UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

FORM 10-Q

 

 

GRIC COMMUNICATIONS, INC.
(Exact Name of Registrant as Specified in Its Charter)
Delaware		77-0368092
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)
1421 McCarthy Blvd., Milpitas, California		95035
(Address of Principal Executive Offices)		(Zip Code)
408-955-1920
(Registrant’s Telephone Number, Including Area Code)

 

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  ý    No  o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

 

Yes  ý    No  o

 

The number of shares of the registrant’s common stock outstanding as of April 30, 2004 was 40,855,874 shares.

 

 

GRIC COMMUNICATIONS, INC.

INDEX

	PART I FINANCIAL INFORMATION
Item 1.	Financial Statements:
	Condensed Consolidated Balance Sheets as of March 31, 2004 and  December 31, 2003
	Condensed Consolidated Statements of Operations for the Three Months Ended March 31, 2004 and 2003
	Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2004 and 2003
	Notes to Condensed Consolidated Financial Statements
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.	Quantitative and Qualitative Disclosures About Market Risk
Item 4.	Controls and Procedures
	PART II OTHER INFORMATION
Item 1.	Legal Proceedings
Item 2.	Changes in Securities and Use of Proceeds
Item 3.	Defaults Upon Senior Securities
Item 4.	Submission of Matters to a Vote of Security Holders
Item 5.	Other Information
Item 6.	Exhibits and Reports on Form 8-K
SIGNATURE

 

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PART I. FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

 

GRIC COMMUNICATIONS, INC.

Condensed Consolidated Balance Sheets

(in thousands, except per share amounts)

 

		Mar 31, 2004			Dec 31, 2003
		(unaudited)
ASSETS
Current assets:
Cash and cash equivalents		$	4,442		$	5,299
Short-term investments		18,005			19,913
Accounts receivable, net of allowances of $799 and $949 at March 31, 2004 and December 31, 2003, respectively		8,168			7,446
Inventory		130			158
Prepaid expenses and other current assets		1,683			1,435
Total current assets		32,428			34,251
Property and equipment, net		1,970			2,009
Goodwill		46,680			46,680
Intangible assets		7,067			7,467
Other assets		1,037			721
Total assets		$	89,182		$	91,128
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	6,194		$	7,205
Accrued compensation and benefits		1,540			1,311
Current portion of deferred revenue		1,041			661
Other current liabilities		714			691
Current portion of long-term debt and capital lease obligations		—			14
Total current liabilities		9,489			9,882
Deferred revenue		555			114
Commitments and contingencies
Stockholders’ equity:
Series A redeemable convertible preferred stock, $0.001 par value: 12,801 shares authorized, no shares issued and outstanding at March 31, 2004 and 3,019 shares issued and outstanding at December 31, 2003		—			3,927
Preferred stock, 5,000 shares authorized March 31, 2004 and December 31, 2003: no shares issued and outstanding		—			—
Common stock, $0.001 par value; 50,000 shares authorized at March 31, 2004 and December 31, 2003: 40,833 and 37,242 shares issued and outstanding at March 31, 2004 and December 31, 2003, respectively		41			37
Additional paid-in capital		212,944			208,228
Deferred stock-based compensation		(554		)	(644		)
Accumulated deficit		(133,293		)	(130,416		)
Total stockholders’ equity		79,138			81,132
Total liabilities and stockholders’ equity		$	89,182		$	91,128

 

See accompanying notes

 

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GRIC COMMUNICATIONS, INC.

Condensed Consolidated Statements of Operations

(in thousands, except per share amounts)
(unaudited)

 

		Three Months Ended March 31,
		2004			2003
Revenues		$	12,960		$	9,491
Costs and expenses:
Cost of revenues		5,293			4,365
Network and operations		2,305			947
Research and development		1,167			645
Sales and marketing		5,063			2,697
General and administrative		1,590			1,400
Amortization of intangible assets		400			—
Amortization of stock-based compensation (1)		90			41
Total costs and expenses		15,908			10,095
Operating loss		(2,948		)	(604		)
Interest income and other, net		93			(9		)
Loss before income taxes		(2,855		)	(613		)
Provision for income taxes		22			8
Net loss		$	(2,877	)	$	(621	)
Basic and diluted net loss per share		$	(0.07	)	$	(0.03	)
Shares used to compute basic and diluted net loss per share		39,476			20,729

 

(1) Amortization of stock-based compensation consists of:

 

Network and operations		$	26		$	1
Research and development		19			2
Sales and marketing		37			1
General and administrative		8			37
Total amortization of stock-based compensation		$	90		$	41

 

See accompanying notes

 

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GRIC COMMUNICATIONS, INC.
Condensed Consolidated Statements of Cash Flows
(in thousands)
(unaudited)

 

		Three Months Ended
		March 31, 2004			March 31, 2003
Cash flows from operating activities:
Net loss		$	(2,877	)	$	(621	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization of property and equipment		399			330
Amortization of stock-based compensation		90			41
Amortization of intangibles		400			—
Gain on sales of assets		—			(104		)
Accounts receivable allowances		—			(5		)
Net changes in assets and liabilities:
Accounts receivable		(722		)	(649		)
Inventories		28			—
Prepaid expenses and other current assets		(248		)	(568		)
Other assets		(316		)	87
Accounts payable		(1,011		)	252
Accrued compensation and benefits		229			12
Deferred revenue		821			273
Other current liabilities		23			1
Other long-term liabilities		—			(70		)
Net cash used in operating activities		(3,184		)	(1,021		)
Cash flows from investing activities:
Available-for-sale investments:
Purchases		(8,300		)	(2,700		)
Maturities		10,208			301
Proceeds from sales of assets		—			104
Capital expenditures		(360		)	(62		)
Net cash provided by (used in) investing activities		1,548			(2,357		)
Cash flows from financing activities:
Payments of capital lease obligations		(14		)	—
Proceeds from sales of common stock, net		793			286
Net cash provided by financing activities		779			286
Net decrease in cash and cash equivalents		(857		)	(3,092		)
Cash and cash equivalents at beginning of the period		5,299			7,314
Cash and cash equivalents at end of the period		$	4,442		$	4,222
Supplemental disclosures of cash flow information:
Income taxes paid		$	—		$	8
Supplemental disclosures of noncash financing activities:
Conversion of Series A redeemable convertible preferred stock into common stock		$	3,927		$	—

 

See accompanying notes

 

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GRIC COMMUNICATIONS, INC.

Notes to Condensed Consolidated Financial Statements
(unaudited)

1.                   Basis of Presentation

 

The financial information at March 31, 2004 and for the three months ended March 31, 2004 and 2003 is unaudited, but includes all adjustments that GRIC Communications, Inc. (the “Company”) considers necessary for a fair presentation of the financial information set forth herein, in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly, the financial information set forth herein does not include all of the information and footnotes required by accounting principles generally accepted in the United States for annual financial statements. The results for the three months ended March 31, 2004 are not necessarily indicative of the results that may be expected for future periods.

 

The balance sheet at December 31, 2003 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements.

 

The following information should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003.

 

2.                   Summary of Significant Accounting Policies

 

Basis of Presentation.  The consolidated financial statements include all the accounts of GRIC and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated. All consolidated financial statements have been prepared in conformity with accounting pronouncements generally accepted in the United States.

 

Use of Estimates.  The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

 

Foreign Currency Remeasurement.  The Company considers the functional currency of its foreign subsidiaries to be the U.S. dollar. Adjustments resulting from the process of remeasurement into U.S. dollars of the foreign currency financial statements of the Company’s foreign subsidiaries are included in operations and have not been material.

 

Cash Equivalents.  Cash equivalents consist of certificates of deposits, money market funds and commercial paper with maturities of 90 days or less at the date of purchase. Cash and cash equivalents are carried at cost which approximates market value.

 

Short-term Investments.  The Company’s policy is to invest in various short-term instruments with investment grade credit ratings. All of the Company’s Investments are classified as available-for-sale, and the Company views its available-for-sale portfolio as available for use in its current operations. Accordingly, the Company has classified all investments as short-term, even though the stated maturity date may be one year or more past the current balance sheet date. Investments with maturities greater than one year are considered short-term and they are classified as available-for-sale in accordance with Statement of Financial Accounting Standards No. 115, “Accounting for Certain Investments in Debt and Equity Securities” (“SFAS No. 115”).

 

The cost of securities sold is based on the specific identification method. Any realized gains or losses and declines in value, judged to be other-than-temporary, are included in interest income and other. The Company includes unrealized gains or losses in comprehensive income in stockholders’ equity, if material.

 

Concentration of Credit Risk.  Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash equivalents, short-term investments and accounts receivable. The Company maintains its cash and cash equivalents and short-term investments principally in domestic financial institutions of high credit standing. The Company is exposed to credit risks in the event of default by these institutions to the extent of the amount recorded on the balance sheet. The credit risk in the Company’s accounts receivable is mitigated by the Company’s credit evaluation process for both domestic and foreign customers. The Company generally does not require collateral and maintains adequate

 

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reserves for potential credit losses. Cash equivalents and short-term investments are recorded at fair value. The carrying value of accounts receivable approximates fair value due to the short-term nature of this instrument.

 

Inventories.  Inventories consist of finished goods and are stated at the lower of cost or market, cost being determined using the first-in, first-out method.

 

Property and Equipment.  Property and equipment are stated at cost, net of accumulated depreciation and amortization. Depreciation and amortization are provided on a straight-line basis over the estimated useful lives of the respective assets, generally over the lease term or two to three years.

 

Impairment of Long-Lived Assets and Intangible Assets.  The Company evaluates the carrying amount of its long-lived assets and other intangible assets, when events or changes in business circumstances have occurred, which indicate the carrying amount of such assets may not be fully realizable. Determination of impairment is based on an estimate of undiscounted future cash flows resulting from the use of the assets and their eventual disposition. If the Company determines these assets have been impaired, the impairment charge is recorded based on a comparison of the net book value of the assets and the fair value. The fair value of the assets is determined by either discounted future cash flows resulting from the use of the assets over their average remaining useful lives or specific appraisal.

 

Goodwill.  Goodwill represents the excess of the purchase price of an acquired enterprise or assets over the fair value of the identifiable assets acquired and liabilities assumed. The Company does not amortize goodwill, but tests for impairment of goodwill on an annual basis and at any other time if events occur or circumstances indicate that the carrying amount of goodwill may not be recoverable.

 

Circumstances that could trigger an impairment test include, but are not limited to, a significant adverse change in the business climate or legal factors, an adverse action or assessment by a regulator, unanticipated competition or loss of key personnel. If the carrying amount of the goodwill exceeds the implied fair value of that goodwill, an impairment loss is recorded in net earnings (loss). Goodwill was not considered impaired as of March 31, 2004.

 

Intangible Assets.  Intangible assets consist of customer relationships and internal use software. Intangible assets are amortized on a straight-line method basis over the estimated useful lives ranging from 1 to 5 years. Intangible assets were not considered impaired as of March 31, 2004.

