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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
Annual Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the fiscal year ended December 31, 2003 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.)
105 Cochrane Circle
Morgan Hill, California 95037
(Address of principal executive offices)
Registrant's telephone number: (800) 472-7466
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.0001 Par Value
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2)
Yes [ ] No [X]
The aggregate market value of the common equity of registrant held by
non-affiliates of the registrant as of June 30, 2003 was approximately
$3,480,200.
Number of shares of Common Stock outstanding as of March 19, 2004: 21,638,097
shares of Common Stock.
GRAPHON CORPORATION
FORM 10-K
Table of Contents
Page
PART I.
Item 1. Business 2
Item 2. Properties 8
Item 3. Legal Proceedings 8
Item 4. Submission of Matters to a Vote of Security Holders 8
PART II.
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters 9
Item 6. Selected Financial Data 9
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operation 10
Item 7A. Quantitative and Qualitative Disclosures About
Market Risk 21
Item 8. Financial Statements and Supplementary Data 21
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 43
Item 9A. Controls and Procedures 43
PART III.
Item 10. Directors and Executive Officers of the Registrant 44
Item 11. Executive Compensation 45
Item 12. Security Ownership of Certain Beneficial Owners
and Management 46
Item 13. Certain Relationships and Related Transactions 48
Item 14. Principal Accounting Fees and Services 48
PART IV.
Item 15. Exhibits, Financial Statement Schedules, and Reports
on Form 8-K 50
SIGNATURES 51
FORWARD LOOKING INFORMATION
This report includes, in addition to historical information, "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995. This Act provides a "safe harbor" for forward-looking statements to
encourage companies to provide prospective information about themselves so long
as they identify these statements as forward-looking and provide meaningful
cautionary statements identifying important factors that could cause actual
results to differ from the projected results. All statements other than
statements of historical fact we make in this report or in any document
incorporated by reference are forward-looking statements. In particular, the
statements regarding industry prospects and our future results of operations or
financial position are forward-looking statements. Such statements are based on
management's current expectations and are subject to a number of uncertainties
and risks that could cause actual results to differ significantly from those
described in the forward looking statements. Factors that may cause such a
difference include, but are not limited to, those discussed in "Management's
Discussion and Analysis of Financial Condition and Results of Operation," as
well as those discussed elsewhere in this report.
PART I
ITEM 1. BUSINESS
General
We are developers of business connectivity software, including Unix, Linux and
Windows server-based software, with an immediate focus on web-enabling
applications for use by independent software vendors (ISVs), application service
providers (ASPs), corporate enterprises, governmental and educational
institutions, and others.
Server-based computing, sometimes referred to as thin-client computing, is a
computing model where traditional desktop software applications are relocated to
run entirely on a server, or host computer. This centralized deployment and
management of applications reduces the complexity and total costs associated
with enterprise computing. Our software architecture provides application
developers with the ability to relocate applications traditionally run on the
desktop to a server, or host computer, where they can be run over a variety of
connections from remote locations to a variety of display devices. With our
server-based software, applications can be web enabled, without any modification
to the original application software required, allowing the applications to be
run from browsers or portals. Our server-based technology can web-enable a
variety of Unix, Linux or Windows applications.
Our headquarters are located at 105 Cochrane Circle, Morgan Hill, California,
95037 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. Our filings with the SEC are linked to the Investors section of our
Internet website.
Industry Background
History
In the 1970s, software applications were executed on central mainframes and
typically accessed by low-cost display terminals. Information technology
departments were responsible for deploying, managing and supporting the
applications to create a reliable environment for users. In the 1980s, the PC
became the desktop of choice: empowering the user with flexibility, a graphical
user interface, and a multitude of productive and inexpensive applications. In
the 1990s, the desktop provided access to mainframe applications and databases,
which run on large, server computers. Throughout the computing evolution, the
modern desktop has become increasingly complex and costly to administer and
maintain. This situation is further worsened as organizations become more
decentralized with remote employees, and as their desire increases to become
more closely connected with vendors and customers through the Internet.
Lowering Total Cost of Ownership
PC software in general has grown dramatically in size and complexity in recent
years. As a result, the cost of supporting and maintaining PC desktops has
increased substantially. Industry analysts and enterprise users alike have begun
to recognize that the total cost of PC ownership, taking into account the
recurring cost of technical support, administration and end-user down time, has
become high, both in absolute terms and relative to the initial hardware
purchase price.
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.
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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.
Of course, businesses that run Linux or Unix on their end user devices require
access to 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 GoGlobal client software,
including: Linux, Unix, Windows and Macintosh desktops and devices.
Application Service Providers (ASPs)
With the ubiquitous nature of the Internet, new operational models and sales
channels are emerging. Traditional high-end software packages that were once too
expensive for many companies are now available for rent over the Internet. By
servicing customers through a centralized operation, rather than installing and
maintaining applications at each customer's site, ASPs play an important role in
addressing an enterprise's computing requirements. Today, ASPs are faced with
the difficult task of creating, or rewriting, applications to entertain the
broader market.
Remote Computing
The cost and complexity of contemporary enterprise computing has been further
complicated by the growth in remote access requirements. As business activities
become physically distributed, computer users have looked to portable computers
with remote access capabilities to stay connected in a highly dispersed work
environment. One problem facing remote computing over the Internet, or direct
telephone connections, is the slow speed of communication in contrast to the
high speed of internal corporate networks. Today, applications requiring remote
access must be tailored to the limited speed and lower reliability of remote
connections, further complicating the already significant challenge of
connecting desktop users to business-critical applications.
Our Approach
Our server-based software deploys, manages, supports and executes applications
entirely on the server computer and publishes their user interface efficiently
and instantaneously to desktop devices. The introduction of the Windows-based
version of our Bridges software, during 2000, enabled us to enter the Windows
application market. This allowed us to provide support for Windows applications
to both enterprise customers and to leverage independent software vendors (ISVs)
as a channel. During the fourth quarter of 2002 we introduced GO-Global for
Windows, a significant upgrade to our product offerings in the Windows market.
This new version has increased application compatibility, server scalability and
improved application performance over our previous version.
Our technology consists of three key components:
o The server component runs alongside the server-based application and is
responsible for intercepting user-specific information for display at the
desktop.
o The desktop component is responsible only for sending keystrokes and mouse
motion to the server. It also presents the application interface to the
desktop user. This keeps the desktop simple, or thin, as well as
independent of application requirements for resources, processing power
and operating systems.
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o Our protocol enables efficient communication over fast networks or slow
dial-up connections and allows applications to be accessed from remote
locations with network-like performance and responsiveness.
We believe that the major benefits of our technology are as follows:
o Lowers Total Cost of Ownership. Reducing information technology (IT)
costs is a primary goal of our products. Today, installing
enterprise applications is time-consuming, complex and expensive. It
typically requires administrators to manually install and support
diverse desktop configurations and interactions. Our server-based
software simplifies application management by enabling deployment,
administration and support from a central location. Installation and
updates are made only on the server, thereby avoiding desktop
software and operating system conflicts and minimizing at-the-desk
support.
o 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 GoGlobal, an organization can publish an
existing application to an Internet enabled device without the need
to rewrite the application. This reduces application development
costs while preserving the rich user interface so difficult to
replicate in a native Web application.
o Connects Diverse Computing Platforms. Today's computing
infrastructures are a mix of computing devices, network connections
and operating systems. Enterprise-wide application deployment is
problematic due to this heterogeneity, often requiring costly and
complex emulation software or application rewrites. For example,
Windows PCs typically may not access a company's Unix applications
without installing complex PC X Server software on each PC. Typical
PC X Servers are large and require an information technology
professional to properly install and configure each desktop. For
Macintosh, the choices are even fewer, requiring the addition of yet
another vendor product. For the newer technologies, such as tablet
PCs or handheld devices, application access will be challenging.
To rewrite an application for each different display device (be that a
desktop PC or tablet PC) and their many diverse operating systems is often
a difficult and time-consuming task. In addition to the development
expense, issues of desktop performance, data compatibility and support
costs often make this option prohibitive. Our products provide
organizations the ability to access applications from virtually all
devices, utilizing their existing computing infrastructure, without
rewriting a single line of code or changing or reconfiguring hardware.
This means that enterprises can maximize their investment in existing
technology and allow users to work in their preferred environment.
o Leverages Existing PCs and Deploys New Desktop Hardware. Our software
brings the benefits of server-based computing to users of existing PC
hardware, while simultaneously enabling enterprises to begin to take
advantage of and deploy many of the new, less complex network
computers. This assists organizations in maximizing their current
investment in hardware and software while, at the same time,
facilitating a manageable and cost effective transition to newer
devices.
o Efficient Protocol. Applications typically are designed for
network-connected desktops, which can put tremendous strain on
congested networks and may yield poor, sometimes unacceptable,
performance over remote connections. For ASPs, bandwidth typically
is the top recurring expense when web-enabling, or renting, access to
applications over the Internet. In the emerging 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.
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) and Fortune 1000
enterprises. By employing our technology, customers benefit from a very quick
time to market, overall cost savings via centralized computing, a client neutral
cross-platform solution, and high performance remote access.
