UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Amendment No. 2 to Form 10-KSB
on Form 10-K
Annual Report Pursuant to Sections 13 or 15(d) of the Securities Exchange
Act of 1934
For the fiscal year ended December 31, 2005
Commission file number: 0-21683
GRAPHON CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 13-3899021
(State of other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
5400 Soquel Avenue, Suite A2
Santa Cruz, California 95062
(Address of principal executive offices)
Registrant's telephone number: (800) 472-7466
Securities registered pursuant to Section 12(b) of the Exchange Act: None
Securities registered pursuant to Section 12(g) of the Exchange Act:
Common Stock, $.0001 Par Value
(Title of class)
Indicate by check mark if the registrant is a well-known seasoned issuer,
as defined in Rule 405 of the Securities Act. Yes [ ] No [X]
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes [ ] No [X]
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Exchange Act during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports) and (2) has been subject to such filing requirements for
the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer" and "large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
[ ] Large accelerated filer [ ] Accelerated filer [X] Non-accelerated filer
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
The aggregate market value of the common equity held by non-affiliates of the
registrant as of March 6, 2006 was approximately $ 7,522,600.
Number of shares of Common Stock outstanding as of March 6, 2006: 46,167,047
shares of Common Stock.
GRAPHON CORPORATION
FORM 10-K
Table of Contents
PART I. Page
----
Item 1. Business 1
Item 1A. Risk Factors 8
Item 1B. Unresolved Staff Comments 12
Item 2. Properties 12
Item 3. Legal Proceedings 12
Item 4. Submission of Matters to a Vote of Security Holders 13
PART II.
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters 14
Item 6. Selected Financial Data 14
Item 7. Management's Discussion and Analysis of Financial 15
Condition and Results of Operations
Item 7A. Quantitative and Qualitative Disclosures About Market 24
Risk
Item 8. Financial Statements and Supplementary Data 25
Item 9 Changes in and Disagreements with Accountants on 49
Accounting and Financial Disclosure
Item 9A. Controls and Procedures 49
Item 9B. Other Information 49
PART III.
Item 10. Directors and Executive Officers of the Registrant 50
Item 11. Executive Compensation 51
Item 12. Security Ownership of Certain Beneficial Owners and
Management and
Related Stockholder Matters 53
Item 13. Certain Relationships and Related Transactions 55
Item 14. Principal Accountant Fees and Services 56
PART IV.
Item 15. Exhibits and Financial Statement Schedules 57
SIGNATURES
FORWARD LOOKING INFORMATION
This report includes, in addition to historical information, "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995. This Act provides a "safe harbor" for forward-looking statements to
encourage companies to provide prospective information about themselves so long
as they identify these statements as forward-looking and provide meaningful
cautionary statements identifying important factors that could cause actual
results to differ from the projected results. All statements other than
statements of historical fact we make in this report or in any document
incorporated by reference are forward-looking statements. In particular, the
statements regarding industry prospects and our future results of operations or
financial position are forward-looking statements. Such statements are based on
management's current expectations and are subject to a number of uncertainties
and risks that could cause actual results to differ significantly from those
described in the forward looking statements. Factors that may cause such a
difference include, but are not limited to, those discussed in "Management's
Discussion and Analysis or Plan of Operation," as well as those discussed
elsewhere in this report. Statements included in this report are based upon
information known to us as of the date that this report is filed with the SEC,
and we assume no obligation to update or alter our forward-looking statements
made in this report, whether as a result of new information, future events or
otherwise, except as otherwise required by applicable federal securities laws.
EXPLANATORY NOTE
We are amending our Annual Report on Form 10-KSB for the year ended December 31,
2005, as filed on April 17, 2006, and amended on June 12, 2006, to change the
form of this filing from Form 10-KSB to Form 10-K. We are providing the
additional disclosures required for filings submitted on Form 10-K; most
significantly; financial statements for the year ended December 31, 2003 within
Part II, Item 8 - Financial Statements and Supplementary Data; a comparison of
operating results for an additional year within Part II, Item 7 - Management's
Discussion and Analysis of Financial Condition and Results of Operations, (year
ended December 31, 2004 as compared with year ended December 31, 2003); and a
five-year summary of selected financial data, within Part II, Item 6 - Selected
Financial Data.
PART I
ITEM 1. BUSINESS
General
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 and/or resale by independent software vendors (ISVs),
application service providers (ASPs), corporate enterprises, governmental and
educational institutions, and others.
Server-based computing, sometimes referred to as thin-client computing, is a
computing model where traditional desktop software applications are relocated to
run entirely on a server, or host computer. This centralized deployment and
management of applications reduces the complexity and total costs associated
with enterprise computing. Our software architecture provides application
developers with the ability to relocate applications traditionally run on the
desktop to a server, or host computer, where they can be run over a variety of
connections from remote locations to a variety of display devices. With our
server-based software, applications can be web enabled, without any modification
to the original application software required, allowing the applications to be
run from browsers or portals. Our server-based technology can web-enable a
variety of Unix, Linux or Windows applications.
On January 31, 2005, we acquired Network Engineering Software, Inc. ("NES"),
which was 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 private placement, we raised a total of
$4,000,000 (the "2005 private placement") inclusive of a $665,000 credit, as
described elsewhere in this Form 10-K.
We are a Delaware corporation, founded in May of 1996. Our headquarters are
located at 5400 Soquel Avenue, Suite A2, Santa Cruz, California, 95062 and our
phone number is 1-800-GRAPHON (1-800-472-7466). Our Internet website is
http://www.graphon.com. The information on our website is not part of this
annual report. We also have offices in Concord, New Hampshire, Rolling Hills
Estates, California and Berkshire, England, United Kingdom.
You may read and copy any materials that we file with the SEC at the SEC's
Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549. You may
obtain information on the operation of the Public Reference Room by calling the
SEC at 1-800-SEC-0330. The SEC also maintains an Internet website
(http://www.sec.gov) that contains reports, proxy and information statements,
and other information that we file electronically with the SEC from time to
time. We post our annual, quarterly and periodic filings that we have made with
the SEC pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of
1934 on our website (please click "About Us," the "Investors," and then "SEC
Filings") as soon as reasonably practicable after such reports and other
materials have been electronically filed with, or furnished to, the SEC.
Business Connectivity Software
History
In the 1970s, software applications were executed on central mainframes and
typically accessed by low-cost display terminals. Information technology
departments were responsible for deploying, managing and supporting the
applications to create a reliable environment for users. In the 1980s, the PC
became the desktop of choice: empowering the user with flexibility, a graphical
user interface, and a multitude of productive and inexpensive applications. In
the 1990s, the desktop provided access to mainframe applications and databases,
which run on large, server computers. Throughout the computing evolution, the
modern desktop has become increasingly complex and costly to administer and
maintain. This situation is further worsened as organizations become more
decentralized with remote employees, and as their desire increases to become
more closely connected with vendors and customers through the Internet.
Lowering Total Cost of Ownership
PC software in general has grown dramatically in size and complexity in recent
years. As a result, the cost of supporting and maintaining PC desktops has
increased substantially. Industry analysts and enterprise users alike have begun
to recognize that the total cost of PC ownership, taking into account the
recurring cost of technical support, administration, security and end-user down
time, has become high, both in absolute terms and relative to the initial
hardware purchase price.
1
With increasing demands to control corporate computing costs, industry leaders
are developing technology to address total cost of ownership issues. One
approach, led by Sun Microsystems and IBM, utilizes Java-based network
computers, which operate by downloading small Java programs to the desktop,
which in turn are used for accessing server-based applications. Another approach
is Microsoft's Windows Terminal Services (TM), introduced in June 1998. It
permits server-based Windows applications to be accessed from Windows-based
network computers. Both initiatives are examples of server-based computing. They
simplify the desktop by moving the responsibility of running applications to a
central server, with the promise of lowering total cost of ownership.
Enterprise Cross-Platform Computing
Today's enterprises contain a diverse collection of end user devices, each with
its particular operating system, processing power and connection type.
Consequently, it is becoming increasingly difficult to provide universal access
to business-critical applications across the enterprise. As a result,
organizations resort to emulation software, new hardware or costly application
rewrites in order to provide universal application access.
A common cross-platform problem for the enterprise is the need to access Unix or
Linux applications from a PC desktop. While Unix-based computers dominate the
enterprise applications market, Microsoft Windows-based PCs dominate the
enterprise desktop market. Since the early 1990s, enterprises have been striving
to connect desktop PCs to Unix applications over all types of connections,
including networks and standard phone lines. This effort, however, is complex
and costly. The primary solution to date is known as PC X Server software. PC X
Server software is a large software program that requires substantial memory and
processing resources on the desktop. Typically, PC X Server software is
difficult to install, configure and maintain. Enterprises are looking for
effective Unix connectivity software for PCs and non-PC desktops that is easier
and less expensive to administer and maintain.
Today businesses are exploring alternatives to the Windows desktop. The Linux
desktop is a popular choice as it promises lower acquisition costs and avoids
"single vendor lock-in." The Linux desktop and the Unix desktop, popular in many
engineering organizations, both need to access the large number of applications
written for the Microsoft operating environment, such as Office 2003. Our
technology enables Windows applications to be published to any client device
running our GO-Global client software, including: Linux, Unix, Windows and
Macintosh desktops and devices.
Application Service Providers (ASPs)
With the ubiquitous nature of the Internet, new operational models and sales
channels are emerging. Traditional high-end software packages that were once too
expensive for many companies are now available for rent over the Internet. By
servicing customers through a centralized operation, rather than installing and
maintaining applications at each customer's site, ASPs play an important role in
addressing an enterprise's computing requirements. Today, ASPs are faced with
the difficult task of creating, or rewriting, applications to serve the broader
market.
Remote Computing
The cost and complexity of contemporary enterprise computing has been further
complicated by the growth in remote access requirements. As business activities
become physically distributed, computer users have looked to portable computers
with remote access capabilities to stay connected in a highly dispersed work
environment. One problem facing remote computing over the Internet, or direct
telephone connections, is the slow speed of communication in contrast to the
high speed of internal corporate networks. Today, applications requiring remote
access must be tailored to the limited speed and lower reliability of remote
connections, further complicating the already significant challenge of
connecting desktop users to business-critical applications.
Our Technology
Our server-based software deploys, manages, supports and executes applications
entirely on a server computer by interfacing efficiently and instantaneously to
the user's desktop device. Introduction of our Windows-based Bridges software
during 2000 enabled us to enter the Windows application market by allowing us to
provide support for Windows applications to both enterprise customers and to
leverage independent software vendors (ISVs) as a distribution channel. We
introduced our GO-Global for Windows product in 2002, which features increased
application compatibility, server scalability and improved application
performance over our Bridges software.
2
Our technology consists of three key components:
o A server component, which runs alongside the server-based
application, is responsible for intercepting user-specific
information for display at the desktop.
o A desktop component, which is responsible only for sending keystrokes
and mouse motion to the server, displays the appearance of the
application to the desktop user. This keeps the desktop simple, or
thin, as well as independent of application requirements for
resources, processing power and operating systems.
o Our protocol, which enables efficient communication over both fast
networks and slow dial-up connections, allows applications to be
accessed from remote locations with network-like performance and
responsiveness.
We believe that the major benefits of our technology are as follows:
o Lowers Total Cost of Ownership. Reducing information technology
(IT) costs is a primary goal of our products. Today, installing
enterprise applications is time-consuming, complex and
expensive. It typically requires administrators to manually
install and support diverse desktop configurations and
interactions. Our server-based software simplifies application
management by enabling deployment, administration and support
from a central location. Installation and updates are made only
on the server, thereby avoiding desktop software and operating
system conflicts and minimizing at-the-desk support.
o Supports Strong Information Security Practices. The distributed
nature of most organizations' computing environments makes
information security difficult. Corporate assets in the form of data
are often dispersed among desktop systems. Our server-based approach
places the application and data on servers behind firewalls. This
allows the corporation to centrally manage its applications and data.
o Web Enables Existing Applications. The Internet represents a
fundamental change in distributed computing. Organizations now
benefit from ubiquitous access to corporate resources by both
local and remote users. However, to fully exploit this
opportunity, organizations need to find a way to publish
existing applications to Internet enabled devices. Our
technology is specifically targeted at solving this problem.
With GO-Global, an organization can publish an existing
application to an Internet-enabled device without the need to
rewrite the application. This reduces application development
costs while preserving the rich user interface so difficult to
replicate in a native Web application.
o Connects Diverse Computing Platforms. Today's computing
infrastructures are a mix of computing devices, network
connections and operating systems. Enterprise-wide application
deployment is problematic due to this heterogeneity, often
requiring costly and complex emulation software or application
rewrites. Our products provide organizations the ability to
access applications from virtually all devices, utilizing their
existing computing infrastructure, without rewriting a single
line of code or changing or reconfiguring hardware. This means
that enterprises can maximize their investment in existing
technology and allow users to work in their preferred
environment.
o Leverages Existing PCs and Deploys New Desktop Hardware. Our
software brings the benefits of server-based computing to users
of existing PC hardware, while simultaneously enabling
enterprises to begin to take advantage of and deploy many of the
new, less complex network computers. This assists organizations
in maximizing their current investment in hardware and software
while, at the same time, facilitating a manageable and cost
effective transition to newer devices.
o Efficient Protocol. Applications typically are designed for
network-connected desktops, which can put tremendous strain on
congested networks and may yield poor, sometimes unacceptable,
performance over remote connections. For ASPs, bandwidth
typically is the top recurring expense when web-enabling, or
renting, access to applications over the Internet. In the
wireless market, bandwidth constraints limit application
deployment. Our protocol sends only keystrokes, mouse clicks
and display updates over the network, resulting in minimal
impact on bandwidth for application deployment, thus lowering
cost on a per user basis. Within the enterprise, our protocol
can extend the reach of business-critical applications to many
areas, including branch offices, telecommuters and remote users
over the Internet, phone lines or wireless connections. This
concept may be extended further to include vendors and customers
for increased flexibility, time-to-market and customer
satisfaction.
3
Our Products
We are dedicated to creating business connectivity technology that brings
Windows, Unix, and Linux applications to the web without modification. Our
customers include ISVs, Value-Added Resellers (VARs), ASPs and small to
medium-sized enterprises. We believe that by employing our technology, our
customers can benefit from a very quick time to market, overall cost savings via
centralized computing, a client neutral cross-platform solution, and high
performance remote access.
Our primary product offerings are:
o GO-Global for Windows allows access to Windows applications from
remote locations and a variety of connections, including the
Internet and dial-up connections. GO-Global for Windows allows
Windows applications to be run via a browser from Windows or
non-Windows devices, over many types of data connections,
regardless of the bandwidth or operating system. With GO-Global
for Windows, web enabling is achieved without modifying the
underlying Windows applications' code or requiring costly
add-ons.
o GO-Global for Unix web-enables Unix and Linux applications, thus
allowing them to be run via a browser from many different
display devices, over various types of data connections,
regardless of the bandwidth or operating systems being used.
GO-Global for Unix web-enables individual Unix and Linux
applications, or entire desktops. When using GO-Global for
Unix, Unix and Linux web enabling is achieved without modifying
the underlying applications' code or requiring costly add-ons.
Target Markets
The target market for our products comprises organizations that need to access
Windows, Unix and/or Linux applications from a wide variety of devices, from
remote locations, including over the Internet, dial-up lines, and wireless
connections. This includes organizations, such as small to medium-sized
companies, governmental and educational institutions, ISVs, VARs and ASPs. Our
software is designed to allow these enterprises to tailor the configuration of
the end user device for a particular purpose, rather than following a "one PC
fits all," high total cost of ownership model. We believe our opportunities are
as follows:
o ISVs. By web-enabling their applications through use of our products,
we believe that our ISV customers can accelerate their time to market
without the risks and delays associated with rewriting applications
or using other third party solutions, thereby opening up additional
revenue opportunities and securing greater satisfaction and loyalty
from their customers.
Our technology quickly integrates with their existing software
applications without sacrificing the full-featured look and feel of
their original software application, thus providing ISVs with
out-of-the-box web-enabled versions of their software applications
with their own branding for licensed, volume distribution to their
enterprise customers. We further believe that ISVs who effectively
address the web computing needs of customers and the emerging ASP
market will have a competitive advantage in the marketplace.
o Enterprises Employing a Mix of Unix, Linux, Macintosh and
Windows. Small to medium-sized companies that utilize a mixed
computing environment require cross-platform connectivity
solutions, like GO-Global, that will allow users to access
applications from different client devices. It has been
estimated that PCs represent over 90% of enterprise desktops.
We believe that our products are well positioned to exploit this
opportunity and that our server-based software products will
significantly reduce the cost and complexity of connecting PCs
to various applications.
o Enterprises With Remote Computer Users and/or Extended Markets.
Remote computer users and enterprises with extended markets
comprise two of the faster growing market segments in the
computing industry. Extended enterprises allow access to their
computing resources to customers, suppliers, distributors and
other partners, thereby gaining flexibility in manufacturing and
increasing speed-to-market and customer satisfaction. For
example, extended enterprises may maintain decreased inventory
via just-in-time, vendor-managed inventory and related
techniques, or they may license their proprietary software
application on a "pay-per-time" model, based on actual time
usage by the customer. The early adoption of extended
enterprise solutions may be driven in part by enterprises' needs
to exchange information over a wide variety of computing
platforms. We believe that our server-based software products,
along with our low-impact protocol, which has been designed to
enable highly efficient low-bandwidth connections, are well
positioned to provide enabling solutions for extended enterprise
computing.
4
o ASPs. High-end software applications in the fields of human
resources, enterprise resource planning, enterprise relationship
management, among others, historically have been available only
to organizations able to make large investments in capital and
personnel. The Internet has opened up global and mid-tier
markets to ASPs, which may now offer their software applications
to a broader market on a rental basis. Our products enable such
ASPs to provide Internet access to their applications with
minimal additional investment in development implementation.
o VARs. The VAR channel potentially presents an additional sales
force for our products and services. In addition to creating
broader awareness of GO-Global, VARs also provide integration
and support services for our current and potential customers.
Our products allow VARs to offer a cost effective competitive
alternative for server-based thin client computing. In
addition, reselling our GO-Global software creates new revenue
streams for our VARs through professional services and
maintenance renewals.
Strategic Relationships
We believe it is important to maintain our current strategic alliances and to
seek suitable new alliances in order to enhance shareholder value, improve our
technology and/or enhance our ability to penetrate relevant target markets. We
also are focusing on strategic relationships that have immediate revenue
generating potential, strengthen our position in the server-based software
market, add complementary capabilities and/or raise awareness of our products
and us. Our strategic relationships include the following:
o In February 2002 we signed a three-year, non-exclusive agreement
with Agilent Technologies, an international provider of
technologies, solutions and services to the communications,
electronics, life sciences and chemical analysis industries.
Pursuant to this agreement, we licensed our Unix-based
web-enabling products to Agilent for inclusion in their Agilent
OSS Web Center, an operations support system that provides
access to mission-critical applications remotely via a secure
Internet browser. This agreement automatically renews for
additional one (1) year periods unless written notice is given
by either Agilent or us, to the other, as to the intention not
to renew this agreement at least sixty (60) days prior to the
end of the initial term or any subsequent period. Accordingly,
this agreement was renewed during February 2006 for an
additional one-year term.
o We are a party to a distribution agreement with KitASP, a
Japanese application service provider founded by companies
within Japan's electronics and infrastructure industries,
including NTT DATA, Mitsubishi Electric, Omron, RICS, Toyo
Engineering and Hitachi, pursuant to which we have afforded
KitASP, should it achieve certain performance criteria, an
exclusive right, within Japan, to distribute our web-enabling
technology, bundled with their ASP services, and to resell our
software. This agreement runs until June 2006. We anticipate
continuing our relationship with KitASP throughout 2006.
o We are a party to a non-exclusive licensing agreement with
FrontRange, an international software and services company,
which affords FrontRange the right to include our GO-Global for
Windows software with its HEAT help desk software system.
FrontRange has completely integrated GO-Global for Windows into
HEAT as iHEAT. We have also licensed our GO-Global for Windows
software to FrontRange for integration with its Goldmine client
relationship management software package. FrontRange has
completely integrated GO-Global for Windows into Goldmine as
iGoldmine. This agreement, which expires in March 2007
automatically renews for additional one (1) year terms, unless
FrontRange gives us written notice of non-renewal within 45 days
prior to the expiration of the then current term. We may
terminate this agreement immediately by written notice upon the
occurrence of certain predetermined events.
o We are a party to a non-exclusive licensing agreement with
Compuware, an international software and services company, which
affords Compuware the right to include our GO-Global for Windows
software with its UNIFACE software, a development and deployment
environment for enterprise customer-facing applications.
Compuware has completely integrated GO-Global for Windows into
its UNIFACE deployment architecture as UNIFACE JTi, thereby
enabling purchasers to access enterprise-level UNIFACE
applications via the Internet. During December 2005, at
Compuware's request, we amended this agreement to include
Compuware's authorized resellers. This agreement, as amended,
is scheduled to expire in September 2006. It automatically
renews for additional successive one (1) year periods unless
canceled by either party at least thirty (30) days prior to the
expiration of the initial term or any subsequent renewal period.
5
Sales, Marketing and Support
Our sales and marketing efforts are directed at increasing product awareness and
demand among ISVs, ASPs, small to medium-sized enterprises, and VARs who have a
vertical orientation or are focused on Unix, Linux or Windows environments.
Current marketing activities include direct mail, targeted advertising
campaigns, tradeshows, production of promotional materials, public relations and
maintaining an Internet presence for marketing and sales purposes.
We consider KitASP, Alcatel Italia and FrontRange to be our most significant
customers. Sales to KitASP, Alcatel Italia (inclusive of all other Alcatel
locations worldwide) and FrontRange represented approximately 16.8%, 16.0% and
11.5% of total sales during 2005 and approximately 14.9%, 20.9% and 14.1% of
total sales during 2004, respectively.
Many of our customers enter into, and periodically renew, maintenance contracts
to ensure continued product updates and support. Currently, we offer maintenance
contracts for one, two, three or five-year periods.