 

Revenue Recognition.  Revenues are recognized when a binding agreement or purchase order from the customer has been received, the services have been delivered, the fee or price was fixed or determinable, the collection of the receivable was reasonably assured, and no significant post-delivery obligations remained. The Company derives revenues primarily from remote Internet access services to customers through its virtual network and by providing monthly security and support services and monthly connectivity services for broadband Internet remote access customers.  Remote Internet access services are generally billed on a per-minute basis for usage or at a flat rate per month per user based on negotiated rates. The Company has some customers with minimum commitment arrangements, which are recognized as revenue in the month it has been determined that the minimum commitments have not been achieved.  Revenues from monthly connectivity services  for broadband remote access are recognized as earned and amounts billed in advance are recorded as deferred revenue if collected. Revenues from security and support services are recognized in the month the service is provided.  Revenues from licenses of the Company’s authentication software, related maintenance and support services, and other optional services related to its GRIC MobileOffice offering are recognized ratably over the life of the contract under which they are provided, which typically ranges from 1 to 12 months. Revenues from installation services and the sale of equipment related to broadband Internet remote access services and managed security services are recognized ratably over 24 months, the expected term of the user relationship.

 

The Company records estimated allowances against revenues in the same period the revenues are recorded. These estimated allowances are based upon historical analysis of our credit memo data and other known factors for pricing and transaction volume disputes that arise in the normal course of business. To date, allowances pertaining to our current business have not been significant.

 

The Company treats the incremental direct costs of installation services related to broadband Internet remote access services and managed security services (which consist primarily of customer premise equipment and installation and service activation fees paid to broadband providers and telecommunications companies) as deferred charges in amounts that do not exceed the upfront fees that are deferred. The deferred incremental direct costs of installation services are amortized to cost of revenues ratably over 24 months, the expected term of the user relationship.

 

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From time to time, the Company’s customers, including significant customers, may seek protection under bankruptcy laws. When this occurs, the Company determines its risk that an account receivable will prove to be uncollectible, and establishes appropriate reserves for that contingency as necessary. In addition, for each continuing customer in bankruptcy, the Company evaluates the creditworthiness of the customer and determines whether revenue should be recognized on an accrual basis or when cash payments are received. When revenue is recorded on an accrual basis, the Company has based its judgment on the creditworthiness of the debtor-in-possession, its payment experience, and whether the collectability of receivables is reasonably assured, in addition to other revenue recognition criteria having been met.

 

Allowance for Doubtful Accounts.  The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. In order to estimate the appropriate level of allowance, the Company analyzes historical bad debts, customer concentrations, customer credit-worthiness, current economic trends and changes in its customer payment patterns. If the financial condition of its customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.

 

Research and Development.  Research and development costs are expensed as incurred until technological feasibility has been established. To date, the software developed by the Company has generally been available for general release concurrent with the establishment of technological feasibility and, accordingly, no software development costs have been capitalized.

 

Stock-based Compensation.  The Company accounts for employee stock-based compensation in accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB No. 25”), using an intrinsic value approach to measure compensation expense, if any. Under APB No. 25, the Company generally recognizes no compensation expense with respect to such awards. Appropriate disclosures using a fair-value based method, as provided by Statement of Financial Accounting Standards No. 123.  “Accounting for Stock-Based Compensation” (“SFAS No. 123”), are also reflected herein. Options issued to non-employees are accounted for in accordance with SFAS 123 using a fair value approach.

 

Pro forma information regarding net income and earnings per share is required by SFAS No. 123 and has been determined as if the Company had accounted for awards to employees under the fair value method of SFAS No. 123. The fair value of stock options under the Equity Plan and stock purchase plan rights under the Purchase Plan was estimated as of the grant date using the Black-Scholes option-pricing model.

 

The fair value of stock options granted during the three months ended March 31, 2004 and 2003 were estimated at the date of grant assuming no expected dividends and the following weighted average assumptions.

 

Stock Options

 

		Three Months Ended March 31,
		2004		2003
Expected life (years)		3.10		1.64
Expected stock price volatility		6.73		1.14
Risk-free interest rate		1.25	%	2.91	%

 

Stock Purchase

 

		Three Months Ended March 31,
		2004		2003
Expected life (years)		0.50		0.50
Expected stock price volatility		5.19		1.07
Risk-free interest rate		1.01	%	2.78	%

 

For purposes of pro forma disclosures, the estimated fair value of stock-based awards is amortized against pro forma net income over the stock-based awards’ vesting period for options and over the offering period for stock purchases under the Company’s 1999 Employee Stock Purchase Plan.

 

The Company’s pro forma information is as follows:

 

		Three Months Ended March 31,
		2004			2003
		(in thousands, except per share amounts)
Net loss attributable to common stockholders as reported		$	(2,877	)	$	(621	)
Add: Amortization of stock compensation measured under APB 25		90			41
Less: Stock-based compensation expense measured under FAS 123		(1,370		)	(693		)
Pro forma net loss		$	(4,157	)	$	(1,273	)
Basic and diluted net loss per share		$	(0.07	)	$	(0.03	)
Pro forma basic and diluted net loss per share		$	(0.11	)	$	(0.06	)

 

Calculated under SFAS No. 123, the weighted-average fair values of the employee stock options granted during the three months ended March 31, 2004 and 2003 were $5.30 and $1.12 per share, respectively.  The weighted-average estimated fair value of shares purchased under the Purchase Plan during the three months ended March 31, 2004 and 2003 were $5.76 and $0.63 per share, respectively.

 

Income Taxes.  The Company accounts for income taxes under the provisions of Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes” (“SFAS No. 109”), which provides for the establishment of deferred tax assets and liabilities based on the difference between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes.

 

Net Loss Per Share.  Net loss per common share and diluted net loss per share are presented in conformity with the Financial Accounting Standards Board’s Statement of Financial Accounting Standards No. 128, “Earnings Per Share” (“SFAS No. 128”) for all years presented.

 

In accordance with SFAS No. 128, basic and diluted net loss per share has been computed using the weighted-average number of shares of common stock outstanding during the period. Potentially dilutive securities have been excluded from the computation of basic and diluted net loss per share, as their effect is antidilutive.

 

Weighted-average options outstanding to purchase approximately 3.0 million and 1.1 million shares of common stock for the three months ended March 31, 2004 and 2003, respectively, were not included in the computation of diluted net loss per share because the effect would be antidilutive. The increase in weighted-average options outstanding in 2003 was primarily due to the grant of new options to the Company’s employees and assumption of options held by former Axcelerant employees in connection with the Company’s acquisition of Axcelerant. Such securities, had they been dilutive, would have been included in the computation of diluted net loss per share using the treasury stock method.

 

Reclassifications.  To conform to the 2004 presentation, $114,000 previously reported on the 2003 consolidated balance sheet under current liabilities as the current portion of deferred revenue has been reclassified by the Company and is now included in long-term liabilities under deferred revenue.

 

Recent Accounting Pronouncements.  In January 2003, the FASB issued Interpretation No. 46 (FIN 46), “Consolidation of Variable Interest Entities.” FIN 46 requires an investor with a majority of the variable interests (primary beneficiary) in a variable interest entity (VIE) to consolidate the entity and also requires majority and significant variable interest investors to provide certain disclosures. A VIE is an entity in which the voting equity investors do not have a

 

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controlling interest, or the equity investment at risk is insufficient to finance the entity’s activities without receiving additional subordinated financial support from other parties. For arrangements entered into with VIEs created prior to January 31, 2003, the provisions of FIN 46 are required to be adopted at the beginning of the first interim or annual period beginning after March 31, 2004. The provisions of FIN 46 were effective immediately for all arrangements entered into with new VIEs created after January 31, 2003. The Company has adopted the provisions of FIN 46 and as of March 31, 2004, there were no entities identified that would require consolidation.

 

3. Business Combination

 

On December 1, 2003, the Company completed its acquisition of Axcelerant, Inc., a privately held provider of broadband Internet remote access services and managed security services. The Company acquired Axcelerant to extend their service offerings, enhance retention of existing customers and improve their ability to obtain new enterprise customers. The purchase price was $58.6 million and the transaction was accounted for as a purchase.

 

The purchase price is not final and may be adjusted for a period of one year from the transaction close date based on higher than expected acquisition costs or unforeseen liabilities. A total of approximately 1.5 million shares of the total consideration that was to be delivered to Axcelerant’s stockholders as a result of the acquisition has been set aside as an escrow fund, serving as collateral for the indemnification obligations of Axcelerant stockholders. The Company may make claims against the escrow fund through December 1, 2004.

 

The results of operations of Axcelerant have been included in the Company’s financial statements subsequent to the date of acquisition.

 

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Deferred Stock Compensation.   The intrinsic value of unvested stock options assumed of approximately $674,000 have been allocated to deferred stock compensation and is being amortized to expense on a straight-line basis over the vesting period. The Company assumed options from Axcelerant to purchase a total of approximately 597,000 shares of the Company’s common stock, of which approximately 462,000 were fully vested. Options assumed in connection with the acquisition had exercise prices between $0.02 and $5.05 per share, with a weighted average exercise price of $1.32 per share and a weighted average remaining vesting period of approximately 2.5 years.

 

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4.  Property and Equipment and Intangible Assets

 

Property and Equipment

 

Property and equipment comprised the following:

 

 

11

 

Purchased Intangible Assets

 

Purchased intangible assets are carried at cost less accumulated amortization. Amortization of purchased intangible assets is computed using the straight-line method over their expected useful lives ranging from one to five years.

 

Purchased intangible assets consisted of the following (in thousands):

 

		March 31,
		2004
Customer relationships		$	7,500
Internal use software		100
		7,600
Less accumulated amortization		(533		)
Total		$	7,067

 

Other Intangible Assets

 

The Company entered into an agreement with a wireless service provider during 2001 for the exchange of services, which resulted in a prepayment for future wireless services and the obligation by the Company to provide future Internet roaming services.  During September 2003, because these assets had not yet been utilized, the Company and the provider amended the underlying agreement to modify the scope of their business relationship and extend the term of the agreement until September 2007, thus permitting the Company to utilize the assets during the extended term. As a result of this amended agreement, the Company entered into a nonmonetary transaction for the exchange of prepaid wireless services for prepaid roaming services and wireless cards. Because this nonmonetary transaction did not represent a culmination of an earnings process, no revenues or expenses have been, or will be recorded by the Company pursuant to this transaction. In addition, there was no indicated loss on this exchange of services. As of March 31, 2004, there was $547,000 of the asset remaining to be utilized, which the Company believes will be utilized over the period of the agreement.

 

5. Commitments and Contingencies

 

Lease Commitments.  The Company leases all of its facilities under operating leases that expire at various dates through 2008. As of March 31, 2004, the Company had $3.9 million in future operating lease commitments.

 

Purchase Commitments.  The Company has entered into certain non-cancelable purchase commitments from suppliers who provide network access, software and related services that are utilized by the Company in order to deliver its GRIC MobileOffice solution. As of March 31, 2004 the Company had $707,000 in future purchase commitments that expire at various dates through 2005.

 

Legal Matters.  The Company is subject to various legal proceedings and claims arising in the ordinary course of business. The Company’s management does not expect that the results in any of these legal proceedings will have a material adverse effect on its financial condition, results of operations, or cash flows.

