<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON SEPTEMBER 16, 1998
REGISTRATION NO.: 333-59617
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
AMENDMENT NO. 1
TO
FORM SB-2
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
------------------------
NETWORK-1 SECURITY SOLUTIONS, INC.
(Name of small business issuer in its charter)
------------------------------
<TABLE>
<S> <C> <C>
DELAWARE 7372 11-3027591
(State or Other Jurisdiction of (Primary Standard Industrial (I.R.S. Employer
Incorporation or Organization) Classification Code Number) Identification Number)
</TABLE>
------------------------
NETWORK-1 SECURITY SOLUTIONS, INC.
70 Walnut Street
Wellesley Hills, Massachusetts 02481
(781) 239-8280
(Address and Telephone Number of Registrant's Principal Executive Offices)
------------------------------
AVI A. FOGEL
President and Chief Executive Officer
Network-1 Security Solutions, Inc.
70 Walnut Street
Wellesley Hills, Massachusetts 02481
(781) 239-8280
(Name, Address and Telephone Number of Agent for Service of Process)
------------------------------
COPIES OF COMMUNICATIONS TO:
------------------------
SAM SCHWARTZ, ESQ. ROBERT J. MITTMAN, ESQ.
Bizar Martin & Taub, LLP Tenzer Greenblatt LLP
1350 Avenue of the Americas The Chrysler Building
New York, New York 10019 405 Lexington Avenue
Telephone: (212) 265-8600 New York, New York 10174
Telecopier: (212) 581-8958 Telephone: (212) 885-5000
Telecopier: (212) 885-5001
--------------------------
APPROXIMATE DATE OF PROPOSED SALE TO THE PUBLIC:
As soon as practicable after the effective date of this Registration Statement.
--------------------------
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. / / [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. / / [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. / / [ ]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. / / [ ]
--------------------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A),
MAY DETERMINE.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
CROSS-REFERENCE SHEET
<TABLE>
<CAPTION>
FORM SB-2 ITEM NUMBER AND CAPTION HEADING IN PROSPECTUS
- ---------------------------------------------------------------- -----------------------------------------------------
<C> <S> <C>
1. Front of Registration Statement and Outside Front
Cover of Prospectus................................ Outside Front Cover of Prospectus
2. Inside Front and Outside Back Cover Pages of
Prospectus......................................... Inside Front and Outside Back Cover
3. Summary Information and Risk Factors................. Prospectus Summary; Risk Factors
4. Use of Proceeds...................................... Use of Proceeds
5. Determination of Offering Price...................... Risk Factors; Underwriting
6. Dilution............................................. Dilution; Risk Factors
7. Selling Security Holders............................. Not Applicable
8. Plan of Distribution................................. Outside Front Cover Page of Prospectus
9. Legal Proceedings.................................... Business
10. Directors, Executive Officers, Promoters and Control
Persons............................................ Risk Factors; Management
11. Security Ownership of Certain Beneficial Owners and
Management......................................... Principal Stockholders
12. Description of Securities............................ Description of Securities
13. Interest of Named Experts and Counsel................ Legal Matters; Experts
14. Disclosure of Commission Position on Indemnification
for Securities Act Liabilities..................... Description of Securities
15. Organization Within Last Five Years.................. Business; Certain Transactions
16. Description of Business.............................. Business
17. Management's Discussion and Analysis or Plan of
Operation.......................................... Management's Discussion and Analysis of Financial
Condition and Results of Operations
18. Description of Property.............................. Prospectus Summary; Risk Factors; Discussion and
Analysis of Financial Results of Operations;
Business
19. Certain Relationships and Related Transactions....... Certain Transactions
20. Market for Common Equity and Related Stockholder
Matters............................................ Risk Factors; Dilution; Management; Shares Eligible
for Future Sale
21. Executive Compensation............................... Management
22. Financial Statements................................. Financial Statements
23. Change in and Disagreements with Accountants on
Accounting and Financial Disclosure................ Not Applicable
</TABLE>
<PAGE>
INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY
OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES
EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES
IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR
TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE.
<PAGE>
PRELIMINARY PROSPECTUS DATED SEPTEMBER 16, 1998
SUBJECT TO COMPLETION
1,875,000 SHARES
[LOGO]
COMMON STOCK
Prior to this offering, there has been no public market for the Common Stock
and there can be no assurance that any such market will develop. It is
anticipated that the Common Stock will be quoted on the Nasdaq SmallCap Market
under the symbol "NSSI." For a discussion of the factors considered in
determining the initial public offering price, see "Underwriting."
------------------------
THE SECURITIES OFFERED HEREBY ARE SPECULATIVE AND INVOLVE A HIGH DEGREE OF RISK
AND IMMEDIATE SUBSTANTIAL DILUTION AND SHOULD NOT BE PURCHASED BY INVESTORS
WHO CANNOT AFFORD THE LOSS OF THEIR ENTIRE INVESTMENT. SEE "RISK FACTORS"
COMMENCING ON PAGE 7 AND "DILUTION" ON PAGE 20.
------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES
COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF
THIS PROSPECTUS. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE.
<TABLE>
<CAPTION>
PRICE UNDERWRITING PROCEEDS
TO DISCOUNTS AND TO
PUBLIC COMMISSIONS(1) COMPANY(2)
<S> <C> <C> <C>
Per Share.......................................... $8.00 $.70 $7.30
Total(3)........................................... $15,000,000 $1,312,500 $13,687,500
</TABLE>
(1) In addition, the Company has agreed to pay to the Underwriter a 3%
nonaccountable expense allowance and to sell to the Underwriter warrants
(the "Underwriter's Warrants") to purchase up to 187,500 shares of Common
Stock. The Company has also agreed to indemnify the Underwriter against
certain liabilities under the Securities Act of 1933, as amended. See
"Underwriting."
(2) Before deducting expenses estimated at $1,077,500, including the
Underwriter's nonaccountable expense allowance in the amount of $450,000
($517,500 if the Underwriter's over-allotment option is exercised in full),
payable by the Company.
(3) The Company has granted the Underwriter an option, exercisable within 45
days from the date of this Prospectus, to purchase up to an additional
281,250 shares of Common Stock on the same terms as set forth above, solely
for the purpose of covering over-allotments, if any. If the Underwriter's
over-allotment option is exercised in full, the price to public,
underwriting discounts and commissions, and proceeds to Company will be
$17,250,000, $1,509,375 and $15,740,625, respectively. See "Underwriting."
The shares of Common Stock are being offered, subject to prior sale, when,
as and if delivered to, and accepted by the Underwriter and subject to approval
of certain legal matters by counsel and to certain other conditions. The
Underwriter reserves the right to withdraw, cancel or modify the offering and to
reject any order in whole or in part. It is expected that delivery of
certificates representing the shares will be made against payment therefor at
the offices of the Underwriter, 650 Fifth Avenue, New York, New York 10019, on
or about , 1998.
------------------------
WHALE SECURITIES CO., L.P.
The date of this Prospectus is , 1998
<PAGE>
[GATEFOLD COVER]
[GRAPHIC ILLUSTRATING DEPLOYMENT OF THE COMPANY'S FIREWALL/PLUS
PRODUCTS THROUGHOUT AN ENTERPRISE'S COMPUTER NETWORK, OFFERING
PROTECTION FOR SUCH NETWORKS AGAINST INTERNAL AND EXTERNAL
SECURITY THREATS.]
The Company's FIREWALL/PLUS family of security software products enables an
organization to protect and secure its computer networks from internal and
external security threats. Specific features include:
ENTERPRISE-WIDE DEPLOYMENT. Unlike most other firewall solutions which focus on
an enterprise's connection to the Internet, FIREWALL/PLUS may be used throughout
the enterprise; as a perimeter firewall to control access to and from the
Internet, between internal networks to protect the network from attacks from
within, and on application servers and clients PCs to protect data.
MULTI-PROTOCOL CAPABILITY. FIREWALL/PLUS provides multi-protocol filtering not
available from network security products offered by other firewall vendors.
FIREWALL/PLUS filters TCP/IP plus all other commonly used network transport
protocols, such as IPX, SNA, DECnet and NetBEUI.
MULTI-LAYER SECURITY. FIREWALL/PLUS' Interceptor Shim and security filter engine
technology introduce a security layer between the network hardware drivers and
the Windows NT operating system by filtering all network traffic before it
reaches Windows NT.
ADVANCED FILTERING SYSTEM. FIREWALL/PLUS incorporates frame, packet, application
layer, proxy, and stateful inspection filtering capabilities. The Company
believes that its hybrid approach to filtering allows the Company to offer a
firewall product that maximizes security without sacrificing performance.
------------------------------
FIREWALL/PLUS is a trademark of the Company. All other trademarks or
tradenames referred to in this Prospectus are the property of their respective
owners.
CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS ON
NASDAQ, IN THE OVER-THE-COUNTER MARKET OR OTHERWISE WHICH STABILIZE, MAINTAIN OR
OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK. SPECIFICALLY, THE UNDERWRITER
MAY OVER-ALLOT IN CONNECTION WITH THE OFFERING AND MAY BID FOR AND PURCHASE
SHARES OF COMMON STOCK IN THE OPEN MARKET. FOR A DESCRIPTION OF THESE
ACTIVITIES, SEE "UNDERWRITING."
<PAGE>
[INSIDE GATEFOLD]
[FOUR PICTURES IN CLOCKWISE ORDER AS FOLLOWS]
[GRAPHIC ILLUSTRATING DEPLOYMENT OF THE COMPANY'S FIREWALL/PLUS ENTERPRISE
VERSION WHICH RESIDES ON THE PERIMETER OF A COMPUTER NETWORK OFFERING A BARRIER
BETWEEN THE ENTERPRISE AND THE INTERNET.]
[The following text appears to the right of the graphic.]
- Sits on the perimeter of a network, offering a barrier between the
enterprise and the Internet.
- Incorporates Virtual Private Network (VPN) technology to enable secure
communications between networks across the Internet, utilizing all
commonly used network transport protocols.
- May be operated in a transparent mode and therefore cannot be identified
for attack.
[GRAPHIC ILLUSTRATING DEPLOYMENT OF THE COMPANY'S FIREWALL/PLUS ENTERPRISE
VERSION BEING USED AS AN INTERNAL GATEWAY SECURITY DEVICE TO PROTECT
SUB-NETWORKS FROM UNAUTHORIZED ATTACK ORIGINATING FROM OTHER SUB-NETWORKS ON THE
NETWORK.]
[The following text appears to the right of the graphic.]
- Controls access by users to sub-networks throughout the enterprise
network.
- Protects against attacks originating from within the internal enterprise
network, where security breaches often originate.
- Supports multiple network transport protocols, including IP, IPX, SNA,
DECnet, and NetBEUI.
<PAGE>
[GRAPHIC ILLUSTRATING DEPLOYMENT OF THE COMPANY'S FIREWALL/PLUS CLIENT
VERSION, WHICH PROTECTS A WINDOWS NT WORKSTATION AGAINST INTERNAL AND EXTERNAL
NETWORK ATTACKS.]
[The following text appears to the right of the graphic.]
- Protects the Windows NT workstation on which it resides against internal
and external network attacks.
- Protects highly sensitive Windows NT workstations (e.g. CEO, human
resources, payroll and accounting).
- Supports multi-protocol environments commonly used in enterprise networks.
[GRAPHIC ILLUSTRATING DEPLOYMENT OF THE COMPANY'S FIREWALL/PLUS SERVER
VERSION WHICH RESIDES ON A WINDOWS NT APPLICATION SERVER PREVENTING UNAUTHORIZED
ACCESS BY INTERNAL NETWORK USERS.]
[The following text appears to the right of the graphic.]
- Installs directly on a Windows NT application server without interfering
with the normal operation of the server.
- Prevents unauthorized access to a secured Windows NT server by internal
users, where security breaches often originate.
- Protects sensitive enterprise systems such as database servers, key escrow
securities, digital certificate servers and authentication servers.
- Security provided for all commonly used network transport protocols.
