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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
AMENDMENT NO. 1 TO
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the quarterly period ended March 31, 2005
Commission File Number: 0-21683
----------------------
GraphOn Corporation
(Exact name of Registrant as specified in its charter)
----------------------
Delaware 13-3899021
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
5400 Soquel Avenue, Suite A2
Santa Cruz, CA 95062
(Address of principal executive offices)
Registrant's telephone number: (800) 472-7466
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Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Exchange Act Rule 12b-2). Yes [ ] No [X]
As of May 11, 2005, there were issued and outstanding 46,147,047 shares of
the Registrant's Common Stock, par value $0.0001.
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Explanatory Note
----------------
The Company has determined that the convertible preferred securities it sold in
the quarter ended March 31, 2005 included a beneficial conversion feature.
Additionally, the Company has restated its disclosure of pro forma loss per
share related to its acquisition of Network Engineering Software, Incorporated.
See Note 2 to the condensed consolidated financial statements, included herein,
for additional discussion. The Company has restated its interim financial
statements in this Report and in an additional Amendment to its Quarterly Report
on Form 10-Q for the quarterly period ended June 30, 2005 to reflect the impact
of these items.
GRAPHON CORPORATION
FORM 10-Q
Table of Contents
Page
PART I. FINANCIAL INFORMATION ----
Item 1. Financial Statements
Unaudited Condensed Consolidated Balance Sheets 2
Unaudited Condensed Consolidated Statements
of Operations and Comprehensive Loss 3
Unaudited Condensed Consolidated
Statements of Cash Flows 4
Notes to Unaudited Condensed Consolidated
Financial Statements 5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 11
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 23
Item 4. Controls and Procedures 23
PART II. OTHER INFORMATION
Item 2. Unregistered Sales of Equity Securities and
Use of Proceeds 24
Item 4. Submission of Matters to a Vote of Security Holders 24
Item 6. Exhibits 24
Signatures 25
PART I--FINANCIAL INFORMATION
ITEM 1 Financial Statements
GRAPHON CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
March 31, December 31,
2005 2004
ASSETS ------------ ------------
------------ (Unaudited)
Current Assets:
Cash and cash equivalents ..................... $ 3,171,300 $ 675,300
Accounts receivable, net of allowance for
doubtful accounts of $46,800 and $46,800 ..... 975,900 518,900
Prepaid expenses and other current assets ..... 10,800 24,100
------------ ------------
Total Current Assets .......................... 4,158,000 1,218,300
------------ ------------
Property and equipment, net ...................... 73,700 75,400
Capitalized software, net ........................ 225,200 273,700
Patents, net ..................................... 5,231,800 -
Deferred acquisition costs ....................... - 269,700
Note receivable - related party .................. - 350,000
Other assets ..................................... 4,800 37,300
------------ ------------
TOTAL ASSETS ............................... $ 9,693,500 $ 2,224,400
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current Liabilities:
Accounts payable .............................. $ 198,100 $ 250,200
Accrued expenses .............................. 285,200 231,400
Accrued wages ................................. 339,100 260,100
Deferred revenue .............................. 1,018,300 689,800
------------ ------------
Total Current Liabilities ..................... 1,840,700 1,431,500
------------ ------------
Long-term Liabilities:
Deferred revenue .............................. 492,700 426,600
------------ ------------
TOTAL LIABILITIES .......................... 2,333,400 1,858,100
------------ ------------
Commitments and contingencies
Stockholders' Equity:
Preferred stock, $0.01 par value, 5,000,000 shares
authorized, no shares issued and outstanding .... - -
Common stock, $0.0001 par value, 195,000,000
shares authorized, 46,147,047 and 21,716,765
shares issued and outstanding ................... 4,600 2,200
Additional paid in capital, restated.............. 58,545,800 46,930,700
Deferred Compensation ............................ (8,400) -
Notes receivable - directors ..................... - (50,300)
Note receivable - shareholder .................... (347,400) -
Accumulated other comprehensive loss ............. - (400)
Accumulated deficit, restated..................... (50,834,500) (46,515,900)
------------ ------------
TOTAL STOCKHOLDERS' EQUITY ................. 7,360,100 366,300
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY . $ 9,693,500 $ 2,224,400
============ ============
<FN>
See accompanying notes to condensed consolidated financial statements.
</FN>
2
GRAPHON CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
Three Months Ended
March 31,
----------------------------
2005 2004
------------ ------------
(Unaudited) (Unaudited)
Revenue:
Product licenses ............................ $ 887,700 $ 646,200
Service fees ................................ 286,700 252,100
Other ....................................... 6,000 4,600
------------ ------------
Total Revenue ............................ 1,180,400 902,900
------------ ------------
Cost of Revenue
Product costs ............................... 50,400 226,300
Service costs ............................... 70,700 83,900
------------ ------------
Total Cost of Revenue .................... 121,100 310,200
------------ ------------
Gross Profit ............................. 1,059,300 592,700
------------ ------------
Operating Expenses:
Selling and marketing ....................... 334,800 358,100
General and administrative .................. 727,100 249,700
Research and development .................... 323,700 419,600
------------ ------------
Total Operating Expenses .................... 1,385,600 1,027,400
------------ ------------
Loss From Operations ........................ (326,300) (434,700)
------------ ------------
Other Income (Expense):
Interest and other income ................ 8,800 3,600
Interest and other expense ............... (1,100) -
------------ ------------
Total Other Income ....................... 7,700 3,600
------------ ------------
Net Loss .................................... (318,600) (431,100)
Other Comprehensive Income (Loss), net of tax
Foreign currency translation gain (loss) . - 600
------------ ------------
Comprehensive Loss .......................... (318,600) (430,500)
Deemed divided on preferred stock, restated (4,000,000) -
------------ ------------
Loss attributable to common shareholders, restated $ (4,318,600) $ (430,500)
============ ============
Basic and Diluted Loss per Common Share, restated $ (0.15) $ (0.02)
============ ============
Weighted Average Common Shares Outstanding .. 28,620,913 20,036,876
============ ============
<FN>
See accompanying notes to condensed consolidated financial statements.
</FN>
3
GRAPHON CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Ended
March 31,
---------------------------
2005 2004
----------- -----------
(Unaudited) (Unaudited)
Cash Flows From Operating Activities:
Net loss .............................................. $ (318,600) $ (431,100)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Depreciation and amortization ...................... 206,800 258,800
Amortization of deferred compensation .............. 500 -
Proceeds from notes receivable - directors ......... 50,300 -
Proceeds from note receivable - shareholder ........ 2,600 -
Interest accrued on notes receivable - directors .... (300) (700)
Interest accrued on note receivable - shareholder .. (2,000) -
Proceeds from interest accrued on notes receivable -
directors ........................................ 4,300 -
Changes in operating assets and liabilities:
Accounts receivable ................................ (457,000) 152,300
Prepaid expenses and other assets .................. 13,300 (4,600)
Accounts payable ................................... 55,800 72,100
Accrued expenses ................................... (5,700) 38,200
Accrued wages ...................................... 79,000 (178,900)
Deferred revenue ................................... 394,600 (180,500)
----------- -----------
Net Cash Provided By (Used In) Operating Activities ... 23,600 (274,400)
----------- -----------
Cash Flows From Investing Activities:
Cash paid for NES acquisition ......................... (612,200) -
Capital expenditures .................................. (10,300) (6,600)
----------- -----------
Net Cash Used In Investing Activities .............. (622,500) (6,600)
----------- -----------
Cash Flows From Financing Activities:
Proceeds from private placement
of preferred stock and warrants....................... 3,335,000 1,150,000
Costs of private placement of preferred stock
and warrants ......................................... (244,600) (179,100)
Proceeds from sale of common stock under
employee stock purchase plan ......................... 4,600 3,600
----------- -----------
Net Cash Provided By Financing Activities .......... 3,095,000 974,500
----------- -----------
Effect of exchange rate fluctuations on cash and
cash equivalents ................................... (100) 600
----------- -----------
Net Increase in Cash and Cash Equivalents ............. 2,496,000 694,100
Cash and Cash Equivalents, beginning of period ........ 675,300 1,025,500
----------- -----------
Cash and Cash Equivalents, end of period .............. $ 3,171,300 $ 1,719,600
=========== ===========
<FN>
See accompanying notes to condensed consolidated financial statements.
