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UNITED STATES 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, 2004 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.)
3130 Winkle Avenue
Santa Cruz, California 95065
(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, 2004 was approximately
$8,676,600.
Number of shares of Common Stock outstanding as of March 30, 2005: 46,147,047
shares of Common Stock.
GRAPHON CORPORATION
FORM 10-K
Table of Contents
Page
PART I.
Item 1. Business 2
Item 2. Properties 9
Item 3. Legal Proceedings 9
Item 4. Submission of Matters to a Vote of Security Holders 10
PART II.
Item 5. Market for Registrant's Common Equity, Related
Stockholder Matters and Issuer Purchases of Equity Securities 10
Item 6. Selected Financial Data 10
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operation 11
Item 7A. Quantitative and Qualitative Disclosures About
Market Risk 24
Item 8. Financial Statements and Supplementary Data 25
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 47
Item 9A. Controls and Procedures 47
Item 9B. Other Information 47
PART III.
Item 10. Directors and Executive Officers of the Registrant 48
Item 11. Executive Compensation 49
Item 12. Security Ownership of Certain Beneficial Owners
and Management and Related Stockholder Matters 51
Item 13. Certain Relationships and Related Transactions 53
Item 14. Principal Accountant Fees and Services 54
PART IV.
Item 15. Exhibits, Financial Statement Schedules 55
SIGNATURES 56
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 a Delaware corporation, founded in May of 1996. 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.
On January 31, 2005, we acquired Network Engineering Software, Inc. ("NES"),
which is engaged in the development and patenting of proprietary technologies
relating to the submission, storage, retrieval and security of information
remotely accessed by computers, typically through computer networks or the
Internet. In a contemporaneous transaction, we raised net proceeds of
approximately $2,000,000 in a private placement (the "2005 private placement")
of newly authorized Series A Preferred Stock and warrants to purchase newly
authorized Series B Preferred Stock. These transactions are described in our
Current Reports on Form 8-K, filed with the Securities and Exchange Commission
(SEC) on February 4, 2005.
Our headquarters are located at 3130 Winkle Avenue, California, 95065 and our
phone number is 1-800-GRAPHON (1-800-472-7466). Our Internet website is
http://www.graphon.com. The information on our website is not part of this
annual report. We also have offices in Concord, New Hampshire, Rolling Hills
Estates, California and Berkshire, England, United Kingdom.
You may read and copy any materials that we file with the SEC at the SEC's
Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549. You may
obtain information on the operation of the Public Reference Room by calling the
SEC at 1-800-SEC-0330. The SEC also maintains an Internet website
(http://www.sec.gov) that contains reports, proxy and information statements,
and other information that we file electronically with the SEC from time to
time. We have made available free of charge through our website (follow the
About Us link to the Investor tab to "SEC Filings") our annual report on Form
10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments
to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the
Securities Exchange Act of 1934 as soon as reasonably practicable after such
material was electronically filed with, or furnished to, the SEC.
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, security and end-user down
time, has become high, both in absolute terms and relative to the initial
hardware purchase price.
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With increasing demands to control corporate computing costs, industry leaders
are developing technology to address total cost of ownership issues. One
approach, led by Sun Microsystems and IBM, utilizes Java-based network
computers, which operate by downloading small Java programs to the desktop,
which in turn are used for accessing server-based applications. Another approach
is Microsoft's Windows Terminal Services(TM), introduced in June 1998. It
permits server-based Windows applications to be accessed from Windows-based
network computers. Both initiatives are examples of server-based computing. They
simplify the desktop by moving the responsibility of running applications to a
central server, with the promise of lowering total cost of ownership.
Enterprise Cross-Platform Computing
Today's enterprises contain a diverse collection of end user devices, each with
its particular operating system, processing power and connection type.
Consequently, it is becoming increasingly difficult to provide universal access
to business-critical applications across the enterprise. As a result,
organizations resort to emulation software, new hardware or costly application
rewrites in order to provide universal application access.
A common cross-platform problem for the enterprise is the need to access Unix or
Linux applications from a PC desktop. While Unix-based computers dominate the
enterprise applications market, Microsoft Windows-based PCs dominate the
enterprise desktop market. Since the early 1990s, enterprises have been striving
to connect desktop PCs to Unix applications over all types of connections,
including networks and standard phone lines. This effort, however, is complex
and costly. The primary solution to date is known as PC X Server software. PC X
Server software is a large software program that requires substantial memory and
processing resources on the desktop. Typically, PC X Server software is
difficult to install, configure and maintain. Enterprises are looking for
effective Unix connectivity software for PCs and non-PC desktops that is easier
and less expensive to administer and maintain.
Today businesses are exploring alternatives to the Windows desktop. The Linux
desktop is a popular choice as it promises lower acquisition costs and avoids
"single vendor lock-in." The Linux desktop or the Unix desktop, popular in many
engineering organizations, both need to access the large number of applications
written for the Microsoft operating environment, such as Office 2003. Our
technology enables Windows applications to be published to any client device
running our GO-Global client software, including: Linux, Unix, Windows and
Macintosh desktops and devices.
Application Service Providers (ASPs)
With the ubiquitous nature of the Internet, new operational models and sales
channels are emerging. Traditional high-end software packages that were once too
expensive for many companies are now available for rent over the Internet. By
servicing customers through a centralized operation, rather than installing and
maintaining applications at each customer's site, ASPs play an important role in
addressing an enterprise's computing requirements. Today, ASPs are faced with
the difficult task of creating, or rewriting, applications to 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.
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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.
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 Supports Strong Information Security Practices. The distributed nature of
most organizations' computing environments makes information security
difficult. Corporate assets in the form of data are often dispersed among
desktop systems. Our server-based approach places the application and data
on servers behind firewalls. This allows the corporation to centrally
manage their applications and data.
o Web Enables Existing Applications. The Internet represents a fundamental
change in distributed computing. Organizations now benefit from
ubiquitous access to corporate resources by both local and remote
users. However, to fully exploit this opportunity, organizations need
to find a way to publish existing applications to Internet enabled
devices. Our technology is specifically targeted at solving this
problem. With GO-Global, an organization can publish an existing
application to an Internet-enabled device without the need to rewrite
the application. This reduces application development costs while
preserving the rich user interface so difficult to replicate in a
native Web application.
o Connects Diverse Computing Platforms. Today's computing infrastructures
are a mix of computing devices, network connections and operating
systems. Enterprise-wide application deployment is problematic due to
this heterogeneity, often requiring costly and complex emulation
software or application rewrites. 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 wireless market, bandwidth
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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.
We also intend to exploit the revenue potential of our NES patent portfolio,
summarized elsewhere herein, by:
o licensing such patents to companies that utilize the technology covered by
such patents in their products or services;
o initiating litigation against those companies who we believe are
infringing such patents and who are unwilling or who refuse to sign
license agreements which provide for royalty payments to us; and
o determining the extent to which the technology covered by the NES patents
has application to our current GO-Global product line and to the
development of new products.