 

In July and August 2001, the Company and certain of its officers were named as defendants in five purported securities class action lawsuits filed in the United States District Court, Southern District of New York, captioned as In re GRIC Communications, Inc. Initial Public Offering Securities Litigation, No. 01 Civ 6771 (SAS), and consolidated with more than three hundred substantially identical proceedings as In re Initial Public Offering Securities Litigation, Master File No. 21 MC 92 (SAS). The Consolidated Amended Class Action Complaint for Violation of the Federal Securities Laws (“Consolidated Complaint”) was filed on or about April 19, 2002, and alleges claims against certain of the Company’s officers and against CIBC World Markets Corp., Prudential Securities Incorporated, DB Alex. Brown, as successor to Deutsche Bank, and U.S. Bancorp Piper Jaffray Inc., underwriters of the Company’s December 14, 1999 initial public offering (“underwriter defendants”), under Sections 11 and 15 of the Securities Act of 1933, as amended, and under Section 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended.

 

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Citing several press articles, the Consolidated Complaint alleges that the underwriter defendants used improper methods in allocating shares in initial public offerings, and claim the underwriter defendants entered into improper commission agreements regarding aftermarket trading in the Company’s common stock purportedly issued pursuant to the registration statement for the initial public offering. The Consolidated Complaint also alleges market manipulation claims against the underwriter defendants based on the activities of their respective analysts, who were allegedly compromised by conflicts of interest. The plaintiffs in the Consolidated Complaint seek damages as measured under Section 11 and Section 10(b) of the Securities Act of 1933, pre-judgment and post-judgment interest, and reasonable attorneys’ and expert witnesses’ fees and other costs; no specific amount is claimed in the plaintiffs’ prayer in the Consolidated Complaint. By Order of the Court, no responsive pleading is yet due, although motions to dismiss on global issues affecting all of the issuers have been filed.

 

In October 2002, certain of the Company’s officers and directors who had been named as defendants in the In re Initial Public Offering Securities Litigation were dismissed without prejudice upon order of the presiding judge. In February 2003, the presiding judge dismissed the Section 10(b) claims against the Company and its named officers and directors with prejudice.

 

From September 2002 through June 2003, the Company participated in settlement negotiations with a committee of Issuers’ litigation counsel, plaintiffs’ executive committee and representatives of various insurance companies (the “Insurers”). The Company’s Insurers were actively involved in the settlement negotiations, and strongly supported a settlement proposal presented to the Company for consideration in early June 2003. The settlement proposed by the plaintiffs would be paid for by the Insurers and would dispose of all remaining claims against the Company.

 

After careful consideration, the Company decided to approve the settlement proposal in July 2003. Although the Company believes that plaintiffs’ claims are without merit, it decided to accept the settlement proposal (which does not admit wrongdoing) to avoid the cost and distraction of continued litigation. Because the settlement will be funded entirely by its Insurers, the Company does not believe that the settlement will have any effect on the Company’s financial condition, results or operations or cash flows.

 

The Company believes that the settlement will be presented to the Court for approval in the summer of 2004. There can be no guarantee that the settlement will be judicially approved.

 

6.                   Segment Information

 

The Company operates in one segment, providing a global remote access solution for corporate enterprises with mobile and remote workforces and for the Company’s service provider resellers and value-added resellers.

 

The following is a summary of revenue by geographical area for the periods presented:

 

		Three months ended March 31,
		2004			2003
		(in thousands)
Revenue by external customers:
United States, Canada and Latin America		$	8,653		$	5,025
Japan/Korea		2,320			2,584
Asia Pacific		866			857
Europe, Middle East and Africa		1,121			1,025
		$	12,960		$	9,491

 

The following is a summary of long-lived assets by geographical area for the periods presented:

 

		March 31, 2004			December 31, 2003
		(in thousands)
Long-lived assets:
United States		$	56,192		$	56,633
Rest of World		72			72
		$	56,264		$	56,705

 

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Revenue by external customer is based on the customer’s billing locations. Long-lived assets are those assets used in each geographic location.  For the three months ended March 31, 2004, two customers each accounted for 10% or more of the Company’s total consolidated revenues.

 

7.             Stockholder’s Equity

 

Series A Redeemable Convertible Preferred Stock.  During the three months ended March 31, 2004 and 2003, 3.0 million and 316,000 shares, respectively, of Series A Preferred Stock were converted into common stock, respectively.

 

Series A Preferred Stock Warrants.  No Series A Preferred Stock warrants were exercised during the three months ended March 31, 2004 and 2003, respectively.

 

Stock Repurchase Program. In September 2001, the Board of Directors approved a program to expend up to $2.0 million to repurchase shares of the Company’s common stock in open market transactions. The Company purchased 110,000 shares for approximately $99,000 during 2001. Although the program approval remains in effect, the Company repurchased no additional shares during 2002, 2003 or during the three months ended March 31, 2004.

 

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion should be read in conjunction with the selected consolidated financial information and the consolidated financial statements and notes appearing elsewhere in this Form 10-Q. The following discussion contains forward-looking statements, such as statements of expected revenues and expenses, that involve risks and uncertainties. We assume no obligation to update any such forward-looking statements. Our actual results could differ materially from those anticipated in these forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those detailed from time to time in our filings with the Securities and Exchange Commission and those discussed in this Form 10-Q, particularly in this Management’s Discussion and Analysis of Financial Condition and Results of Operations and under “Factors That May Affect Future Results.”

 

Unless expressly stated or the context otherwise requires, the terms “we”, “our”, “us”, “the Company” and “GRIC” refer to GRIC Communications, Inc. and its subsidiaries as a whole.

 

Overview

 

We provide secure managed broadband and remote access solutions to enterprises and service providers. Our solutions enable enterprises to securely, reliably, and cost-effectively extend their corporate networks and applications to mobile and remote workers outside the corporate firewall. These workers include mobile professionals such as sales professionals, project managers and engineers; teleworkers including call center agents; telecommuters; and employees in branch offices and retail settings. We provide comprehensive and integrated managed broadband and global remote access services that include: intelligent client software; multiple network access types including broadband, Wi-Fi and dial-up; security capabilities that ensure security policy compliance by remote workers; a real-time remote access management console; end-to-end managed and value-added services including managed security services; and design, deployment, monitoring, and technical support. Our products and services enable enterprises to reduce the cost, complexity and risk of remote office networking, while maximizing the productivity of mobile and remote workers.

 

In December 2003, we acquired Axcelerant, Inc., a privately-held provider of broadband Internet remote access services and managed security services.

 

The majority of our revenue comes from providing settlement and clearing-house services for our customers. We provide services over a heterogeneous virtual network known as the GRIC TierOne Network. As of May 1, 2004, the GRIC TierOne Network included more than 34,000 Internet access-dialing locations, over 7,600 public wireless fidelity—or WiFi—hotspots and approximately 1,400 public broadband access points in approximately 150 countries. Through the acquisition of Axcelerant, we added a virtual broadband cable modem and DSL network that spans the United States and

 

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Canada. This network is an aggregation of the networks of more than 150 broadband providers, including virtually all of the leading cable companies, ILECs and CLECs in the United States. By utilizing this network, we are able to provide comprehensive coverage in the United States for enterprises requiring broadband branch office and broadband teleworker solutions. We created the GRIC TierOne Network by forming contractual relationships with over 500 access providers — Internet service providers, cable companies, DSL companies and telecommunication companies. These providers, which we refer to as the GRIC TierOne Network members, are able to share their communications networks. Our customers, who are enterprises, value added resellers (VARs) and service provider resellers, benefit from the resulting network delivering secure mobile Internet access cost-effectively. Our member providers benefit from the GRIC TierOne Network because we manage this shared network and provide settlement services as a clearinghouse. As a clearinghouse, we have established common technical, service and payment standards to settle charges that our customers incur when their end users access the network facilities of GRIC TierOne Network members to conduct Internet-based communications, such as Internet roaming. We intend to continue developing our service offering to introduce new Internet-based remote communications services that may be adopted, deployed and managed on a global scale across the GRIC TierOne Network.

 

We have incurred substantial losses since our inception as a result of expenses associated with building the GRIC TierOne Network and related network infrastructure, developing our software products and marketing our solutions to our customers. We had an accumulated deficit of approximately $133.3 million as of March 31, 2004. We cannot assure you that we will achieve or sustain profitability. See “Factors That May Affect Future Results—We have a history of net losses and may incur future losses.”

 

Our business model has evolved in the course of our development and we believe that period-to-period comparisons of our operating results should not be relied upon as indicative of future performance. Our future prospects must be considered in light of the risks, expenses and difficulties frequently encountered by companies in the early stages of development, particularly companies in new and rapidly evolving markets. See “Factors That May Affect Future Results—We have limited experience in our business, which makes it more difficult for us to execute our business plan and for you to evaluate us.”

 

Critical Accounting Policies and Estimates

 

The methods, estimates and judgments we use in applying our most critical accounting policies have a significant impact on the results we report in our consolidated financial statements. We evaluate our estimates and judgments on an on-going basis. We base our estimates on historical experience and on assumptions that we believe to be reasonable under the circumstances when made. Our experience and assumptions form the basis for our judgments about the carrying value of assets and liabilities and reported amounts of revenues and expenses that are not readily apparent from other sources. Actual results may vary from what we anticipate, and different assumptions or estimates about the future could change our reported results. We believe the following accounting policies are the most critical to us, because they are important to the portrayal of our financial statements and they require our most difficult, subjective or complex judgments in the preparation of our consolidated financial statements.

 

Revenue Recognition and Related Allowances.  We enter into agreements to sell our managed broadband and global access solutions, which may include one or more of our services and product offerings. Revenues are recognized when a binding agreement or purchase order from the customer has been received, the services have been delivered, the fee or price was fixed or determinable, the collection of the receivable was reasonably assured, and no significant post-delivery obligations remain. Our revenue recognition policy is one of our critical accounting policies because revenue is a key component of our results of operations and is based on complex rules, which require us to make certain judgments and estimates. In applying our revenue recognition policy we must determine which portions of our revenues are recognized currently and which portions must be deferred. In order to recognize revenue, we make judgments and estimates with regard to the revenues earned for services—including related installation services and products—and maintenance services, as well as the timing of the delivery of such services and products. In addition, we provide services over a heterogeneous virtual network, which was created by forming contractual relationships with over 500 access providers — Internet service providers, cable companies, DSL companies and telecommunications companies. These companies may provide us their services under either a reseller or an agency arrangement. In applying our revenue recognition policy we must make judgments and estimates with regard to the specific facts and circumstances surrounding each provider relationship to determine which portion of our revenues we provide under a reseller arrangement, where we would record gross revenues and cost of revenues, and which portion of our revenues we provide as an agent, where we would record revenues and cost of revenues combined on a net basis. We base our estimates on historical experience and on various other assumptions believed to be applicable and reasonable under the circumstances. These estimates may change as new events occur, as additional information is obtained and as our operating environment changes, any of which could cause a material impact on the revenues that we have reported.