</FN>
4
GRAPHON CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Basis of Presentation
The unaudited condensed consolidated financial statements of GraphOn
Corporation (the Company) and its subsidiaries included herein have been
prepared in accordance with the instructions for Form 10-Q and, therefore, do
not include all information and footnotes necessary for a complete presentation
of the Company's results of operations, financial position and cash flows.
The unaudited condensed consolidated financial statements included herein
reflect all adjustments (which include only normal, recurring adjustments in the
three-month periods ended March 31, 2005 and 2004) that are, in the opinion of
management, necessary to state fairly the results for the periods presented.
This Quarterly Report on Form 10-Q should be read in conjunction with the
Company's audited financial statements contained in the Company's Annual Report
on Form 10-K for the year ended December 31, 2004, which was filed with the
Securities and Exchange Commission (the Commission) on April 15, 2005. The
interim results presented herein are not necessarily indicative of the results
of operations that may be expected for the full fiscal year ending December 31,
2005, or any future period.
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenue and
expenses during the reporting period. These estimates include the allowance for
doubtful accounts, the estimated lives of intangible assets, depreciation of
fixed assets and accrued liabilities, among others. Actual results could differ
materially from those estimates.
Significant intercompany accounts and transactions are eliminated upon
consolidation.
2. Restatement of Financial Statements
The Company determined that the convertible preferred stock (the "Preferred
Shares") it sold during the quarter contained a beneficial conversion feature.
As the Preferred Shares were converted during the quarter, the amount of the
beneficial conversion (Beneficial Amount) should have been recorded as a
non-cash dividend to the holders of the Preferred Shares (see Note 4). As a
result, additional paid-in capital and accumulated deficit were increased by
$4,000,000.
Although the net loss previously recorded by the Company is unchanged, the
Company has amended its statement of operations to reflect the net loss
attributable to common shareholders, giving effect to the treatment of the
Beneficial Amount as a dividend to the holders of the Preferred Shares. Basic
and diluted loss per share has been restated giving effect to the use of net
loss attributable to common shareholders as the numerator. As a result, basic
and diluted loss per share increased from $0.01 to $0.15.
Additionally, the Company has restated its pro forma basic and diluted loss per
share (see Note 3) to give effect to the stock issued in the NES acquisition
(see Note 3) as if the stock had been issued on January 1, 2004. As a result,
pro forma basic and diluted loss per share for the three-month period ended
March 31, 2004 decreased from $0.04 to $0.03.
5
3. NES Acquisition
On January 31, 2005, the Company acquired all of the outstanding common stock
of NES in exchange for 9,599,993 shares of the Company's common stock and
approximately $897,800 in cash. The acquisition was pursuant to an acquisition
agreement between the Company and NES dated December 3, 2004. A portion of the
acquisition proceeds was used to repay all liabilities of NES that were not
forgiven in conjunction with the acquisition.
The acquisition was accounted for as an asset acquisition. Accordingly, the
assets acquired (primarily consisting of patents and patent applications) have
been recorded at their cost. There were no liabilities acquired.
The estimated cost of the patents acquired in the acquisition was calculated
as follows:
Value of GraphOn common stock issued $ 3,916,800
NES liabilities settled with cash:
Accounts payable $ 81,200
Note payable (shareholders) * 665,000
Other liabilities 151,600
------------
Total NES cash settlements 897,800
Transaction costs 563,500
------------
NES acquisition costs as of March 31, 2005 1,461,300
------------
Estimated cost of patents $ 5,378,100
============
* Includes $88,500 of accrued interest. The cash payment for this note, which
was the subject of certain shareholder litigation against NES, was made by
AIGH Investment Partners, LLC ("AIGH"), an affiliate of a major shareholder
(Orin Hirschman), during December 2004. The Company reimbursed AIGH via a
$665,000 credit (the "$665,000 credit") against the price of securities
acquired by AIGH in the 2005 Private Placement (see Note 4) upon the
assignment by AIGH of its security interest in NES' patents.
The estimated cost of the patent portfolio is being amortized over a 6-year
period using the straight-line method. The estimated cost of the patents may
change as a result of the completion of a valuation study and as all direct
acquisition costs are finalized. The final adjustments to the estimated costs of
the patents are not expected to be material.
As of December 31, 2004, prior to the consummation of the acquisition, the
Company had deferred approximately $269,700 of the acquisition costs. These
deferred acquisition costs are included in the transaction costs, in the table
above.
On October 6, 2004, upon entering into a letter of intent to acquire NES, the
Company contemporaneously loaned $350,000 to Ralph Wesinger, NES' majority
shareholder, to fund his purchase of all the NES common stock then owned by
another person. The Company received Mr. Wesinger's 5-year promissory note,
which bears interest at a rate of 3.62% per annum and which was secured by his
approximately 65% equity interest in NES, to evidence this loan. Mr. Wesinger
also agreed that the Company would receive 25% of the gross proceeds of any sale
or transfer of any of Mr. Wesinger's NES shares, which shall be applied in
reduction of the then outstanding balance of his note, until the note is paid in
full or becomes due, whichever occurs first. The Company has the option to
accelerate the maturity date of this note upon the occurrence of certain events.
6
Upon the completion of the Company's acquisition of NES, 3,260,391 shares of
the Company's common stock replaced the 52,039 shares of NES stock
collateralizing the note. The outstanding balance of this note receivable is
reported in the stockholders' equity section of the Company's balance sheet as
note receivable - shareholder at March 31, 2005 (see Note 6).
The following unaudited pro forma information presents the consolidated
results of the Company as if the NES acquisition had occurred at the beginning
of the respective period. The pro forma information is not necessarily
indicative of what would have occurred had the acquisition been made as of such
period, nor is it indicative of future results of operations. The pro forma
amounts give effect to appropriate adjustments for the fair value of the
patents, amortization and income taxes.
Three Months Ended March 31,
2005 2004
------------ ------------
Revenue $ 1,180,400 $ 902,900
Net loss (424,700) (869,200)
Net loss attributable to common
shareholders, restated (4,424,700) (869,200)
Loss per share - basic and diluted, restated (0.14) (0.03)
4. 2005 Private Placement
On February 2, 2005, the Company completed the 2005 Private Placement, which
raised a total of $4,000,000 (inclusive of the $665,000 credit) through the sale
of 148,148 shares of Series A preferred stock and five-year warrants to purchase
74,070 shares of Series B preferred stock.