Our product offerings include GoGlobal for Windows and GoGlobal for Unix.
4
GoGlobal for Windows allows access to Windows applications from remote locations
and a variety of connections, including the Internet and dial-up connections.
GoGlobal 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 GoGlobal for Windows, web enabling is
achieved without modifying the underlying Windows applications' code or
requiring costly add-ons.
GoGlobal for Unix web-enables Unix and Linux applications allowing them to be
run via a browser from many different display devices, over various types of
data connections, regardless of the bandwidth or operating systems being used.
GoGlobal for Unix web-enables individual Unix and Linux applications, or entire
desktops. When using GoGlobal 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 Fortune 1000 companies,
governmental and educational institutions, ISVs, VARs and ASPs. Our software is
designed to allow these enterprises to tailor the configuration of the end user
device for a particular purpose, rather than following a "one PC fits all," high
total cost of ownership model. Our opportunity within the marketplace is more
specifically broken down as follows:
o ISVs. By web-enabling their applications, software developers can
strengthen the value of their product offerings, opening up additional
revenue opportunities and securing greater satisfaction and loyalty from
their customers. We believe that ISVs who effectively address the web
computing needs of customers and the emerging ASP market will have a
competitive advantage in the marketplace.
By combining our products with desktop versions of their software
applications, our ISV customers have been able to accelerate the time to
market for web-enabled versions of their software applications without the
risks and delays associated with rewriting applications or using third
party solutions. Our technology quickly integrates with their existing
software applications without sacrificing the full-featured look and feel
of their original software application, thus providing ISVs with
out-of-the-box web-enabled versions of their software applications with
their own branding for licensed, volume distribution to their enterprise
customers.
o Enterprises Employing a Mix of Unix, Linux, Macintosh and Windows.
Most major enterprises employ a heterogeneous mix of computing
environments. Companies that utilize a mixed computing environment
require cross-platform connectivity solutions, like GoGlobal, that
will allow users to access applications from different client
devices. It has been estimated that PCs represent over 90% of
enterprise desktops. We believe that our products are well
positioned to exploit this opportunity and that our server-based
software products will significantly reduce the cost and complexity
of connecting PCs to various applications.
o Enterprises With Remote Computer Users. Remote computer users comprise one
of the fastest growing market segments in the computing industry.
Efficient remote access to applications has become an important part of
many enterprises' computing strategies. Our protocol is designed to enable
highly efficient low-bandwidth connections.
o ASPs. High-end software applications in the fields of human resources,
enterprise resource planning, enterprise relationship management and
others, historically have only been available to organizations able
to make large investments in capital and personnel. The Internet has
opened up global and mid-tier markets to vendors of this software who
may now offer it to a broader market on a rental basis. Our products
enable the vendors to provide Internet access to their applications
with minimal additional investment in development implementation.
o VARs. The VAR channel presents an additional sales force for our
products and services. In addition to creating broader awareness of
Go-Global, the VAR channel also provides integration and support
services for our current and potential customers. Our products allow
software resellers to offer a cost effective competitive alternative
for Server-Base Thin Client computing. In addition, reselling our
Go-Global software creates new revenue streams for our VARs through
professional services and maintenance renewals.
o Extended Enterprise Software Market. Extended enterprises allow access to
their computing resources to customers, suppliers, distributors and other
5
partners, thereby gaining flexibility in manufacturing and increasing
speed-to-market and customer satisfaction. For example, extended
enterprises may maintain decreased inventory via just-in-time,
vendor-managed inventory and related techniques.
The early adoption of extended enterprise solutions may be driven in part by
enterprises' need to exchange information over a wide variety of computing
platforms. We believe that our server-based software products, along with our
low-impact protocol, are well positioned to provide enabling solutions for
extended enterprise computing.
Strategic Relationships
We believe it is important to maintain our current strategic alliances and to
seek suitable new alliances in order to enhance shareholder value, improve our
technology and/or enhance our ability to penetrate relevant target markets. We
also are focusing on strategic relationships that have immediate revenue
generating potential, strengthen our position in the server-based software
market, add complementary capabilities and/or raise awareness of our products
and us.
In July 1999, we entered into a five-year, non-exclusive agreement with Alcatel
Italia, the Italian Division of Alcatel, the telecommunications, network systems
and services company. Pursuant to this agreement, Alcatel has licensed our
GoGlobal thin client PC X server software for inclusion with their Turn-key
Solution software, an optical networking system. Alcatel's customers are using
our server-based solution to access Alcatel's UNIX/X Network Management Systems
applications from T-based PCs. Alcatel has deployed GoGlobal internally to
provide their employees with high-speed network access to their own server-based
software over dial-up connections, local area networks (LANs) and wide area
networks (WANs). We anticipate renewing this agreement during 2004.
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.
In December 2002, we agreed to an eighteen-month extension of our exclusive
distribution agreement with KitASP, a Japanese application service provider,
which was founded by companies within Japan's electronics and infrastructure
industries, including NTT DATA, Mitsubishi Electric, Omron, RICS, Toyo
Engineering and Hitachi. Pursuant to the original agreement, KitASP was granted
an exclusive right, within Japan, to distribute our web-enabling technology,
bundled with their ASP services, and to resell our software. The original
agreement provided for an optional second year, which was exercisable at our
discretion. As a result of the extension, KitASP's one-year exclusivity period
has been extended for an additional 18 months in lieu of the optional second
year that we had formerly held. We anticipate renewing the KitASP distribution
agreement during 2004.
In March 2003, we entered into a fourth consecutive one-year, non-exclusive
agreement with FrontRange, an international software and services company.
Pursuant to the original agreement, we licensed our Bridges for Windows
server-based software for integration with FrontRange's HEAT help desk software
system. FrontRange has private labeled and completely integrated Bridges for
Windows into its HEAT help desk software as iHEAT. As part of the 2003 renewal,
we have licensed our GoGlobal for Windows server-based software for integration
with both FrontRange's HEAT and its Client Relationship Management software
package Goldmine. We anticipate renewing the FrontRange agreement during 2004.
In September 2003, we amended our non-exclusive agreement with Compuware, an
international software and services company. Pursuant to this amendment, we
licensed, for three years, our GoGlobal for Windows server-based software for
inclusion with Compuware's UNIFACE software, a development and deployment
environment for enterprise customer-facing applications. Compuware's customers
are using our server-based solution to provide enterprise-level UNIFACE
applications over the Internet. Compuware has private labeled and completely
integrated GoGlobal for Windows into its UNIFACE deployment architecture as
UNIFACE Jti. Negotiations are currently underway with Compuware on a renewal
involving our latest Windows-based product, GoGlobal for Windows.
Sales, Marketing and Support
Our customers, to date, include Fortune 1000 enterprises, ISVs, VARs and large
governmental organizations. Sales to FrontRange and Alcatel generated
approximately 27.4% and 18.4%, respectively, of our revenues in 2003. Sales to
FrontRange, Verizon and Alcatel generated approximately 28.0%, 24.4% and 13.1%,
respectively, of our revenues in 2002. We consider FrontRange to be our most
significant customer.
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Our sales and marketing efforts will be focused on increasing product awareness
and demand among ISVs, Global 10,000 enterprises, and VARs who have a vertical
orientation or are focused on Unix, Linux or Windows environments. Current
marketing activities include direct mail, a targeted advertising campaign,
tradeshows, production of promotional materials, public relations and
maintaining an Internet presence for marketing and sales purposes.
Research and Development
Our research and development efforts currently are focused on developing new
products and further enhancing the functionality, performance and reliability of
existing products. We invested $1,797,200, $3,129,800 and $4,530,900 in research
and development in 2003, 2002 and 2001, respectively, including capitalized
software development costs of $282,200, $298,500 and $396,500, respectively. We
expect research and development expenditures in 2004 to approximate 2003 levels.
We have made significant investments in our protocol and in the performance and
development of our server-based software.
Competition
The server-based software market in which we participate is highly competitive.
We believe that we have significant advantages over our competitors, both in
product performance and market positioning. This market ranges from remote
access for a single PC user to server-based software for large numbers of users
over many different types of device and network connections. Our competitors
include manufacturers of conventional PC X server software. Competition is
expected from these and other companies in the server-based software market.
Competitive factors in our market space include; price, product quality,
functionality, product differentiation and breadth.
We believe our principal competitors for our current products include Citrix
Systems, Inc., Hummingbird Communications, Ltd., Tarantella, WRQ, Network
Computing Devices and NetManage. Citrix is the established leading vendor of
server-based computing software. Hummingbird is the established market leader in
PC X Servers. WRQ, Network Computing Devices, and NetManage also offer
traditional PC X Server software.
Operations
Our current staff performs all purchasing, order processing and shipping of our
products and accounting functions related to our operations. Production of
software masters, development of documentation, packaging designs, quality
control and testing are also performed by us. When required by a customer,
CD-ROM and floppy disk duplication, printing of documentation and packaging are
also accomplished through in-house means. We generally ship products
electronically immediately upon receipt of order. As a result, we have
relatively little backlog at any given time, and do not consider backlog a
significant indicator of future performance. Additionally, since virtually all
of our orders are currently being fulfilled electronically, we do not maintain
any prepackaged inventory.
