-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, B9+SaNXaTVTZwufzLTrQFSVmTVxMxrXPKLxpNPQOB6nF7hPZD1li9wUxlVUXNs6h tH7IgPsKGkabV4QirILW5Q== 0001021435-05-000034.txt : 20051108 0001021435-05-000034.hdr.sgml : 20051108 20051108084658 ACCESSION NUMBER: 0001021435-05-000034 CONFORMED SUBMISSION TYPE: 10-Q/A PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 20050331 FILED AS OF DATE: 20051108 DATE AS OF CHANGE: 20051108 FILER: COMPANY DATA: COMPANY CONFORMED NAME: GRAPHON CORP/DE CENTRAL INDEX KEY: 0001021435 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 133899021 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q/A SEC ACT: 1934 Act SEC FILE NUMBER: 000-21683 FILM NUMBER: 051184816 BUSINESS ADDRESS: STREET 1: 3130 WINKLE AVENUE CITY: SANTA CRUZ STATE: CA ZIP: 95065 BUSINESS PHONE: 8004727466 MAIL ADDRESS: STREET 1: 3130 WINKLE AVENUE CITY: SANTA CRUZ STATE: CA ZIP: 95065 FORMER COMPANY: FORMER CONFORMED NAME: UNITY FIRST ACQUISITION CORP DATE OF NAME CHANGE: 19960823 10-Q/A 1 q105qa1.txt Q105 AMENDMENT NO 1 ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 AMENDMENT NO. 1 TO FORM 10-Q Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended March 31, 2005 Commission File Number: 0-21683 ---------------------- GraphOn Corporation (Exact name of Registrant as specified in its charter) ---------------------- Delaware 13-3899021 (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 5400 Soquel Avenue, Suite A2 Santa Cruz, CA 95062 (Address of principal executive offices) Registrant's telephone number: (800) 472-7466 ---------------------- Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes [ ] No [X] As of May 11, 2005, there were issued and outstanding 46,147,047 shares of the Registrant's Common Stock, par value $0.0001. ================================================================================ Explanatory Note ---------------- The Company has determined that the convertible preferred securities it sold in the quarter ended March 31, 2005 included a beneficial conversion feature. Additionally, the Company has restated its disclosure of pro forma loss per share related to its acquisition of Network Engineering Software, Incorporated. See Note 2 to the condensed consolidated financial statements, included herein, for additional discussion. The Company has restated its interim financial statements in this Report and in an additional Amendment to its Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2005 to reflect the impact of these items. GRAPHON CORPORATION FORM 10-Q Table of Contents Page PART I. FINANCIAL INFORMATION ---- Item 1. Financial Statements Unaudited Condensed Consolidated Balance Sheets 2 Unaudited Condensed Consolidated Statements of Operations and Comprehensive Loss 3 Unaudited Condensed Consolidated Statements of Cash Flows 4 Notes to Unaudited Condensed Consolidated Financial Statements 5 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 11 Item 3. Quantitative and Qualitative Disclosures About Market Risk 23 Item 4. Controls and Procedures 23 PART II. OTHER INFORMATION Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 24 Item 4. Submission of Matters to a Vote of Security Holders 24 Item 6. Exhibits 24 Signatures 25 PART I--FINANCIAL INFORMATION ITEM 1 Financial Statements
GRAPHON CORPORATION CONDENSED CONSOLIDATED BALANCE SHEETS March 31, December 31, 2005 2004 ASSETS ------------ ------------ ------------ (Unaudited) Current Assets: Cash and cash equivalents ..................... $ 3,171,300 $ 675,300 Accounts receivable, net of allowance for doubtful accounts of $46,800 and $46,800 ..... 975,900 518,900 Prepaid expenses and other current assets ..... 10,800 24,100 ------------ ------------ Total Current Assets .......................... 4,158,000 1,218,300 ------------ ------------ Property and equipment, net ...................... 73,700 75,400 Capitalized software, net ........................ 225,200 273,700 Patents, net ..................................... 5,231,800 - Deferred acquisition costs ....................... - 269,700 Note receivable - related party .................. - 350,000 Other assets ..................................... 4,800 37,300 ------------ ------------ TOTAL ASSETS ............................... $ 9,693,500 $ 2,224,400 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY ------------------------------------ Current Liabilities: Accounts payable .............................. $ 198,100 $ 250,200 Accrued expenses .............................. 285,200 231,400 Accrued wages ................................. 339,100 260,100 Deferred revenue .............................. 1,018,300 689,800 ------------ ------------ Total Current Liabilities ..................... 1,840,700 1,431,500 ------------ ------------ Long-term Liabilities: Deferred revenue .............................. 492,700 426,600 ------------ ------------ TOTAL LIABILITIES .......................... 2,333,400 1,858,100 ------------ ------------ Commitments and contingencies Stockholders' Equity: Preferred stock, $0.01 par value, 5,000,000 shares authorized, no shares issued and outstanding .... - - Common stock, $0.0001 par value, 195,000,000 shares authorized, 46,147,047 and 21,716,765 shares issued and outstanding ................... 4,600 2,200 Additional paid in capital, restated.............. 58,545,800 46,930,700 Deferred Compensation ............................ (8,400) - Notes receivable - directors ..................... - (50,300) Note receivable - shareholder .................... (347,400) - Accumulated other comprehensive loss ............. - (400) Accumulated deficit, restated..................... (50,834,500) (46,515,900) ------------ ------------ TOTAL STOCKHOLDERS' EQUITY ................. 7,360,100 366,300 ------------ ------------ TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY . $ 9,693,500 $ 2,224,400 ============ ============ See accompanying notes to condensed consolidated financial statements.
2
GRAPHON CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS Three Months Ended March 31, ---------------------------- 2005 2004 ------------ ------------ (Unaudited) (Unaudited) Revenue: Product licenses ............................ $ 887,700 $ 646,200 Service fees ................................ 286,700 252,100 Other ....................................... 6,000 4,600 ------------ ------------ Total Revenue ............................ 1,180,400 902,900 ------------ ------------ Cost of Revenue Product costs ............................... 50,400 226,300 Service costs ............................... 70,700 83,900 ------------ ------------ Total Cost of Revenue .................... 121,100 310,200 ------------ ------------ Gross Profit ............................. 1,059,300 592,700 ------------ ------------ Operating Expenses: Selling and marketing ....................... 334,800 358,100 General and administrative .................. 727,100 249,700 Research and development .................... 323,700 419,600 ------------ ------------ Total Operating Expenses .................... 1,385,600 1,027,400 ------------ ------------ Loss From Operations ........................ (326,300) (434,700) ------------ ------------ Other Income (Expense): Interest and other income ................ 8,800 3,600 Interest and other expense ............... (1,100) - ------------ ------------ Total Other Income ....................... 7,700 3,600 ------------ ------------ Net Loss .................................... (318,600) (431,100) Other Comprehensive Income (Loss), net of tax Foreign currency translation gain (loss) . - 600 ------------ ------------ Comprehensive Loss .......................... (318,600) (430,500) Deemed divided on preferred stock, restated (4,000,000) - ------------ ------------ Loss attributable to common shareholders, restated $ (4,318,600) $ (430,500) ============ ============ Basic and Diluted Loss per Common Share, restated $ (0.15) $ (0.02) ============ ============ Weighted Average Common Shares Outstanding .. 28,620,913 20,036,876 ============ ============ See accompanying notes to condensed consolidated financial statements.
3