The deemed fair value of the Series A preferred stock was estimated based on
the market price and underlying number of common shares they would have
converted into had the conversion occurred immediately upon their issuance. The
market price for the Company's common stock on February 2, 2005 was $0.46 and
the Series A preferred stock would have converted into 14,814,800 common shares,
thus deriving an estimated fair value of approximately $6,814,800 at that date.
The fair value of the warrants was estimated to be $1,877,700 and was
calculating using the Black-Scholes option pricing model with the following
weighted average assumptions: a risk-free interest rate of 1.5%, a volatility
factor of 60%, a dividend yield of 0%, and a five year contractual life.
Based on the relative fair values of the Preferred Shares and the warrants at
the time of their issuance, the Company allocated $3,136,000 of the $4,000,000
proceeds of the 2005 Private Placement to the Preferred Shares and $864,000 to
the warrants.
The Preferred Shares issued by the Company contained a nondetachable
conversion feature (the "Beneficial Conversion Feature") that was in-the-money
upon completion of the 2005 Private Placement, in that the deemed fair value
of common stock into which the Preferred Shares could be converted exceeded the
allocated value of $3,136,000 by $3,678,800 (using the intrinsic value method).
This discount resulting from recording the Beneficial Conversion Feature was
limited to the allocated proceeds of $3,136,000 and has been recognized as if
this amount had been declared a non-cash dividend to the preferred shareholders
during the quarter ended March 31, 2005.
Additionally, the approximate $864,000 discount resulting from the allocation
of the proceeds of the 2005 Private Placement on a relative fair value basis to
7
the Series A preferred stock and the warrant issued in the 2005 Private
Placement has also been recognized as if this amount had been declared a non-
cash dividend to the preferred shareholders during the quarter ended March 31,
2005.
Under the terms of the 2005 Private Placement, upon the effectiveness of an
amendment to the Company's Certificate of Incorporation to increase the
authorized number of shares of common stock from 45,000,000 to 195,000,000, all
shares of Series A Stock and Series B Stock would automatically convert into
shares of common stock at a rate of 100 shares of common stock for each share of
Preferred Stock, and all Warrants issued in the 2005 Private Placement would
automatically become exercisable for shares of common stock at a rate of 100
shares of common stock for each share of Preferred Stock underlying such
Warrants.
At the special meeting of the Company's stockholders, held on March 29, 2005,
the stockholders approved the amendment to the Company's Certificate of
Incorporation to increase the authorized number of common shares from 45,000,000
to 195,000,000. Consequently, an aggregate of 148,148 shares of Series A Stock
were converted into 14,814,800 shares of common stock and warrants to purchase
an aggregate of 74,070 Series B Stock were converted into warrants to purchase
an aggregate 7,407,000 shares of common stock. In addition, the warrants issued
in the 2005 Private Placement pursuant to the finder's agreement, which had been
entered into with the agent who arranged the Company's January 2004 private
placement and was still effective at the time of the 2005 Private Placement,
converted as follows: the warrants to purchase 14,815 shares of Series A Stock
and the warrants to purchase 7,407 shares of Series B Stock converted into
warrants to purchase 1,481,500 and 740,700 shares of common stock, respectively.
The following table summarizes the common stock warrants issued upon
conversion of the preferred warrants, as discussed above, all of which were
outstanding as of March 31, 2005:
Shares subject Exercise Expiration
Warrant holder to warrant Price Date
-------------- ------------ ------------ ------------
Investors 7,407,000 $ 0.40 02/10
Agent 1,481,500 $ 0.27 02/10
Agent 740,700 $ 0.40 02/10
5. Revenue
Product line revenue for the three-month periods ended March 31, 2005 and
2004, was as follows:
Change in
Product licenses 2005 2004 Dollars Percent
---------------- ------------ ------------ ------------ ---------
Windows $ 620,900 $ 429,700 $ 191,200 44.5%
Unix 266,900 216,500 50,400 23.3
------------ ------------ ------------
887,800 646,200 241,600 37.4
------------ ------------ ------------
Service fees
Windows 143,100 136,900 6,200 4.5
Unix 143,500 115,200 28,300 24.6
------------ ------------ ------------
286,600 252,100 34,500 13.7
------------ ------------ ------------
Other (1) 6,000 4,600 1,400 30.4
------------ ------------ ------------
Total Revenue $ 1,180,400 $ 902,900 $ 277,500 30.7%
============ ============ ============
(1) Amortization of private labeling fees.
8
6. Stockholders' Equity
During the first quarter of 2005, the Company issued 15,489 shares of common
stock to employees under provisions of the Employee Stock Purchase Plan (the
ESPP), resulting in cash proceeds of approximately $4,600.
During the first quarter of 2005, the Company completed the 2005 Private
Placement (see Note 4), which, after the Company's stockholders approved the
amendment to the Company's Certificate of Incorporation (see Note 4), resulted
in the issuance of 14,814,800 shares of common stock.
Also during the first quarter of 2005, the Company issued 9,599,993 shares of
common stock to consummate the NES acquisition (see Note 3).
During the first quarter of 2005, the Company reclassified note receivable -
third party from the long-term assets section of its balance sheet to the equity
section under the title note receivable - shareholder to reflect the replacement
of the NES stock that had been collateralizing the note, as of December 31,
2004, with Company stock, upon the consummation of the acquisition of NES on
January 31, 2005 (see Note 3).
During the first quarter of 2005, the Company received an aggregate of
approximately $54,600 as payment in full of the principal and accrued interest
due from the notes receivable - directors.
7. Litigation
The Company is currently not involved in any litigation that it believes
would have a materially adverse affect upon its financial results or financial
position.
8. Stock-Based Incentive Programs
The Company accounts for stock-based compensation under the intrinsic value
method of accounting for stock awards, in accordance with Accounting Principles
Board Opinion number 25, "Accounting for Stock Issued to Employees" (APB 25) as
permitted by Statement of Financial Accounting Standards number 123,
"Stock-Based Compensation" (SFAS 123). The Company has not changed to the fair
value method of accounting for stock-based employee compensation. Had the
Company applied the fair value recognition provisions of SFAS 123 to stock-based
compensation, the Company's net loss and basic and diluted loss per share would
have been changed from the "as reported" amounts to the "pro forma" amounts as
follows for each of the respective periods:
Three months ended
March 31,
2005 2004
------------ ------------
Net loss:
As reported: $ (318,600) $ (431,100)
Less: deemed preferred dividend, restated (4,000,000) -
Add: stock-based compensation expense
included in net loss, net of related
tax effects 500 -
Deduct: total stock-based compensation
expense determined under fair-value
method for all awards, net of related
9
tax effects (83,500) (28,600)
----------- -----------
Pro forma net loss, restated $(4,401,600) $ (459,700)
=========== ===========
Basic and diluted loss per share:
As reported, restated $ (0.15) $ (0.02)
Pro forma, restated $ (0.15) $ (0.02)
9. Commitments and Contingencies
In October 2004, the Company renewed its operating lease for an approximate
3,300 square foot facility in New Hampshire. This lease is cancelable by the
landlord or the Company upon 30-days written notice. Monthly rental payments for
this facility are approximately $5,300.
The Company currently occupies approximately 1,000 square feet of office
space in Santa Cruz, California. The office space is rented pursuant to a
one-year operating lease, which became effective August 1, 2004. Rent on the
Santa Cruz facility is approximately $1,400 per month.