Proprietary Technology
We rely primarily on trade secret protection, copyright law, confidentiality and
proprietary information agreements to protect our proprietary technology and
registered trademarks. The loss of any material trade secret, trademark, trade
name or copyright could have a material adverse effect on our results of
operations and financial condition. There can be no assurance that our efforts
to protect our proprietary technology rights will be successful.
Despite our precautions, it may be possible for unauthorized third parties to
copy portions of our products, or to obtain information we regard as
proprietary. We do not believe our products infringe on the rights of any third
parties, but there can be no assurance that third parties will not assert
infringement claims against us in the future, or that any such assertion will
not result in costly litigation or require us to obtain a license to proprietary
technology rights of such parties.
In November 1999, we acquired a U.S. patent for the remote display of Microsoft
Windows applications on Unix and Linux desktops with X Windows. As a result, we
believe that we have acquired patent protection and licensing rights for the
deployment of all Windows applications remoted, or displayed, over a network or
any other type of connection to any X Windows systems. This patent, which covers
our Bridges for Windows (formerly jBridge) technology, was originally developed
by a team of engineers formerly with Exodus Technology and hired by us in May
1998.
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Employees
As of March 18, 2004, we had a total of 25 employees, including six in
marketing, sales and support, 15 in research and development and four in
administration and finance. We believe our relationship with our employees is
good. No employees are covered by a collective bargaining agreement.
ITEM 2. PROPERTIES
We currently occupy approximately 500 square feet of office space in Morgan
Hill, California. The office space is rented pursuant to an oral month-to-month
lease, which became effective in September 2003. Rent on the Morgan Hill
facility is approximately $1,200 per month, which is inclusive of various fees
proportioned to us under the terms of the lease agreement.
During October 2003 we entered into a one-year lease for approximately 3,300
square feet of office space in Concord, New Hampshire. Rent on the Concord
facility is approximately $5,000 per month.
We also occupy leased facilities in Rolling Hills Estates, California and
Berkshire, England, United Kingdom. The Rolling Hills Estates and Berkshire
offices are very small and each are leased on a month-to-month basis. Rent on
the Rolling Hills Estates office is approximately $1,000 per month and the rent
on the Berkshire, England office, which fluctuates slightly depending on
exchange rates, is approximately $400 per month.
We believe our current facilities will be adequate to accommodate our needs for
the foreseeable future.
ITEM 3. LEGAL PROCEEDINGS
We are currently not party to any legal proceedings that we believe will have a
material negative impact on our operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS
Our 2003 Annual Meeting of Stockholders was held on December 30, 2003. At the
meeting, one director was reelected. The vote was as follows:
For Withheld
---------- ---------
Michael Volker 13,346,253 1,403,615
The following individuals continue in their capacity as directors: Robert
Dilworth, August Klein and Gordon Watson. Their current terms expire during
2004, 2004 and 2005, respectively.
The shareholders approved the increase in our stock option plan. The result of
the vote for the amendment of our 1998 Stock Option/Stock Issuance Plan to
increase the number of shares of common stock available thereunder from
3,655,400 to 4,455,400 was as follows:
For Against Abstain
--- ------- -------
3,553,848 1,879,947 11,831
Also at the meeting, the shareholders ratified the reappointment of BDO Seidman,
LLP as our independent auditors for fiscal 2003. The vote was as follows:
For Against Abstain
--- ------- -------
14,616,890 112,837 20,141
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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. From August 9, 2000 to May 27, 2002,
our common stock was quoted on the Nasdaq National Market System. From May 28,
2002 to March 26, 2003, our common stock was quoted on the Nasdaq SmallCap
Market System. Since March 27, 2003 our common stock has been quoted on the
Over-the-Counter Bulletin Board. Our common stock is quoted under the symbol
"GOJO."
Fiscal 2003 Fiscal 2002
------------- -------------
Quarter High Low High Low
----- ------ ------ -----
1st $0.28 $0.13 $ 0.80 $0.24
2nd $0.34 $0.13 $ 0.37 $0.15
3rd $0.28 $0.18 $ 0.52 $0.08
4th $0.28 $0.15 $ 0.29 $0.12
On March 18, 2004, there were approximately 148 holders of record of our common
stock. On March 18, 2004, the last reported sales price was $0.77.
We have never declared or paid dividends on our common stock. We do not
anticipate paying any cash dividends for the foreseeable future. We currently
intend to retain future earnings, if any, to finance operations and the
expansion of our business. Any future determination to pay cash dividends will
be at the discretion of our Board of Directors and will be dependent upon the
earnings, financial condition, operating results, capital requirements and other
factors as deemed necessary by the Board of Directors.
ITEM 6. SELECTED FINANCIAL DATA
The following selected historical financial data should be read in conjunction
with "Management's Discussion and Analysis of Financial Condition and Results of
Operation" and our historical financial statements and the notes thereto
included elsewhere herein. Our selected historical financial data as of December
31, 2003, 2002, 2001, 2000, and 1999, and for the years ended December 31, 2003,
2002, 2001, 2000, and 1999 have been derived from our financial statements which
have been audited by BDO Seidman LLP, independent public accountants.
Statement of Operations Data:
Year Ended December 31,
2003 2002 2001 2000 1999
------------- -------------- ------------- ------------- --------------
(Amounts in thousands, except share and per share data)
Revenues $ 4,170 $ 3,535 $ 5,911 $ 7,567 $ 3,635
Costs of revenues 1,371 1,680 2,613 1,044 2,800
------------ -------------- ------------- ------------- --------------
Gross profit 2,799 1,855 3,298 6,523 835
------------ -------------- ------------- ------------- --------------
Operating expenses:
Selling and marketing 1,680 2,235 5,989 5,750 3,279
General and administrative 1,419 2,801 4,561 4,653 2,265
Research and development 1,515 2,831 4,134 4,060 2,467
Asset impairment loss - 914 4,501 - -
Restructuring charge 80 1,943 - - -
------------ -------------- ------------- ------------- --------------
Total operating expenses 4,694 10,724 19,185 14,463 8,011
------------ -------------- ------------- ------------- --------------
Loss from operations (1,895) (8,869) (15,887) (7,940) (7,176)
Other income (expense) net 8 77 410 (1,434) 144
------------ -------------- ------------- -------------- --------------
Loss before provision
for income taxes (1,887) (8,792) (15,477) (9,374) (7,032)
Provision for income taxes - - 1 1 1
------------ -------------- ------------- ------------- --------------
Net loss $ (1,887) $ (8,792) $ (15,478) $ (9,375) $ (7,033)
============ ============== ============= ============= ==============
Basic and diluted loss per share $ (0.11) $ (0.50) $ (0.97) $ (0.65) $ (0.71)
============ ============== ============= ============= ===============
Weighted average common
shares outstanding 16,607,328 17,465,099 16,007,763 14,396,435 9,950,120
============ ============== ============= ============= ==============
9
As of December 31,
2003 2002 2001 2000 1999
------------ -------------- ------------- ------------- --------------
(Amounts in thousands)
Working capital $ (145) $ 668 $ 6,173 $ 12,879 $ 11,701
Total assets 2,562 4,550 12,986 21,040 15,224
Total liabilities 1,715 1,820 1,660 1,983 842
Shareholders' equity 847 2,730 11,326 19,057 14,382
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 provided under Part II, ITEM 8 of 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 effect the amounts reported in the Consolidated Financial
Statements and accompanying notes. The Summary of Significant Accounting
Policies appears in Part II, Item 8 - Financial Statements and Supplementary
Data, of this Form 10-K, which describes the significant accounting polices and
methods used in the preparation of the Consolidated Financial Statements.
Estimates are used for, but not limited to, the accounting for the allowance for
doubtful accounts, the impairment of intangible assets, contingencies and other
special charges and taxes. Actual results could differ materially from these
estimates. The following critical accounting policies are impacted significantly
by judgments, assumptions and estimates used in the preparation of the
Consolidated Financial Statements.
The recognition of revenue is based on our assessment of the facts and
circumstances of the sales transaction. In general, 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.
Under Statement of Position (SOP) 97-2, "Software Revenue Recognition," revenue
earned on software arrangements involving multiple elements is allocated to each
element arrangement based on the relative fair values of the elements. If there
is no evidence of the fair value for all the elements in a multiple element
arrangement, all revenue from the arrangement is deferred until such evidence
exists or until all elements are delivered. In accordance with SOP 97-2, we
recognize revenue from the sale of software licenses when all the following
conditions are met:
o Persuasive evidence of an arrangement exists;
o Delivery has occurred or services have been rendered;
o Our price to the customer is fixed or determinable; and
o Collectibility is reasonably assured.
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.
We perform impairment tests on our intangible assets on an annual basis and
between annual tests in certain circumstances. In response to changes in
industry and market conditions, we may strategically realign our resources and
consider restructuring, disposing of, or otherwise exiting businesses, which
could result in an impairment of intangible assets. During 2002 and 2001 we
recorded significant write-downs to the value of our intangible assets as a
result of the impairment tests performed. A significant consideration impacting
10
the results of the impairment tests was the substantial delay in getting our
most recently released Windows-based product upgrade, GoGlobal for Windows, into
marketable condition. The engineering delays we encountered resulted in a
substantial decrease in our revenue in both 2002 and 2001, which ultimately
caused us to consume almost all of our cash balances in our day-to-day
operations.
