UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
--------------
FORM 10-Q
--------------
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 2008
Commission File Number: 0-21683
--------------
GraphOn Corporation
(Exact name of registrant as specified in its charter)
--------------
Delaware 13-3899021
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
5400 Soquel Avenue, Suite A2
Santa Cruz, CA 95062
(Address of principal executive offices)
Registrant's telephone number: (800) 472-7466
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the past 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No [ ]
Indicate by check mark whether the registrant is a large accelerated
filer, an accelerated filer, a non-accelerated filer, or a smaller reporting
company. See the definitions of "large accelerated filer," "accelerated filer"
and "smaller reporting company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer [ ] Accelerated filer [ ]
Non-accelerated filer [ ] Smaller reporting company [X]
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No |X|
As of November 7, 2008 there were issued and outstanding 47,322,292 shares
of the issuer's common stock, par value $0.0001.
GRAPHON CORPORATION
FORM 10-Q
Table of Contents
-------------------
PART I. FINANCIAL INFORMATION PAGE
------------------------------------------------------------ --------
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of
September 30, 2008 (unaudited) and December
31, 2007 2
Unaudited Condensed Consolidated Statements of
Operations for the Three and Nine Months Ended
September 30, 2008 and 2007 3
Unaudited Condensed Consolidated Statements of
Cash Flows for the Nine Months Ended September
30, 2008 and 2007 4
Notes to Unaudited Condensed Consolidated
Financial Statements 5
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 13
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 22
Item 4T. Controls and Procedures 22
PART II. OTHER INFORMATION
------------------------------------------------------------
Item 1. Legal Proceedings 23
Item 1A. Risk Factors 23
Item 2. Unregistered Sales of Equity Securities and Use
of Proceeds 23
Item 3. Defaults Upon Senior Securities 24
Item 4. Submission of Matters to a Vote of Security 24
Holders
Item 5. Other Information 24
Item 6. Exhibits 24
Signatures 24
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
GraphOn Corporation
Condensed Consolidated Balance Sheets
(Unaudited)
September 30,
Assets 2008 December 31, 2007
------ ------------------ ------------------
Current Assets
Cash and cash equivalents $ 4,201,900 $ 5,260,800
Accounts receivable, net 852,400 886,600
Prepaid expenses 62,100 42,600
------------------ ------------------
Total Current Assets 5,116,400 6,190,000
Patents, net 2,074,500 2,741,300
Other assets, net 203,000 143,100
------------------ ------------------
Total Assets $ 7,393,900 $ 9,074,400
================== ==================
Liabilities and Stockholders' Equity
Current Liabilities
Accounts payable and accrued expense $ 907,800 $ 867,200
Deferred revenue 1,588,900 1,475,000
------------------ ------------------
Total Current Liabilities 2,496,700 2,342,200
Deferred revenue 1,806,500 1,833,100
Other long term liability 28,400 -
------------------ ------------------
Total Liabilities 4,331,600 4,175,300
------------------ ------------------
Commitments and contingencies - -
Stockholders' Equity
Common stock, $0.0001 par value,
195,000,000 shares authorized,
47,322,292 and 47,576,401 shares
issued and outstanding at
September 30, 2008 and
December 31, 2007, respectively 4,700 4,800
Additional paid-in capital 59,606,400 59,399,000
Accumulated deficit (56,548,800) (54,504,700)
------------------ ------------------
Total Stockholders' Equity 3,062,300 4,899,100
------------------ ------------------
Total Liabilities and
Stockholders' Equity $ 7,393,900 $ 9,074,400
================== ==================
See accompanying notes to unaudited condensed consolidated financial
statements
2
GraphOn Corporation
Condensed Consolidated Statements of Operations
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- --------------------------
2008 2007 2008 2007
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
------------ ----------- ------------ ------------
Revenue $ 1,594,100 $ 1,270,300 $ 4,279,500 $ 3,715,700
Costs of revenue 136,600 113,900 441,900 356,100
------------ ----------- ------------ ------------
Gross profit 1,457,500 1,156,400 3,837,600 3,359,600
------------ ----------- ------------ ------------
Operating expenses
Selling and marketing 473,700 438,100 1,309,400 1,291,500
General and
administrative 1,015,000 1,261,000 2,925,500 3,372,400
Research and development 628,600 446,600 1,714,400 1,757,300
------------ ----------- ------------ ------------
Total operating expenses 2,117,300 2,145,700 5,949,300 6,421,200
------------ ----------- ------------ ------------
Loss from operations (659,800) (989,300) (2,111,700) (3,061,600)
------------ ----------- ------------ ------------
Other income, net 17,700 11,400 70,300 45,400
------------ ----------- ------------ ------------
Loss before provision for
income tax (642,100) (977,900) (2,041,400) (3,016,200)
Provision for income tax 1,100 1,700 2,700 5,600
------------ ----------- ------------ ------------
Net loss (643,200) (979,600) (2,044,100) (3,021,800)
============ =========== ============ ============
Basic and diluted loss per
share $ (0.01) $ (0.02) $ (0.04) $ (0.07)
============ =========== ============ ============
Average weighted common
shares outstanding 47,084,241 46,764,015 47,090,128 46,418,462
============ =========== ============ ============
See accompanying notes to unaudited condensed consolidated financial
statements
3
GraphOn Corporation
Condensed Consolidated Statements of Cash Flows
Nine Months Ended September 30,
-------------------------------------
2008 2007
(Unaudited) (Unaudited)
----------------- ----------------
Cash Flows Provided By (Used In) Operating
Activities:
---------------------------------------------
Net Loss $ (2,044,100) $ (3,021,800)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Depreciation and amortization 726,800 720,600
Stock-based compensation expense 286,800 375,500
Provision for doubtful accounts 12,600 115,900
Other items - (1,400)
Changes in operating assets and liabilities
Accounts receivable 21,600 (146,600)
Prepaid expense (19,500) 11,300
Accounts payable and accrued expense 25,500 98,100
Deferred revenue 87,300 266,000
----------------- ----------------
Net Cash Used In Operating Activities (903,000) (1,582,400)
----------------- ----------------
Cash Flows Used In Investing Activities:
---------------------------------------------
Purchases of equipment (76,300) (64,700)
Other assets (200) (100)
----------------- ----------------
Net Cash Used In Investing Activities (76,500) (64,800)
----------------- ----------------
Cash Flows Provided By (Used In) Financing Activities:
---------------------------------------------
Proceeds from sale of common stock -
employee stock purchase plan 8,300 7,100
Proceeds from exercise of stock options - 60,000
Costs of stock purchased and retired under
stock buy-back program (87,700) -
----------------- ----------------
Net Cash Provided By (Used In) Financing Activities (79,400) 67,100
----------------- ----------------
Net Decrease in Cash and Cash Equivalents (1,058,900) (1,580,100)
Cash and Cash Equivalents, Beginning of Period 5,260,800 2,937,100
----------------- ----------------
Cash and Cash Equivalents, End of Period $ 4,201,900 $ 1,357,000
================= ================
See accompanying notes to unaudited condensed consolidated financial
statements
4
GraphOn Corporation
Notes to Unaudited Condensed Consolidated Financial Statements
1. Basis of Presentation
The unaudited condensed consolidated financial statements included herein have
been prepared in accordance with accounting principles generally accepted in the
United States ("GAAP") applicable to interim financial information and the rules
and regulations promulgated by the Securities and Exchange Commission (the
"SEC"). Accordingly, such financial statements do not include all information
and footnote disclosures required in annual financial statements.
The unaudited condensed consolidated financial statements included herein
reflect all adjustments, which include only normal, recurring adjustments, that
are, in the opinion of management, necessary to state fairly the results for the
periods presented. This Quarterly Report on Form 10-Q should be read in
conjunction with the audited consolidated financial statements of GraphOn
Corporation (the "Company") contained in the Company's Annual Report on Form
10-KSB for the year ended December 31, 2007, which was filed with the SEC on
March 31, 2008 ("2007 10-KSB Report"). The interim results presented herein are
not necessarily indicative of the results of operations that may be expected for
the full fiscal year ending December 31, 2008, or any future period.
2. Significant Accounting Policies
Use of Estimates
The preparation of financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the amounts reported in
the unaudited condensed consolidated financial statements and accompanying
notes. While the Company believes that such estimates are fair when considered
in conjunction with the unaudited condensed consolidated financial statements
and accompanying notes, the actual amount of such estimates, when known, may
vary from those estimates.
Intercompany Accounts and Transactions
Significant intercompany accounts and transactions are eliminated upon
consolidation.