The Company has been occupying leased facilities in Rolling Hills Estates,
California, on a month-to-month basis since October 2002. Rent on this facility
is approximately $1,000 per month.
The Company has also been renting a small office in Berkshire, England,
United Kingdom since December 2002. This operating lease runs through December
2005. Rent on this office, which can fluctuate depending on exchange rates, is
approximately $400 per month.
As a condition of the 2004 private placement, the Company entered into an
Investment Advisory Agreement with Orin Hirschman, a significant stockholder of
the Company, pursuant to which it was agreed that in the event the Company
completes a transaction with a third party introduced by Mr. Hirschman, the
Company shall pay to Mr. Hirschman 5% of the value of that transaction. The
agreement, as amended, expires on January 29, 2008.
10. Supplemental Disclosure of Cash Flow Information
The Company disbursed no cash for the payment of either income taxes or
interest expense during the quarter ended March 31, 2005 or the similar period
in 2004.
As of December 31, 2004, the Company had capitalized approximately $179,500
and $31,000 of deferred acquisition costs, related to the NES acquisition, that
were included in accounts payable and accrued expenses, respectively.
Additionally, the Company accrued approximately $32,500 of deferred financing
costs, related to the 2005 Private Placement, as other assets, as of December
31, 2004.
During the first quarter of 2005, the Company capitalized approximately
$72,100 and $106,000 of costs related to the NES acquisition that were included
in accounts payable and accrued expenses, respectively. Additionally, the
Company accrued approximately $17,000 of costs related to the 2005 Private
Placement.
11. Loss Per Share
Potentially dilutive securities have been excluded from the computation, as
their effect is antidilutive. For the quarters ended March 31, 2005 and 2004,
10
22,437,157 and 9,582,738 shares, respectively, of common stock equivalents were
excluded from the computation of diluted loss per share since their effect would
be antidilutive.
12. Subsequent Event
During the first quarter of 2005, the Company deferred approximately $200,000
of Windows-based product revenue, derived from a transaction entered into with a
significant distributor because not all of the Company's criteria necessary for
revenue recognition had been met. During April 2005, all such criteria were
satisfied. Consequently, deferred revenue - current portion was reduced and the
Company recognized the revenue.
ITEM 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Forward-Looking Statements
The following discussion of our financial condition and results of operations
contains forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.
Actual results and the timing of certain events could differ materially from
those anticipated in these forward-looking statements as a result of certain
factors. Such factors, including:
o our history of operating losses, and expectation that those losses will
continue;
o the uncertainty as to whether or not we will realize the anticipated
benefits of acquiring NES;
o that a significant portion of our revenue has been and continues to be
earned from a very limited number of significant customers;
o that our stock price has been volatile and you could lose your investment;
and
o other factors set forth under "Risk Factors" in our Annual Report on
Form 10-K for the year ended December 31, 2004 and in other documents
we filed with the Securities and Exchange Commission, could have a
material adverse effect upon our business, results of operations and
financial condition.
Overview
We are developers of business connectivity software, including Unix, Linux
and Windows server-based software, with an immediate focus on web-enabling
applications for use by independent software vendors (ISVs), application service
providers (ASPs), corporate enterprises, governmental and educational
institutions, and others.
Server-based computing, sometimes referred to as thin-client computing, is a
computing model where traditional desktop software applications are relocated to
run entirely on a server, or host computer. This centralized deployment and
management of applications reduces the complexity and total costs associated
with enterprise computing. Our software architecture provides application
developers with the ability to relocate applications traditionally run on the
desktop to a server, or host computer, where they can be run over a variety of
connections from remote locations to a variety of display devices. With our
11
server-based software, applications can be web enabled, without any modification
to the original application software required, allowing the applications to be
run from browsers or portals. Our server-based technology can web-enable a
variety of Unix, Linux or Windows applications.
On January 31, 2005, we acquired NES, which is engaged in the development and
patenting of proprietary technologies relating to the submission, storage,
retrieval and security of information remotely accessed by computers, typically
through computer networks or the Internet. In a contemporaneous transaction, we
issued, in a private placement, (the "2005 Private Placement") newly authorized
Series A Preferred Stock and warrants to purchase newly authorized Series B
Preferred Stock. We estimate that the 2005 Private Placement will have raised
net proceeds of approximately $2,130,000, after giving effect to:
o the $665,000 credit issued to AIGH in the 2005 Private Placement;
o approximately $437,700 of cash to be disbursed to pay for estimated costs
associated with the 2005 Private Placement; and
o approximately $767,300 of cash to be disbursed to pay for estimated costs
associated with the NES acquisition.
These transactions are described in our Current Report on Form 8-K, filed
with the Securities and Exchange Commission (SEC) on February 4, 2005.
In order to ensure that we will be able to realize our assets and settle our
liabilities within the normal course of our business operations, we must
consider several aggressive strategic initiatives aimed at increasing revenue or
securing additional alternative sources of financing. If we were unsuccessful in
increasing revenues or finding additional alternative sources of financing, we
would face a severe constraint on our ability to sustain operations in a manner
that would create future growth and viability, and we may need to cease
operations entirely.
Critical Accounting Policies
The preparation of financial statements and related disclosures in conformity
with accounting principles generally accepted in the United States requires us
to make judgments, assumptions and estimates that affect the amounts reported in
the Condensed Financial Statements and accompanying notes. Estimates are used
for, but not limited to, the accounting for the allowance for doubtful accounts,
the impairment of intangible assets, contingencies and other special charges and
taxes. Actual results could differ materially from these estimates. The
following critical accounting policies are impacted significantly by judgments,
assumptions and estimates used in the preparation of the Condensed Consolidated
Financial Statements.
Revenue Recognition
Generally, software license revenues are recognized when a non-cancelable
license agreement has been signed and the customer acknowledges an unconditional
obligation to pay, the software product has been delivered, there are no
uncertainties surrounding product acceptance, the fees are fixed or determinable
and collection is considered probable. Delivery is considered to have occurred
when title and risk of loss have been transferred to the customer, which occurs
when the customer is given access to the licensed programs. If collectibility is
not considered probable, revenue is recognized when the fee is collected.
Revenue earned on software arrangements involving multiple elements is
allocated to each element arrangement based on the relative fair values of the
elements. If there is no evidence of the fair value for all the elements in a
12
multiple element arrangement, all revenue from the arrangement is deferred until
such evidence exists or until all elements are delivered. We recognize revenue
from the sale of software licenses when all the following conditions are met:
o Persuasive evidence of an arrangement exists;
o Delivery has occurred or services have been rendered;
o Our price to the customer is fixed or determinable; and
o Collectibility is reasonably assured.
Revenues recognized from multiple-element software arrangements are allocated
to each element of the arrangement based on the fair values of the elements,
such as licenses for software products, maintenance, consulting services or
customer training. The determination of fair value is based on objective
evidence. We limit our assessment of objective evidence for each element to
either the price charged when the same element is sold separately or the price
established by management having the relevant authority to do so, for an element
not yet sold separately. If evidence of fair value of all undelivered elements
exists but evidence does not exist for one or more delivered elements, then
revenue is recognized using the residual method. Under the residual method, the
fair value of the undelivered elements is deferred and the remaining portion of
the arrangement fee is recognized as revenue.
