires advance approval of all
audit, audit-related, tax services and other services performed by our
independent auditor. The policy provides for pre-approval by the audit committee
of specifically defined audit and non-audit services. Unless the specific
service has been previously pre-approved with respect to that year, the audit
committee must approve the permitted service before the independent auditor is
engaged to perform it.
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PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a) The following documents are filed as part of this report:
(1) Financial statements filed as part of this report are listed on the
"Index to Consolidated Financial Statements" at page 25 herein.
(2) Financial Statement Schedules. The applicable financial statement
schedules required under Regulation S-X have been included beginning
on page 45 of this report, as follows:
i. Report of Independent Registered Public Accounting Firm on
Financial Statement Schedule: page 45
ii. Schedule II - Valuation and Qualifying Accounts: page 46
(b) Exhibits.
Exhibit
Number Description of Exhibit
2.1 Agreement and Plan of Merger and Reorganization dated as of December
3, 2004, between registrant and GraphOn NES Sub, LLC, a California
limited liability company, GraphOn Via SUB III Inc., a Delaware
corporation, Network Engineering Software, Inc., a California
corporation and Ralph Wesinger (1)
3.1 Amended and Restated Certificate of Incorporation of Registrant (2)
3.2 Amended and Restated Bylaws of Registrant (3)
4.1 Form of certificate evidencing shares of common stock of Registrant (4)
4.2 Form of Warrant issued by Registrant on January 29, 2004 (5)
4.3 Form of Warrant issued by Registrant on February 2, 2005 (6)
4.4 Investors Rights Agreement, dated January 29, 2004, by and among
Registrant and the investors named therein (5)
4.5 Investors Rights Agreement, dated February 2, 2005, by and among
Registrant and the investors named therein (6)
10.1 1996 Stock Option Plan of Registrant (4)
10.2 1998 Stock Option/Stock Issuance Plan of Registrant (3)
10.3 Supplemental Stock Option Agreement, dated as of June 23, 2000 (7)
10.4 Employee Stock Purchase Plan of Registrant (7)
10.5 Lease Agreement between Registrant and Central United Life Insurance,
dated as of October 24, 2003 (5)
10.6 Financial Advisory Agreement, dated January 29, 2004, by and between
Registrant and Orin Hirschman
10.7 Amendment to Financial Advisory Agreement, dated February 2, 2005,
by and between Registrant and Orin Hirschman (6)
10.8 Reimbursement Agreement, dated December 10, 2004, by and between
Registrant and AIGH Investment Partners LLC
10.9 Holder Agreement, dated January 31, 2005, by and between Registrant and
the holders named therein (6)
10.10 Non-recourse Secured Promissory Note, dated October 6, 2004, by and
between Registrant and Ralph Wesinger
10.11 Stock Pledge Agreement, dated October 6, 2004, by and between Registrant
and Ralph Wesinger
10.12 Agreement, dated December 16, 2003, by and between Registrant and
Griffin Securities, Inc.
16.1 Letter from BDO Seidman, LLP, dated February 10, 2005 regarding
change in certifying accountant (8)
14.1 Code of Ethics (5)
23.1 Consent of BDO Seidman, LLP
23.2 Consent of Macias Gini & Company LLP
31.1 Rule 13a-14(a)/15d-14(a) Certifications
32.1 Section 1350 Certifications
(1) Incorporated by reference from Registrant's Current Report on Form 8-K,
dated December 3, 2004, filed with the SEC on December 9, 2004
(2) Incorporated by reference from Registrant's Current Report on Form 8-K,
dated January 28, 2005, filed with the SEC on February 3, 2005
(3) Incorporated by reference from Registrant's Form S-4, file number
333-76333.
(4) Incorporated by reference from Registrant's Form S-1, file number
333-11165.
(5) Incorporated by reference from Registrant's Annual Report on Form 10-K for
the year ended December 31, 2003, dated March 30, 2003, filed with the SEC
on March 30, 2003
(6) Incorporated by reference from Registrant's Current Report on Form 8-K,
dated January 31, 2005, filed with the SEC on February 4, 2005
(7) Incorporated by reference from Registrant's Form S-8, file number
333-40174.
55
(8) Incorporated by reference from Registrant's Current Report on Form 8-K,
dated February 9, 2005, filed with the SEC on February 14, 2005
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized.
GRAPHON CORPORATION
Date: April 15, 2005 By: /s/ William Swain
-----------------
William Swain
Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Name Title
/s/ Robert Dilworth Chairman of the Board and
- -------------------
Robert Dilworth Interim Chief Executive Officer
April 15, 2005 (Principal Executive Officer)
/s/ William Swain Chief Financial Officer and
- -----------------
Secretary
William Swain (Principal Financial Officer and
April 15, 2005 Principal Accounting Officer)
/s/ August P. Klein Director
- -------------------
August P. Klein
April 15, 2005
/s/ Michael Volker Director
- ------------------
Michael Volker
April 15, 2005
/s/ Gordon Watson Director
- -----------------
Gordon Watson
April 15, 2005
56