Revenue Recognition
The Company markets and licenses products through various means, such as;
channel distributors, independent software vendors ("ISVs"), value-added
resellers ("VARs") (collectively "resellers") and direct sales to enterprise end
users. Its product licenses are generally perpetual. The Company also separately
sells maintenance contracts, which are comprised of license updates and customer
service access, private-label branding kits, software developer kits and product
training services.
Generally, software license revenues are recognized when:
o Persuasive evidence of an arrangement exists, (i.e., when the Company
signs 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 programs) 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, and customer training. The Company
limits its 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.
5
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 purchase product licenses that they hold in inventory until
they are resold to the ultimate end user (an "inventory stocking order"). The
Company provides maintenance services to these resellers for such licenses at no
charge. Generally, the Company defers the recognition of revenue for inventory
stocking orders until the underlying licenses are sold to the end user. The
Company allocates revenue to the service fee (maintenance) component based on
VSOE prorated to the time period between the inventory order date and date of
sale to the end user. For certain resellers, assuming all other revenue
recognition criteria have been met, the Company recognizes and allocates revenue
for inventory stocking orders based upon the estimated time frame the licenses
will be held by the reseller. Such estimates are based upon the Company's
historical experience with the reseller.
There are no rights of return granted to resellers or other purchasers of the
Company's software programs.
Revenue from maintenance contracts is recognized ratably over the related
contract period, which generally ranges from one to five years.
Long-Lived Assets
Long-lived assets, which consist primarily of patents, are assessed for possible
impairment whenever events or changes in circumstances indicate that the
carrying amounts may not be recoverable, whenever the Company has committed to a
plan to dispose of the assets or, at a minimum, as it relates to the Company's
patents, annually. Measurement of the impairment loss is based on the fair value
of the assets. Generally, fair value is determined based on appraisals, current
market value, comparable sales value, and undiscounted future cash flows, as
appropriate. Assets to be held and used affected by such impairment loss are
depreciated or amortized at their new carrying amount over the remaining
estimated life; assets to be sold or otherwise disposed of are not subject to
further depreciation or amortization. No such impairment charge was recorded
during either of the three or nine-month periods ended September 30, 2008 or
2007.
Patents
The Company's patents are being amortized over their estimated remaining
economic lives, currently estimated to be until approximately December 31, 2010.
Costs associated with filing, documenting or writing method patents are expensed
as incurred. Contingent legal fees paid in connection with a patent lawsuit, or
settlements thereof, are charged to cost of goods sold. All other non-contingent
legal fees and costs incurred in connection with a patent lawsuit, or
settlements thereof, are charged to general and administrative expense as
incurred.
3. Stock-Based Compensation
The Company recorded stock-based compensation expense of $72,100 and $113,300 in
the three-month periods ended September 30, 2008 and 2007, respectively, and
$286,800 and $375,500 in the nine-month periods ended September 30, 2008 and
2007, respectively.
The following table illustrates the stock-based compensation expense recorded
during the three and nine-month periods ended September 30, 2008 and 2007 by
income statement classification:
Three months ended Nine months ended
September 30, September 30,
----------------------------- -----------------------------
Income Statement Classification 2008 2007 2008 2007
- ---------------------------------- ------------- ------------- ------------- -------------
Cost of revenue $ 4,100 $ 2,600 $ 14,900 $ 10,600
Selling and marketing expense 6,500 6,300 25,500 26,100
General and administrative expense 17,900 80,900 139,100 258,300
Research and development expense 43,600 23,500 107,300 80,500
------------- ------------- ------------- -------------
$ 72,100 $ 113,300 $ 286,800 $ 375,500
============= ============= ============= =============
The Company estimated the fair value of each stock-based award granted during
the three and nine-month periods ended September 30, 2008 and 2007, as of the
date of grant, using a binomial model with the assumptions set forth in the
following table:
6
Three Months Ended
September 30, Nine Months Ended September 30,
----------------------------- -------------------------------------
2008 2007 2008 2007
------------ ------------- ----------------- -----------------
Estimated volatility 160.00% 154.22% 158.00 - 160.00% 153.66 - 154.44%
Annualized forfeiture rate 4.00% 5.37% 4.00% 5.06 - 5.37%
Prior forfeiture rate 4.00% 5.25% 5.30% 5.50%
Expected option term (years) 7.5 7.5 7.5 7.5
Estimated exercise factor 10.00% 10.00% 10.00% 10.00%
Approximate risk-free
interest rate 3.44% 4.60% 3.15 - 3.46% 4.58 - 4.60%
Expected dividend yield 0% 0% 0% 0%
The Company also recognized compensation costs for common shares purchased under
its Employee Stock Purchase Plan ("ESPP") during the three and nine-month
periods ended September 30, 2008 and 2007, applying the same variables as noted
in the table above to the calculation of such costs, except that the expected
term was 0.5 years for each respective period and for shares purchased during
the three months ended September 30, 2008 the risk-free interest rate was 3.79%.
The time span from the date of grant of ESPP shares to the date of purchase is
six months.
The Company does not anticipate paying dividends on its common stock for the
foreseeable future. Expected volatility is based on the historical volatility of
the Company's common stock over the 7.5 year period ended on the end of each
respective quarterly reporting period noted in the above table.
The approximate risk free interest rate was based on the implied yield available
on U.S. Treasury issues with remaining terms equivalent to the Company's
expected term on its stock-based awards. The expected term of the Company's
stock-based option awards was based on historical award holder exercise patterns
and considered the market performance of the Company's common stock and other
items. The annualized forfeiture rate was based on an analysis of historical
data and considered the impact of events such as the work force reductions the
Company carried out during previous years. The estimated exercise factor was
based on an analysis of historical data and included a comparison of historical
and current share prices.
For stock-based awards granted during the three-month periods ended September
30, 2008 and 2007, exclusive of common shares purchased pursuant to the
Company's ESPP, the weighted average fair value was $0.22 and $0.23,
respectively. For stock-based awards granted during the nine-month periods ended
September 30, 2008 and 2007, exclusive of common shares purchased pursuant to
the Company's ESPP, the weighted average fair values were $0.34 and $0.15,
respectively.
The weighted average fair values of common shares purchased pursuant to the
Company's ESPP during the three-month periods ended September 30, 2008 and 2007
were $0.24 and $0.14, respectively. The weighted average fair values of common
shares purchased pursuant to the Company's ESPP during the nine-month periods
ended September 30, 2008 and 2007 were $0.21 and $0.14, respectively.
The following table presents a summary of the status and activity of the
Company's stock option awards for the three and nine-month periods ended
September 30, 2008.
Weighted
Average
Weighted Remaining
Number Average Contractual Aggregate
of Exercise Term Intrinsic
Shares Price (Years) Value
---------- ---------- ------------ ----------
For the Three Months Ended September 30, 2008
- ---------------------------------------------
Outstanding - June 30, 2008 7,499,286 $ 0.45 6.57 $ 196,400
Granted 15,000 0.25
Exercised - -
Forfeited or expired (19,698) 0.29
----------
Outstanding - September 30, 2008 7,494,588 $ 0.45 6.34 $ 40,300
==========
7
For the Nine Months Ended September 30, 2008
- ---------------------------------------------
Outstanding - December 31, 2007 6,569,286 $ 0.46 6.70 $ 545,000
Granted 945,000 0.38
Exercised - -
Forfeited or expired (19,698) 0.29
----------
Outstanding - September 30, 2008 7,494,588 $ 0.45 6.34 $ 40,300
==========
Of the options outstanding as of September 30, 2008, 6,188,181 were vested,
1,258,490 were estimated to vest in future periods and 47,917 were estimated to
be forfeited prior to their vesting.
All options are exercisable immediately upon grant. Options vest, generally
ratably over a 33-month period commencing in the fourth month after the grant
date. The Company has the right to repurchase exercised options that have not
vested upon their forfeiture at the respective option's exercise price.
As of September 30, 2008, there was approximately $213,600 of total unrecognized
compensation cost, net of estimated forfeitures, related to stock-based
compensation. That cost is expected to be recognized over a weighted-average
period of approximately one year.