Given our limited cash resources, we intend to prosecute any infringement
litigation that we initiate, as well as defend attempts to declare one or more
of our patents invalid, by engaging law firms on a contingency basis. If we are
able to engage one or more law firms in this manner, as to which we can offer no
assurance, this would reduce our net proceeds from successful litigation.
We anticipate that any cash flow that we are able to derive from our licensing
activities, if not used for working capital in the ordinary course of our
business, will be deployed to develop additional patentable technology.
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), Application Service
Providers (ASPs) and small to medium-sized 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 GO-Global for Windows and GO-Global for Unix.
GO-Global for Windows allows access to Windows applications from remote
locations and a variety of connections, including the Internet and dial-up
connections. GO-Global for Windows allows Windows applications to be run via a
browser from Windows or non-Windows devices, over many types of data
connections, regardless of the bandwidth or operating system. With GO-Global for
Windows, web enabling is achieved without modifying the underlying Windows
applications' code or requiring costly add-ons.
GO-Global 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.
GO-Global for Unix web-enables individual Unix and Linux applications, or entire
desktops. When using Go-Global for Unix, Unix and Linux web enabling is achieved
without modifying the underlying applications' code or requiring costly add-ons.
Target Markets
The target market for our products comprises organizations that need to access
Windows, Unix and/or Linux applications from a wide variety of devices, from
remote locations, including over the Internet, dial-up lines, and wireless
connections. This includes organizations, such as small to medium-sized
companies, governmental and educational institutions, ISVs, VARs and ASPs. Our
software is designed to allow these enterprises to tailor the configuration of
the end user device for a particular purpose, rather than following a "one PC
fits all," high total cost of ownership model. 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
5
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. Small to medium-sized companies that utilize a mixed
computing environment require cross-platform connectivity solutions,
like GO-Global, that will allow users to access applications from
different client devices. It has been estimated that PCs represent
over 90% of enterprise desktops. We believe that our products are well
positioned to exploit this opportunity and that our server-based
software products will significantly reduce the cost and complexity of
connecting PCs to various applications.
o Enterprises With Remote Computer Users. 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
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). Although this agreement expired in July 2004, our relationship
with Alcatel continues as if the contract were still in effect. We anticipate
renewing this agreement during 2005.
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
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support system that provides access to mission-critical applications remotely
via a secure Internet browser. This agreement was renewed during February 2005
for an additional one-year term.
In June 2002, we amended our 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, to extend its term through
June 2006 and to afford KitASP, should it achieve certain performance criteria,
an exclusive right, within Japan, to distribute our web-enabling technology,
bundled with their ASP services, and to resell our software.
In March 2004, we entered into our fifth consecutive one-year, non-exclusive
licensing agreement with FrontRange, an international software and services
company. Pursuant to our 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 our 2003 renewal
of this agreement, we licensed our GO-Global for Windows server-based software
to FrontRange for integration with both FrontRange's HEAT and its Client
Relationship Management software package Goldmine. We anticipate restructuring
our licensing agreement with FrontRange during 2005.
In September 2003, we amended our non-exclusive licensing agreement with
Compuware, an international software and services company, to afford Compuware
the right to include, for a three year period, our GO-Global for Windows
server-based software 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 GO-Global for Windows into its UNIFACE deployment
architecture as UNIFACE Jti.
Sales, Marketing and Support
Our customers, to date, have included small to medium-sized enterprises, ISVs,
VARs and large governmental organizations. Sales to Alcatel, KitASP and
FrontRange represented approximately 20.9%, 14.9% and 14.1%, respectively, of
our revenues in 2004. Sales to FrontRange and Alcatel represented approximately
27.4% and 18.4%, respectively, of our revenues in 2003. We consider KitASP,
Alcatel and FrontRange to be our most significant customers.
Our sales and marketing efforts will be focused on increasing product awareness
and demand among ISVs, ASPs, small to medium-sized enterprises, and VARs who
have a vertical orientation or are focused on Unix, Linux or Windows
environments. Current marketing activities include direct mail, targeted
advertising campaigns, tradeshows, production of promotional materials, public
relations and maintaining an Internet presence for marketing and sales purposes.
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 $1,500,900, $1,797,200 and $3,129,800 in research
and development in 2004, 2003 and 2002, respectively, including capitalized
software development costs of $0, $282,200 and $298,500, respectively. We have
made significant investments in our protocol and in the performance and
development of our server-based software. We expect investments in research and
development during 2005 to approximate 2004 levels.
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.
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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.
Upon our acquisition of NES on January 31, 2005, we acquired the right to 11
patents, all of which were either owned by, or exclusively licensed to NES.
These are primarily method patents that describe software and network
architectures to accomplish certain tasks. Generally, our patents describe:
o methods to collect, store and display information developed and accessed
by users and stored on host computer servers
o methods to provide multiple virtual websites on one computer
o methods to protect computers and computer networks from unauthorized
access
o methods to provide on-line information and directory service
The patents, summarized below, have applicability to computer networks, virtual
private networks and the Internet.
------------------ --------------------- ---------------------------------------------
Patent Date of Grant Scope of Coverage
Number
------------------ --------------------- ---------------------------------------------
5,778,367 July 7, 1998 Automated, network-accessible,
.................. ..................... user-populated database, particularly
6,324,538 November 27, 2001 for the World Wide Web.
.................. .....................
6,850,940 February 1, 2005 " "
(1) (1)
------------------ --------------------- ---------------------------------------------
5,870,550 February 9, 1999 Network-accessible server that hosts
.................. ..................... multiple websites
6,647,422 November 11, 2003 " "
------------------ --------------------- ---------------------------------------------
5,826,014 October 20, 1998 Internet firewall application in which
a "proxy agent" screens incoming
.................. ..................... request from network users and
6,061,798 May 9, 2000 verifies the authority of the incoming
request before permitting access to a
network element.
------------------ --------------------- ---------------------------------------------
5,898,830 April 27, 1999 Firewall computers that act as intermediaries
.................. ..................... between pairs of other computers including
6,052,788 April 18, 2000 control of access to a virtual private
.................. ..................... network.
8
6,751,738 June 15, 2004 " "
.................. .....................
6,804,783 October 12, 2004 " "
------------------ --------------------- ---------------------------------------------
5,790,664 August 4, 1998 Technology for monitoring the license
status of software application(s)
installed on a client computer
------------------ --------------------- ---------------------------------------------
(1) Patent granted on February 1, 2005, subsequent to the acquisition of NES,
thereby increasing the number of issued patents from 11 to 12.
As of February 21, 2005, we have 43 applications for patents filed in the US
Patent Office covering various aspects of methods relating to the submission,
storage, retrieval and security of information stored on computers accessed
remotely, typically through computer networks or the Internet. At that date, the
applications had been pending for various periods ranging from 7 to 55 months.