Research and Development
Our research and development efforts currently are focused on further enhancing
the functionality, performance and reliability of existing products and
developing new products. We invested approximately $1,277,600 and $1,500,900
into research and development with respect to our software products in 2005 and
2004, respectively. We historically have made significant investments in our
protocol and in the performance and development of our server-based software and
expect to continue to make significant product investments during 2006. We also
anticipate increasing the size of our in-house research and development
workforce during 2006 so that we may accelerate our efforts to further stabilize
and enhance our current product offerings and help determine the extent to which
the technology covered by the patents we acquired from NES have application,
among other possibilities, to our current GO-Global product line.
Competition
The server-based software market in which we participate is highly competitive.
We believe that we have significant advantages over our competitors, both in
product performance and market positioning. This market ranges from remote
access for a single PC user to server-based software for large numbers of users
over many different types of device and network connections. Our competitors
include manufacturers of conventional PC X server software. Competition is
expected from these and other companies in the server-based software market.
Competitive factors in our market space include; price, product quality,
functionality, product differentiation and breadth.
We believe our principal competitors for our current products include Citrix
Systems, Inc., Hummingbird Communications, Ltd., WRQ, Network Computing Devices
and NetManage. Citrix is the established leading vendor of server-based
computing software. Hummingbird is the established market leader in PC X
Servers. WRQ, Network Computing Devices, and NetManage also offer traditional PC
X Server software.
Proprietary Technology - Intellectual Property Portfolio
We rely primarily on trade secret protection, copyright law, confidentiality and
proprietary information agreements to protect our proprietary technology and
registered trademarks. The loss of any material trade secret, trademark, trade
name or copyright could have a material adverse effect on our results of
operations and financial condition. We intend to vigorously defend our patents.
There can be no assurance that our efforts to protect our proprietary technology
rights will be successful.
Despite our precautions, it may be possible for unauthorized third parties to
copy portions of our products, or to obtain information we regard as
proprietary. We do not believe our products infringe on the rights of any third
parties, but there can be no assurance that third parties will not assert
infringement claims against us in the future, or that any such assertion will
not result in costly litigation or require us to obtain a license to proprietary
technology rights of such parties.
Upon our acquisition of NES on January 31, 2005, we acquired the rights to 11
patents, which are primarily method patents that describe software and network
architectures to accomplish certain tasks. Generally, our patents describe:
o methods to collect, store and display information developed and
accessed by users and stored on host computer servers;
o methods to provide multiple virtual websites on one computer;
o methods to protect computers and computer networks from unauthorized
access; and
o methods to provide on-line information and directory service.
6
The patents, summarized below, have applicability to computer networks, virtual
private networks and the Internet.
Patent
Number Date of Grant Scope of Coverage
------ ------------- ------------------------------------------------
5,778,367 July 7, 1998 Automated, network-accessible, user-populated
database, particularly for the World Wide Web
6,324,538 November 27, Automated, network-accessible, user-populated
2001 database, particularly for the World Wide Web
6,850,940 February 1, Automated, network-accessible, user-populated
(1) 2005 database, particularly for the World Wide Web
(1
5,870,550 February 9, Network-accessible server that hosts multiple
1999 websites
6,647,422 November 11, Network-accessible server that hosts multiple
2003 websites
5,826,014 October 20, Internet firewall application in which a "proxy
1998 agent" screens incoming request from network
users and verifies the authority of the incoming
request before permitting access to a network
element
6,061,798 May 9, 2000 Internet firewall application in which a "proxy
agent" screens incoming request from network
users and verifies the authority of the incoming
request before permitting access to a network
element
5,898,830 April 27, 1999 Firewall computers that act as intermediaries
between pairs of other computers including
control of access to a virtual private network
6,052,788 April 18, 2000 Firewall computers that act as intermediaries
between pairs of other computers including
control of access to a virtual private network
6,751,738 June 15, 2004 Firewall computers that act as intermediaries
between pairs of other computers including
control of access to a virtual private network
6,804,783 October 12, Firewall computers that act as intermediaries
2004 between pairs of other computers including
control of access to a virtual private network
5,790,664 August 4, 1998 Technology for monitoring the license status of
software application(s) installed on a client
computer
(1) Patent granted on February 1, 2005, subsequent to the acquisition of
NES, thereby increasing the number of issued patents from 11 to 12.
As of March 6, 2006, we have 75 applications for method patents filed in the
United States Patent Office relating to the various aspects of submission,
storage, retrieval and security of information stored on computers accessed
remotely, typically through computer networks or the Internet. At that date, the
applications had been pending for various periods ranging from approximately 16
to 64 months. Of the 75 applications, 73 are continuations of previously issued
patents and two are continuations in part. Additionally as of March 6, 2006,
three of the applications have been allowed but have not yet been issued. No
applications for patents have been filed in any foreign jurisdiction.
We intend to maximize the revenue potential of our intellectual property
portfolio, primarily consisting of the patents we acquired from NES, by
initiating litigation, when appropriate, against those companies who we believe
are infringing such patents. We also intend to expand our research and
7
development workforce in order to enhance our current product offerings and to
review our intellectual property portfolio to help determine the extent to which
the technology covered by our patents has application to our current GO-Global
product line. As more fully discussed elsewhere in this Form 10-K, in November
2005, we initiated an infringement action with respect to two of our patents.
Operations
We perform all purchasing, order processing and shipping of our products and
accounting functions related to our operations. We also perform production of
software masters, development of documentation, packaging designs, quality
control and testing. When required by a customer, CD-ROM and floppy disk
duplication, printing of documentation and packaging are also accomplished
through in-house means. We generally ship products electronically immediately
upon receipt of order. As a result, we have relatively little backlog at any
given time, and do not consider backlog a significant indicator of future
performance. Additionally, since virtually all of our orders are currently being
fulfilled electronically, we do not maintain any prepackaged inventory.
Employees
As of March 6, 2006, we had a total of 26 employees, including five in
marketing, sales and support, 12 in research and development, seven in
administration and finance and two in our patent group. We believe our
relationship with our employees is good. No employees are covered by a
collective bargaining agreement.
ITEM 1A. RISK FACTORS
The risks and uncertainties described below are not the only ones facing our
company. Additional risks and uncertainties not presently known to us, or risks
that we do not consider significant, may also impair our business. This document
also contains forward-looking statements that involve risks and uncertainties,
and actual results may differ materially from the results we discuss in the
forward-looking statements. If any of the following risks actually occur, they
could have a severe negative impact on our financial results and stock price.
We have a history of operating losses and expect these losses to continue, at
least for the near future.
We have experienced significant losses since we began operations. We expect to
continue to incur losses at least for the near future. We incurred operating
losses of approximately $1,166,200 and $1,442,200 for the years ended December
31, 2005 and 2004, respectively. Our expenses have increased as we have begun
our efforts to enforce our rights under the patents we acquired in the NES
acquisition; however, we cannot give assurance that revenues will increase
sufficiently to exceed costs. We do not expect to be profitable in 2006. In
future reporting periods, if revenues grow more slowly than anticipated, or if
operating expenses exceed expectations, we may not become profitable. Even if we
become profitable, we may be unable to sustain profitability.
If we are unable to generate a positive cash flow from operations, or are
unsuccessful in securing external means of financing, we may not be able to
continue our operations.
We have not been able to consistently generate positive cash flow from our
operations. For the year ended December 31, 2005, we generated approximately
$747,200 net cash from our operations, as compared with consuming approximately
$863,000 in our operations for the year ended December 31, 2004. We have been
financing our operations primarily from selling common and preferred stock. We
believe that we have sufficient cash to meet our operating needs throughout 2006
with the cash we raised in the 2005 private placement and the cash we had on
hand as of December 31, 2005. However, if we were unable to generate positive
cash flow from our operations in future periods or were unable to raise external
sources of financing, we might need to discontinue our operations entirely.
We may not realize the anticipated benefits of acquiring NES.
We acquired NES in January 2005 with the anticipation that we would realize
various benefits, including, among other things, licensing revenues through
expansion of our product offerings or enhancement of our current product line,
ownership of 11 issued patents and another 43 patent applications in process. We
may not fully realize some or all of these benefits and the acquisition may
result in the diversion of management time and cash resources to the detriment
of our core software business. Costs incurred and liabilities assumed in
connection with this acquisition could also have an adversely impact our future
operating results.
8
Our revenue is typically generated from a very limited number of significant
customers.
A material portion of our revenue during any reporting period is typically
generated from a very limited number of significant customers. Consequently, if
any of these significant customers reduce their order level or fail to order
during a reporting period, our revenue could be materially adversely impacted.
Several of our significant customers are ISVs who have bundled our products with
theirs to sell as web-enabled versions of their products. Other significant
customers include distributors who sell our products directly. We do not control
our significant customers. Some of our significant customers maintain
inventories of our products for resale to smaller end-users. If they reduce
their inventory of our products, our revenue and business could be materially
adversely impacted.
If we are unable to develop new products and enhancements to our existing
products, our business, results of operations and financial condition could
be materially adversely impacted.
The market for our products and services are characterized by:
o frequent new product and service introductions and enhancements;
o rapid technological change;
o evolving industry standards;
o fluctuations in customer demand; and
o changes in customer requirements.
Our future success depends on our ability to continually enhance our current
products and develop and introduce new products that our customers choose to
buy. If we are unable to satisfy our customers' demands and remain competitive
with other products that could satisfy their needs by introducing new products
and enhancements, our business, results of operations and financial condition
could be materially adversely impacted. Our future success could be hindered by:
o delays in our introduction of new products and/or enhancements of
existing products;
o delays in market acceptance of new products and/or enhancements of
existing products;
o our, or a competitor's, announcement of new products and/or product
enhancements or technologies that could replace or shorten the life
cycle of our existing products.
For example, sales of our GO-Global for Windows software could be affected by
the announcement from Microsoft of the release and the actual release of a new
Windows-based operating system or an upgrade to a previously released
Windows-based operating system version as these new or upgraded systems may
contain similar features to our products or they could contain architectural
changes that temporarily prevent our products from functioning properly within a
Windows-based operating system environment.
Our business could be adversely impacted by conditions affecting the
information technology market.
The demand for our products depends substantially upon the general demand for
business-related software, which fluctuates on numerous factors, including
capital spending levels, the spending levels and growth of our current and
prospective customers and general economic conditions. Fluctuations in the
demand for our products could have a material adverse effect on our business,
results of operations and financial condition.
Our business could be adversely impacted by changes pending in the United
States Patent and Trademark Office ("PTO") or by cases being reviewed by the
United States Supreme Court ("Supreme Court").
Currently, proposed rule changes are pending in the PTO that will affect how
currently pending and new patent applications are processed by the PTO. These
rule changes may have an adverse affect on our presently pending patent
applications and any patent applications we may file in the future.
Several cases have been selected for review this term by the Supreme Court that
involve patent law. In particular, MercExchange v. eBay examines the right for a
patent holder to obtain permanent injunctive relief when a patent is found to be
valid and infringed. One possible outcome is that permanent injunctive relief
may be less readily available to patent holders. Such a result could adversely
affect our ability to obtain permanent injunctive relief in the future,
potentially weakening our position in settlement negotiations.
9
Sales of products within our GO-Global product line constitute a substantial
majority of our revenue.
We anticipate that sales of products within our GO-Global product line, and
related enhancements, will continue to constitute a substantial majority of our
revenue for the foreseeable future. Our ability to continue to generate revenue
from our GO-Global product line will depend on continued market acceptance of
GO-Global. Declines in demand for our GO-Global product line could occur as a
result of:
o lack of success with our strategic partners;
o new competitive product releases and updates to existing competitive
products;
o decreasing or stagnant information technology spending levels;
o price competition;
o technological changes, or;
o general economic conditions in the market in which we operate.
If our customers do not continue to purchase GO-Global products as a result of
these or other factors, our revenue would decrease and our results of operations
and financial condition would be adversely affected.
If we determine that any of our intangible assets, including the patents
acquired from NES, are impaired, we would be required to write down the value
of the asset(s) and record a charge to our income statement, which could have
a material adverse effect on our results of operations.
We have a significant amount of intangible assets reported on our balance sheet
as of December 31, 2005. We have net balances of approximately $4,519,400 and
$80,100 reported as Patents and Capitalized Software, respectively. We review
for asset impairment annually, or sooner if events or changes in circumstances
indicate that the carrying amounts could be impaired. Due to uncertain market
conditions, potential changes in our strategy and product portfolio, and other
factors, it is possible that the forecasts we use to support our intangible
assets could change in the future, which could result in non-cash charges that
would adversely affect our results of operations and financial condition.
Our stock price has been historically volatile and you could lose the value
of your investment.
Our stock price has historically been volatile; it has fluctuated significantly
to date. The trading price of our stock is likely to continue to be highly
volatile and subject to wide fluctuations. Your investment in our stock could
lose value.
Our operating results in one or more future periods are likely to fluctuate
significantly and may fail to meet or exceed the expectations of securities
analysts or investors.
Our operating results are likely to fluctuate significantly in the future on a
quarterly and on an annual basis due to a number of factors, many of which are
outside our control. Factors that could cause our revenues to fluctuate include
the following:
o Our ability to maximize the revenue opportunities of our patents;
o The degree of success of products or product enhancements that we may
introduce;
o Variations in the size of orders by our customers;
o Increased competition;
o The proportion of overall revenues derived from different sales
channels such as distributors, original equipment manufacturers (OEMs)
and others;
o Changes in our pricing policies or those of our competitors;
o The financial stability of major customers;
o New product introductions or enhancements by us or by competitors;
o Delays in the introduction of products or product enhancements by us or by
competitors;
o The degree of success of new products;
o Any changes in operating expenses; and
o General economic conditions and economic conditions specific to the
software industry.
In addition, our royalty and license revenues are impacted by fluctuations in
OEM licensing activity from quarter to quarter, which may involve one-time
orders from non-recurring customers, or customers who order infrequently. Our
expense levels are based, in part, on expected future orders and sales;
therefore, if orders and sales levels are below expectations, our operating
results are likely to be materially adversely affected. Additionally, because
significant portions of our expenses are fixed, a reduction in sales levels may
disproportionately affect our net income. Also, we may reduce prices or increase
spending in response to competition or to pursue new market opportunities.
10
Because of these factors, our operating results in one or more future periods
may fail to meet or exceed the expectations of securities analysts or investors.
In that event, the trading price of our common stock would likely be adversely
affected.
We may not be successful in attracting and retaining key management or other
personnel.
Our success and business strategy is also dependent in large part on our ability
to attract and retain key management and other personnel. The loss of the
services of one or more members of our management group and other key personnel,
including our interim Chief Executive Officer, may have a material adverse
effect on our business.
Our failure to adequately protect our proprietary rights may adversely affect
us.
Our commercial success is dependent, in large part, upon our ability to protect
our proprietary rights. We rely on a combination of patent, copyright and
trademark laws, and on trade secrets and confidentiality provisions and other
contractual provisions to protect our proprietary rights. These measures afford
only limited protection. We cannot assure you that measures we have taken will
be adequate to protect us from misappropriation or infringement of our
intellectual property. Despite our efforts to protect proprietary rights, it may
be possible for unauthorized third parties to copy aspects of our products or
obtain and use information that we regard as proprietary. In addition, the laws
of some foreign countries do not protect our intellectual property rights as
fully as do the laws of the United States. Furthermore, we cannot assure you
that the existence of any proprietary rights will prevent the development of
competitive products. The infringement upon, or loss of any proprietary rights,
or the development of competitive products despite such proprietary rights,
could have a material adverse effect on our business.
As regards our intention to maximize the revenue opportunities the portfolio of
patents that we acquired from NES:
o Although we believe the NES patents to be strong, there can be no
assurance that they will not be found invalid either in whole or in part
if challenged.
o Invalidation of their broadest claims could result in very narrow claims
that do not have the potential to produce meaningful license revenues.
o Many of the companies that we intend to seek licenses from are very large
with significant financial resources. We currently lack the ability to
defend our patents against claims of invalidity if such litigation is
heavily contested over an extended period of months or even years.
o We have engaged attorneys that work on our behalf on a contingent fee
basis and intend to pursue litigation until a resolution is achieved that
is favorable to us. Such attorneys may seek to limit their exposure
either by advocating licensing settlements that are not favorable to us
or may abandon their efforts on our behalf.
o Because NES obtained no foreign patents or filed any foreign patent
applications, infringing companies may seek to avoid our demand for
licenses by moving the infringing activities offshore where U.S. patents
cannot be enforced.
We face risks of claims from third parties for intellectual property
infringement that could adversely affect our business.
At any time, we may receive communications from third parties asserting that
features or content of our products may infringe upon their intellectual
property rights. Any such claims, with or without merit, and regardless of their
outcome, may be time consuming and costly to defend. We may not have sufficient
resources to defend such claims and they could divert management's attention and
resources, cause product shipment delays or require us to enter into new royalty
or licensing agreements. New royalty or licensing agreements may not be
available on beneficial terms, and may not be available at all. If a successful
infringement claim is brought against us and we fail to license the infringed or
similar technology, our business could be materially adversely affected.
Our business significantly benefits from strategic relationships and there
can be no assurance that such relationships will continue in the future.
Our business and strategy relies to a significant extent on our strategic
relationships with other companies. There is no assurance that we will be able
to maintain or develop any of these relationships or to replace them in the
event any of these relationships are terminated. In addition, any failure to
renew or extend any licenses between any third party and us may adversely affect
our business.
11
We rely on indirect distribution channels for our products and may not be
able to retain existing reseller relationships or to develop new reseller
relationships.
Our products are primarily sold through several distribution channels. An
integral part of our strategy is to strengthen our relationships with resellers
such as OEMs, systems integrators, VARs, distributors and other vendors to
encourage these parties to recommend or distribute our products and to add
resellers both domestically and internationally. We currently invest, and intend
to continue to invest, significant resources to expand our sales and marketing
capabilities. We cannot assure you that we will be able to attract and/or retain
resellers to market our products effectively. Our inability to attract resellers
and the loss of any current reseller relationships could have a material adverse
effect on our business, results of operations and financial condition.
Additionally, we cannot assure you that resellers will devote enough resources
to provide effective sales and marketing support to our products.
The market in which we participate is highly competitive and has more
established competitors.
The market we participate in is intensely competitive, rapidly evolving and
subject to technological changes. We expect competition to increase as other
companies introduce additional competitive products. In order to compete
effectively, we must continually develop and market new and enhanced products
and market those products at competitive prices. As markets for our products
continue to develop, additional companies, including companies in the computer
hardware, software and networking industries with significant market presence,
may enter the markets in which we compete and further intensify competition. A
number of our current and potential competitors have longer operating histories,
greater name recognition and significantly greater financial, sales, technical,
marketing and other resources than we do. We cannot assure you that our
competitors will not develop and market competitive products that will offer
superior price or performance features or that new competitors will not enter
our markets and offer such products. We believe that we will need to invest
increased financial resources in research and development to remain competitive
in the future. Such financial resources may not be available to us at the time
or times that we need them, or upon terms acceptable to us. We cannot assure you
that we will be able to establish and maintain a significant market position in
the face of our competition and our failure to do so would adversely affect our
business.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES
We currently occupy approximately 1,850 square feet of office space in Santa
Cruz, California, under a lease that will expire in July 2008. Rental of these
premises will average approximately $3,600 per month over the term of the lease,
which is inclusive of our pro rata share of utilities, facilities maintenance
and other costs. We have the option to renew the lease for one three-year term
upon its expiration by giving written notice to the landlord not later than 180
days prior to the expiration of the initial lease term. Santa Cruz is our
corporate headquarters and is staffed by administrative personnel.
During October 2005 we renewed our lease for approximately 3,300 square feet of
office space in Concord, New Hampshire, for a one-year term, which is cancelable
upon 30-days written notice by either our landlord or us. Rent on the Concord
facility is approximately $5,300 per month. Concord is our primary engineering
facility and is staffed by our Windows software engineers.
We currently occupy approximately 800 square feet of office space in Rolling
Hills Estates, California, under a lease that will expire in March 2007. Monthly
rental payments are approximately $1,400 for the Rolling Hills Estates office.
This office is staffed by a sales representative and an administrative employee.
We also lease approximately 250 square feet of office space in Berkshire,
England, United Kingdom under a lease that runs through December 2006. Monthly
rent on this office is approximately $400 per month, which rate is subject to
fluctuation, depending on exchange rates. This office is staffed by a sales
representative.
We believe our current facilities will be adequate to accommodate our needs for
the foreseeable future.
ITEM 3. LEGAL PROCEEDINGS
On November 23, 2005, we initiated a proceeding against AutoTrader.com in the
United States District Court in the Eastern District of Texas, alleging that
Autotrader.com was infringing two of our patents, namely Nos. 6,324,538 and
6,850,940 (the "538" and "940" patents, respectively), which protect our unique
method of maintaining an automated and network accessible database, on its
AutoTrader.com website. We seek preliminary and permanent injunctive relief
along with unspecified damages and fees. Autotrader.com filed its Answer and
12
Counterclaims on January 17, 2006 seeking a declaratory judgment that it does
not infringe the 538 and 940 patents and that both patents are invalid. On March
24, 2006, Autotrader.com filed a motion for summary judgment seeking to
invalidate the 538 and 940 patents.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Our 2005 Annual Meeting of Stockholders was held on December 22, 2005. At the
meeting, one director was reelected to serve for a three-year term. The vote was
as follows:
For Withheld
---------- ----------
Gordon Watson 31,530,396 370,929
The following individuals continue in their capacity as directors: Robert
Dilworth, August Klein and Michael Volker. Their current terms expire during
2007, 2007 and 2006, respectively.
The shareholders approved adoption of the 2005 Equity Incentive Plan. The vote
was as follows:
Broker
For Against Abstain Non-votes
---------- ------- ------- ------------
20,692,571 656,532 224,580 10,327,642
The shareholders also ratified the reappointment of Macias Gini &O'Connelll LLP
as our independent auditors for fiscal 2005. The vote was as follows:
For Against Abstain
---------- --------- --------
31,560,364 76,272 264,689
13
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The following table sets forth, for the periods indicated, the high and low
reported sales price of our common stock. Since March 27, 2003 our common stock
has been quoted on the Over-the-Counter Bulletin Board. Our common stock is
quoted under the symbol "GOJO."