4. Revenue
Revenue for the three-month periods ended September 30, 2008 and 2007 was
comprised as follows:
2008 Over (Under) 2007
--------------------------
Revenue 2008 2007 Dollars Percent
------------------- ------------- ------------ --------------- --------
Product Licenses
Windows $ 751,800 $ 415,700 $ 336,100 80.9%
Unix 246,200 372,800 (126,600) -34.0%
------------- ------------ ---------------
998,000 788,500 209,500 26.6%
------------- ------------ ---------------
Service Fees
Windows 271,700 229,800 41,900 18.2%
Unix 285,300 248,400 36,900 14.9%
------------- ------------ ---------------
557,000 478,200 78,800 16.5%
Other 39,100 3,600 35,500 986.1%
------------- ------------ ---------------
Total Revenue $ 1,594,100 $1,270,300 $ 323,800 25.5%
============= ============ ===============
Revenue for the nine-month periods ended September 30, 2008 and 2007 was
comprised as follows:
2008 Over (Under) 2007
--------------------------
Revenue 2008 2007 Dollars Percent
------------------- ------------- ------------ --------------- --------
Product Licenses
Windows $ 1,657,500 $ 1,432,400 $ 225,100 15.7%
Unix 947,400 860,000 87,400 10.2%
------------- ------------ ---------------
2,604,900 2,292,400 312,500 13.6%
------------- ------------ ---------------
Service Fees
Windows 763,800 621,100 142,700 23.0%
Unix 839,700 707,800 131,900 18.6%
------------- ------------ ---------------
1,603,500 1,328,900 274,600 20.7%
Other 71,100 94,400 (23,300) -24.7%
------------- ------------ ---------------
Total Revenue $ 4,279,500 $ 3,715,700 $ 563,800 15.2%
============= ============ ===============
8
5. Patents
Patents consisted of the following:
September 30, 2008 December 31, 2007
-------------------- ---------------------
Patents $ 5,340,400 $ 5,340,400
Accumulated amortization (3,265,900) (2,599,100)
-------------------- ---------------------
$ 2,074,500 $ 2,741,300
==================== =====================
Patent amortization, which aggregated $222,300 and $666,800 during each of the
three and nine-month periods ended September 30, 2008 and 2007, respectively, is
a component of general and administrative expenses.
6. Accounts Receivable, Net
Accounts receivable were net of allowances totaling $241,600 and $229,000 as of
September 30, 2008 and December 31, 2007, respectively.
7. Other Liabilities
Other liabilities are comprised of the final principal payment due under a
three-year extended payment agreement (the "agreement") between the Company and
a software vendor, for software used internally by the Company as well as a
support contract and product training. A similar amount, which is due and
payable during April 2009, has been accrued as a component of accrued expenses.
The initial payment, plus interest, was made during the nine-month period ended
September 30, 2008. See Note 10.
Interest on the agreement, in the aggregate approximately $6,700 over the
three-year agreement, is expensed ratably upon payment.
8. Stockholders' Equity - Stock Buy Back Program
During the three months ended September 30, 2008, the Company repurchased
294,000 shares of its common stock, at an average price of $0.29, for an
aggregate cost of $87,700. As of September 30, 2008, approximately $912,300 of
the Board approved $1,000,000 stock buy back program remained available for
future purchases. The Company is not obligated to repurchase any specific number
of shares and the program may be suspended or terminated at the Company's
discretion.
9. Commitments and Contingencies
During May 2008, the Company's Board of Directors approved a Director Severance
Plan and a Key Employee Severance Plan.
Director Severance Plan: This agreement provides for accelerated vesting of a
director's stock options in the event of any transaction or series of
transactions that constitute a change in the ownership or effective control of
the Company, or in the ownership of a substantial portion of the assets of the
Company, as defined in regulations promulgated under Section 409A of the
Internal Revenue Code of 1986, as amended (the "Code"), and the termination of
the director.
Key Employee Severance Plan: This agreement provides for 12-month salary
continuation for key employees (24 months for certain senior management),
accelerated vesting of key employees' stock options, the payment of bonuses that
key employees would have been entitled to under the Company's incentive bonus
plan and provides key employees with certain health plan and other benefits in
the event of Involuntary Termination or Constructive Termination (as both terms
are defined in the Key Employee Severance Plan) upon any transaction or series
of transactions that constitute a change in the ownership or effective control
of the Company, or in the ownership of a substantial portion of the assets of
the Company, as defined in the Code.
The Company has the right to amend or terminate each of the above listed
severance plans; however, the plans may not be amended or terminated following
the occurrence of a change in control, or in the case of the Key Employee
Severance Plan, a relocation, as outlined above. In any event, each of the above
listed plans will terminate no later than December 31, 2010.
9
Juniper Networks, Inc. has petitioned the United States Patent and Trademark
Office (the "PTO") to reexamine two of the Company's patents, namely; U. S.
Patent Nos. 5,826,014 and 6,061,798 (the "'014" and "'798" patents,
respectively). On April 5, 2008, the PTO ordered the reexamination of the `798
patent, and on July 25, 2008, the PTO ordered the reexamination of the `014
patent. Juniper also asked the PTO to reexamine the Company's U.S. Patent No.
7,127,464 (the "'464" patent), a patent unrelated to any litigation. The PTO
ordered the reexamination of the `464 patent on April 17, 2008. Such
reexaminations will result in the PTO either: confirming all of the patent's
claims, narrowing all, or some, of the patent's claims, or cancelling all of the
patent's claims in their entirety. Pending completion of the reexamination
processes of these patents, the Company does not believe such patents have been
impaired.
Effective August 1, 2008, the Company's wholly-owned Israeli subsidiary, GraphOn
Research Labs, Ltd. ("GRLL") vacated its office space upon expiration of its
lease. GRLL's two current engineer employees currently operate from home
offices. The Company believes that adequate office space is available in Israel
should it be deemed necessary to secure such space for GRLL's operations in the
future. The Company continues to maintain its offices in Santa Cruz and Irvine,
California as well as Concord, New Hampshire.
10. Supplemental Disclosure of Cash Flow Information
The Company disbursed approximately $800 and $43,600 for the payment of income
taxes during each of the three and nine-month periods ended September 30, 2008.
The Company disbursed approximately $0 and $2,000 for the payment of income
taxes during each of the three and nine-month periods ended September 30, 2007.
The Company disbursed approximately $0 and $2,200 for the payment of interest
expense during each of the three and nine-month periods ended September 30,
2008. The Company disbursed no cash for the payment of interest expense during
either the three or nine-month period ended September 30, 2007.
During the nine-month period ended September 30, 2008, the Company capitalized
approximately $28,200 of fixed assets, related to software purchased for
internal use, and recorded approximately $15,200 of other assets, related to
future support services for the software purchased, for which no cash was
disbursed. The Company accrued $15,000 as a current liability and $28,400 as a
long term liability, for these items. See Note 7.
11. 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 three
and nine-month periods ended September 30, 2008, 21,118,788 shares of common
stock equivalents were excluded from the computation of diluted loss per share
since their effect would be antidilutive. For the three and nine-month periods
ended September 30, 2007, 20,343,486 shares of common stock equivalents were
excluded from the computation of diluted loss per share since their effect would
be antidilutive.
12. Segment Information
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information," establishes standards for reporting information about operating
segments. This standard requires segmentation based on the Company's internal
organization and reporting of revenue and operating income based on internal
accounting methods. The Company's financial reporting systems present various
data for management to operate the business prepared in methods consistent with
GAAP. The segments were defined in order to allocate resources internally.
Operating segments are defined as components of an enterprise about which
separate financial information is available that is evaluated regularly by the
chief operating decision maker, or the decision making group, in deciding how to
allocate resources and in assessing performance. The Company's chief operating
decision maker is its Chief Executive Officer. The Company has determined that
it operates its business in two segments: software and intellectual property.
Segment revenue was as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------- ----------------------------
Revenue 2008 2007 2008 2007
---------------------- ------------ ------------ ------------ ------------
Software $ 1,594,100 $ 1,270,300 $ 4,279,500 $ 3,715,700
Intellectual Property - - - -
------------ ------------ ------------ ------------
Consolidated Revenue $ 1,594,100 $ 1,270,300 $ 4,279,500 $ 3,715,700
============ ============ ============ ============
10
Segment loss from operations was as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------- ---------------------------
Loss From Operations 2008 2007 2008 2007
------------------------ ------------ ------------ ------------ ------------
Software $ (126,500) $ (180,400) $ (711,600) $(1,263,000)
Intellectual Property (533,300) (808,900) (1,400,100) (1,798,600)
------------ ------------ ------------ ------------
Consolidated Loss From
Operations $ (659,800) $ (989,300) $(2,111,700) $(3,061,600)
============ ============ ============ ============
The Company does not allocate interest and other income, interest and other
expense or income tax to its segments.
As of September 30, 2008, segment fixed assets (long-lived assets) were as
follows:
Accumulated
Depreciation Net, as
Fixed Assets Cost Basis /Amortization Reported
-------------- --------------- ---------------
Software $ 1,249,900 $ (1,051,900) $ 198,000
Intellectual Property 5,340,400 (3,265,900) 2,074,500
Unallocated 5,000 - 5,000
-------------- --------------- ---------------
$ 6,595,300 $ (4,317,800) $ 2,277,500
============== =============== ===============
The Company does not allocate other assets, which consists primarily of
deposits, to its segments.