Certain of our ISV, VAR or ASP customers (who we refer to as "resellers")
prepay for licenses they intend to resell. Upon receipt of the prepayment, if
all other revenue recognition criteria outlined above have been met, we
recognize licensing revenue when the reseller is given access to the licensed
programs. The resellers provide us with monthly sell-through reports that
detail, for the respective month, the number of licenses purchased from us, the
number they have sold to other parties, the ending balance of licenses they hold
as inventory available for future sale and certain information pertaining to
their customers such as customer name, licenses purchased, purchase date and
contact information. We monitor and reconcile the resellers' inventory records
to our records via the monthly sell-through reports.
Other resellers will only purchase licenses from us when they have already
closed a deal to sell our product to another party. These resellers will
typically submit a purchase order to us in order to receive product that they
can deliver to their customer. In these cases, assuming all other revenue
recognition criteria, as set forth above, have been satisfied, we recognize
licensing revenue when the reseller has been given access to the licensed
programs. There are no rights of return granted to resellers or other purchasers
of our software programs.
We recognize revenue from service contracts ratably over the related contract
period, which generally ranges from 1-5 years.
Allowance for Doubtful Accounts
The allowance for doubtful accounts is based on our assessment of the
collectibility of specific customer accounts and the aging of the accounts
receivable. If there is a deterioration of a major customer's credit worthiness
or actual defaults are higher than our historical experience, our estimates of
the recoverability of amounts due us could be adversely affected.
13
Capitalized Software Development Costs
Software development costs incurred in the research and development of new
products are expensed as incurred until technological feasibility, in the form
of a working model, has been established, at which time such costs are typically
capitalized until the product is available for general release to customers.
Capitalized costs are amortized based on either estimated current and future
revenue for the product or straight-line amortization over the shorter of three
years or the remaining estimated life of the product, whichever produces the
higher expense for the period.
Impairment of Intangible Assets
We perform impairment tests on our intangible assets on an annual basis or
when circumstances indicate that a potential impairment may have occurred. In
response to changes in industry and market conditions, we may strategically
realign our resources and consider restructuring, disposing of, or otherwise
exiting businesses, which could result in an impairment of intangible assets.
During 2002 we recorded significant write-downs to the value of our intangible
assets as a result of the impairment tests performed. A significant
consideration impacting the results of the impairment tests was the substantial
delay in getting our most recently released Windows-based product upgrade,
GO-Global for Windows, into marketable condition. The engineering delays we
encountered resulted in a substantial decrease in our revenue in 2002, which
ultimately caused us to consume almost all of our cash balances in our
day-to-day operations.
Loss Contingencies
We are subject to the possibility of various loss contingencies arising in
the ordinary course of business. We consider the likelihood of the loss or
impairment of an asset or the incurrence of a liability as well as our ability
to reasonably estimate the amount of loss in determining loss contingencies. An
estimated loss contingency is accrued when it is probable that a liability has
been incurred or an asset has been impaired and the amount of the loss can be
reasonably estimated. We regularly evaluate current information available to us
to determine whether such accruals should be adjusted.
Stock Compensation
We apply Accounting Principles Board (APB) Opinion No. 25, "Accounting for
Stock Issued to Employees" and related interpretations thereof (hereinafter
collectively referred to as APB 25) when accounting for our employee and
directors stock options and employee stock purchase plans. In accordance with
APB 25, we apply the intrinsic value method in accounting for employee stock
options. Accordingly, we generally recognize no compensation expense with
respect to stock-based awards to employees.
We have determined pro forma information regarding net income and earnings
per share as if we had accounted for employee stock options under the fair value
method as required by Statement of Financial Accounting Standards (SFAS) No.
123, "Accounting for Stock-Based Compensation" as amended by SFAS 148
(hereinafter collectively referred to as SFAS 123). The fair value of these
stock-based awards to employees was estimated using the Black-Scholes
option-pricing model. Had compensation cost for our stock option plans and
employee stock purchase plan been determined consistent with SFAS 123, our
reported net loss and net loss common per share would have been changed to the
amounts discussed elsewhere in this Form 10-Q.
14
Loss Per Share of Common Stock
Basic loss per share includes no dilution and is computed by dividing loss
attributable to common shareholders by the weighted-average number of common
shares outstanding for the period. Diluted loss per share reflects the potential
dilution of securities by adding other common stock equivalents, including
common stock options, warrants and redeemable convertible preferred stock, in
the weighted average number of common shares outstanding for a period, if
dilutive. Potentially dilutive securities have been excluded from the
computation, as their effect is antidilutive. For the quarters ended March 31,
2005 and 2004, 22,437,157 and 9,582,738 shares, respectively, of common stock
equivalents were excluded from the computation of diluted loss per share since
their effect would be antidilutive.
Results of Operations for the Three-Month Period Ended March 31, 2005 Versus the
Three-Month Period Ended March 31, 2004.
Revenue
Product line revenue for the three-month periods ended March 31, 2005 and
2004, was as follows:
Change in
Product licenses 2005 2004 Dollars Percent
---------------- ------------ ------------ ------------ ---------
Windows $ 620,900 $ 429,700 $ 191,200 44.5%
Unix 266,900 216,500 50,400 23.3
------------ ------------ ------------
887,800 646,200 241,600 37.4
------------ ------------ ------------
Service fees
------------
Windows 143,100 136,900 6,200 4.5
Unix 143,500 115,200 28,300 24.6
------------ ------------ ------------
286,600 252,100 34,500 13.7
------------ ------------ ------------
Other (1) 6,000 4,600 1,400 30.4
------------ ------------ ------------
Total Revenue $ 1,180,400 $ 902,900 $ 277,500 30.7%
============ ============ ============
(1) Amortization of private labeling fees. Private labeling fees are derived
when we contractually agree to allow a customer to brand our product with
their name. We defer these fees upon contract signing and recognize the
revenue ratably over the initial term of the contract, typically, three
years.
The increase in Windows-based product revenue was reflective of how our
revenue varies from quarter to quarter because a significant portion of our
revenue has been, and continues to be earned from a very limited number of
significant customers. Two ISVs that have been customers for a few years
generated approximately $104,700 more in Windows-based product revenue in the
first quarter of 2005 as compared with 2004. An ISV we started doing business
with during the second quarter of 2004 generated approximately $33,900 of
Windows-based product revenue during the first quarter of 2005. We recognized
$12,500 more in Windows-based product revenue from our distributor in Japan in
the first quarter of 2005 as compared to the same period in 2004. We also
recognized approximately $72,000 in Windows-based product revenue from a sale to
a new enterprise customer during the first quarter of 2005.
Partially offsetting these amounts was an approximate $70,200 decrease in
Windows-based product revenue to a large ISV who, beginning in the third quarter
of 2004, is no longer bundling our product with every product of theirs that
they ship. This ISV began offering our Windows-based products as an add-on extra
feature to their product line during the third quarter of 2004. Windows-based
15
product revenue from this ISV declined from approximately $146,300 in the first
quarter of 2004 to approximately $76,100 in the first quarter of 2005.
The increase in Windows-based product revenue was also partially offset by
approximately $48,000 as a result of two enterprise customers who did not
purchase any product during the first quarter of 2005.