<PAGE>
PROSPECTUS SUMMARY
THE FOLLOWING SUMMARY IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO THE MORE
DETAILED INFORMATION AND FINANCIAL STATEMENTS, INCLUDING THE NOTES THERETO,
APPEARING ELSEWHERE IN THIS PROSPECTUS. EXCEPT AS OTHERWISE INDICATED, ALL
INFORMATION IN THIS PROSPECTUS, INCLUDING PER SHARE DATA AND INFORMATION
RELATING TO THE NUMBER OF SHARES OUTSTANDING, (I) HAS BEEN ADJUSTED TO REFLECT A
1-FOR-1.61083 REVERSE STOCK SPLIT OF THE COMMON STOCK EFFECTED ON JULY 20, 1998,
(II) GIVES EFFECT TO THE CONVERSION OF THE OUTSTANDING SHARES OF SERIES B
CONVERTIBLE PREFERRED STOCK INTO 310,399 SHARES OF COMMON STOCK UPON THE
CONSUMMATION OF THIS OFFERING, AND THE ISSUANCE OF AN AGGREGATE OF 48,125 SHARES
OF COMMON STOCK UPON THE CONSUMMATION OF THIS OFFERING IN CONNECTION WITH THE
ACQUISITION OF COMMHOME SYSTEMS CORPORATION (THE "COMMHOME ACQUISITION") AND
SATISFACTION OF CERTAIN INDEBTEDNESS OF COMMHOME, AND (III) ASSUMES NO EXERCISE
OF THE UNDERWRITER'S OVER-ALLOTMENT OPTION TO PURCHASE UP TO 281,250 ADDITIONAL
SHARES OF COMMON STOCK. SEE "BUSINESS--COMMHOME SYSTEM CORPORATION ACQUISITION,"
"CERTAIN TRANSACTIONS" AND NOTE J TO NOTES TO FINANCIAL STATEMENTS.
CERTAIN STATEMENTS CONTAINED HEREIN UNDER "PROSPECTUS SUMMARY," "RISK
FACTORS," "USE OF PROCEEDS," "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS" AND "BUSINESS" INCLUDING, WITHOUT
LIMITATION, STATEMENTS CONCERNING THE COMPANY'S STRATEGY AND GROWTH PLANS,
CONTAIN CERTAIN FORWARD-LOOKING STATEMENTS CONCERNING THE COMPANY'S OPERATIONS,
ECONOMIC PERFORMANCE AND FINANCIAL CONDITION. BECAUSE SUCH STATEMENTS INVOLVE
RISKS AND UNCERTAINTIES, ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE
EXPRESSED OR IMPLIED BY SUCH FORWARD LOOKING STATEMENTS. FACTORS THAT COULD
CAUSE SUCH DIFFERENCES INCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED UNDER
"RISK FACTORS."
THE COMPANY
Network-1 Security Solutions, Inc. (the "Company") develops, markets,
licenses and supports a family of network security software products designed to
provide comprehensive security to computer networks, including Internet based
systems and internal networks and computing resources. The Company's FIREWALL/
PLUS family of security software products enables an organization to protect its
computer networks from internal and external attacks and to secure
organizational communications over such internal networks and the Internet. The
Company also offers its customers a full range of consulting services in network
security and network design and support in order to build, maintain and enhance
customer relationships and increase the demand for its software products.
The FIREWALL/PLUS family of security solutions is designed to protect
against Internet and intranet (internal networks utilizing Internet technology
and applications based upon TCP/IP--the Internet network transport protocol)
based security threats and to address security needs that arise from within
internal networks that often utilize other network transport protocols besides
TCP/IP including, among others, Novell's IPX, Digital Equipment's DECnet and
IBM's SNA. The Company's FIREWALL/PLUS family of firewall products operates on
the Microsoft Windows NT operating system platform. FIREWALL/PLUS' proprietary
Interceptor Shim and filter engine software technology, with its unique ability
to handle and filter all commonly used network transport protocols, provide
organizations with a highly secure and flexible security solution. Additionally,
unlike most other firewall solutions which focus on an enterprise's connection
to the Internet, the FIREWALL/PLUS solution can be deployed throughout the
enterprise; at the perimeter to control access to and from the Internet, between
internal networks and on application servers and desktop PCs to protect data
residing on such servers and PCs. FIREWALL/PLUS for Windows NT received the 1997
Internet and Electronic Commerce Conference award for "Best Intranet Solution"
and the 1997 ENT Magazine Readers Choice Award for "Best NT Firewall."
As a result of the explosive growth in network computing and Internet use
(as well as use of intranets and extranets), protection of an organization's
network and data has become a significant economic concern for businesses.
According to the 1997 Annual Information Week/Ernst & Young LLP Information
Security Survey of information technology managers and professionals, 42% of the
respondents reported malicious acts from external sources, as compared to 16% in
the prior year, and 43% of the respondents
3
<PAGE>
reported malicious acts by employees as compared to 29% in the prior year.
According to FBI estimates, U.S. companies suffer estimated losses of $5 to $10
billion per year as a result of unauthorized access to information and data.
According to the 1998 Computer Security Institute/FBI Computer Crime and
Security Survey, 44% of the respondents reported unauthorized access by
employees. The Company believes that securely segmenting internal network areas
and computing resources from unauthorized access will become paramount to
insuring the integrity of both the internal network and an organization's
intranet and extranet (intranets which allow access to one or more users outside
of the internal network) resources.
In a Windows NT based environment, it is typical for multiple network
transport protocols to co-exist, as Windows NT comes pre-equipped with TCP/IP,
IPX (Novell), NetBEUI (LAN Manager) and AppleTalk. In addition, certain
applications require the use of non-TCP/IP protocols to operate between
sub-networks within a network. The Company believes that multiple network
transport protocols will remain prevalent in computing environments because of
the large installed base of non-TCP/IP based computer systems and applications.
As a result, the Company believes that its FIREWALL/PLUS technology offers
significant advantages as a security product for computer networks because of
its unique ability to filter all commonly used network transport protocols and
reside in multiple locations throughout an organization's network.
The Company intends to pursue an aggressive growth strategy and to focus its
efforts on marketing its FIREWALL/PLUS family of network security products. Key
elements of the Company's strategy are to:
- Provide comprehensive network security solutions by developing, marketing
and supporting a family of network security products to address a broad
range of security issues confronting computer networks and computing,
including concerns arising from allowing access to the Internet as well as
concerns relating to the security of internal networks.
- Emphasize internal network security because of the ability of
FIREWALL/PLUS to filter a multitude of network transport protocols which
are common in many organizations. The Company intends to devote a
significant portion of the proceeds of this offering for sales and
marketing toward educating potential end users and third-party
distributors as to the need to protect networks and computing resources
from unauthorized access and attacks from within an internal network and
the capabilities and benefits of the Company's products.
- Implement a marketing plan which includes a multi-channel distribution
strategy which emphasizes establishing and maintaining third-party
distributor relationships with systems integrators, VARs, OEMs and
resellers in the United States and internationally.
- Increase sales of FIREWALL/PLUS by leveraging relationships with
consulting clients.
Since its inception, the Company has incurred significant losses. The future
success of the Company is largely dependent upon its FIREWALL/PLUS family of
software products achieving market acceptance. There can be no assurance that
the Company will be able to successfully implement its marketing strategy,
achieve significant market acceptance of its FIREWALL/PLUS products or achieve
profitable operations.
The Company was incorporated under the laws of the State of Delaware in July
1990. Unless the context requires otherwise, all references to the Company
include the Company's wholly-owned subsidiary, Network-1 Acquisition Corp.,
which was formed to acquire CommHome Systems Corporation upon the consummation
of this offering. The Company's executive offices are located at 70 Walnut
Street, Wellesley Hills, Massachusetts 02481 and its telephone number at that
address is (781) 239-8280. The Company intends to relocate its executive offices
to a new facility in the Boston, Massachusetts area following the consummation
of this offering. The Company's website can be found at
http://www.network-1.com.
4
<PAGE>
THE OFFERING
<TABLE>
<S> <C>
Common Stock offered.............. 1,875,000 shares
Common Stock to be outstanding
after the offering.............. 4,508,369 shares(1)
Use of Proceeds................... The Company intends to use the net proceeds of this
offering for sales and marketing; repayment of
indebtedness; software development; purchase of computer
equipment; payment of trade payables; establishing a new
office facility; and the balance for working capital and
general corporate purposes.
Risk Factors...................... The securities offered hereby involve a high degree of
risk and immediate substantial dilution to new investors
and should not be purchased by investors who cannot
afford the loss of their entire investment. See "Risk
Factors" and "Dilution."
Proposed Nasdaq SmallCap Market
symbol.......................... NSSI
</TABLE>
- ------------------------
(1) Does not include: (i) 187,500 shares of Common Stock reserved for issuance
upon exercise of the Underwriter's Warrants; (ii) 509,829 shares of Common
Stock reserved for issuance upon exercise of stock options granted under the
Company's 1996 Stock Option Plan (the "Stock Option Plan"); (iii) 240,171
shares of Common Stock reserved for issuance upon exercise of stock options
available for future grant under the Stock Option Plan; and (iv) 630,886
shares of Common Stock reserved for issuance upon exercise of other
outstanding warrants and options. See "Management--Stock Option Plan,"
"Description of Securities--Warrants and Options" and "Underwriting."
------------------------
NOTICE TO OHIO, SOUTH CAROLINA AND WASHINGTON INVESTORS: Each purchaser of
Common Stock in Ohio, South Carolina and Washington must be an "accredited
investor" as that term is defined in Rule 501(a) of Regulation D promulgated
under the Securities Act.
5
<PAGE>
SUMMARY FINANCIAL INFORMATION
The summary financial information set forth below is derived from and should
be read in conjunction with the financial statements, including the notes
thereto, and "Management's Discussion and Analysis of Financial Condition and
Results of Operations," contained elsewhere in this Prospectus.
STATEMENT OF OPERATIONS DATA:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, SIX MONTHS ENDED JUNE 30,
---------------------------- ---------------------------
1996 1997 1997 1998
------------- ------------- ------------ -------------
<S> <C> <C> <C> <C>
Total revenues......................................... $ 1,027,000 $ 2,369,000 $ 1,427,000 $ 902,000
Loss from operations................................... (4,239,000) (1,837,000) (640,000) (1,552,000)
Net loss............................................... (4,499,000) (2,390,000) (781,000) (1,990,000)
Loss per share (1)..................................... (2.46) (1.29) (.40) (1.17)
Weighted average number of shares
outstanding.......................................... 1,825,163 1,855,244 1,934,334 1,699,120
</TABLE>
BALANCE SHEET DATA:
<TABLE>
<CAPTION>
DECEMBER 31, 1997 JUNE 30, 1998
----------------- -----------------------------
ACTUAL ACTUAL AS ADJUSTED(2)
----------------- ------------- --------------
<S> <C> <C> <C>
Cash and cash equivalents...................................... $ 60,000 $ 634,000 $ 9,882,000
Working capital (deficit)...................................... (661,000) (2,429,000) 11,056,000
Total assets................................................... 2,404,000 3,129,000 12,027,000
Total liabilities.............................................. 2,479,000 3,707,000 806,000
Accumulated deficit............................................ (7,470,000) (9,460,000) (10,656,000)
Total stockholders' equity (deficit)........................... (75,000) (578,000) 11,221,000
</TABLE>
- ------------------------
(1) See Notes A and B to Notes to Financial Statements for an explanation of
shares used in net loss per share calculations.
(2) Gives effect to (i) the sale of 1,875,000 shares of Common Stock offered
hereby and the application of the estimated net proceeds therefrom, (ii)
aggregate non-cash charges estimated to be $668,000 relating to the
amortization of the debt discount on $3,250,000 principal amount promissory
notes upon the repayment of such notes, plus accrued interest thereon, upon
consummation of this offering and (iii) the issuance of an aggregate of
48,125 shares of Common Stock, upon consummation of this offering, in
connection with the CommHome Acquisition and the satisfaction of an
aggregate of $105,000 of indebtedness of CommHome owed to certain officers
of the Company, and a charge related to the CommHome Acquisition for
purchased research and development of $469,000 (such adjustment, together
with the adjustment described in (ii) above, collectively the "Offering
Adjustments"). See "Use of Proceeds," "Business--CommHome Systems
Corporation Acquisition" and "Capitalization."
6
<PAGE>
RISK FACTORS
AN INVESTMENT IN THE SHARES OF COMMON STOCK OFFERED HEREBY IS SPECULATIVE
AND INVOLVES A HIGH DEGREE OF RISK AND SHOULD NOT BE PURCHASED BY ANYONE WHO
CANNOT AFFORD THE LOSS OF THEIR ENTIRE INVESTMENT. EACH PROSPECTIVE INVESTOR
SHOULD CAREFULLY CONSIDER THE FOLLOWING RISK FACTORS AS WELL AS THE OTHER
INFORMATION SET FORTH IN THIS PROSPECTUS IN EVALUATING AN INVESTMENT IN THE
SHARES OF COMMON STOCK OFFERED HEREBY. THIS PROSPECTUS CONTAINS FORWARD-LOOKING
STATEMENTS BASED UPON CURRENT EXPECTATIONS THAT INVOLVE RISKS AND UNCERTAINTIES.