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.
Results of Operations
The first table that follows sets forth our income statement data for the years
ended December 31, 2003 and 2002, respectively, and calculates the dollar change
and percentage change from 2002 to 2003 in the respective line items. The second
table that follows presents the same information for the years ended December
31, 2002 and 2001.
Year Ended
December 31,
------------------- Dollars Percentage
(Dollars in 000s) 2003 2002 Change Change
- ----------------- -------- -------- -------- -------
Revenue $ 4,170 $ 3,535 $ 635 18.0%
Cost of sales 1,371 1,680 (309) (18.4)
-------- -------- -------- -------
Gross Profit 2,799 1,855 944 50.9
-------- -------- -------- -------
Operating expenses:
Selling & marketing 1,680 2,235 (555) (24.8)
General & administrative 1,419 2,801 (1,382) (49.3)
Research & development 1,515 2,831 (1,316) (46.5)
Fixed assets impairment - 914 (914) (100.0)
Restructuring charge 80 1,943 (1,863) (95.9)
-------- -------- -------- -------
Total operating expenses 4,694 10,724 (6,030) (56.2)
-------- -------- -------- -------
Loss from operations (1,895) (8,869) 6,974 78.6
-------- -------- -------- -------
Other income (expense):
Interest & other income 13 153 (140) (91.5)
Interest & other expense (5) (76) 71 93.4
-------- -------- -------- -------
Total other income (expense) 8 77 (69) (89.6)
-------- -------- -------- -------
Loss before provision
for income taxes (1,887) (8,792) 6,905 78.5
Provision for income taxes - - - -
-------- -------- -------- -------
Net loss $ (1,887) $ (8,792) $ 6,905 78.5%
======== ======== ======== =======
Year Ended
December 31,
------------------- Dollars Percentage
(Dollars in 000s) 2002 2001 Change Change
- ----------------- -------- -------- -------- -------
Revenue $ 3,535 $ 5,911 $ (2,376) (40.2%)
Cost of sales 1,680 2,613 (933) (35.7)
-------- -------- -------- -------
Gross Profit 1,855 3,298 (1,433) (43.8)
-------- -------- -------- -------
Operating expenses:
Selling & marketing 2,235 5,989 (3,754) (62.7)
General & administrative 2,801 4,561 (1,760) (38.6)
Research & development 2,831 4,134 (1,303) (31.5)
Fixed assets impairment 914 4,501 (3,587) (79.7)
Restructuring charge 1,943 - 1,943 n/a
-------- -------- -------- -------
Total operating expenses 10,724 19,185 (8,461) (44.1)
-------- -------- -------- -------
11
Loss from operations (8,869) (15,887) 7,018 44.2
-------- -------- -------- -------
Other income (expense):
Interest & other income 153 516 (363) (70.4)
Interest & other expense (76) (65) (11) (16.9)
Loss on long-term investment - (41) 41 100.0
-------- -------- -------- -------
Total other income (expense) 77 410 (333) (81.2)
-------- -------- -------- -------
Loss before provision
for income taxes (8,792) (15,477) 6,685 43.2
Provision for income taxes - 1 (1) (100.0)
-------- -------- -------- -------
Net loss $ (8,792) $(15,478) $ 6,686 43.2%
======== ======== ======== =======
Revenues. Our revenues are primarily derived from product licensing fees. Other
sources of revenues include service fees from maintenance contracts and private
labeling fees. Private labeling fees are derived when we contractually agree to
allow a customer to brand our product with their name. 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 during
2004. The increase in revenues in 2003 from 2002 was due primarily to increases
in product licensing fees and the revenue recognized from items previously
deferred, principally deferred maintenance revenue.
The decrease in revenues in 2002 from 2001 was due primarily to a decrease in
licensing fees derived from licensing our patented technology. During 2002 we
recognized $0 in patent licensing revenue as compared to approximately
$2,200,000 during 2001. We believe that the market for licensing our patented
technology is very limited, accordingly, we wrote the carrying value of our
patent down to $0 as part of our year end 2001 asset impairment write off. We do
not anticipate recognizing licensing revenue from our patent in the future.
We recognized approximately $1,649,000 of revenue from product licensing fees
for our Windows-based products during 2003 as compared with approximately
$1,394,200 during 2002, an increase of $254,800, or 18.3%. The increase was
primarily due to our customers' response to the release of the significantly
upgraded version of our Windows product, GoGlobal for Windows, during the fourth
quarter of 2002. We expect 2004 product licensing fee revenue from our
Windows-based products to exceed 2003 levels as we enhance and introduce
additional features to GoGlobal for Windows and increase our overall sales and
marketing efforts during 2004.
The amount of revenue we recognized from product licensing fees for our
Windows-based products in 2002 decreased from 2001, to approximately $1,394,200
as compared with $2,203,700, respectively, a decrease of $809,500, or 36.7%. The
decrease was principally due to the overall decrease in corporate spending
pervasive throughout the economy as well as the delay in releasing the upgraded
version of our Windows-based product, until the fourth quarter of 2002.
We recognized approximately $1,523,100 of revenue from product licensing fees
for our Unix-based products during 2003 as compared with approximately
$1,547,800 during 2002, a decrease of $24,700, or 1.6%. During the fourth
quarter of 2002, we entered into a significant one-time transaction with a
customer that generated approximately $552,500 of Unix product licensing fee
revenue. Net of this transaction, 2003 revenue from Unix product licensing fees
increased by approximately $527,800, or 53.0%, from 2002 levels. Approximately
$300,000 of this increase has come from one long-standing Unix ISV customer. We
expect 2004 product licensing fee revenue from our Unix-based products to exceed
2003 levels as we enhance our Unix-based products and increase our overall sales
and marketing efforts during 2004.
We recognized approximately $1,547,800 of product licensing fees revenue from
our Unix-based products during 2002 as compared with approximately $1,222,300
during 2001, an increase of $325,500, or 26.6%. Net of the one-time transaction
described in the preceding paragraph, 2002 revenue from Unix product licensing
fees decreased by approximately $227,000, or 18.6%, from 2001 levels. This
decrease was principally due to the delay in introducing our GoGlobal for Unix
product until the second quarter of 2002, as well as the continued weakness in
the overall economy.
Our licensing fees have been realized from a limited number of customers. As
such, revenues from these products have varied from quarter to quarter
reflecting the aggregate demand of the individual customers. We expect our
quarterly licensing fees to continue to vary during 2004.
12
During 2003, we recognized approximately $830,900 of revenue from service fees
that had previously been deferred, an increase of $388,700, or 87.9%, from the
approximately $442,200 recognized during 2002. The $442,200 of revenue from
service fees that we recognized during 2002 was an increase of $158,200, or
55.7%, from the $284,000 we recognized during 2001. The main factor contributing
to the 2003 increase was the large Unix transaction that we entered into during
the fourth quarter of 2002, which was discussed elsewhere within this section.
That transaction included approximately $300,000 worth of service fees that are
being amortized over a three-year period. A negligible amount of deferred
service fees was recognized as revenue from this transaction during 2002 as
compared with approximately $100,000, or one full-year's worth, during 2003.
A general factor contributing to both the 2003 and 2002 increases in revenue
from service fees sold was the steady increase in their sales since December 31,
2001. Deferred revenue, as reported on our balance sheet, was $1,192,000,
$796,100 and $577,800 as of December 31, 2003, 2002 and 2001, respectively.
Growth in our deferred revenue balance is primarily indicative of the sale of
maintenance contracts. Revenue from maintenance contracts is recognized ratably
over the underlying service periods, which, in our case and depending on the
respective contract, can be either one, two, three or five years in length.
Although the deferred revenue balance reported as of December 31, 2001, 2002 and
2003, respectively, has continued to increase, the amount of revenue recognized
from service fees has also increased because of the high amount of maintenance
contracts carrying one-year service terms.
We anticipate that many of our customers will enter into, and periodically
renew, maintenance contracts to ensure continued product updates and support.
Revenue from deferred items was approximately 19.9%, 12.5% and 4.8% of revenue
in 2003, 2002 and 2001, respectively. We expect revenue from deferred items in
2004 to exceed 2003 levels.
Revenues from our three largest customers for 2003 represented approximately
27.4%, 18.4% and 9.2%, respectively, of total revenues. These three customers'
December 31, 2003 year-end accounts receivable balances represented
approximately 0.0%, 28.0% and 44.1% of reported net accounts receivable. By
March 18, 2004, we had collected the majority of these outstanding balances.
Revenues from our three largest customers for 2002 represented approximately
26.9%, 23.4% and 12.5%, respectively, of total revenues. These three customers'
December 31, 2002 year-end accounts receivable balances represented
approximately 0.0%, 0.0%, and 15.1% of reported net accounts receivable. By
March 21, 2003, we had collected the substantial majority of this outstanding
balance.
Cost of Revenues. Cost of revenues consists primarily of the amortization of
acquired technology and the amortization of capitalized technology developed
in-house. 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 revenues over the
shorter of three years or the remaining estimated life of the products.