The increase in Unix-based product revenue was primarily due to an
approximate $52,500 increase in orders from one of our significant ISVs during
the first quarter of 2005, as compared with 2004. Other significant Unix-based
product revenue increases included revenue from one other ISV, which increased
by approximately $14,300, and revenue of approximately $11,000 from a new
enterprise customer. Partially offsetting these increases was $0 of Unix-based
product revenue from an enterprise customer during the first quarter of 2005, as
compared with approximately $18,000 during the first quarter of 2004. Also
offsetting these increases was an approximate $10,700 decrease in Unix-based
product revenue from an enterprise customer in the first quarter of 2005 as
compared with the same period in 2004.
The remainder of the increases in the first quarter 2005 Windows-based
product revenue and Unix-based product revenue, as compared with the first
quarter of 2004, was due to a combination of the demand by and composition of
our many smaller customers.
A material portion of our product licenses revenue during any reporting
period is typically generated from a very limited number of significant
customers. Consequently, if any of these significant customers change their
order level or fail to order during the reporting period, our revenue could be
materially adversely impacted. We expect this trend to continue throughout 2005.
Our customers typically purchase a maintenance contract at the time they
license our product. Our Windows-based maintenance contracts are primarily for a
one-year time period and generally are renewed upon expiration. Our Unix-based
maintenance contracts vary in term from one to five years and generally are
renewed upon expiration. Service fees associated with maintenance contracts are
deferred and recognized as revenue ratably over the underlying service period of
the maintenance contract.
The increase in Unix-based service fees is due to higher levels of
maintenance contract purchases from the significant Unix-based ISV referred to
above, which began approximately during the third quarter of 2004 and continued
into the first quarter of 2005.
Cost of Revenue
Cost of revenue consists primarily of the amortization of capitalized
technology developed in-house and customer service costs. Shipping and packaging
materials are immaterial as virtually all of our deliveries are made via
electronic means over the Internet. Under accounting principles generally
accepted in the United States, research and development costs for new product
development, after technological feasibility is established, are recorded as
"capitalized software" on our balance sheet and are subsequently amortized as
cost of revenue over the shorter of three years or the remaining estimated life
of the products.
Cost of revenue decreased by $189,100, or 61.0%, to $121,100 for the first
quarter of 2005, from $310,200 for the first quarter of 2004. Product costs
decreased by $175,900, or 77.7%, to $50,400 for the first quarter of 2005, from
16
$226,300 for the first quarter of 2004. Service costs decreased by $13,200, or
15.7%, to $70,700 for the first quarter of 2005, from $83,900 for the first
quarter of 2004.
The decrease in first quarter 2005 product costs, as compared with 2004 was
because our purchased technology became fully amortized as of June 30, 2004.
First quarter 2005 product costs primarily consisted of the amortization of
capitalized software development costs. We expect these costs to remain
consistent throughout 2005.
The decrease in first quarter 2005 service costs, as compared with 2004,
resulted from certain engineers spending more time in other engineering-related
tasks than customer service in 2005, as compared with 2004. The amount of time
our engineers spend in customer service is a function of the number of customer
service inquiries received, and their complexity. Whenever the resolution of
customers' inquiries permit, engineers whose first priority is customer service
will assist with other engineering-related tasks.
We expect costs of revenue to remain fairly constant over the next few
reporting periods. Cost of revenue was approximately 10.2% and 34.4% of revenue
for the first quarter of 2005 and 2004, respectively.
Selling and Marketing Expenses
Selling and marketing expenses primarily consist of employee costs,
consulting services and travel and entertainment. Selling and marketing expenses
for the first quarter of 2005 decreased by $23,300, or 6.5%, to $334,800 from
$358,100 for the first quarter of 2004.
Expense categories that were primary contributors to the net decrease in
first quarter 2005 as compared with 2004 are summarized as follows:
Increase
(Decrease)
Expense From 2004
------- ---------
Employees costs $ 46,100
Consulting services (58,300)
Travel & entertainment (9,200)
Other items (1,900)
---------
$ (23,300)
=========
The increase in employee costs resulted primarily from increased commissions
and performance bonuses attributable to first quarter 2005 sales. These
increases were partially offset by lower wages and benefits expense attributable
to having one less sales person in the first quarter of 2005 as compared with
2004.
The decrease in consulting services was due to a reduction in the general
selling and marketing activities that had been being outsourced. We began
deferring certain planned selling and marketing activities towards the end of
the fourth quarter of 2004 and continued doing so into the first quarter of 2005
as we needed to conserve our cash on hand until we consummated both the NES
acquisition and the 2005 Private Placement.
Similar to the decrease in consulting services, the decrease in travel and
entertainment expense primarily resulted from curtailing expenditures in order
to conserve our cash on hand, pending the consummation of the NES acquisition
and the 2005 Private Placement. Also contributing to the 2005 decrease in travel
17
and entertainment expense was having one less salesperson in 2005, as compared
with 2004.
We anticipate that selling and marketing expenses for 2005 will approximate
2004 levels. Selling and marketing expenses were 28.4% and 39.7% of revenue for
the first quarter of 2005 and 2004, respectively.
General and Administrative Expenses
General and administrative expenses primarily consist of employee costs,
legal, professional and other outside services, amortization and depreciation,
travel and entertainment, certain costs associated with being a publicly held
corporation, and bad debts expense. General and administrative expenses for the
first quarter of 2005 increased by $477,400, or 191.2%, to $727,100 from
$249,700 for the first quarter of 2004.
Expense categories that were primary contributors to the net increase in
first quarter 2005 as compared with 2004 are summarized as follows:
Increase
(Decrease)
Expense From 2004
------- ---------
Employee costs $ 99,300
Professional services 219,000
Depreciation and amortization 142,800
Travel & entertainment 10,600
Other items 5,700
---------
$ 477,400
=========
The increase in employee costs in the first quarter of 2005, as compared with
2004, was primarily due to hiring two additional employees during the first
quarter of 2005. These employees have been tasked with developing internal and
external revenue opportunities for the patents and patent applications we
acquired in conjunction with the NES acquisition. Additionally, these employees
are also responsible for developing additional patent applications.
The primary reason for the increase in professional services was legal fees
related to the administration of the patent portfolio, which we began incurring
upon the consummation of the NES acquisition in January 2005, as well as legal
fees pertaining to general corporate operations.
The increase in depreciation and amortization was primarily due to the
commencement of amortization of the patents acquired from NES in January 2005.
Partially offsetting this amortization was a decrease in fixed asset
depreciation related to property and equipment. We expect depreciation and
amortization to be significantly higher for the remainder of 2005 due to the
amortization of the patents.
Travel and entertainment expense was higher primarily due to activities
related to the NES acquisition, the exploitation of the patents acquired therein
and the 2005 Private Placement.
We anticipate that aggregate general and administrative expenses for 2005
will be substantially higher than 2004, primarily due to the amortization of the
patents and the costs associated with developing them. General and
administrative expenses were approximately 61.6% and 27.7% of revenues for the
first quarter of 2005 and 2004, respectively.
18
Research and Development Expenses
Research and development expenses consist primarily of employee costs,
payments to contract programmers, rent, depreciation and computer related
supplies. Research and development expenses for the first quarter of 2005
decreased by $95,900, or 22.9%, to $323,700 from $419,600 for the first quarter
of 2004.
Under accounting principles generally accepted in the United States, all
costs of product development incurred once technological feasibility has been
established, but prior to general release of the product, are typically
capitalized and amortized to expense over the estimated life of the underlying
product, rather than being charged to expense in the period incurred. No product
development costs were capitalized during either the first quarter of 2005 or
2004.