GRAPHON CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS Three Months Ended March 31, --------------------------- 2005 2004 ----------- ----------- (Unaudited) (Unaudited) Cash Flows From Operating Activities: Net loss .............................................. $ (318,600) $ (431,100) Adjustments to reconcile net loss to net cash provided by (used in) operating activities: Depreciation and amortization ...................... 206,800 258,800 Amortization of deferred compensation .............. 500 - Proceeds from notes receivable - directors ......... 50,300 - Proceeds from note receivable - shareholder ........ 2,600 - Interest accrued on notes receivable - directors .... (300) (700) Interest accrued on note receivable - shareholder .. (2,000) - Proceeds from interest accrued on notes receivable - directors ........................................ 4,300 - Changes in operating assets and liabilities: Accounts receivable ................................ (457,000) 152,300 Prepaid expenses and other assets .................. 13,300 (4,600) Accounts payable ................................... 55,800 72,100 Accrued expenses ................................... (5,700) 38,200 Accrued wages ...................................... 79,000 (178,900) Deferred revenue ................................... 394,600 (180,500) ----------- ----------- Net Cash Provided By (Used In) Operating Activities ... 23,600 (274,400) ----------- ----------- Cash Flows From Investing Activities: Cash paid for NES acquisition ......................... (612,200) - Capital expenditures .................................. (10,300) (6,600) ----------- ----------- Net Cash Used In Investing Activities .............. (622,500) (6,600) ----------- ----------- Cash Flows From Financing Activities: Proceeds from private placement of preferred stock and warrants....................... 3,335,000 1,150,000 Costs of private placement of preferred stock and warrants ......................................... (244,600) (179,100) Proceeds from sale of common stock under employee stock purchase plan ......................... 4,600 3,600 ----------- ----------- Net Cash Provided By Financing Activities .......... 3,095,000 974,500 ----------- ----------- Effect of exchange rate fluctuations on cash and cash equivalents ................................... (100) 600 ----------- ----------- Net Increase in Cash and Cash Equivalents ............. 2,496,000 694,100 Cash and Cash Equivalents, beginning of period ........ 675,300 1,025,500 ----------- ----------- Cash and Cash Equivalents, end of period .............. $ 3,171,300 $ 1,719,600 =========== =========== See accompanying notes to condensed consolidated financial statements.
4 GRAPHON CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. Basis of Presentation The unaudited condensed consolidated financial statements of GraphOn Corporation (the Company) and its subsidiaries included herein have been prepared in accordance with the instructions for Form 10-Q and, therefore, do not include all information and footnotes necessary for a complete presentation of the Company's results of operations, financial position and cash flows. The unaudited condensed consolidated financial statements included herein reflect all adjustments (which include only normal, recurring adjustments in the three-month periods ended March 31, 2005 and 2004) that are, in the opinion of management, necessary to state fairly the results for the periods presented. This Quarterly Report on Form 10-Q should be read in conjunction with the Company's audited financial statements contained in the Company's Annual Report on Form 10-K for the year ended December 31, 2004, which was filed with the Securities and Exchange Commission (the Commission) on April 15, 2005. The interim results presented herein are not necessarily indicative of the results of operations that may be expected for the full fiscal year ending December 31, 2005, or any future period. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. These estimates include the allowance for doubtful accounts, the estimated lives of intangible assets, depreciation of fixed assets and accrued liabilities, among others. Actual results could differ materially from those estimates. Significant intercompany accounts and transactions are eliminated upon consolidation. 2. Restatement of Financial Statements The Company determined that the convertible preferred stock (the "Preferred Shares") it sold during the quarter contained a beneficial conversion feature. As the Preferred Shares were converted during the quarter, the amount of the beneficial conversion (Beneficial Amount) should have been recorded as a non-cash dividend to the holders of the Preferred Shares (see Note 4). As a result, additional paid-in capital and accumulated deficit were increased by $4,000,000. Although the net loss previously recorded by the Company is unchanged, the Company has amended its statement of operations to reflect the net loss attributable to common shareholders, giving effect to the treatment of the Beneficial Amount as a dividend to the holders of the Preferred Shares. Basic and diluted loss per share has been restated giving effect to the use of net loss attributable to common shareholders as the numerator. As a result, basic and diluted loss per share increased from $0.01 to $0.15. Additionally, the Company has restated its pro forma basic and diluted loss per share (see Note 3) to give effect to the stock issued in the NES acquisition (see Note 3) as if the stock had been issued on January 1, 2004. As a result, pro forma basic and diluted loss per share for the three-month period ended March 31, 2004 decreased from $0.04 to $0.03. 5 3. NES Acquisition On January 31, 2005, the Company acquired all of the outstanding common stock of NES in exchange for 9,599,993 shares of the Company's common stock and approximately $897,800 in cash. The acquisition was pursuant to an acquisition agreement between the Company and NES dated December 3, 2004. A portion of the acquisition proceeds was used to repay all liabilities of NES that were not forgiven in conjunction with the acquisition. The acquisition was accounted for as an asset acquisition. Accordingly, the assets acquired (primarily consisting of patents and patent applications) have been recorded at their cost. There were no liabilities acquired. The estimated cost of the patents acquired in the acquisition was calculated as follows: Value of GraphOn common stock issued $ 3,916,800 NES liabilities settled with cash: Accounts payable $ 81,200 Note payable (shareholders) * 665,000 Other liabilities 151,600 ------------ Total NES cash settlements 897,800 Transaction costs 563,500 ------------ NES acquisition costs as of March 31, 2005 1,461,300 ------------ Estimated cost of patents $ 5,378,100 ============ * Includes $88,500 of accrued interest. The cash payment for this note, which was the subject of certain shareholder litigation against NES, was made by AIGH Investment Partners, LLC ("AIGH"), an affiliate of a major shareholder (Orin Hirschman), during December 2004. The Company reimbursed AIGH via a $665,000 credit (the "$665,000 credit") against the price of securities acquired by AIGH in the 2005 Private Placement (see Note 4) upon the assignment by AIGH of its security interest in NES' patents. The estimated cost of the patent portfolio is being amortized over a 6-year period using the straight-line method. The estimated cost of the patents may change as a result of the completion of a valuation study and as all direct acquisition costs are finalized. The final adjustments to the estimated costs of the patents are not expected to be material. As of December 31, 2004, prior to the consummation of the acquisition, the Company had deferred approximately $269,700 of the acquisition costs. These deferred acquisition costs are included in the transaction costs, in the table above. On October 6, 2004, upon entering into a letter of intent to acquire NES, the Company contemporaneously loaned $350,000 to Ralph Wesinger, NES' majority shareholder, to fund his purchase of all the NES common stock then owned by another person. The Company received Mr. Wesinger's 5-year promissory note, which bears interest at a rate of 3.62% per annum and which was secured by his approximately 65% equity interest in NES, to evidence this loan. Mr. Wesinger also agreed that the Company would receive 25% of the gross proceeds of any sale or transfer of any of Mr. Wesinger's NES shares, which shall be applied in reduction of the then outstanding balance of his note, until the note is paid in full or becomes due, whichever occurs first. The Company has the option to accelerate the maturity date of this note upon the occurrence of certain events. 6 Upon the completion of the Company's acquisition of NES, 3,260,391 shares of the Company's common stock replaced the 52,039 shares of NES stock collateralizing the note. The outstanding balance of this note receivable is reported in the stockholders' equity section of the Company's balance sheet as note receivable - shareholder at March 31, 2005 (see Note 6). The following unaudited pro forma information presents the consolidated results of the Company as if the NES acquisition had occurred at the beginning of the respective period. The pro forma information is not necessarily indicative of what would have occurred had the acquisition been made as of such period, nor is it indicative of future results of operations. The pro forma amounts give effect to appropriate adjustments for the fair value of the patents, amortization and income taxes. Three Months Ended March 31, 2005 2004 ------------ ------------ Revenue $ 1,180,400 $ 902,900 Net loss (424,700) (869,200) Net loss attributable to common shareholders, restated (4,424,700) (869,200) Loss per share - basic and diluted, restated (0.14) (0.03) 4. 