Products and services provided by the software segment include all currently
available versions of GO-Global for Windows, GO-Global for Unix, OEM private
labeling kits, software developer's kits, maintenance contracts and product
training and support. The intellectual property segment provides licenses to our
intellectual property. The Company's two segments do not engage in cross-segment
transactions.
13. New Accounting Pronouncements
In May 2008, the Financial Accounting Standards Board ("FASB") issued SFAS No.
162, "The Hierarchy of Generally Accepted Accounting Principles" ("SFAS 162"),
which is intended to improve financial reporting by identifying a consistent
framework, or hierarchy, for selecting accounting principles to be used in
preparing financial statements that are presented in conformity with GAAP for
nongovernmental entities. SFAS 162 is effective as of November 15, 2008. The
Company is currently evaluating the impact of adoption of SFAS 162 and does not
expect adoption to have a material impact on results of operations, cash flows
or financial position.
In April 2008, FASB issued FSP FAS 142-3, "Determination of the Useful Life of
Intangible Assets" ("FSP"), which amends the factors that should be considered
in developing renewal or extension assumptions used to determine the useful life
of a recognized intangible asset under FASB Statement No. 142, "Goodwill and
Other Intangible Assets" ("SFAS 142"). The intent of this FSP is to improve the
consistency between the useful life of a recognized intangible asset under SFAS
142 and the period of expected cash flows used to measure the fair value of the
asset under FASB Statement No. 141 (revised 2007), "Business Combinations," and
other accounting principles generally accepted in the United States. This FSP is
effective for financial statements issued for fiscal years beginning after
December 15, 2008, and interim periods within those fiscal years. Early adoption
is prohibited. The Company is currently evaluating the impact of adoption of
this FSP and does not expect adoption to have a material impact on results of
operations, cash flows or financial position.
In March 2008, FASB issued SFAS No. 161, "Disclosures about Derivatives
Instruments and Hedging Activities, an Amendment of FASB Statement No. 133"
("SFAS 161"). SFAS 161 requires enhanced disclosures about a company's
derivative and hedging activities. SFAS is effective for financial statements
issued for fiscal years beginning after December 15, 2008. The Company is
currently evaluating the impact of the adoption of SFAS 161 and does not expect
adoption to have a material impact on results of operations, cash flows or
financial position.
In December 2007, the FASB issued SFAS No. 141 (revised 2007), "Business
Combinations" ("SFAS 141R") which replaces SFAS No. 141, "Business
Combinations." SFAS 141R establishes principles and requirements for recognizing
and measuring identifiable assets and goodwill acquired, liabilities assumed and
any noncontrolling interest in a business combination at their fair value at
acquisition date. SFAS 141R alters the treatment of acquisition related costs,
11
business combinations achieved in stages (referred to as a step acquisition),
the treatment of gains from a bargain purchase, the recognition of contingencies
in business combinations, the treatment of in-process research and development
in a business combination as well as the treatment of recognizable deferred tax
benefits. SFAS 141R is effective for business combinations closed in fiscal
years beginning after December 15, 2008. The Company is currently evaluating the
impact of SFAS 141R and expects results of operations, cash flows or financial
position would only be impacted in relation to future business combination
activities, if any.
In February 2007, FASB issued SFAS No. 159, "The Fair Value Option for Financial
Assets and Financial Liabilities" ("SFAS 159") which permits entities to choose
to measure many financial instruments and certain other items at fair value. The
objective of SFAS 159 is to improve financial reporting by providing entities
with the opportunity to mitigate volatility in reported earnings caused by
measuring related assets and liabilities differently without having to apply
complex hedge accounting provisions. SFAS 159 is effective as of an entity's
first fiscal year that begins after November 15, 2007. The adoption of SFAS 159
did not have a material impact on results of operations, cash flows or financial
position.
In September 2006, FASB issued SFAS No. 157, "Fair Value Measurements" ("SFAS
157") which defines fair value, establishes a framework for measuring fair value
in GAAP and expands disclosures about fair value measurements. SFAS 157 applies
under other accounting pronouncements that require or permit fair value
measurements, FASB having previously concluded in those accounting
pronouncements that fair value is the relevant measurement attribute.
Accordingly, SFAS 157 does not require any new fair value measurements, however,
for some entities; application of SFAS 157 will change current practice. SFAS
157 is effective for financial statements issued for the first fiscal year
beginning after November 15, 2007 and interim periods within those fiscal years.
In February 2008, FASB issued FASB Staff Position No. 157-2 that defers the
effective date of SFAS 157 for nonfinancial assets and nonfinancial liabilities,
except for items that are recognized or disclosed at fair value in the financial
statements on a recurring basis, to fiscal years beginning after November 15,
2008. In addition, FASB also agreed to exclude from the scope of FASB 157 fair
value measurements made for purposes of applying SFAS No. 13, "Accounting for
Leases" and related interpretive accounting pronouncements. The adoption of SFAS
157 did not have a material impact on results of operations, cash flows or
financial position.
12
ITEM 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Forward-Looking Statements
The following discussion of our financial condition and results of operations
contains forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.
Actual results and the timing of certain events could differ materially from
those anticipated in these forward-looking statements as a result of certain
factors, including:
o our history of operating losses, and expectation that those losses
will continue;
o that a significant portion of our operating revenue has been and
continues to be earned from a very limited number of significant
customers;
o that our stock price has been volatile and you could lose your
investment; and
o other factors, including those set forth under Item 6. "Management's
Discussion and Analysis or Plan of Operation - Risk Factors" in our
2007 10-KSB Report and in other documents we have filed with the
Securities and Exchange Commission.
These factors could have a material adverse effect upon our business, results of
operations and financial condition.
Overview
We are developers of business connectivity software, including Unix, Linux and
Windows server-based software, with an immediate focus on web-enabling
applications for use and/or resale by independent software vendors ("ISVs"),
corporate enterprises, governmental and educational institutions, and others.
Server-based computing, which is 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.
Critical Accounting Policies
We believe that several accounting policies are important to understanding our
historical and future performance. We refer to these policies as "critical"
because these specific areas generally require us to make judgments and
estimates about matters that are uncertain at the time we make the estimates,
and different estimates, which also would have been reasonable, could have been
used, which would have resulted in different financial results. Our critical
accounting policies are identified in our 2007 10-KSB Report, and included:
revenue recognition, the allowance for doubtful accounts, patents, long-lived
assets, capitalized software development costs, impairment of intangible assets,
loss contingencies and stock-based compensation expense. The following operating
results should be read in conjunction with our critical accounting policies.
Stock-Based Compensation
On January 1, 2006, we adopted the fair value recognition provisions of
Statement of Financial Accounting Standards No. 123R, "Share-Based Payment,"
("FAS123R") and related interpretations using the modified prospective
transition method. Under that method, compensation cost recognized in the three
and nine-month periods ended September 30, 2008 and 2007 includes (a)
compensation cost for all stock-based awards granted prior to, but not yet
vested as of January 1, 2006 based on the grant date fair value estimated in
accordance with the original provisions of Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation," ("FAS123") and (b)
compensation cost for all stock-based awards granted on or subsequent to January
1, 2006, based on the grant-date fair value estimated in accordance with the
provisions of FAS123R.
The valuation provisions of FAS123R apply to new awards and to awards that were
outstanding on the adoption date and subsequently modified or cancelled.
Estimated compensation expense for awards outstanding at the adoption date is
13
recognized over the remaining service period using the compensation cost
calculated for pro forma disclosure purposes under FAS123.
The valuation of employee stock options is an inherently subjective process
since market values are generally not available for long-term, non-transferable
employee stock options. Accordingly, an option pricing model is utilized to
derive an estimated fair value. In calculating the estimated fair value of our
stock options, we used a binomial pricing model which requires the consideration
of the following variables for purposes of estimating fair value:
o the expected volatility of our common stock,
o the annualized forfeiture/termination rate,
o the prior forfeiture/termination rate,
o the expected term of the option,
o the exercise factor for optionees,
o the risk free interest rate for the expected option term, and
o expected dividends on our common stock (we do not anticipate paying
dividends for the foreseeable future).
Of the variables above, the selection of an expected term, an annualized
forfeiture rate and expected stock price volatility are the most subjective. Our
estimate of the expected term was derived based on our analysis of historical
data and future projections. We estimated forfeiture rate by analyzing our
historical forfeiture data, including consideration of the impact of certain
non-recurring events, such as reductions in work force. We estimated stock price
volatility by referencing our actual stock prices over the period commensurate
with the expected life of the options and ending on the balance sheet date, for
each period currently being reported. We believe that each of these estimates is
reasonable in light of the data we analyzed. However, as with any estimate, the
ultimate accuracy of these estimates is only verifiable over time.