Fiscal 2005 Fiscal 2004
------------ -----------
Quarter High Low High Low
----- ----- ----- -----
1st $0.65 $0.39 $1.03 $0.20
2nd $0.45 $0.26 $0.93 $0.41
3rd $0.48 $0.29 $0.51 $0.25
4th $0.38 $0.18 $0.56 $0.25
On March 7, 2006, there were approximately 178 holders of record of our common
stock. Between January 1, 2006 and March 6, 2006, the high and low reported
sales price of our common stock was $0.30 and $0.19, respectively, and on March
6, 2006 the closing price of our common stock was $0.25.
We have never declared or paid dividends on our common stock, nor do we
anticipate paying any cash dividends for the foreseeable future. We currently
intend to retain future earnings, if any, to finance the operations and
expansion of our business. Any future determination to pay cash dividends will
be at the discretion of our Board of Directors and will be dependent upon the
earnings, financial condition, operating results, capital requirements and other
factors as deemed necessary by the Board of Directors.
Information regarding our equity compensation plans, including stockholder
approved plans and plans not approved by stockholders, is set forth in Item 11
of this Annual Report on Form 10-K.
ITEM 6. SELECTED FINANCIAL DATA
The following selected historical financial data should be read in conjunction
with "Management's Discussion and Analysis of Financial Condition and Results of
Operations" and our historical financial statements and notes thereto included
elsewhere herein. Macias Gini & O'Connell LLP, independent registered public
accounting firm, has audited our financial statements as of December 31, 2005
and 2004, and for the years then ended, from which our respective historical
data for those years has been derived. BDO Seidman LLP, independent registered
public accounting firm, has audited our financial statements as of December 31,
2003, 2002 and 2001, and for the years then ended, from which our respective
historical financial data for those years has been derived.
Statement of Operations Data:
Year Ended December 31,
----------------------------------------------------------
($000, except per share data) 2005 2004 2003 2002 2001
---------- ---------- ---------- ---------- ----------
Revenue $ 5,180 $ 3,530 $ 4,170 $ 3,535 $ 5,911
Costs of revenue 504 904 1,371 1,680 2,613
---------- ---------- ---------- ---------- ----------
Gross profit 4,676 2,626 2,799 1,855 3,298
---------- ---------- ---------- ---------- ----------
Operating expenses
Selling and marketing 1,523 1,384 1,680 2,235 5,989
General and administrative 3,042 1,183 1,419 2,801 4,561
Research and development 1,277 1,501 1,515 2,831 4,134
Asset impairment loss - - - 914 4,501
Restructuring charge - - 80 1,943 -
---------- ---------- ---------- ---------- ----------
Total operating expenses 5,842 4,068 4,694 10,724 19,185
---------- ---------- ---------- ---------- ----------
Loss from operations (1,166) (1,442) (1,895) (8,869) (15,887)
Other income (expense) 37 15 8 77 410
---------- ---------- ---------- ---------- ----------
Loss before provision for income taxes (1,129) (1,427) (1,887) (8,792) (15,477)
Provision for income taxes 18 - - - 1
---------- ---------- ---------- ---------- ----------
Net loss (1,147) (1,427) (1,887) (8,792) (15,478)
Other comprehensive income (expense) - 1 1 (4) -
14
Deemed dividends on preferred stock (4,000) - - - -
---------- ---------- ---------- ---------- ----------
Loss attributable to common shareholders $ (5,147) $ (1,426) $ (1,886) $ (8,796) $ (15,478)
========== ========== ========== ========== ==========
Basic and diluted loss per common share $ (0.12) $ (0.07) $ (0.11) $ (0.50) $ (0.97)
========== ========== ========== ========== ==========
Weighted average common shares outstanding 41,834 21,308 16,607 17,465 16,008
========== ========== ========== ========== ==========
Balance Sheet Data: As of December 31,
----------------------------------------------------------
($000) 2005 2004 2003 2002 2001
---------- ---------- ---------- ---------- ----------
Working capital $ 2,494 $ (213) $ 284 $ 668 $ 6,173
Total assets 9,037 2,224 2,562 4,550 12,986
Total liabilities 2,619 1,858 1,715 1,820 1,660
Shareholders' equity 6,418 366 847 2,730 11,326
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION
The following discussion should be read in conjunction with the consolidated
financial statements and related notes provided elsewhere in this Annual Report
on Form 10-K.
Critical Accounting Policies. The preparation of financial statements and
related disclosures in conformity with accounting principles generally accepted
in the United States requires management to make judgments, assumptions and
estimates that affect the amounts reported in the Consolidated Financial
Statements and accompanying notes. The Summary of Significant Accounting
Policies appears in Part II, Item 7 - Financial Statements, of this Form 10-K,
which describes the significant accounting polices and methods used in the
preparation of the Consolidated Financial Statements. Estimates are used for,
but not limited to, the accounting for the allowance for doubtful accounts, the
impairment of intangible assets, contingencies and other special charges and
taxes. Actual results could differ materially from these estimates. The
following critical accounting policies are impacted significantly by judgments,
assumptions and estimates used in the preparation of the Consolidated Financial
Statements.
Revenue Recognition
We market and license products through various means, such as; channel
distributors, independent software vendors ("ISVs"), value-added resellers
("VARs"), application service providers ("ASPs") (collectively "resellers") and
direct sales to enterprise end users. Our product licenses are generally
perpetual. We also separately sell maintenance contracts, which are comprised of
license updates and customer service access, private-label branding kits,
software developer kits ("SDKs") and product training services.
Generally, software license revenues are recognized when:
o Persuasive evidence of an arrangement exists, (i.e when we sign a
non-cancelable license agreement wherein the customer acknowledges an
unconditional obligation to pay, or upon receipt of the customer's
purchase order) and
o Delivery has occurred or services have been rendered and there are no
uncertainties surrounding product acceptance, (i.e., when title and risk
of loss have been transferred to the customer, which generally occurs when
the media containing the licensed programs is provided to a common carrier
or, in the case of electronic delivery, when the customer is given access
to the licensed program(s))and
o The price to the customer is fixed or determinable, as typically evidenced
in a signed non-cancelable contract, or a customer's purchase order, and
o Collectibility is probable. If collectibility is not considered probable,
revenue is recognized when the fee is collected.
Revenue recognized on software arrangements involving multiple elements is
allocated to each element of the arrangement based on vendor-specific objective
evidence ("VSOE") of the fair values of the elements; such elements include
licenses for software products, maintenance, or customer training. We limits our
assessment of VSOE 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.
15
If sufficient VSOE of fair values does not exist so as to permit the allocation
of revenue to the various elements of the arrangement, all revenue from the
arrangement is deferred until such evidence exists or until all elements are
delivered. If evidence of VSOE 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 resellers prepay for licenses they intend to resell bundled together
with maintenance that provides the reseller with license updates and customer
service. Upon receipt of the prepayment, if all other revenue recognition
criteria outlined above have been met, product licensing revenue is recognized
when the reseller is given access to the licensed program(s). The resellers are
generally required to provide periodic (monthly or quarterly) sell-through
reports that detail, for the respective period, various items, such as the
number of licenses purchased, the number sold to other parties and the ending
balance of licenses held as inventory available for future sale. The recognition
of maintenance revenue for these resellers is based on estimated reseller
inventory turnover levels reconciled to actual upon receipt of the sell-through
report.
There are no rights of return granted to resellers or other purchasers of our
software programs.
We recognize revenue from maintenance contracts ratably over the related
contract period, which generally ranges from one to five 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.
Patents
The patents we acquired in the NES acquisition are being amortized over their
estimated remaining economic lives, currently estimated to be approximately five
years, as of December 31, 2005. Costs associated with filing, documenting or
writing method patents are expensed as incurred.
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, including our patents, on
an annual basis and between annual tests in certain circumstances. In response
to changes in industry and market conditions, we may strategically realign our
resources and consider restructuring, disposing of, or otherwise exiting
businesses, which could result in an impairment of intangible assets.
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 per common share would have been changed to the
amounts discussed elsewhere in this Form 10-K. See New Accounting
Pronouncements, below, for further details on accounting for stock-based
compensation.
16
Results of Operations
Set forth below is statement of operations data for the years ended December 31,
2005 and 2004 along with the dollar and percentage changes from 2004 to 2005 in
the respective line items.
Year Ended December 31, Change in
-------------------------- ------------------------
2005 2004 Dollars Percentage
------------ ------------ ------------ ----------
Revenue $ 5,180,200 $ 3,529,800 $ 1,650,400 46.8%
Cost of revenue 503,700 903,800 (400,100) (44.3)
------------ ------------ ------------
Gross profit 4,676,500 2,626,000 2,050,500 78.1
------------ ------------ ------------
Operating expenses:
Selling and marketing 1,523,000 1,383,700 139,300 10.1
General and administrative 3,042,100 1,183,600 1,858,500 157.0
Research and development 1,277,600 1,500,900 (223,300) (14.9)
------------ ------------ ------------
Total operating expenses 5,842,700 4,068,200 1,774,500 43.6
------------ ------------ ------------
Loss from operations (1,166,200) (1,442,200) 276,000 19.1
------------ ------------ ------------
Other income (expense):
Interest and other income 41,700 14,700 27,000 183.7
Interest and other expense (4,500) - (4,500) na
------------ ------------ ------------
Total other income (expense) 37,200 14,700 22,500 153.1
------------ ------------ -----------
Loss before provision for income tax (1,129,000) (1,427,500) 298,500 20.9
Provision for income tax 18,200 - 18,200 na
------------ ------------ ------------
Net loss (1,147,200) (1,427,500) 280,300 19.6
Other comprehensive loss - (1,000) 1,000 100.0
------------ ------------ ------------
Comprehensive loss (1,147,200) (1,426,500) 279,300 19.6
Deemed dividends on preferred stock (4,000,000) - (4,000,000) na
------------ ------------ ------------
Net loss attributable to common
shareholders $ (5,147,200) $ (1,426,500) $ (3,720,700) (260.8)%
============ ============ ============
Set forth below is statement of operations data for the years ended December 31,
2004 and 2003 along with the dollar and percentage changes from 2003 to 2004 in
the respective line items.
Year Ended December 31, Change in
-------------------------- ------------------------
2004 2003 Dollars Percentage
------------ ------------ ------------ ----------
Revenue $ 3,529,800 $ 4,170,300 $ (640,500) (15.4)%
Cost of revenue 903,800 1,371,600 (467,800) (34.1)
------------ ------------ ------------
Gross profit 2,626,000 2,798,700 (172,700) (6.2)
------------ ------------ ------------
Operating expenses:
Selling and marketing 1,383,700 1,679,800 (296,100) (17.6)
General and administrative 1,183,600 1,419,100 (235,500) (16.6)
Research and development 1,500,900 1,515,000 (14,100) (0.9)
Restructuring charges - 80,100 (80,100) (100.0)
------------ ------------ ------------
Total operating expenses 4,068,200 4,694,000 (625,800) (13.3)
------------ ------------ ------------
Loss from operations (1,442,200) (1,895,300) (453,100) 23.9
Interest and other income 14,700 8,700 6,000 69.0
------------ ------------ ------------
Net loss (1,427,500) (1,886,600) (459,100) 24.3
Other comprehensive income 1,000 1,000 - -
------------ ------------ ------------
Comprehensive loss $ (1,426,500) $ (1,885,600) $ (459,100) 24.3
============ ============ ============
Revenue. Our revenue is primarily derived from product licensing fees and
service fees from maintenance contracts. Other sources of revenue include
private labeling fees and sales of software development kits. Private labeling
fees are derived when we contractually agree to allow a customer to brand our
product with their name. We defer these fees upon contract signing and recognize
the revenue ratably over the initial term of the contract. Software development
17
kits are tools that allow end users to develop, interface and brand their own
applications for use in conjunction with either our Windows or Unix/Linux
products. Currently, we do not generate a significant amount of revenue from
private labeling transactions, nor do we anticipate generating a significant
amount of revenue from them or from the sale of software development kits during
2006.
The table that follows summarizes product licensing fees for the years ended
December 31, 2005 and 2004 and calculates the change in dollars and percentage
from 2004 to 2005 in the respective line item.
Year Ended December 31, Increase/(Decrease)
-------------------------- ------------------------
Product licensing fees 2005 2004 Dollars Percentage
---------------------- ------------ ------------ ------------ ----------
Windows $ 2,271,000 $ 1,361,600 $ 909,400 66.8%
Unix/Linux 1,501,400 1,033,600 467,800 45.3
------------ ------------ ------------
Total $ 3,772,400 $ 2,395,200 $ 1,377,200 57.5
============ ============ ============
The table that follows summarizes product licensing fees for the years ended
December 31, 2004 and 2003 and calculates the change in dollars and percentage
from 2003 to 2004 in the respective line item.
Year Ended December 31, Increase/(Decrease)
-------------------------- ------------------------
Product licensing fees 2004 2003 Dollars Percentage
---------------------- ------------ ------------ ------------ ----------
Windows $ 1,361,600 $ 1,649,000 $ (287,400) (17.4)%
Unix/Linux 1,033,600 1,523,100 (489,500) (32.1)
------------ ------------ ------------
Total $ 2,395,200 $ 3,172,100 $ (777,000) (24.5)
============ ============ ============
The increases in both Windows and Unix-based product licensing fees revenue for
the year ended December 31, 2005 as compared with the prior year were reflective
of how such revenue varies because a significant portion of this revenue has
been, and continues to be earned from a limited number of significant customers,
most of whom are original equipment manufacturers (OEMs) or VARs. Consequently,
if any of these significant customers change their order level, or fail to
order, our product licensing fees revenue can be materially adversely impacted.
We expect this situation to continue during 2006.
During the year ended December 31, 2005, two of our most significant Windows
customers (KitASP and FrontRange) purchased approximately an aggregate $641,300
more Windows product licenses than they did during the prior year. Three other
Windows customers, who are also OEMs and/or VARs, purchased approximately an
aggregate $452,400 more Windows product licenses during the year ended December
31, 2005 than they did during the prior year. Partially offsetting these
increases were aggregate decreases approximating $184,300 resulting from reduced
Windows product licenses purchases from our other customers.
During the year ended December 31, 2005, our most significant Unix customer
(Alcatel) purchased approximately $112,600 more Unix product licenses than they
did during the prior year. Additionally, a reseller with whom we do business
periodically, who resells to the United States military, purchased approximately
an aggregate $415,800 of Unix product licenses during the year ended December
31, 2005, as compared with no such purchases during the prior year. Partially
offsetting these increases were aggregate decreases approximating $60,600
resulting from reduced Unix product licenses purchases from our other customers.
We anticipate that many of our customers will enter into, and periodically
renew, maintenance contracts to ensure continued product updates and support.
Currently we offer maintenance contracts for one, two, three or five-year
periods. Revenue from maintenance contracts totaled approximately $1,358,600 in
2005 and $1,015,000 in 2004 and was approximately 26.2% and 28.8% of revenue in
2005 and 2004, respectively. We expect revenue from maintenance contracts in
2006 to exceed 2005 levels due to an increase in license sales in 2005 and
anticipated renewals in 2006.
For the year ended December 31, 2005, approximately 82.8% of our total sales
were made to 26 customers. The three largest of these customers accounted for
approximately 16.8%, 16.0% and 11.5%, respectively, of total sales. These three
customers' December 31, 2005 year-end accounts receivable balances represented
approximately 0.0%, 11.6%, and 6.0% of reported net accounts receivable. By
March 16, 2006, we had collected the majority of these outstanding balances.
For the year ended December 31, 2004, approximately 75.9% of our total sales
were made to 20 customers. The three largest of these customers accounted for
approximately 20.9%, 14.9% and 14.1%, respectively, of total sales. These three
customers' December 31, 2004 year-end accounts receivable balances represented
approximately 30.9%, 2.9% and 0.0% of reported net accounts receivable. By March
16, 2005, we had collected the majority of these outstanding balances.
During 2004, one of our significant ISV customers informed us that they would
begin selling our Windows-based products as an add-on to their software
applications products, instead of bundling our products with theirs, as had been
done previously. Sales to this customer declined by approximately $419,000 in
2004 from 2003, and were the primary contributing factor to our overall decline
18
in Windows product licensing fees. Partially offsetting this decrease was the
recognition of approximately $188,000 of revenue from a Windows product
licensing sale that we had originally recorded as a deferred item during
December of 2003 because not all of the criteria for revenue recognition had
been met. Once all the criteria were met, in early 2004, we recognized this
revenue.
Approximately $302,800 of the decrease in 2004 Unix/Linux product licensing fee
revenue was due to a one-time sale to a governmental end-user, which occurred
during 2003. The majority of the remaining 2004 decrease was due to the
aggregate variations in our other customers' sales orders.
During 2004, we recognized approximately $1,015,000 of revenue from service
fees, an increase of $184,100, or approximately 22.2% from the approximately
$830,900 recognized during 2003. This increase has primarily resulted from
continued increases in sales of maintenance contracts to our Windows customers
resulting from the release of GO-Global for Windows during the fourth quarter of
2002.
During 2004, we recognized approximately $119,600 of revenue from other items, a
decrease of $47,700, or approximately 28.5%, from the approximately $167,300
recognized during 2003. The decrease was primarily due to a $150,000 decrease in
distributor fee revenue, which was partially offset by $100,000 of revenue
recognized from the sale of a software development kit. We had signed a $300,000
two-year distribution agreement with our distributor in Japan and had been
ratably recognizing the distributor fee as revenue over the underlying initial
two-year term, which expired on December 31, 2003.
Cost of Revenue. Cost of revenue consists primarily of the amortization of
acquired technology and the amortization of capitalized technology developed
in-house. Also included in cost of revenue are the costs of servicing
maintenance contracts. Research and development costs for new product
development, after technological feasibility is established, are recorded as
"capitalized software" on our balance sheet and subsequently amortized as cost
of revenue over the shorter of three years or the remaining estimated life of
the products.
Cost of revenue was approximately 9.7%, 25.6% and 32.9% of total revenues for
the years 2005, 2004 and 2003, respectively. The decrease in product costs in
2005 from 2004 was primarily due to all remaining elements of our acquired
technology becoming fully amortized during 2004. The decrease in service costs
was due to changes in the mix of engineers who were providing such services and
the amount of time they spent providing such services. We review our engineering
activities on an on-going basis to ensure that our resources are deployed most
efficiently to allow us to strike an appropriate balance between servicing
customers' needs and product development. The decrease in cost of revenue in
2004 from 2003 was due primarily to certain elements of our acquired technology
becoming fully amortized during 2003, additional elements becoming fully
amortized during 2004 and the write-downs of the estimated remaining carrying
values of our intangible assets that were recorded during the third quarter of
2002.
We anticipate that our 2006 cost of revenue will approximate our 2005 cost of
revenue.
Sales and Marketing Expenses. Sales and marketing expenses primarily consist of
salaries and related benefits, sales commissions, outside consultants, travel
expenses, trade show related activities and promotional costs.
Sales and marketing expenses were approximately 29.4 %, 39.2 % and 40.3% of
total revenues for the years 2005, 2004 and 2003, respectively. The increase in
sales and marketing expenses in 2005 from 2004 was primarily caused by increased
commissions ($283,300) and bonuses ($85,100), which were partially offset by
decreased wages and benefits ($116,800), and outside consultants ($61,600). The
reasons for these changes were as follows:
o The increase in commissions was the result of higher sales in 2005,
as compared with 2004, and the attainment of various sales quotas
during 2005.
o The increase in bonuses was due to the attainment of certain
performance-based goals and objectives during 2005.
o The decrease in wages and benefits was the result of having two less
sales representatives during 2005, as compared with 2004.
o The decrease in outside marketing consultants was a result of
reducing the budget for such 2005 expenditures and prioritizing 2005
activities to live within the budgetary constraints.
The decrease in sales and marketing expenses in 2004 from 2003 was primarily
caused by decreased salaries, benefits and commissions ($240,600) and facilities
allocations ($170,200), which were partially offset by an increase in outside
consultants ($123,300). The reasons for these changes were as follows:
19
o The decrease in salaries, benefits and commissions was the result of
terminating two people during late 2003 and two during 2004.
o The decrease in facilities allocation was the result of the 2003
terminations. All of the sales and marketing employees who had been
sharing space with general and administrative employees at our corporate
headquarters location were terminated during 2003. Accordingly, the
allocation of overhead costs to sales and marketing ceased.
o The increase in outside consultants was a result of outsourcing
marketing work upon the 2003 terminations.
We expect that cumulative sales and marketing expenses in 2006 will exceed 2005
levels, which will be inclusive of the impact of hiring an additional sales
representative during 2006.
General and Administrative Expenses. General and administrative expenses
primarily consist of salaries and related benefits, legal and professional
services, depreciation of fixed assets, amortization of patents, insurance,
costs associated with being a publicly held company and bad debts expense.
General and administrative expenses were approximately 58.7%, 33.5% and 34.0% of
2005, 2004 and 2003 total revenues, respectively. General and administrative
expense increased in 2005 from 2004 primarily as a result of our acquisition of
NES and their patent portfolio and a resulting increase to our administrative
staff. Significant increases included wages and benefits ($494,700),
depreciation and amortization, primarily of the patent portfolio, ($816,400),
legal fees ($258,100) and bonuses ($97,800). The reasons for these increases
were as follows:
o Wages and benefits were up as a result of hiring five new employees
during 2005, including two associated with our newly-acquired patents
and three administrative people, one of whom replaced an outside
consultant whose contract was not renewed during 2005.
o Depreciation and amortization increased as a direct result of the
amortization of the newly-acquired patents.
o Legal fees increased primarily as a result of costs associated with
the newly-acquired patents and certain costs associated with the
private placement of our capital stock, which occurred during the
first three months of 2005.
o Bonuses increased primarily as the result of the attainment of certain
performance-based goals and objectives during 2005.
General and administrative expense decreased in 2004 from 2003 primarily because
of decreased facilities allocations ($152,900) and decreased directors and
officers insurance ($103,100). The reasons for these decreases were as follows:
o Our overhead structure was greatly reduced when we consummated a buy-out
of our former lease for our corporate headquarters facilities at 400
Cochrane Circle, Morgan Hill, CA. This facility had been approximately
14,000 square feet. Since October 2003, we have maintained our corporate
offices in approximately 1,000 square feet of space.
o Our directors and officers insurance expense was lower in 2004 than 2003
because we did not renew our policy upon its expiration in 2003.