Of the 43 applications, 41 are continuations of previously issued patents and
two are continuations in part. No applications for patents have been filed in
any non-US jurisdiction.
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.
Employees
As of March 15, 2005, we had a total of 23 employees, including five in
marketing, sales and support, 12 in research and development, four in
administration and finance and two in our patent group. We believe our
relationship with our employees is good. No employees are covered by a
collective bargaining agreement.
ITEM 2. PROPERTIES
We currently occupy approximately 1,000 square feet of office space in Santa
Cruz, California. The office space is rented pursuant to a one-year operating
lease, which became effective August 1, 2004. Rent on the Santa Cruz facility is
approximately $1,400 per month.
During October 2004 we renewed our lease for approximately 3,300 square feet of
office space in Concord, New Hampshire, for a one-year term, which is cancelable
upon 30-days written notice by either our landlord or us. Rent on the Concord
facility is approximately $5,300 per month.
We have been occupying leased facilities in Rolling Hills Estates, California on
a month-to-month basis since October 2002. Rent on this office is approximately
$1,000 per month.
We also have been renting a small office in Berkshire, England, United Kingdom
since December 2002. Our current lease runs through December 2005. Rent on this
office, which can fluctuate 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.
9
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Our 2004 Annual Meeting of Stockholders was held on December 30, 2004. At the
meeting, two directors were reelected to serve for a three-year term. The vote
was as follows:
For Withheld
---------- --------
Robert Dilworth 14,847,998 319,777
August Klein 15,032,643 135,132
The following individuals continue in their capacity as directors: Gordon
Watson and Michael Volker. Their current terms expire during 2005 and 2006,
respectively.
The shareholders also ratified the reappointment of BDO Seidman, LLP as our
independent auditors for fiscal 2004. The vote was as follows:
For Against Abstain
---------- ------- -------
15,075,513 59,902 32,360
Subsequently, in February 2005, the audit committee appointed Macias Gini &
Company LLP as the Company's Independent Registered Public Accounting firm.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS
AND ISSUER PURCHASES OF EQUITY SECURITIES
The following table sets forth, for the periods indicated, the high and low
reported sales price of our common stock. 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 2004 Fiscal 2003
------------------- -------------------
Quarter High Low High Low
-------- -------- -------- --------
1st $ 1.03 $ 0.20 $ 0.28 $ 0.13
2nd $ 0.93 $ 0.41 $ 0.34 $ 0.13
3rd $ 0.51 $ 0.25 $ 0.28 $ 0.18
4th $ 0.56 $ 0.25 $ 0.28 $ 0.15
On March 30, 2005, there were approximately 165 holders of record of our common
stock. On April 11, 2005, the last reported sales price was $0.36.
During the fourth quarter of 2004, we granted stock options to our two executive
officers to purchase an aggregate of 680,000 shares of common stock at an
exercise price of $0.34 per share. The grant of such stock options to the
executive officers was not registered under the Securities Act of 1933 because
the stock options either did not involve an offer or sale for purposes of
Section 2(a)(3) of the Securities Act, in reliance on the fact that the stock
options were granted for no consideration, or were offered and sold in
transactions not involving a public offering, exempt from registration under the
Securities Act pursuant to Section 4(2).
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.
Information regarding our equity compensation plans, including stockholder
approved plans and plans not approved by stockholders, is set forth in Item 12
of this Annual Report on Form 10-K.
ITEM 6. SELECTED FINANCIAL DATA
The following selected historical financial data should be read in conjunction
with "Management's Discussion and Analysis of Financial Condition and Results of
Operation" and our historical financial statements and the notes thereto
included elsewhere herein. BDO Seidman LLP, independent registered public
accounting firm, has audited our financial statements as of December 31, 2003,
2002, 2001 and 2000, and for the years then ended, from which our respective
10
historical financial data for those years has been derived. Macias Gini &
Company LLP independent registered public accounting firm, has audited our
financial statements as of December 31, 2004 and for the year then ended, from
which our respective historical financial data for that year has been derived.
Statement of Operations Data:
Year Ended December 31,
2004 2003 2002 2001 2000
------------ -------------- ------------- ------------- --------------
(Amounts in thousands, except share and per share data)
--------------------------------------------------------------------------
Revenue $ 3,530 $ 4,170 $ 3,535 $ 5,911 $ 7,567
Costs of revenue 904 1,371 1,680 2,613 1,044
------------ -------------- ------------- ------------- --------------
Gross profit 2,626 2,799 1,855 3,298 6,523
------------ -------------- ------------- ------------- --------------
Operating expenses:
Selling and marketing 1,384 1,680 2,235 5,989 5,750
General and administrative 1,183 1,419 2,801 4,561 4,653
Research and development 1,501 1,515 2,831 4,134 4,060
Asset impairment loss - - 914 4,501 -
Restructuring charge - 80 1,943 - -
------------ -------------- ------------- ------------- --------------
Total operating expenses 4,068 4,694 10,724 19,185 14,463
------------ -------------- ------------- ------------- --------------
Loss from operations (1,442) (1,895) (8,869) (15,887) (7,940)
Other income (expense) 15 8 77 410 (1,434)
------------ -------------- ------------- ------------- ---------------
Loss before provision
for income taxes (1,427) (1,887) (8,792) (15,477) (9,374)
Provision for income taxes - - - 1 1
------------ -------------- ------------- ------------- --------------
Net loss $ (1,427) $ (1,887) $ (8,792) $ (15,478) $ (9,375)
============ ============== ============= ============= ==============
Basic and diluted loss per
common share $ (0.07) $ (0.11) $ (0.50) $ (0.97) $ (0.65)
============ ============== ============= ============= ===============
Weighted average common
shares outstanding 21,307,966 16,607,328 17,465,099 16,007,763 14,396,435
============ ============== ============= ============= ==============
Balance Sheet Data:
As of December 31,
2004 2003 2002 2001 2000
------------ -------------- ------------- ------------- --------------
(Amounts in thousands)
--------------------------------------------------------------------------
Working capital $ (213) $ 284 $ 668 $ 6,173 $ 12,879
Total assets 2,224 2,562 4,550 12,986 21,040
Total liabilities 1,858 1,715 1,820 1,660 1,983
Shareholders' equity 366 847 2,730 11,326 19,057
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION
The following discussion should be read in conjunction with the consolidated
financial statements and related notes provided elsewhere in this Annual Report
on Form 10-K.
Critical Accounting Policies. The preparation of financial statements and
related disclosures in conformity with accounting principles generally accepted
in the United States requires management to make judgments, assumptions and
estimates that affect the amounts reported in the Consolidated Financial
Statements and accompanying notes. The Summary of Significant Accounting
Policies appears in Part II, Item 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
11
by judgments, assumptions and estimates used in the preparation of the
Consolidated Financial Statements.