We estimated the fair value of each stock-based award granted during the three
and nine-month periods ended September 30, 2008 and 2007, as of the grant date,
using a binomial model with the assumptions set forth in the following table:
Three Months Ended
September 30, Nine Months Ended September 30,
----------------------------- -------------------------------------
2008 2007 2008 2007
------------ ------------- ----------------- -----------------
Estimated volatility 160.00% 154.22% 158.00 - 160.00% 153.66 - 154.44%
Annualized forfeiture rate 4.00% 5.37% 4.00% 5.06 - 5.37%
Prior forfeiture rate 4.00% 5.25% 5.30% 5.50%
Expected option term (years) 7.5 7.5 7.5 7.5
Estimated exercise factor 10.00% 10.00% 10.00% 10.00%
Approximate risk-free
interest rate 3.44% 4.60% 3.15 - 3.46% 4.58 - 4.60%
Expected dividend yield 0% 0% 0% 0%
We applied the same variables to the valuation of shares purchased under our
ESPP, except that the expected term was 0.5 years, as the time span from the
date of grant of ESPP shares to the date of purchase is six months, and the
risk-free interest rate was 3.79% for ESPP shares purchased during the three
months ended September 30, 2008.
The following table illustrates the stock-based compensation expense recorded
during the three and nine-month periods ended September 30, 2008 and 2007 by
income statement classification:
Three months ended Nine months ended
September 30, September 30,
----------------------------- -----------------------------
Income Statement Classification 2008 2007 2008 2007
- ---------------------------------- ------------- ------------- ------------- -------------
Cost of revenue $ 4,100 $ 2,600 $ 14,900 $ 10,600
Selling and marketing expense 6,500 6,300 25,500 26,100
General and administrative expense 17,900 80,900 139,100 258,300
Research and development expense 43,600 23,500 107,300 80,500
------------- ------------- ------------- -------------
$ 72,100 $ 113,300 $ 286,800 $ 375,500
============= ============= ============= =============
14
We expect that stock-based compensation expense will continue to have a material
impact on our financial results for the remainder of the fiscal year. For the
remainder of fiscal 2008 we expect to incur stock-based compensation expense of
approximately $59,000.
Results of Operations for the Three and Nine-Month Periods Ended September 30,
2008 and 2007.
Revenue
Our software revenue has historically been primarily derived from product
licensing fees and service fees from maintenance contracts. Other sources of
software revenue include sales of software development kits and training.
Software development kits are tools that allow end users to develop, interface
and brand their own applications for use in conjunction with either our Windows
or Unix/Linux products. Currently, we do not generate a significant amount of
revenue from either the sale of software development kits or training, nor do we
anticipate generating a significant amount from their sale during 2008.
Revenue for the three-month periods ended September 30, 2008 and 2007 was as
follows:
2008 Over (Under) 2007
--------------------------
Revenue 2008 2007 Dollars Percent
------------------- ------------- ------------ --------------- --------
Product Licenses
Windows $ 751,800 $ 415,700 $ 336,100 80.9%
Unix 246,200 372,800 (126,600) -34.0%
------------- ------------ ---------------
998,000 788,500 209,500 26.6%
------------- ------------ ---------------
Service Fees
Windows 271,700 229,800 41,900 18.2%
Unix 285,300 248,400 36,900 14.9%
------------- ------------ ---------------
557,000 478,200 78,800 16.5%
Other 39,100 3,600 35,500 986.1%
------------- ------------ ---------------
Total Revenue $ 1,594,100 $1,270,300 $ 323,800 25.5%
============= ============ ===============
Revenue for the nine-month periods ended September 30, 2008 and 2007 was as
follows:
2008 Over (Under) 2007
--------------------------
Revenue 2008 2007 Dollars Percent
------------------- ------------- ------------ --------------- --------
Product Licenses
Windows $ 1,657,500 $ 1,432,400 $ 225,100 15.7%
Unix 947,400 860,000 87,400 10.2%
------------- ------------ ---------------
2,604,900 2,292,400 312,500 13.6%
------------- ------------ ---------------
Service Fees
Windows 763,800 621,100 142,700 23.0%
Unix 839,700 707,800 131,900 18.6%
------------- ------------ ---------------
1,603,500 1,328,900 274,600 20.7%
Other 71,100 94,400 (23,300) -24.7%
------------- ------------ ---------------
Total Revenue $ 4,279,500 $ 3,715,700 $ 563,800 15.2%
============= ============ ===============
During the three month period ended September 30, 2008, seven customers
increased their aggregate sales orders for Windows-based product licenses by
approximately $329,900 as compared with the same period of the prior year. These
aggregate increases were the main factor in the increased Windows-based product
licenses revenue for both the three and nine-month periods ended September 30,
2008, as compared with the same periods of the prior years.
For the nine-month period ended September 30, 2008, the aggregate increase in
Windows-based product licenses revenue was partially offset by an aggregate
decrease in such revenue from all other customers, as compared with the same
period of the prior year.
The increases in Windows-based product licenses revenue for both the three and
nine-month periods ended September 30, 2008, as compared with the same periods
of the prior year, respectively, are reflective of how such revenue can vary
from period to period because a significant portion of this revenue has
historically been earned, and continues to be earned, from a limited number of
15
significant customers, most of whom are resellers. Consequently, if any of these
significant customers change their order level, or fail to order during the
reporting period, our product licenses revenue could be materially impacted. We
expect this situation to continue throughout the next several quarterly
reporting periods.
The decrease in Unix product license revenue for the three-month period ended
September 30, 2008, as compared with the same period of the prior year, was
primarily due to an approximate $121,600 decrease in aggregate purchases, from
Alcatel-Lucent, our most significant Unix customer.
The increase in Unix product license revenue for the nine-month period ended
September 30, 2008, as compared with the same period of the prior year, was
primarily due to an approximate $164,500 increase in aggregate purchases from
three significant Unix customers, Alcatel-Lucent, Ericsson and ARC Systems
Telecomicacoes, which was partially offset by aggregate decreases from other
customers.
Our customers typically purchase a maintenance contract at the time they license
our product. Such maintenance contracts vary in term from one to five years and
generally are renewed upon expiration. Service fees associated with maintenance
contracts are deferred and recognized as revenue ratably over the underlying
service period of the maintenance contract.
The increases in service fees for the three and nine-month periods ended
September 30, 2008, as compared with the same periods of the prior year, were
primarily a result of the continued growth of the number of licenses our
end-user customers have installed. Since our customers typically purchase
maintenance contracts, and, subsequently, renew them upon expiration, as
end-user customers continue to deploy more and more of our products, the revenue
we are able to recognize from the sale of such maintenance contracts increases.
We expect aggregate service fees revenue for 2008 to exceed those of 2007.
Segment Revenue
For the three and nine-month periods ended September 30, 2008 and 2007 all of
our revenue was derived from our software segment. Revenues from our
intellectual property segment are non-predictable and are dependent upon the
outcome of pending litigation and the results of licensing discussions with
companies potentially infringing upon our patents. As a result, we expect all
2008 revenue to be earned from our software segment.
Cost of Revenue
Cost of revenue is comprised primarily of service costs, which represent the
costs of customer service, and product costs. We incur no shipping or packaging
costs as all of our deliveries are made via electronic means over the Internet.
Under accounting principles generally accepted in the United Sates ("GAAP"),
research and development costs for new product development, after technological
feasibility is established, are recorded as "capitalized software" on our
balance sheet. Such capitalized costs are subsequently amortized as cost of
revenue over the shorter of three years or the remaining estimated life of the
products. No such costs were capitalized during either of the three or
nine-month periods ended September 30, 2008. Approximately $3,600 of such costs
was capitalized during the three and nine-month periods ended September 30,
2007.
Cost of revenue increased by $22,700, or 19.9%, to $136,600, for the three
months ended September 30, 2008, from $113,900 for the same period of 2007. Cost
of revenue was 8.6% and 9.0% of revenue for the three months ended September 30,
2008 and 2007, respectively.
Cost of revenue increased by $85,800 or 24.1%, to $441,900, for the nine months
ended September 30, 2008, from $356,100 for the same period of 2007. Cost of
revenue was 10.3% and 9.6% of revenue for the nine months ended September 30,
2008 and 2007, respectively.
Factors contributing to the increases in cost of revenue included service costs,
which increased by $26,400 and $67,200 during the three and nine-month periods
ended September 30, 2008, respectively, as compared with the same periods in
2007, resulted primarily from increased engineering time spent performing
customer service in order to better meet the needs of our customers. Partially
offsetting the increase for the three-month period ended September 30, 2008, as
compared with the same period of the prior year, was an approximate $3,700
decrease in product costs that resulted from a decrease in amortization of
certain licensed technology no longer incorporated into our GO-Global product
line.
