GRAPHON CORP/DE - GOJO Annual Report (Small Business Issuers) (10KSB) Results of Operations

The following is an excerpt from a 10KSB SEC Filing, filed by GRAPHON CORP/DE on 3/31/2008.

Jump to :

Results of Operations

During the year ended December 31, 2007, we determined that we operated our business in two segments versus one for prior years. Our two segments are software and intellectual property.

Set forth below is statement of operations data for the years ended December 31, 2007 and 2006 along with the dollar and percentage changes from 2006 to 2007 in the respective line items. Percentage changes that are not meaningful are marked NM.

Year Ended December 31, Change in -------------------------------------- ------------------------------------ 2007 2006 Dollars Percentage Revenue: ----------------- ----------------- ------------------- ------------- Product licenses $ 3,325,100 $ 3,513,000 $ (187,900) -5.3% Intellectual property license 6,250,000 - 6,250,000 NM Service fees 1,794,400 1,588,300 206,100 13.0% Other 116,100 69,300 46,800 67.5% ----------------- ----------------- ------------------- Total Revenue 11,485,600 5,170,600 6,315,000 122.1% Cost of revenue 2,623,000 534,000 2,089,000 391.2% ----------------- ----------------- ------------------- Gross profit 8,862,600 4,636,600 4,226,000 91.1% ----------------- ----------------- ------------------- Operating expenses: Selling and marketing 1,819,900 1,650,600 169,300 10.3% General and administrative 4,703,000 3,975,900 727,100 18.3% Research and development 2,162,700 2,093,700 69,000 3.3% ----------------- ----------------- ------------------- Total operating expenses 8,685,600 7,720,200 965,400 12.5% ----------------- ----------------- ------------------- Income (loss) from operations 177,000 (3,083,600) 3,260,600 NM ----------------- ----------------- ------------------- Other income (expense): Interest and other income 62,700 57,000 5,700 10.0% Interest and other expense (4,100) (4,200) 100 2.4% ----------------- ----------------- ------------------- Total other income 58,600 52,800 5,800 11.0% ----------------- ----------------- ------------------- Income (loss) before income taxes 235,600 (3,030,800) 3,266,400 107.8% Income taxes 42,100 4,300 37,800 879.1% ----------------- ----------------- ------------------- Net income (loss) attributable to common shareholders $ 193,500 $ (3,035,100) $ 3,228,600 NM ================= ================= ===================

Revenue. During December 2007, we entered into a $6,250,000 settlement and licensing agreement with AutoTrader.com (as explained elsewhere in this Form 10-KSB), under which they, their parent company Cox Enterprises, Inc. and all of their affiliates received an irrevocable, perpetual, world-wide, non-exclusive license to all of our patents and patent applications, including the `538 and `940 patents.

Although we intend to attempt to further exploit and monetize our intellectual property in the future, there can be no assurances that we will be successful.

Our software revenue has historically been primarily derived from product licensing fees and service fees from maintenance contracts. Other sources of software revenue include sales of software development kits and training. Software development kits are tools that allow end users to develop, interface and brand their own applications for use in conjunction with either our Windows or Unix/Linux products. Currently, we do not generate a significant amount of revenue from the sale of software development kits nor do we anticipate generating a significant amount from them during 2008.

The table that follows summarizes product licensing fees for the years ended December 31, 2007 and 2006 and calculates the change in dollars and percentage from 2006 to 2007 in the respective line item.

Year Ended December 31, Increase/(Decrease) ------------------------------------ ----------------------------- Product licensing fees 2007 2006 Dollars Percentage ---------------------- ----------------- ----------------- ----------------- ---------- Windows $ 1,959,500 $ 1,903,600 $ 55,900 2.9% Unix/Linux 1,365,600 1,609,500 (243,900) (15.2) ----------------- ----------------- ----------------- Total $ 3,325,100 $ 3,513,100 $ (188,000) (5.4) ================= ================= =================

The changes in both Windows and Unix-based product licensing fees revenue for the year ended December 31, 2007 as compared with the prior year was reflective of how such revenue varies because a significant portion of this revenue has historically been earned, and continues to be earned from a limited number of significant customers, most of whom are resellers. Consequently, if any of these significant customers change their order level, or fail to order, our product licensing fees revenue can be materially adversely impacted. We expect this situation to continue during 2008.