Revenue Recognition
Generally, software license revenues are recognized when a non-cancelable
license agreement has been signed and the customer acknowledges an unconditional
obligation to pay, the software product has been delivered, there are no
uncertainties surrounding product acceptance, the fees are fixed or determinable
and collection is considered probable. Delivery is considered to have occurred
when title and risk of loss have been transferred to the customer, which
generally occurs when the media containing the licensed programs is provided to
a common carrier. In the case of electronic delivery, delivery occurs when the
customer is given access to the licensed programs. If collectibility is not
considered probable, revenue is recognized when the fee is collected.
Revenue earned on software arrangements involving multiple elements is allocated
to each element arrangement based on the relative fair values of the elements.
If there is no evidence of the fair value for all the elements in a multiple
element arrangement, all revenue from the arrangement is deferred until such
evidence exists or until all elements are delivered. We recognize revenue from
the sale of software licenses when all the following conditions are met:
o Persuasive evidence of an arrangement exists;
o Delivery has occurred or services have been rendered;
o Our price to the customer is fixed or determinable; and
o Collectibility is reasonably assured.
Revenues recognized from multiple-element software arrangements are allocated to
each element of the arrangement based on the fair values of the elements, such
as licenses for software products, maintenance, consulting services or customer
training. The determination of fair value is based on objective evidence. We
limit our assessment of objective evidence for each element to either the price
charged when the same element is sold separately or the price established by
management having the relevant authority to do so, for an element not yet sold
separately. If evidence of fair value of all undelivered elements exists but
evidence does not exist for one or more delivered elements, then revenue is
recognized using the residual method. Under the residual method, the fair value
of the undelivered elements is deferred and the remaining portion of the
arrangement fee is recognized as revenue.
Allowance for Doubtful Accounts
The allowance for doubtful accounts is based on our assessment of the
collectibility of specific customer accounts and the aging of the accounts
receivable. If there is a deterioration of a major customer's credit worthiness
or actual defaults are higher than our historical experience, our estimates of
the recoverability of amounts due us could be adversely affected.
Capitalized Software Development Costs
Software development costs incurred in the research and development of new
products are expensed as incurred until technological feasibility, in the form
of a working model, has been established, at which time such costs are typically
capitalized until the product is available for general release to customers.
Capitalized costs are amortized based on either estimated current and future
revenue for the product or straight-line amortization over the shorter of three
years or the remaining estimated life of the product, whichever produces the
higher expense for the period.
Impairment of Intangible Assets
We perform impairment tests on our intangible assets on an annual basis 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 we recorded
significant write-downs to the value of our intangible assets as a result of the
impairment tests performed. A significant consideration impacting the results of
the impairment tests was the substantial delay in getting our most recently
released Windows-based product upgrade, GO-Global for Windows, into marketable
condition. The engineering delays we encountered resulted in a substantial
decrease in our revenue in 2002, which ultimately caused us to consume almost
all of our cash balances in our day-to-day operations.
Loss Contingencies
We are subject to the possibility of various loss contingencies arising in the
ordinary course of business. We consider the likelihood of the loss or
impairment of an asset or the incurrence of a liability as well as our ability
to reasonably estimate the amount of loss in determining loss contingencies. An
estimated loss contingency is accrued when it is probable that a liability has
been incurred or an asset has been impaired and the amount of the loss can be
reasonably estimated. We regularly evaluate current information available to us
to determine whether such accruals should be adjusted.
12
Stock Compensation
We apply Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock
Issued to Employees" and related interpretations thereof (hereinafter
collectively referred to as APB 25) when accounting for our employee and
directors stock options and employee stock purchase plans. In accordance with
APB 25, we apply the intrinsic value method in accounting for employee stock
options. Accordingly, we generally recognize no compensation expense with
respect to stock-based awards to employees.
We have determined pro forma information regarding net income and earnings per
share as if we had accounted for employee stock options under the fair value
method as required by Statement of Financial Accounting Standards (SFAS) No.
123, "Accounting for Stock-Based Compensation" as amended by SFAS 148
(hereinafter collectively referred to as SFAS 123). The fair value of these
stock-based awards to employees was estimated using the Black-Scholes
option-pricing model. Had compensation cost for our stock option plans and
employee stock purchase plan been determined consistent with SFAS 123, our
reported net loss and net loss common per share would have been changed to the
amounts discussed elsewhere in this Form 10-K. See New Accounting
Pronouncements, below, for further details on accounting for stock-based
compensation.
Results of Operations
The first table that follows sets forth our income statement data for the years
ended December 31, 2004 and 2003, respectively, and calculates the dollar change
and percentage change from 2003 to 2004 in the respective line items. The second
table that follows presents the same information for the years ended December
31, 2003 and 2002.
Year Ended
December 31,
------------------- Dollars Percentage
(Dollars in 000s) 2004 2003 Change Change
- ----------------- -------- -------- ------- -------
Revenue $ 3,530 $ 4,170 $ (640) (15.3)%
Cost of revenue 904 1,371 (467) (34.1)
-------- -------- -------
Gross profit 2,626 2,799 (173) (6.2)
-------- -------- -------
Operating expenses:
Selling and marketing 1,384 1,680 (296) (17.6)
General and administrative 1,183 1,419 (236) (16.6)
Research and development 1,501 1,515 (14) (0.9)
Restructuring charges - 80 (80) (100.0)
-------- -------- -------
Total operating expenses 4,068 4,694 (626) (13.3)
-------- -------- -------
Loss from operations (1,442) (1,895) 453 23.9
-------- -------- -------
Other income (expense):
Interest and other income 15 13 2 15.4
Interest and other expense - (5) 5 100.0
-------- -------- -------
Total other income (expense) 15 8 7 87.5
-------- -------- -------
Net loss $ (1,427) $ (1,887) $ 460 24.4%
======== ======== =======
Year Ended
December 31,
------------------- Dollars Percentage
(Dollars in 000s) 2003 2002 Change Change
- ----------------- -------- -------- -------- -------
Revenue $ 4,170 $ 3,535 $ 635 18.0
Cost of revenue 1,371 1,680 (309) (18.4)
-------- -------- --------
Gross profit 2,799 1,855 (944) (50.9)
-------- -------- --------
Operating expenses:
Selling and marketing 1,680 2,235 (555) (24.8)
General and administrative 1,419 2,801 (1,382) (49.3)
Research and development 1,515 2,831 (1,316) (46.5)
Asset impairment loss - 914 (914) (100.0)
Restructuring charges 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
-------- -------- --------
13
Other income (expense):
Interest and other income 13 153 (140) (91.5)
Interest and other expense (5) (76) 71 (93.4)
-------- -------- --------
Total other income (expense) 8 77 (69) (89.6)
-------- -------- --------
Net loss $ (1,887) $ (8,792) $ 6,905 78.5%
======== ======== ========
Revenue. Our revenue is primarily derived from product licensing fees and
service fees from maintenance contracts. Other sources of revenue include
private labeling fees and sales of software development kits. Private labeling
fees are derived when we contractually agree to allow a customer to brand our
product with their name. We defer these fees upon contract signing and recognize
the revenue ratably over the initial term of the contract. Software development
kits are tools that allow end users to develop, interface and brand their own
applications for use in conjunction with either our Windows or Unix/Linux
products. Currently, we do not generate a significant amount of revenue from
private labeling transactions, nor do we anticipate generating a significant
amount of revenue from them or from the sale of software development kits during
2005.