 

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Our services for remote Internet access are generally billed on a per-minute basis for usage or at a flat rate per month per user based on negotiated rates for which we recognize revenue in the month the services are provided. Our solutions may also include installation services, the sale of customer premise equipment and managed security services related to our broadband services offerings. Revenue from broadband installation services and the sale of related equipment is deferred and recognized ratably over a 24-month period. We consider these services and products to be an enabler of the related remote access service contracts and we estimate that on average our customer’s remote broadband access workers use our services for a period of approximately 24 months. Revenues from managed security services are recognized in the month the service is provided. To a lesser extent, we also derive a portion of our revenues from licenses of our authentication software, related maintenance and support services, and other optional services related to our remote access solutions which are recognized ratably over the term of service, which is typically 1 to 12 months. These other revenues amounted to five percent or less of total revenues over the last three years. Fees generated from maintenance contracts are recognized over the life of those contracts. The majority of the maintenance contracts cover periods of one to twelve months. Amounts billed in advance of revenue recognition are recorded to deferred revenue as collected. We have some customers with minimum commitment arrangements. We record such revenue in the month that we determine that minimum commitments have not been met. We recognize certain broadband connectivity revenues generated under agency arrangements on a net basis. Product returns and allowances have not been significant.

 

We record estimated allowances against revenues in the same period the revenues are recorded. These estimates are based upon historical analysis of our credit memo data and other known factors for pricing and transaction volume disputes that arise in the normal course of business. To date, allowances pertaining to our current business have not been significant. If the historical data we use to calculate these estimates does not accurately reflect amounts associated with future disputes, our actual revenues could be higher or lower than what we have recognized.

 

From time to time our customers, including significant customers, may seek protection under bankruptcy laws. While we assess the credit-worthiness of our customers on an on-going basis, when such a bankruptcy event occurs, our management determines our risk that an account receivable will prove to be uncollectable, and establishes appropriate reserves for that contingency as necessary. In addition, for each continuing customer in bankruptcy management evaluates the creditworthiness of the customer and determines whether revenue should be recognized on an accrual basis or when cash payments are received. When we record revenue on an accrual basis, management has based their judgment on the creditworthiness of the debtor-in-possession, their payment experience and whether the collectability of receivables is reasonably assured, in addition to other revenue recognition criteria having been met.

 

Allowance for Doubtful Accounts.  We maintain allowances for doubtful accounts for estimated losses from our customers’ inability to make payments they owe us. In order to estimate the appropriate level of this allowance, we analyze historical bad debts, customer concentrations, current customer credit-worthiness, current economic trends and changes in our customer payment patterns. If the financial condition of our customers were to deteriorate and to impair their ability to make payments to us, additional allowances might be required in future periods. If our estimates prove too low, our bad debt expense will increase.

 

Valuation of Long-Lived Assets including Intangible Assets.  We evaluate the carrying amount of property and equipment and intangible assets for impairment whenever events or circumstances indicate the amount of the assets may not be recoverable. Determination of impairment of property and equipment, goodwill and intangible assets is highly subjective and requires significant judgment at many points during the analysis. This analysis is based on our estimate of future cash flows that the assets are expected to generate and their eventual disposition. If we determine that any of these assets have been impaired, the impairment charge will be charged to earnings in the period such determination is made.

 

Valuation of Goodwill.  We test goodwill for possible impairment on an annual basis and at any other time if events occur or circumstances indicate that the carrying amount of goodwill may not be recoverable. Circumstances that could trigger an impairment test include, but are not limited to, a significant adverse change in the business climate or legal factors, an adverse action or assessment by a regulator, unanticipated competition and loss of key personnel. The determination as to whether a write down of goodwill is necessary involves significant judgment based on the short-term and long-term projections of our future performance. The assumptions supporting the estimated future cash flows, including the discount rate used and estimated terminal value, reflect our best estimates.

 

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Business Combination

 

On December 1, 2003, we completed our acquisition of Axcelerant, a privately-held provider of broadband Internet remote access services and managed security services. Our acquisition of Axcelerant did not result in a new reportable segment. The results of operations of Axcelerant have been included in our financial statements subsequent to the date of the acquisition. See “Note 3 of Notes to the Condensed Consolidated Financial Statements.”

 

Results of Operations

Three Months Ended March 31, 2004 Compared to Three Months Ended March 31,2003

 

Overview of the First Quarter of 2004

 

During the first quarter of 2004, we continued to develop our business from being based principally on an indirect sales model — as it was in the first quarter of 2003 when we sold our services on a wholesale basis through large telecommunications companies and service providers — to a model under which we sell a significant portion of our services directly or through VARs to enterprise customers.  During the first quarter of fiscal 2004, 42% of our quarterly revenues were derived from services sold to enterprise customers both directly and indirectly through our VARs. We continued our focus on acquiring and serving enterprise customers by enhancing the quality and breadth of the GRIC TierOne Network and increasing the value of our solution offering by delivering new products such as our management and administrative console for enterprise IT departments and our end–to–end remote access security solution. As a result of our December 2003 acquisition of Axcelerant, Inc., the GRIC TierOne Network now also includes a virtual broadband cable modem and DSL network that spans the United States and Canada. By aggregating the networks of more than 150 broadband providers, we are able to provide enterprise branch offices and teleworkers with comprehensive broadband coverage in North America.

 

In the first quarter of 2004, our revenues, expenses and gross margin each increased over the first quarter of 2003. Cost of revenues was lower as a percentage of revenues principally as a result of sales to enterprise customers representing a higher percentage of our total revenues during the first quarter of 2004. Our operating expenses were higher in the first quarter of 2004 than in the first quarter of 2003 principally due to the addition of personnel at our Irvine, California facility that resulted from our acquisition of Axcelerant and our increased investment in enterprise focused sales and marketing efforts.   We expect our quarterly operating expenses to continue increasing in absolute dollar terms in the second quarter of 2004 as we continue to invest in developing and supporting our enterprise customer base.

 

We continue to focus on delivering innovative services for our customers to drive revenues and achieve positive earnings. In fiscal 2004 we plan to release a number of new value added services, which we expect will augment the revenues we derive from our existing customers and, together with expanding the global footprint of the GRIC TierOne Network, drive revenues from new enterprise customers. Several factors will impact our ability to achieve and sustain profitability, including the effectiveness of our sales and marketing efforts through both direct and VAR sales channels, the timely release of new services and the introduction of new services by existing or new competitors.  Currently, we do not expect to be profitable during 2004.  For a discussion of these and other risk factors, see the section titled “Factors That May Affect Future Results.”

 

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Revenues

 

Revenues for the three months ended March 31, 2004 and 2003 were as follows:

 

		2004			2003
		(in millions)
Revenues		$	13.0		$	9.5

 

Total revenues increased approximately $3.5 million in the three months ended March 31, 2004, compared to the three months ended March 31, 2003, which represented an increase of 37%.  The increase was principally due to the addition of broadband revenues during the three months ended March 31, 2004.  Approximately 25% of our revenues for the three months ended March 31, 2004 were generated from sales of broadband and Wi-Fi services.  Sony Communication Network Corporation and Fiberlink Communications Corporation, both of which are service provider resellers, accounted for 12% and 11%, respectively, of our consolidated revenues during the three months ended March 31, 2004.

 

We expect 2004 revenues to exceed 2003 revenues, based on both sales to new customers and sales of additional services (such as our managed security service offering) to our existing customers, partially offset by competitive pricing pressures on our Internet access services.

 

Costs and Expenses

 

Costs and expenses for the three months ended March 31, 2004 and 2003 were as follows:

 

		2004			2003
		(in millions)
Cost of revenues		$	5.3		$	4.4
Percentage of net revenues		40.8		%	46.0		%
Network and operations		$	2.3		$	0.9
Percentage of net revenues		17.8		%	10.0		%
Research and Development		$	1.2		$	0.6
Percentage of net revenues		9.0		%	6.8		%
Sales and Marketing		$	5.1		$	2.7
Percentage of net revenues		39.1		%	28.4		%
General and administrative		$	1.6		$	1.4
Percentage of net revenues		12.3		%	14.8		%
Amortization of intangibles		$	0.4		$	—
Percentage of net revenues		3.1		%	—		%
Amortization of stock-based compensation		$	0.09		$	0.04
Percentage of net revenues		0.7		%	0.4		%

 

Cost of Revenues.  Cost of revenues consists of amounts we pay to access the Internet in order to provide remote Internet access services for our customers and to offer other mobile broadband services.

 

Cost of revenues increased approximately $928,000 in the three months ended March 31, 2004 compared to the three months ended March 31, 2003, representing an increase of 21%.  The increase was primarily due to the corresponding increases in the volume of remote Internet access, the expansion of our customer base and the inclusion of three months of the cost of broadband revenues following our acquisition of Axcelerant.  We expect that for the remainder of 2004 the cost of revenues will increase in absolute dollars as remote Internet access revenues and broadband revenues increase, but be similar to the quarter ending December 31, 2003 as a percentage of revenues.

 

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Network and Operations.  Network and operations expenses consist of salaries and benefits, depreciation on network equipment, allocated facility and management information systems expenses, administrative expenses, costs of co-location of network equipment and leased telecommunication lines and other related costs.

 

Network and operations expenses increased approximately $1.4 million in the three months ended March 31, 2004 compared to the three months ended March 31, 2003, representing an increase of 143%. The increase was primarily due to an increase in compensation and benefits related expenses of approximately $953,00 and increased facility allocation of approximately $254,000, both of which are primarily related to the inclusion of three months of network and operations expenses incurred in our Irvine, California facility following our acquisition of Axcelerant.  Additionally, there was approximately $57,000 of increased professional fees related to post-acquisition integration activities and improving network systems.  We expect the network and operations expenses to remain constant in absolute dollars as we continue to expand the GRIC TierOne Network and support a growing base of enterprise customers, but decline as a percentage of sales in 2004.

 

Research and Development.  Research and development expenses consist of salaries and benefits, allocated facility and management information systems, depreciation costs, outside consultants, facilities costs, administration and other related costs.

 

Research and development expenses increased approximately $522,000 in the three months ended March 31, 2004 compared to the three months ended March 31,2003, representing an increase of 81%.  The increase was primarily due to an increase in compensation and benefits expenses of approximately $253,000 primarily related to the inclusion of three months of research and development expenses incurred in our Irvine, California facility following our acquisition of Axcelerant, and approximately $129,000 related to increased compensation costs due to adding staff in the United States and India in order to service our growing enterprise customer base. In addition, engineering consulting fees increased by approximately $78,000.  We expect research and development expenses to increase moderately in absolute dollars as we continue to invest in developing our remote access solutions for our enterprise customers, but stay approximately the same as a percentage of revenues in 2004.

 

Sales and Marketing.  Sales and marketing expenses consist of salaries and benefits, allocated facility and management information systems costs, travel and entertainment costs, costs for marketing and promotional programs, outside consultants, commissions earned by sales and marketing personnel, and costs associated with domestic and international sales offices and other related costs.