The decreases in cost of revenues in 2003 from 2002 and in 2002 from 2001 were
due to the write-downs of the estimated remaining carrying values of our
intangible assets that were recorded during the third quarter of 2002 as well as
the fourth quarter of 2001.
As more fully explained below under Asset Impairment Loss, during September 2002
and December 2001, we wrote down the historical cost of various components of
our purchased technology assets as part of our periodic assessments of asset
impairment. The amortization of our technology assets, as explained above, is
recorded as a component of Cost of Revenues. As a result of these write-downs
and that certain components of our intangible assets will become fully amortized
during 2004, we expect that our cost of revenues will be significantly lower in
2004 as compared with 2003. Cost of revenues were approximately 32.9%, 47.5% and
44.2%, of total revenues for the years 2003, 2002 and 2001, respectively.
Sales and Marketing Expenses. Sales and marketing expenses primarily consist of
salaries, sales commissions, non-cash compensation, travel expenses, trade show
related activities and promotional costs.
The decrease in sales and marketing expenses in 2003 from 2002 was primarily
caused by decreased human resources costs ($392,900), trade show activities and
promotional costs ($134,300) and travel and entertainment ($62,600). Partially
offsetting these decreases was an increase in outside consulting services
($115,800). The reasons for these changes were as follows:
o The decrease in human resources costs was the result of the
restructurings made in 2002.
o The decrease in trade shows activities and promotional costs was part
of our decision in 2002 to cut these costs to a minimal level while
using our remaining cash on strategic engineering initiatives.
o The decrease in travel and entertainment was due to the reductions in
head count in 2002 as well as prioritizing the engineering
initiatives over sales and marketing activities.
13
o The increase in outside consulting services reflected the hiring of a
marketing firm to assist with marketing efforts during 2003, once
various elements of the engineering initiatives reached completion.
The decrease in sales and marketing expense in 2002 from 2001 was primarily
caused by decreased human resources costs ($2,057,200), public relations
($399,300), the allocation of corporate overheads ($390,900), travel and
entertainment ($236,300), outside services ($197,400), recruitment, including
relocation ($155,500), and deferred compensation expense ($80,200). The reasons
for these decreases were as follows:
o The decreased human resources costs were the result of the
restructurings undertaken during 2002 and 2001. We reduced sales and
marketing headcount from 24 at year-end 2001 to nine at the end of
2002.
o Public relations costs were reduced as we elected not to renew our
contract with a public relations firm, upon its expiration during
2001.
o The allocation of corporate overheads was reduced as a result of the
headcount decrease as well as the overall lowered cost structure.
o Travel and entertainment expenses decreased primarily due to the
reduction in headcount.
o The decrease in outside services resulted from electing to not renew
a contract with a marketing services firm.
o The decrease in recruitment, including relocation, was a result of
the headcount reductions.
o The decrease in deferred compensation expense was because the amounts
previously deferred became fully amortized during 2002.
We expect that cumulative sales and marketing expenses in 2004 will be higher
than those incurred during 2003. Driving the higher expected costs during 2004
are planned expansions of the sales force and marketing efforts, including trade
show participation, direct mail campaigns and other advertising efforts. Sales
and marketing expenses were approximately 40.3%, 63.2% and 101.3% of total
revenues for the years 2003, 2002 and 2001, respectively.
General and Administrative Expenses. General and administrative expenses
primarily consist of salaries, legal and professional services, non-cash
compensation, insurance and bad debts expense.
The decrease in general and administrative expenses in 2003 from 2002 was
primarily caused by decreased outside services ($446,000), legal fees
($324,800), deferred compensation ($187,400), insurance ($158,600) travel and
entertainment ($141,000) and human resources costs ($173,100). The reasons for
these decreases were as follows:
o We abandoned the merger talks we had conducted throughout 2002 with
three related entities in the telecommunications industry, thus
reducing our needs for general and administrative outside services
during 2003. Also contributing to lower outside consulting fees
during 2003 were lower fees charged by our Interim Chief Executive
Officer.
o As a result of the abandonment of the merger talks, we also reduced
the need for legal services.
o The decrease in deferred compensatin expense was because the amounts
previously deferred became fully amortized during 2002.
o We discontinued our director's and officer's liability insurance
policy during 2003, hence insurance expense decreased.
o Travel and entertainment and human resource costs were lower in 2003
as a result of the reduction in headcount experienced as part of the
restructurings that occurred in 2002.
The decrease in general and administrative expense in 2002 from 2001 was
primarily caused by decreased compensation expense ($823,700), human resources
costs ($593,300), legal fees ($216,200), the allocation of corporate overheads
($179,800) and a decrease in the bad debts reserve ($299,700). Offsetting these
decreases was an increase in outside service ($592,200). The reasons for these
changes were as follows:
o Deferred compensation decreased in 2002 as the amounts that had been
previously deferred became fully amortized during 2002.
o Human resources costs decreased as a result of the 2002
restructurings. We reduced general and administrative headcount from
nine at year-end 2001 to four at year-end 2002.
14
o Lower legal fees were the result of settling the lawsuit with Citrix
during 2001, which was partially offset by legal fees incurred as
part of the merger negotiations that occurred during 2002.
o The allocation of corporate overheads reflected an overall lower cost
base and fewer employees in the allocation pool, both resulting from
the 2002 and 2001 restructurings.
o The decrease in the bad debts reserve was due to an overall lower
accounts receivable level as well as the collection of previously
written off accounts.
o These decreases were offset by increased outside services, which
resulted from consulting fees associated with the merger that was
under consideration in 2002 as well as the commencement of fees being
paid to our Interim Chief Executive Officer.
The ending balance of our allowance for doubtful accounts as of December 31,
2003, 2002 and 2001, was $46,800, $50,300 and $350,000, respectively. Bad debts
expense was $16,300, $31,600 and $250,000 for the years ended December 31, 2003,
2002 and 2001, respectively.
We anticipate that cumulative general and administrative expense in 2004 will be
lower than those incurred during 2003. General and administrative expenses were
approximately 34.0%, 79.2% and 77.2% of 2003, 2002 and 2001 total revenues,
respectively.
Research and Development Expenses. Research and development expenses consist
primarily of salaries and benefits paid to software engineers, payments to
contract programmers, and facility expenses related to our remotely located
engineering offices.
The decrease in research and development expense in 2003 from 2002 was primarily
caused by decreased human resources costs ($693,500), depreciation of fixed
assets ($130,100), rent ($113,000), the allocation of corporate overheads
($78,000), outside services ($38,100) and an increase in customer service costs
($144,600). The reasons for these changes were as follows:
o Human resources costs were decreased as a result of the 2002
restructuring. We began 2002 with 28 Research and development
employees and ended the year with 15. No changes were made to
research and development headcount during 2003.
o The decrease in depreciation expense was due to the timing of various
assets reaching the end of their useful lives, as well as an overall
decrease in the asset base that resulted from the 2002 and 2001
restructuring charges.
o The decrease in rent was primarily due to the negotiated settlement
of the lease on our former Bellevue, Washington engineering offices.
o The allocation of corporate overheads decreased as a result of the
headcount reductions as well as the overall lowered cost structure
resulting from the 2002 and 2001 restructurings.
o The reduction in outside services was primarily due to the
non-renewal of an engineering consultant's contract as the requested
work had been completed.
o Customer service costs consist primarily of wages and benefits paid to
various engineers and are charged to cost of sales. More engineering
time was spent providing customer service during 2003, as compared to
2002, consequently, more costs were charged to cost of sales than to
research and development.
The decrease in research and development expense in 2002 from 2001 was primarily
caused by decreased human resources costs ($839,100), outside services
($379,400) and an increase in customer service costs ($132,400). These decreases
were partially offset by a decrease in capitalized software development costs
($98, 100). The reasons for these changes were as follows:
o Human resources were decreased as a result of the 2002 and 2001
restructurings. We began 2001 with 35 research and development
employees and ended the year with 28. During 2002, we reduced
headcount further, to 15.
o The decrease in outside services resulted primarily from the
non-renewal of an engineering contract with an engineering consulting
firm that had completed the task for which they were engaged.
o Customer service costs increased, resulting from an increase in
maintenance contracts being purchased by our customers.
o Partially offsetting these decreases was a decrease in capitalized
software development costs. When these costs are capitalized, there
are reclassified from research and development expense to the
capitalized software account on the balance sheet. Consequently, a
reduction in capitalization causes expense to increase. We only
capitalize our software development costs when certain criteria are
met.
15
We believe that a significant level of investment for research and development
is required to remain competitive. Accordingly, during 2004 we will continue
working towards our goal of full maturity for our products through a combination
of in-house and contracted research and development efforts. We anticipate that
these efforts will include a combination of enhancing the functionality of our
current product offerings and adding additional features to them. Research and
development expense was approximately 36.3%, 80.1% and 70.0% of total revenues
for the years 2003, 2002 and 2001, respectively.