2005 Private Placement On February 2, 2005, the Company completed the 2005 Private Placement, which raised a total of $4,000,000 (inclusive of the $665,000 credit) through the sale of 148,148 shares of Series A preferred stock and five-year warrants to purchase 74,070 shares of Series B preferred stock. The deemed fair value of the Series A preferred stock was estimated based on the market price and underlying number of common shares they would have converted into had the conversion occurred immediately upon their issuance. The market price for the Company's common stock on February 2, 2005 was $0.46 and the Series A preferred stock would have converted into 14,814,800 common shares, thus deriving an estimated fair value of approximately $6,814,800 at that date. The fair value of the warrants was estimated to be $1,877,700 and was calculating using the Black-Scholes option pricing model with the following weighted average assumptions: a risk-free interest rate of 1.5%, a volatility factor of 60%, a dividend yield of 0%, and a five year contractual life. Based on the relative fair values of the Preferred Shares and the warrants at the time of their issuance, the Company allocated $3,136,000 of the $4,000,000 proceeds of the 2005 Private Placement to the Preferred Shares and $864,000 to the warrants. The Preferred Shares issued by the Company contained a nondetachable conversion feature (the "Beneficial Conversion Feature") that was in-the-money upon completion of the 2005 Private Placement, in that the deemed fair value of common stock into which the Preferred Shares could be converted exceeded the allocated value of $3,136,000 by $3,678,800 (using the intrinsic value method). This discount resulting from recording the Beneficial Conversion Feature was limited to the allocated proceeds of $3,136,000 and has been recognized as if this amount had been declared a non-cash dividend to the preferred shareholders during the quarter ended March 31, 2005. Additionally, the approximate $864,000 discount resulting from the allocation of the proceeds of the 2005 Private Placement on a relative fair value basis to 7 the Series A preferred stock and the warrant issued in the 2005 Private Placement has also been recognized as if this amount had been declared a non- cash dividend to the preferred shareholders during the quarter ended March 31, 2005. Under the terms of the 2005 Private Placement, upon the effectiveness of an amendment to the Company's Certificate of Incorporation to increase the authorized number of shares of common stock from 45,000,000 to 195,000,000, all shares of Series A Stock and Series B Stock would automatically convert into shares of common stock at a rate of 100 shares of common stock for each share of Preferred Stock, and all Warrants issued in the 2005 Private Placement would automatically become exercisable for shares of common stock at a rate of 100 shares of common stock for each share of Preferred Stock underlying such Warrants. At the special meeting of the Company's stockholders, held on March 29, 2005, the stockholders approved the amendment to the Company's Certificate of Incorporation to increase the authorized number of common shares from 45,000,000 to 195,000,000. Consequently, an aggregate of 148,148 shares of Series A Stock were converted into 14,814,800 shares of common stock and warrants to purchase an aggregate of 74,070 Series B Stock were converted into warrants to purchase an aggregate 7,407,000 shares of common stock. In addition, the warrants issued in the 2005 Private Placement pursuant to the finder's agreement, which had been entered into with the agent who arranged the Company's January 2004 private placement and was still effective at the time of the 2005 Private Placement, converted as follows: the warrants to purchase 14,815 shares of Series A Stock and the warrants to purchase 7,407 shares of Series B Stock converted into warrants to purchase 1,481,500 and 740,700 shares of common stock, respectively. The following table summarizes the common stock warrants issued upon conversion of the preferred warrants, as discussed above, all of which were outstanding as of March 31, 2005: Shares subject Exercise Expiration Warrant holder to warrant Price Date -------------- ------------ ------------ ------------ Investors 7,407,000 $ 0.40 02/10 Agent 1,481,500 $ 0.27 02/10 Agent 740,700 $ 0.40 02/10 5. Revenue Product line revenue for the three-month periods ended March 31, 2005 and 2004, was as follows: Change in Product licenses 2005 2004 Dollars Percent ---------------- ------------ ------------ ------------ --------- Windows $ 620,900 $ 429,700 $ 191,200 44.5% Unix 266,900 216,500 50,400 23.3 ------------ ------------ ------------ 887,800 646,200 241,600 37.4 ------------ ------------ ------------ Service fees Windows 143,100 136,900 6,200 4.5 Unix 143,500 115,200 28,300 24.6 ------------ ------------ ------------ 286,600 252,100 34,500 13.7 ------------ ------------ ------------ Other (1) 6,000 4,600 1,400 30.4 ------------ ------------ ------------ Total Revenue $ 1,180,400 $ 902,900 $ 277,500 30.7% ============ ============ ============ (1) Amortization of private labeling fees. 8 6. Stockholders' Equity During the first quarter of 2005, the Company issued 15,489 shares of common stock to employees under provisions of the Employee Stock Purchase Plan (the ESPP), resulting in cash proceeds of approximately $4,600. During the first quarter of 2005, the Company completed the 2005 Private Placement (see Note 4), which, after the Company's stockholders approved the amendment to the Company's Certificate of Incorporation (see Note 4), resulted in the issuance of 14,814,800 shares of common stock. Also during the first quarter of 2005, the Company issued 9,599,993 shares of common stock to consummate the NES acquisition (see Note 3). During the first quarter of 2005, the Company reclassified note receivable - third party from the long-term assets section of its balance sheet to the equity section under the title note receivable - shareholder to reflect the replacement of the NES stock that had been collateralizing the note, as of December 31, 2004, with Company stock, upon the consummation of the acquisition of NES on January 31, 2005 (see Note 3). During the first quarter of 2005, the Company received an aggregate of approximately $54,600 as payment in full of the principal and accrued interest due from the notes receivable - directors. 7. Litigation The Company is currently not involved in any litigation that it believes would have a materially adverse affect upon its financial results or financial position. 8. Stock-Based Incentive Programs The Company accounts for stock-based compensation under the intrinsic value method of accounting for stock awards, in accordance with Accounting Principles Board Opinion number 25, "Accounting for Stock Issued to Employees" (APB 25) as permitted by Statement of Financial Accounting Standards number 123, "Stock-Based Compensation" (SFAS 123). The Company has not changed to the fair value method of accounting for stock-based employee compensation. Had the Company applied the fair value recognition provisions of SFAS 123 to stock-based compensation, the Company's net loss and basic and diluted loss per share would have been changed from the "as reported" amounts to the "pro forma" amounts as follows for each of the respective periods: Three months ended March 31, 2005 2004 ------------ ------------ Net loss: As reported: $ (318,600) $ (431,100) Less: deemed preferred dividend, restated (4,000,000) - Add: stock-based compensation expense included in net loss, net of related tax effects 500 - Deduct: total stock-based compensation expense determined under fair-value method for all awards, net of related 9 tax effects (83,500) (28,600) ----------- ----------- Pro forma net loss, restated $(4,401,600) $ (459,700) =========== =========== Basic and diluted loss per share: As reported, restated $ (0.15) $ (0.02) Pro forma, restated $ (0.15) $ (0.02) 9. Commitments and Contingencies In October 2004, the Company renewed its operating lease for an approximate 3,300 square foot facility in New Hampshire. This lease is cancelable by the landlord or the Company upon 30-days written notice. Monthly rental payments for this facility are approximately $5,300. The Company currently occupies approximately 1,000 square feet of office space in Santa Cruz, California. The office space is rented pursuant to a one-year operating lease, which became effective August 1, 2004. Rent on the Santa Cruz facility is approximately $1,400 per month. The Company has been occupying leased facilities in Rolling Hills Estates, California, on a month-to-month basis since October 2002. Rent on this facility is approximately $1,000 per month. The Company has also been renting a small office in Berkshire, England, United Kingdom since December 2002. This operating lease runs through December 2005. Rent on this office, which can fluctuate depending on exchange rates, is approximately $400 per month. As a condition of the 2004 private placement, the Company entered into an Investment Advisory Agreement with Orin Hirschman, a significant stockholder of the Company, pursuant to which it was agreed that in the event the Company completes a transaction with a third party introduced by Mr. Hirschman, the Company shall pay to Mr. Hirschman 5% of the value of that transaction. The agreement, as amended, expires on January 29, 2008. 