 

Sales and marketing expenses increased $2.4 million in the three month period ended March 31, 2004 compared the three month period ended March 31, 2003, representing an increase of 88%. The increase was primarily due to an increase in compensation and benefits of approximately $1.1 million related to our increased sales force and marketing personnel, an increase of approximately $607,000 in marketing and promotional programs, an increase of approximately $201,000 in travel and entertainment expenses, and an increase of approximately $141,000 in outside consulting services as we expanded our marketing activities.  In addition, allocated facilities costs and administrative expenses increased by approximately $203,000.  We expect the overall amount of sales and marketing expenses to increase during 2004 in absolute dollars as we shift our sales strategy from predominantly an indirect sales channel to both indirect and direct sales efforts, but be approximately the same as 2003 as a percentage of revenues.

 

General and Administrative.  General and administrative expenses consist of general corporate and facility costs as well as salary, benefits and related costs for executive, finance, legal, administrative, human resources, investor relations and management information systems functions and provisions for uncollectible receivables.

 

General and administrative expenses increased approximately $190,000 in the three months ended March 31, 2004 compared to the three months ended March 31, 2003, representing an increase of 14%. The increase was primarily due to higher compensation and benefits expenses of approximately $279,000 principally due to the inclusion of three months of general and administrative expenses incurred in our Irvine, California facility following the acquisition of Axcelerant, approximately $253,000 of increased professional fees primarily related to services provided by our independent auditors and approximately $76,000 of consulting associated with the integration of Axcelerant. These increases were largely offset by approximately $408,000 for costs related to payments made in connection with the resignation of our former Chief Executive Officer during the first quarter of 2003 and a $69,000 reduction in insurance costs. We expect the amount of general and administrative expenses to increase during 2004 in absolute dollars while we complete the back office automation and integration of our Irvine, California operations and update certain other back office processes and procedures to implement the requirements of the Sarbanes-Oxley Act of 2002 and related regulations, but stay approximately the same as a percentage of revenues.

 

Amortization of Intangibles.  Amortization of intangibles includes three months of amortization of the intangible assets acquired in connection with the acquisition of Axcelerant. The value assigned to Axcelerant customer relationships

 

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was $7.5 million, which is amortized on a straight-line basis over a five-year life at a rate of $125,000 per month. The value assigned to internal use software was $100,000, which is amortized on a straight-line basis over a one-year life at a rate of $8,000 per month.

 

Amortization of Stock-Based Compensation.  Some stock options previously granted through December 14, 1999 were considered compensatory because the deemed fair value for accounting purposes was higher than the stock option exercise price as determined by the board of directors on the date of grant. Additionally, in connection with of our acquisition of Axcelerant, we recorded $674,000 of additional deferred stock-based compensation, which will be amortized over the vesting period of the underlying stock options assumed during the acquisition. As a result, we recorded amortization of deferred compensation expense of $90,000 and $41,000 during the three months ended March 31, 2004 and 2003, respectively. We expect to record amortization of deferred compensation expense of approximately $359,000 in 2004, related to options assumed by us in connection with our acquisition of Axcelerant.

 

As of March 31, 2004, we had an aggregate of $554,000 of deferred compensation related to the acquisition of Axcelerant that remained to be amortized. Deferred compensation is amortized on a straight-line basis over the vesting period of the options. We expect amortization of stock-based compensation to end in 2007.

 

Interest Income (Expense) and Other and Taxes

 

Interest income and other, net, interest expense and taxes for the three months ended March 31, 2004 and 2003 were as follows:

 

		2004			2003
		(In thousands)
Interest income and other, net		$	93		$	(9	)
Provision for income taxes		$	22		$	8

 

Interest Income and Other, Net

 

Interest income and other, net, primarily represents interest income on cash balances and on short-term investments, gain on disposition of assets and sales, use and value-added tax.

 

Interest income and other, net, increased $102,000 in the three months ended March 31, 2004 compared to the three months ended March 31, 2003.  This increase primarily reflects higher sales, use and value-added tax for approximately $177,000 during 2003 offset by a gain on the sale of an asset of $104,000 during 2003, which did not reoccur in 2004 and a increase of approximately $19,000 due to a gain on foreign currency re-measurement offset by approximately $13,000 in interest income due to lower interest rate yields.

 

Income Taxes

 

The provision for income taxes was $22,000 and $8,000 for the three months ended March 31, 2004 and 2003, respectively.  The provision for income taxes consists of foreign tax provisions.

 

Liquidity and Capital Resources

 

		March 31,
		2004			2003
		(in thousands)
Cash and cash equivalents		$	4,442		$	4,222
Net cash used in operating activities		(3,184		)	(1,021		)
Net cash (used in) provided by investing activities		1,548			(2,357		)
Net cash provided by financing activities		779			286

 

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Cash and Cash Equivalents.  Our principal source of liquidity is our cash, cash equivalents and short-term investments. As of March 31, 2004, in addition to our cash and cash equivalents balance of $4.4 million, we had a short-term investment balance of approximately $18.0 million.

 

Operating Activities.  Net cash used in operating activities in the three months ended March 31, 2004 of $3.2 million was primarily a result of our net operating losses of $2.9 million and higher accounts receivable balances of approximately $722,000 from increased revenues and by decreased accounts payable balances of approximately $1.0 million offset by increased deferred revenues of approximately $821,000 primarily related to deferred installation revenues. We expect the number of days it takes for us to collect our accounts receivable to lengthen from the periods experienced historically, primarily due to the longer payment cycles generally associated with enterprise customers and the increasing percentage of our revenue base represented by such customers.

 

Investing Activities.  Net cash provided by investing activities during the three months ended March 31, 2004 of approximately $1.5 million was primarily the result of liquidation of certain short-term instruments offset by capital expenditures of approximately $361,000.

 

Financing Activities.  Net cash provided by financing activities during the three months ended March 31, 2004 of approximately $779,000 was primarily the result of proceeds of sales of common stock to our employees and option holders.

 

Commitments.  We lease all of our facilities under operating leases that expire at various dates through 2008. We have entered into certain purchase commitments from suppliers who provide network access, software and related services that are utilized by us in order to deliver our products and services solution.

 

During 2004, we expect to increase capital equipment expenditures in absolute dollars as compared to 2003 while we complete the back office automation and integration of Axcelerant and update certain other back office processes and procedures required for us to efficiently run our business.

 

The future minimum operating lease and purchase commitments were as follows at March 31, 2004:

 

		Operating Leases			Purchase Commitments
		(in thousands)
2004		$	1,463		$	413
2005		1,005			294
2006		796			—
2007		563			—
2008		90			—
Thereafter		—			—
		$	3,917		$	707

 

Indemnifications.  From time to time we enter into types of contracts that contingently require us to indemnify parties against third party claims. These contracts primarily relate to: (i) divestiture agreements, under which we may provide customary indemnifications to purchasers of our assets; (ii) real estate leases, under which we may be required to indemnify property owners for environmental and other liabilities, and other claims arising from our use of the applicable premises; (iii) agreements with our officers, directors and employees, under which we may be required to indemnify such persons for liabilities arising out of their employment relationship; and (iv) agreements with customers and resellers, under which we may provide customary indemnifications against claims that our products and services infringe certain copyrights, patents or trademarks, or incorporate misappropriated trade secrets.

 

The terms of such obligations vary. Generally, a maximum obligation is not explicitly stated, except for indemnifications involving infringement of third party intellectual property rights. Because the obligated amounts of these types of agreements often are not explicitly stated, the overall maximum amount of the obligations cannot be reasonably estimated. Historically, we have not been obligated to make any payments for these obligations, and no liabilities have been recorded for these obligations on our balance sheet as March 31, 2004.

 

Summary of Liquidity.  We believe that our available cash, cash equivalents and short-term investments of $22.4 million at March 31, 2004 and cash expected to be generated by operations during the next twelve months, will fund planned operations for at least the next twelve months. We utilized $2.8 million in cash during the quarter ended March 31, 2004.

 

We plan to invest in expanding our mobile office communications services, on a global basis, by continuing to build strategic partnering relationships. This will require us to maintain market acceptance, and to grow our mobile office communications services offerings in order for us to continue our research and development activities and fund planned

 

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operating expenses. There can be no assurance that our mobile office communications services offerings will maintain market acceptance, growth and operating margins.

 

If we are unable to attain our revenue and margin goals, significant reductions in spending and the delay or cancellation of planned activities or more substantial restructuring may be necessary to enable us to meet our cash requirements through the next 12 months. These actions could have a material adverse effect on our business, results of operations and prospects. Furthermore, we may need to raise additional funds in future periods through public or private financing, or other arrangements, to fund operations and potential acquisitions, if any. If additional financing is needed, it might not be available on reasonable terms or at all. Failure to raise capital when needed could seriously harm our business and results of operations. If additional funds were raised through the issuance of equity securities, the percentage of ownership of our stockholders would be reduced. Furthermore, these equity securities might have rights, preferences or privileges senior to our common stock.

 

Recent Accounting Pronouncements

 

In January 2003, the FASB issued Interpretation No. 46 (FIN 46), “Consolidation of Variable Interest Entities.” FIN 46 requires an investor with a majority of the variable interests (primary beneficiary) in a variable interest entity (VIE) to consolidate the entity and also requires majority and significant variable interest investors to provide certain disclosures. A VIE is an entity in which the voting equity investors do not have a controlling interest, or the equity investment at risk is insufficient to finance the entity’s activities without receiving additional subordinated financial support from other parties. For arrangements entered into with VIEs created prior to January 31, 2003, the provisions of FIN 46 are required to be adopted at the beginning of the first interim or annual period beginning after March 31, 2004. The provisions of FIN 46 were effective immediately for all arrangements entered into with new VIEs created after January 31, 2003. We have adopted the provisions of FIN 46 and as of December 31, 2003, there was no entities identified that would require consolidation.

 

Factors That May Affect Future Results

 

In addition to the information in this Quarterly Report on Form 10-Q, the following should be considered in evaluating GRIC and our business.

 

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The markets that we serve are highly competitive and there is no assurance that we will be able to achieve or maintain profitability.

 

We are aware of many companies in related markets that address particular aspects of the features and functions that our products provide. Currently, we compete directly with iPass and Fiberlink Communications Corporation in the market for Internet roaming and related settlement services, and each of iPass and Fiberlink has a network that competes with the GRIC TierOne Network. In addition, iPass has greater cash resources than we do and each of iPass and Fiberlink has a larger sales force than our own dedicated to enterprise sales. Large communications service providers such as AT&T, Equant and MCI also have the ability and resources to compete with us in the Internet-based mobile office communications services market. In the mobile broadband services market, our primary competitors include Megapath, ePresence and Netifice. Many of our competitors have longer operating histories, greater name recognition or larger customer bases, which they may leverage in order to obtain more favorable volume discounts from suppliers. In addition, these competitors may be able to undertake more extensive marketing efforts, adopt more aggressive pricing policies and provide more favorable payment terms to customers than we can, which could limit our opportunities to obtain new customers or cause us to lose our existing customers.

 

If we fail in our strategy of focusing our sales efforts on larger companies, our revenue and profitability goals will likely not be achieved.