The ending balance of our allowance for doubtful accounts as of December 31,
2005, 2004 and 2003 was $46,800. Bad debts expense was approximately $2,300, $0
and $16,300, for the years ended December 31, 2005, 2004 and 2003, respectively.
We anticipate that cumulative general and administrative expense in 2006 will
exceed those incurred during 2005. During 2006 we will recognize salaries and
related benefits for our five 2005 new hires for the entire year, versus their
actual periods of employment during 2005, and we will recognize patent-related
expenses, including amortization, for a full year, as compared with eleven
months during 2005
Research and Development Expenses. Research and development expenses consist
primarily of salaries and related benefits paid to software engineers, payments
to contract programmers, depreciation and facility expenses related to our
remotely located engineering offices.
Under accounting principles generally accepted in the United States, all costs
of product development incurred once technological feasibility has been
established, but prior to the 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 2005 or 2004. Product
development costs approximating $282,200 were capitalized during 2003.
20
Research and development expense was approximately 24.7%, 42.5% and 36.3% of
total revenues for the years 2005, 2004 and 2003, respectively. The decrease in
research and development expense in 2005 from 2004 was primarily caused by
decreased wages and benefits ($197,000) and decreased depreciation of fixed
assets ($45,900). The reasons for these changes were as follows:
o We had three fewer engineers during 2005 as compared with 2004.
o Depreciation expense decreased due to the timing of various assets
reaching the end of their estimated useful lives, as well as minimal
capital expenditures over the course of the last few years.
Research and development expense for 2004 approximated 2003 levels, as reported.
Research and development expense for 2003 does not include approximately
$149,100 of wages and related costs and $133,100 of outside consulting services
related to software development costs that were capitalized during 2003. No such
costs were capitalized during 2004.
Our research and development efforts currently are focused on further enhancing
the functionality, performance and reliability of existing products and
developing new products. We historically have made significant investments in
our protocol and in the performance and development of our server-based software
and expect to continue to make significant product investments during 2006. We
also anticipate increasing the size of our in-house research and development
workforce during 2006 so that we may accelerate our efforts to further stabilize
and enhance our current product offerings and help determine the extent to which
the technology covered by the patents we acquired from NES have application,
among other possibilities, to our current GO-Global product line.
Restructuring charges. During 2003 we negotiated settlements of the leases for
our former offices in Bellevue, Washington and Morgan Hill, California, which
completed the restructuring activities that had been approved under Emerging
Issues Task Force (EITF) 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (Including Certain
Costs Incurred in a Restructuring)," during 2002 and had begun in 2002.
Additionally, we relocated our Morgan Hill, California offices from 400 Cochrane
Circle to 105 Cochrane Circle and further disposed of certain assets that were
no longer in service. A summary of the restructuring charge recorded during 2003
is as follows:
Additional Ending Balance
Restructuring Cash Non-cash Restructuring
Charge Payments Charges Accrual
----------------------------- ------------- ---------- ---------- -------------
Year ended December 31, 2003:
Opening accrual balance $ - $ - $ - $ 282,200
Fixed assets abandonment 42,200 - (42,200) -
Lease settlement - rent 36,800 (269,000) - (232,200)
Deposits forfeited 16,000 - (56,000) (40,000)
Commissions 12,000 (22,000) - (10,000)
Other (1) (26,900) - 26,900 -
------------- ---------- ---------- -------------
Totals $ 80,100 $ (291,000) $ (71,300) $ -
============= ========== ========== =============
(1) Includes the write-off of deferred rent associated with the Morgan Hill
lease and other miscellaneous items.
During June 2003, we negotiated a buy out of the lease for our former
engineering offices in Bellevue, Washington. The total buy out price was
approximately $184,000 and consisted of a lump-sum cash payment of $144,000, the
forfeiture of an approximate $40,000 security deposit and a $10,000 commission
to the real estate broker who was involved in the transaction. It is estimated
that the buy out saved approximately $355,800 over the contractually scheduled
lease term.
During August 2003, we negotiated a buy out of the lease for our former
corporate offices in Morgan Hill, California. The total buy out price was
approximately $153,000 and consisted of a lump-sum cash payment of $125,000, the
forfeiture of an approximate $16,000 security deposit and a $12,000 commission
to the real estate broker who was involved in the transaction. It is estimated
that the buy out saved approximately $270,000 over the contractually scheduled
lease term.
Interest and Other Income. During 2005, 2004 and 2003, the primary component of
interest and other income was interest income derived on excess cash. Our excess
cash was held in relatively low-risk, highly liquid investments, such as U.S.
Government obligations, bank and/or corporate obligations rated "A" or higher by
independent rating agencies, such as Standard and Poors, or interest bearing
money market accounts with minimum net assets greater than or equal to one
billion U.S. dollars.
21
Interest and other income was approximately 0.8%, 0.4% and 0.3% of total
revenues for the years ended December 31, 2005, 2004 and 2003, respectively. The
increases in interest income in 2005 from 2004 and in 2004 from 2003 was
primarily due to higher average balances of cash and cash equivalents during
each year, as compared with each prior year, which resulted from the proceeds of
the private placements of our stock which occurred during the first quarter of
2005 and 2004. During 2005, another factor leading to the increase in interest
and other income was interest income derived from our note receivable -
shareholder, as explained elsewhere in this Form 10-K.
Provision for Income Taxes. For the year ended December 31, 2005 we have
recorded a current tax provision of approximately $18,200. No provision for
taxes was recorded during either the year ended December 31, 2004 or 2003. At
December 31, 2005, we had approximately $42 million of federal net operating
loss carryforwards and approximately $14 million of California state net
operating loss carryforwards available to reduce future taxable income, which
will begin to expire in 2013 for federal tax purposes and 2006 for state tax
purposes, respectively.
In 1998, we experienced a "change of ownership" as that term is defined in the
Tax Reform Act of 1986. As such, utilization of our net operating loss
carryforwards through 1998 will be limited to $400,000 per year until such
carryforwards are fully utilized or expire.
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 fair value of the Series A preferred stock was calculated 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 the commitment date of the 2005 private placement
was $0.46 and the Series A preferred stock would have converted into 14,814,800
common shares, thus deriving a fair value of approximately $6,814,800.
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 life.
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 non-detachable conversion feature
(the "Beneficial Conversion Feature") that was in-the-money upon completion of
the 2005 Private Placement. The discount resulting from recording the Beneficial
Conversion Feature, as determined using the intrinsic value method, was
calculated to be approximately $3,136,000 and was recognized as if this amount
had been declared a non-cash dividend to the preferred shareholders when the
preferred stock was converted to common stock.
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
was recognized as if this amount had been declared a non-cash dividend to the
preferred shareholders when the preferred stock was converted to common stock.
On March 29, 2005, our stockholders approved an amendment to our certificate of
incorporation increasing our authorized but unissued common stock from
45,000,000 to 195,000,000 shares. Upon the effectiveness of the certificate of
amendment to our certificate of incorporation implementing this increase, each
share of Series A preferred stock was automatically converted into 100 shares of
our common stock and each warrant was automatically converted into a warrant to
purchase that number of shares of common stock equal to the number of shares of
preferred stock subject to the warrant multiplied by 100. As a result, all
outstanding shares of Series A Preferred Stock (148,148 shares) were converted
into 14,814,800 shares of our common stock. In addition, upon the effectiveness
of the certificate of amendment, all outstanding warrants to purchase shares of
Series A preferred stock (14,815 shares) and Series B preferred stock (81,477
shares) were converted into five-year warrants to purchase 1,481,500 shares of
our common stock at an exercise price of $0.27 per share and five-year warrants
to purchase 8,147,700 shares of our common stock at an exercise price of $0.40
per share, respectively.
Liquidity and Capital Resources
On January 29, 2004, we completed a private placement, which raised a total of
$1,150,000 through the sale of 5,000,000 shares of common stock and five-year
warrants to purchase 2,500,000 shares of common stock (the "2004 private
placement"). Net proceeds of approximately $931,400, as well as other working
capital items, were used to fund our operations during 2004.
22
On February 2, 2005, we completed the 2005 private placement, which raised a
total of $4,000,000 (inclusive of a $665,000 credit as described below) through
the sale of 148,148 shares of Series A preferred stock and five-year warrants to
purchase 74,070 shares of Series B preferred stock. In a contemporaneous
transaction, we acquired NES for 9,599,993 shares of common stock, the
assumption of approximately $235,000 of NES' indebtedness and the reimbursement
to AIGH Investment Partners, LLC ("AIGH"), an affiliate of a principal
stockholder (Orin Hirschman), of $665,000 for its advance on our 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.
As of December 31, 2005, we had consumed approximately $467,300 and $699,000 of
the cash raised in the 2005 private placement paying for expenses related to the
2005 private placement and the NES acquisition, respectively. We will disburse
an additional $58,000 and $0 of cash paying for expenses related to the 2005
private placement and the NES acquisition, respectively, in 2006, however, there
can be no guarantees that these amounts will be final. Once all aggregate costs
associated with the 2005 private placement and NES acquisition have been paid,
there will be net proceeds of approximately $2,110,700 remaining from the 2005
private placement available for general corporate purposes.
Our operating activities provided approximately $747,200 of net cash during
2005. This net cash was provided primarily by a $675,600 increase in deferred
revenue and $1,065,800 of depreciation and amortization charges during 2005.
Partially offsetting these amounts was our $1,129,000 net loss for 2005. We
consumed approximately $772,100 of net cash in our 2005 investing activities.
This amount was primarily comprised of $699,000 cash disbursed as part of the
NES acquisition and $70,600 of general capital expenditures. Our financing
activities provided net cash of approximately $2,877,700 during 2005. The
majority of this net cash was the result of the 2005 private placement.
During 2004 we consumed $863,000 of net cash in our operating activities. This
net consumption of cash related primarily to our net loss of $1,427,500 and an
aggregate decrease in cash flow from our operating assets and liabilities of
$98,800, which were offset by certain non-cash charges, primarily depreciation
and amortization of $664,700. We consumed $435,500 of net cash in our investing
activities, primarily resulting from a $350,000 increase in note receivable -
related party, a $59,200 increase in deferred acquisition costs, (both of which
were related to our acquisition of NES) and the purchase of approximately
$33,400 of fixed assets. We generated net positive financing cash flows of
approximately $947,300. These cash flows primarily related to net proceeds from
the 2004 private placement of $931,400 and proceeds from the exercise of
warrants issued as part of the 2004 private placement of $6,900.
During 2003 we consumed $710,800 of cash in our operating activities. This
consumption of cash related primarily to our net loss of $1,886,600, which
included non-cash charges, primarily depreciation and amortization of
$1,248,400, the write-off of fixed assets abandoned as part of our 2003
restructuring of $42,200, the loss on assets disposed in our normal operations
of $4,300, which were partially offset by a decrease in our provision for
doubtful accounts of $3,500, and an aggregate decrease in cash flow from our
operating assets and liabilities of $115,600. We consumed $225,700 of cash in
our investing activities, resulting primarily from the capitalization of
software development costs of $282,200 and the purchase of fixed assets of
$1,600, which were partially offset by a $58,100 decrease in other assets. We
generated positive financing cash flows of $2,800, resulting from the proceeds
of the sale of common stock to our employees under the provisions of our
employee stock purchase plan.
We are planning to increase investments in our operations during 2006 and to
fund these increases through our cash on hand, as of December 31, 2005, and our
2006 anticipated revenue streams. We are aggressively looking at ways to improve
our revenue stream, including through the development of new products and
further acquisitions. 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 maintaining our current revenue stream, coupled
with our cash on hand, will be sufficient to support our operational plans for
2006.
Cash and cash equivalents
As of December 31, 2005, cash and cash equivalents were approximately $3,528,100
as compared with $675,300 as of December 31, 2004. The main reason for our
increased cash position was the influx of cash from the 2005 private placement.
We anticipate that our cash and cash equivalents as of December 31, 2005,
together with revenue from 2006 operations will be sufficient to fund our
anticipated expenses during the next twelve months. However, due to the inherent
uncertainties associated with predicting future operations, there can be no
assurances that these resources will be sufficient to fund our anticipated
expenses during the next twelve months.
Accounts receivable, net
At December 31, 2005 and 2004, we had approximately $763,300 and $518,900,
respectively, in accounts receivable, net of allowances totaling $46,800 at each
date. The increase in our net accounts receivable balance was primarily due to
23
an approximate $320,000 order received from one sporadic customer late in 2005
that was not paid until early 2006. This customer had no outstanding balance
with us at year end 2004. Partially offsetting this amount was an approximate
$60,000 decrease in the 2005 year end receivable balance of one of our
significant recurring customers, as compared with their year end 2004 receivable
balance. During 2005 we wrote off receivables aggregating approximately $2,300.
From time to time, we could maintain individually significant accounts
receivable balances from one or more of our significant customers. If the
financial condition of any of these significant customers should deteriorate,
our operating results could be materially adversely affected.
Commitments and contingencies
We do not anticipate any material capital expenditure commitments for the next
twelve months.
The following table discloses our contractual commitments for future periods,
which consist entirely of leases for office space, as previously discussed and
assumes that we will occupy all current leased facilities for the full term of
the underlying leases:
Year ending December 31,
2006 $ 114,500
2007 $ 44,200
2008 $ 25,400
2009 and thereafter $ -
Rent expense aggregated approximately $123,100 and $95,700 for the years ended
December 31, 2005 and 2004, respectively.
As a condition of the 2004 private placement, we entered into an Investment
Advisory Agreement with Orin Hirschman, a significant stockholder of ours.
Pursuant to this agreement, in the event that we complete a transaction with a
third party introduced to us by Mr. Hirschman, we shall pay to Mr. Hirschman 5%
of the value of that transaction. The agreement, as amended, expires on January
29, 2008.
New Accounting Pronouncements
In May 2005, the Financial Accounting Standards Board (FASB) issued SFAS
No. 154, "Accounting Changes and Error Corrections - replacement of APB
Opinion No. 20 and FASB Statement No. 3." SFAS No. 154 changes the
accounting for and the reporting of a change in accounting principle by
requiring retrospective application to prior periods' financial statements
of changes in accounting principle unless impracticable. SFAS No. 154 is
effective for accounting changes made in fiscal years beginning after
December 31, 2005. We do not expect the adoption of SFAS No. 154 to have
a material impact on our results of operations, financial position or cash
flows.
In December 2004, FASB issued SFAS No. 123R, "Share-Based Payment," which
requires companies to expense the value of employee stock options and similar
awards. As of the effective date, we will be required to expense all awards
granted, modified, cancelled or repurchased as well as the portion of prior
awards for which requisite service has not yet been rendered, based on the
grant-date fair value of those awards as calculated for pro forma disclosures
under SFAS No. 123 "Stock-Based Compensation." We will apply SFAS No. 123R using
a modified version of prospective application.
Under this method, compensation cost is recognized on or after the required
effective date for the portion of outstanding awards for which the requisite
service has not yet been rendered, based on the grant-date fair value of those
awards calculated under SFAS No. 123R for either recognition or pro forma
disclosures. We adopted SFAS No. 123R as of January 1, 2006. We expect the
adoption SFAS No. 123R will have a material impact on our statement of
operations. Compensation expense associated with stock options and similar
awards will now be recorded in the statement of operations, instead of being
reported within the footnote disclosures to the financial statements. We expect
that such recorded future compensation expense, as calculated under SFAS No.
123R, will approximate amounts that have historically been disclosed within the
footnotes to our prior years' financial statements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are currently not exposed to any significant financial market risks from
changes in foreign currency exchange rates or changes in interest rates and do
not use derivative financial instruments. Substantially all of our revenue and
capital spending is transacted in U.S. dollars. However, in the future, we may
enter into transactions in other currencies. An adverse change in exchange rates
would result in a decline in income before taxes, assuming that each exchange
rate would change in the same direction relative to the U.S. dollar. In addition
to the direct effects of changes in exchange rates, such changes typically
affect the volume of sales or foreign currency sales price as competitors'
products become more or less attractive.
24
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Index to Consolidated Financial Statement
Page
Report of Independent Registered Public Accounting Firm 26
(Macias Gini & O'Connell LLP)
Report of Independent Registered Public Accounting Firm (BDO 27
Seidman, LLP)
Consolidated Balance Sheet as of December 31, 2005 and 2004 28
Consolidated Statements of Operations and Comprehensive Loss 29
for the Years Ended December 31, 2005, 2004 and 2003
Consolidated Statements of Shareholders' Equity for the Years 30
Ended December 31, 2005, 2004 and 2003
Consolidated Statements of Cash Flows for the Years Ended 32
December 31, 2005, 2004 and 2003
Summary of Significant Accounting Policies 33
Notes to Consolidated Financial Statements 36
25
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders of GraphOn Corporation
We have audited the accompanying consolidated balance sheet of GraphOn
Corporation and subsidiary (the "Company") as of December 31, 2005 and 2004 and
the related consolidated statements of operations and comprehensive loss,
shareholders' equity and cash flows for each of the two years in the period
ended December 31, 2005. We have also audited the accompanying financial
statement schedule. These financial statements and the schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audits to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
consideration of internal control over financial reporting as a basis for
designing audit procedures that are appropriate in the circumstances, but not
for the purpose of expressing an opinion on the effectiveness of the Company's
internal control over financial reporting. Accordingly, we express no such
opinion. An audit also includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of GraphOn
Corporation and subsidiary as of December 31, 2005 and 2004, and the
consolidated results of its operations and its cash flows for each of the two
years in the period ended December 31, 2005 in conformity with accounting
principles generally accepted in the United States of America. Also, in our
opinion, the related financial statement schedule presents fairly, in all
material respects, the information set forth therein.
/s/ Macias Gini & O'Connell LLP
Macias Gini & O'Connell LLP
Sacramento, California
April 17, 2006 (August 8, 2006 as to the second paragraph of Note 14)
26
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders of GraphOn Corporation
We have audited the accompanying consolidated statements of operations and
comprehensive loss, shareholders' equity, and cash flows of GraphOn Corporation
and Subsidiary (the Company) for the year ended December 31, 2003. We have also
audited the financial statement schedule listed in the Index at Item 15(a) as of
and for the year ended December 31, 2003. These financial statements and
schedule are the responsibility of the Company's management. Our responsibility
is to express an opinion on these financial statements and schedule based on our
audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements and schedule are free of material misstatement. The Company is not
required to have, nor were we engaged to perform, an audit of its internal
control over financial reporting. Our audit included consideration of internal
control over financial reporting as a basis for designing audit procedures that
are appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, and schedule, assessing the accounting principles used
and significant estimates made by management, as well as evaluating the overall
presentation of the financial statements and schedule. We believe that our audit
provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the results of operations and cash flows of
GraphOn Corporation and Subsidiary for the year ended December 31, 2003 in
conformity with accounting principles generally accepted in the United States
of America.
Also, in our opinion, the financial statement schedule as of and for the year
ended December 31, 2003, presents fairly in all material respects the
information set forth therein.