Included in service costs for the three-month periods ended September 30, 2008
and 2007 was non-cash stock-based compensation costs aggregating approximately
$4,100 and $2,600, respectively. Included in service costs for the nine-month
16
periods ended September 30, 2008 and 2007 was non-cash stock-based compensation
costs aggregating approximately $14,900 and $10,600, respectively.
Also contributing to the increased cost of revenue for the nine-month period
ended September 30, 2008, as compared with the same period of the prior year,
was an $18,600 increase in product costs. The increase was primarily due to
costs associated with the expansion of our GO-Global for Unix product's ability
to web-enable various Linux platforms as well as increased costs from our
supplier of certain licensing technology that we incorporate into both GO-Global
for Windows and GO-Global for Unix.
Due to these factors, we expect 2008 cost of revenue to exceed 2007 levels.
Selling and Marketing Expenses
Selling and marketing expenses primarily consist of employee costs (inclusive of
non-cash stock-based compensation expense), outside services and travel and
entertainment expense.
Selling and marketing expenses for the three-month period ended September 30,
2008 increased by $35,600, or 8.1%, to $473,700, from $438,100 for the same
period of 2007. Selling and marketing expenses for the nine-month period ended
September 30, 2008 approximated those for the same period of 2007. Selling and
marketing expenses were 29.7% and 34.5% of revenue for the three-month periods
ended September 30, 2008 and 2007, respectively, and 30.6% and 34.8% of revenue
for the nine-month periods ended September 30, 2008 and 2007, respectively.
The main factor contributing to the increase in selling and marketing expenses
was an approximate $29,200 increase in outside services during the three-month
period ended September 30, 2008, as compared with the same period of 2007.
Included in employee costs were non-cash stock-based compensation costs
aggregating approximately $6,500 and $6,300, respectively, for the three-month
periods ended September 30, 2008 and 2007, and $25,500 and $26,100,
respectively, for the nine-month periods ended September 30, 2008 and 2007.
We currently expect our full-year 2008 sales and marketing expense will
approximate 2007 levels.
General and Administrative Expenses
General and administrative expenses primarily consist of employee costs
(inclusive of non-cash stock-based compensation expense), amortization and
depreciation, legal, professional and other outside services (including those
related to realizing benefits from our patent-related assets), travel and
entertainment, certain costs associated with being a publicly held corporation,
and bad debts expense.
General and administrative expenses decreased by $246,000, or 19.5%, to
$1,015,000, for the three-month period ended September 30, 2008, from $1,261,000
for the same period of 2007. General and administrative expenses were
approximately 63.7% and 99.3% of revenues for the three-month periods ended
September 30, 2008 and 2007, respectively.
For the nine-month period ended September 30, 2008, general and administrative
expenses decreased by $446,900, or 13.3%, to $2,925,500 from $3,372,400 for the
same period of 2007. General and administrative expenses were approximately
68.4% and 90.8% of revenues for the nine-month periods ended September 30, 2008
and 2007, respectively.
The main factors that contributed to the decrease in general and administrative
expense for the three-month period ended September 30, 2008, as compared with
the same period of 2007, were an aggregate $111,300 decrease in outside
services, primarily related to the timing of certain fees associated with our
patent litigation, and an aggregate $85,600 decrease in legal and accounting
fees, primarily related to various SEC filings we were required to make during
2007. During the three-month period ended September 30, 2007 we incurred higher
costs associated with the Autotrader.com patent litigation as it was nearing
trial, as compared with the aggregate costs associated with the patent
litigation efforts underway during the current year as the trial dates for each
of the various current patent litigation efforts underway are not imminent.
During the three-month period ended September 30, 2007 we made certain filings
with the SEC that were not required to be made during the same period of 2008,
thus resulting in lower legal and accounting fees during the same period of
2008.
Also contributing to the decrease in general and administrative expense for the
three-month period ended September 30, 2008, as compared with the same period of
the prior year, were lower employee costs ($19,200) and lower insurance costs
17
($7,500). Employee costs were lower primarily as a result of lower non-cash
stock-based compensation costs, as discussed below, which were partially offset
by a discretionary bonus and higher salaries, as a result of salary increases.
Insurance costs were lower as a result of small decreases to both our directors
and officers coverage as well as our general liability policy.
Costs associated with other individual components of general and administrative
expense, notably depreciation and amortization, travel and entertainment
insurance, and rent, did not change significantly during the three-month period
ended September 30, 2008, as compared with the same period of the prior year.
In addition to the above-listed items contributing to the decrease in general
and administrative expense for the nine-month period ended September 30, 2008,
as compared with the same period of the prior year, bad debts expense decreased
by $103,300 during the nine-month period ended September 30, 2008, as compared
with the same period for the prior year, primarily due to a charge recorded
during the nine-month period ended September 30, 2007, which charge was related
to a customer whose financial condition had deteriorated.
Included in general and administrative employee costs were non-cash stock-based
compensation expense aggregating $17,900 and $80,900, respectively, for the
three-month periods ended September 30, 2008 and 2007, and $139,100 and
$258,300, respectively, for the nine-month periods ended September 30, 2008 and
2007.
We currently expect 2008 general and administrative expenses to be significantly
lower than 2007 levels, primarily because we do not anticipate incurring
significant contingent legal fees in conjunction with any of our current patent
litigation prior to the end of the 2008, as we did during December 2007.
Research and Development Expenses
Research and development expenses consist primarily of employee costs (inclusive
of stock-based compensation expense), payments to contract programmers and rent.
Research and development expenses increased by $182,000, or 40.8%, to $628,600,
for the three-month period ended September 30, 2008, from $446,600 for the same
period of 2007. Research and development expenses were approximately 39.4% and
35.2% of revenues for the three-month periods ended September 30, 2008 and 2007,
respectively.
Research and development expenses for the nine-month period ended September 30,
2008 approximated those for the same period of 2007. Research and development
expenses were approximately 40.1% and 47.3% of revenue for the nine-month
periods ended September 30, 2008 and 2007, respectively.
Under GAAP, all costs of product development incurred once technological
feasibility has been established, but prior to general release of the product,
are typically capitalized and amortized to expense over the estimated life of
the underlying product, rather than being charged to expense in the period
incurred. No such product development costs were capitalized during either of
the three or nine-month periods ended September 30, 2008. During each of the
three and nine-month periods ended September 30, 2007, $3,600 of product
development costs was capitalized.
Factors contributing to the increase in research and developments costs during
the three-month period ended September 30, 2008, as compared with the same
period of the prior year included; an $87,700 increase in employee costs, which
resulted from having four more employees, and a $96,600 increase in outside
services as we increased our use of contract engineers to assist in research and
development activities surrounding GO-Global for Windows.
Included in employee costs were non-cash stock-based compensation costs
aggregating $43,600 and $23,500, respectively, for the three-month periods ended
September 30, 2008 and 2007, and $107,300 and $80,500, respectively, for the
nine-month periods ended September 30, 2008 and 2007.
We currently expect 2008 research and development expenses to be higher as
compared with 2007 levels as a result of the increases to our engineering staff,
and a continued increase in the use of outside consultants and our overall
investments in this area.
Segment Operating Loss
Segment operating loss for the three-and nine month periods ended September 30,
2008 and 2007 was as follows:
18
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------- ---------------------------
Loss From Operations 2008 2007 2008 2007
------------------------ ------------ ------------ ------------ ------------
Software $ (126,500) $ (180,400) $ (711,600) $(1,263,000)
Intellectual Property (533,300) (808,900) (1,400,100) (1,798,600)
------------ ------------ ------------ ------------
Consolidated Loss From
Operations $ (659,800) $ (989,300) $(2,111,700) $(3,061,600)
============ ============ ============ ============
The $53,900 decrease in the operating loss we experienced from our software
segment for the three-month period ended September 30, 2008, as compared with
same period of the prior year, was primarily due to a $323,800 increase in
software revenue that was partially offset by an aggregate $247,200 increase in
software operating expenses and a $22,700 increase in cost of revenue.
The $551,400 decrease in operating loss we experienced from our software segment
for the nine-month period ended September 30, 2008, as compared with the same
period of the prior year, was primarily due to a $563,800 increase in software
revenue and an aggregate $74,600 decrease in software operating expenses, which
were partially offset by an aggregate $85,800 increase in cost of revenue.
The $275,600 and $398,500 decreases in the operating losses we experienced from
our intellectual property segment for the three and nine-month periods ended
September 30, 2008, as compared with the same periods of the prior year, was
primarily due to reductions in fees associated with our Autotrader.com legal
dispute aggregating $380,700 and $509,200, respectively, which were partially
offset by increases in fees incurred for the lawsuits we initiated subsequent to
September 30, 2007, which aggregated approximately $115,500 and $167,200,
respectively.