THE COMPANY'S ACTUAL RESULTS AND THE TIMING OF CERTAIN EVENTS MAY DIFFER
MATERIALLY FROM THOSE DISCUSSED IN SUCH FORWARD-LOOKING STATEMENTS AS A RESULT
OF CERTAIN FACTORS, INCLUDING, BUT NOT LIMITED TO, THOSE SET FORTH IN THE
FOLLOWING RISK FACTORS AND ELSEWHERE IN THIS PROSPECTUS.
LIMITED RELEVANT OPERATING HISTORY; SIGNIFICANT AND CONTINUING LOSSES;
EXPLANATORY PARAGRAPH IN INDEPENDENT PUBLIC ACCOUNTANT'S REPORT. Although the
Company was organized in July 1990, it was engaged primarily in providing
network consulting and training services through 1994 and did not commence
marketing of its first FIREWALL/PLUS product until June 1995. Accordingly, the
Company has a limited relevant operating history as a software developer upon
which an evaluation of its prospects and future performance can be made. Such
prospects must be considered in light of the risks, expenses and difficulties
frequently encountered in the operation and expansion of a new business and the
shift from research and product development to commercialization of products
based on rapidly changing technologies in a highly specialized and emerging
market. Since inception, the Company has incurred significant net losses,
including net losses of $4,499,000, $2,390,000 and $1,990,000 for the years
ended December 31, 1996, December 31, 1997 and the six months ended June 30,
1998, respectively. At June 30, 1998, the Company had an accumulated deficit of
$9,460,000 and, since June 30, 1998, the Company has continued to incur
significant and increasing losses. The Company will also incur aggregate
non-cash charges upon consummation of this offering of approximately $1,137,000
relating to (i) the amortization of debt discount with respect to $3,250,000
principal amount promissory notes which will be repaid in full, together with
accrued interest thereon, upon consummation of this offering and (ii) purchased
research and development in connection with the CommHome Acquisition. In
addition, the Company will incur additional non-cash charges of $572,000 over
the vesting period related to stock options issued in May 1998 to Avi A. Fogel,
President and Chief Executive Officer of the Company. Inasmuch as the Company
intends to increase its level of activities following the consummation of this
offering and will be required to make significant up-front capital expenditures
in connection with its sales and marketing and continuing research and product
development efforts, the Company anticipates that losses will continue until
such time, if ever, as the Company is able to attain sales levels sufficient to
support its operations. There can be no assurance that the Company will ever
achieve significantly increased revenues or profitable operations. The Company's
independent auditors have included an explanatory paragraph in their report on
the Company's financial statements for the years ended December 31, 1996 and
December 31, 1997, stating that certain factors raise substantial doubt about
the Company's ability to continue as a going concern. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations,"
"Certain Transactions" and Financial Statements.
SIGNIFICANT CAPITAL REQUIREMENTS; WORKING CAPITAL DEFICIT; DEPENDENCE ON
PROCEEDS FOR PLAN OF OPERATION; CONTINUING NEED FOR ADDITIONAL FINANCING. The
Company's capital requirements have been and will continue to be significant,
and its cash requirements have been exceeding its cash flow from operations. At
June 30, 1998, the Company had a working capital deficit of $2,429,000. As a
result, the Company has been substantially dependent on private sales of equity
and debt securities to fund its operations. The Company is dependent on the
proceeds of this offering to implement its business plan and finance its working
capital requirements. The Company anticipates, based on currently proposed plans
and assumptions relating to the implementation of its business plan (including
the timetable of, costs and expenses associated with, and success of, its
marketing efforts), that the net proceeds of this offering, together with
projected revenues from operations, will be sufficient to satisfy the Company's
operations and capital requirements for approximately twelve months following
the consummation of this offering. There can be no assurance,
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however, that such funds will not be expended prior thereto due to unanticipated
changes in economic conditions or other unforeseen circumstances. In the event
the Company's plans change or its assumptions change or prove to be inaccurate
(due to unanticipated expenses, difficulties, delays or otherwise) or the net
proceeds of this offering and projected revenues otherwise prove to be
insufficient to fund the implementation of the Company's business plan or
working capital requirements, the Company could be required to seek additional
financing sooner than currently anticipated. The Company has no current
arrangements with respect to any additional financing. Consequently, there can
be no assurance that any additional financing will be available to the Company
when needed, on commercially reasonable terms or at all. Any inability to obtain
additional financing when needed would have a material adverse effect on the
Company, requiring it to curtail and possibly cease its operations. In addition,
any additional equity financing may involve substantial dilution to the
interests of the Company's then existing stockholders. See "Use of Proceeds" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
UNCERTAINTY OF MARKET ACCEPTANCE OF PRODUCTS. The future success of the
Company is largely dependent upon market acceptance of its FIREWALL/PLUS family
of software products. The network security market is at an early stage of
development and is rapidly evolving. Accordingly, demand for the Company's
products and market acceptance are subject to a high level of uncertainty. While
the Company believes that its FIREWALL/PLUS family of software products offers
advantages over competing products for network security, revenue from licenses
of FIREWALL/PLUS products since introduction (June 1995) through June 30, 1998
have been only $2,561,000, including a non-refundable prepaid royalty of
$500,000. There can be no assurance that FIREWALL/PLUS will gain market
acceptance. Revenues from such products depend on a number of factors, including
the influence of market competition, technological changes in the network
security market, the Company's ability to design, develop and introduce
enhancements on a timely basis, and the ability of the Company to successfully
establish and maintain distribution channels. Moreover, there are commercially
available competitive products, offered by companies with significantly greater
resources than the Company, which have comparable or more favorable price
characteristics and which may be perceived to have performance characteristics
comparable to the Company's products. In addition, the Company anticipates the
introduction of additional competitive products, particularly if the demand for
network security products continues to increase. Existing and future competition
may make it more difficult to achieve market acceptance for FIREWALL/PLUS.
Additionally, potential customers may be reluctant to purchase the Company's
products due to significant investments in other network security products.
Consequently, although the Company intends to utilize a significant portion of
the proceeds of this offering to expand its marketing and sales activities,
there can be no assurance that such funds will be sufficient, that the Company's
increased marketing efforts and expenditures will result in significant levels
of revenue or that the FIREWALL/PLUS family of products will achieve significant
market acceptance. Moreover, a highly publicized breach of network security
involving the Company's products could adversely affect public perception of,
and confidence in, the Company's products. See "Use of Proceeds,"
"Business--Sales and Marketing" and "Business--Competition."
LIMITED MARKETING CAPABILITIES AND EXPERIENCE; DEPENDENCE UPON THIRD-PARTY
MARKETING ARRANGEMENTS. The Company has not yet undertaken significant marketing
efforts relating to product commercialization, has limited marketing experience
and has limited financial, personnel and other resources to undertake extensive
marketing activities independently. Accordingly, the Company has relied and
intends to continue to rely to a large extent on arrangements with third parties
for the marketing and distribution of its products, including arrangements with
VARs, systems integrators, resellers, distributors and OEMs. The Company has
only recently entered into marketing arrangements with most of its distributors
and, to date, most of such arrangements have generated limited revenues. For the
year ended December 31, 1997 and the six months ended June 30, 1998, the
Company's five largest distributors accounted for an aggregate of approximately
28% and 25% of the Company's revenues, respectively. Trusted Information
Systems, Inc. (as a result of a non-refundable pre-paid royalty), Electronic
Data Systems Corporation ("EDS") and Atlantic Richfield Company and related
entities ("ARCO") accounted for 21%, 15% and
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13%, of the Company's revenues, respectively, for the year ended December 31,
1997, and The City of Hope, EDS and The Sabre Group, Inc. accounted for 32%, 17%
and 11% of the Company's revenues, respectively, for the six months ended June
30, 1998. The Company's prospects will be dependent upon its ability to develop
and maintain strategic marketing relationships with additional third parties and
upon the marketing and distribution efforts of its third-party distributors.
While the Company believes that the third parties with which it enters into
marketing arrangements have an economic incentive to commercialize the Company's
products, the time and resources devoted to these activities will be contributed
and controlled by such third parties. Many of the Company's third-party
distributors represent various product lines, including those competing with the
Company's products. A decline in the prospects of key distributors could have an
adverse effect on the Company. There can be no assurance that the Company will
be able, for financial or other reasons, to finalize any additional third-party
distribution or marketing arrangements, maintain its existing marketing and
distribution arrangements or that any such arrangements will result in the
successful commercialization of the Company's products. See "Business--Sales and
Marketing."
COMPETITION. The network security market in general, and the firewall
product market in particular, is characterized by intense competition and
rapidly changing business conditions, customer requirements and technologies.
The Company believes that the principal competitive factors affecting the market
for network security products include security effectiveness, scope of product
offerings, name recognition, product features, distribution channels, price,
ease of use and customer service and support. Currently, the Company's principal
competitors include AXENT Technologies Inc., Bay Networks, Inc., CheckPoint
Software Technologies, Ltd., Cisco Systems, Inc., Compaq Computer Corporation,
Cyberguard Corp., International Business Machines Corporation, ISS Group, Inc.,
Microsoft Corporation, Network Associates, Inc. and Secure Computing
Corporation. Due to the rapid expansion of the network security market, the
Company may face competition from new entrants to the firewall product market.
Most of the Company's current and potential competitors have longer operating
histories, greater name recognition, larger installed customer bases and possess
substantially greater financial, technical and marketing and other competitive
resources than the Company. As a result, the Company's competitors may be able
to adapt more quickly to new or emerging technologies and changes in customer
requirements or to devote greater resources to the promotion and sale of their
products than the Company. While the Company believes that its firewall products
do not compete against manufacturers of other types of security products (such
as encryption and authentication products), there can be no assurance that
potential customers will not perceive the products of such other companies as
substitutes for the Company's products. In addition, certain of the Company's
competitors may determine for strategic reasons to consolidate, to substantially
lower the price of their network security products or to bundle their products
with other products, such as hardware or other enterprise software products.
Accordingly, it is possible that new competitors and alliances among competitors
may emerge and rapidly acquire significant market share. There can be no
assurance that the Company's current and potential competitors will not develop
products that may be more effective than the Company's current or future
products or that the Company's products would not be rendered obsolete or less
marketable by evolving technologies or changing consumer demands or that the
Company will otherwise be able to compete successfully. Increased competition
for firewall products may result in price reductions and reduced gross margins
and may adversely effect the Company's ability to gain market share, any of
which would adversely affect the Company's business, operating results and
financial condition. See "Business--Competition."
RAPID TECHNOLOGICAL CHANGE; POTENTIAL PRODUCT OBSOLESCENCE. The network
security industry is characterized by rapid technological advances, increasingly
sophisticated and changing customer requirements, frequent new product
introductions and enhancements, new and continuously evolving network security
threats and attack methodologies and evolving industry standards in computer
hardware and software technology. As a result, the Company must continually
change and improve its products in response to such advances and changes in
operating systems, application software, computer and communications hardware,
networking software, programming tools and computer language technology. The
introduction
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of products embodying new technologies and the emergence of new industry
standards may render existing products obsolete or unmarketable. The Company's
future operating results will depend upon the Company's ability to enhance its
current products and to develop and introduce new products on a timely basis
that address the increasingly sophisticated needs of the marketplace and that
keep pace with technological developments, new competitive product offerings and
emerging industry standards. There can be no assurance that the Company will be
successful in developing and marketing new products or product enhancements that
respond to technological change and evolving industry standards and customer
requirements, that the Company will not experience difficulties that could delay
or prevent the successful development, introduction and marketing of these
products, or that any new products and product enhancements will adequately meet
the requirements of the marketplace and achieve market acceptance. In the event
that the Company does not respond adequately to the need to develop and
introduce new products or enhancements of existing products in a timely manner
in response to changing market conditions or customer requirements, the
Company's business, operating results and financial condition will be materially
adversely affected. See "Business--Product Development."