Revenue recognized from Windows product licenses for the year ended December 31, 2007 was virtually unchanged from the prior year. During June 2007, we released an updated version of our Windows product, GO-Global for Windows, version 3.2, which enhanced the functionality and performance of earlier versions.

The decrease in Unix product license revenue for the year ended December 31, 2007, as compared with 2006, was primarily due to a $250,000 one-time sale to an enterprise customer during 2006, which was partially offset by an overall increase in sales made to various other Unix customers.

We anticipate that many of our customers will enter into, and periodically renew, maintenance contracts to ensure continued product updates and support. Currently we offer maintenance contracts for one, two, three or five-year periods. Revenue from maintenance contracts totaled approximately $1,794,400 in 2007, an increase of $206,100, or 13.0%, from the $1,588,300 reported for 2006. Revenue from maintenance contracts comprised approximately 15.6% and 30.7% of total revenue for the years ended December 31, 2007 and 2006, respectively. We expect revenue from maintenance contracts in 2008 to exceed 2007 levels due to an increase in maintenance contract sales in 2007, the continued growth in the size of our channel partner base and anticipated maintenance contract renewals in 2008.

For the year ended December 31, 2007 our three most significant customers accounted for approximately 21.3%, 8.1% and 5.0%, respectively, of total sales. These three customers' December 31, 2007 year-end accounts receivable balances represented approximately 43.2%, 2.6%, and 8.9% of reported net accounts receivable, respectively, and included a significant sale made to our largest customer during December 2007. By March 12, 2008, we had collected approximately 88% of these outstanding balances.

Segment Revenue. Segment revenue was as follows:

Year Ended December 31 2007 2006 ----------------------- --------------- -------------- Software $ 5,235,600 $ 5,170,600 Intellectual Property 6,250,000 - --------------- -------------- Consolidated Total $ 11,485,600 $ 5,170,600 =============== ==============

As set forth above, the increase in software revenues for the year ended December 31, 2007, as compared with the prior year was primarily due to increased service fees and other revenues, which were partially offset by a decrease in product license revenue. During December 2007 we recognized $6,250,000 of revenue related to the settlement and licensing agreement of our intellectual property that we entered into with Autotrader.com. For the year ended December 31, 2006 we did not license our intellectual property.

Cost of Revenue. Cost of revenue is comprised primarily of contingent legal fees resulting from settlements and/or licensing agreements incurred as a result of our patent litigation efforts, service costs, which represent the costs of customer service (and is inclusive of non-cash stock-based compensation expense calculated in accordance with FAS123R), and product costs. Shipping and packaging materials are immaterial as virtually all of our license 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. Such capitalized costs are subsequently amortized as cost of revenue over the shorter of three years or the remaining estimated life of the products.

Cost of revenue increased by $2,089,000, or 391.2%, to $2,623,000 for the year ended December 31, 2007 from $534,000 for the prior year. Cost of revenue for the year ended December 31, 2007 represented approximately 22.8% of total revenue, as compared with 10.3% for the prior year. Had we not entered into the settlement and licensing agreement with AutoTrader.com, we would have reported cost of revenue of approximately $503,900 for the year ended December 31, 2007, a decrease of $30,100, or 5.6%, from the prior year.

We recorded $2,119,100 of contingent legal fees as a cost of revenue for the year ended December 31, 2007 as a result of the $6,250,000 settlement and license agreement we entered into with Autotrader.com during December 2007. No such contingent legal fees were recorded in the prior year.

Service costs increased by $44,600, or 10.3%, to $475,600 for the year ended December 31, 2007 from $431,000 for the prior year. The increase resulted primarily from increasing the amount of engineering time spent performing customer service. Service costs for the years ended December 31, 2007 and 2006 were inclusive of $13,300 and $17,500 of non-cash stock-based compensation expense, respectively.

Product costs decreased by $74,700, or 72.5%, to $28,300 for the year ended December 31, 2007 from $103,000 for the prior year. The decrease was primarily due to a decrease in the amortization of capitalized software development costs as almost all of the elements of our capitalized software development costs became fully amortized during either 2006 or 2007. Amortization of capitalized software development costs charged to cost of revenue aggregated $5,800 and $74,300 for the years ended December 31, 2007 and 2006, respectively.

We expect that cost of revenue for 2008, assuming that we incur no contingent legal fees during 2008, will approximate 2007 levels, net of the contingent legal fees recorded during 2007.