 

Historically, a significant portion of our revenues was derived from smaller companies in the Internet marketplace, but in recent periods we have attempted to focus our sales and marketing efforts on larger corporate and enterprise-level customers. This strategy places new demands on our business, such as the longer sales cycles and higher levels of service and support that larger accounts generally require. Some of our competitors with greater financial resources than ours have focused their sales efforts on selling to large enterprises for a longer period of time with more success than we have enjoyed, which adds to the risk of our strategy. If we fail in this strategy, or if we have underestimated the costs of this strategy, we will likely miss our revenue and profitability goals.

 

If we are unable to increase revenues associated with broadband services, our ability to grow our business will be impaired.

 

Until our acquisition of Axcelerant in December 2003, we have generated our remote Internet access services revenues to date almost exclusively from the sale of services based on dialup access—a narrowband technology. In some countries, including the United States, the use of narrowband as a primary means of remote access is expected to decline over time as broadband access technologies, such as cable modem, DSL and Wi-Fi, become more widely adopted and used. Our experience in the first quarter of 2004 showed us that the decline in dialup revenues from service providers may decline at a pace more rapid than previously projected.  Although we have recently begun to generate revenues from managed broadband access following our acquisition of Axcelerant, the future growth of our business may depend in large part upon our ability to expand the broadband elements of our virtual network and generate broadband revenues at a substantially higher level and growth rate. We may not succeed in this expansion and we may not generate substantial new revenues, which could harm our results and cause our stock price to decline.

 

Our business strategy has shifted over time and remains unproven, so the success of our strategy cannot be assured.

 

Our business strategy has changed over time. For example, we ceased to be an Internet service provider in 1997 and abandoned our Internet telephony services business in 2001. We have pursued our current business—remote access, managed security and related mobile office services—for a relatively brief period and in markets that are rapidly changing. We have only been offering managed broadband services to enterprises with branch offices and large teleworker populations since December 2003, following our acquisition of Axcelerant. There can be no assurance that we will succeed in our efforts to make our current business profitable, and there can be no assurance that our recent acquisition of Axcelerant will make us more likely to succeed.

 

Since we have no assurance that customers will continue to use our services or that our customer base will expand, we will have little ability to predict revenue growth or operating results.

 

Our customers are generally free to use competing products and services and dialup remote access prices are declining, so we could face significant customer losses, at unpredictable times. We had two customers in the three months

 

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ended March 31, 2004 that each accounted for more than ten percent of our revenues: Sony Communication Network Corporation (12%) and Fiberlink Communications Corporation (11%). This concentration of revenue from two customers, each of which principally purchases our dialup remote access service, makes our business more risky.  Losing either of these customers could result in a significant revenue shortfall for us. In addition, large customers have significant negotiating power during contract discussions or in the event of a customer dispute, which may make it more likely that the terms of the customer arrangement or settlement may be more favorable to the customer. We are in direct competition with Fiberlink, which makes it more likely that revenues from Fiberlink will decline in the future. These factors make it difficult to anticipate the level of our future revenues from existing customers. In addition, our success depends on our ability to expand and diversify the composition of our customer base. If we are unable to expand our customer base and increase our average revenues per customer, our business success will be less likely.

 

If we cannot effectively integrate Axcelerant’s operations with our own operations, we will not realize the potential benefits of our recent merger.

 

The integration of Axcelerant into our company has been and continues to be a time consuming and expensive process and may disrupt our operations if it is not completed in a timely and efficient manner.  If this integration effort is not successful, our results of operations could be harmed, employee morale could decline, key employees could leave and customers could cancel existing orders or choose not to place new ones. In addition, we may not achieve anticipated synergies or other benefits of the merger. Having completed the merger, we must now operate a single organization utilizing common information and communication systems, operating procedures, financial controls and human resources practices. We may encounter the following difficulties, costs and delays involved in fully integrating Axcelerant’s operations into our operations:

 

•                                          failure to successfully manage relationships with customers and other important relationships;

 

•                                          failure of customers to accept new services or to continue using the products and services of the combined company;

 

•                                          potential incompatibility of technologies and systems; and

 

•                                          potential difficulties in successfully integrating the employees of GRIC and Axcelerant;

 

•                                          managing our growth and managing larger, more geographically dispersed operations;

 

•                                          perceived adverse changes in business focus;

 

•                                          the loss of key employees and diversion of the attention of management from other ongoing business concerns; and

 

•                                          potential incompatibility of business cultures.

 

We may not succeed in cost-effectively automating, integrating and updating critical back office systems and processes, which could limit our ability to achieve and maintain profitability.

 

Historically, we have invested in the automation of back office systems and processes in order to enable us to cost effectively grow our traditional mobile office communications business. The back office systems and process of Axcelerant, whose business we acquired in December 2003, are largely manual. In order to efficiently provision, support and service our customers, we will be required to cost-effectively update, automate and, where appropriate, integrate these systems and processes. We will need to ensure that the combined company’s financial reporting, financial controls and documentation processes meet all applicable financial controls certification standards, such as Section 404 of the Sarbanes-Oxley Act. We may underestimate the investments required to accomplish this automation, integration, updating and certification. We may not succeed in this effort, which could impair our ability to scale our operations, limit our growth and lessen the likelihood that we would achieve profitability.

 

The market price of our common stock has traditionally been highly volatile, and if we do not realize the anticipated benefits of our acquisition of Axcelerant or meet the expectations of analysts, the market price of our common stock could decline further.

 

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In the past, the price of our common stock has experienced large swings up and down. As of May 1, 2004, our common stock is valued less than it was at the time of the closing of our acquisition of Axcelerant. This volatility might occur again in the future. Volatility can arise particularly in response to quarter-to-quarter variations in the actual or anticipated financial results of us or our customers or competitors, and announcements that our competitors or we make regarding new product and service introductions. The market price of our common stock can also fluctuate in response to price and volume fluctuations in the stock market, particularly those that affect the market prices of technology stocks.

 

In addition, the market price of our common stock is subject to decline if we do not achieve the expected benefits of the Axcelerant acquisition as quickly as anticipated or the costs of or operational difficulties arising from the merger are greater than anticipated.

 

We have incurred significant losses to date and expect to continue to incur losses for some period of time. If we fail to generate sufficient revenue to achieve and sustain positive cash flow or profits, our stock price will decline.

 

We have incurred significant losses to date and we expect to continue to incur losses for some period of time. We incurred operating losses before income taxes of approximately $1.8 million for 2003, $5.0 million for 2002 and $31.6 million for 2001. As of March 31, 2004, we had an accumulated deficit of $133.3 million and incurred a loss of $2.9 million for the quarter then ended.

 

We have experienced negative cash flows in each year since our inception in 1994, and we expect to continue to do so for some time in the future. In addition, we may also incur significant new costs related to possible acquisitions, the development of new products and services, the integration of new technologies or the update of old technologies. Moreover, we might not be able to increase our operating profitability on a quarterly or annual basis. To increase profits, we will need to maintain our relationships with existing customers, generate additional revenue growth from our existing customers and obtain new customers, while continuing to control our expenses. We expect to continue to invest in network and operations, research and development and sales and marketing, and we expect to face pressure to adopt new pricing arrangements, including volume discounts, that may lower our gross margins. As a result, our ability to achieve and sustain profitability will depend on our ability to sustain and achieve substantially higher revenue while maintaining reasonable cost and expense levels. If we fail to sustain or achieve profitability, our stock price could decline.

 

We may require additional capital for our operations, which could have a negative effect on your investment.

 

If our cash proves to be insufficient to fund our operations, we may need to raise additional funds at some point in the future. In the quarter ended March 31, 2004, we utilized $2.8 million in cash, leaving us with a cash balance of $22.4 million. If we raise additional funds by selling equity or convertible debt securities, our stockholders may experience additional dilution and these new securities may have powers, preferences and rights that are senior to those of the rights of our common stock. We cannot predict whether additional financing will be available on terms favorable to us, or at all. If adequate funds are not available or are not available on acceptable terms, we may be unable to fund our business operations, promote our brand identity, take advantage of acquisition opportunities, develop or enhance services or respond to competitive pressures. Any inability to do so could have a negative effect on our business, revenues, financial condition and results of operations.

 

The telecommunications industry continues to experience a dramatic decline, which may cause consolidation among network service providers and impair our ability to provide reliable, redundant service coverage and negotiate favorable network access terms.

 

The telecommunications industry continues to experience dramatic technological change and increased competition that have led to significant declines in network access pricing. In addition, the revenues of network service providers have declined as a result of the general economic slowdown. As a result, network service providers have experienced operating difficulties in the last several years, resulting in poor operating results and a number of these providers declaring bankruptcy. If these conditions continue, some of these service providers may consolidate or otherwise cease operations, which would reduce the number of network service providers from which we are able to obtain network access. To the extent this were to occur, while we would still be able to maintain operations and provide enterprise connectivity services with a small number of network service providers, we would potentially not be able to provide sufficient alternative access points in some geographic areas, which could diminish our ability to provide broad, reliable, redundant coverage. Further, our ability to

 

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negotiate favorable access rates from network service providers could be impaired, which could increase our network access expenses and harm our operating results.

 

If we fail to enhance our existing products or if new services, products or features we introduce do not succeed in the marketplace, we will not be able to generate new revenues and we will have increased costs without the expected returns.

 

Our target markets are characterized by rapid technological advances, changes in end-user requirements, and frequent new product introductions. Our future success will depend on our ability to anticipate or adapt to such changes and to offer, on a timely and cost-effective basis, products that meet changing customer demands. For example, our growth prospects will be determined, among other things, by our ability to grow our new branch office services offering, which is an offering into a highly competitive market with a large number of incumbents. We may lack sufficient resources to anticipate technological and market trends, manage long development cycles or develop, introduce and market new products and enhancements. In addition, we cannot predict whether our products and services will meet with market acceptance or be profitable.

 

Any strategic acquisitions or investments we engage in could dilute our stockholders and/or result in the assumption of additional liabilities, loss of sales and disruption of our business.

 

We expect that we will consider future acquisitions of, or investments in, complementary businesses, products or technologies. We may encounter difficulties in identifying and acquiring suitable candidates on reasonable terms.

 

In the event of any future acquisitions, we could:

 

•                                          issue stock that would dilute our current stockholders’ percentage ownership;

 

•                                          incur debt that will give rise to interest charges and may impose material restrictions on the manner in which we operate our business;

 

•                                          assume liabilities;

 

•                                          incur expenses related to impairment of goodwill and other intangible assets; or

 

•                                          incur large write-offs.

 

Any strategic acquisitions or investments that we make in the future will involve many risks, including the following:

 

•                                          problems combining the acquired operations, technologies, products or personnel;

 

•                                          unanticipated costs;

 

•                                          diversion of management time and attention from our existing business;

 

•                                          adverse effects on existing business relationships with our suppliers and customers;

 

•                                          risks associated with entering markets in which we have no or limited prior experience; and

 

•                                          potential loss of key employees, particularly those of acquired companies.

 

We may not be able to successfully integrate the businesses, products, technologies or personnel that we might acquire in the future. We cannot assure you that any strategic investments we may make will meet our financial or other investment objectives. Any failure to do so could seriously harm our business, financial condition and results of operations.

 

Our ability to compete could be jeopardized if we are unable to protect our intellectual property.