The first table that follows summarizes product licensing fees for the years
ended December 31, 2004 and 2003, respectively and calculates the change in
dollars and percentage from 2003 to 2004 in the respective line item. The second
table that follows presents the same information for the years ended December
31, 2003 and 2002, respectively.
Year Ended December 31, Increase/(Decrease)
------------------------ -----------------------
Product licensing fees 2004 2003 Dollars Percentage
- ---------------------- ----------- ----------- ---------- ----------
Windows $ 1,361,600 $ 1,649,000 $ (287,400) (17.4%)
Unix/Linux 1,033,600 1,523,100 (489,600) (32.1)
----------- ----------- ----------
Total $ 2,395,200 $ 3,172,100 $ (777,000) (24.5%)
=========== =========== ==========
2003 2002 Dollars Percentage
----------- ----------- ---------- ----------
Windows $ 1,649,000 $ 1,394,200 $ 254,800 18.3%
Unix/Linux 1,523,100 1,547,800 (24,700) (1.6)
----------- ----------- ----------
Total $ 3,172,100 $ 2,942,000 $ 230,100 7.8%
=========== =========== ==========
The majority of our product licensing fees has been realized from a limited
number of customers. As such, product licensing fees revenue has varied,
sometimes substantially, from quarter to quarter and year to year. We expect our
quarterly product licensing fees revenue to continue to vary during 2005.
During 2004, one of our significant ISV customers informed us that they would
begin selling our Windows-based products as an add-on to their software
applications products, instead of bundling our products with theirs, as had been
done previously. Sales to this customer declined by approximately $419,000 in
2004 from 2003, and were the primary contributing factor to our overall decline
in Windows product licensing fees. Partially offsetting this decrease was the
recognition of approximately $188,000 of revenue from a Windows product
licensing sale that we had originally recorded as a deferred item during
December of 2003 because not all of the criteria for revenue recognition had
been met. Once all the criteria were met, in early 2004, we recognized this
revenue.
Approximately $302,800 of the decrease in 2004 Unix/Linux product licensing fee
revenue was due to a one-time sale to a governmental end-user, which occurred
during 2003. The majority of the remaining 2004 decrease was due to the
aggregate variations in our other customers' sales orders.
Our customers' response to the release of the significantly upgraded version of
our Windows product, GO-Global for Windows, during the fourth quarter of 2002
was a significant contributing factor to the increase in 2003 of Windows product
licensing fees from 2002.
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 came from one long-standing Unix
ISV customer.
During 2004, we recognized approximately $1,015,000 of revenue from service
fees, an increase of $184,100, or approximately 22.2% from the approximately
$830,900 recognized during 2003. This increase has primarily resulted from
continued increases in sales of maintenance contracts to our Windows customers
resulting from the release of GO-Global for Windows during the fourth quarter of
2002.
14
During 2004, we recognized approximately $119,600 of revenue from other items, a
decrease of $47,700, or approximately 28.5%, from the approximately $167,300
recognized during 2003. The decrease was primarily due to a $150,000 decrease in
distributor fee revenue, which was partially offset by $100,000 of revenue
recognized from the sale of a software development kit. We had signed a $300,000
two-year distribution agreement with our distributor in Japan and had been
ratably recognizing the distributor fee as revenue over the underlying initial
two-year term, which expired on December 31, 2003. The sale of the software
development kit was a one-time transaction and we do not currently anticipate
selling another kit during 2005.
During 2003, we recognized approximately $830,900 of revenue from service fees,
an increase of $388,700, or 87.9%, from the approximately $442,200 recognized
during 2002. The increase was primarily attributable to an increased level of
sales of maintenance contracts, which began when we introduced our GO-Global for
Windows product during the fourth quarter of 2002. Additionally, we sold
approximately $300,000 worth of maintenance contracts as part of the large Unix
transaction that we entered into during the fourth quarter of 2002, (discussed
above), that are being amortized over a three-year period. A negligible amount
of service fees from this transaction was recognized as revenue during 2002 as
compared with approximately $100,000, or one full-year's worth, during 2003.
During 2003, we recognized approximately $167,300 of revenue from other items,
an increase of $16,500, or approximately 10.9%, from the approximately $150,800
recognized during 2002. The increase was primarily due to the recognition of
private labeling revenue derived from two customers. If customers, typically
ISVs, wish to brand our product with their name, we charge them a private
labeling fee, which we recognize as revenue, ratably, over a three-year period.
We anticipate that many of our customers will enter into, and periodically
renew, maintenance contracts to ensure continued product updates and support.
Revenue from maintenance contracts was approximately 28.8%, 19.9% and 12.5% of
revenue in 2004, 2003 and 2002, respectively. We expect revenue from maintenance
contracts in 2005 to approximate 2004 levels.
Sales to our three largest customers for 2004 represented approximately 20.9%,
14.9% and 14.1%, respectively, of total revenue. These three customers' December
31, 2004 year-end accounts receivable balances represented approximately 30.9%,
2.9% and 0.0% of reported net accounts receivable. By March 16, 2005, we had
collected the majority of these outstanding balances.
Sales to our three largest customers for 2003 represented approximately 27.4%,
18.4% and 9.2%, respectively, of total revenue. 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.
Cost of Revenue. Cost of revenue consists primarily of the amortization of
acquired technology and the amortization of capitalized technology developed
in-house. Also included in cost of revenue are the costs of servicing
maintenance contracts. Research and development costs for new product
development, after technological feasibility is established, are recorded as
"capitalized software" on our balance sheet and subsequently amortized as cost
of revenue over the shorter of three years or the remaining estimated life of
the products.
The decreases in cost of revenues in 2004 from 2003 and in 2003 from 2002 were
due primarily to certain elements of our acquired technology becoming fully
amortized during 2003, additional elements becoming fully amortized during 2004
and the write-downs of the estimated remaining carrying values of our intangible
assets that were recorded during the third quarter of 2002.
As more fully explained below under Asset Impairment Loss, during September 2002
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 Revenue.
Based on our current product development plan and as a result of our intangible
assets becoming fully amortized during 2004, we expect that our cost of revenue
will be significantly lower in 2005 as compared with 2004. Cost of revenue was
approximately 25.6%, 32.9% and 47.5% of total revenues for the years 2004, 2003
and 2002, respectively.
Sales and Marketing Expenses. Sales and marketing expenses primarily consist of
salaries and related benefits, sales commissions, outside consultants, travel
expenses, trade show related activities and promotional costs.