Asset Impairment Loss. During 2002 and 2001, we recorded impairment charges of
$914,000 and $4,500,900, respectively, against several of our intangible assets,
primarily capitalized technology assets. We review our long-lived assets for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Examples of events or
changes in circumstances that indicate that the recoverability of the carrying
amount of an asset should be addressed, including the following:
o A significant decrease in the market value of an asset;
o A significant change in the extent or manner in which an asset is used;
o A significant adverse change in the business climate that could affect
the value of an asset; and
o Current and historical operating or cash flow losses.
We believed that a review of our current carrying values to evaluate whether the
value of any of our long-lived technology assets had been impaired was
warranted, due to several factors, including:
o The challenges we faced in bringing our GoGlobal for Windows and
GoGlobal:XP products to maturity;
o The continued pervasive weakness in the world-wide economy;
o How we were incorporating and planning to incorporate each element of
the purchased technologies into our legacy technology;
o Our continued and historical operating and cash flow losses.
Based on studies of the various factors affecting asset impairment, as outlined
above, the following asset impairment charges were determined to be necessary in
order to reduce the carrying value of certain of these assets to our current
estimate of the present value of the expected future cash flows to be derived
from these assets:
Net Book Value Impairment Net Book Value
Before Impairment Write Down After Impairment
---------------- ------------- ---------------
2002 Impairment
Purchased Technology $ 2,145,200 $ 775,100 $ 1,370,100
Capitalized Software 277,800 138,900 138,900
---------------- ------------- ---------------
Totals $ 2,423,000 $ 914,000 $ 1,509,000
================ ============= ===============
2001 Impairment
Purchased Technology $ 7,283,300 $ 4,150,900 $ 3,132,400
Patent 350,000 350,000 -
---------------- ------------- ---------------
Totals $ 7,633,300 $ 4,500,900 $ 3,132,400
================ ============= ===============
We do not anticipate recording an asset impairment charge during 2004. The asset
impairment charges were approximately 0.0%, 25.9% and 76.2% of total revenues
for the years 2003, 2002 and 2001, respectively.
Restructuring charge. During 2002 we closed our Morgan Hill, California and
Bellevue Washington office locations as part of our strategic initiatives to
reduce operating costs. In conjunction with these closures, we reduced headcount
in all of our operating departments and wrote off the costs of leasehold
improvements and other assets that were abandoned. A summary of the
restructuring charges recorded during 2002 is as follows:
Ending Balance
Restructuring Cash Non-cash Restructuring
Category Charge Payments Charges Accrual
- -------- ------------- ------------- ------------- --------------
Year ended December 31, 2002:
Employee severance $ 831,000 $ (831,000) $ - $ -
Fixed assets abandonment 657,800 - (657,800) -
16
Minimum lease payments 443,800 (161,600) - 282,200
Other 10,200 (10,200) - -
------------- ------------- ------------- --------------
Totals $ 1,942,800 $ (1,002,800) $ (657,800) $ 282,200
============= ============= ============= ==============
During 2003 we negotiated settlements of the leases for our former offices in
Bellevue, Washington and Morgan Hill, California, which completed the
restructuring activities that had been approved under EITF 94-3 during 2002 and
had begun in 2002, as explained above. Additionally, we relocated our Morgan
Hill, California offices from 400 Cochrane Circle to 105 Cochrane Circle and
further disposed of certain assets that were no longer in service. To the extent
that the December 31, 2002 ending restructuring charge accrual balance was less
than the costs incurred for these activities, we recorded an additional
restructuring charge during 2003. A summary of the restructuring charges
recorded during 2003 is as follows:
Ending Balance
Restructuring Cash Non-cash Restructuring
Category Charge Payments Charges Accrual
- -------- ------------- ------------- ------------ --------------
Year ended December 31, 2003:
Opening accrual balance $ - $ - $ - $ 282,200
Fixed assets abandonment 42,200 - (42,200) -
Leases settlements - rent 36,800 (269,000) - (232,200)
Deposits forfeited 16,000 - (56,000) (40,000)
Commissions 12,000 (22,000) - (10,000)
Other (1) (26,900) - 26,900 -
------------- ------------- ------------ --------------
Totals $ 80,100 $ (291,000) $ (71,300) $ -
============= ============= ============ ==============
(1) Includes the write-off of deferred rent associated with the Morgan Hill
lease and other miscellaneous items.
During June 2003, we negotiated a buy out of the lease for our former
engineering offices in Bellevue, Washington. The total buy out price was
approximately $184,000 and consisted of a lump-sum cash payment of $144,000, the
forfeiture of an approximate $40,000 security deposit and a $10,000 commission
to the real estate broker who was involved in the transaction. It is estimated
that the buy out saved approximately $355,800 over what would have been the
remainder of the 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 what would have been the
remainder of the lease term.
The net aggregate amount of the annual lease payments made under all of our
leases in the years 2003, 2002 and 2001 was approximately $295,400, $525,700 and
$558,700, respectively.
Interest and Other Income. During 2003, 2002 and 2001, the primary component of
interest and other income was interest income derived on excess cash. Our excess
cash was held in relatively low-risk, highly liquid investments, such as U.S.
Government obligations, bank and/or corporate obligations rated "A" or higher by
independent rating agencies, such as Standard and Poors, or interest bearing
money market accounts with minimum net assets greater than or equal to one
billion U.S. dollars. The decreases in interest income in 2003 from 2002 and
2002 from 2001, was due to lower average cash and cash equivalents, and
available-for-sale securities balances in 2003 as compared with 2002, and 2002
as compared with 2001. Additionally, the decreases were reflective of a decrease
in our portfolio's average yield rate, which reflected the market's response to
the cuts and subsequent stabilization made in interest rates by the Federal
Reserve during these time periods.
The lower average cash and cash equivalents and available-for-sale securities
balances at year end 2003, 2002 and 2001, as compared with each respective
preceding year, is primarily due to the outflow of approximately $712,500,
$4,606,000 and $6,752,700, during each year, respectively, resulting from our
operations. As more fully explained under Liquidity and Capital Resources, we
have been consuming cash in our operations and have seen our cash reserves
continually decline for the past several years. Interest and other income was
approximately 0.3%, 4.3% and 8.7% of total revenues for the years 2003, 2002 and
2001, respectively.
Interest and Other Expense. Interest and other expense consists primarily of the
cost of accrued interest on bonds and other investments that we purchased with
our excess cash. The decrease in 2003 from 2002 was primarily due to our
discontinuance of purchasing bonds with our excess cash. The increase in 2002
from 2001 was primarily due to faster rollovers of investments, as we required
more readily available cash to finance our operations. The faster rollovers were
17
reflective of the shorter time frame that we decided to keep the excess cash
invested. These increases were partially offset by cumulative marked-to-market
gains recorded on the value of the securities held in our investment account.
Interest and other expense was approximately 0.1%, 2.2% and 1.1% of total
revenues for the years 2003, 2002 and 2001, respectively.
Provision for Income Taxes. At December 31, 2002, we had approximately
$36,625,000 in federal net operating loss carryforwards. The federal net
operating loss carryforwards will expire at various times from 2007 through
2020, if not utilized. In addition, the Tax Reform Act of 1986 contains
provisions that may limit the net operating loss carryforwards available for use
in any given period upon the occurrence of various events, including a
significant change in ownership interests. In 1998, we experienced a "change of
ownership" as defined by the provisions of the Tax Reform Act of 1986. As such,
our utilization of our net operating loss carryforwards through 1998 will be
limited to approximately $400,000 per year until such carryforwards are fully
utilized or expire.
Liquidity and Capital Resources
We have suffered recurring losses and have absorbed significant cash in our
operating activities. Further, we have limited alternative sources of financing
available to fund any additional cash required for our operations or otherwise.
These matters raise substantial doubt about our ability to continue as a going
concern. Our plan in regard to these matters is described below. The
consolidated financial statements included in this report do not include any
adjustments that might result from the outcome of this uncertainty.
In January 2004, we raised $1,150,000 through the private placement of 5,000,000
shares of our common stock and five-year warrants to purchase 2,500,000 shares
of our common stock at an exercise price of $0.33 per shares (the "private
placement"). Net proceeds of approximately $975,000 were available for operating
needs after the payment of commissions, legal and other fees associated with the
private placement.
We are continuing to operate the business on a cash basis by striving to bring
our cash expenditures in line with our revenues. We are simultaneously looking
at ways to improve or maintain our revenue stream. Additionally, we continue to
review potential merger opportunities as they present themselves to us and at
such time as a merger might make financial sense and add value for our
shareholders, we will pursue that merger opportunity. We anticipate increasing
our sales and marketing and research and development expenditures during 2004 as
we believe further development of these areas are critical to our ability to
continue our business as a going concern. We believe that improving or
maintaining our current revenue stream, coupled with our cash on hand, including
the cash raised in the private placement, will support these planned increases
during 2004.
During 2003 we used $712,500 of cash from our operating activities that related
primarily to our net loss of $1,886,600, offset by non-cash items including
depreciation and amortization, totaling $1,248,400, and the non-cash portion of
the restructuring charge of $42,200. Operating cash outflow was generated by an
aggregate decrease in cash from operating assets and liabilities of $115,600,
which was partially offset by a $3,500 decrease in our provision for doubtful
accounts.