Selling and Marketing Expenses. Selling and marketing expenses primarily consist of employee costs (inclusive of non-cash stock-based compensation expense calculated in accordance with FAS123R), outside services and travel and entertainment expenses.

Selling and marketing expenses for the year ended December 31, 2007 increased by $169,300, or 10.3%, to $1,819,900 from $1,650,600 for 2006. Selling and marketing expenses represented approximately 15.8% and 31.9% of total revenue, respectively, for the years ended December 31, 2007 and 2006. Included in selling and marketing expenses for the years ended December 31, 2007 and 2006 were approximately $32,100 and $35,100, respectively, of non-cash stock-based compensation expense.

Our selling and marketing expenses were higher in 2007 than 2006 primarily because employee costs were higher, resulting from having approximately two more sales representatives in 2007 as compared with 2006, higher commissions expense resulting from an increase in commissionable sales, and changes in which sales representatives attained quarterly and annual quotas. Also, costs related to outside services in 2007 exceeded 2006 levels mainly due to increased marketing activities from our marketing consultants as well as recruiting costs incurred in the hiring of a new sales representative. Partially offsetting these increases was a decrease in travel and entertainment expense in 2007, as compared with 2006, that primarily resulted from participating in fewer tradeshows as a vendor and costs associated with a 2006 incentive program that was not repeated during 2007.

We expect aggregate 2008 selling and marketing expenses to approximate 2007 levels.

General and Administrative Expenses. General and administrative expenses primarily consist of employee costs (inclusive of non-cash stock-based compensation expense calculated in accordance with FAS123R), amortization and depreciation, legal, professional and other outside services (including those related to realizing benefits from our patents), rent, travel and entertainment and insurance. Certain costs associated with being a publicly-held corporation are also included in general and administrative expenses, as well as bad debts expense.

General and administrative expenses for the year ended December 31, 2007 increased by $727,100, or 18.3%, to $4,703,000 from $3,975,900 for 2006. General and administrative expenses for the years ended December 31, 2007 and 2006 represented approximately 40.9% and 76.9% of total revenue, respectively. Included in general and administrative expenses for the years ended December 31, 2007 and 2006 were approximately $366,300 and $337,100, respectively, of non-cash stock-based compensation expense.

During 2007 non-contingent legal fees and outside services fees associated with our lawsuit against Autotrader.com (as explained elsewhere in this Form 10-KSB) exceeded 2006 levels by approximately $768,400, which was primarily comprised of costs associated with trial preparation.

During 2007 we increased our allowance for doubtful accounts by approximately $182,200 primarily as the result of a downward evaluation of the current financial condition of a significant customer's aggregate outstanding balance due us. Although we currently anticipate continuing our relationship with this customer, we do not anticipate delivering further product until their receivable has been fully satisfied.

Partially offsetting these increases were decreases in travel and entertainment, primarily as a result of less travel by our Chief Executive Officer and using short-term housing, versus hotels, for extended trips to our New Hampshire engineering facility, and non-patent related outside services, which was due to our hiring our Chief Executive Officer on a full-time basis during September 2006. Employee costs were not significantly impacted by the hiring of our Chief Executive Officer on a full-time basis as prior to his hiring, our former Chief Operating Officer was terminated in July 2006.

Costs associated with other major components of general and administrative expenses, notably, depreciation and amortization, insurance, rent and costs associated with being a public entity did not change significantly during the year ended December 31, 2007, as compared with the prior year.

The ending balance of our allowance for doubtful accounts as of December 31, 2007 and 2006 was $229,000 and $46,800, respectively. Bad debts expense was approximately $182,200 and $0 for the years ended December 31, 2007 and 2006, respectively.

We anticipate that cumulative general and administrative expense in 2008 will be lower than those incurred during 2007, primarily resulting from lower legal fees associated with intellectual property litigation. Although we currently have two legal actions underway (See Note 12 to the Financial Statements), we believe that increased expenditures associated with trail preparation, such as those we incurred during the last few months before the AutoTrader.com litigation was scheduled to commence during December 2007, will tend to occur closer to the actual trial dates. No trial dates have been set for either action currently underway and we believe that such dates will be set for the second half of 2009, at the earliest.

Research and Development Expenses. Research and development expenses consist primarily of employee costs (inclusive of non-cash stock-based compensation expense calculated in accordance with FAS123R), payments to contract programmers, all costs of GraphOn Research Labs Limited, and rent.