The decrease in sales and marketing expenses in 2004 from 2003 was primarily
caused by decreased salaries, benefits and commissions ($240,600) and facilities
allocations ($170,200), which were partially offset by an increase in outside
consultants ($123,300). The reasons for these changes were as follows:
15
o The decrease in salaries, benefits and commissions was the result of
terminating two people during late 2003 and two during 2004.
o The decrease in facilities allocation was the result of the 2003
terminations. All of the sales and marketing employees who had been
sharing space with general and administrative employees at our
corporate headquarters location were terminated during 2003.
Accordingly, the allocation of overhead costs to sales and marketing
ceased.
o The increase in outside consultants was a result of outsourcing
marketing work upon the 2003 terminations.
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 during 2002 and was reflected for a full year in
2003.
o The decrease in trade shows activities and promotional costs was part
of our decision made 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 made in 2002 as well as prioritizing the engineering
initiatives over sales and marketing activities.
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.
We expect that cumulative sales and marketing expenses in 2005 will approximate
those incurred during 2004. Sales and marketing expenses were approximately
39.2%, 40.3% and 63.2% of total revenues for the years 2004, 2003 and 2002,
respectively.
General and Administrative Expenses. General and administrative expenses
primarily consist of salaries and related benefits, legal and professional
services, insurance, costs associated with being a publicly held company and bad
debts expense.
General and administrative expense decreased in 2004 from 2003 primarily because
of decreased facilities allocations ($152,900) and decreased directors and
officers insurance ($103,100). The reasons for these decreases were as follows:
o Our overhead structure was greatly reduced when we consummated a
buy-out of our former lease for our corporate headquarters facilities
at 400 Cochrane Circle, Morgan Hill, CA. This facility had been
approximately 14,000 square feet. Since October 2003, we have
maintained our corporate offices in approximately 1,000 square feet of
space.
o Our directors and officers insurance expense was lower in 2004 than
2003 because we did not renew our policy upon its expiration in 2003.
The 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), directors and officers 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 compensation expense was because the amounts
previously deferred became fully amortized during 2002.
o In addition to our 2002 restructurings, we also aggressively reduced
costs during 2002, including the costs of our directors and officers
insurance. Upon its renewal for the 2002/2003 policy year, we reduced
the policy's coverage by approximately 40% and then discontinued it
entirely upon its expiration in June 2003.
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 ending balance of our allowance for doubtful accounts as of December 31,
2004, 2003 and 2002, was $46,800, $46,800 and $50,300, respectively. Bad debts
expense was $0, $16,300 and $31,600 for the years ended December 31, 2004, 2003
and 2002, respectively.
16
We anticipate that cumulative general and administrative expense in 2005 will
exceed those incurred during 2004 primarily due to the costs we expect our newly
initiated patent group to incur as they begin exploring viable means of
commercially exploiting the NES patent portfolio. General and administrative
expenses were approximately 33.5%, 34.0% and 79.2% of 2004, 2003 and 2002 total
revenues, respectively.
Research and Development Expenses. Research and development expenses consist
primarily of salaries and related benefits paid to software engineers, payments
to contract programmers, and facility expenses related to our remotely located
engineering offices.
Research and development expense for 2004 approximated 2003 levels, as reported.
Research and development expense for 2003 does not include approximately
$149,100 of wages and related costs and $133,100 of outside consulting services
related to software development costs that were capitalized during 2003. No such
costs were capitalized during 2004.
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 consultants ($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 estimated 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 consultants 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 instead of being
charged to research and development. 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.
We believe that a significant level of investment for research and development
is required to remain competitive. Accordingly, during 2005 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. We expect
research and development expenditures in 2005 to approximate 2004 levels.
Research and development expense was approximately 42.5%, 36.3% and 80.1% of
total revenues for the years 2004, 2003 and 2002, respectively.
Asset Impairment Loss. During 2002 we recorded an asset impairment charge of
$914,000 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 carrying values in 2002 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 GO-Global for Windows and
GO-Global: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.
17
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
------------------ -------------- ------------------
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
================== ============== ==================
The asset impairment charges were approximately 0.0%, 0.0% and 25.9% of total
revenues for the years 2004, 2003 and 2002, respectively. We do not anticipate
recording an asset impairment charge during 2005.
Restructuring charges. 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 charge recorded during 2002 is as follows:
December 31, 2002
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) -
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 Emerging Issues Task Force
(EITF) 94-3, "Liability Recognition for Certain Employee Termination Benefits
and Other Costs to Exit an Activity (Including Certain Costs Incurred in a
Restructuring)," during 2002 and had begun in 2002, 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 charge recorded during 2003 is as follows:
December 31, 2003
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 the contractually scheduled
lease term.
18
During August 2003, we negotiated a buy out of the lease for our former
corporate offices in Morgan Hill, California. The total buy out price was
approximately $153,000 and consisted of a lump-sum cash payment of $125,000, the
forfeiture of an approximate $16,000 security deposit and a $12,000 commission
to the real estate broker who was involved in the transaction. It is estimated
that the buy out saved approximately $270,000 over the contractually scheduled
lease term.
The net aggregate amount of the annual lease payments made under all of our
leases in the years 2004, 2003 and 2002, excluding lease buyout payments, was
approximately $95,700, $295,400 and $525,700, respectively.
Interest and Other Income. During 2004, 2003 and 2002, 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 increase in interest income in 2004 from 2003 was primarily due to interest
income accrued on our note receivable ($3,000), which was partially offset by
lower interest income on excess cash due to lower amounts of excess cash in 2004
as compared with 2003. The decrease in interest income in 2003 from 2002 was due
to lower average cash and cash equivalents, and available-for-sale securities
balances in 2003 as compared with 2002. Additionally, the decrease was
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 cash and cash equivalents balance at year end 2004, as compared with
year end 2003, is primarily due to the outflow of approximately $620,000
resulting from operating activities. 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 0.4%, 0.3% and 4.3% of total revenues for the
years 2004, 2003 and 2002, respectively.
Interest and Other Expense. Interest and other expense has historically
consisted primarily of the cost of accrued interest on bonds and other
investments that we purchased with our excess cash. However we incurred no such
interest and other expense during 2004 as all of our excess cash was maintained
in a highly-liquid money market account and we purchased no bonds. The decrease
in 2003 from 2002 was primarily due to our discontinuance of purchasing bonds
with our excess cash.
Interest and other expense was approximately 0.0%, 0.1% and 2.2% of total
revenues for the years 2004, 2003 and 2002, respectively.
Provision for Income Taxes. At December 31, 2004, we had approximately
$41,464,000 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 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 believe that improving
or maintaining our current revenue stream, coupled with our cash on hand,
including the cash raised in the 2005 private placement will sufficiently
support our operations during 2005.