10. Supplemental Disclosure of Cash Flow Information The Company disbursed no cash for the payment of either income taxes or interest expense during the quarter ended March 31, 2005 or the similar period in 2004. As of December 31, 2004, the Company had capitalized approximately $179,500 and $31,000 of deferred acquisition costs, related to the NES acquisition, that were included in accounts payable and accrued expenses, respectively. Additionally, the Company accrued approximately $32,500 of deferred financing costs, related to the 2005 Private Placement, as other assets, as of December 31, 2004. During the first quarter of 2005, the Company capitalized approximately $72,100 and $106,000 of costs related to the NES acquisition that were included in accounts payable and accrued expenses, respectively. Additionally, the Company accrued approximately $17,000 of costs related to the 2005 Private Placement. 11. Loss Per Share Potentially dilutive securities have been excluded from the computation, as their effect is antidilutive. For the quarters ended March 31, 2005 and 2004, 10 22,437,157 and 9,582,738 shares, respectively, of common stock equivalents were excluded from the computation of diluted loss per share since their effect would be antidilutive. 12. Subsequent Event During the first quarter of 2005, the Company deferred approximately $200,000 of Windows-based product revenue, derived from a transaction entered into with a significant distributor because not all of the Company's criteria necessary for revenue recognition had been met. During April 2005, all such criteria were satisfied. Consequently, deferred revenue - current portion was reduced and the Company recognized the revenue. ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Forward-Looking Statements The following discussion of our financial condition and results of operations contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Actual results and the timing of certain events could differ materially from those anticipated in these forward-looking statements as a result of certain factors. Such factors, including: o our history of operating losses, and expectation that those losses will continue; o the uncertainty as to whether or not we will realize the anticipated benefits of acquiring NES; o that a significant portion of our revenue has been and continues to be earned from a very limited number of significant customers; o that our stock price has been volatile and you could lose your investment; and o other factors set forth under "Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2004 and in other documents we filed with the Securities and Exchange Commission, could have a material adverse effect upon our business, results of operations and financial condition. Overview We are developers of business connectivity software, including Unix, Linux and Windows server-based software, with an immediate focus on web-enabling applications for use by independent software vendors (ISVs), application service providers (ASPs), corporate enterprises, governmental and educational institutions, and others. Server-based computing, sometimes referred to as thin-client computing, is a computing model where traditional desktop software applications are relocated to run entirely on a server, or host computer. This centralized deployment and management of applications reduces the complexity and total costs associated with enterprise computing. Our software architecture provides application developers with the ability to relocate applications traditionally run on the desktop to a server, or host computer, where they can be run over a variety of connections from remote locations to a variety of display devices. With our 11 server-based software, applications can be web enabled, without any modification to the original application software required, allowing the applications to be run from browsers or portals. Our server-based technology can web-enable a variety of Unix, Linux or Windows applications. On January 31, 2005, we acquired NES, which is engaged in the development and patenting of proprietary technologies relating to the submission, storage, retrieval and security of information remotely accessed by computers, typically through computer networks or the Internet. In a contemporaneous transaction, we issued, in a private placement, (the "2005 Private Placement") newly authorized Series A Preferred Stock and warrants to purchase newly authorized Series B Preferred Stock. We estimate that the 2005 Private Placement will have raised net proceeds of approximately $2,130,000, after giving effect to: o the $665,000 credit issued to AIGH in the 2005 Private Placement; o approximately $437,700 of cash to be disbursed to pay for estimated costs associated with the 2005 Private Placement; and o approximately $767,300 of cash to be disbursed to pay for estimated costs associated with the NES acquisition. These transactions are described in our Current Report on Form 8-K, filed with the Securities and Exchange Commission (SEC) on February 4, 2005. In order to ensure that we will be able to realize our assets and settle our liabilities within the normal course of our business operations, we must consider several aggressive strategic initiatives aimed at increasing revenue or securing additional alternative sources of financing. If we were unsuccessful in increasing revenues or finding additional alternative sources of financing, we would face a severe constraint on our ability to sustain operations in a manner that would create future growth and viability, and we may need to cease operations entirely. Critical Accounting Policies The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States requires us to make judgments, assumptions and estimates that affect the amounts reported in the Condensed Financial Statements and accompanying notes. Estimates are used for, but not limited to, the accounting for the allowance for doubtful accounts, the impairment of intangible assets, contingencies and other special charges and taxes. Actual results could differ materially from these estimates. The following critical accounting policies are impacted significantly by judgments, assumptions and estimates used in the preparation of the Condensed Consolidated Financial Statements. Revenue Recognition Generally, software license revenues are recognized when a non-cancelable license agreement has been signed and the customer acknowledges an unconditional obligation to pay, the software product has been delivered, there are no uncertainties surrounding product acceptance, the fees are fixed or determinable and collection is considered probable. Delivery is considered to have occurred when title and risk of loss have been transferred to the customer, which occurs when the customer is given access to the licensed programs. If collectibility is not considered probable, revenue is recognized when the fee is collected. Revenue earned on software arrangements involving multiple elements is allocated to each element arrangement based on the relative fair values of the elements. If there is no evidence of the fair value for all the elements in a 12 multiple element arrangement, all revenue from the arrangement is deferred until such evidence exists or until all elements are delivered. We recognize revenue from the sale of software licenses when all the following conditions are met: o Persuasive evidence of an arrangement exists; o Delivery has occurred or services have been rendered; o Our price to the customer is fixed or determinable; and o Collectibility is reasonably assured. Revenues recognized from multiple-element software arrangements are allocated to each element of the arrangement based on the fair values of the elements, such as licenses for software products, maintenance, consulting services or customer training. The determination of fair value is based on objective evidence. We limit our assessment of objective evidence for each element to either the price charged when the same element is sold separately or the price established by management having the relevant authority to do so, for an element not yet sold separately. If evidence of fair value of all undelivered elements exists but evidence does not exist for one or more delivered elements, then revenue is recognized using the residual method. Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the arrangement fee is recognized as revenue. Certain of our ISV, VAR or ASP customers (who we refer to as "resellers") prepay for licenses they intend to resell. Upon receipt of the prepayment, if all other revenue recognition criteria outlined above have been met, we recognize licensing revenue when the reseller is given access to the licensed programs. The resellers provide us with monthly sell-through reports that detail, for the respective month, the number of licenses purchased from us, the number they have sold to other parties, the ending balance of licenses they hold as inventory available for future sale and certain information pertaining to their customers such as customer name, licenses purchased, purchase date and contact information. We monitor and reconcile the resellers' inventory records to our records via the monthly sell-through reports. Other resellers will only purchase licenses from us when they have already closed a deal to sell our product to another party. These resellers will typically submit a purchase order to us in order to receive product that they can deliver to their customer. In these cases, assuming all other revenue recognition criteria, as set forth above, have been satisfied, we recognize licensing revenue when the reseller has been given access to the licensed programs. There are no rights of return granted to resellers or other purchasers of our software programs. We recognize revenue from service contracts ratably over the related contract period, which generally ranges from 1-5 years. Allowance for Doubtful Accounts The allowance for doubtful accounts is based on our assessment of the collectibility of specific customer accounts and the aging of the accounts receivable. If there is a deterioration of a major customer's credit worthiness or actual defaults are higher than our historical experience, our estimates of the recoverability of amounts due us could be adversely affected. 13 Capitalized Software Development Costs Software development costs incurred in the research and development of new products are expensed as incurred until technological feasibility, in the form of a working model, has been established, at which time such costs are typically capitalized until the product is available for general release to customers. Capitalized costs are amortized based on either estimated current and future revenue for the product or straight-line amortization over the shorter of three years or the remaining estimated life of the product, whichever produces the higher expense for the period. Impairment of Intangible Assets We perform impairment tests on our intangible assets on an annual basis or when circumstances indicate that a potential impairment may have occurred. In response to changes in industry and market conditions, we may strategically realign our resources and consider restructuring, disposing of, or otherwise exiting businesses, which could result in an impairment of intangible assets. During 2002 we recorded significant write-downs to the value of our intangible assets as a result of the impairment tests performed. A significant consideration impacting the results of the impairment tests was the substantial delay in getting our most recently released Windows-based product upgrade, GO-Global for Windows, into marketable condition. The engineering delays we encountered resulted in a substantial decrease in our revenue in 2002, which ultimately caused us to consume almost all of our cash balances in our day-to-day operations. Loss Contingencies We are subject to the possibility of various loss contingencies arising in the ordinary course of business. We consider the likelihood of the loss or impairment of an asset or the incurrence of a liability as well as our ability to reasonably estimate the amount of loss in determining loss contingencies. An estimated loss contingency is accrued when it is probable that a liability has been incurred or an asset has been impaired and the amount of the loss can be reasonably estimated. We regularly evaluate current information available to us to determine whether such accruals should be adjusted. Stock Compensation We apply Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees" and related interpretations thereof (hereinafter collectively referred to as APB 25) when accounting for our employee and directors stock options and employee stock purchase plans. In accordance with APB 25, we apply the intrinsic value method in accounting for employee stock options. Accordingly, we generally recognize no compensation expense with respect to stock-based awards to employees. We have determined pro forma information regarding net income and earnings per share as if we had accounted for employee stock options under the fair value method as required by Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation" as amended by SFAS 148 (hereinafter collectively referred to as SFAS 123). The fair value of these stock-based awards to employees was estimated using the Black-Scholes option-pricing model. Had compensation cost for our stock option plans and employee stock purchase plan been determined consistent with SFAS 123, our reported net loss and net loss common per share would have been changed to the amounts discussed elsewhere in this Form 10-Q. 14 Loss Per Share of Common Stock Basic loss per share includes no dilution and is computed by dividing loss attributable to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted loss per share reflects the potential dilution of securities by adding other common stock equivalents, including common stock options, warrants and redeemable convertible preferred stock, in the weighted average number of common shares outstanding for a period, if dilutive. Potentially dilutive securities have been excluded from the computation, as their effect is antidilutive. For the quarters ended March 31, 2005 and 2004, 22,437,157 and 9,582,738 shares, respectively, of common stock equivalents were excluded from the computation of diluted loss per share since their effect would be antidilutive. Results of Operations for the Three-Month Period Ended March 31, 2005 Versus the Three-Month Period Ended March 31, 2004. Revenue Product line revenue for the three-month periods ended March 31, 2005 and 2004, was as follows: Change in Product licenses 2005 2004 Dollars Percent ---------------- ------------ ------------ ------------ --------- Windows $ 620,900 $ 429,700 $ 191,200 44.5% Unix 266,900 216,500 50,400 23.3 ------------ ------------ ------------ 887,800 646,200 241,600 37.4 ------------ ------------ ------------ Service fees ------------ Windows 143,100 136,900 6,200 4.5 Unix 143,500 115,200 28,300 24.6 ------------ ------------ ------------ 286,600 252,100 34,500 13.7 ------------ ------------ ------------ Other (1) 6,000 4,600 1,400 30.4 ------------ ------------ ------------ Total Revenue $ 1,180,400 $ 902,900 $ 277,500 30.7% ============ ============ ============ (1) Amortization of private labeling fees. Private labeling fees are derived when we contractually agree to allow a customer to brand our product with their name. We defer these fees upon contract signing and recognize the revenue ratably over the initial term of the contract, typically, three years. The increase in Windows-based product revenue was reflective of how our revenue varies from quarter to quarter because a significant portion of our revenue has been, and continues to be earned from a very limited number of significant customers. Two ISVs that have been customers for a few years generated approximately $104,700 more in Windows-based product revenue in the first quarter of 2005 as compared with 2004. An ISV we started doing business with during the second quarter of 2004 generated approximately $33,900 of Windows-based product revenue during the first quarter of 2005. We recognized $12,500 more in Windows-based product revenue from our distributor in Japan in the first quarter of 2005 as compared to the same period in 2004. We also recognized approximately $72,000 in Windows-based product revenue from a sale to a new enterprise customer during the first quarter of 2005. Partially offsetting these amounts was an approximate $70,200 decrease in Windows-based product revenue to a large ISV who, beginning in the third quarter of 2004, is no longer bundling our product with every product of theirs that they ship. This ISV began offering our Windows-based products as an add-on extra feature to their product line during the third quarter of 2004. Windows-based 15 product revenue from this ISV declined from approximately $146,300 in the first quarter of 2004 to approximately $76,100 in the first quarter of 2005. The increase in Windows-based product revenue was also partially offset by approximately $48,000 as a result of two enterprise customers who did not purchase any product during the first quarter of 2005. The increase in Unix-based product revenue was primarily due to an approximate $52,500 increase in orders from one of our significant ISVs during the first quarter of 2005, as compared with 2004. Other significant Unix-based product revenue increases included revenue from one other ISV, which increased by approximately $14,300, and revenue of approximately $11,000 from a new enterprise customer. Partially offsetting these increases was $0 of Unix-based product revenue from an enterprise customer during the first quarter of 2005, as compared with approximately $18,000 during the first quarter of 2004. Also offsetting these increases was an approximate $10,700 decrease in Unix-based product revenue from an enterprise customer in the first quarter of 2005 as compared with the same period in 2004. The remainder of the increases in the first quarter 2005 Windows-based product revenue and Unix-based product revenue, as compared with the first quarter of 2004, was due to a combination of the demand by and composition