UNPROVEN MARKET FOR INTERNAL NETWORK SECURITY PRODUCTS. Many of the
Company's competitors in the firewall market have largely devoted their
resources to the development and marketing of perimeter firewall products ("IP
Firewalls") designed primarily to protect an internal network from internet
based security threats or threats from within intranets. While TCP/IP is a
dominant network transport protocol, network environments often use other
network transport protocols such as Novell's IPX, Digital Equipment's DECnet and
IBM's SNA. The Company believes that the ability of the FIREWALL/PLUS technology
to filter all commonly used network transport protocols and reside in multiple
locations throughout the enterprise network offers significant advantages as a
security product for internal networks. However, the Company's limited sales to
date have not established that, in fact, this is a significant marketing
advantage. The Company's future success depends in large part on the Company's
ability to successfully market its technology and the increased awareness and
demand in the market for the need to address security threats that arise from
within internal networks which may require substantial marketing efforts and the
expenditure of significant funds. Furthermore, firewall vendors and other
vendors of network security products with substantially greater financial,
technical and marketing resources than the Company may modify existing security
products or develop new products which would address the internal network
security market. The Company's failure to successfully implement marketing
efforts emphasizing the internal network security market would have a material
adverse effect on its business, financial condition and results of operations in
the future. See "Business--Network-1 Strategy" and "Business--FIREWALL/PLUS
Technology."
SIGNIFICANT FLUCTUATIONS IN QUARTERLY OPERATING RESULTS. The Company
anticipates significant quarterly fluctuations in its operating results in the
future. The Company generally ships orders for commercial products as they are
received and, as a result, does not have any material backlog. As a result,
quarterly revenues and operating results depend on the volume and timing of
orders received during the quarter, which are difficult to forecast. Operating
results may also fluctuate on a quarterly basis due to factors such as the
demand for the Company's products, purchasing patterns and budgeting cycles of
customers, the introduction of new products and product enhancements by the
Company or its competitors, market acceptance of new products introduced by the
Company or its competitors and the size, timing, cancellation or delay of
customer orders, including cancellation or delay in anticipation of new product
introduction or enhancement. Therefore, comparisons of quarterly operating
results may not be meaningful and should not be relied upon, nor will they
necessarily reflect the Company's future performance. Because of the foregoing
factors, it is likely that in some future quarters the Company's operating
results will be below the expectations of public market analysts and investors.
In such event, the price of the Common Stock would likely be materially
adversely affected. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
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PROPOSED EXPANSION; MANAGEMENT OF GROWTH; NEED FOR QUALIFIED
PERSONNEL. Following the consummation of this offering, the Company intends to
use a substantial portion of the proceeds to expand its current level of
operations and expects to significantly increase the number of its employees.
This growth will result in an increase in responsibilities placed upon the
Company's management and will place added pressures on the Company's operating
and financial resources. The Company's success will be dependent in part on its
ability to manage its growth, recruit additional management personnel, expand
its sales and marketing personnel and research and development staff, improve
its operational and financial systems, expand its customer support functions and
train, motivate and manage additional employees, monitor operations and control
costs. Competition with respect to the recruiting of highly qualified personnel
in the software industry is intense and many of the Company's competitors have
significantly greater resources than the Company. The Company's ability to
attract and assimilate new personnel will be critical to the Company's
performance and there can be no assurance that the Company will be successful in
attracting and retaining the personnel it requires to enhance its products,
develop new products and conduct its operations successfully. Moreover, the
Company may also use a portion of the net proceeds for the acquisition of
businesses, technologies or products which it believes are complimentary to
those of the Company, although there are currently no commitments or agreements
with respect to any such acquisitions as of the date of this prospectus, except
for the acquisition of CommHome. See "Business--CommHome Systems Corporation
Acquisition."
LIMITED PROTECTION OF PROPRIETARY RIGHTS; RELIANCE ON TRADE SECRETS. The
Company's success is substantially dependent on its proprietary technologies.
The Company does not hold any patents and relies on copyright and trade secret
laws, non-disclosure agreements with employees, distributors and customers,
including "shrink wrap" license agreements that are not signed by the customer,
and technical measures to protect the ideas, concepts and documentation of its
proprietary technologies and know-how to protect its intellectual property
rights. Such methods may not afford complete protection, and there can be no
assurance that third parties will not independently develop substantially
equivalent or superior technologies or obtain access to the Company's
technologies, ideas, concepts and documentation. In addition, there can be no
assurance that any confidentiality agreements between the Company and its
employees, distributors or customers will provide meaningful protection for the
Company's proprietary information in the event of any unauthorized use or
disclosure. Furthermore, the Company may be subject to additional risk as it
enters into transactions in countries where intellectual property laws are not
well developed or are poorly enforced. Legal protection of the Company's rights
may be ineffective in such countries. The inability of the Company to protect
its proprietary technologies could have a material adverse effect on the
Company. The Company also licenses from a third-party certain proxy technology
which is incorporated into its FIREWALL/PLUS products. The Company is dependent
in part on its ability to continue to license such technology and any inability
of the Company to be able to continue to utilize such technology either as a
result of the Company's breach or the termination of the license agreement or
otherwise, in the absence of similar available technologies, could have a
material adverse effect on the Company.
The Company received a U.S. trademark registration for the FIREWALL/PLUS
name in December 1996. Although the Company is not aware of any challenges to
the Company's rights to use this trademark, there can be no assurance that the
use of this mark would be upheld if challenged. See "Business--Proprietary
Rights."
POTENTIAL INFRINGEMENT ON INTELLECTUAL PROPERTY RIGHTS OF OTHERS. Although
the Company believes that its technologies and products have been developed
independently and do not infringe upon the proprietary rights of others, there
can be no assurance that the Company's technologies and products do not and will
not so infringe or that third parties will not assert infringement claims
against the Company in the future. The Company is not aware of any patent
infringement charge or any violation of other proprietary rights claimed by any
third party relating to the Company or the Company's products. In response to
certain public statements made by CheckPoint Software Technologies, Ltd. related
to a patented technology referred to as "stateful inspection" (the "Checkpoint
Patent"), the Company retained patent counsel in
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April 1997 to review the Checkpoint Patent as compared to the Company's
intellectual property and associated products. Based upon the opinion of the
Company's intellectual property counsel, the Company does not believe that the
CheckPoint Patent will have a material adverse effect on the Company. If,
however, the Company's technologies or products were deemed to infringe upon the
Checkpoint Patent, or if the Company's technologies or products were deemed to
infringe upon the proprietary rights of other third parties, the Company could
become liable for damages or be required to modify its products or to obtain a
license. As the number of and variety of security products being offered
continue to increase the functionality of such products may further overlap,
which could result in increased infringement claims by software developers,
including infringement claims against the Company with respect to future
products. There can be no assurance that the Company would be able to modify its
products or obtain a license in a timely manner, upon acceptable terms and
conditions, or at all, or that the Company will have the financial or other
resources necessary to defend a patent infringement or other proprietary rights
infringement action. Failure to do any of the foregoing could have a material
adverse effect on the Company, including possibly requiring the Company to cease
marketing its products. See "Business--Proprietary Rights."
DEPENDENCE ON REVENUES FROM LIMITED PRODUCT LINE; NON-RECURRING
REVENUES. Since 1996, a substantial portion of the Company's revenues have been
derived from licenses of its FIREWALL/PLUS products. For the year ended December
31, 1997 and the six months ended June 30, 1998, revenues from FIREWALL/PLUS
products accounted for approximately 60% and 35% of the Company's revenues,
respectively. A decline in revenues from FIREWALL/PLUSproducts would have a
material adverse effect on the Company. In addition, revenues from the Company's
products are generally non-recurring in nature. There can be no assurance that
the Company will not remain dependent upon non-recurring revenues from
FIREWALL/PLUS products licensed to a limited number of customers, which revenues
could constitute a considerable portion of the Company's revenues. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
DEPENDENCE ON CONTINUED GROWTH OF THE INTERNET AND INTERNAL NETWORKS. Since
the Company's products are designed to protect internal networks from
unauthorized access and attacks via the Internet and from within internal
networks, the Company's success is substantially dependent upon the widespread
acceptance and use of the Internet, intranets and extranets as effective means
of communication and commerce. Rapid growth in the use of and interest in the
Internet, intranets and extranets is a recent phenomenon, and there can be no
assurance that acceptance and use will continue to develop or that a
sufficiently broad base of consumers will adopt and continue to use the
Internet, intranets and extranets as means of communication and commerce. The
Internet may not be accepted as a viable commercial marketplace for a number of
reasons, including potentially inadequate development of the necessary network
infrastructure or delayed development of enabling technologies and performance
improvements. If use of the Internet does not continue to grow or grows more
slowly than expected, if the infrastructure for the Internet does not
effectively support growth that may occur, or if the Internet and online
services do not become a viable commercial marketplace, market demand for the
Company's products may not develop or be maintained. See "Business--Industry
Background."
FOCUS ON WINDOWS NT PLATFORM. Currently, the Windows NT operating system is
the principal platform for the Company's FIREWALL/PLUS family of products.
According to a recent International Data Corporation survey, Windows NT
shipments are expected to assume a majority market share by 1999. While the
Windows NT platform is perceived to have security weaknesses, many of the
Company's competitors currently offer Windows NT based firewalls and the Company
believes that the use of Windows NT as the preferred operating system will
continue to grow dramatically over the next five years. In the event that demand
for Windows NT based firewalls declines, or other platforms become the preferred
platforms, and the Company is unable to adapt its products to the preferred
platforms on a timely basis, the Company's business, financial condition and
results of operations may be materially adversely affected. See
"Business--Industry Background" and "Business--FIREWALL/PLUS Technology."
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POTENTIAL LIABILITY EXPOSURE. Since the Company's products are network
security products and are used to prevent unauthorized access to and attacks
upon critical enterprise information, the Company may be exposed to potential
liability claims for damage caused to a network as a result of an actual or
alleged failure of an installed product. Although the Company's license
agreements typically contain provisions that are designed to limit the Company's
exposure to potential product liability or related claims, including provisions
that limit the Company's liability for special, consequential or incidental
damages, there can be no assurance that such provisions will be enforceable
under the laws of applicable domestic or foreign jurisdictions. The Company's
consulting engagements often involve development, implementation and maintenance
of networking systems that are critical to the operations of its clients'
businesses. The Company's failure or inability to meet a client's expectations
in the performance of its services could harm the Company's business reputation
or result in a claim for substantial damages against the Company, regardless of
the Company's responsibility for such failure or inability. In addition, in the
course of performing services, the Company's personnel often gain access to
technologies and content which include confidential or proprietary client
information. Any unauthorized disclosure or use of such information could result
in a claim for substantial damages. The Company currently maintains product
liability insurance coverage in the amount of $1,000,000 per occurrence
($2,000,000 in the aggregate) that, subject to customary exclusions, covers
claims resulting from failure of the Company's products or services to perform
the function or to serve the purpose intended. There can be no assurance that
the Company's insurance will be sufficient to cover potential claims or that
adequate levels of coverage will be available in the future at reasonable cost.
A partially or completely uninsured successful claim against the Company could
have a material adverse effect on the Company. See "Business--Proprietary
Rights."
RISK OF PRODUCT DEFECTS. Software products as complex as those offered by
the Company may contain undetected errors or result in failures when first
introduced or when new versions are released. In particular, the personal
computer hardware environment is characterized by a wide variety of non-standard
configurations that make pre-release testing for programming or compatibility
errors very difficult and time-consuming. Despite testing by the Company and by
current and potential customers, there can be no assurance that errors will not
be found in new products or enhancements after commencement of commercial
shipments. The occurrence of these errors could result in adverse publicity,
loss of or delay in market acceptance, claims by customers against the Company,
or could cause the Company to incur additional costs, any of which could have a
material adverse effect upon the Company's business, operating results and
financial condition. See "Business--Products" and "Business--Product
Development."