Depreciation and amortization primarily relates to our purchased technology, as
outlined above in Costs of Revenues. Also included in depreciation and
amortization is the amortization of deferred compensation expense related to
non-cash compensation paid to various third parties, primarily consultants, who
provide us services. This amortization is recorded as sales and marketing
expense or general and administrative expense, depending on the nature of the
underlying services provided.
The cash outflow generated from aggregated operating assets and liabilities was
primarily due to the reductions in both accounts payable and accrued expenses as
of year-end 2003 as compared to year-end 2002. These decreases both primarily
resulted from the continued cost-cutting measures we enacted throughout 2003.
We are exploring options available to increase revenues and to find alternative
sources of financing our operations. If we were unsuccessful in identifying and
implementing such options, we would face a severe constraint on our ability to
sustain operations in a manner that would create future growth and viability,
and we may need to cease operations entirely.
During 2003 we consumed $225,700 of cash in our investing activities that
included the capitalization of software development costs, totaling $282,200,
which were partially offset by a decrease in other assets of $58,100. The
decrease in other assets was primarily attributable to the approximate $40,000
and $16,000 deposits we forfeited upon the settlement of our lease obligations
for our former engineering facility in Bellevue, Washington, and corporate
offices in Morgan Hill, California, respectively, as explained elsewhere within
this section.
18
The capitalized software development costs were incurred in the development of
GoGlobal for Windows, our latest Windows-based product upgrade.
As of December 31, 2003, cash and cash equivalents were approximately
$1,025,500. We anticipate that our cash and cash equivalents as of December 31,
2003, together with anticipated revenue from operations, cost savings from the
2003 and 2002 restructuring charges, the 2002 asset impairment charges and the
approximate $975,000 we raised in the private placement will be sufficient to
meet our working capital and capital expenditure needs through the next twelve
months. We have no material capital expenditure commitments for the next twelve
months. However, due to the inherent uncertainties associated with predicting
future operations, there can be no assurances that such anticipated revenue and
cumulative operational savings will ultimately be realized during the next
twelve months.
During October 2003 we entered into a one-year lease for the period November 1,
2003 through October 31, 2004, for approximately 3,300 square feet of office
space in Concord, New Hampshire. Rent on the Concord facility is approximately
$5,000 per month, consequently, we are committed to making rental payments on
this facility totaling approximately $50,000 in 2004.
New Accounting Pronouncements
In November 2002, the Financial Accounting Standards Board (FASB) issued
Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for
Guarantees, including Indirect Guarantees of Indebtedness of Others," (FIN 45)
which clarifies disclosure and recognition/measurement requirements related to
certain guarantees. The disclosure requirements are effective for financial
statements issued after December 31, 2002 and the recognition/measurement
requirements are effective on a prospective basis for guarantees issued or
modified after December 31, 2002. The application of the requirements of FIN 45
did not have a material impact on our financial position or results of
operations.
In December 2002, the FASB issued Statement No. 148, " Accounting for
Stock-Based Compensation - Transition and Disclosure." (SFAS 148) This Statement
amends SFAS 123, "Stock-Based Compensation," (SFAS 123) to provide alternative
methods of transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. Additionally, SFAS 148 amends
the disclosure requirements of SFAS 123 to require prominent disclosures in both
annual and interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method used on reported
results. SFAS 148 is effective for financial statements for fiscal years ended
after December 31, 2002. In compliance with SFAS 148 we have elected to continue
to follow the intrinsic value method in accounting for our stock-based employee
compensation arrangement as defined by Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employee" (APB 25).
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities," (FIN 46) which addresses consolidation by a
business of variable interest entities in which it is the primary beneficiary.
FIN 46 is effective immediately for certain disclosure requirements and for
variable interest entities created after January 1, 2003, and in the first
fiscal year or interim period beginning after June 15, 2003 for all other
variable interest entities. It is expected that the adoption of FIN 46 will not
have a material impact on our consolidated results of operations or financial
position.
In April 2003, the FASB issued Statement No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities" (SFAS 149). This statement amends
and clarifies accounting for derivative instruments, including certain
derivative instruments embedded in other contracts, and for hedging activities
under Statement No. 133, "Accounting for Derivative Instruments and Hedging
Activities" (SFAS 133). This statement is effective for contracts entered into
or modified after June 30, 2003, for hedging relationships designated after June
30, 2003, and to certain preexisting contracts. It is expected that the adoption
of SFAS 149 will not have a material impact on our consolidated results of
operations or financial position.
In May 2003, the FASB issued Statement No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity" (SFAS
150). This statement establishes standards for how an issuer classifies and
measures in its financial position certain financial instruments with
characteristics of both liabilities and equity. In accordance with this
standard, financial instruments that embody obligations for the issuer are
required to be classified as liabilities. SFAS 150 generally is effective for
financial instruments created or modified after May 31, 2003, and otherwise
effective at the beginning of the first interim period beginning after June 15,
2003. It is expected that the adoption of SFAS 150 will not have a material
impact on our consolidated results of operations or financial position.
19
In December 2003, the SEC issued Staff Accounting Bulletin ("SAB") No. 104,
"Revenue Recognition," (SAB 104) which codifies, revised and rescinds certain
sections of SAB No. 101, "Revenue Recognition," (SAB 101) in order to make this
interpretive guidance consistent with current authoritative guidance. The
changes noted in SAB 104 did not have a material impact on our consolidated
results of operations or financial position.
Risk Factors
The risks and uncertainties described below are not the only ones facing our
company. Additional risks and uncertainties not presently known to us, or risks
that we do not consider significant, may also impair our business. This document
also contains forward-looking statements that involve risks and uncertainties,
and actual results may differ materially from the results we discuss in the
forward-looking statements. If any of the following risks actually occur, they
could have a severe negative impact on our financial results and stock price.
We Have A History Of Operating Losses And Expect These Losses To
Continue, At Least For The Near Future.
We have experienced significant losses since we began operations. We expect to
continue to incur losses at least for the near future. We incurred net losses of
approximately $1,886,600, $8,792,500 and $15,478,000 for the years ended
December 31, 2003, 2002 and 2001, respectively. We expect our expenses to
increase as we have planned to increase our sales and marketing efforts,
however, we cannot give assurance that revenues will increase sufficiently to
exceed costs. 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.
Our Operating Results In One Or More Future Periods Are Likely To
Fluctuate Significantly And May Fail To Meet Or Exceed The Expectations
Of Securities Analysts Or Investors.
Our operating results are likely to fluctuate significantly in the future on a
quarterly and on an annual basis due to a number of factors, many of which are
outside our control. Factors that could cause our revenues to fluctuate include
the following:
o The degree of success of our recently introduced products;
o Variations in the timing of and shipments of our products;
o Variations in the size of orders by our customers;
o Increased competition; o The proportion of overall revenues derived from
different sales channels such as distributors, original equipment
manufacturers (OEMs) and others;
o Changes in our pricing policies or those of our competitors;
o The financial stability of major customers;
o New product introductions or enhancements by us or by competitors;
o Delays in the introduction of products or product enhancements by us or
by competitors;
o The degree of success of new products;
o Any changes in operating expenses; and
o General economic conditions and economic conditions specific to the
software industry.
In addition, our royalty and license revenues are impacted by fluctuations in
OEM licensing activity from quarter to quarter, which may involve one-time
royalty payments and license fees. Our expense levels are based, in part, on
expected future orders and sales; therefore, if orders and sales levels are
below expectations, our operating results are likely to be materially adversely
affected. Additionally, because significant portions of our expenses are fixed,
a reduction in sales levels may disproportionately affect our net income. Also,
we may reduce prices or increase spending in response to competition or to
pursue new market opportunities. Because of these factors, our operating results
in one or more future periods may fail to meet or exceed the expectations of
securities analysts or investors. In that event, the trading price of our common
stock would likely be affected.
We May Not Be Successful In Attracting And Retaining Key Management Or
Other Personnel.
Our success and business strategy is also dependent in large part on our ability
to attract and retain key management and other personnel. The loss of the
services of one or more members of our management group and other key personnel,
including our interim Chief Executive Officer, may have a material adverse
effect on our business.
20
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.
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.
Because Our Market Is New And Emerging, We Cannot Accurately Predict
Its Future Growth Rate Or Its Ultimate Size, And Widespread Acceptance
Of Our Products Is Uncertain.
The market for business infrastructure software, which enables programs to be
accessed and run with minimal memory resident on a desktop computer or remote
user device, still is emerging, and we cannot assure you that our products will
receive broad-based market acceptance or that this market will continue to grow.
Additionally, we cannot accurately predict our market's future growth rate or
its ultimate size. Even if business infrastructure software products achieve
market acceptance and the market for these products grows, we cannot assure you
that we will have a significant share of that market. If we fail to achieve a
significant share of the business infrastructure software market, or if such
market does not grow as anticipated, our business, results of operations and
financial condition may be adversely affected.
We Rely On Indirect Distribution Channels For Our Products And May Not
Be Able To Retain Existing Reseller Relationships Or To Develop New
Reseller Relationships.