 

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Our products rely upon intellectual property rights. For example, we have been issued United States Patent Number 5,898,780 dated April 27, 1999 for “Method and Apparatus for Authorizing Remote Internet Access,” and have other U.S. patents pending. We cannot assure you that patents will issue from the pending applications or, if any patents are issued, that they will be sufficiently broad to protect our technology adequately. In addition, we have a number of trademarks and trademark applications and we use copyright and trade secret protection to protect its software and other original works. Because the technology and intellectual property associated with these products are evolving rapidly, current intellectual property rights may not adequately protect us. In addition, despite efforts to protect our proprietary rights, unauthorized parties may attempt to copy or otherwise obtain and use our products or technology. Monitoring unauthorized use of technology is difficult, and we cannot assure you that the steps they have taken will prevent unauthorized use of the technology. Moreover, effective patent, trademark, copyright and trade secret protection may not be available in some countries in which we provide, or may anticipate providing, our products. Furthermore, our competitors may independently develop similar technologies that limit the value of our intellectual property. If competitors are able to use our technology, our competitive edge would be reduced or eliminated.

 

We may become involved in litigation regarding intellectual property rights that could be costly, could cause us to lose significant rights, and divert our management time and attention.

 

In the future, we, or our customers, may become a party to litigation to protect our intellectual property or to respond to allegations that we infringe others’ intellectual property. We may receive communications from third parties inquiring about their interest in licensing certain of the third party’s intellectual property or more generally identifying intellectual property that could be the basis of a future infringement claim. If a party accuses us of infringing upon its proprietary rights, we would have to defend our company and possibly our customers against the alleged infringement. These lawsuits, regardless of their success, would likely be time-consuming and expensive to resolve and would divert management’s time and attention. Any potential intellectual property litigation could also force us to:

 

•                                          stop or delay selling, incorporating or using products that use the challenged intellectual property;

 

•                                          obtain a license to sell or use the relevant technology, which license might not be available on reasonable terms or at all; and

 

•                                          redesign the products and services that use that technology.

 

If we are forced to take any of these actions, it may have a material adverse effect on our business, financial condition and results of operations.

 

Terrorist acts and acts of war may seriously harm our business and revenue, costs and expenses and financial condition.

 

Terrorist acts or acts of war, including military actions in Iraq and other parts of the Middle East and the geo-political uncertainties in other continents are having an adverse effect on the U.S. economy and could possibly induce or accelerate the advent of a more severe economic recession. The U.S. government’s political, social and economic policies and policy changes as a result of these circumstances could have consequences that we cannot predict, including causing further weaknesses in the economy. In addition, as a multi-national company with headquarters and significant operations located in the United States, we may be impacted by actions against the United States. We will be predominantly uninsured for losses and interruptions caused by terrorist acts and acts of war. Thus, the long-term impact of these events on our business is uncertain. As a result, our operating results and financial condition could be materially and adversely affected.

 

Our customers require a high degree of reliability in the delivery of our services, and if we cannot meet their expectations for any reason, demand for our products and services will suffer.

 

Our success depends on our ability to assure generally error-free clearinghouse services, uninterrupted operation of our network and software infrastructure, and a satisfactory experience for our customers’ end users. In the past, we have experienced problems due to our inability to detect system malfunctions and due to errors in collecting or processing account usage and settlement data. Due to the high level of performance required for critical communications traffic, any failure to deliver a satisfactory experience to end users, whether or not caused by our own failures, and any failure to provide accurate settlement data in connection with acting as a clearinghouse, could reduce demand for our products and services.

 

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We depend on our reseller customers to market Internet-based communications services to their end users, so if our reseller customers fail to market their services effectively, our revenues may be reduced.

 

Our business depends in part on the efforts and success of our Internet service provider and telecommunications service customers in marketing Internet-based communications services to their end users. Although we have recently focused more heavily on selling to large enterprise customers, the highest percentage of our revenues is derived from our traditional service provider business. It is important that we maintain a healthy service provider business while we attempt to grow a more expansive enterprise customer base. Recently, we have experienced a faster than projected decline in revenues derived from our service provider customers.  We have little ability to promote our services, or to promote demand for our reseller customers’ services generally. The use of the Internet as a medium for communications services remains unproven. If our reseller customers fail to market their Internet-based communications services effectively, our revenues will be reduced. Similarly, if the market for Internet-based communications services fails to grow, or expands more slowly than anticipated, our revenues will be lower than expected. The Internet-based services we provide are relatively new and have not achieved widespread market acceptance. Network service providers and communication solutions providers may be reluctant to promote or rely upon our services until they gain greater commercial acceptance, which may never occur.

 

The unpredictability of our quarterly results may cause the trading price of our common stock to decline.

 

Our quarterly revenues and operating results have varied in the past and are likely to fluctuate unpredictably in the future for many reasons beyond our control. Any of these factors could cause our stock price to decline. The primary factors that affect revenues and operating results, in addition to the factors discussed elsewhere in this section, include the following:

 

•                                          the volume of transaction-based revenues;

 

•                                          the timing of deployment of services by our customers;

 

•                                          competitive pricing pressure;

 

•                                          changes in global travel patterns due to past and potential future terrorist activities in the U.S. and the military responses to them in the Middle East, Southern Asia and elsewhere;

 

•                                          the mix of services used by our customers’ end users;

 

•                                          difficulty collecting accounts receivable, particularly from customers based outside the U.S.; and

 

•                                          regulation, domestically and internationally.

 

Our operating expenses are largely determined based on our expectations about revenues. A high percentage of our expenses are fixed in the short term. As a result, lower than anticipated revenues for any reason could cause substantial operating losses.

 

If SARS re-emerges, business travelers could restrict their travel to and from Asia, which could harm our revenues.

 

Severe Acute Respiratory Syndrome, which is generally known as SARS, is a highly communicable disease that emerged in Asia during the first half of 2003. Concerns about the spread of SARS led to quarantines and travel restrictions being imposed on individuals with suspected symptoms in some countries, and some companies restricted or banned nonessential travel to and from certain parts of Asia. If business travel to Asia or elsewhere were to decline for a sustained period of time due to the re-emergence of SARS-related issues or other health concerns, the level of demand for our services is also likely to decline which could result in reduced revenues.

 

If we fail to attract and retain qualified sales personnel, our business might be harmed.

 

Our success depends in large part upon our ability to identify, attract and retain qualified sales individuals. Competition for these individuals is often intense, and we may not be able to hire the type and number of sales personnel it needs. Moreover, even after we hire salespersons, they require extensive training in our combined products and services. This training typically covers several weeks of formal in-class and on-the-job instruction. If we are unable to continue to retain our current employees and train new sales personnel as rapidly as necessary, we may not be able to increase market awareness

 

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and sales of our services, which may prevent us from generating revenue and may negatively impact our ability to maintain customer relationships.

 

The uncertain economic environment in general could adversely affect our revenue, gross margins and expenses.

 

Our revenue and gross margins depend in part on the overall demand for information technology products and services, particularly in the product and service segments in which we compete. Softening demand for our products and services caused by the ongoing economic downturn has resulted in decreased revenue growth rates, and may in the future result in decreased revenue, earnings or growth rates and problems with our ability to realize customer receivables. The global economy has weakened and market conditions continue to be challenging. As a result, companies are delaying or reducing expenditures, including those for information technology. In addition, if our customers experience financial difficulties, we could suffer losses associated with the outstanding portion of accounts receivable. The global economic downturn has contributed to reported declines in our revenue growth during fiscal 2003. Further delays or reductions in information technology spending could have a material adverse effect on demand for our products and services and consequently our results of operations, prospects and stock price.

 

Security concerns may deter the use of the Internet for Internet-based communications, which would reduce demand for our products and services.

 

The secure transmission of confidential information over public networks is a significant barrier to widespread adoption of electronic commerce and communications. The Internet is a public network and information is sent over this network from many sources. Advances in computer capabilities, new discoveries in the field of code breaking or other developments could result in compromised security on our network or the networks of others. Security and authentication concerns with respect to the transmission over the Internet of confidential information, such as corporate access passwords, and the ability of unauthorized computer users, so-called hackers, to penetrate online security systems may reduce the demand for our services. If any well-publicized compromises of confidential information were to occur, it could reduce demand for Internet-based communications and our products and services.

 

Government regulations and legal uncertainties regarding the Internet could harm GRIC’s business.

 

GRIC will be subject to local regulations or laws applicable to access to or commerce on the Internet, in addition to regulations applicable to businesses generally. However, the Federal Communications Commission has initiated several proceedings that may change the regulatory and legal framework for the provision of broadband and Internet services and current and future Federal Communications Commission rules and regulations, as well as judicial interpretations of these rules and regulations, could negatively affect GRIC’s business. In addition, international regulatory standards will govern GRIC’s products and services in foreign markets and could impair its ability to develop products and services for international service providers in the future. GRIC may not be able to obtain or maintain all of the regulatory approvals that may be required to operate its business. The inability to obtain these approvals, as well as any delays caused by its compliance and its customers’ compliance with regulatory requirements or resulting from uncertainty associated with future regulatory decisions, could result in postponements or cancellations of product orders, which would significantly reduce GRIC’s revenue.

 

Recently enacted and proposed regulatory changes may cause us to incur increased costs.

 

Recently enacted and proposed changes in the laws and regulations affecting public companies, including the provisions of the Sarbanes-Oxley Act of 2002, will increase our expenses as we evaluate the implications of new rules and devote resources to respond to the new requirements. In particular, we expect to incur additional administrative expense as we implement Section 404 of the Sarbanes-Oxley Act, which requires management to report on, and our independent auditors to attest to, our internal controls. The Sarbanes-Oxley Act mandates, among other things, that companies adopt new corporate governance measures and imposes comprehensive reporting and disclosure requirements, sets stricter independence and financial expertise standards for audit committee members and imposes increased civil and criminal penalties for companies, their chief executive officers and chief financial officers and directors for securities law violations. In addition, The Nasdaq National Stock Market, on which our common stock is listed, has also adopted comprehensive rules and regulations relating to corporate governance. These laws, rules and regulations have increased and will continue to increase the scope, complexity and cost of our corporate governance, reporting and disclosure practices, which could harm our results of operations and divert management’s attention from business operations. We also expect these developments to make it

 

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more difficult and more expensive for us to obtain director and officer liability insurance in the future, and we may be required to accept reduced coverage or incur substantially higher costs to obtain coverage.

 

Further, our board members, Chief Executive Officer and Chief Financial Officer could face an increased risk of personal liability in connection with the performance of their duties. As a result, we may have difficultly attracting and retaining qualified board members and executive officers, which would adversely affect our business.

 

If we fail to maintain an effective system of internal controls, we may not be able to report our financial results accurately or detect fraud. As a result, we could be subject to costly litigation, and current and potential shareholders could lose confidence in our financial reporting, which could harm our business and the trading price of our common stock.