Expense categories that were primary contributors to the net decrease in
first quarter 2005 as compared with 2004 are summarized as follows:
Increase
(Decrease)
Expense From 2004
------- ---------
Employee costs $ (40,200)
Contract programmers (29,100)
Depreciation (18,800)
Supplies (3,400)
Other items (4,400)
---------
$ (95,900)
=========
The decrease in employee costs for the first quarter of 2005 from 2004 levels
was primarily due to having two fewer engineers during the first quarter of 2005
as compared with 2004.
The decrease in contract programmers for the first quarter of 2005, as
compared with 2004, was due to the non-renewal of certain contracts upon their
expiration. Once certain elements of the work being performed for us was
completed, the underlying programmers contracts were not renewed as their
services were not immediately required. We believe that we will be able to enter
into new contracts with these engineers, or ones with similar talents, without
difficulty in the future, should we need their services again.
Depreciation expense was lower in the first quarter of 2005, as compared with
2004, because during 2003 and 2004, we purchased virtually no new capitalizable
assets in support of our research and development efforts. Since the beginning
of 2003, various assets have become fully depreciated more quickly than we have
replaced them and hence, depreciation expense has steadily declined. We expect
to make more fixed asset purchases in 2005 than we did in 2004, however, we do
not expect to replace all the assets that have, or will, become fully
depreciated. Consequently, we expect depreciation expense for 2005 to remain
lower than 2004 levels.
We spent less on supplies during the first quarter of 2005, as compared with
2004, as we were trying to conserve our cash, pending the consummation of the
NES acquisition and the 2005 Private Placement.
We anticipate that research and development expenses for 2005, inclusive of
capitalized software development costs, will be lower than those incurred during
2004, primarily due to the lower number of engineers and lower depreciation, as
19
outlined above. Research and development expenses were approximately 27.4% and
46.5% of revenues for the first quarter of 2005 and 2004, respectively.
Interest and other income
Interest and other income consists primarily of interest income on excess
cash. Our excess cash is held in interest bearing money market accounts with
minimum net assets greater than or equal to one billion U.S. dollars.
Interest and other income for the first quarter of 2005 increased by $5,200,
or 144.4%, to $8,800 from $3,600 for the first quarter of 2004. The increase was
primarily due to higher average cash balances and rates of interest being earned
on those balances throughout the first quarter of 2005 as compared with 2004.
The increase in the average cash balances in the first quarter of 2005, as
compared with 2004, was primarily due to the net proceeds of the 2005 Private
Placement, approximately $3,090,400, as compared with the net proceeds of the
2004 private placement, approximately $970,900.
We anticipate that interest income for the remainder of 2005 will be higher
than comparable periods from 2004 as we expect that we will continue to have
higher average cash balances for the remainder of the year, as compared with the
prior year.
Net Loss
As a result of the foregoing items, net loss for the first quarter of 2005
was $318,600 a decrease of $112,500, or 26.1%, from a net loss of $431,100 for
the first quarter of 2004. As a result of our continued operating loss we intend
to continue to pursue revenue growth opportunities through all available means.
Net loss attributable to common shareholders increased from $318,600, as
originally reported, to $4,318,60000 as the result of the beneficial conversion
amount of $3,136,000 and the $864,000 discount resulting from the allocation of
the proceeds of the 2005 Private Placement on a relative fair value basis
between the Series A preferred shares and the warrants, both of which were
treated as deemed non-cash dividends to the preferred shareholders during the
three-month period ended March 31, 2005.
Deemed Dividends on Preferred Stock
On February 2, 2005, we completed the 2005 Private Placement, which raised a
total of $4,000,000 through the sale of 148,148 shares of Series A preferred
stock and five-year warrants to purchase 74,070 shares of Series B preferred
stock.
The deemed fair value of the Series A preferred stock was estimated based on
the market price and underlying number of common shares they would have
converted into had the conversion occurred immediately upon their issuance. The
market price for our common stock on February 2, 2005 was $0.46 and the Series A
preferred stock would have converted into 14,814,800 common shares, thus
deriving an estimated fair value of approximately $6,814,800 at that date.
The fair value of the warrants was estimated to be $1,877,700 and was
calculated using the Black-Scholes option pricing model with the following
weighted average assumptions: a risk free interest rate of 1.5%, a volatility
factor of 60%, a dividend yield of 0% and a five year contractual life.
20
Based on the relative fair values of the preferred shares and the warrants at
the time of their issuance, we allocated $3,136,000 of the $4,000,000 proceeds
of the 2005 Private Placement to the preferred shares and $864,000 to the
warrants.
The preferred shares we issued contained a nondetachable conversion feature
(the "Beneficial Conversion Feature") that was in-the-money upon completion of
the 2005 Private Placement, in that the deemed fair value of Common Stock into
which the Preferred Shares could be converted exceeded the allocated value of
$3,136,000 by $3,678,800 (using the intrinsic value method). This discount
resulting from recording the Beneficial Conversion Feature was limited to the
allocated proceeds of $3,136,000 and has been recognized as if this amount had
been declared a non-cash dividend to the preferred shareholders during the
quarter ended March 31, 2005.
Additionally, the approximate $864,000 discount resulting from the allocation
of the proceeds of the 2005 Private Placement on a relative fair value basis to
the Series A preferred shares and the warrants issued in the 2005 Private
Placement has also been recognized as if this amount had been declared a non-
cash dividend to the preferred shareholders during the quarter ended March 31,
2005.
Liquidity and Capital Resources
We continue to manage our operations to bring our cash expenditures in line
with our revenues in order conserve our cash on hand. We are simultaneously
looking at ways to improve or maintain our revenue stream. Additionally, we
continue to review potential merger opportunities as they present themselves to
us and at such time as a merger might make financial sense and add value for our
shareholders, we will pursue that merger opportunity. We believe that improving
or maintaining our current revenue stream, coupled with our cash on hand,
including the cash raised in the 2005 Private Placement will sufficiently
support our operations during 2005.
On January 31, 2005, we acquired NES for 9,599,993 shares of common stock,
the assumption of approximately $232,800 of NES' indebtedness and the
reimbursement to AIGH Investment Partners, LLC ("AIGH"), an affiliate of a
principal stockholder (Orin Hirschman), of $665,000 for its advance on our
behalf of a like sum in December 2004 to settle certain third party litigation
against NES. We reimbursed the advance through a partial credit against the
price of our securities acquired by AIGH in the 2005 Private Placement.
The 2005 Private Placement, which was consummated on February 2, 2005, raised
a total of $4,000,000, inclusive of the $665,000 credit issued to AIGH. As of
March 31, 2005 we had consumed approximately $244,600 and $671,400 of the cash
raised paying for expenses related to the 2005 Private Placement and the NES
acquisition, respectively. We estimate that we will disburse an additional
$121,100 and $167,900 of cash paying for expenses related to the 2005 Private
Placement and the NES acquisition, respectively, however, there can be no
guarantees that these amounts will be final.
We anticipate incurring further costs associated with the development of the
patents and patent applications acquired from NES for the next several reporting
periods. We expect to fund these development costs through working capital.