Other Income
During the three and nine-month periods ended September 30, 2008 and 2007, other
income consisted primarily of interest income on excess cash. During the
nine-month period ended September 30, 2007, other income also included interest
income on note receivable - shareholder. The increases in other income were
primarily a result of higher cash balances throughout the three and nine-month
periods ended September 30, 2008, as compared with the same periods of 2007, as
a result of the Autotrader.com settlement that occurred in December 2007, which
were partially offset by a decrease in interest income on note
receivable-shareholder as such note was repaid as of December 31, 2007..
We anticipate that interest and other income for 2008 will exceed 2007 levels as
we anticipate having higher average cash balances for the remainder of the year.
Net Loss
As a result of the foregoing items, net loss for the three-month period ended
September 30, 2008 was $643,200, a decrease of $336,400, or 34.3%, from a net
loss of $979,600 for the same period of 2007 and $2,044,100 for the nine-month
period ended September 30, 2008, a decrease of $977,700, or 32.4%, from a net
loss of $3,021,800 for the same period of 2007. We currently do not expect to be
profitable either during or for the year ended December 31, 2008.
Liquidity and Capital Resources
We are planning to increase investments in our operations during the last
quarter of 2008 and to fund these increases through our cash on hand as of
September 30, 2008 and our fourth quarter 2008 anticipated revenue streams. We
are continually looking at ways to improve our revenue stream, including through
the development of new products and further acquisitions. We continue to review
potential acquisition and other investment opportunities as they present
themselves to us. We believe that maintaining our current revenue stream,
coupled with our cash on hand, will be sufficient to support our operational
plans for the next twelve months.
During the nine-month periods ended September 30, 2008 and 2007 our reported net
losses of $2,044,100 and $3,021,800 respectively, included significant non-cash
items, namely; depreciation and amortization of $726,800 and $720,600,
respectively, which were primarily related to amortization of our patents, and
stock-based compensation expense of $286,800 and $375,500, respectively.
Additionally, during the nine-month periods ended September 30, 2008 and 2007 we
also incurred an additional non-cash item related to an increase in our
allowance for doubtful accounts of $12,600 and $115,900, respectively.
19
During the nine-month periods ended September 30, 2008 and 2007 we closely
monitored our investing activities, spending approximately a net $76,500 and
$64,800, respectively, in those activities. Our investing activities were
primarily comprised of fixed asset purchases, mainly office furniture and
equipment. Our financing activities for the nine-month period ended September
30, 2008 included the repurchase of shares of our common stock in accordance
with our Board approved stock buy back program, as discussed elsewhere in this
Form 10-Q and receiving proceeds from the sale of stock to our employees under
the terms of our employee stock purchase plan. Our financing activities for the
same period of the prior year included receiving proceeds from the sale of stock
to our employees under the terms of our employee stock purchase plan and the
exercise of employee stock options.
Cash and Cash Equivalents
As of September 30, 2008, cash and cash equivalents were $4,201,900, as compared
with $5,260,800 as of December 31, 2007, a decrease of $1,058,900, or 20.1%. The
majority of this decrease was due to the consumption of $903,000 of cash and
cash equivalents by our operations.
Accounts Receivable, net
At September 30, 2008 and December 31, 2007, we had approximately $852,400 and
$886,600, respectively, in accounts receivable, net of allowances totaling
$241,600 and $229,000, respectively. From time to time, we could have
individually significant accounts receivable balances due us 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 affected.
Stock Buy Back Program
As of September 30, 2008, we had repurchased 294,000 shares of common stock for
$87,700 under terms of the Board approved stock buy back program. Under this
program, the Board approved up to $1,000,000 to be used in repurchasing our
stock, however; we are not obligated to repurchase any specific number of shares
and the program may be suspended or terminated at our discretion. All such
shares were repurchased during the three-month period ended September 30, 2008.
As of September 30, 2008, $912,300 remains authorized but unused.
Working Capital
As of September 30, 2008, we had current assets of $5,116,400 and current
liabilities of $2,496,700, which netted to working capital of $2,619,700.
Included in current liabilities was the current portion of deferred revenue of
$1,588,900.
Segment Fixed Assets
As of September 30, 2008, segment fixed assets (long-lived assets) were as
follows:
Accumulated
Depreciation Net, as
Fixed Assets Cost Basis /Amortization Reported
-------------- --------------- ---------------
Software $ 1,249,900 $ (1,051,900) $ 198,000
Intellectual Property 5,340,400 (3,265,900) 2,074,500
Unallocated 5,000 - 5,000
-------------- --------------- ---------------
$ 6,595,300 $ (4,317,800) $ 2,277,500
============== =============== ===============
Contingencies
During May 2008, our Board of Directors approved two severance plans, one of
which covers directors and one of which covers key employees. Each of these
plans provide for certain non-cash benefits to their respective plan
participants, principally the accelerated vesting of stock options, in the event
we experience a change of control in our company or our company's assets and the
participant terminates employment with us. The severance plan for key employees
contains certain cash benefits that would accrue to the key employees as a
result of termination following a change in control, including; salary
continuation, payment of bonuses earned under our incentive bonus plan and
health plan and other benefits.
20
Juniper Networks, Inc. has petitioned the United States Patent and Trademark
Office (the "PTO") to reexamine two of our patents, namely; U. S. Patent Nos.
5,826,014 and 6,061,798 (the "'014" and "'798" patents, respectively). On April
5, 2008, the PTO ordered the reexamination of the `798 patent, and on July 25,
2008, the PTO ordered the reexamination of the `014 patent. Juniper also asked
the PTO to reexamine our U.S. Patent No. 7,127,464 (the "'464" patent), a patent
unrelated to any litigation. The PTO ordered the reexamination of the `464
patent on April 17, 2008. Such reexaminations will result in the PTO either:
confirming all of the patent's claims, narrowing all, or some, of the patent's
claims, or cancelling all of the patent's claims in their entirety. Pending
completion of the reexamination processes of these patents, we do not believe
such patents have been impaired.
New Accounting Pronouncements
In May 2008, FASB issued SFAS No. 162, "The Hierarchy of Generally Accepted
Accounting Principles" ("SFAS 162"), which is intended to improve financial
reporting by identifying a consistent framework, or hierarchy, for selecting
accounting principles to be used in preparing financial statements that are
presented in conformity with GAAP for nongovernmental entities. SFAS 162 is
effective as of November 15, 2008. We are currently evaluating the impact of
adoption of SFAS 162 and do not expect adoption to have a material impact on
results of operations, cash flows or financial position.
In April 2008, FASB issued FSP FAS 142-3, "Determination of the Useful Life of
Intangible Assets" ("FSP"), which amends the factors that should be considered
in developing renewal or extension assumptions used to determine the useful life
of a recognized intangible asset under FASB Statement No. 142, "Goodwill and
Other Intangible Assets" ("SFAS 142"). The intent of this FSP is to improve the
consistency between the useful life of a recognized intangible asset under SFAS
142 and the period of expected cash flows used to measure the fair value of the
asset under FASB Statement No. 141 (revised 2007), "Business Combinations," and
other accounting principles generally accepted in the United States. This FSP is
effective for financial statements issued for fiscal years beginning after
December 15, 2008, and interim periods within those fiscal years. Early adoption
is prohibited. We are currently evaluating the impact of adoption of this FSP
and do not expect adoption to have a material impact on results of operations,
cash flows or financial position.
In March 2008, the Financial Accounting Standards Board ("FASB") issued SFAS No.
161, "Disclosures about Derivatives Instruments and Hedging Activities, an
Amendment of FASB Statement No. 133" ("SFAS 161"). SFAS 161 requires enhanced
disclosures about a company's derivative and hedging activities. SFAS is
effective for financial statements issued for fiscal years beginning after
December 15, 2008. We are currently evaluating the impact of the adoption of
SFAS 161 and do not expect adoption to have a material impact on results of
operations, cash flows or financial position.
In December 2007, the FASB issued SFAS No. 141 (revised 2007), "Business
Combinations" ("SFAS 141R") which replaces SFAS No. 141, "Business
Combinations." SFAS 141R establishes principles and requirements for recognizing
and measuring identifiable assets and goodwill acquired, liabilities assumed and
any noncontrolling interest in a business combination at their fair value at
acquisition date. SFAS 141R alters the treatment of acquisition related costs,
business combinations achieved in stages (referred to as a step acquisition),
the treatment of gains from a bargain purchase, the recognition of contingencies
in business combinations, the treatment of in-process research and development
in a business combination as well as the treatment of recognizable deferred tax
benefits. SFAS 141R is effective for business combinations closed in fiscal
years beginning after December 15, 2008. We are currently evaluating the impact
of SFAS 141R and expect that results of operations, cash flows or financial
position would only be impacted in relation to future business combination
activities, if any.