On January 29, 2004, we completed a private placement, which raised a total of
$1,150,000 through the sale of 5,000,000 shares of common stock and five-year
warrants to purchase 2,500,000 shares of common stock (the "2004 private
placement"). Net proceeds of approximately $930,000, as well as other working
capital items, were used to fund our operations during 2004.
On February 2, 2005, we completed a private placement, which raised a total of
$4,000,000 (inclusive of a $665,000 credit as described below) through the sale
of 148,148 shares of Series A preferred stock and five-year warrants to purchase
74,070 shares of Series B preferred stock (the "2005 private placement"). In a
contemporaneous transaction, we acquired NES for 9,600,000 shares of common
stock, the assumption of approximately $235,000 of NES' indebtedness and the
reimbursement to AIGH Investment Partners, LLC ("AIGH"), an affiliate of a
principal stockholder (Orin Hirschman), of $665,000 for its advance on our
19
behalf of a like sum in December 2004 to settle certain third party litigation
against NES. We reimbursed the advance through a partial credit against the
price of our securities acquired by Mr. Hirschman in the 2005 private placement.
Our net proceeds from the 2005 private placement were approximately $2,000,000,
after giving effect to:
o our issuance of a $665,000 partial credit against the price of our
securities acquired by Mr. Hirschman in the 2005 private placement;
o our assumption of approximately $235,000 of NES' indebtedness;
o our payment of NES' legal fees and expenses of approximately $108,000;
o our payment of professional fees and expenses of approximately $692,000,
which we incurred in the NES acquisition;
o our payment of Mr. Hirschman's legal fees and expenses of approximately
$108,000;
o a fee paid to Griffin Securities Inc. in the amount of $50,000 in
connection with the 2005 private placement; and
o our payment of professional fees and expenses of approximately $142,000,
which we incurred in the 2005 private placement.
Pursuant to the terms of an agreement with the purchasers of the securities in
the 2005 private placement, we have agreed to prepare and file with the SEC a
registration statement covering the resale of shares of our common stock
underlying the Series A preferred stock and the Series B preferred stock. In
addition, under the terms of an agreement entered into in connection with the
NES acquisition, we agreed to register the shares of common stock issued in the
NES acquisition.
During 2004 we consumed $863,000 of cash in our operating activities. This
consumption of cash related primarily to our net loss of $1,427,500, which
included non-cash charges, primarily depreciation and amortization of $664,700,
interest accrued on our directors' notes of $1,400 and an aggregate decrease in
cash flow from our operating assets and liabilities of $98,800. We consumed
$435,500 of cash in our investing activities, primarily resulting from a
$350,000 increase in note receivable - related party, a $59,200 increase in
deferred acquisition costs, (both of which were related to our acquisition of
NES), the purchase of approximately $33,400 of fixed assets and a $7,100
reduction in other assets. We generated positive financing cash flows of
$947,300. These cash flows primarily related to net proceeds from the 2004
private placement of $931,400, proceeds from the exercise of warrants issued as
part of the 2004 private placement of $6,900 and the proceeds of sales of common
stock to our employees under the provisions of our employee stock purchase plan
of $9,000.
During 2003 we consumed $710,800 of cash in our operating activities. This
consumption of cash related primarily to our net loss of $1,886,600, which
included non-cash charges, primarily depreciation and amortization of
$1,248,400, the write-off of fixed assets abandoned as part of our 2003
restructuring of $42,200, the loss on assets disposed in our normal operations
of $4,300, which were partially offset by a decrease in our provision for
doubtful accounts of $3,500, and an aggregate decrease in cash flow from our
operating assets and liabilities of $115,600. We consumed $225,700 of cash in
our investing activities, resulting primarily from the capitalization of
software development costs of $282,200 and the purchase of fixed assets of
$1,600, which were partially offset by a $58,100 decrease in other assets. We
generated positive financing cash flows of $2,800, resulting from the proceeds
of the sale of common stock to our employees under the provisions of our
employee stock purchase plan.
Cash and cash equivalents
As of December 31, 2004, cash and cash equivalents were approximately $675,300
as compared with $1,025,500 at December 31, 2003. The $350,200 decrease was
primarily due to the cash consumed by our operations, partially offset by the
net proceeds of the 2004 private placement. We anticipate that our cash and cash
equivalents as of December 31, 2004, and the net proceeds from the 2005 private
placement, together with revenue from operations will be sufficient to fund our
anticipated expenses, inclusive of those that will be attributable to taking
steps to realize the maximum value of the patents we acquired from NES, during
the next twelve months. However, due to the inherent uncertainties associated
with predicting future operations, there can be no assurances that these
resources will be sufficient to fund our anticipated expenses during the next
twelve months.
Accounts receivable, net
At December 31, 2004, we had approximately $518,900 in accounts receivable, net
of allowances totaling $46,800. The net accounts receivable were virtually the
same as the approximately $521,000, net of the $46,800 allowance we reported at
December 31, 2003. We did not write off any receivables during 2004. From time
to time, we could maintain individually significant accounts receivable balances
from one or more of our significant customers. If the financial condition of any
of these significant customers should deteriorate, our operating results could
be materially adversely affected.
20
Commitments and contingencies
On December 10, 2004 we entered into an agreement (the "Reimbursement
Agreement") with AIGH pursuant to which we agreed to reimburse AIGH $665,000, as
well as its legal fees and expenses, relating to its successful efforts to
settle certain third party litigation against NES and certain affiliates of NES.
The third party litigation was brought against NES by one of its creditors.
Our obligation to reimburse AIGH was contingent upon several conditions,
including the consummation of the NES acquisition, the completion of the 2005
private placement, and our receipt of an assignment of the rights to NES'
intellectual property, which were held by AIGH, and was to be satisfied within
five business days of the occurrence of the contingencies. Since these events
had not occurred as of December 31, 2004 we did not recognize a liability on our
balance sheet for the Reimbursement Agreement. In January 2005, upon the
consummation of these contingencies, we credited the $665,000 owed to AIGH
against Mr. Hirschman's approximate $820,000 investment in the 2005 private
placement.
We have no material capital expenditure commitments for the next twelve months.
The following table discloses our contractual commitments for future periods,
which consist entirely of leases for office space, as previously discussed and
assumes that we will occupy all current leased facilities for the full term of
the underlying leases:
Year ending December 31,
------------------------
2005 $ 62,600
2006 and thereafter $ -
Rent expense aggregated approximately $95,700, $295,400 and $525,700 in fiscal
2004, 2003 and 2002, respectively.
New Accounting Pronouncements
In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS
No. 123R, "Share-Based Payment," which requires companies to expense the value
of employee stock options and similar awards. SFAS No. 123R is effective as of
the beginning of the first annual reporting period that begins after June 15,
2005. As of the effective date, we will be required to expense all awards
granted, modified, cancelled or repurchased as well as the portion of prior
awards for which requisite service has not yet been rendered, based on the
grant-date fair value of those awards as calculated for pro forma disclosures
under SFAS No. 123 "Stock-Based Compensation." We will apply SFAS No. 123R using
a modified version of prospective application. Under this method, compensation
cost is recognized on or after the required effective date for the portion of
outstanding awards for which the requisite service has not yet been rendered,
based on the grant-date fair value of those awards calculated under SFAS No. 123
for either recognition or pro forma disclosures.