Under accounting principles generally accepted in the United States, all costs of product development incurred once technological feasibility has been established, but prior to the general release of the product, are typically capitalized and amortized to expense over the estimated life of the underlying product, rather than being charged to expense in the period incurred. There was no significant capitalization of product development costs during either 2007 or 2006.

Research and development expenses increased by $69,000, or 3.3%, to $2,162,700 for the year ended December 31, 2007 from $2,093,700 in the prior year. Research and development expenses for the years ended December 31, 2007 and 2006 represented approximately 18.8% and 40.5% of total revenue, respectively.

Research and development costs for the years ended December 31, 2007 and 2006 are inclusive of $101,500 and $80,700, respectively, of non-cash stock-based compensation.

Employee costs were higher in 2007 than 2006 primarily resulting from hiring three additional engineers at various times throughout 2006, including; a vice-president of engineering, a president for our Israeli subsidiary, a staff engineer and an additional staff engineer during January 2007. Partially offsetting the increased costs associated with these hires was lowered employee costs associated with the termination of four staff engineers at various times throughout 2007.

Costs associated with outside consultants, including recruiters, were lower during the year ended December 31, 2007, as compared with 2006, primarily due to the hiring of a president for our Israeli subsidiary, the curtailing of certain consulting contracts as various projects were completed and the hiring of a vice-president of engineering during 2006. Prior to hiring the president of our Israeli subsidiary, the individual had been providing engineering consulting services to us. During August 2006, he was hired on a full-time basis and no longer charged us consulting fees. Additionally, as certain engineering projects that had been outsourced to consultants were completed during 2006 and 2007, the consultants' underlying contracts were not renewed as we were trying to conserve our cash. We believe that we have sufficient resources to rehire the consultants if needed. Also, fees paid to a recruiter who found the vice president of engineering we hired during 2006 were not repeated during 2007.

Rent expense increased by almost 50% during the year ended December 31, 2007, as compared with the prior year, primarily because we expanded the size of our New Hampshire engineering facility during October 2006, and we paid a full year's worth of rent for our Israeli subsidiary, which opened during August 2006.

Our research and development efforts currently are focused on further enhancing the functionality, performance and reliability of existing products. We historically have made significant investments in our protocol and in the performance and development of our server-based software, and we expect to continue to make significant product investments during 2008. We also anticipate increasing the size of our in-house research and development workforce during 2008 so that we may accelerate our efforts to further stabilize and enhance our current and new product offerings. Consequently, we expect 2008 research and development expense to be higher than 2007 levels.

Interest and Other Income. During 2007 and 2006, the primary component of interest and other income was interest income derived on excess cash. Our excess cash was held in interest bearing money market accounts with institutions whose minimum net assets were greater than or equal to one billion U.S. dollars.

Interest and other income was approximately 0.5% and 1.1% of total revenues for the years ended December 31, 2007 and 2006, respectively. The increase in interest income in 2007, as compared to 2006, was primarily due to higher average interest rates being earned by our money market account.

Segment Operating Income (Loss). As a result of the foregoing items, segment operating income (loss) was as follows:

Year Ended December 31 2007 2006 ---------------------------------- ---------------- ---------------- Software $ (1,413,700) $ (1,321,900) Intellectual Property 1,590,700 (1,761,700) Unallocated 58,600 52,800 ---------------- ---------------- Consolidated Total $ 235,600 $ (3,030,800) ================ ================

We do not allocate interest and other income, interest and other expense or income tax to our segments.

Provision for Income Taxes. For the years ended December 31, 2007 and 2006 we recorded current tax provisions of approximately $42,100 and $4,300, respectively. At December 31, 2007, we had approximately $39 million of federal net operating loss carryforwards, which will begin to expire in 2010. Also at December 31, 2007, we had approximately $12 million of California state net operating loss carryforwards available to reduce future taxable income, which will began to expire in 2010. During the year ended December 31, 2007, we utilized $2,268,700 and $1,289,000 of our federal and California net operating losses, respectively.

Net Income (Loss). Primarily as the result of the $6,250,000 settlement and licensing agreement we entered into with Autotrader.com we reported net income of $193,500 for the year ended December 31, 2007, as compared with a net loss of $3,035,100 for the prior year. Absent the settlement and licensing agreement with Autotrader.com, we would have reported a net loss of approximately $3,901,300 for the year ended December 31, 2007 as a result of the factors described above.