The accompanying financial statements have been prepared on a going concern
basis, which contemplates the realization of assets and the settlement of
liabilities in the normal course of business. As discussed in Note 1 to the
financial statements, the Company has suffered recurring losses and has absorbed
significant cash in its operating activities. Further, the Company has limited
alternative sources of financing available to fund any additional cash required
for its operations or otherwise. These matters raise substantial doubt about the
ability of the Company to continue as a going concern. Management's plan in
regard to these matters is also described in Note 1. The accompanying financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
/s/ BDO Seidman, LLP
BDO Seidman, LLP
San Jose, California
February 23, 2004
27
GraphOn Corporation
Consolidated Balance Sheets
As of December 31, 2005 and 2004
Assets
Current Assets 2005 2004
-------------- ------------ ------------
Cash and cash equivalents $ 3,528,100 $ 675,300
Accounts receivable, net of allowance
for doubtful accounts of $46,800 and $46,800 763,300 518,900
Prepaid expenses and other current assets 43,700 24,100
------------ ------------
Total Current Assets 4,335,100 1,218,300
------------ ------------
Property and equipment, net 94,800 75,400
Capitalized software, net 80,100 273,700
Patents, net 4,519,400 -
Note receivable - related party - 350,000
Deferred acquisition costs - 269,700
Other assets 7,300 37,300
------------ ------------
Total Assets $ 9,036,700 $ 2,224,400
============ ============
Liabilities and Shareholders' Equity
------------------------------------
Current Liabilities
Accounts payable $ 145,800 $ 250,200
Accrued expenses 196,300 231,400
Accrued wages 484,700 260,100
Deferred revenue 1,014,600 689,800
------------ ------------
Total Current Liabilities 1,841,400 1,431,500
------------ ------------
Deferred revenue 777,400 426,600
------------ ------------
Total Liabilities 2,618,800 1,858,100
------------ ------------
Commitments and contingencies (Note 11) - -
Shareholders' 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, 46,167,047
and 21,716,765 shares issued and outstanding 4,600 2,200
Additional paid-in capital 58,342,700 46,930,700
Deferred compensation (6,200) -
Note receivable - shareholder (260,100) -
Notes receivable - directors - (50,300)
Accumulated other comprehensive loss - (400)
Accumulated deficit (51,663,100) (46,515,900)
------------ ------------
Total Shareholders' Equity 6,417,900 366,300
------------ ------------
Total Liabilities and Shareholders' Equity $ 9,036,700 $ 2,224,400
============ ============
See accompanying summary of significant accounting policies and notes
to consolidated financial statements
28
GraphOn Corporation
Consolidated Statements of Operations and Comprehensive Loss
For the Year Ended December 31,
Revenue 2005 2004 2003
- ------- ------------ ------------ ------------
Product licenses $ 3,772,400 $ 2,395,200 $ 3,172,100
Service fees 1,358,600 1,015,000 830,900
Other 49,200 119,600 167,300
------------ ------------ ------------
Total Revenue 5,180,200 3,529,800 4,170,300
------------ ------------ ------------
Cost of Revenue
Product costs 207,900 572,100 1,017,300
Service costs 295,800 331,700 354,300
------------ ------------ ------------
Total Cost of Revenue 503,700 903,800 1,371,600
------------ ------------ ------------
Gross Margin 4,676,500 2,626,000 2,798,700
------------ ------------ ------------
Operating Expenses
Selling and marketing 1,523,000 1,383,700 1,679,800
General and administrative 3,042,100 1,183,600 1,419,100
Research and development 1,277,600 1,500,900 1,515,000
Restructuring charges - - 80,100
------------ ------------ ------------
Total Operating Expenses 5,842,700 4,068,200 4,694,000
------------ ------------ ------------
Loss From Operations (1,166,200) (1,442,200) (1,895,300)
------------ ------------ ------------
Other Income (Expense)
Interest and other income 41,700 14,700 13,000
Interest and other expense (4,500) - (4,300)
------------ ------------ ------------
Total Other Income, net 37,200 14,700 8,700
------------ ------------ ------------
Loss Before Provision for Income Tax (1,129,000) (1,427,500) (1,886,600)
Provision for income tax 18,200 - -
------------ ------------ ------------
Net Loss (1,147,200) (1,427,500) (1,886,600)
Other Comprehensive Income
Foreign currency translation adjustment - 1,000 1,000
------------ ------------ ------------
Comprehensive Loss (1,147,200) (1,426,500) (1,885,600)
Deemed dividends on preferred stock (4,000,000) - -
------------ ------------ ------------
Loss Attributable to Common Shareholders $ (5,147,200) $ (1,426,500) $ (1,885,600)
============ ============ ============
Basic and Diluted Loss per Common Share $ (0.12) $ (0.07) $ (0.11)
============ ============ ============
Weighted Average Common Shares Outstanding 41,833,535 21,307,966 16,607,328
============ ============ ============
See accompanying summary of significant accounting policies and notes
to consolidated financial statements
29
GraphOn Corporation
Consolidated Statements of Shareholders' Equity
For the Year Ended December 31,
2005 2004 2003
Preferred stock - shares outstanding ------------ ------------ ------------
Beginning Balance - - -
Private placement of preferred stock and warrants 148,148 - -
Conversion of preferred stock to common (148,148) - -
------------ ------------ ------------
Ending balance - - -
============ ============ ============
Common stock - shares outstanding
Beginning Balance 21,716,765 16,618,459 16,580,719
Conversion of preferred stock to common 14,814,800 - -
Issuance of stock for NES acquisition 9,599,993 - -
Private placement of common stock - 5,000,000
Employee stock purchase issuances 35,489 37,638 37,740
Exercise of warrants - 30,000 -
Other - 30,668 -
------------ ------------ ------------
Ending balance 46,167,047 21,716,765 16,618,459
============ ============ ============
Common stock, amount
Beginning Balance $ 2,200 $ 1,700 $ 1,700
Conversion of preferred stock to common 1,500 - -
Issuance of stock for NES acquisition 900 - -
Private placement - common stock - 500 -
------------ ------------ ------------
Ending balance $ 4,600 $ 2,200 $ 1,700
------------ ------------ ------------
Additional paid-in capital
Beginning Balance $ 46,930,700 $ 45,985,300 $ 45,982,500
Private placement proceeds preferred stock and warrants 4,000,000 - -
Costs of private placement - preferred stock and warrants (525,300) - -
Private placement costs common stock - 1,149,500 -
Costs of private placement - common stock - (218,600) -
Deemed dividend - preferred shareholders 3,136,000 - -
Accreted dividend - preferred shareholders 864,000 - -
Agency fees - Agent's warrants (251,400) - -
Non-cash contribution - Agent's warrants 251,400 - -
Conversion of preferred stock to common (1,500) - -
Issuance of stock for NES acquisition 3,915,900 - -
Stock-based compensation expense 8,900 - -
Employee stock purchase plan issuances 10,000 9,000 2,800
Exercise of warrants - 6,900 -
Other 4,000 (1,400) -
------------ ------------ ------------
Ending balance $ 58,342,700 $ 46,930,700 $ 45,985,300
------------ ------------ ------------
Deferred compensation
Beginning Balance $ - $ - $ -
Issuance of options (8,900) - -
Amortization of deferred compensation expense 2,700 - -
------------ ------------ ------------
Ending balance $ (6,200) $ - $ -
------------ ------------ ------------
30
Directors' notes receivable
Beginning Balance $ (50,300) $ (50,300) $ (50,300)
Note payments - directors 50,300 - -
------------ ------------ ------------
Ending balance $ - $ (50,300) $ (50,300)
------------ ------------ ------------
Shareholder note receivable
Beginning Balance $ - $ - $ -
Reclassification of note from related party to shareholder (350,000) - -
Note payments - shareholder 89,900 - -
------------ ------------ ------------
Ending balance $ (260,100) $ - $ -
------------ ------------ ------------
Accumulated other comprehensive income (loss)
Beginning Balance $ (400) $ (1,400) $ (2,400)
Foreign currency translation - 1,000 1,000
Translation write off - liquidation of subsidiary 400 - -
------------ ------------ ------------
Ending balance $ - $ (400) $ (1,400)
------------ ------------ ------------
Accumulated deficit
Beginning Balance $(46,515,900) $(45,088,400) $(43,201,800)
Deemed dividend - beneficial conversion feature (3,136,000) - -
Accreted dividend - discount on private placement (864,000) - -
Net Loss (1,147,200) (1,427,500) (1,886,600)
------------ ------------ ------------
Ending balance $(51,663,100) $(46,515,900) $(45,088,400)
------------ ------------ ------------
Total shareholders' equity $ 6,417,900 $ 366,300 $ 846,900
============ ============ ============
<FN>
See accompanying summary of significant accounting policies and notes
to consolidated financial statements
</FN>
31
GraphOn Corporation
Consolidated Statements of Cash Flow
For the Year Ended December 31,
2005 2004 2003
Cash Flows From Operating Activities ------------ ------------ ------------
Net Loss $ (1,147,200) $ (1,427,500) $ (1,886,600)
Adjustments to reconcile net loss to net cash provided by (used in)
operating activities:
Depreciation and amortization 1,065,800 664,700 1,248,400
Non-cash restructuring charge - - 42,200
Loss on disposal of fixed assets - - 4,300
Amortization of deferred compensation 2,700 - -
Charges to provision for doubtful accounts - - 16,300
Reduction of provision for doubtful accounts - - (19,800)
Repayment of directors' notes receivable 50,300 - -
Repayment of note receivable shareholder - - -
Interest accrued on directors' notes receivable (300) (1,400) -
Interest payments - directors' notes receivable 4,300 - -
Interest payments - shareholder note receivable 89,900 - -
Proceeds from accrued interest on note receivable shareholder 12,600 - -
Interest accrued on note receivable shareholder (12,600) - -
Changes in operating assets and liabilities
Accounts receivable (244,400) 2,200 (179,700)
Prepaid expenses and other assets (19,600) (1,000) 168,900
Accounts payable 51,300 18,400 (176,400)
Accrued expenses (5,800) 3,300 (366,700)
Accrued wages 224,600 (46,100) 42,400
Deferred revenue 675,600 (75,600) 395,900
------------ ------------ ------------
Net Cash Provided By (Used In) Operating Activities 747,200 (863,000) (710,800)
------------ ------------ ------------
Cash Flows Used In Investing Activities
Capitalization of software development costs - - (282,200)
Acquisition costs - NES (699,000) - -
Deferred acquisition costs - NES - (59,200) -
Note receivable - related party - (350,000) -
Capital expenditures (70,600) (33,400) (1,600)
Other assets (2,500) 7,100 58,100
------------ ------------ ------------
Net Cash Used In Investing Activities: (772,100) (435,500) (225,700)
------------ ------------ ------------
Cash Flows Provided By (Used In) Financing Activities
Proceeds from sale of common stock under Employee stock purchase plan 10,000 9,000 2,800
Proceeds from exercise of warrants - 6,900 -
Proceeds from private placement of preferred stock and warrants 3,335,000 1,150,000 -
Costs of private placement of preferred stock and warrants (467,300) (218,600) -
------------ ------------ ------------
Net Cash Provided By Financing Activities: 2,877,700 947,300 2,800
------------ ------------ ------------
Effect of exchange rate fluctuations on cash and cash equivalents - 1,000 1,000
Net Increase (Decrease) in Cash and Cash Equivalents 2,852,800 (350,200) (932,700)
Cash and Cash Equivalents, beginning of period 675,300 1,025,500 1,958,200
------------ ------------ ------------
Cash and Cash Equivalents, end of period $ 3,528,100 $ 675,300 $ 1,025,500
============ ============ ============
<FN>
See accompanying summary of significant accounting policies and notes to consolidated financial statements
</FN>
32
GraphOn Corporation
Summary of Significant Accounting Policies
The Company. GraphOn Corporation (the "Company") was founded in May 1996 and is
incorporated in the state of Delaware. The Company's headquarters are currently
in Santa Cruz, California. The Company develops, markets, sells and supports
business connectivity software, including Unix, Linux and Windows server-based
software, with an immediate focus on web-enabling applications for use by
Independent Software Vendors (ISVs), Application Service Providers (ASPs),
corporate enterprises, governmental and educational institutions, and others,
primarily in the United States, Asia and Europe.
Basis of Presentation and Use of Estimates. The consolidated financial
statements include the accounts of the Company and its subsidiary (collectively,
the "Company"), significant intercompany accounts and transactions are
eliminated upon consolidation. In the Company's opinion, the consolidated
financial statements presented herein include all necessary adjustments,
consisting of only normal recurring adjustments to fairly state the Company's
financial position, results of operations and cash flows for the periods
indicated. The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. These estimates include the allowance for doubtful
accounts, the estimated lives of intangible assets, depreciation of fixed assets
and accrued liabilities, among others. Actual results could differ materially
from those estimates.
Cash and Cash Equivalents. The Company considers all highly liquid investments
purchased with original maturities of three months or less to be cash
equivalents.
Property and Equipment. Property and equipment are stated at cost. Depreciation
is calculated using the straight-line method over the estimated useful lives of
the respective assets, generally three to seven years. Amortization of leasehold
improvements is calculated using the straight-line method over the lesser of the
lease term or useful lives of the respective assets, generally seven years.
Shipping and Handling. Shipping and handling costs are included in cost of
revenue for all periods presented.
Purchased Technology. Purchased technology is amortized on a straight line basis
over the expected life of the related technology or five years, whichever is
less.
Patents. The patents acquired in the NES acquisition are being amortized over
their estimated remaining economic lives, currently estimated to be
approximately 5 years, as of December 31, 2005. Costs associated with filing,
documenting or writing patents are expensed as incurred.
Capitalized Software Costs. Under the criteria set forth in SFAS No. 86,
"Accounting for the Cost of Computer Software to be Sold, Leased or Otherwise
Marketed," development costs incurred in the research and development of new
software products are expensed as incurred until technological feasibility, in
the form of a working model, has been established, at which time such costs are
capitalized until the product is available for general release to customers.
Capitalized costs are amortized to cost of sales based on either estimated
current and future revenue for each product or straight-line amortization over
the shorter of three years or the remaining estimated life of the product,
whichever produces the higher expense for the period.
Impairment of Intangible Assets. Impairment tests on intangible assets are
performed on an annual basis and between annual tests in certain circumstances.
In response to changes in industry and market conditions, the Company may
strategically realign resources and consider restructuring, disposing of, or
otherwise exiting businesses, which could result in an impairment of intangible
assets.
Revenue. Software license revenues are recognized when a non-cancelable license
agreement has been signed and the customer acknowledges an unconditional
obligation to pay, the software product has been delivered, there are no
uncertainties surrounding product acceptance, the fees are fixed or determinable
and collection is considered probable. Delivery is considered to have occurred
when title and risk of loss have been transferred to the customer, which
generally occurs when the media containing the licensed programs is provided to
a common carrier. In the case of electronic delivery, delivery occurs when the
customer is given access to the licensed programs. If collectibility is not
considered probable, revenue is recognized when the fee is collected.
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
33
multiple-element arrangement, all revenue from the arrangement is deferred until
such evidence exists or until all elements are delivered. The Company recognizes
revenue from the sale of software licenses when all the following conditions are
met:
o Persuasive evidence of an arrangement exists;
o Delivery has occurred or services have been rendered;
o The price to the customer is fixed or determinable; and
o Collectibility is reasonably assured.
Revenues recognized from multiple-element software arrangements are allocated to
each element of the arrangement based on the fair values of the elements, such
as licenses for software products, maintenance, consulting services or customer
training. The determination of fair value is based on objective evidence. The
Company limits its assessment of objective evidence for each element to either
the price charged when the same element is sold separately or the price
established by management having the relevant authority to do so, for an element
not yet sold separately. If evidence of fair value of all undelivered elements
exists but evidence does not exist for one or more delivered elements, then
revenue is recognized using the residual method. Under the residual method, the
fair value of the undelivered elements is deferred and the remaining portion of
the arrangement fee is recognized as revenue.
Certain of the Company's ISV, VAR or ASP customers (individually "reseller" or
collectively "resellers") prepay for licenses they intend to resell. Upon
receipt of the prepayment, if all other revenue recognition criteria outlined
above have been met, the Company recognizes licensing revenue when the reseller
is given access to the licensed programs. The resellers provide monthly
sell-through reports that detail, for the respective month, various items, such
as the number of licenses purchased, the number they have sold to third 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. The Company monitors
the resellers' inventory records via the monthly sell-through reports.
Other resellers will only purchase licenses when they have already closed a deal
to sell the Company's product to another party. These resellers will typically
submit a purchase order 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, the Company recognizes 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 the
Company's software programs.
The Company recognizes revenue from service contracts ratably over the related
contract period, which generally ranges from one to five years.
Segment information. The Company operates in one business segment.
Allowance for Doubtful Accounts. The allowance for doubtful accounts is based on
assessments of the collectibility of specific customer accounts and the aging of
the accounts receivable. If there is a deterioration of a major customer's
credit worthiness or actual defaults are higher than historical experience, the
allowance for doubtful accounts is increased.
Income Taxes. Under SFAS No. 109, "Accounting for Income Taxes," deferred income
taxes are recognized for the tax consequences of temporary differences between
the financial statement and income tax bases of assets, liabilities and
carryforwards using enacted tax rates. Valuation allowances are established,
when necessary, to reduce deferred tax assets to the amount expected to be
realized. Realization is dependent upon future pre-tax earnings, the reversal of
temporary differences between book and tax income, and the expected tax rates in
effect in future periods.
Fair Value of Financial Instruments. The Company used the following methods and
assumptions in estimating the fair value disclosures for financial instruments:
Cash and cash equivalents: The carrying amount reported on the balance sheet
for cash and cash equivalents approximates fair value.
Notes receivable: The carrying amount reported on the balance sheet for the
note receivable - shareholder reflects the current principal balance
remaining to be repaid to the Company. The estimated fair value is based on
the Company's estimates of interest rates on similar instruments.
Long-Lived Assets. Long-lived assets are assessed for possible impairment
whenever events or changes in circumstances indicate that the carrying amounts
may not be recoverable, or whenever the Company has committed to a plan to
dispose of the assets. Measurement of the impairment loss is based on the fair
value of the assets. Generally, the Company determines fair value based on
34
appraisals, current market value, comparable sales value, and undiscounted
future cash flows as appropriate. Assets to be held and used affected by such
impairment loss are depreciated or amortized at their new carrying amount over
the remaining estimated life; assets to be sold or otherwise disposed of are not
subject to further depreciation or amortization.
Loss Contingencies. The Company is subject to the possibility of various loss
contingencies arising in the ordinary course of business. The Company considers
the likelihood of the loss or impairment of an asset or the incurrence of a
liability as well as its 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. The Company regularly
evaluates current information available to it to determine whether such accruals
should be adjusted.
Stock-Based Incentive Programs. The Company accounts for its stock-based
incentive programs using the intrinsic value method, as prescribed by Accounting
Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to
Employees" and interpretations thereof (collectively APB 25). Accordingly, the
Company records deferred compensation expense costs related to its employee
stock options when the market price of the underlying stock exceeds the exercise
price of each option on the date of grant. The Company records and measures
deferred compensation for stock options granted to non-employees, other than
members of the board, at their fair value. Deferred compensation is expensed on
a straight-line basis over the vesting period of the related stock option for
options issued to employees. Deferred compensation is expensed on a
straight-line basis over the shorter of the vesting period of the related stock
option or the contractual period of service for option grants to non-employees.
The Company did not grant any stock options at exercise prices below the fair
market value of the Company's common stock on the grant date during the years
ended December 31, 2005, 2004 or 2003.
As of December 31, 2005, the Company's deferred compensation balance was $6,200.
The accompanying statements of operations reflect stock-based compensation
expense of $2,700, $0 and $0 for the years ended December 31, 2005, 2004 and
2003, respectively.
An alternative to the intrinsic value method of accounting for stock-based
compensation is the fair value approach prescribed by SFAS No. 123, "Accounting
for Stock-Based Compensation" as amended by SFAS 148 (hereinafter collectively
referred to as SFAS 123). If the Company followed the fair value approach, the
Company would be required to record deferred compensation based on the fair
value of the stock option at the date of grant. The fair value of the stock
option must be computed using an option-pricing model, such as the Black-Scholes
option valuation method, at the date of grant. The deferred compensation
calculated under the fair value method would then be amortized over the
respective vesting period of the stock option. See New Accounting
Pronouncements.
SFAS 123 requires the Company to provide pro forma information regarding net
income (loss) and earnings (loss) per share as if compensation cost for the
stock option plan had been determined in accordance with the fair value-based
method prescribed in SFAS 123 throughout the year. The Company estimated the
fair value of stock options at the grant date by using the Black-Scholes option
pricing-model with the following weighted average assumptions used for grants in
2005, 2004 and 2003: dividend yield of 0; expected volatility of 60%; risk-free
interest rate of 1.5% (except for 2003, which was 2.5%) and expected lives
(approximately) of five years, for all plan options.
Under SFAS 123, the Company's net loss and the basic and diluted net loss per
common share would have been adjusted to the pro forma amounts below.
Year Ended December 31, 2005 2004 2003
------------ ------------ ------------
Net loss as reported $ (1,147,200) $ (1,427,500) $ (1,886,600)
Add: stock-based employee compensation expense included in reported
net loss, net of related tax effects - - -
Deduct: deemed dividends on preferred stock (4,000,000) - -
Deduct: total stock-based compensation determined under the fair
value-based method for all accounts, net of related tax effects (425,000) (191,700) (265,300)
------------ ------------ ------------
Pro forma loss $ (5,572,200) $ (1,619,200) $ (2,151,900)
============ ============ ============
Basic and diluted loss per share
As reported $ (0.12) $ (0.07) $ (0.11)
Pro forma $ (0.13) $ (0.08) $ (0.13)
35
Earnings Per Share of Common Stock. SFAS No. 128, "Earnings Per Share," provides
for the calculation of basic and diluted earnings per share. Basic earnings per
share includes no dilution and is computed by dividing income available to
common shareholders by the weighted-average number of common shares outstanding
for the period. Diluted earnings per share reflects the potential dilution of
securities by adding other common stock equivalents, including common stock
options, warrants and redeemable convertible preferred stock, in the weighted
average number of common shares outstanding for a period, if dilutive.
Potentially dilutive securities are excluded from the computation if their
effect is antidilutive. For the years ended December 31, 2005, 2004 and 2003,
19,022,157, 6,641,957 and 2,104,483 shares, respectively, of common stock
equivalents were excluded from the computation of diluted earnings per share
since their effect would be antidilutive.
Comprehensive Income. SFAS No. 130, "Reporting Comprehensive Income,"
establishes standards for reporting comprehensive income and its components in a
financial statement that is displayed with the same prominence as other
financial statements. Comprehensive income, as defined, includes all changes in
equity (net assets) during the period from non-owner sources. Examples of items
to be included in comprehensive income, which are excluded from net income,
include foreign currency translation adjustments and unrealized gain/loss of
available-for-sale securities. The individual components of comprehensive income
(loss) are reflected in the statements of shareholders' equity. As of December
31, 2005, 2004 and 2003 accumulated other comprehensive income (loss) was
comprised of foreign currency translation gains.
New Accounting Pronouncements. In May 2005, the Financial Accounting Standards
Board (FASB) issued SFAS No. 154, "Accounting Changes and Error Corrections -
replacement of APB Opinion No. 20 and FASB Statement No. 3." SFAS No. 154
changes the accounting for and the reporting of a change in accounting principle
by requiring retrospective application to prior periods' financial statements of
changes in accounting principle unless impracticable. SFAS No. 154 is effective
for accounting changes made in fiscal years beginning after December 31, 2005.
The Company does not expect the adoption of SFAS No. 154 to have a material
impact on its results of operations, financial position or cash flows.
In December 2004, the FASB issued SFAS No. 123R, "Share-Based Payment," which
requires companies to expense the value of employee stock options and similar
awards. As of the effective date, the Company will be required to expense all
awards granted, modified, cancelled or repurchased as well as the portion of
prior awards for which requisite service has not yet been rendered, based on the
grant-date fair value of those awards as calculated for pro forma disclosures
under SFAS No. 123 "Stock-Based Compensation." The Company will apply SFAS No.
123R using a modified version of prospective application.
Under this method, compensation cost is recognized on or after the required
effective date for the portion of outstanding awards for which the requisite
service has not yet been rendered, based on the grant-date fair value of those
awards calculated under SFAS No. 123R for either recognition or pro forma
disclosures. The Company adopted SFAS No. 123R as of January 1, 2006. The
Company expects the adoption SFAS No. 123R will have a material impact on its
statement of operations. Compensation expense associated with stock options and
similar awards will now be recorded in the statement of operations, instead of
being reported within the footnote disclosures to the financial statements. The
Company expects such recorded future compensation expense, as calculated under
SFAS No. 123R, to approximate amounts that have historically been disclosed
within the footnotes to prior years' financial statements.
Reclassifications. Certain amounts in the prior years' financial statements have
been reclassified to conform to the current year's presentation.