of our many smaller customers. A material portion of our product licenses revenue during any reporting period is typically generated from a very limited number of significant customers. Consequently, if any of these significant customers change their order level or fail to order during the reporting period, our revenue could be materially adversely impacted. We expect this trend to continue throughout 2005. Our customers typically purchase a maintenance contract at the time they license our product. Our Windows-based maintenance contracts are primarily for a one-year time period and generally are renewed upon expiration. Our Unix-based maintenance contracts vary in term from one to five years and generally are renewed upon expiration. Service fees associated with maintenance contracts are deferred and recognized as revenue ratably over the underlying service period of the maintenance contract. The increase in Unix-based service fees is due to higher levels of maintenance contract purchases from the significant Unix-based ISV referred to above, which began approximately during the third quarter of 2004 and continued into the first quarter of 2005. Cost of Revenue Cost of revenue consists primarily of the amortization of capitalized technology developed in-house and customer service costs. Shipping and packaging materials are immaterial as virtually all of our deliveries are made via electronic means over the Internet. Under accounting principles generally accepted in the United States, research and development costs for new product development, after technological feasibility is established, are recorded as "capitalized software" on our balance sheet and are subsequently amortized as cost of revenue over the shorter of three years or the remaining estimated life of the products. Cost of revenue decreased by $189,100, or 61.0%, to $121,100 for the first quarter of 2005, from $310,200 for the first quarter of 2004. Product costs decreased by $175,900, or 77.7%, to $50,400 for the first quarter of 2005, from 16 $226,300 for the first quarter of 2004. Service costs decreased by $13,200, or 15.7%, to $70,700 for the first quarter of 2005, from $83,900 for the first quarter of 2004. The decrease in first quarter 2005 product costs, as compared with 2004 was because our purchased technology became fully amortized as of June 30, 2004. First quarter 2005 product costs primarily consisted of the amortization of capitalized software development costs. We expect these costs to remain consistent throughout 2005. The decrease in first quarter 2005 service costs, as compared with 2004, resulted from certain engineers spending more time in other engineering-related tasks than customer service in 2005, as compared with 2004. The amount of time our engineers spend in customer service is a function of the number of customer service inquiries received, and their complexity. Whenever the resolution of customers' inquiries permit, engineers whose first priority is customer service will assist with other engineering-related tasks. We expect costs of revenue to remain fairly constant over the next few reporting periods. Cost of revenue was approximately 10.2% and 34.4% of revenue for the first quarter of 2005 and 2004, respectively. Selling and Marketing Expenses Selling and marketing expenses primarily consist of employee costs, consulting services and travel and entertainment. Selling and marketing expenses for the first quarter of 2005 decreased by $23,300, or 6.5%, to $334,800 from $358,100 for the first quarter of 2004. Expense categories that were primary contributors to the net decrease in first quarter 2005 as compared with 2004 are summarized as follows: Increase (Decrease) Expense From 2004 ------- --------- Employees costs $ 46,100 Consulting services (58,300) Travel & entertainment (9,200) Other items (1,900) --------- $ (23,300) ========= The increase in employee costs resulted primarily from increased commissions and performance bonuses attributable to first quarter 2005 sales. These increases were partially offset by lower wages and benefits expense attributable to having one less sales person in the first quarter of 2005 as compared with 2004. The decrease in consulting services was due to a reduction in the general selling and marketing activities that had been being outsourced. We began deferring certain planned selling and marketing activities towards the end of the fourth quarter of 2004 and continued doing so into the first quarter of 2005 as we needed to conserve our cash on hand until we consummated both the NES acquisition and the 2005 Private Placement. Similar to the decrease in consulting services, the decrease in travel and entertainment expense primarily resulted from curtailing expenditures in order to conserve our cash on hand, pending the consummation of the NES acquisition and the 2005 Private Placement. Also contributing to the 2005 decrease in travel 17 and entertainment expense was having one less salesperson in 2005, as compared with 2004. We anticipate that selling and marketing expenses for 2005 will approximate 2004 levels. Selling and marketing expenses were 28.4% and 39.7% of revenue for the first quarter of 2005 and 2004, respectively. General and Administrative Expenses General and administrative expenses primarily consist of employee costs, legal, professional and other outside services, amortization and depreciation, travel and entertainment, certain costs associated with being a publicly held corporation, and bad debts expense. General and administrative expenses for the first quarter of 2005 increased by $477,400, or 191.2%, to $727,100 from $249,700 for the first quarter of 2004. Expense categories that were primary contributors to the net increase in first quarter 2005 as compared with 2004 are summarized as follows: Increase (Decrease) Expense From 2004 ------- --------- Employee costs $ 99,300 Professional services 219,000 Depreciation and amortization 142,800 Travel & entertainment 10,600 Other items 5,700 --------- $ 477,400 ========= The increase in employee costs in the first quarter of 2005, as compared with 2004, was primarily due to hiring two additional employees during the first quarter of 2005. These employees have been tasked with developing internal and external revenue opportunities for the patents and patent applications we acquired in conjunction with the NES acquisition. Additionally, these employees are also responsible for developing additional patent applications. The primary reason for the increase in professional services was legal fees related to the administration of the patent portfolio, which we began incurring upon the consummation of the NES acquisition in January 2005, as well as legal fees pertaining to general corporate operations. The increase in depreciation and amortization was primarily due to the commencement of amortization of the patents acquired from NES in January 2005. Partially offsetting this amortization was a decrease in fixed asset depreciation related to property and equipment. We expect depreciation and amortization to be significantly higher for the remainder of 2005 due to the amortization of the patents. Travel and entertainment expense was higher primarily due to activities related to the NES acquisition, the exploitation of the patents acquired therein and the 2005 Private Placement. We anticipate that aggregate general and administrative expenses for 2005 will be substantially higher than 2004, primarily due to the amortization of the patents and the costs associated with developing them. General and administrative expenses were approximately 61.6% and 27.7% of revenues for the first quarter of 2005 and 2004, respectively. 18 Research and Development Expenses Research and development expenses consist primarily of employee costs, payments to contract programmers, rent, depreciation and computer related supplies. Research and development expenses for the first quarter of 2005 decreased by $95,900, or 22.9%, to $323,700 from $419,600 for the first quarter of 2004. Under accounting principles generally accepted in the United States, all costs of product development incurred once technological feasibility has been established, but prior to general release of the product, are typically capitalized and amortized to expense over the estimated life of the underlying product, rather than being charged to expense in the period incurred. No product development costs were capitalized during either the first quarter of 2005 or 2004. Expense categories that were primary contributors to the net decrease in first quarter 2005 as compared with 2004 are summarized as follows: Increase (Decrease) Expense From 2004 ------- --------- Employee costs $ (40,200) Contract programmers (29,100) Depreciation (18,800) Supplies (3,400) Other items (4,400) --------- $ (95,900) ========= The decrease in employee costs for the first quarter of 2005 from 2004 levels was primarily due to having two fewer engineers during the first quarter of 2005 as compared with 2004. The decrease in contract programmers for the first quarter of 2005, as compared with 2004, was due to the non-renewal of