Until the revenues we derive from either the sale of software products or the
licensing of patents are sufficient enough to generate positive cash flows from
operations, we will continue to experience operating losses. Although we believe
that we will be able to attain sufficient sales levels to meet our operational
needs, there can be no certainty that we will be able to do so. Should the cash
flows generated from sales and working capital be insufficient to satisfy short
21
term operating needs, or should we be unsuccessful in securing alternative
sources of financing, we may have to significantly curtail the current nature of
our operations.
As of March 31, 2005, cash and cash equivalents totaled $3,171,300, an
increase of $2,496,000, or 369.6%, from $675,300 as of December 31, 2004. The
increase in cash and cash equivalents was primarily attributable to the
$3,090,400 net cash infusion from the 2005 Private Placement, which comprises
the majority of the cash provided by our financing activities for the first
quarter of 2005. The balance of the cash provided by our financing activities
was derived by stock sales to our employees under the provisions of our employee
stock purchase plan.
Our net loss for the first quarter of 2005 was $318,600. Included in the net
loss were non-cash charges, comprised of depreciation and amortization, which
aggregated approximately $207,200.
Accounts Receivable
The increase in accounts receivable was primarily due to the timing of sales
transactions, as many transactions were closed towards the end of the first
quarter.
Deferred Revenue
The increase in total deferred revenue, aggregate short and long-term,
generated $394,600 of cash flow during the first quarter of 2005. This amount
includes approximately $200,000 of Windows-based product revenue, which we
derived from a transaction entered into with a significant distributor. This
transaction did not meet all of the criteria for revenue recognition at the end
of the first quarter of 2005; consequently, the revenue was deferred. All
revenue recognition criteria were met for this transaction during April 2005;
accordingly, we recognized the revenue during the second quarter of 2005.
Accounts Payable
Accounts payable as of March 31, 2005 decreased by $52,100, or 20.8%, to
$198,100 from $250,200 as of December 31, 2004. Accounts payable are comprised
of our various operating expenses and decreased due to the timing of the payment
of various invoices.
Accrued Expenses
Accrued expenses as of March 31, 2005 increased by $53,800, or 23.2%, to
$285,200 from $231,400 as of December 31, 2004. Accrued expenses are charges for
services rendered for which an invoice has not yet been received such as
consulting fees, legal and accounting fees, and utilities. During the first
quarter of 2005 we increased accrued legal fees pertaining to the administration
of the acquired patents and public company reporting requirements oversight by
approximately $92,400 over December 31, 2004 levels. Additionally, we accrued
approximately $106,000 of estimated capitalizable costs to be incurred in future
periods related to the NES acquisition. Partially offsetting these increases
were items that were accrued as of December 31, 2004 that were paid out during
the first quarter of 2005, thereby decreasing accrued expenses, including
approximately $72,500 of accounting fees and $79,400 of legal fees.
22
Accrued Wages
Accrued wages as of March 31, 2005 increased by $79,000, or 30.4%, to
$339,100 from $260,100 as of December 31, 2004. The increase was primarily due
to increased commissions and bonuses, based on first quarter 2005 sales, as well
as an increase in the costs of employee benefits.
Deferred Compensation
We deferred, and amortized, compensation totaling approximately $8,900 and
$500, respectively, related to stock options granted to our interim Chief
Executive Officer, Robert Dilworth, during January 2005. We are amortizing this
amount monthly on the straight-line method, to compensation expense over a
three-year period ending in January 2008.
Notes Receivable - Directors
During the first quarter of 2005, we received payment in full of our notes
receivable - directors, generating operating cash of $50,300. Also during the
first quarter of 2005, we received a $2,600 principal repayment of the note
receivable - shareholder.
Working Capital
As of March 31, 2005, we had current assets of $4,158,000 and current
liabilities of $1,840,700, which netted to working capital of $2,317,300.
Included in current liabilities was the current portion of deferred revenue of
$1,018,300.
We have been successful in significantly reducing operating costs through a
series of strategic restructurings and work force reductions that began in
September of 2001. Based on our current operating revenues and reduced operating
cost structure, and the cash raised in the 2005 Private Placement, we believe
that we will be able to support our operational needs with currently available
resources for at least the next twelve months. However, due to inherent
uncertainties associated with predicting future operations, there can be no
assurances that these resources will be sufficient to fund our anticipated
expenses during the next twelve months.
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
We are currently not exposed to any significant financial market risks from
changes in foreign currency exchange rates or changes in interest rates and do
not use derivative financial instruments. A substantial majority of our revenue
and capital spending is transacted in U.S. dollars. However, in the future, we
may enter into transactions in other currencies. An adverse change in exchange
rates would result in a decline in income before taxes, assuming that each
exchange rate would change in the same direction relative to the U.S. dollar. In
addition to the direct effects of changes in exchange rates, such changes
typically affect the volume of sales or foreign currency sales price as
competitors' products become more or less attractive.
ITEM 4. Controls and Procedures
Our management carried out an evaluation, with the participation of our Chief
Executive Officer and Chief Financial Officer, of the effectiveness of our
disclosure controls and procedures as of March 31, 2005. Based upon that
evaluation, our Chief Executive Officer and Chief Financial Officer concluded
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that our disclosure controls and procedures were effective to ensure that
information required to be disclosed by us in reports that we file or submit
under the Securities Exchange Act of 1934 is recorded, processed, summarized and
reported, within the time periods specified in the rules and forms of the
Securities and Exchange Commission.
There has not been any change in our internal control over financial
reporting in connection with the evaluation required by Rule 13a-15(d) under the
Exchange Act that occurred during the quarter ended March 31, 2005 that has
materially affected, or is reasonably likely to materially affect, our internal
control over financial reporting.
PART II--OTHER INFORMATION
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds
During the first quarter of 2005, we granted the following stock options:
o stock options to purchase an aggregate 1,806,000 shares of common
stock, at exercise prices ranging from $0.43 to $0.59 per share, were
granted to our non-executive employees;
o stock options to purchase an aggregate 200,000 shares of common stock,
at an exercise price of $0.43 per share, were granted to our executive
officers; and
o stock options to purchase an aggregate 640,000 shares of common stock,
at an exercise price of $0.43 per share, were granted to our directors.
The grant of such stock options to the above-listed persons was not
registered under the Securities Act of 1933 because the stock options either did
not involve an offer or sale for purposes of Section 2(a)(3) of the Securities
Act, in reliance on the fact that the stock options were granted for no
consideration, or were offered and sold in transactions not involving a public
offering, exempt from registration under the Securities Act pursuant to Section
4(2).
ITEM 4. Submission of Matters to a Vote of Security Holders
At a special meeting of stockholders held on March 29, 2005, the stockholders
voted to approve an amendment to our Certificate of Incorporation to increase
the authorized number of common shares from 45,000,000 to 195,000,000 shares.
The votes were as follows:
For 134,848,669
Against 1,207,677
Broker non-votes 965,055
Abstain 16,590
ITEM 6. Exhibits
Exhibit 31 - Rule 13a-14(a)/15d-14(a) Certifications
Exhibit 32 - Section 1350 Certifications
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the Registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.
GraphOn Corporation
(Registrant)
Date: November 7, 2005
By: /s/ Robert Dilworth
----------------------------
Robert Dilworth,
Chief Executive Officer (Interim) and
Chairman of the Board
(Principal Executive Officer)
Date: November 7, 2005
By: /s/ William Swain
----------------------------
William Swain,
Chief Financial Officer
(Principal Financial Officer and
Principal Accounting Officer)
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