LENGTHY SALES CYCLE. Licensing of the Company's software products generally
involves a significant commitment of capital by customers, with the attendant
delays frequently associated with large capital expenditures for complex
technology. Accordingly, the sales cycle for the Company's products can be
lengthy and generally commences at the time a prospective customer demonstrates
an interest in purchasing a FIREWALL/PLUS solution, typically includes a 30-day
free evaluation period and ends upon execution of a purchase order by the
customer. The length of the sales cycle varies depending on the type and
sophistication of the customer and the complexity of the operating system and
may extend for periods of six to nine months. As a result of the Company's
lengthy sales cycle, sales of the Company's products generally require the
Company to make expenditures and use significant resources prior to receipt, if
any, of corresponding revenues. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
LICENSING IN FOREIGN MARKETS. The Company relies on software licenses to
foreign customers for a portion of its revenues. For the years ended December
31, 1996 and 1997 and the six months ended June 30, 1998, licensing of the
Company's software products to foreign customers accounted for approximately 7%,
16% and 2%, respectively, of the Company's revenues. The Company is seeking to
increase the licensing of its products in foreign markets, but there can be no
assurance that the Company will be successful or that such markets will prove to
be viable. To the extent that the Company is able to successfully expand its
licenses to foreign markets, the Company will become increasingly subject to
risks
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inherent in foreign trade, including shipping delays, increased collection
risks, trade restrictions, export duties and tariffs and international
political, regulatory and economic developments, all of which could have an
adverse effect on the Company's operating margins and results of operations and
exacerbate the risks inherent in the Company's business. The Company may seek to
limit its exposure to the risk of currency fluctuations by engaging in foreign
currency hedging transactions that could expose the Company to substantial risk
of loss. The Company is not currently engaged in any currency hedging or other
activities involving derivative financial instruments. The Company has limited
experience in managing international transactions and has not yet formulated a
strategy to protect the Company against currency fluctuations. See
"Business--Sales and Marketing."
DEPENDENCE UPON KEY PERSONNEL; NEW MANAGEMENT. The success of the Company
will be largely dependent on the personal efforts of Avi A. Fogel, President and
Chief Executive Officer, William Hancock, Chief Technology Officer, and Robert
P. Olsen, Vice President of Product Management. Although the Company has entered
into employment agreements with each of Messrs. Fogel, Hancock and Olsen, the
loss of the services of any of such officers could have a material adverse
effect on the Company's business and prospects. Prior to the consummation of
this offering, the Company will obtain "key-man" life insurance on each of the
lives of Messrs. Fogel and Olsen in the amount of $2,000,000. The Company is
currently seeking "key-man" life insurance on the life of Mr. Hancock, however,
there is no certainty that such insurance may be obtained at reasonable cost.
Messrs. Fogel and Olsen as well as Murray P. Fish, Chief Financial Officer, only
joined the Company in May 1998. In addition, Joseph A. Donohue, Vice President
of Engineering, and Joseph D. Harris, Vice President of International Sales,
only joined the Company in July 1998 and August 1998, respectively. There can be
no assurance that such officers will become sufficiently familiar with the
Company's operations on a timely basis, or at all. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations" and "Management."
CONTROL BY MANAGEMENT. Upon consummation of this offering, the Company's
officers and directors, will beneficially own, in the aggregate, approximately
38.0% of the outstanding Common Stock. Accordingly, such persons will continue
to exert significant influence over the outcome of all matters submitted to a
vote of the holders of Common Stock, including the election of directors,
amendments to the Company's Certificate of Incorporation and approval of
significant corporate transactions. Such consolidation of voting power could
also have the effect of delaying, deterring or preventing a change in control of
the Company that might be beneficial to other stockholders. See "Management" and
"Principal Stockholders."
USE OF PROCEEDS TO REPAY INDEBTEDNESS AND TRADE PAYABLES; BENEFITS TO
RELATED PARTIES. The Company has allocated approximately $3,537,000 (28.0%) of
the net proceeds of this offering to repay outstanding indebtedness, including
$1,900,000 principal amount of notes, plus accrued interest thereon, payable to
Applewood Associates, L.P., a principal stockholder of the Company, $200,000
principal amount of notes plus accrued interest thereon, payable to CMH Capital
Management Corp., whose sole stockholder is Corey M. Horowitz, Chairman of the
Board of Directors and a principal stockholder of the Company, and $50,000
principal amount of a note plus interest payable to Mr. Horowitz. Furthermore,
the Company has allocated approximately $500,000 (4.0%) to pay past due trade
payables upon consummation of this offering. In addition, simultaneously with
the consummation of this offering, the Company is acquiring CommHome, of which
Avi A. Fogel is President and Chief Executive Officer and a principal
stockholder, in exchange for 35,000 shares of Common Stock and the assumption of
approximately $200,000 of liabilities, of which $55,000 and $50,000 are owed to
Mr. Fogel and Robert P. Olsen, Vice President of Product Management,
respectively. Messrs. Fogel and Olsen have agreed to cancel such obligations in
exchange for the issuance of 6,875 and 6,250 shares of Common Stock,
respectively, upon the consummation of this offering. See "Use of Proceeds,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Certain Transactions."
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POTENTIAL CONFLICTS OF INTERESTS AS TO PRIOR TRANSACTIONS. The Company has
from time to time entered into transactions with certain of its officers,
directors and principal stockholders and their affiliates. Although the Company
believes that transactions with such persons and their affiliates were on terms
no less favorable than could have been obtained from unaffiliated third parties,
the Company lacked sufficient disinterested independent directors at the time of
certain of such transactions. See "Certain Transactions."
BROAD DISCRETION IN APPLICATION OF PROCEEDS. Approximately $1,813,000
(14.4%) of the estimated net proceeds of this offering has been allocated to
working capital and general corporate purposes. Management will have broad
discretion as to the application of such proceeds. Furthermore, to the extent
cash flow from operations is insufficient for such purposes, a portion of the
proceeds allocated to working capital may be utilized to pay a portion of the
salary of the Company's officers over the twelve months following the
consummation of this offering (such aggregate salaries estimated to be
approximately $850,000). See "Use of Proceeds."
IMMEDIATE AND SUBSTANTIAL DILUTION. This offering involves an immediate and
substantial dilution of $5.51 per share (or 68.9%) between the adjusted net
tangible book value per share of Common Stock after this offering and the
initial public offering price per share. See "Dilution."
NO DIVIDENDS. The Company has never paid any dividends on its Common Stock
and does not anticipate paying cash dividends in the foreseeable future. The
Company currently intends to retain all earnings for use in connection with the
operation and expansion of its business. The declaration and payment of future
dividends, if any, will be at the sole discretion of the Company's Board of
Directors and will depend upon a variety of factors, including future earnings,
if any, operations, capital requirements, the general financial condition of the
Company, the preferences of any series of Preferred Stock which may be
designated in the future, the general business conditions and future contractual
restrictions on payments of dividends, if any. See "Dividend Policy" and
"Description of Securities--Common Stock."
SHARES ELIGIBLE FOR FUTURE SALE; REGISTRATION RIGHTS. Upon the consummation
of this offering, the Company will have 4,508,369 shares of Common Stock
outstanding, of which the 1,875,000 shares being offered hereby will be freely
tradeable without restriction or further registration under the Securities Act.
All of the remaining 2,633,369 shares of Common Stock outstanding are
"restricted securities," as that term is defined in Rule 144 promulgated under
the Securities Act, and in the future may be sold only pursuant to an effective
registration statement under the Securities Act, in compliance with the
exemption provisions of Rule 144, on various dates commencing 90 days following
the date of this Prospectus, or pursuant to another exemption under the
Securities Act. The Company has granted certain registration rights with respect
to an aggregate of 1,126,750 shares of Common Stock, and the Company has granted
the Underwriter demand and piggyback registration rights with respect to the
shares of Common Stock issuable upon exercise of the Underwriter's Warrants. No
prediction can be made as to the effect, if any, that sales of such securities
or the availability of such securities for sale will have on the market prices
prevailing from time to time. While all of the Company's principal
securityholders, officers and directors, have agreed not to (i) sell or
otherwise dispose of any shares of Common Stock in any public market transaction
(including pursuant to Rule 144) or (ii) exercise any registration rights for a
period of twelve months following the date of this Prospectus without the
Underwriter's prior written consent, the possibility that a substantial number
of the Company's securities may be sold in the public market may adversely
affect prevailing market prices for the Common Stock and could impair the
Company's ability to raise capital through the sale of its equity securities.
See "Description of Securities" and "Shares Eligible for Future Sale."
SIGNIFICANT OUTSTANDING OPTIONS AND WARRANTS; POTENTIAL ADVERSE EFFECT ON
MARKET PRICE OF COMMON STOCK. Upon the consummation of this offering, there will
be outstanding options and warrants to purchase an aggregate of 1,328,215 shares
of Common Stock (including 187,500 shares of Common Stock issuable upon exercise
of the Underwriter's Warrants) at exercise prices ranging from $1.61 to $13.20
per share. To the extent that outstanding options and warrants are exercised,
dilution to the percentage
15
<PAGE>
ownership of the Company's stockholders will occur and any sales in the public
market of the Common Stock underlying such options and warrants may adversely
affect prevailing market prices for the Common Stock. Moreover, the terms upon
which the Company will be able to obtain additional equity capital may be
adversely effected since the holders of outstanding options and warrants can be
expected to exercise them at a time when the Company would, in all likelihood,
be able to obtain any needed capital on terms more favorable to the Company than
those provided in the outstanding options and warrants. See "Management--Stock
Option Plan," "Description of Securities--Warrants and Options" and
"Underwriting."
NO ASSURANCE OF PUBLIC MARKET; ARBITRARY DETERMINATION OF OFFERING PRICE;
POSSIBLE VOLATILITY OF MARKET PRICE OF COMMON STOCK. Prior to this offering,
there has been no public trading market for the Common Stock. There can be no
assurance that a regular trading market for the Common Stock will develop after
this offering or that, if developed, it will be sustained. The initial public
offering price of the Common Stock has been determined arbitrarily by
negotiation between the Company and the Underwriter and is not necessarily
related to the assets, book value or potential earnings of the Company or any
other recognized criteria of value and may not be indicative of the prices that
may prevail in the public market. In addition, the market price for the Common
Stock following this offering may be highly volatile as has been the case with
the securities of other companies in emerging businesses. Factors such as the
Company's operating results, announcements of the Company or its competitors,
introduction of new products or technologies by the Company or its competitors
and various factors affecting the network security industry generally or the
market for firewall products in particular may have a significant impact on the
market price of the Common Stock. Additionally, in recent years, the stock
market has experienced a high level of price and volume volatility and market
prices for the stock of many companies, particularly of small and emerging
growth companies, the common stock of which trade in the over-the-counter
market, have experienced wide price fluctuations which have not necessarily been
related to the operating performance of such companies. See "Underwriting."
POSSIBLE DELISTING OF SECURITIES FROM NASDAQ SYSTEM; RISKS RELATING TO
LOW-PRICED STOCKS. It is currently anticipated that the Common Stock will be
eligible for listing on Nasdaq upon the completion of this offering. In order to
continue to be listed on Nasdaq, however, the Company must maintain $2,000,000
in net tangible assets (total assets, other than goodwill, less total
liabilities), and a $1,000,000 market value of the public float. In addition,
continued inclusion requires two market-makers, a minimum bid price of $1.00 per
share and adherence to certain corporate governance provisions. The failure to
meet these maintenance criteria in the future may result in the delisting of the
Common Stock from Nasdaq, and trading, if any, in the Common Stock would
thereafter be conducted in the non-Nasdaq over-the-counter market. As a result
of such delisting, an investor could find it more difficult to dispose of or to
obtain accurate quotations as to the market value of the Common Stock.
In addition, if the Common Stock were to become delisted from trading on
Nasdaq and the trading price of the Common Stock were to fall below $5.00 per
share, trading in the Common Stock would also be subject to the requirements of
certain rules promulgated under the Securities Exchange Act of 1934, as amended
(the "Exchange Act"), which require additional disclosure by broker-dealers in
connection with any trades involving a stock defined as a penny stock
(generally, any non-Nasdaq equity security that has a market price of less than
$5.00 per share, subject to certain exceptions). Such rules require the
delivery, prior to any penny stock transaction, of a disclosure schedule
explaining the penny stock market and the risks associated therewith and impose
various sales practice requirements on broker-dealers who sell penny stocks to
persons other than established customers and accredited investors (generally
defined as an investor with a net worth in excess of $1,000,000 or annual income
exceeding $200,000 individually or $300,000 together with a spouse). For these
types of transactions, the broker-dealer must make a special suitability
determination for the purchaser and have received the purchaser's written
consent to the transaction prior to the sale. The broker-dealer also must
disclose the commissions payable to the broker-dealer, current bid and offer
quotations for the penny stock and, if the broker-dealer is the sole market-
maker, the broker-dealer must disclose this fact and the broker-dealer's
presumed control over the market.
16
<PAGE>
Such information must be provided to the customer orally or in writing before or
with the written confirmation of trade sent to the customer. Monthly statements
must be sent disclosing recent price information for the penny stock held in the
account and information on the limited market in penny stocks. The additional
burdens imposed upon broker-dealers by such requirements could, in the event the
Common Stock were deemed to be a penny stock, discourage broker-dealers from
effecting transactions in the Common Stock which could severely limit the market
liquidity of the Common Stock and the ability of purchasers in this offering to
sell the Common Stock in the secondary market.