certain contracts upon their expiration. Once certain elements of the work being performed for us was completed, the underlying programmers contracts were not renewed as their services were not immediately required. We believe that we will be able to enter into new contracts with these engineers, or ones with similar talents, without difficulty in the future, should we need their services again. Depreciation expense was lower in the first quarter of 2005, as compared with 2004, because during 2003 and 2004, we purchased virtually no new capitalizable assets in support of our research and development efforts. Since the beginning of 2003, various assets have become fully depreciated more quickly than we have replaced them and hence, depreciation expense has steadily declined. We expect to make more fixed asset purchases in 2005 than we did in 2004, however, we do not expect to replace all the assets that have, or will, become fully depreciated. Consequently, we expect depreciation expense for 2005 to remain lower than 2004 levels. We spent less on supplies during the first quarter of 2005, as compared with 2004, as we were trying to conserve our cash, pending the consummation of the NES acquisition and the 2005 Private Placement. We anticipate that research and development expenses for 2005, inclusive of capitalized software development costs, will be lower than those incurred during 2004, primarily due to the lower number of engineers and lower depreciation, as 19 outlined above. Research and development expenses were approximately 27.4% and 46.5% of revenues for the first quarter of 2005 and 2004, respectively. Interest and other income Interest and other income consists primarily of interest income on excess cash. Our excess cash is held in interest bearing money market accounts with minimum net assets greater than or equal to one billion U.S. dollars. Interest and other income for the first quarter of 2005 increased by $5,200, or 144.4%, to $8,800 from $3,600 for the first quarter of 2004. The increase was primarily due to higher average cash balances and rates of interest being earned on those balances throughout the first quarter of 2005 as compared with 2004. The increase in the average cash balances in the first quarter of 2005, as compared with 2004, was primarily due to the net proceeds of the 2005 Private Placement, approximately $3,090,400, as compared with the net proceeds of the 2004 private placement, approximately $970,900. We anticipate that interest income for the remainder of 2005 will be higher than comparable periods from 2004 as we expect that we will continue to have higher average cash balances for the remainder of the year, as compared with the prior year. Net Loss As a result of the foregoing items, net loss for the first quarter of 2005 was $318,600 a decrease of $112,500, or 26.1%, from a net loss of $431,100 for the first quarter of 2004. As a result of our continued operating loss we intend to continue to pursue revenue growth opportunities through all available means. Net loss attributable to common shareholders increased from $318,600, as originally reported, to $4,318,60000 as the result of the beneficial conversion amount of $3,136,000 and the $864,000 discount resulting from the allocation of the proceeds of the 2005 Private Placement on a relative fair value basis between the Series A preferred shares and the warrants, both of which were treated as deemed non-cash dividends to the preferred shareholders during the three-month period ended March 31, 2005. Deemed Dividends on Preferred Stock On February 2, 2005, we completed the 2005 Private Placement, which raised a total of $4,000,000 through the sale of 148,148 shares of Series A preferred stock and five-year warrants to purchase 74,070 shares of Series B preferred stock. The deemed fair value of the Series A preferred stock was estimated based on the market price and underlying number of common shares they would have converted into had the conversion occurred immediately upon their issuance. The market price for our common stock on February 2, 2005 was $0.46 and the Series A preferred stock would have converted into 14,814,800 common shares, thus deriving an estimated fair value of approximately $6,814,800 at that date. The fair value of the warrants was estimated to be $1,877,700 and was calculated using the Black-Scholes option pricing model with the following weighted average assumptions: a risk free interest rate of 1.5%, a volatility factor of 60%, a dividend yield of 0% and a five year contractual life. 20 Based on the relative fair values of the preferred shares and the warrants at the time of their issuance, we allocated $3,136,000 of the $4,000,000 proceeds of the 2005 Private Placement to the preferred shares and $864,000 to the warrants. The preferred shares we issued contained a nondetachable conversion feature (the "Beneficial Conversion Feature") that was in-the-money upon completion of the 2005 Private Placement, in that the deemed fair value of Common Stock into which the Preferred Shares could be converted exceeded the allocated value of $3,136,000 by $3,678,800 (using the intrinsic value method). This discount resulting from recording the Beneficial Conversion Feature was limited to the allocated proceeds of $3,136,000 and has been recognized as if this amount had been declared a non-cash dividend to the preferred shareholders during the quarter ended March 31, 2005. Additionally, the approximate $864,000 discount resulting from the allocation of the proceeds of the 2005 Private Placement on a relative fair value basis to the Series A preferred shares and the warrants issued in the 2005 Private Placement has also been recognized as if this amount had been declared a non- cash dividend to the preferred shareholders during the quarter ended March 31, 2005. Liquidity and Capital Resources We continue to manage our operations to bring our cash expenditures in line with our revenues in order conserve our cash on hand. We are simultaneously looking at ways to improve or maintain our revenue stream. Additionally, we continue to review potential merger opportunities as they present themselves to us and at such time as a merger might make financial sense and add value for our shareholders, we will pursue that merger opportunity. We believe that improving or maintaining our current revenue stream, coupled with our cash on hand, including the cash raised in the 2005 Private Placement will sufficiently support our operations during 2005. On January 31, 2005, we acquired NES for 9,599,993 shares of common stock, the assumption of approximately $232,800 of NES' indebtedness and the reimbursement to AIGH Investment Partners, LLC ("AIGH"), an affiliate of a principal stockholder (Orin Hirschman), of $665,000 for its advance on our behalf of a like sum in December 2004 to settle certain third party litigation against NES. We reimbursed the advance through a partial credit against the price of our securities acquired by AIGH in the 2005 Private Placement. The 2005 Private Placement, which was consummated on February 2, 2005, raised a total of $4,000,000, inclusive of the $665,000 credit issued to AIGH. As of March 31, 2005 we had consumed approximately $244,600 and $671,400 of the cash raised paying for expenses related to the 2005 Private Placement and the NES acquisition, respectively. We estimate that we will disburse an additional $121,100 and $167,900 of cash paying for expenses related to the 2005 Private Placement and the NES acquisition, respectively, however, there can be no guarantees that these amounts will be final. We anticipate incurring further costs associated with the development of the patents and patent applications acquired from NES for the next several reporting periods. We expect to fund these development costs through working capital. Until the revenues we derive from either the sale of software products or the licensing of patents are sufficient enough to generate positive cash flows from operations, we will continue to experience operating losses. Although we believe that we will be able to attain sufficient sales levels to meet our operational needs, there can be no certainty that we will be able to do so. Should the cash flows generated from sales and working capital be insufficient to satisfy short 21 term operating needs, or should we be unsuccessful in securing alternative sources of financing, we may have to significantly curtail the current nature of our operations. As of March 31, 2005, cash and cash equivalents totaled $3,171,300, an increase of $2,496,000, or 369.6%, from $675,300 as of December 31, 2004. The increase in cash and cash equivalents was primarily attributable to the $3,090,400 net cash infusion from the 2005 Private Placement, which comprises the majority of the cash provided by our financing activities for the first quarter of 2005. The balance of the cash provided by our financing activities was derived by stock sales to our employees under the provisions of our employee stock purchase plan. Our net loss for the first quarter of 2005 was $318,600. Included in the net loss were non-cash charges, comprised