Notes to Consolidated Financial Statements
1. Patents (Network Engineering Software Acquisition)
On January 31, 2005, the Company acquired all of the outstanding common stock of
Network Engineering Software ("NES") in exchange for 9,599,993 shares of the
Company's common stock, valued at $3,916,800, and approximately $897,800 in cash
payments to settle various claims against NES prior to the acquisition.
Approximately $665,000 of the $897,800 cash payments was made in December 2004
by AIGH Investment Partners, LLC ("AIGH"), an affiliate of a principal
stockholder (Orin Hirschman), to settle, on the Company's behalf, certain third
party litigation against NES. The Company reimbursed this amount through a
partial credit against the price of its securities acquired by AIGH in the 2005
private placement (See Note 2).
The Company incurred $525,800 of transaction costs, resulting in a purchase
price of $5,340,400. The acquisition was accounted for as a business
combination, in accordance with SFAS No. 141, "Business Combinations."
Accordingly, the assets acquired (primarily consisting of patents, patent
applications, and in-process patent applications) have been recorded at their
estimated fair value. The results of operations of NES are included in the
Company's statement of operations for the year ended December 31, 2005.
In connection with the acquisition, the Company recorded a deferred tax
liability of $2,151,200, resulting from a difference between the tax basis and
financial statement basis of the assets acquired. Furthermore, the Company has
recorded a corresponding $2,151,200 reduction in its valuation allowance on its
deferred tax assets as of March 31, 2005 to reflect management's estimate that
36
it is more likely than not that the Company will realize the tax benefits from
utilization of certain of its tax net operating loss carryforwards from future
reversals of the taxable temporary differences arising from the NES acquisition.
These amounts have been netted together on the Company's consolidated balance
sheet.
The estimated cost of the patent related assets is being amortized over its
estimated remaining five year life, as of December 31, 2005, using the
straight-line method. For the year ended December 31, 2005, approximately
$821,000 of amortization was charged against the cost of the patent related
assets. No such amortization was charged in the prior year. The Company
anticipates charging approximately $889,000 of amortization against the cost of
the patent related assets in each of the years ended December 31, 2006, 2007,
2008, 2009 and 2010 and approximately $74,000 in the year ended December 31,
2011.
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 above.
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 periods. 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.
Year Ended December 31,
----------------------------
2005 2004
------------ ------------
Revenue $ 5,180,200 $ 3,529,800
Net loss (1,253,300) (2,990,500)
Net loss attributable to common shareholders (5,253,300) (6,990,500)
Loss per common share - basic and diluted (0.11) (0.15)
The allocation of the purchase price to the identifiable intangible assets
acquired and liabilities assumed was as follows:
Fair value of stock issued $ 3,916,800
Fair value of liabilities settled with cash 897,800
Transaction costs settled with cash 525,800
-----------
Purchase price of patent related assets $ 5,340,400
===========
The fair value of the stock issued was based upon the issuance of 9,599,993
shares of the Company's common stock at approximately $0.408 per share. The fair
value of the liabilities settled with cash includes the $665,000 cash payments
made by AIGH, as previously discussed.
2. Deemed Dividends on Preferred Stock
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 issued to AIGH;
See Note 1) 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 the commitment date of the 2005 private
placement 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.
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 non-detachable 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 was recognized as if this
amount had been declared a non-cash dividend to the preferred shareholders when
the preferred stock converted to common stock.
37
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
was also recognized as if this amount had been declared a non-cash dividend to
the preferred shareholders when the preferred stock converted to common stock.
On March 29, 2005, the Company's stockholders approved an amendment to the
Company's certificate of incorporation increasing its authorized but unissued
common stock from 45,000,000 to 195,000,000 shares. Upon the effectiveness of
the certificate of amendment to the Company's certificate of incorporation
implementing this increase, each share of Series A preferred stock was
automatically converted into 100 shares of common stock and each warrant was
automatically converted into a warrant to purchase that number of shares of
common stock equal to the number of shares of preferred stock subject to the
warrant multiplied by 100. As a result, all outstanding shares of Series A
Preferred Stock (148,148 shares) were converted into 14,814,800 shares of common
stock. In addition, upon the effectiveness of the certificate of amendment, all
outstanding warrants to purchase shares of Series A preferred stock (14,815
shares) and Series B preferred stock (81,477 shares) were converted into
five-year warrants to purchase 1,481,500 shares of common stock at an exercise
price of $0.27 per share and five-year warrants to purchase 8,147,700 shares of
common stock at an exercise price of $0.40 per share, respectively.
3. Property and Equipment.
Property and equipment consisted of the following:
December 31 2005 2004
----------- ------------ ------------
Equipment $ 940,300 $ 903,200
Furniture & fixtures 252,200 236,700
Leasehold improvements 48,400 30,400
------------ ------------
1,240,900 1,170,300
Less: accumulated depreciation and amortization 1,146,100 1,094,900
------------ ------------
$ 94,800 $ 75,400
============ ============
4. Capitalized Software.
Capitalized software consisted of the following:
December 31, 2005 2004
------------ ------------ ------------
Capitalized software development costs $ 719,500 $ 719,500
Less: accumulated amortization 639,400 445,800
------------ ------------
$ 80,100 $ 273,700
============ ============
5. Note Receivable - Shareholder.
On October 6, 2004, the Company entered into a letter of intent to acquire NES
(see Note 1). The Company contemporaneously loaned $350,000 to Ralph Wesinger,
NES' majority shareholder, to fund his purchase of all the NES common stock then
owned by another person. The Company received Mr. Wesinger's 5-year promissory
note, which bears interest at a rate of 3.62% per annum and which was secured by
his approximately 65% equity interest in NES, to evidence this loan. Mr.
Wesinger also agreed that the Company would receive 25% of the gross proceeds of
any sale or transfer of any of Mr. Wesinger's NES shares, which shall be applied
in reduction of the then outstanding balance of his note, until the note is paid
in full or becomes due, whichever occurs first. The Company has the option to
accelerate the maturity date of this note upon the occurrence of certain events.
Upon completion of the Company's acquisition of NES (see Note 1), the 52,039
shares of NES common stock collateralizing the note receivable were replaced by
4,830,207 shares of the Company's common stock. As of December 31, 2005,
1,500,000 of such shares had been sold; resulting in payments to the Company of
approximately $89,900 and $15,600, principal and interest, respectively, and
3,330,207 shares collateralized the note.
38
6. Accrued Liabilities.
Accrued liabilities consisted of the following:
December 31, 2005 2004
------------ ------------ ------------
Professional fees $ 125,800 $ 212,200
2005 private placement fees 34,200 -
Provision for taxes 18,200 -
Other 18,100 19,200
------------ ------------
$ 196,300 $ 231,400
============ ============
7. Restructuring Charge.
During 2003 the Company negotiated settlements of the leases for its former
offices in Bellevue, Washington and Morgan Hill, California, which completed the
restructuring activities that had been approved under Emerging Issues Task Force
(EITF) 94-3, "Liability Recognition for Certain Employee Termination Benefits
and Other Costs to Exit an Activity (Including Certain Costs Incurred in a
Restructuring)," during 2002 and had begun in 2002. Additionally, the Company
relocated its Morgan Hill, California offices from 400 Cochrane Circle to 105
Cochrane Circle and further disposed of certain assets that were no longer in
service. In conjunction with these closures, headcount was reduced in all
operating departments and the costs of leasehold improvements and other assets
that were abandoned were written off. A summary of the restructuring charges
recorded during 2003 related to these activities is as follows:
Additional Ending Balance
Restructuring Cash Non-cash Restructuring
Charge Payments Charges Accrual
----------------------------- ------------- ---------- ---------- -------------
Year ended December 31, 2003:
Opening accrual balance $ - $ - $ - $ 282,200
Fixed assets abandonment 42,200 - (42,200) -
Lease settlement - rent 36,800 (269,000) - (232,200)
Deposits forfeited 16,000 - (56,000) (40,000)
Commissions 12,000 (22,000) - (10,000)
Other (1) (26,900) - 26,900 -
------------- ---------- ---------- -------------
Totals $ 80,100 $ (291,000) $ (71,300) $ -
============= ========== ========== =============
(1) Includes the write-off of deferred rent associated with the Morgan Hill
lease and other miscellaneous items.
During June 2003, the Company negotiated a buy out of the lease for its former
engineering offices in Bellevue, Washington. The total buy out price was
approximately $184,000 and consisted of a lump-sum cash payment of $144,000, the
forfeiture of an approximate $40,000 security deposit and a $10,000 commission
to the real estate broker who was involved in the transaction. It is estimated
that the buy out saved approximately $355,800 over what would have been the
remainder of the lease term.
During August 2003, the Company negotiated a buy out of the lease for its former
corporate offices in Morgan Hill, California. The total buy out price was
approximately $153,000 and consisted of a lump-sum cash payment of $125,000, the
forfeiture of an approximate $16,000 security deposit and a $12,000 commission
to the real estate broker who was involved in the transaction. It is estimated
that the buy out saved approximately $270,000 over what would have been the
remainder of the lease term.
8. Stockholders' Equity.
Common Stock. During 2004 the Company issued 5,000,000 shares of common stock as
part of a private placement (the "2004 private placement") that resulted in
gross proceeds of $1,150,000, which were offset by costs associated with the
private placement aggregating approximately $218,600. The Company issued 30,000
shares of common stock upon the exercise of warrants that had been issued in
conjunction with the 2004 private placement, resulting in gross proceeds of
$6,900.
During 2005 the Company issued 148,148 shares of Series A preferred stock and
five-year warrants to purchase 74,070 shares of Series B preferred stock as part
of the 2005 private placement (See Note 2) that raised gross proceeds of
$4,000,000, which were offset by costs aggregating approximately $1,888,200.
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, all shares of Series A preferred
stock and Series B preferred stock would automatically convert into shares of
39
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
preferred stock were converted into 14,814,800 shares of common stock and
warrants to purchase an aggregate of 74,070 Series B preferred stock were
converted into warrants to purchase an aggregate 7,407,000 shares of common
stock.
The Company also issued to Griffin Securities Inc., ("Griffin") as a placement
agent fee in respect to the 2004 private placement, warrants to acquire 500,000
shares of common stock at an exercise price of $0.23 per share and warrants to
acquire 250,000 shares of common stock at an exercise price of $0.33 per share.
Additionally, pursuant to an agreement dated December 16, 2003 with Griffin, the
Company paid Griffin a $50,000 agent fee and issued to Griffin five-year
warrants to purchase 14,815 shares of Series A preferred stock at an exercise
price of $27.00 per share and five-year warrants to purchase 7.407 shares of
Series B preferred stock at an exercise price of $40.00 per share as a finder's
fee in respect of the 2005 private placement.
Also during 2005, the Company acquired NES (See Note 1) for 9,599,993 shares of
common stock, the assumption of approximately $235,000 of NES' indebtedness and
the reimbursement to AIGH Investment Partners, LLC ("AIGH"), an affiliate of a
principal stockholder (Orin Hirschman), of $665,000 for its advance on the
Company's behalf of a like sum in December 2004 to settle certain third party
litigation against NES. This reimbursement was effected by a partial credit
against the price of the securities acquired by Mr. Hirschman in the 2005
private placement (See Note 2).
During 2005, 2004 and 2003, the Company issued 35,489, 37,638 and 37,740 shares
of common stock to employees in connection with the Employee Stock Purchase
Plan, resulting in net cash proceeds of $10,000, $9,000 and $2,800,
respectively.
The Company increased the number of its common shares outstanding during 2004 by
30,668 shares, related to restricted shares that had been repurchased for which
the shareholder has not yet surrendered the stock certificate to the Company's
transfer agent for cancellation. The Company believes the risk of these shares
being traded is negligible as the share certificate carries a restrictive legend
on its face and cannot be traded without prior consent of the Company's counsel.
The Company believed that a more conservative accounting treatment should be
afforded theses shares, after consultations with its transfer agent, and decided
to add back these shares to its issued and outstanding totals.
Note Receivable - Shareholder. See Note 5.
Stock Purchase Warrants. As of December 31, 2005, the following common
stock warrants were issued and outstanding:
Shares
subject to Exercise Expiration
Issued with respect to: warrant price date
----------------------- ----------- -------- ----------
2004 Private placement 2,750,000 $ 0.33 01/09
2004 Private placement 470,000 $ 0.23 01/09
2005 Private placement 8,147,700 $ 0.40 02/10
2005 Private placement 1,481,500 $ 0.27 02/10
Convertible notes (1) 83,640 $ 1.79 01/06
Private placement (2) 373,049 $ 1.79 01/06
(1) The convertible notes warrants were issued in September 1998.
All such notes expired in January 2006.
(2) The private placement warrants were issued in conjunction
with the private placements that closed either during
October 1998, December 1998 or January 1999. All such warrants
expired during January 2006.
1996 Stock Option Plan. In May 1996 the Company's 1996 Stock Option Plan (the
"96 Plan") was adopted by the board and approved by the stockholders. The 96
Plan is restricted to employees, including officers, and to non-employee
directors. As of December 31, 2005, the Company is authorized to issue up to
187,500 shares of its common stock in accordance with the terms of the 96 Plan.
Under the 96 Plan the exercise price of options granted is either at least equal
to the fair market value of the Company's common stock on the date of the grant
or, in the case when the grant is to a holder of more than 10% of the Company's
common stock, at least 110% of the fair market value of the Company's common
stock on the date of the grant. As of December 31, 2005, options to purchase
40
159,625 shares of common stock were outstanding, 538 options had been exercised
and options to purchase 27,337 shares of common stock remained available for
further issuance under the 96 Plan.
1998 Stock Option/Stock Issuance Plan. In June 1998 the Company's 1998 Stock
Option/Stock Issuance Plan (the "98 Plan") was adopted by the board and approved
by the stockholders. Pursuant to the terms of the 98 Plan, options or stock may
be granted and issued, respectively, to officers and other employees,
non-employee board members and independent consultants who render services to
the Company. As of December 31, 2005, the Company is authorized to issue up to
4,455,400 options or stock in accordance with the terms of the 98 Plan, as
amended.
Under the 98 Plan the exercise price of options granted is to be not less than
85% of the fair market value of the Company's common stock on the date of the
grant. The purchase price of stock issued under the 98 Plan shall also not be
less than 85% of the fair market value of the Company's stock on the date of
issuance or as a bonus for past services rendered to the Company. As of December
31, 2005, options to purchase 3,920,643 shares of common stock were outstanding,
323,904 options had been exercised, 248,157 shares of common stock had been
issued directly under the 98 Plan, an aggregate 40,558 unvested options and
common stock previously issued had been repurchased and 3,254 shares remained
available for grant/issuance. The Company did not issue any direct shares under
the 98 Plan in either 2005 or 2004, and does not anticipate issuing shares in
2006.
Supplemental Stock Option Plan. In May 2000, the board approved an additional
stock option plan (the "Supplemental Plan"). Pursuant to the terms of the
Supplemental Plan, options are restricted to employees who are neither officers
nor directors at the grant date. As of December 31, 2005, the Company is
authorized to issue up to 400,000 shares in accordance with the terms of the
Supplemental Plan.
Under the Supplemental Plan the exercise price of options granted is to be not
less than 85% of the fair market value of the Company's common stock on the date
of the grant or, in the case when the grant is to a holder of more than 10% of
the Company's common stock, at least 110% of the fair market value of the
Company's common stock on the date of the grant. As of December 31, 2005,
options to purchase 386,000 shares of common stock were outstanding and 14,000
remained available for issuance under the Supplemental Plan.
NES Stock Option Plan. In January 2005, the board approved an additional stock
option plan (the "NES Plan"). Pursuant to the terms of the NES Plan, options are
restricted to a named employee who was neither an officer nor director at the
grant date. The Company is authorized to issue up to 1,000,000 shares in
accordance with the terms of the NES Plan.
Under the NES Plan the exercise price of options granted is to be equal to the
fair market value of the Company's common stock on the date of the grant. As of
December 31, 2005, options to purchase 1,000,000 shares of common stock were
outstanding and none remained available for issuance under the NES Plan.
GG Stock Plan. In February 2005, the board approved an additional stock option
plan (the "GG Plan"). Pursuant to the terms of the GG Plan, options are
restricted to a named employee who was neither an officer nor director at the
grant date. The Company is authorized to issue up to 250,000 shares in
accordance with the terms of the GG Plan.
Under the GG Plan the exercise price of options granted is to be equal to the
fair market value of the Company's common stock on the date of the grant. As of
December 31, 2005, options to purchase 250,000 shares of common stock were
outstanding and none remained available for issuance under the GG Plan.
2005 Equity Incentive Plan. In December 2005, the Company's 2005 Equity
Incentive Plan (the "05 Plan") was adopted by the board and approved by the
stockholders. Pursuant to the terms of the 05 Plan, options or
performance-vested stock may be granted to officers and other employees,
non-employee board members and independent consultants and advisors who render
services to the Company. The Company is authorized to issue up to 3,500,000
options or performance vested stock in accordance with the terms of the 05 Plan.
Under the 05 Plan the exercise price of non-qualified stock options granted is
to be no less than 100% of the fair market value of the Company's common stock
on the date the option is granted. The exercise price of incentive stock options
granted is to be no less than 100% of the fair market value of the Company's
common stock on the date the option is granted provided, however, that if the
recipient of the incentive stock option owns greater than 10% of the voting
power of all shares of the Company's capital stock then the exercise price will
be no less than 110% of the fair market value of the Company's common stock on
the date the option is granted. The purchase price of the performance-vested
stock issued under the 05 Plan shall also not be less than 100% of the fair
market value of the Company's common stock on the date the performance-vested
stock is granted. As of December 31, 2005, the Company had not granted any
options or performance-vested stock, consequently 3,500,000 shares remained
available for issuance.
41
Employee Stock Purchase Plan. In February 2000, the Employee Stock Purchase Plan
(the "ESPP") was adopted by the board and approved by the stockholders in June
2000. The ESPP provides for the purchase of shares of the Company's common stock
by eligible employees, including officers, at semi-annual intervals through
payroll deductions. No participant may purchase more than $25,000 worth of
common stock under the ESPP in one calendar year or more than 2,000 shares on
any purchase date. Purchase rights may not be granted to an employee who
immediately after the grant would own or hold options or other rights to
purchase stock and cumulatively possess 5% or more of the total combined voting
power or value of common stock of the Company.
Pursuant to the terms of the ESPP, shares of common stock are offered through a
series of successive offering periods, each with a maximum duration of six
months beginning on the first business day of February and August each year. The
purchase price of the common stock purchased under the ESPP is equal to 85% of
the lower of the fair market value of such shares on the start date of an
offering period or the fair market value of such shares on the last day of such
offering period. As of December 31, 2005, the ESPP is authorized to offer for
sale to participating employees 300,000 shares of common stock, of which,
203,545 shares have been purchased and 96,455 are available for future purchase.
A summary of the status of the Company's stock option plans as of December 31,
2005, 2004 and 2003, and changes during the years then ended is presented in the
following table:
2005 2004 2003
--------------------- --------------------- ---------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Options Outstanding Shares Price Shares Price Shares Price
- ------------------------------ ---------- -------- ---------- -------- ---------- --------
Beginning 2,965,268 $0.56 2,104,483 $2.47 2,584,307 $3.05
Granted 2,751,000 $0.50 1,803,187 $0.45 207,500 $0.18
Exercised - - - - - -
Forfeited - - (942,402) $4.60 (687,324) $3.95
---------- -------- ---------- -------- ---------- --------
Ending 5,716,268 $0.53 2,965,268 $0.56 2,104,483 $2.47
========== ======== ========== ======== ========== ========
Exercisable at year-end 5,716,268 $0.53 2,965,268 $0.56 2,104,483 $2.47
========== ======== ========== ======== ========== ========
Weighted-average fair value of
options granted during the
period $0.29 $0.26 $0.10
The following table summarizes information about stock options outstanding as of
December 31, 2005:
Options Outstanding Options Exercisable
------------------------------------------ ------------------------
Weighted Weighted
Number Weighted Average Number Average
Range of Outstanding Average Remaining Exercise Exercisable Exercise
Exercise Price at 12/31/05 Contractual Life Price at 12/31/05 Price
--------------- ----------- ----------------- -------- ------------- --------
$ 0.01 - 0.25 1,102,500 6.68 Yrs. $ 0.15 1,102,500 $ 0.15
$ 0.26 - 0.41 1,288,882 7.05 Yrs. $ 0.37 1,288,882 $ 0.37
$ 0.42 - 0.54 1,646,000 9.08 Yrs. $ 0.45 1,646,000 $ 0.45
$ 0.55 - 7.31 1,678,886 8.21 Yrs. $ 0.99 1,678,886 $ 0.99
----------- ------------
5,716,268 $ 0.53 5,716,268 $ 0.53
=========== ============
9. Income Taxes.
The components of the provision for income taxes consisted of the following:
December 31,
---------------------------------
Current 2005 2004 2003
------- --------- --------- ---------
Federal $ 10,300 $ - $ -
State 7,900 - -
--------- --------- ---------
18,200 - -
--------- --------- ---------
42
Deferred
--------
Federal - - -
State - - -
--------- --------- ---------
- - -
--------- --------- ---------
$ 18,200 $ - $ -
========= ========= =========
The following summarizes the differences between income tax expense and the
amount computed applying the federal income tax rate of 34%:
December 31,
---------------------------------------
2005 2004 2003
----------- ----------- -----------
Federal income tax at statutory rate $ (383,900) $ (485,200) $ (641,400)
State income taxes, net of federal benefit (65,500) (83,300) (97,100)
Tax benefit not currently recognizable 449,400 560,600 706,300
Other 18,200 7,900 32,200
---------- ----------- -----------
Provision for income tax $ 18,200 $ - $ -
========== =========== ===========
Deferred income taxes and benefits result from temporary timing differences in
the recognition of certain expense and income items for tax and financial
reporting purposes, as follows:
December 31,
---------------------------
2005 2004
------------ ------------
Net operating loss carryforwards $ 14,988,000 $ 14,961,000
Tax credit carryforwards 806,000 654,000
Capitalized software (32,000) (261,000)
Depreciation and amortization 717,000 760,000
Basis difference (1,808,000) -
Reserves and other 782,000 585,000
------------ ------------
Total deferred tax asset 15,453,000 16,699,000
Valuation allowance (15,453,000) (16,699,000)
------------ ------------
Net deferred tax asset $ - $ -
============ ============
For financial reporting purposes, the Company has incurred a loss in each year
since inception. Based on the available objective evidence, management believes
it is more likely than not that the net deferred tax assets will not be fully
realizable. Accordingly, the Company has provided a full valuation allowance
against its net deferred tax assets at December 31, 2005 and 2004. The net
change in valuation allowance was $(1,246,000), $1,358,200 and $(706,300)for the
years ended December 31, 2005, 2004 and 2003, respectively.