Our products primarily are sold through several distribution channels. An
integral part of our strategy is to strengthen our relationships with resellers
such as OEMs, systems integrators, value-added resellers, distributors and other
vendors to encourage these parties to recommend or distribute our products and
to add resellers both domestically and internationally. We currently invest, and
intend to continue to invest, significant resources to expand our sales and
marketing capabilities. We cannot assure you that we will be able to attract
and/or retain resellers to market our products effectively. Our inability to
attract resellers and the loss of any current reseller relationships could have
a material adverse effect on our business, results of operations and financial
condition. Additionally, we cannot assure you that resellers will devote enough
resources to provide effective sales and marketing support to our products.
Our Failure To Manage Expanding Operations Could Adversely Affect Us.
To exploit the emerging business infrastructure software market, we must rapidly
execute our business strategy and further develop products while managing our
anticipated growth in operations. To manage our growth, we must:
21
o Continue to implement and improve our operational, financial and
management information systems;
o Hire and train additional qualified personnel;
o Continue to expand and upgrade core technologies; and
o Effectively manage multiple relationships with various licensees,
consultants, strategic and technological partners and other third
parties.
We cannot assure you that our systems, procedures, personnel or controls will be
adequate to support our operations or that management will be able to execute
strategies rapidly enough to exploit the market for our products and services.
Our failure to manage growth effectively or execute strategies rapidly could
have a material adverse effect on our business, financial condition and results
of operations.
The Market In Which We Participate Is Highly Competitive And Has More
Established Competitors.
The market we participate in is intensely competitive, rapidly evolving and
subject to technological changes. We expect competition to increase as other
companies introduce additional competitive products. In order to compete
effectively, we must continually develop and market new and enhanced products
and market those products at competitive prices. As markets for our products
continue to develop, additional companies, including companies in the computer
hardware, software and networking industries with significant market presence,
may enter the markets in which we compete and further intensify competition. A
number of our current and potential competitors have longer operating histories,
greater name recognition and significantly greater financial, sales, technical,
marketing and other resources than we do. We cannot assure you that our
competitors will not develop and market competitive products that will offer
superior price or performance features or that new competitors will not enter
our markets and offer such products. We believe that we will need to invest
increasing financial resources in research and development to remain competitive
in the future. Such financial resources may not be available to us at the time
or times that we need them, or upon terms acceptable to us. We cannot assure you
that we will be able to establish and maintain a significant market position in
the face of our competition and our failure to do so would adversely affect our
business.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are currently not exposed to any significant financial market risks from
changes in foreign currency exchange rates or changes in interest rates and do
not use derivative financial instruments. A substantial majority of our revenue
and capital spending is transacted in U.S. dollars. However, in the future, we
may enter into transactions in other currencies. An adverse change in exchange
rates would result in a decline in income before taxes, assuming that each
exchange rate would change in the same direction relative to the U.S. dollar. In
addition to the direct effects of changes in exchange rates, such changes
typically affect the volume of sales or foreign currency sales price as
competitors' products become more or less attractive.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Index to Consolidated Financial Statements
Page
Report of Independent Certified Public Accountants........................... 23
Consolidated Balance Sheets as of December 31, 2003 and 2002................. 24
Consolidated Statements of Operations and Comprehensive Loss for
the Years Ended December 31, 2003, 2002, and 2001...........................25
Consolidated Statements of Shareholders' Equity for the Years Ended
December 31, 2003, 2002 and 2001................. ..........................26
Consolidated Statements of Cash Flows for the Years Ended
December 31, 2003, 2002 and 2001............................................27
Summary of Significant Accounting Policies....................................28
Notes to Consolidated Financial Statements....................................31
Report of Independent Certified Public Accountants on
Supplemental Schedule.......................................................41
Supplemental Schedule II......................................................42
22
Report of Independent Certified Public Accountants
To the Board of Directors and Shareholders of GraphOn Corporation
We have audited the accompanying consolidated balance sheets of GraphOn
Corporation and Subsidiary (the Company) as of December 31, 2003 and 2002, and
the related consolidated statements of operations and comprehensive loss,
shareholders' equity, and cash flows for each of the three years in the period
ended December 31, 2003. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of GraphOn Corporation
and Subsidiary as of December 31, 2003 and 2002, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2003 in conformity with accounting principles generally accepted in
the United States of America.
The accompanying financial statements have been prepared on a going concern
basis, which contemplates the realization of assets and the settlement of
liabilities in the normal course of business. As discussed in Note 1 to the
financial statements, the Company has suffered recurring losses and has absorbed
significant cash in its operating activities. Further, the Company has limited
alternative sources of financing available to fund any additional cash required
for its operations or otherwise. These matters raise substantial doubt about the
ability of the Company to continue as a going concern. Management's plan in
regard to these matters is also described in Note 1. The accompanying financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
/s/ BDO Seidman, LLP
BDO Seidman, LLP
San Jose, California
February 23, 2004
23
GraphOn Corporation
Consolidated Balance Sheets
December 31, 2003 2002
- ------------ ------------ ------------
CURRENT ASSETS
Cash and cash equivalents ................................. $ 1,025,500 $ 1,958,200
Accounts receivable, net of allowance for doubtful accounts
of $46,800 and $50,300 ................................... 521,100 337,900
Prepaid expenses and other current assets ................. 23,100 192,000
------------ ------------
TOTAL CURRENT ASSETS ........................................... 1,569,700 2,488,100
------------ ------------
Property and equipment, net .................................... 144,800 421,900
Purchased technology, net ...................................... 335,000 1,163,100
Capitalized software, net ...................................... 500,600 406,500
Other assets ................................................... 11,900 70,000
------------ ------------
TOTAL ASSETS ................................................... $ 2,562,000 $ 4,549,600
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable .......................................... $ 52,300 $ 228,700
Accrued liabilities ....................................... 470,800 795,100
Deferred revenue .......................................... 1,192,000 796,100
------------ ------------
TOTAL CURRENT LIABILITIES ...................................... 1,715,100 1,819,900
------------ ------------
Commitments and contingencies
SHAREHOLDERS' EQUITY
Preferred stock, $0.01 par value, 5,000,000 shares
authorized, no shares issued and outstanding ............ - -
Common stock, $0.0001 par value, 45,000,000 shares
authorized, 16,618,459 and 16,580,719 shares
issued and outstanding ................................. 1,700 1,700
Additional paid-in capital ................................ 45,985,300 45,982,500
Notes receivable .......................................... (50,300) (50,300)
Accumulated other comprehensive loss ...................... (1,400) (2,400)
Accumulated deficit ....................................... (45,088,400) (43,201,800)
------------ ------------
TOTAL SHAREHOLDERS' EQUITY ..................................... 846,900 2,729,700
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY ..................... $ 2,562,000 $ 4,549,600
============ ============
See accompanying summary of significant accounting policies and
notes to consolidated financial statements
24
GraphOn Corporation
Consolidated Statements of Operations and Comprehensive Loss
Years Ended December 31, 2003 2002 2001
- ------------------------ ------------ ------------ -------------
Revenue:
Product licenses ......................... $ 3,172,100 $ 2,942,000 $ 3,426,000
Service fees ............................. 830,900 442,200 284,000
Other .................................... 167,300 150,800 2,200,700
------------ ------------ ------------
Total Revenue ............................ 4,170,300 3,535,000 5,910,700
------------ ------------ ------------
Cost of Revenue:
Product costs ............................ 1,017,300 1,470,200 2,510,800
Service costs ............................ 354,300 209,700 101,800
------------ ------------ ------------
Total Cost of Revenue .................... 1,371,600 1,679,900 2,612,600
------------ ------------ ------------
Gross Profit ............................. 2,798,700 1,855,100 3,298,100
------------ ------------ ------------
Operating Expenses
Selling and marketing .................... 1,679,800 2,235,100 5,989,400
General and administrative ............... 1,419,100 2,801,000 4,560,800
Research and development ................. 1,515,000 2,831,300 4,134,400
Asset impairment loss .................... - 914,000 4,500,900
Restructuring charges .................... 80,100 1,942,800 -
------------ ------------ ------------
Total Operating Expenses ............... 4,694,000 10,724,200 19,185,500
------------ ------------ ------------
Loss From Operations ........................ (1,895,300) (8,869,100) (15,887,400)
------------ ------------ ------------
Other Income (Expense)
Interest and other income ................ 13,000 152,500 516,100
Interest and other expense ............... (4,300) (75,900) (64,800)
Loss on long-term investment.............. - - (41,100)
------------ ------------ ------------
Total Other Income (Expense) ........... 8,700 76,600 410,200
------------ ------------ ------------
Loss Before Provision for Income Taxes ...... (1,886,600) (8,792,500) (15,477,200)
Provision for Income Taxes .................. - - 800
------------ ------------ ------------
Net Loss .................................... (1,886,600) (8,792,500) (15,478,000)
Other Comprehensive Income (Loss), net of tax
Unrealized holding gain (loss)
on investment .......................... - (7,500) 200
Foreign currency translation adjustment .. 1,000 3,600 (600)
------------ ------------ ------------
Comprehensive Loss .......................... $ (1,885,600) $ (8,796,400) $(15,478,400)
============ ============ ============
Basic and Diluted Loss per Common Share ..... $ (0.11) $ (0.50) $ (0.97)
============ ============ ============
Weighted Average Common Shares Outstanding .. 16,607,328 17