In February 2007, FASB issued SFAS No. 159, "The Fair Value Option for Financial
Assets and Financial Liabilities" ("SFAS 159") which permits entities to choose
to measure many financial instruments and certain other items at fair value. The
objective of SFAS 159 is to improve financial reporting by providing entities
with the opportunity to mitigate volatility in reported earnings caused by
measuring related assets and liabilities differently without having to apply
complex hedge accounting provisions. SFAS 159 is effective as of an entity's
first fiscal year that begins after November 15, 2007. The adoption of SFAS 159
did not have a material impact on results of operations, cash flows or financial
position.
21
In September 2006, FASB issued SFAS No. 157, "Fair Value Measurements" ("SFAS
157") which defines fair value, establishes a framework for measuring fair value
in GAAP and expands disclosures about fair value measurements. SFAS 157 applies
under other accounting pronouncements that require or permit fair value
measurements, FASB having previously concluded in those accounting
pronouncements that fair value is the relevant measurement attribute.
Accordingly, SFAS 157 does not require any new fair value measurements, however,
for some entities; application of SFAS 157 will change current practice. SFAS
157 is effective for financial statements issued for the first fiscal year
beginning after November 15, 2007 and interim periods within those fiscal years.
In February 2008, FASB issued FASB Staff Position No. 157-2 that defers the
effective date of SFAS 157 for nonfinancial assets and nonfinancial liabilities,
except for items that are recognized or disclosed at fair value in the financial
statements on a recurring basis, to fiscal years beginning after November 15,
2008. In addition, FASB also agreed to exclude from the scope of FASB 157 fair
value measurements made for purposes of applying SFAS No. 13, "Accounting for
Leases" and related interpretive accounting pronouncements. The adoption of
SFAS 157 did not have a material impact on results of operations, cash flows or
financial position.
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
Not applicable
ITEM 4T. Controls and Procedures
Under the supervision and with the participation of our management, including
our Chief Executive Officer and Chief Financial Officer, we evaluated the
effectiveness of our disclosure controls and procedures (as defined in Rule
13a-15(e) under the Securities Exchange Act of 1934) as of the end of the period
covered by this report. Based upon that evaluation, our Chief Executive Officer
and Chief Financial Officer concluded that our disclosure controls and
procedures were effective as of September 30, 2008.
There has not been any change in our internal control over financial reporting
(as defined in Rule 13a-15(f) under the Exchange Act) during the quarter ended
September 30, 2008 that has materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting.
22
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings
On August 28, 2007, we filed a proceeding against Juniper Networks, Inc.
("Juniper") in the United States District Court in the Eastern District of Texas
(the "court") alleging that certain of Juniper's products infringe three of our
patents, namely; U.S. Patent Nos. 5,826,014, 6,061,798 and 7,028,336, (the
"'014," "'798" and "'336" patents, respectively) which protect our fundamental
network security and firewall technologies. We seek preliminary and permanent
injunctive relief along with unspecified damages and fees. Juniper filed its
Answer and Counterclaims on October 26, 2007 seeking a declaratory judgment that
it does not infringe the `014, `798 and `336 patents and that all three of these
patents are invalid and unenforceable. Subsequent to October 26, 2007 and
through the date hereof, we and Juniper have filed further replies and responses
addressing the issues raised in our original complaint and Juniper's Answer and
Counterclaims. On May 30, 2008 the court issued a Docket Control Order setting
the dates of April 7, 2010 for the Markman Hearing and July 6, 2010 for jury
selection. Also on May 30, 2008, we served our Asserted Claims and Infringement
Contentions. On July 25, 2008, we filed an amended complaint removing the `336
patent from our infringement claim. Juniper responded with its answer and
counterclaim to the amended complaint on August 11, 2008. On September 5, 2008,
we filed a second amended complaint to correct Juniper's corporate name, which
was followed by Juniper's answer and our reply during October 2008.
Separately, Juniper has petitioned the United States Patent and Trademark
Office (the "PTO") to reexamine the `014 and `798 patents. On April 17, 2008,
the PTO ordered the reexamination of the `798 patent, and on July 25, 2008, the
PTO ordered the reexamination of the `014 patent. Juniper has also asked the PTO
to reexamine our U.S. Patent No. 7,127,464 (the "'464" patent), a patent
unrelated to any litigation. The PTO ordered the reexamination of the `464
patent on April 17, 2008.
On March 10, 2008, we initiated a proceeding against Classified Ventures, LLC;
IAC/InterActiveCorp; Match.com (an operating business of IAC/InterActiveCorp);
Yahoo! Inc.; eHarmony.com; and CareerBuilder, LLC in the United States District
Court in the Eastern District of Texas alleging infringement of four of our
patents, namely; U.S. Patent Nos. 6,324,538, 6,850,940, 7,028,034 and 7,269,591,
which protect our unique method of maintaining an automated and
network-accessible database. The suit alleges that the named companies infringe
our patents on each of their Web sites. The suit seeks permanent injunctive
relief along with unspecified damages. During late April and early May 2008, the
opposing parties in the proceeding filed their Answers and Counterclaims seeking
a declaratory judgment that they do not infringe the patents in the suit and
that each of the patents in the suit are invalid and unenforceable. On June 5,
2008, we filed our answers to each of the opposing parties' counterclaims.
On August 13, 2008, the opposing parties filed their respective motions for
early hearing on inequitable conduct. Responses and replies were filed during
August and September 2008 addressing this motion. On August 21, 2008,
IAC/interactive Corp. was dismissed from the lawsuit without prejudice. A status
conference has been set by the court for December 2, 2008 at which time the
Markman Hearing (the claim construction hearing) and trial dates will be set.
On August 13, 2008, we initiated a proceeding against Google Inc. ("Google") in
the United States District Court in the Eastern District of Texas alleging
infringement of four of our patents, namely; U.S. Patent Nos. 6,324,538,
6,850,940, 7,028,034 and 7,269,591, which protect our unique method of
maintaining an automated and network-accessible database. The suit alleges that
Google infringes our patents on their Web sites. The suit seeks permanent
injunctive relief along with unspecified damages. On October 8, 2008, Google
filed its Answers and Counterclaims seeking a declaratory judgment that they
do not infringe the patents referenced in the suit and that each of the patents
in the suit are invalid and unenforceable. On October 31, 2008, we filed our
answers to each of the counterclaims.
ITEM 1A. Risk Factors
Not Applicable
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds
During the three-month period ended September 30, 2008, we granted stock options
to purchase an aggregate 15,000 shares of common stock, at an exercise price of
$0.25, to a non-executive employee. The grant of such stock options was not
registered under the Securities Act of 1933, because the stock options either
did not involve an offer or sale for purposes of Section 2(a)(3) of the
23
Securities Act, in reliance on the fact that the stock options were granted for
no consideration, or were offered and sold in transactions not involving a
public offering, exempt from registration under the Securities Act pursuant to
Section 4(2).
On January 8, 2008, our Board of Directors authorized a stock buy back program
to repurchase up to $1,000,000 of our outstanding common stock. Under terms of
the program, we are not obligated to repurchase any specific number of shares
and the program may be suspended or terminated at management's discretion.
The following is a summary of our share repurchases of our common stock during
the three-month period ended September 30, 2008 under our Board authorized buy
back program:
Total Number Approximate
of Shares Dollar Value
Purchased as of Shares
Part of Total Dollars That May Yet
Total Number Publicly Purchased Be Purchased
of Shares Average Price Announced Under the Under the
Period Purchased Per Share Program Program Program
- --------- ---------------- ---------------- --------------- ---------------- ---------------
July - - - - $ 1,000,000
August 15,000 $ 0.26 15,000 $ 4,000 $ 996,000
September 279,000 $ 0.29 279,000 $ 83,700 $ 912,300
---------------- --------------- ---------------- ---------------
294,000 $ 0.29 294,000 $ 87,700 $ 912,300
================ =============== ================ ===============
ITEM 3. Defaults Upon Senior Securities
Not Applicable
ITEM 4. Submission of Matters to a Vote of Security Holders
Not Applicable
ITEM 5. Other Information
Not Applicable
ITEM 6. Exhibits
Exhibit 31 - Rule 13a-14(a)/15d-14(a) Certifications
Exhibit 32 - Section 1350 Certifications
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
GraphOn Corporation
(Registrant)
Date: November 14, 2008 Date: November 14, 2008
By: /s/ Robert Dilworth By: /s/ William Swain
------------------- -----------------
Robert Dilworth William Swain
Chief Executive Officer and Chief Financial Officer
Chairman of the Board (Principal Financial Officer and
(Principal Executive Officer) (Principal Accounting Officer)
24