of depreciation and amortization, which aggregated approximately $207,200. Accounts Receivable The increase in accounts receivable was primarily due to the timing of sales transactions, as many transactions were closed towards the end of the first quarter. Deferred Revenue The increase in total deferred revenue, aggregate short and long-term, generated $394,600 of cash flow during the first quarter of 2005. This amount includes approximately $200,000 of Windows-based product revenue, which we derived from a transaction entered into with a significant distributor. This transaction did not meet all of the criteria for revenue recognition at the end of the first quarter of 2005; consequently, the revenue was deferred. All revenue recognition criteria were met for this transaction during April 2005; accordingly, we recognized the revenue during the second quarter of 2005. Accounts Payable Accounts payable as of March 31, 2005 decreased by $52,100, or 20.8%, to $198,100 from $250,200 as of December 31, 2004. Accounts payable are comprised of our various operating expenses and decreased due to the timing of the payment of various invoices. Accrued Expenses Accrued expenses as of March 31, 2005 increased by $53,800, or 23.2%, to $285,200 from $231,400 as of December 31, 2004. Accrued expenses are charges for services rendered for which an invoice has not yet been received such as consulting fees, legal and accounting fees, and utilities. During the first quarter of 2005 we increased accrued legal fees pertaining to the administration of the acquired patents and public company reporting requirements oversight by approximately $92,400 over December 31, 2004 levels. Additionally, we accrued approximately $106,000 of estimated capitalizable costs to be incurred in future periods related to the NES acquisition. Partially offsetting these increases were items that were accrued as of December 31, 2004 that were paid out during the first quarter of 2005, thereby decreasing accrued expenses, including approximately $72,500 of accounting fees and $79,400 of legal fees. 22 Accrued Wages Accrued wages as of March 31, 2005 increased by $79,000, or 30.4%, to $339,100 from $260,100 as of December 31, 2004. The increase was primarily due to increased commissions and bonuses, based on first quarter 2005 sales, as well as an increase in the costs of employee benefits. Deferred Compensation We deferred, and amortized, compensation totaling approximately $8,900 and $500, respectively, related to stock options granted to our interim Chief Executive Officer, Robert Dilworth, during January 2005. We are amortizing this amount monthly on the straight-line method, to compensation expense over a three-year period ending in January 2008. Notes Receivable - Directors During the first quarter of 2005, we received payment in full of our notes receivable - directors, generating operating cash of $50,300. Also during the first quarter of 2005, we received a $2,600 principal repayment of the note receivable - shareholder. Working Capital As of March 31, 2005, we had current assets of $4,158,000 and current liabilities of $1,840,700, which netted to working capital of $2,317,300. Included in current liabilities was the current portion of deferred revenue of $1,018,300. We have been successful in significantly reducing operating costs through a series of strategic restructurings and work force reductions that began in September of 2001. Based on our current operating revenues and reduced operating cost structure, and the cash raised in the 2005 Private Placement, we believe that we will be able to support our operational needs with currently available resources for at least the next twelve months. However, due to inherent uncertainties associated with predicting future operations, there can be no assurances that these resources will be sufficient to fund our anticipated expenses during the next twelve months. ITEM 3. Quantitative and Qualitative Disclosures About Market Risk We are currently not exposed to any significant financial market risks from changes in foreign currency exchange rates or changes in interest rates and do not use derivative financial instruments. A substantial majority of our revenue and capital spending is transacted in U.S. dollars. However, in the future, we may enter into transactions in other currencies. An adverse change in exchange rates would result in a decline in income before taxes, assuming that each exchange rate would change in the same direction relative to the U.S. dollar. In addition to the direct effects of changes in exchange rates, such changes typically affect the volume of sales or foreign currency sales price as competitors' products become more or less attractive. ITEM 4. Controls and Procedures Our management carried out an evaluation, with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures as of March 31, 2005. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded 23 that our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the time periods specified in the rules and forms of the Securities and Exchange Commission. There has not been any change in our internal control over financial reporting in connection with the evaluation required by Rule 13a-15(d) under the Exchange Act that occurred during the quarter ended March 31, 2005 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. PART II--OTHER INFORMATION ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds During the first quarter of 2005, we granted the following stock options: o stock options to purchase an aggregate 1,806,000 shares of common stock, at exercise prices ranging from $0.43 to $0.59 per share, were granted to our non-executive employees; o stock options to purchase an aggregate 200,000 shares of common stock, at an exercise price of $0.43 per share, were granted to our executive officers; and o stock options to purchase an aggregate 640,000 shares of common stock, at an exercise price of $0.43 per share, were granted to our directors. The grant of such stock options to the above-listed persons was not registered under the Securities Act of 1933 because the stock options either did not involve an offer or sale for purposes of Section 2(a)(3) of the Securities Act, in reliance on the fact that the stock options were granted for no consideration, or were offered and sold in transactions not involving a public offering, exempt from registration under the Securities Act pursuant to Section 4(2). ITEM 4. Submission of Matters to a Vote of Security Holders At a special meeting of stockholders held on March 29, 2005, the stockholders voted to approve an amendment to our Certificate of Incorporation to increase the authorized number of common shares from 45,000,000 to 195,000,000 shares. The votes were as follows: For 134,848,669 Against 1,207,677 Broker non-votes 965,055 Abstain 16,590 ITEM 6. Exhibits Exhibit 31 - Rule 13a-14(a)/15d-14(a) Certifications Exhibit 32 - Section 1350 Certifications 24 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. GraphOn Corporation (Registrant) Date: November 7, 2005 By: /s/ Robert Dilworth ---------------------------- Robert Dilworth, Chief Executive Officer (Interim) and Chairman of the Board (Principal Executive Officer) Date: November 7, 2005 By: /s/ William Swain ---------------------------- William Swain, Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer) 25 EX-31 2 exhbt31.txt 302 CERTIFICATIONS Exhibit 31 I, Robert Dilworth, certify that: 1. I have reviewed this Amendment No. 1 to the quarterly report on Form 10-Q of GraphOn Corporation ("registrant"); 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. 1 Date: November 7, 2005 /s/ Robert Dilworth -------------------- Robert Dilworth Chief Executive Officer (Interim) and Chairman of the Board I, William Swain, certify that: 1. I have reviewed this Amendment No. 1 to the quarterly report on Form 10-Q of GraphOn Corporation ("registrant"); 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are 2 reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: November 7, 2005 /s/ William Swain ----------------- William Swain Chief Financial Officer EX-32 3 exhbt32.txt 906 CERTIFICATIONS Exhibit 32 (a) Certification of Quarterly Report by Chief Executive Officer. CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with Amendment No. 1 to the Quarterly Report of GraphOn Corporation (the "Company") on Form 10-Q for the period ending March 31, 2005 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Robert Dilworth, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. /s/ Robert Dilworth ------------------- Robert Dilworth Chief Executive Officer November 7, 2005 (b) Certification of Quarterly Report by Chief Financial Officer. CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with Amendment No. 1 to the Quarterly Report of GraphOn Corporation (the "Company") on Form 10-Q for the period ending March 31, 2005 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, William Swain, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. /s/ William Swain ----------------- William Swain Chief Financial Officer November 7, 2005 -----END PRIVACY-ENHANCED MESSAGE-----