At December 31, 2005, the Company had approximately $42 million of federal net
operating loss carryforwards and approximately $14 million of California state
net operating loss carryforwards available to reduce future taxable income,
which will begin to expire in 2013 for federal tax purposes and 2006 for state
tax purposes, respectively.
In 1998, the Company experienced a "change of ownership" as that term is defined
by the provisions of the Tax Reform Act of 1986. As such, utilization of the
Company's net operating loss carryforwards through 1998 will be limited to
$400,000 per year until such carryforwards are fully utilized or expire.
10. Concentration of Credit Risk.
Financial instruments, which potentially subject the Company to concentration of
credit risk, consist principally of cash and cash equivalents, trade receivables
and notes receivable. The Company places cash and cash equivalents with high
quality financial institutions and, by policy, limits the amount of credit
exposure to any one financial institution. As of December 31, 2005, the Company
had approximately $3,426,800 of cash and cash equivalents with financial
institutions, in excess of FDIC insurance limits.
For the year ended December 31, 2005, approximately 82.8% of the Company's total
sales were made to 26 customers. The three largest of these customers accounted
for approximately 16.8%, 16.0% and 11.5%, respectively, of total sales. These
three customers' December 31, 2005 year-end accounts receivable balances
represented approximately 0.0%, 11.6%, and 6.0% of reported net accounts
receivable.
43
For the year ended December 31, 2004, approximately 75.9% of the Company's total
sales were made to 20 customers. The three largest of these customers accounted
for approximately 20.9%, 14.9% and 14.1%, respectively, of total sales. These
three customers' December 31, 2004 year-end accounts receivable balances
represented approximately 30.9%, 2.9% and 0.0% of reported net accounts
receivable.
For the year ended December 31, 2003, approximately 86.1% of the Company's total
sales were made to 20 customers. The three largest of these customers accounted
for approximately 27.4%, 18.4% and 9.2%, respectively, of total sales. These
three customers' December 31, 2003 year-end accounts receivable balances
represented approximately 0.0%, 28.0% and 44.1% of reported net accounts
receivable.
The Company performs credit evaluations of customers' financial condition
whenever necessary, and generally does not require cash collateral or other
security to support customer receivables.
Approximately 3,330,207 shares of the Company's common stock collateralized the
note receivable - shareholder (see Note 5), as of December 31, 2005, which bears
interest at 3.62% per annum and matures in 2009. The Company reviews the
collectibility of the note on a regular basis.
11. Commitments and Contingencies.
Operating Leases. The Company currently occupies approximately 1,862 square feet
of office space in Santa Cruz, California. The office space is rented pursuant
to a three-year operating lease, which became effective August 1, 2005. Rent on
the Santa Cruz facility will average approximately $3,600 per month over the
term of the lease, which is inclusive of a pro rata share of utilities,
facilities maintenance and other costs. The Company has the option to renew the
lease for one three-year term upon its expiration and can exercise this option
by giving written notice to the landlord not later than 180 days prior to the
expiration of the initial lease term.
During October 2005, the Company renewed its lease for approximately 3,300
square feet of office space in Concord, New Hampshire, for a one-year term,
which is cancelable upon 30-days written notice by either the landlord or the
Company. Rent on the Concord facility is approximately $5,300 per month.
The Company has been occupying leased facilities in Rolling Hills Estates,
California on a month-to-month basis since October 2002. During December 2005,
the Company signed a one-year lease for this property for the period February 1,
2006 through January 31, 2007. During January 2006, this lease was amended to
extend the lease through March 1, 2007. Under the terms of the new lease,
monthly rental payments are approximately $1,400.
The Company has also been renting an office in Berkshire, England, United
Kingdom since December 2002. The current lease runs through December 2006. Rent
on this office, which can fluctuate depending on exchange rates, is
approximately $400 per month.
Future minimum lease payments under all leases in effect as of December 31,
2005, assuming all currently occupied facilities will remain occupied by the
Company until each current lease's expiration:
Year Ending December 31,
2006 $ 114,500
2007 $ 44,200
2008 $ 25,400
2009 and thereafter $ -
Rent expense aggregated approximately $123,100, $95,700 and $295,400 for the
years ended December 31, 2005, 2004 and 2003, respectively.
Commitments. 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 this agreement, in the event that the
Company completes a transaction with a third party introduced to the Company 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.
44
Contingencies. Under its Amended and Restated Certificate of Incorporation and
Amended and Restated Bylaws and certain agreements with officers and directors,
the Company has agreed to indemnify its officers and directors for certain
events or occurrences arising as a result of the officer or director's serving
in such capacity. Generally, the term of the indemnification period is for the
officer's or director's lifetime. The maximum potential amount of future
payments the Company could be required to make under these indemnification
agreements is unlimited as the Company does not currently have a directors and
officers liability insurance policy that limits its exposure and enables it to
recover a portion of any future amounts paid. The Company believes the estimated
fair value of these indemnification agreements is minimal and has no liabilities
recorded for these agreements as of December 31, 2005.
The Company enters into indemnification provisions under (i) its agreements with
other companies in its ordinary course of business, including contractors and
customers and (ii) its agreements with investors. Under these provisions, the
Company generally indemnifies and holds harmless the indemnified party for
losses suffered or incurred by the indemnified party as a result of the
Company's activities or, in some cases, as a result of the indemnified party's
activities under the agreement. These indemnification provisions often include
indemnifications relating to representations made by the Company with regard to
intellectual property rights, and often survive termination of the underlying
agreement. The maximum potential amount of future payments the Company could be
required to make under these indemnification provisions is unlimited. The
Company has not incurred material costs to defend lawsuits or settle claims
related to these indemnification agreements. As a result, the Company believes
the estimated fair value of these agreements is minimal. Accordingly, the
Company has no liabilities recorded for these agreements as of December 31,
2005.
The Company's software license agreements also generally include a performance
guarantee that the Company's software products will substantially operate as
described in the applicable program documentation for a period of 90 days after
delivery. The Company also generally warrants that services that the Company
performs will be provided in a manner consistent with reasonably applicable
industry standards. To date, the Company has not incurred any material costs
associated with these warranties.
12. Employee 401(k) Plan.
In December 1998, the Company adopted a 401(k) Plan (the Plan) to provide
retirement benefits for employees. As allowed under Section 401(k) of the
Internal Revenue Code, the Plan provides tax-deferred salary deductions for
eligible employees. Employees may contribute up to 15% of their annual
compensation to the Plan, limited to a maximum annual amount as set periodically
by the Internal Revenue Service. In addition, the Company may make
discretionary/matching contributions. During 2005, 2004 and 2003, the Company
contributed a total of approximately $21,500, $23,000 and $27,200 to the Plan,
respectively.
13. Supplemental Disclosure of Cash Flow Information.
The following is supplemental disclosure for the statements of cash flows.
Year Ended December 31,
2005 2004 2003
--------- ------- -------
Cash paid:
Income taxes $ - $ - $ -
Interest $ 2,700 $ - $ -
During 2004, the Company capitalized approximately $179,500 and $31,000 of
deferred acquisition costs, related to the NES acquisition, that were included
in accounts payable and accrued expenses, respectively, as of December 31, 2004.
Additionally, during 2004, the Company accrued approximately $32,500 of deferred
financing costs, related to the 2005 private placement, as other assets, as of
December 31, 2004.
As of December 31, 2005, financing costs related to the 2005 private placement
of approximately $34,200 and $23,800 had been recorded in accrued expenses and
accounts payable, respectively.
In conjunction with its acquisition of NES (See Note 1), the Company issued
9,599,993 shares of its common stock, with a value of $3,916,800. Additionally,
the Company issued 24,630 shares of its Series A preferred stock to AIGH as a
credit against its purchase of 30,368 shares of Series A preferred stock in the
2005 private placement (See Note 1). Further, pursuant to an agreement, dated
December 16, 2003, with Griffin, placement agent for the 2004 private placement,
the Company issued Griffin five-year warrants to purchase 14,815 shares of
Series A preferred stock at an exercise price of $27.00 per share and five-year
warrants to purchase 7,407 shares of Series B preferred stock at an exercise
price of $40.00 per share as a finder's fee in respect of the 2005 private
placement.
Upon the Company's stockholders approving the amendment to the Company's
certificate of incorporation (See Note 2), the warrants issued to Griffin were
converted into warrants to purchase common stock. The warrants to purchase
14,815 shares of Series A preferred stock were converted into warrants to
purchase 1,481,500 shares of common stock at an exercise price of $0.27 per
share and the warrants to purchase 7,407 shares or Series B preferred stock were
45
converted into warrants to purchase 740,700 shares of common stock at an
exercise price of $0.40 per share. The value of the warrants issued to Griffin
was determined using the Black-Scholes method, with the following assumptions:
dividend yield of 0, expected volatility of 60%, risk-free interest rate of 1.5%
and expected life of 5 years.
14. Litigation
On November 23, 2005, the Company initiated a proceeding against AutoTrader.com
in United States District Court in the Eastern District of Texas, alleging that
Autotrader.com was infringing two of the Company's patents, namely Nos.
6,324,538 and 6,850,940 (the "538" and "940" patents, respectively), which
protect the Company's unique method of maintaining an automated and network
accessible database, on its AutoTrader.com website. The Company seeks
preliminary and permanent injunctive relief along with unspecified damages and
fees. Autotrader.com filed its Answer and Counterclaim on January 17, 2006
seeking a declaratory judgment that it does not infringe the 538 and 940 patents
and that both patents are invalid.
On March 24, 2006, Autotrader.com filed a motion for summary judgment seeking to
invalidate the 538 and 940 patents. On May 1, 2006 we filed a response in
opposition to Autotrader's motion. On August 8, 2006, Autotrader's motion for
summary judgment was denied.
15. Loss Per Share
Potentially dilutive securities have been excluded from the computation of
diluted loss per common share, as their effect is antidilutive. For the years
ended December 31, 2005, 2004 and 2003, 19,022,157, 6,641,957 and 2,104,483
shares, respectively, of common stock equivalents were excluded from the
computation of diluted loss per common share since their effect would be
antidilutive.
16. Quarterly Information (Unaudited)
The summarized quarterly financial data presented below reflect all adjustments,
which, in the opinion of management, are of a normal and recurring nature,
except for the adjustment related to the deemed dividends on preferred stock,
necessary to present fairly the results of operations for the periods presented.
First Second Third Fourth
Year Ended December 31, 2005 Quarter Quarter Quarter Quarter Full Year
---------------------------------------- ----------- ----------- ----------- ----------- -----------
Total revenues $ 1,180,400 $ 1,275,800 $ 1,176,400 $ 1,547,600 $ 5,180,200
Gross profit 1,059,300 1,145,200 1,061,100 1,410,900 4,676,500
Operating income (loss) (326,300) (277,900) (366,100) (195,900) (1,166,200)
Net income (loss) (318,600) (267,300) (359,400) (201,900) (1,147,200)
Deemed dividends on preferred stock (4,000,000) - - - (4,000,000)
Loss attributable to common shareholders (4,318,600) (267,300) (359,400) (201,900) (5,147,200)
Income (loss) per common share
Basic (1) $ (0.15) $ (0.01) $ (0.01) $ - $ (0.12)
Diluted - - - - -
Year Ended December 31, 2004
----------------------------------------
Total revenues $ 902,900 $ 677,400 $ 931,500 $ 1,018,000 $ 3,529,800
Gross profit 592,700 372,800 784,400 876,100 2,626,000
Operating income (loss) (434,700) (734,900) (296,100) 23,500 (1,442,200)
Net income (loss) (431,100) (732,000) (293,600) 29,200 (1,427,500)
Income (loss) per common share
Basic $ (0.03) $ (0.03) $ (0.01) $ - $ (0.07)
Diluted - - - - -
<FN>
(1) Full year basic loss per common share is less than the quarterly totals due to the impact
46
on the quarterly and yearly average weighted shares outstanding resulting from the conversion
of preferred stock to common stock that occurred during the first quarter of 2005.
</FN>
47
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
Allowance
for Charged to
Doubtful Beginning Costs and Ending
Accounts Balance Expenses Deductions Balance
---------- --------- ---------- ------------ ---------
2005 $ 46,800 $ - $ - $ 46,800
2004 $ 46,800 $ - $ - $ 46,800
2003 $ 50,300 $ 16,300 $ 19,800 $ 46,800
48
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not Applicable.
ITEM 9A. CONTROLS AND PROCEDURES
Our management carried out an evaluation, with the participation of our Chief
Executive Officer and Chief Financial Officer, of the effectiveness of our
disclosure controls and procedures as of December 31, 2005. Based upon that
evaluation, our Chief Executive Officer and Chief Financial Officer concluded
that our disclosure controls and procedures (as defined in Rule 13a-159e) under
the Securities Exchange Act of 1934) 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 SEC.
There has not been any change in our internal control over financial reporting
in connection with the evaluation required by Rule 13a-15(d) under the Exchange
Act that occurred during the quarter ended December 31, 2005 that has materially
affected, or is reasonably likely to materially affect, our internal control
over financial reporting.
ITEM 9B. OTHER INFORMATION
Not Applicable.
49
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Set forth below is information concerning each of our directors and
executive officers as of March 6, 2006.
Name Age Position
--------------- --- --------
Robert Dilworth 64 Chairman of the Board of Directors and
Chief Executive Officer (Interim)
William Swain 65 Chief Financial Officer and Secretary
August P. Klein 69 Director
Michael Volker 57 Director
Gordon Watson 70 Director
Robert Dilworth has served as one of our directors since July 1998 and was
appointed Chairman in December 1999. In January 2002, Mr. Dilworth was appointed
Interim Chief Executive Officer upon the termination, by mutual agreement, of
our former Chief Executive Officer, Walter Keller. From 1987 to 1998 he served
as the Chief Executive Officer and Chairman of the Board of Metricom, Inc., a
leading provider of wireless data communication and network solutions. Prior to
joining Metricom, from 1985 to 1988, Mr. Dilworth served as President of Zenith
Data Systems Corporation, a microcomputer manufacturer. Earlier positions
included Chief Executive Officer and President of Morrow Designs, Chief
Executive Officer of Ultramagnetics, Group Marketing and Sales Director of
Varian Associates Instruments Group, Director of Minicomputer Systems at Sperry
Univac and Vice President of Finance and Administration at Varian Data Machines.
Mr. Dilworth is currently a director of eOn Communications and Amber
Communications. Mr. Dilworth previously served as director of Mobility
Electronics, Get2Chip.com, Inc., Sky Pipeline and Yummy Interactive.
William Swain has served as our Chief Financial Officer and Secretary since
March 2000. Mr. Swain was a consultant from August 1998 until February 2000,
working with entrepreneurs in the technology industry in connection with the
start-up and financing of new business opportunities. Mr. Swain was Chief
Financial Officer and Secretary of Metricom Inc., from January 1988 until June
1997, during which time he was instrumental in private financings as well as
Metricom's initial public offering and subsequent public financing activities.
He continued as Senior Vice President of Administration with Metricom from June
1997 until July 1998. Prior to joining Metricom, Mr. Swain held top financial
positions with leading companies in the computer industry, including Morrow
Designs, Varian Associates and Univac. Mr. Swain holds a Bachelors degree in
Business Administration from California State University of Los Angeles and is a
Certified Public Accountant in the State of California.
August P. Klein has served as one of our directors since August 1998. Mr. Klein
has been, since 1995, the founder, Chief Executive Officer and Chairman of the
Board of JSK Corporation. From 1989 to 1993, Mr. Klein was founder and Chief
Executive Officer of Uniquest, Inc., an object-oriented application software
company. From 1984 to 1988, Mr. Klein served as Chief Executive Officer of
Masscomp, Inc., a developer of high performance real time mission critical
systems and Unix-based applications. Mr. Klein has served as Group Vice
President, Serial Printers at Data Products Corporation and President and Chief
Executive Officer at Integral Data Systems, a manufacturer of personal computer
printers. Mr. Klein spent 25 years with IBM Corporation, rising to a senior
executive position as General Manager of the Retail/Distribution Business Unit.
Mr. Klein is a director of QuickSite Corporation and has served as a trustee of
the Computer Museum in Boston, Massachusetts since 1988. Mr. Klein holds a B.S.
in Mathematics from St. Vincent College.
Michael Volker has served as one of our directors since July 2001. Mr. Volker
has been, since 1996, Director of Simon Fraser University's Industry Liaison
Office. He is also Chief Executive Officer of WUTIF Capital, an "angel" fund
that invests in technology startup companies. From 1996 to 2001, Mr. Volker was
Chairman of the Vancouver Enterprise Forum, a non-profit organization dedicated
to the development of British Columbia's technology enterprises. From 1987 to
1996, Mr. Volker was Chief Executive Officer and Chairman of the Board of
Directors of RDM Corporation, a publicly-listed company. RDM is a developer of
specialized hardware and software products for both Internet electronic commerce
and paper payment processing. From 1988 to 1992, Mr. Volker was Executive
Director of BC Advanced Systems Institute, a hi-tech research institute. Since
1982, Mr. Volker had been active in various early stage businesses as a founder,
investor, director and officer. Mr. Volker, a registered professional engineer
in the Province of British Columbia, holds a Bachelor's and Master's degree from
the University of Waterloo.
Gordon Watson has served as one of our directors since April 2002. In 1997, Mr.
Watson founded Watson Consulting, LLC, a consulting company for early stage
technology companies and has served as its President since its inception. From
1996 to 1997 he served as Western Regional Director, Lotus Consulting of Lotus
Development Corporation. From 1988 to 1996, Mr. Watson held various positions
with Platinum Technology, Incorporated, most recently serving as Vice President
Business Development, Distributed Solutions. Earlier positions include Senior
Vice President of Sales for Local Data, Incorporated, President, Troy Division,
Data Card Corporation, and Vice President and General Manager, Minicomputer
Division, Computer Automation, Incorporated. Mr. Watson also held various
50
executive and director level positions with TRW, Incorporated, Varian Data
Machines, and Computer Usage Company. Mr. Watson holds a Bachelors of Science
degree in electrical engineering from the University of California at Los
Angeles and has taught at the University of California at Irvine. Mr. Watson is
also a director of DPAC Technologies, PATH Communications and SoftwarePROSe,
Inc.
Our Board of Directors has an audit committee consisting of three directors, all
of whom are independent as defined by the listing standards of The Nasdaq Stock
Market. The current members of the audit committee are August P. Klein
(committee chairman), Michael Volker and Gordon Watson. Our Board of Directors
has determined that Mr. Klein meets the SEC's definition of an audit committee
financial expert.
Our Board of Directors has adopted a Code of Ethics applicable to all of our
employees, including our chief executive officer, chief financial officer and
controller. This code of ethics was filed as an exhibit to the annual report on
Form 10-K for the year ended December 31, 2003.
All executive officers serve at the discretion of the Board of Directors.
Compliance With Section 16(a) of the Securities Exchange Act
Section 16(a) of the Securities Exchange Act of 1934 requires our officers and
directors, as well as those persons who own more than 10% of our common stock,
to file reports of ownership and changes in ownership with the SEC. These
persons are required by SEC rule to furnish us with copies of all Section 16(a)
forms they file.
Based solely on our review of the copies of such forms, or written
representations from certain reporting persons that no such forms were required,
we believe that during the year ended December 31, 2005, all filing requirements
applicable to our officers, directors and greater than 10% owners of our common
stock were complied with.
ITEM 11. EXECUTIVE COMPENSATION
Summary Compensation Table. The following table sets forth information for the
fiscal years ended December 31, 2005, 2004 and 2003, concerning compensation we
paid to our Chief Executive Officer and our other executive officers whose total
annual salary and bonus exceeded $100,000 for the year ended December 31, 2005.
Long-term Compensation
------------------------------------
Annual Compensation Awards Payouts
-------------------------- ------------------------------------------- -------------------------- -------
Name and Other Restricted Securities All
Principal Annual Stock Underlying LTIP Other
Position Year Salary Bonus Compensation Awards Options Payouts Compensation
-------------------------- ------ --------- ------- ------------ ---------- ------------- ------- ------------
Robert Dilworth 2005 $ 149,500 - - - 200,000 (2) - -
Chairman of the Board 2004 $ 99,000 - - - 300,000 (3) - -
Chief Executive Officer 2003 $ 129,000 - - - 40,000 - -
(Interim) (1)
-------------------------- ------ --------- ------- ------------ ---------- ------------- ------- ------------
William Swain 2005 $ 127,400 - - - 160,000 - $ 2,000 (4)
Chief Financial Officer 2004 $ 123,100 - - - 380,000 (3) - $ 2,000 (4)
Secretary 2003 $ 96,200 - - - 40,000 - $ 2,000 (4)
(1) Mr. Dilworth began as Chief Executive Officer (Interim) during January
2002. As interim Chief Executive Officer, Mr. Dilworth is compensated as a
consultant and not an employee, consequently; he is eligible to receive
compensation for his services as a director. Mr. Dilworth has elected,
since assuming the interim Chief Executive Officer position, to forgo the
cash compensation we pay all directors for their attendance at board and
committee meetings as well as the quarterly retainer.
(2) Of the options granted to Mr. Dilworth during 2005, 40,000 were granted as
part of his compensation package as our interim Chief Executive Officer and
the balance were for his role as one of our directors.
(3) Mr. Dilworth and Mr. Swain voluntarily surrendered, on May 14, 2004,
260,000 and 380,000 out-of-the-money options, respectively, in conjunction
with participation in a voluntary stock option exchange program. New option
grants equal to the number cancelled were made on November 15, 2004. All
options granted to Mr. Dilworth during fiscal 2004 were granted in his
capacity as one of our directors.
51
(4) Company contribution to the 401(k) Plan.