ADVERSE EFFECT OF THE AUTHORIZATION OF PREFERRED STOCK; ANTI-TAKEOVER
PROVISIONS AFFECTING STOCKHOLDERS. The Company's Certificate of Incorporation
authorizes the Company's Board of Directors to issue 5,000,000 shares of "blank
check" Preferred Stock and to fix the rights, preferences, privileges and
restrictions, including voting rights, of these shares, without further
stockholder approval. The rights of the holders of Common Stock will be subject
to and may be adversely affected by the rights of holders of any Preferred Stock
that may be issued in the future. The ability to issue Preferred Stock without
stockholder approval could have the effect of making it more difficult for a
third party to acquire a majority of the voting stock of the Company thereby
delaying, deferring or preventing a change in control of the Company. Moreover,
following the consummation of this offering, the Company will be subject to the
State of Delaware's "business combination" statute, which prohibits a
publicly-traded Delaware corporation from engaging in various business
combination transactions with any of its 15% stockholders for a period of three
years after the date of the transaction in which the person became an
"interested stockholder," unless certain approvals are obtained or other events
occur. The statute could prohibit or delay mergers or other attempted takeovers
or changes in control with respect to the Company and, accordingly, may
discourage attempts to acquire the Company. See "Description of Securities."
TAX LOSS CARRYFORWARD. The Company's net operating loss carryforwards
("NOLs") expire in the years 2009 to 2012. Under Section 382 of the Internal
Revenue Code of 1986, as amended, utilization of prior NOLs is limited after an
ownership change, as defined in Section 382, to an annual amount equal to the
value of the corporation's outstanding stock immediately before the date of the
ownership change multiplied by the long-term tax exempt rate. The additional
equity financing obtained by the Company in connection with recent financings
and this offering will result in an ownership change if the over-allotment
option is exercised and may otherwise result in an ownership change as a result
of subsequent issuances of securities and, thus, will limit the Company's use of
its prior NOLs. In the event the Company achieves profitable operations, any
significant limitation on the utilization of its NOLs would have the effect of
increasing the Company's tax liability and reducing net income and available
cash reserves. The Company is unable to determine the availability of such NOLs
since this availability is dependent upon profitable operations, which the
Company has not achieved in prior periods. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and Note H to Notes
to Financial Statements.
LIMITATIONS ON LIABILITY OF DIRECTORS AND OFFICERS. The Company's
Certificate of Incorporation includes provisions to eliminate, to the full
extent permitted by Delaware General Corporation Law as in effect from time to
time, the personal liability of directors of the Company for monetary damages
arising from a breach of their fiduciary duties as directors. The Certificate of
Incorporation also includes provisions to the effect that the Company shall, to
the maximum extent permitted from time to time under the law of the State of
Delaware, indemnify any director or officer to the extent that such
indemnification and advancement of expense is permitted under such law, as it
may from time to time be in effect. In addition, the Company's By-laws require
the Company to indemnify, to the fullest extent permitted by law, any director,
officer, employee or agent of the Company for acts which such person reasonably
believes are not in violation of the Company's corporate purposes as set forth
in the Certificate of Incorporation. See "Management--Limitation of Liability
and Indemnification Matters."
17
<PAGE>
USE OF PROCEEDS
The net proceeds to the Company from the sale of the 1,875,000 shares of
Common Stock offered hereby, (after deducting underwriting discounts and
commissions and other expenses of the offering) are estimated to be
approximately $12,610,000 ($14,595,625 if the Underwriter's over-allotment
option is exercised in full). The Company expects to use the net proceeds
(assuming no exercise of the Underwriter's over-allotment option) during the
twelve months following this offering approximately as follows:
<TABLE>
<CAPTION>
APPROXIMATE APPROXIMATE PERCENTAGE
APPLICATION OF NET PROCEEDS DOLLAR AMOUNT OF NET PROCEEDS
- -------------------------------------------------------------------------- -------------- -----------------------
<S> <C> <C>
Sales and marketing(1).................................................... $ 3,860,000 30.6%
Repayment of outstanding indebtedness(2).................................. 3,537,000 28.0
Software development(3)................................................... 2,100,000 16.6
Purchase of computer equipment(4)......................................... 500,000 4.0
Payment of trade payables(5).............................................. 500,000 4.0
Relocation of offices(6).................................................. 300,000 2.4
Working capital and general corporate purposes(7)......................... 1,813,000 14.4
-------------- -----
Total................................................................. $ 12,610,000 100.0%
-------------- -----
-------------- -----
</TABLE>
- ------------------------
(1) Represents (i) approximately $2,460,000 for sales, marketing and promotional
activities related to the Company's software products and (ii) approximately
$1,400,000 for the salaries and related costs of up to 15 additional sales
and marketing personnel. See "Business--Sales and Marketing."
(2) Represents amounts to repay (i) $3,250,000 principal amount of promissory
notes (the "Notes") issued in private offerings from February 1997 through
May 1998, plus estimated accrued interest thereon at annual rates between 6%
and 8%, including $1,900,000, $200,000 and $50,000 principal amount of Notes
held by Applewood Associates, L.P., a principal stockholder of the Company,
CMH Capital Management Corp., a corporation wholly-owned by Corey M.
Horowitz, Chairman of the Board of Directors and a principal stockholder of
the Company, and Mr. Horowitz, respectively, and (ii) approximately $95,000
of certain liabilities assumed by the Company in connection with the
CommHome Acquisition and paid upon consummation of this offering. The
Company used the net proceeds from the issuance of the Notes for working
capital and general corporate purposes. See "Business--CommHome Systems
Corporation Acquisition" and "Certain Transactions."
(3) Represents estimated costs associated with software development, including
the salaries of up to 17 additional software engineers and developers. See
"Business--Product Development."
(4) Represents expenditures to purchase hardware and software as well as servers
and test equipment for the Company's operations.
(5) Represents estimated past due trade payables to be paid upon the
consummation of this offering. See Financial Statements.
(6) Represents costs associated with relocating the Company's principal office
location to the Boston, Massachusetts area, including rent and related
costs. See "Business--Facilities."
(7) Represents amounts which may be used to pay a portion of the compensation
for executive officers (such aggregate salaries are estimated to be $850,000
during the twelve months following the consummation of this offering), rent,
trade payables, consulting fees and professional fees.
If the Underwriter's over-allotment option is exercised in full, the Company
will realize additional net proceeds of $1,985,625, which will be allocated to
working capital and general corporate purposes.
The allocation of the net proceeds from this offering set forth above
represents the Company's best estimate based upon its currently proposed plans
and assumptions relating to its operations and certain
18
<PAGE>
assumptions regarding general economic conditions. If any of these factors
change, the Company may find it necessary or advisable to reallocate some of the
proceeds within the above-described categories or to use portions thereof for
other purposes. The Company may also use a portion of the net proceeds for the
acquisition of businesses, technologies, or products which it believes are
complimentary to those of the Company, although there are currently no
commitments or agreements with respect to any such acquisitions as of the date
of this Prospectus, except for the acquisition of CommHome. See "Business--
CommHome Systems Corporation Acquisition."
Based on currently proposed plans and assumptions relating to its
operations, and implementation of its business plan (including the timetable of
costs and expenses associated with, and success of, its marketing efforts) the
Company anticipates that the net proceeds of this offering, together with
projected revenues from operations, will be sufficient to fund the Company's
operations and capital requirements for approximately twelve months following
the consummation of this offering. There can be no assurance, however, that such
funds will not be expended prior thereto due to unanticipated changes in
economic conditions or other unforeseen circumstances. In the event the
Company's plans change or its assumptions change or prove to be inaccurate (due
to unanticipated expenses, difficulties, delays or otherwise) or the net
proceeds of this offering and projected revenues otherwise prove to be
insufficient to fund the implementation of the Company's business plan or
working capital requirements, the Company could be required to seek additional
financing sooner than currently anticipated. The Company has no current
arrangements with respect to any additional financing. Consequently, there can
be no assurance that any additional financing will be available to the Company
when needed, on commercially reasonable terms or at all.
Proceeds not immediately required for the purposes described above will be
invested principally in United States government securities, short-term
certificates of deposit, or other similar short-term, interest bearing
investments.
19
<PAGE>
DILUTION
The difference between the initial public offering price per share of Common
Stock and the net tangible book value per share of Common Stock after this
offering constitutes the dilution to investors in this offering. Net tangible
book value per share is determined by dividing the net tangible book value of
the Company (total tangible assets less total liabilities) by the number of
outstanding shares of Common Stock.
At June 30, 1998, the negative net tangible book value of the Company was
($928,000) or $(.55) per share ($(.36) per share, on a pro forma basis after
giving effect to (i) the conversion of the outstanding shares of Series B
Convertible Preferred Stock into 310,399 shares of Common Stock upon
consummation of this offering, and (ii) the issuance of 596,741 shares of Common
Stock in exchange for the cancellation of outstanding warrants and options to
purchase 789,521 shares of Common Stock on July 8, 1998 (collectively, the "Pro
Forma Adjustments"). After also giving effect to the sale by the Company of the
1,875,000 shares of Common Stock offered hereby (after deducting underwriting
discounts and commissions and estimated expenses of this offering) and the
Offering Adjustments (see footnote 2 of "Prospectus Summary--Summary Financial
Information"), the adjusted net tangible book value of the Company at June 30,
1998 would have been $11,221,000, or $2.49 per share, representing an immediate
increase in net tangible book value of $2.85 per share to the existing
stockholders and an immediate dilution of $5.51 (68.9%) per share to new
investors. The following table illustrates the foregoing information with
respect to dilution to new investors on a per share basis:
<TABLE>
<S> <C> <C>
Initial public offering price................................. $ 8.00
Pro forma net tangible book value before offering........... $ (.36)
Increase attributable to new investors...................... 2.85
---------
Adjusted net tangible book value after offering............... 2.49
---------
Dilution per share to new investors........................... $ 5.51
---------
---------
</TABLE>
The following table sets forth, with respect to the Company's existing
stockholders (after giving effect to the Pro Forma Adjustments and the Offering
Adjustments) and new investors in this offering, a comparison of the number of
shares of Common Stock acquired from the Company, the percentage ownership of
such shares, the total consideration paid, the percentage of total consideration
paid and the average price per share.
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION
----------------------- -------------------------- AVERAGE
NUMBER PERCENT AMOUNT PERCENT PRICE PER SHARE
---------- ----------- ------------- ----------- -----------------
<S> <C> <C> <C> <C> <C>
Existing Stockholders............................ 2,633,369 58.4% $ 7,165,000 32.3% $ 2.72
New Investors.................................... 1,875,000 41.6 15,000,000 67.7 8.00
---------- ----- ------------- -----
Total............................................ 4,508,369 100.0% $ 22,165,000 100.0%
---------- ----- ------------- -----
---------- ----- ------------- -----
</TABLE>
The above tables assume no exercise of the Underwriter's over-allotment
option. If such option is exercised in full, the new investors will have paid
$17,250,000 for 2,156,250 shares of Common Stock, representing approximately
70.7% of the total consideration, for 45.0% of the total number of shares of
Common Stock outstanding. In addition, the above tables do not give effect to
shares issuable upon exercise of outstanding warrants and options to purchase
1,328,215 shares of Common Stock, including options to purchase 509,829 shares
of Common Stock issued under the Stock Option Plan and 187,500 shares of Common
Stock issuable upon exercise of the Underwriter's Warrants. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations,"
"Management--Stock Option Plan," Description of Securities--Warrants and
Options" and "Underwriting."
20
<PAGE>
DIVIDEND POLICY
The Company has never declared or paid any cash dividends on its Common
Stock and does not intend to declare or pay cash or other dividends in the
foreseeable future. The Board of Directors currently expects to retain any
future earnings for use in the operation and expansion of its business. The
declaration and payment of any future dividends will be at the discretion of the
Board of Directors and will depend upon a variety of factors, including future
earnings, if any, operations, capital requirements, the general financial
condition of the Company, the preferences of any series of Preferred Stock which
may be designated in the future, the general business conditions and future
contractual restrictions on payment of dividends, if any.