 

Effective internal controls are necessary for us to provide reliable financial reports and to detect and prevent fraud. We are currently performing the system and process evaluation required to ensure compliance with the management certification and auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act. This evaluation may conclude that enhancements, modifications or changes to our internal controls are necessary. Completing this evaluation, performing testing and implementing required remedial changes will require significant expenditures in the short term and on a regular basis in the future. We cannot be certain as to the timing of completion of our evaluation, testing and remediation actions or the impact of the same on our operations.  We have in the past discovered, and may in the future discover, areas of our internal controls that need improvement. For example, during our 2003 audit, our independent auditor brought to our attention a need to improve the closing process used at our recently-acquired Irvine, California location by formally documenting our policy relating to recognition of revenues derived from agency arrangements versus reseller arrangements, correcting recognition of broadband service installation revenues, training employees performing key finance and accounting functions and documenting certain judgmental accounting matters. The auditor identified these items, collectively, as a "reportable condition," which means that it was a matter that in the auditor's judgment could adversely affect our ability to record, process, summarize and report financial data consistent with the assertions of management in the financial statements.  Completing our evaluation of internal controls, implementing any changes that are necessary, and maintaining an effective system of internal controls will be expensive and require considerable management attention. However, if we fail to implement and maintain an effective system of internal controls or prevent fraud, we could be subject to costly litigation, we may be delisted from trading, investors could lose confidence in our reported financial information and our brand and operating results could be harmed, which could have a negative effect on the trading price of our common stock.

 

The current regulatory environment affecting accounting principles generally accepted in the United States of America is uncertain and volatile, and significant changes in current principles could affect our financial statements going forward.

 

Recent actions and public comments from the Securities and Exchange Commission have focused on the integrity of financial reporting generally. In addition, the FASB and other regulatory accounting agencies have recently introduced several new or proposed accounting standards, or are developing new proposed standards, such as accounting for stock options, some of which would represent a significant change from current industry practices. While we believe that our financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America, we cannot predict the impact of the adoption of any such proposals on our financial statements going forward.

 

For example, we currently are not required to record stock-based compensation charges if the employee’s stock option exercise price equals or exceeds the deemed fair value of our common stock at the date of grant. However, several companies have recently elected to change their accounting policies and begun to record the fair value of stock options as an expense. Although the standards have not been finalized and the timing of a final statement has not been established, the FASB has announced their support for recording expense for the fair value of stock options granted. If we were to change our accounting policy in accordance with Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation and SFAS No. 148, Accounting for Stock- Based Compensation—Transition and Disclosure and retroactively restate all prior periods as if we had adopted SFAS 123 for all periods presented, then our operating expenses would increase by approximately $1.4 million and $693,000 for the three months ended March 31, 2004 and 2003, respectively.

 

Provisions in our charter documents might deter a company from acquiring us, which could inhibit your ability to receive an acquisition premium for your shares.

 

Provisions of our certificate of incorporation, bylaws and Delaware law make it difficult for a third party to acquire us, despite the possible benefit to our stockholders, and this may potentially lower the price of our common stock. These provisions of our certificate of incorporation and bylaws:

 

•                                          authorize the board to issue preferred stock without stockholder approval;

 

•                                          prohibit cumulative voting in the election of directors;

 

•                                          limit the persons who may call special meetings of stockholders; and

 

•                                          establish advance notice requirements for nominations for the election of the board of directors or for proposing matters that can be acted on by stockholders at stockholder meetings.

 

In addition, we have elected to remain subject to the anti-takeover provisions of Delaware law. These factors may discourage takeover attempts.

 

ITEM 3.  QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK

 

Foreign Currency Risk.  We have limited exposure to financial market risks, including changes in foreign currency exchange rates and interest rates. Although we have foreign operations in Europe and Asia, to date our exposure to foreign currency fluctuations has not been significant. Therefore, no accompanying table has been provided.

 

Interest Rate Risk.  Our exposure to interest rate risk relates primarily to our investment portfolio and debt obligations. Interest rate risk occurs when we cannot hold a purchased investment to its maturity. The weighted-average maturity of our investment portfolio, when taking into account the reset feature of floating rate municipal bonds, is limited to

 

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90 days. We intend to have our securities available for sale. We do not expect to recognize an adverse impact on income or cash flows, although there can be no assurance of this. We have established policies and business practices regarding our investment portfolio to preserve principal while obtaining reasonable rates of return without significantly increasing risk. We place investments with high credit quality issuers according to our investment policy. We do not use derivative financial instruments in our investment portfolio. All investments are carried at fair market value at March 31, 2004. Due to the short-term nature of our investments and the immaterial amount of our debt obligation, we believe that there is no material exposure to interest fluctuation. Therefore, no accompanying table has been provided.

 

ITEM 4.  CONTROLS AND PROCEDURES

 

Evaluation of Disclosure Controls and Procedures.  Regulations under the Securities Exchange Act of 1934 require public companies to maintain “disclosure controls and procedures,” which are defined to mean a company’s controls and other procedures that are designed to ensure that information required to be disclosed in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the Commission’s rules and forms. Our Chief Executive Officer and our Chief Financial Officer, based on their evaluation of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report, concluded that our disclosure controls and procedures were effective for this purpose.

 

Changes in Internal Controls.  During the period covered by this report, there were no changes in the Company’s internal control over financial reporting that materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.  However, we intend to continue to refine our internal controls on an ongoing basis.  Our management believes that it has taken the necessary steps to fully resolve the reportable condition that was previously reported to our Audit Committee relating to the financial close process used in December 2003 at our Irvine, California facility and that the reportable condition no longer exists.  Under the direction of our recently hired Chief Financial Officer, we reviewed and documented key accounting procedures, trained our finance personnel and realigned accounting responsibilities in our Irvine, California facility to support our operations and external reporting requirements.

 

                Limitations on Effectiveness of Controls and Procedures.  Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include, but are not limited to, the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, control may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

 

PART II. OTHER INFORMATION

 

ITEM 1.  LEGAL PROCEEDINGS

 

We are subject to various legal proceedings and claims arising in the ordinary course of business. Our management does not expect that the results in any of these legal proceedings will have a material adverse effect on our financial condition, results of operations, or cash flows.

 

In July and August 2001, we and certain of our officers were named as defendants in five purported securities class action lawsuits filed in the United States District Court, Southern District of New York, captioned as In re GRIC Communications, Inc. Initial Public Offering Securities Litigation, No. 01 Civ 6771 (SAS), and consolidated with more than three hundred substantially identical proceedings as In re Initial Public Offering Securities Litigation, Master File No. 21 MC 92 (SAS). The Consolidated Amended Class Action Complaint for Violation of the Federal Securities Laws (“Consolidated Complaint”) was filed on or about April 19, 2002, and alleges claims against certain of our officers and against CIBC World Markets Corp., Prudential Securities Incorporated, DB Alex. Brown, as successor to Deutsche Bank, and U.S. Bancorp Piper Jaffray Inc., underwriters of our December 14, 1999 initial public offering (“underwriter defendants”), under Sections 11 and 15 of the Securities Act of 1933, as amended, and under Section 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended.

 

Citing several press articles, the Consolidated Complaint alleges that the underwriter defendants used improper methods in allocating shares in initial public offerings, and claims the underwriter defendants entered into improper commission agreements regarding aftermarket trading in our common stock purportedly issued pursuant to the registration statement for the initial public offering. The Consolidated Complaint also alleges market manipulation claims against the underwriter defendants based on the activities of their respective analysts, who were allegedly compromised by conflicts of interest. The plaintiffs in the Consolidated Complaint seek damages as measured under Section 11 and Section 10(b) of the Securities Act of 1933, pre-judgment and post-judgment interest, and reasonable attorneys’ and expert witnesses’ fees and other costs; no specific amount is claimed in the plaintiffs’ prayer in the Consolidated Complaint. By Order of the Court, no responsive pleading is yet due, although motions to dismiss on global issues affecting all of the issuers have been filed.

 

In October 2002, certain of our officers and directors who had been named as defendants in the In re Initial Public Offering Securities Litigation were dismissed without prejudice upon order of the presiding judge. In February 2003, the presiding judge dismissed the Section 10(b) claims against us and our named officers and directors with prejudice.

 

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From September 2002 through June 2003, we participated in settlement negotiations with a committee of issuers’ litigation counsel, plaintiffs’ executive committee and representatives of various insurance companies (the “Insurers”). Our Insurers were actively involved in the settlement negotiations, and strongly supported a settlement proposal presented to us for consideration in early June 2003. The settlement proposed by the plaintiffs would be paid for by the Insurers and would dispose of all remaining claims against us.

 

After careful consideration, we decided to approve the settlement proposal in July 2003. Although we believe that plaintiffs’ claims are without merit, we have decided to accept the settlement proposal (which does not admit wrongdoing) to avoid the cost and distraction of continued litigation. Because the settlement will be funded entirely by our Insurers, we do not believe that the settlement will have any effect on our financial condition, results or operations or cash flows.

 

We believe that the settlement will be presented to the Court for approval in the summer of 2004. There can be no guarantee that the settlement will be judicially approved.

 

ITEM 2.  CHANGES IN SECURITIES AND USE OF PROCEEDS

 

See “Note 7 of Notes to the Condensed Consolidated Financial Statements.”

 

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES

 

Not applicable.

 

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

 

Not applicable.

 

ITEM 5.  OTHER INFORMATION

 

Not applicable.

 

ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K

 

(a)                                  Exhibits

Exhibit

Incorporated by Reference

Filed or Furnished

Number

Exhibit Description

Form

File No.

Exhibit

Filing Date

Herewith

31.01

Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 of the Registrant’s Chief Executive Officer, dated May 10, 2004.

X

31.02

Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 of the Registrant’s Chief Financial Officer, dated May 10, 2004.

X

32.01*

Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 of the Registrant’s Chief Executive Officer, dated May 10, 2004.

X*

32.02*

Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 of the Registrant’s Chief Financial Officer, dated May 10, 2004.

X*

 

*                                         These certifications accompany GRIC’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2004.  These certifications are not deemed filed with the Securities and Exchange Commission and are not to be incorporated by reference in any filing of GRIC under the Securities Act of 1933 or the Securities Exchange Act of 1934, whether made before or after the date hereof and irrespective of any general incorporation language in any

 

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filings.

 

(b) Reports on Form 8-K

 

Date Filed or Furnished		Item(s)		Description
2/13/04		7, 12		On February 13, 2004, we filed a Form 8-K regarding a press release announcing our financial results for the fourth quarter of 2003.*
2/13/04		5, 7		On February 13, 2004, we filed Amendment No. 1 to the Form 8-K filed December 3, 2003, regarding our acquisition of Axcelerant, Inc.*
2/25/04		5, 7		On February 25, 2004, we filed a Form 8-K regarding a press release announcing that we had hired Daniel Fairfax as our new Senior Vice President of Finance and Chief Financial Officer.

 

*  The information included under Items 7 and 12 of these reports on Form 8-K was furnished, but is not intended to be deemed filed or incorporated by reference into any filing.

 

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SIGNATURE

 

Pursuant to the requirements 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, on May 10, 2004.

 

	GRIC COMMUNICATIONS, INC.
	/s/ DANIEL W. FAIRFAX
	Daniel W. Fairfax
	Senior Vice President and Chief Financial Officer
	(principal financial officer and duly authorized officer)

 

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