Option Grants in Last Fiscal Year. The following table shows the stock option
grants made to the executive officers named in the Summary Compensation Table
during the 2005 fiscal year:
Potential Realizable
Percent of Value at Assumed
Number of Shares Total Options Annual Rates of Stock
of Common Stock Granted to Appreciation for
Underlying Options Employees in Exercise Expiration Option Term
Granted Fiscal Year Price Date 5% 10%
- --------------- ------------------ ------------- -------- ---------- -------------------------
Robert Dilworth 200,000 (2) 9.7% $ 0.43 1/26/15 $ 1,271,400 $ 1,719,500
- --------------- ------------------ ------------- -------- ---------- -------------------------
William Swain 160,000 7.7% $ 0.43 1/26/15 $ 1,017,100 $ 1,375,600
- --------------- ------------------ ------------- -------- ---------- -------------- ----------
(1) Options were granted at an exercise price equal to the fair market value of
our common stock, as determined by the closing sales price reported on the
Over-the-Counter Bulletin Board on the date of grant.
(2) Of the options granted to Mr. Dilworth during fiscal 2005, 40,000 were
granted in his capacity as our Chief Executive Officer (interim) and the
balance in his capacity as one of our directors.
Fiscal Year-End Option Values. The following table shows information with
respect to unexercised stock options held by the executive officers named in the
Summary Compensation Table as of December 31, 2005. No options held by such
individuals were exercised during 2005.
Number of Securities
Underlying Value of Unexercised
Unexercised Options at In-The-Money Options
Fiscal Year-End (1) at Fiscal Year-End (2)
Name Exercisable Unexercisable Exercisable Unexercisable
--------------- -------------------------- --------------------------
Robert Dilworth 640,000 - $ 400 -
--------------- -------------------------- --------------------------
William Swain 580,000 - $ 400 -
--------------- -------------------------- --------------------------
(1) Options are generally immediately exercisable and vest in 33 equal monthly
installments beginning three months after the date of grant. Shares issued
upon the exercise of options are subject to our repurchase, which right
lapses as the shares vest.
(2) The value of the in-the-money options was calculated as the difference
between the exercise price of the options and $0.19, the fair market value
of our common stock as of December 31, 2005, multiplied by the number of
the in-the-money options outstanding.
Compensation of Directors. During the year ended December 31, 2005, since all of
our directors were outside directors, they were eligible to be compensated at
the rate of $1,000 for attendance at each meeting of our board, $500 if their
attendance was via telephone, $500 for attendance at each meeting of a board
committee, and a $1,500 quarterly retainer. Additionally, outside directors are
granted stock options periodically, typically on a yearly basis. In the
aggregate, our directors received options to purchase 640,000 shares of our
common stock during 2005 at an average exercise price of $0.43 per share.
Compensation Committee Interlocks and Insider Participation. During the year
ended December 31, 2005, the Compensation Committee was comprised of Robert
Dilworth, our Interim Chief Executive Officer and Chairman of the Board, and
August Klein, a non-employee director.
52
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
AND RELATED STOCKHOLDER MATTERS
The following table sets forth certain information, as of March 6, 2006, with
respect to the beneficial ownership of shares of our common stock held by: (i)
each director; (ii) each person known by us to beneficially own 5% or more of
our common stock; (iii) each executive officer named in the summary compensation
table; and (iv) all directors and executive officers as a group. Unless
otherwise indicated, the address for each stockholder is c/o GraphOn
Corporation, 5400 Soquel Avenue, Suite A2, Santa Cruz, California 95062.
Number of Shares of Common Percent of
Name and Address of Beneficial Owner Stock Beneficially Owned (1)(2) Class (%)
- ---------------------------------------- ----------------------------- ----------
Robert Dilworth (3) 693,820 1.5
William Swain (4) 603,000 1.3
August P. Klein (5) 445,760 1.0
Michael Volker (6) 318,200 *
Gordon Watson (7) 280,000 *
Orin Hirschman (8) 9,120,417 18.5
6006 Berkeley Avenue
Baltimore, MD 21209
Ralph Wesinger (9) 3,879,822 8.3
IDT Capital, Inc. (10) 5,555,500 11.6
520 Broad Street
Newark, NJ 07102
Globis Capital Partners (11) 3,821,278 8.1
60 Broad Street, 38th Floor
New York, NY 10004
All current executive officers
and directors as a group (5 persons)(12) 2,340,780 4.9
* Denotes less than 1%.
(1) As used in this table, beneficial ownership means the sole or shared
power to vote, or direct the voting of, a security, or the sole or
shared power to invest or dispose, or direct the investment or
disposition, of a security. Except as otherwise indicated, based on
information provided by the named individuals, all persons named herein
have sole voting power and investment power with respect to their
respective shares of our common stock, except to the extent that
authority is shared by spouses under applicable law, and record and
beneficial ownership with respect to their respective shares of our
common stock. With respect to each stockholder, any shares issuable
upon exercise of options and warrants held by such stockholder that are
currently exercisable or will become exercisable within 60 days of
March 6, 2006 are deemed outstanding for computing the percentage of
the person holding such options, but are not deemed outstanding for
computing the percentage of any other person.
(2) Percentage ownership of our common stock is based on 46,167,047 shares
of common stock outstanding as of March 6, 2006.
(3) Includes 640,000 shares of common stock issuable upon the exercise of
outstanding options.
(4) Includes 580,000 shares of common stock issuable upon the exercise of
outstanding options.
(5) Includes 295,000 shares of common stock issuable upon the exercise of
outstanding options.
(6) Includes 260,000 shares of common stock issuable upon the exercise of
outstanding options.
(7) Includes 280,000 shares of common stock issuable upon the exercise of
outstanding options.
(8) Based on information contained in a Schedule 13D/A filed by Orin
Hirschman on February 17, 2005. Includes 3,040,139 shares of common
stock issuable upon the exercise of outstanding warrants. Mr. Hirschman
is the managing member of AIGH Investment Partners, LLC (AIGH) and has
sole voting and dispositive power with respect to 4,555,200 shares held
by AIGH, which shares are included in Mr. Hirschman's beneficial
ownership total.
(9) Based on information contained in a Form 4 filed by Mr. Wesinger on
February 10, 2005 and supplemental information provided to us by Mr.
Wesinger. Includes 1,569,816 shares held in escrow pursuant to the
terms of an escrow agreement (the "NES Escrow Agreement") entered into
in connection with the acquisition by GraphOn of NES. For the duration
of the escrow, Mr. Wesinger has the right to vote, but not to dispose
of, such shares. Includes 416,664 shares of common stock issuable upon
exercise of outstanding options.
(10) Based on information contained in a Schedule 13D filed by IDT Capital,
Inc. on February 15, 2005. Includes 1,851,800 shares of common stock
issuable upon the exercise of warrants. Howard S. Jonas exercises sole
voting and dispositive power with respect to the listed shares.
53
(11) Based on information contained in a Schedule 13G filed by Paul Packer
on February 10, 2004. Includes 587,791 shares held by Mr. Paul Packer
and 370,400 shares held by Globis Overseas Fund Ltd. (Globis Overseas).
Includes 1,273,726 shares of common stock issuable upon the exercise of
warrants. Mr. Packer is the Managing Member of Globis Capital Partners
(Globis) and is the Managing Member of the general partner of the
manager of Globis Overseas. Mr. Packer exercises sole voting and
dispositive power with respect to the shares beneficially owned by
Globis and Globis Overseas.
(12) Includes 2,055,000 shares of common stock issuable upon the exercise of
outstanding options.
Equity Compensation Plan Information. The following table sets forth
information related to all of our equity compensation plans as of December
31, 2005:
Number of Securities to be Weighted Average
Issued Upon Exercise of Exercise Price of Number of Securities
Outstanding Options, Outstanding Options Remaining Available
Plan Category Warrants and Rights Warrants and Rights for Future Issuance
- ---------------------------------- -------------------------- ------------------- --------------------
Equity compensation plans approved
by security holders:
Stock option plans 4,080,268 $ 0.53 3,530,591
Employee stock purchase plan (1) (1) (1)
- ---------------------------------- -------------------------- ------------------- --------------------
Equity compensation plans not
approved by security holders:
Stock option plans (2) 1,636,000 $ 0.54 14,000
- ---------------------------------- -------------------------- ------------------- --------------------
Total 5,716,268 $ 0.53 3,544,591
- ---------------------------------- -------------------------- ------------------- --------------------
(1) Under terms of the employee stock purchase plan (ESPP), employees who
participate in the plan are eligible to purchase shares of common stock.
As of December 31, 2005, 203,545 shares had been purchased through the
ESPP, at an average cost of $0.89 per share and 96,455 shares are
available for future purchase.
(2) On April 30, 2000 our board approved a supplemental stock option plan
(the "supplemental plan"). Participation in the supplemental plan is
limited to those employees who are, at the time of the option grant,
neither officers nor directors. The supplemental plan was initially
authorized to issue options for up to 400,000 shares of common stock. The
exercise price per share is subject to the following provisions:
o The exercise price per share shall not be less than 85% of the
fair market value per share of common stock on the option grant
date.
o If the person to whom the option is granted is a 10% shareholder,
then the exercise price per share shall not be less than 110% of
the fair market value per share of common stock on the option
grant date.
All options granted are immediately exercisable by the optionee. The
options vest, ratably, over a 33-month period, however no options vest
until after three months from the date of the option grant. The exercise
price is immediately due upon exercise of the option. The supplemental
plan shall terminate no later than April 30, 2010. As of December 31,
2005, options to purchase 386,000 shares of common stock had been issued
under the supplemental plan and 14,000 shares remained available for
issuance.
On January 27, 2005 our board approved a stock option plan (the "NES
Plan") for a named employee, who at the time of the option grant was
neither an officer nor a director. The NES Plan was initially authorized
to issue options for up to 1,000,000 shares of common stock. Under the
terms of the NES Plan, the exercise price of all options issued under the
NES Plan would be equal to the fair market value of our common stock on
the date of the grant.
All options granted under the NES Plan are immediately exercisable by the
optionee, however, there is a vesting period for the options. During the
optionee's first three months of employment, no options would vest. In
the optionee's fourth month of employment, approximately 8.33% of the
shares granted would vest with the remainder vesting ratably over a
33-month period, beginning in the optionee's fifth month of employment.
The exercise price is immediately due upon exercise of the option. The
NES Plan shall terminate no later than January 31, 2015. As of December
31, 2005, options to purchase 1,000,000 shares of common stock had been
54
issued under the NES plan and no shares remained available for issuance.
On February 14, 2005 our board of directors approved a stock option plan
(the "GG Plan") for a named employee, who at the time of the option grant
was neither an officer nor a director. The GG Plan was initially
authorized to issue options for up to 250,000 shares of common stock.
Under the terms of the GG Plan, the exercise price of all options issued
under the GG Plan would be equal to the fair market value of our common
stock on the date of the grant.
All options granted under the GG Plan are immediately exercisable by the
optionee, however, there is a vesting period for the options. The options
vest, ratably, over a 33-month period, however no options vest until
after three months from the date of the option grant. The exercise price
is immediately due upon exercise of the option. The GG Plan shall
terminate no later than February 15, 2015. As of December 31, 2005,
options to purchase 250,000 shares of common stock had been issued under
the GG Plan and no shares remained available for issuance.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
On January 29, 2004, we issued and sold to certain individuals and entities in a
private placement (the "2004 private placement") 5,000,000 shares of common
stock and five-year warrants to acquire 2,500,000 shares of common stock at an
exercise price of $0.33 per share. We derived net proceeds of approximately
$931,400 from the 2004 private placement. We also issued to Griffin Securities
Inc., ("Griffin") as a placement agent fee in respect to the 2004 private
placement, warrants to acquire 500,000 shares of common stock at an exercise
price of $0.23 per share and warrants to acquire 250,000 shares of our common
stock at an exercise price of $0.33 per share.
Orin Hirschman purchased 3,043,478 shares of common stock and warrants to
acquire 1,521,739 shares of common stock in the 2004 private placement for
approximately $700,000 in cash (representing in the aggregate 9.9% of our
outstanding shares of common stock as of March 30, 2005). As a condition of the
sale, we entered into an Investment Advisory Agreement, expiring on January 29,
2007, with Mr. Hirschman, which provides for our payment of 5% of the value of
any business transaction that he introduces to us and which we accept.
On October 6, 2004, we entered into a letter of intent to acquire NES. We
contemporaneously loaned $350,000 to Ralph Wesinger, NES' majority shareholder,
to fund his purchase of all the NES common stock then owned by another person.
We received Mr. Wesinger's 5-year promissory note, which bears interest at a
rate of 3.62% per annum and which was secured by his approximately 65% equity
interest in NES, to evidence this loan. Mr. Wesinger also agreed that we would
receive 25% of the gross proceeds of any sale or transfer of these shares, which
shall be applied in reduction of the then outstanding balance of his note. We
have the option to accelerate the maturity date of this note upon the occurrence
of certain events.
On December 10, 2004 we entered into an agreement with AIGH Investment Partners,
LLC ("AIGH"), an affiliate of Orin Hirschman, to reimburse AIGH $665,000, as
well as its legal fees and expenses, relating to its successful efforts to
settle certain third party litigation against NES and certain of its affiliates.
On January 31, 2005, we completed our acquisition of NES in exchange for
9,599,993 shares of common stock, the assumption of approximately $235,000 of
NES' indebtedness and the reimbursement to AIGH of $665,000 for its advance on
our behalf of a like sum in December 2004 to settle certain third party
litigation against NES. This reimbursement was effected (as discussed below) by
a partial credit against the purchase price of our securities acquired by Mr.
Hirschman in the 2005 private placement. Of such 9,599,993 shares, 4,963,158
were issued to Mr. Wesinger, an aggregate 2,439,342 shares were issued to NES'
other shareholders and an aggregate 2,197,500 shares to two of NES' remaining
creditors. Immediately thereafter, 3,260,391 of the shares issued to Mr.
Wesinger were substituted for the NES shares that he had previously pledged to
us to secure repayment of his $350,000 note. In accordance with the terms of the
acquisition, Mr. Wesinger became a non-executive employee of our company upon
consummation of the acquisition.
On February 2, 2005, we issued and sold to certain individuals and entities in
the 2005 private placement 148,148 shares of newly authorized Series A preferred
stock at a price of $27.00 per share and five-year warrants to acquire 74,070
shares of newly authorized Series B preferred stock at an exercise price of
$40.00 per share. We derived net proceeds of approximately $2,110,700 from the
2005 private placement.
AIGH purchased 30,368 shares of Series A preferred stock and warrants to acquire
15,184 shares of Series B preferred stock in the 2005 private placement for an
aggregate purchase price of $820,000. We repaid the $665,000 we owed AIGH by
crediting its purchase price of our securities with a like sum. The balance of
the purchase price ($155,000) was paid in cash. As an inducement to his
participation in the 2005 private placement, we extended the expiration date of
55
Mr. Hirschman's Investment Advisory Agreement to January 29, 2008. Pursuant to
the agreement with AIGH as described above, we also paid Mr. Hirschman's legal
fees and expenses of approximately $108,000.
Pursuant to an agreement, dated December 16, 2003, with Griffin, placement agent
for our 2004 private placement, we issued Griffin five-year warrants to purchase
14,815 shares of Series A preferred stock at an exercise price of $27.00 per
share and five-year warrants to purchase 7,407 shares of Series B preferred
stock at an exercise price of $40.00 per share as a finder's fee in respect of
our 2005 private placement. Additionally, pursuant to the agreement dated
December 16, 2003, we paid Griffin a $50,000 agent fee in respect of our 2005
private placement.
On March 29, 2005, our shareholders approved an amendment to our certificate of
incorporation increasing our authorized but unissued common stock from
45,000,000 to 195,000,000 shares. Upon the effectiveness of the certificate of
amendment to our certificate of incorporation implementing this increase, each
share of Series A preferred stock will automatically convert into 100 shares of
our common stock and each warrant will automatically convert into a warrant to
purchase that number of shares of common stock equal to the number of shares of
preferred stock subject to the warrant multiplied by 100. As a result, upon the
effectiveness of the certificate of amendment, all outstanding shares of Series
A Preferred Stock (148,148 shares) were converted into 14,814,800 shares of our
common stock. In addition, upon the effectiveness of the certificate of
amendment, all outstanding warrants to purchase shares of Series A preferred
stock (14,815 shares) and Series B preferred stock (81,477 shares) were
converted into five-year warrants to purchase 1,481,500 shares of our common
stock at an exercise price of $0.27 per share and five-year warrants to purchase
8,147,700 shares of our common stock at an exercise price of $0.40 per share,
respectively.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Fees for professional services provided by Macias Gini & O'Connell LLP for the
years ended December 31, 2005 and 2004 were as follows:
Category 2005 2004
-------------------- ------------ ------------
Audit fees $ 173,500 $ 150,000
Audit - related fees - -
Tax fees 13,500 13,600
Other fees - -
------------ ------------
Totals $ 187,000 $ 163,300
============ ============
Audit fees include fees associated with our annual audit, the reviews of our
quarterly reports on Form 10-Q, and assistance with and review of documents
filed with the Securities and Exchange Commission (the "SEC"). Audit-related
fees include consultations regarding revenue recognition rules and
interpretations as they related to the financial reporting of certain
transactions. Tax fees included tax compliance and tax consultations.
The audit committee has adopted a policy that requires advance approval of all
audit, audit-related, tax services and other services performed by our
independent auditor. The policy provides for pre-approval by the audit committee
of specifically defined audit and non-audit services. Unless the specific
service has been previously pre-approved with respect to that year, the audit
committee must approve the permitted service before the independent auditor is
engaged to perform it.
56
PART IV.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a) The following documents are filed as part of this report:
(1) Financial statements filed as part of this report are listed on the
"Index to Consolidated Financial Statements" at page 25 herein.
(2) Financial Statement Schedules. The applicable financial statement
schedules required under Regulation S-X have been included as
follows:
Schedule II - Valuation and Qualifying Accounts: page 48
(b) Exhibits.
Exhibit
Number Description of Exhibit
2.1 Agreement and Plan of Merger and Reorganization dated as of December
3, 2004, between registrant and GraphOn NES Sub, LLC, a California
limited liability company, GraphOn Via SUB III Inc., a Delaware
corporation, Network Engineering Software, Inc., a California
corporation and Ralph Wesinger (1)
3.1 Amended and Restated Certificate of Incorporation of Registrant (2)
3.2 Amended and Restated Bylaws of Registrant (3)
4.1 Form of certificate evidencing shares of common stock of Registrant
(4)
4.2 Form of Warrant issued by Registrant on January 29, 2004 (5)
4.3 Form of Warrant issued by Registrant on February 2, 2005 (6)
4.4 Investors Rights Agreement, dated January 29, 2004, by and among
Registrant and the investors named therein (5)
4.5 Investors Rights Agreement, dated February 2, 2005, by and among
Registrant and the investors named therein (6)
10.1 1996 Stock Option Plan of Registrant (4)
10.2 1998 Stock Option/Stock Issuance Plan of Registrant (3)
10.3 Supplemental Stock Option Agreement, dated as of June 23, 2000 (7)
10.4 Employee Stock Purchase Plan of Registrant (7)
10.5 Lease Agreement between Registrant and Central United Life Insurance,
dated as of October 24, 2003 (5)
10.6 Financial Advisory Agreement, dated January 29, 2004, by and between
Registrant and Orin Hirschman (9)
10.7 Amendment to Financial Advisory Agreement, dated February 2, 2005, by
and between Registrant and Orin Hirschman (6)
10.8 Reimbursement Agreement, dated December 10, 2004, by and between
Registrant and AIGH Investment Partners LLC (9)
10.9 Holder Agreement, dated January 31, 2005, by and between Registrant
and the holders named therein (6)
10.10 Non-recourse Secured Promissory Note, dated October 6, 2004, by and
between Registrant and Ralph Wesinger (9)
10.11 Stock Pledge Agreement, dated October 6, 2004, by and between
Registrant and Ralph Wesinger (9)
10.12 Agreement, dated December 16, 2003, by and between Registrant and
Griffin Securities, Inc. (9)
10.13 2005 Equity Incentive Plan (10)
10.14 Stock Option Agreement, dated February 1, 2005 by and between
Registrant and Ralph Wesinger *
10.15 Stock Option Agreement, dated January 29, 2005 by and between
Registrant and Gary Green *
14.1 Code of Ethics (5)
16.1 Letter from BDO Seidman, LLP, dated February 10, 2005 regarding change
in certifying accountant (8)
21.1 Subsidiary of Registrant *
23.1 Consent of Macias Gini & O'Connell LLP
23.2 Consent of BDO Seidman, LLP
31.1 Rule 13a-14(a)/15d-14(a) Certifications
32.1 Section 1350 Certifications
* Previously filed as an exhibit to this Annual Report
(1) Incorporated by reference from Registrant's Current Report on Form
8-K, dated December 3, 2004, filed with the SEC on December 9, 2004
(2) Incorporated by reference from Registrant's Current Report on Form
8-K, dated January 28, 2005, filed with the SEC on February 3, 2005
(3) Incorporated by reference from Registrant's Form S-4, file number
333-76333.
(4) Incorporated by reference from Registrant's Form S-1, file number
333-11165.
(5) Incorporated by reference from Registrant's Annual Report on Form
10-K for the year ended December 31, 2003, dated March 30, 2003,
filed with the SEC on March 30, 2003
57
(6) Incorporated by reference from Registrant's Current Report on Form
8-K, dated January 31, 2005, filed with the SEC on February 4, 2005
(7) Incorporated by reference from Registrant's Form S-8, file number
333-40174.
(8) Incorporated by reference from Registrant's Current Report on Form
8-K, dated February 9, 2005, filed with the SEC on February 14, 2005
(9) Incorporated by reference from Registrant's Annual Report on Form
10-K for the year ended December 31, 2004, dated April 15, 2005,
filed with the SEC on April 15, 2005.
(10) Incorporated by reference from Registrant's Definitive Proxy
Statement, dated November 21, 2005, filed with the SEC on November
25, 2005
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized.
GRAPHON CORPORATION
Date: January 15, 2007 By: /s/ William Swain
-----------------
William Swain
Chief Financial Officer
58