CAPITALIZATION
The following table sets forth the capitalization of the Company (i) as of
June 30, 1998 and (ii) as adjusted to give effect to the sale of the Common
Stock offered hereby, the anticipated application of the estimated net proceeds
therefrom and the Pro Forma Adjustments (see "Dilution") and the Offering
Adjustments (see footnote 2 of "Prospectus Summary -- Summary Financial
Information"). The information set forth below should be read in conjunction
with the Financial Statements and Notes thereto and "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
<TABLE>
<CAPTION>
JUNE 30, 1998
-----------------------------
<S> <C> <C>
ACTUAL AS ADJUSTED
------------- --------------
Short-term debt.................................................................... $ 2,582,000 --
------------- --------------
------------- --------------
Stockholders' equity (deficit)(1):
Preferred Stock, $.01 par value, 5,000,000 shares authorized.....................
Series A Preferred Stock, no shares issued or outstanding, actual, and as
adjusted..................................................................... -- --
Series B Convertible Preferred Stock, 500,000 shares issued and outstanding,
actual; no shares issued and outstanding, as adjusted........................ $ 5,000 --
Common Stock, $.01 par value; 25,000,000 shares authorized; 1,678,104 shares
issued and outstanding, actual; 4,508,369 shares issued and outstanding, as
adjusted(2).................................................................... 17,000 $ 45,000
Additional paid-in capital....................................................... 9,432,000 22,404,000
Accumulated deficit.............................................................. (9,460,000) (10,656,000)
Unearned portion of compensatory stock options................................... (572,000) (572,000)
------------- --------------
Total stockholders' equity (deficit)........................................... (578,000) 11,221,000
------------- --------------
Total capitalization......................................................... $ (578,000) $ 11,221,000
------------- --------------
------------- --------------
</TABLE>
- ------------------------
(1) See Note F to Notes to Financial Statements.
(2) Does not include (i) 509,829 shares of Common Stock issuable upon exercise
of stock options (of which options to purchase 381,829 shares were granted
as of June 30, 1998) under the Stock Option Plan, (ii) 630,886 shares of
Common Stock issuable upon exercise of other outstanding options and
warrants and (iii) 187,500 shares of Common Stock reserved for issuance upon
exercise of the Underwriter's Warrants.
21
<PAGE>
SELECTED FINANCIAL DATA
The following selected financial data for the years ended December 31, 1996
and December 31, 1997 and at December 31, 1997 have been derived from the
Company's audited financial statements. The following selected financial data
for the six month periods ended June 30, 1997 and 1998 and at June 30, 1998 have
been derived from unaudited financial statements which have been prepared on the
same basis as the audited financial statements and, in the opinion of
management, contain all adjustments, consisting only of normal recurring
adjustments, necessary to present fairly the information presented. The results
for the six month period ended June 30, 1998 are not necessarily indicative of
the results to be expected for any other interim period or the fiscal year. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and Financial Statements.
STATEMENT OF OPERATIONS DATA:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, SIX MONTHS ENDED JUNE 30,
---------------------------- ----------------------------
<S> <C> <C> <C> <C>
1996 1997 1997 1998
------------- ------------- ------------- -------------
Revenues:
Licenses................................................. $ 624,000 $ 1,132,000 $ 506,000 $ 412,000
Royalties................................................ -- 500,000 500,000 --
Services................................................. 403,000 737,000 421,000 490,000
------------- ------------- ------------- -------------
Total revenues....................................... 1,027,000 2,369,000 1,427,000 902,000
------------- ------------- ------------- -------------
Cost of revenues:
Amortization of software development costs............... 246,000 321,000 125,000 267,000
Cost of licenses......................................... 193,000 176,000 52,000 128,000
Cost of services......................................... 390,000 418,000 212,000 272,000
------------- ------------- ------------- -------------
Total cost of revenues............................... 829,000 915,000 389,000 667,000
------------- ------------- ------------- -------------
Gross profit............................................... 198,000 1,454,000 1,038,000 235,000
Operating expenses:
Product development...................................... 892,000 792,000 235,000 283,000
Selling and marketing.................................... 1,614,000 926,000 524,000 351,000
General and administrative............................... 1,931,000 1,573,000 919,000 1,153,000
------------- ------------- ------------- -------------
Total operating expenses............................. 4,437,000 3,291,000 1,678,000 1,787,000
------------- ------------- ------------- -------------
Loss from operations....................................... (4,239,000) (1,837,000) (640,000) (1,552,000)
Interest expense........................................... (260,000) (553,000) (141,000) (438,000)
------------- ------------- ------------- -------------
Net loss................................................... $ (4,499,000) $ (2,390,000) $ (781,000) $ (1,990,000)
------------- ------------- ------------- -------------
------------- ------------- ------------- -------------
Loss per share (1)......................................... $ (2.46) $ (1.29) $ (.40) $ (1.17)
Weighted average number of shares outstanding (1).......... 1,825,163 1,855,244 1,934,334 1,699,120
</TABLE>
BALANCE SHEET DATA:
<TABLE>
<CAPTION>
DECEMBER 31, 1997 JUNE 30, 1998
----------------- ----------------------------
ACTUAL ACTUAL AS ADJUSTED
----------------- ------------ --------------
<S> <C> <C> <C>
Cash and cash equivalents............................................ $ 60,000 $ 634,000 $ 9,882,000
Working capital (deficit)............................................ (661,000) (2,429,000) 11,056,000
Total assets......................................................... 2,404,000 3,129,000 12,027,000
Total liabilities.................................................... 2,479,000 3,707,000 806,000
Accumulated deficit.................................................. (7,470,000) (9,460,000) (10,656,000)
Total stockholders' equity (deficit)................................. (75,000) (578,000) 11,221,000
</TABLE>
- ------------------------
(1) See Notes A and B to Notes to Financial Statements for an explanation of
shares used in net loss per share calculations.
22
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION AND ANALYSIS SHOULD BE READ IN CONJUNCTION WITH THE
COMPANY'S FINANCIAL STATEMENTS, INCLUDING THE NOTES THERETO, INCLUDED ELSEWHERE
IN THIS PROSPECTUS. EXCEPT FOR THE HISTORICAL INFORMATION CONTAINED HEREIN, THIS
DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND
UNCERTAINTIES, INCLUDING, WITHOUT LIMITATION, THOSE CONCERNING THE COMPANY'S
STRATEGY AND GROWTH PLANS. BECAUSE SUCH STATEMENTS INVOLVE RISKS AND
UNCERTAINTIES, ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE EXPRESSED OR
IMPLIED BY SUCH FORWARD-LOOKING STATEMENTS. FACTORS THAT COULD CAUSE SUCH
DIFFERENCES INCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED UNDER "RISK
FACTORS."
GENERAL
The Company develops, markets, licenses and supports a family of network
security software products designed to provide comprehensive security to
computer networks including Internet based systems and internal networks and
computing resources. The Company also offers to its customers a full range of
consulting services in network security, network design and support. From
inception (July 1990) through December 31, 1994, the Company was primarily
engaged in providing consulting and training services. In 1995, the Company
began to shift its focus from consulting and training to the development and
marketing of network security software products. The Company introduced its
first FIREWALL/PLUS software product in June 1995. Accordingly, the Company has
a limited relevant operating history as a software developer upon which an
evaluation of its prospects and future performance can be made. Such prospects
must be considered in light of the risks, expenses and difficulties frequently
encountered in the operation and expansion of a new business and the shift from
research and product development to commercialization of products based on
rapidly changing technologies in a highly specialized and emerging market. The
Company will be required to significantly expand its product and development
capabilities, introduce new products, introduce enhanced features to existing
products, expand its in-house sales force, establish and maintain distribution
channels through third-party vendors, increase marketing expenditures, further
expand its management team and attract additional qualified personnel. In
addition, the Company must adapt to the demands of an emerging and rapidly
changing computer network security market, intense competition and rapidly
changing technology and industry standards. There can be no assurance that the
Company can successfully address such risks, and the failure to do so would have
a material adverse effect on the Company's business, results of operations and
financial condition.
To date, the Company has incurred significant losses and, at June 30, 1998,
had an accumulated deficit of $9,460,000. Inasmuch as the Company intends to
increase its level of activities following the consummation of this offering and
will be required to make significant up-front capital expenditures in connection
with its sales and marketing and continuing research and product development
efforts, the Company anticipates that losses will continue until such time, if
ever, as the Company is able to attain sales levels sufficient to support its
operations. There can be no assurance that the Company will ever achieve
profitable operations. The Company's independent auditors have included an
explanatory paragraph in their report on the Company's financial statements for
the year ended December 31, 1996 and December 31, 1997, stating that certain
factors raise substantial doubt about the Company's ability to continue as a
going concern.
The Company has only recently employed certain members of senior management
relating to expansion of its operations and this offering, including Avi A.
Fogel, President and Chief Executive Officer, Robert P. Olsen, Vice President of
Product Management, Murray P. Fish, Chief Financial Officer, Joseph A. Donohue,
Vice President of Engineering and Joseph D. Harris, Vice President of
International Sales. In addition, the Company intends to hire approximately 17
additional software engineers and developers and 15 additional sales and
marketing personnel within twelve months of consummation of this offering, as
well as expand its finance and administrative staff and increase expenses for
employee benefits,
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facilities, consulting, insurance, and other general operating expenses. See
"Business--Sales and Marketing," "Business--Product Development" and
"Management."
The Company's FIREWALL/PLUS family of software products has not yet achieved
market acceptance. The future success of the Company is largely dependent upon
market acceptance of its FIREWALL/PLUS family of software products. While the
Company believes that its FIREWALL/PLUS family of software products offer
advantages over competing products for network security, license revenues and
royalties from FIREWALL/PLUS products since their introduction (June 1995)
through June 30, 1998 has only been $2,561,000, including a non-refundable
pre-paid royalty of $500,000. There can be no assurance that FIREWALL/PLUS will
gain significant market acceptance. Revenue from such commercial products depend
on a number of factors, including the influence of market competition,
technological changes in the network security market, the Company's ability to
design, develop and introduce enhancements on a timely basis, and the ability of
the Company to successfully establish and maintain distribution channels. The
failure of FIREWALL/PLUS to achieve significant market acceptance, as a result
of competition, technological change or other factors, would have a material
adverse effect on the Company's business, operating results and financial
condition.
The Company's revenues are generated primarily from product license fees for
the use of the Company's software products (license revenues) and service fees
for consulting services, including training and maintenance (service revenues).
Revenues from licenses are recognized upon (i) delivery of the software or, if
the customer has evaluation software, delivery of the software key, and (ii)
issuance of the related license, assuming that no significant vendor obligations
or customer acceptance rights exist. In October 1997, the American Institute of
Certified Public Accountants issued Statement of Position ("SOP") No. 97-2,
SOFTWARE REVENUE RECOGNITION, which the Company adopted, effective January 1,
1997. Such adoption had no effect on the Company's methods of recognizing
revenue from its license and maintenance activities. Prior to 1997, the
Company's revenue policy was in accordance with the preceding authoritative
guidance provided by SOP No. 91-1, SOFTWARE REVENUE RECOGNITION.
The Company recognizes service revenue upon delivery of the service or
ratably over the period of service. Consulting fees are recognized as such
services are performed. Annual maintenance, which may be purchased in
conjunction with the licensing of a product, is offered for an annual fee
generally equal to 15% of the then current license fee and is recorded as
service revenue ratably over the contract term.
The Company markets and licenses its products and services primarily through
third parties, such as VARs, systems integrators, resellers, distributors and
OEMs, and to a lesser extent, through the Company's limited in-house sales
force. Licenses through distributors typically have a lower gross margin than
in-house generated licenses since distributors usually receive discounts.
Revenues from third-party distributors accounted for approximately 23% and 72%
of the Company's license revenues for the years ended December 31, 1996 and
1997, respectively, and 60% of the Company's license revenues for the six months
ended June 30, 1998. The Company expects that the percentage of license revenues
generated from third-party distributors to increase in future periods. Pricing
is based upon the number of concurrent connections, the nature of the user's
operating system and whether hardware is needed. Selling and marketing expenses
are expected to increase as a result of proposed expansion of distribution
channels and marketing programs and hiring of additional personnel.
The Company has committed significant product and development resources to
its FIREWALL/PLUS family of products. The Company's anticipated levels of
expenditures for product development are based on its plans for product
enhancements and new product development. The Company capitalizes and amortizes
software development costs in accordance with Statement of Financial Accounting
Standards No. 86. These costs consist of salaries, consulting fees and
applicable overhead. The Company intends to use a portion of the proceeds of
this offering to significantly increase its product development expenditures.
See "Business--Product Development."