Benefits of tax deductions in excess of recognized compensation cost are
required by SFAS 123R to be reported as a financing cash flow, rather than as an
operating cash flow as required under current literature. This requirement will
reduce net cash flows from operations and increase cash flows from financing in
periods after adoption. The adoption of SFAS 123R will have an impact on our
results of operations; however, we cannot currently estimate what the impact
will be because, among other things, it will depend on the levels of share-based
payments granted in the future. We are currently in the process of determining
the effects on our financial position, results of operations and cash flows that
will result from the adoption of SFAS 123R.
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 $1,427,500, $1,886,600 and $8,792,500 for the years ended December
31, 2004, 2003 and 2002, respectively. Our expenses will increase as we begin
our efforts to commercially exploit the patents we acquired in the NES
acquisition; however, we cannot give assurance that revenues will increase
sufficiently to exceed costs. We do not expect to be profitable in 2005. In
future reporting periods, if revenues grow more slowly than anticipated, or if
operating expenses exceed expectations, we may not become profitable. Even if we
become profitable, we may be unable to sustain profitability.
21
If We Are Unable To Generate A Positive Cash Flow From Operations, Or Are
Unsuccessful In Securing External Means of Financing, We May Not Be Able
To Continue Our Operations.
We have not been able to generate positive cash flow from our operations and
have been financing our operations primarily from the cash raised when we called
various warrants in 1999 and 2000, and from selling common and preferred stock
in private placements. We believe that we have sufficient cash to meet our
operating needs throughout 2005 and the first few reporting periods of 2006 with
the cash we raised in the 2005 private placement and the cash we had on hand as
of December 31, 2004. However, if we were unable to generate positive cash flow
from our operations in future periods or were unable to raise external sources
of financing, we might need to discontinue our operations entirely.
We May Not Realize the Anticipated Benefits of Acquiring NES.
We acquired NES in January 2005 with the anticipation that we would realize
various benefits, including, among other things, expansion of our product
offerings, enhancement of our current product line, ownership of 11 issued
patents and another 43 patent applications in process. We may not fully realize
some or all of these benefits and the acquisition may result in the diversion of
management time and cash resources to the detriment of our core software
business. Costs incurred and liabilities assumed in connection with this
acquisition could also have an adversely impact our future operating results.
Our Revenue Is Typically Generated From A Very Limited Number Of
Significant Customers.
A material portion of our revenue during any reporting period is typically
generated from a very limited number of customers. Consequently, if any of these
significant customers reduce their order level or fail to order during a
reporting period, our revenue could be materially adversely impacted.
Several of our significant customers are ISVs who have bundled our products with
theirs to sell as web-enabled versions of their products. Other significant
customers include distributors who sell our products directly. We do not control
our significant customers. Some of our significant customers maintain
inventories of our products for resale to smaller end-users. If they reduce
their inventory of our products, our revenue and business could be materially
adversely impacted.
If We Are Unable To Develop New Products And Enhancements To Our Existing
Products, Our Business, Results Of Operations And Financial Condition
Could Be Materially Adversely Impacted.
Our future success depends on our ability to continually enhance our current
products and develop and introduce new products that our customers choose to
buy. If we are unable to satisfy our customers' demands and remain competitive
with other products that could satisfy their needs by introducing new products
and enhancements, our business, results of operations and financial condition
could be materially adversely impacted.
Our Stock Price Has Historically Been Volatile And You Could Lose The
Value Of Your Investment.
Our stock price has historically been volatile; it has fluctuated significantly
to date. The trading price of our stock is likely to continue to be highly
volatile and subject to wide fluctuations. Your investment in our stock could
lose value.
Our Operating Results In One Or More Future Periods Are Likely To
Fluctuate Significantly And May Fail To Meet Or Exceed The Expectations Of
Securities Analysts Or Investors.
Our operating results are likely to fluctuate significantly in the future on a
quarterly and on an annual basis due to a number of factors, many of which are
outside our control. Factors that could cause our revenues to fluctuate include
the following:
o The degree of success of our commercial exploitation of the NES patents;
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;
22
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.
Our Failure To Adequately Protect Our Proprietary Rights May Adversely
Affect Us.
Our commercial success is dependent, in large part, upon our ability to protect
our proprietary rights. We rely on a combination of patent, copyright and
trademark laws, and on trade secrets and confidentiality provisions and other
contractual provisions to protect our proprietary rights. These measures afford
only limited protection. We cannot assure you that measures we have taken will
be adequate to protect us from misappropriation or infringement of our
intellectual property. Despite our efforts to protect proprietary rights, it may
be possible for unauthorized third parties to copy aspects of our products or
obtain and use information that we regard as proprietary. In addition, the laws
of some foreign countries do not protect our intellectual property rights as
fully as do the laws of the United States. Furthermore, we cannot assure you
that the existence of any proprietary rights will prevent the development of
competitive products. The infringement upon, or loss of any proprietary rights,
or the development of competitive products despite such proprietary rights,
could have a material adverse effect on our business.
As regards our intention to exploit the portfolio of patents that we acquired
from NES:
o Although we believe the NES patents to be strong, there can be no
assurance that they will not be found invalid either in whole or in part
if challenged.
o Invalidation of their broadest claims could result in very narrow claims
that do not have the potential to produce meaningful license revenues.
o Many of the companies that we intend to seek licenses from are very large
with significant financial resources. We currently lack the ability to
initiate infringement litigation or to defend our patents against claims
of invalidity if such litigation is heavily contested over an extended
period of months or even years.
o We may not be able to engage attorneys that will work on our behalf on a
contingent fee basis or that will pursue litigation until a resolution is
achieved that is favorable to us. Such attorneys may seek to limit their
exposure either by advocating licensing settlements that are not favorable
to us or may abandon their efforts on our behalf.
o Because NES obtained no foreign patents or filed any foreign patent
applications, infringing companies may seek to avoid our demand for
licenses by moving the infringing activities offshore where US patents
cannot be enforced.
We Face Risks Of Claims From Third Parties For Intellectual Property
Infringement That Could Adversely Affect Our Business.
At any time, we may receive communications from third parties asserting that
features or content of our products may infringe upon their intellectual
property rights. Any such claims, with or without merit, and regardless of their
outcome, may be time consuming and costly to defend. We may not have sufficient
resources to defend such claims and they could divert management's attention and
resources, cause product shipment delays or require us to enter into new royalty
or licensing agreements. New royalty or licensing agreements may not be
available on beneficial terms, and may not be available at all. If a successful
infringement claim is brought against us and we fail to license the infringed or
similar technology, our business could be materially adversely affected.
23
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.
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.
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 a