The Company's net operating loss carryforwards ("NOLs") expire in the years
2009 to 2012. Under Section 382 of the Internal Revenue Code of 1986, as
amended, utilization of prior NOLs is limited after
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an ownership change, as defined in Section 382, to an annual amount equal to the
value of the corporation's outstanding stock immediately before the date of the
ownership change multiplied by the long-term tax exempt rate. The additional
equity financing obtained by the Company in connection with recent financings
and this offering will result in an ownership change if the over-allotment
option is exercised and may otherwise result in an ownership change as a result
of subsequent issuances of securities and, thus, will limit the Company's use of
its prior NOLs. In the event the Company achieves profitable operations, any
significant limitation on the utilization of its NOLs would have the effect of
increasing the Company's tax liability and reducing net income and available
cash reserves. The Company is unable to determine the availability of such NOL's
since this availability is dependent upon profitable operations, which the
Company has not achieved in prior periods. See Note H to Notes to Financial
Statements.
RESULTS OF OPERATIONS
SIX MONTHS ENDED JUNE 30, 1998 COMPARED TO SIX MONTHS ENDED JUNE 30, 1997
Revenues decreased by $525,000 or 37%, from $1,427,000 for the six months
ended June 30, 1997 to $902,000 for the six months ended June 30, 1998,
primarily as a result of the Company's receipt of a non-refundable pre-paid
royalty of $500,000 during the six months ended June 30, 1997.
License revenues decreased by $94,000 or 19%, from $506,000 for the six
months ended June 30, 1997 to $412,000 for the six months ended June 30, 1998,
primarily due to a lack of financial resources for marketing of the Company's
software products during the six months ended June 30, 1998 and certain initial
product licensing payments received from international resellers during the six
months ended June 30, 1997. During the six months ended June 30, 1998, revenues
from FIREWALL/PLUS products and third party virtual private network ("VPN")
products accounted for $326,000 and $86,000 of license revenues, respectively,
and during the six months ended June 30, 1997, license revenues consisted solely
of licenses of FIREWALL/PLUS products. Royalties were $500,000 for the six
months ended June 30, 1997 as a result of the receipt of a non-refundable
pre-paid royalty of $500,000 from Trusted Information Systems, Inc. ("TIS") in
June 1997 and $0 for the six months ended June 30, 1998.
Service revenues increased by $69,000 or 16%, from $421,000 for the six
months ended June 30, 1997 to $490,000 for the six months ended June 30, 1998.
Service revenues from consulting increased by $71,000 or 20%, from $353,000 for
the six months ended June 30, 1997 to $424,000 for the six months ended June 30,
1998. The increase in service revenues from consulting was attributable to a
large consulting project serviced during the six months ended June 30, 1998.
The Company's three largest customers, The City of Hope, Electronic Data
Systems Corporation ("EDS") and The Sabre Group, Inc. accounted for 32%, 17% and
11% of the Company's revenues, respectively, during the six months ended June
30, 1998. The Company's revenues from customers in the United States represented
83% of its revenues during the six months ended June 30, 1997 and 98% of its
revenues during the six months ended June 30, 1998.
Cost of revenues consists of cost of licenses, amortization of software
development costs and cost of services. Cost of licenses consist of software
media (disks), documentation, product packaging, production costs, product
royalties and the cost of hardware associated with sales of FIREWALL/PLUS
PREMIER VERSION. Cost of licenses increased by $76,000 or 146%, from $52,000 for
the six months ended June 30, 1997 to $128,000 for the six months ended June 30,
1998, representing 10% and 31% of license revenues, respectively. The increase
in cost of licenses in dollar amount and as a percentage of license revenues
resulted primarily from increased hardware costs associated with sales of
FIREWALL/PLUS PREMIER VERSION, which includes computer hardware and, therefore,
has a lower gross margin, and sales of third party VPN products. Cost of
licenses as a percentage of license revenues may fluctuate from period to period
due to changes in product mix, changes in the number or size of transactions
recorded in a given period or an increase or decrease in licenses of products
which would require the Company to pay royalties to third parties. Amortization
of software development costs increased by $142,000 or 114%, from $125,000 for
the six
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months ended June 30, 1997 to $267,000 for the six months ended June 30, 1998,
representing 25% and 65% of license revenues, respectively. The increase in the
amortization of software development costs for the six months ended June 30,
1998 was due to the commencement of amortization of costs of the FIREWALL/ PLUS
WINDOWS NT Version 4.0 upon its release in September 1997.
Cost of services consist of salaries, benefits and overhead associated with
consulting services and maintenance. Cost of services increased by $60,000 or
28%, from $212,000 for the six months ended June 30, 1997 to $272,000 for the
six months ended June 30, 1998, representing 50% and 56% of service revenues,
respectively, due to increases in employees and outside consultants.
Gross profit decreased from $1,038,000 for the six months ended June 30,
1997 to $235,000 for the six months ended June 30, 1998, representing 73% and
26% of revenues, respectively. The decrease in gross profit was due to the
receipt of the non-refundable prepaid royalty of $500,000 in June 1997,
decreased license revenues and the increase in cost of sales as a result of
increased amortization of software costs, licenses of third party VPN products
and hardware costs associated with licenses of FIREWALL/PLUS PREMIER VERSION.
Product development consists of salaries, benefits, travel and related costs
of the Company's product development personnel, including consulting fees, the
costs of computer equipment used in product and technology development and
third-party development contracts. Product development expense increased $48,000
or 20%, from $235,000 for the six months ended June 30, 1997 to $283,000 for the
six months ended June 30, 1998, representing 16% and 31% of revenues,
respectively. Total product development costs, including capitalized costs of
$567,000 and $50,000, were $802,000 and $333,000 for the six months ended June
30, 1997 and June 30, 1998, respectively. The decrease in total product
development costs was due to the significant costs incurred during the six
months ended June 30, 1997 for the development of FIREWALL/PLUS Version 4.0
which was released in September 1997, and reduced expenditures during the six
months ended June 30, 1998 resulting from the Company's lack of financial
resources. The Company currently anticipates that product development costs will
increase as the Company hires additional software engineers and developers to
support the Company's growth. See "Business--Product Development."
Sales and marketing expenses consist primarily of salaries, including
commissions, benefits, bonuses and travel, advertising, public relations,
consultants and trade shows. Selling and marketing expenses decreased by
$173,000 or 33%, from $524,000 for the six months ended June 30, 1997 to
$351,000 for the six months ended June 30, 1998, representing 37% and 39% of
revenues, respectively. The decrease in selling and marketing expenses was due
primarily to a decrease in marketing efforts during such period resulting from
the Company's lack of financial resources for such purposes.
General and administrative expenses include employee costs, including
salary, benefits, travel and other related expenses associated with management,
finance and accounting operations, and legal and other professional services
provided to the Company. General and administrative expenses increased by
$234,000 or 25%, from $919,000 for the six months ended June 30, 1997 to
$1,153,000 for the six months ended June 30, 1998, representing 64% and 128% of
revenue, respectively. The increase in general and administrative expenses was
due primarily to non-cash charges of $583,000 during the six months ended June
30, 1998 related to the value of stock options issued to the Company's Chief
Executive Officer and other securities issued to an affiliate of the Company's
Chairman of the Board of Directors and third parties for services, as compared
to non-cash charges of $95,000 during the six months ended June 30, 1997 related
to consulting services. This increase was partially offset by reduced
professional fees, recruitment fees and travel and entertainment expenses during
the six months ended June 30, 1998. The Company currently anticipates that
general and administrative expenses will increase significantly as the Company
hires additional personnel to support its growth in future periods.
Interest expense increased by $297,000 or 211%, from $141,000 for the six
months ended June 30, 1997 to $438,000 for the six months ended June 30, 1998,
representing 10% and 49% of revenues,
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respectively. The increase in interest expense was due primarily to an increase
in the amortization of debt discount for the six months ended June 30, 1998
related to private financings consisting of notes and warrants. Interest expense
is expected to be significantly reduced following consummation of the offering
since the Company intends to use approximately $3,442,000 of the proceeds of
this offering to repay outstanding debt.
No provision for or benefit from federal, state or foreign income taxes was
recorded for the six months ended June 30, 1997 or the six months ended June 30,
1998 because the Company incurred net operating losses during each period and
fully reserved its deferred tax assets as their future realization could not be
determined.
As a result of the foregoing, the net loss increased by $1,209,000 or 155%,
from $781,000 for the six months ended June 30, 1997 to $1,990,000 for the six
months ended June 30, 1998.
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996
Revenues increased by $1,342,000 or 131%, from $1,027,000 for the year ended
December 31, 1996 ("1996") to $2,369,000 for the year ended December 31, 1997
("1997"). License revenues increased by $508,000 or 81%, from $624,000 for 1996
to $1,132,000 for 1997, as a result of introduction of FIREWALL/PLUS for Windows
NT. Royalties were $500,000 in 1997 and $0 in 1996 as a result of receipt of a
non-refundable pre-paid royalty of $500,000 from TIS relating to licensing
certain of the Company's technology in June 1997. Service revenues increased by
$334,000 or 83%, from $403,000 for 1996 to $737,000 for 1997. Service revenues
from consulting increased by $245,000 or 68% from $359,000 in 1996 to $604,000
in 1997, primarily as a result of servicing a large consulting project during
1997. Service revenues from maintenance increased by $89,000 or 202% from
$44,000 in 1996 to $133,000 in 1997, as a result of an increase in the customer
base for FIREWALL/PLUS products which purchased maintenance contracts. The
Company's three largest customers, TIS, EDS and ARCO accounted for 21%, 15% and
13% of the Company's revenues, respectively, in 1997. The Company's revenues
from customers in the United States represented 93% of its revenues in 1996 and
84% of its revenues in 1997.
Cost of licenses decreased $17,000 or 9%, from $193,000 for 1996 to $176,000
for 1997, representing 31% and 16% of license revenues, respectively. The
decrease in the cost of licenses resulted primarily from the hardware costs
associated with decreased licenses of both FIREWALL/PLUS PREMIER VERSION and
third party products. The decrease in cost of licenses as a percentage of
license revenues was due to the change in product mix as license revenue from
FIREWALL/PLUS PREMIER VERSION, which includes hardware, accounted for a lower
percentage of license revenues in 1997. Amortization of software development
costs increased by $75,000 or 30%, from $246,000 for 1996 to $321,000 for 1997,
representing 39% and 28% of license revenues, respectively. The increase in
amortization of software development costs was due to the commencement of
amortization of costs of Windows NT Version 3.0 of FIREWALL/PLUS upon its
release in December 1996 and Version 4.0 upon its release in September 1997.
Cost of services increased by $28,000 or 7%, from $390,000 for 1996 to
$418,000 for 1997, representing 97% and 57% of service revenues, respectively.
The decrease in cost of services as a percentage of service revenues was due
primarily to the increase in service revenues which did not require increased
personnel.
Gross profit increased from $198,000 for 1996 to $1,454,000 for 1997,
representing 19% and 61% of revenues, respectively. The increase in gross profit
was due to increased license revenue of $508,000, and the receipt of a $500,000
prepaid royalty in June 1997 and a $334,000 increase in service revenue.
Product development expenses decreased by $100,000 or 11%, from $892,000 for
1996 to $792,000 for 1997, representing 87% and 33% of revenues, respectively.
The decrease in product development costs was due primarily to an increased
portion of time spent by developers on the development of Windows NT Versions
3.0 and 4.0 of FIREWALL/PLUS and the capitalization of such costs. During 1996
and 1997, the
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Company capitalized $750,000 and $850,000, respectively, of additional software
development costs associated with the development and enhancement of its
FIREWALL/PLUS family of products.
Sales and marketing expenses decreased by $688,000 or 43%, from $1,614,000
for 1996 to $926,000 for 1997, representing 157% and 39% of revenues,
respectively. The decrease in sales and marketing expenses in dollar amount was
due primarily to a decrease in advertising expenses and the reduction of trade
shows and related travel in the aggregate amount of $633,000 due to the
Company's lack of funds for sales and marketing. The decrease in sales and
marketing expenses as a percentage of sales was due to the aforementioned
factors, as well as the Company's significant increase in revenues.
General and administrative expenses decreased by $358,000 or 19%, from
$1,931,000 for 1996 to $1,573,000 for 1997, representing 188% and 66% of
revenues for 1996 and 1997, respectively. The decrease in general and
administrative expenses in dollar amount and as a percentage of revenues in 1997
was due primarily to a charge of $518,000 related to the issuance of warrants to
advisory board members in 1996 and reduced professional fees, recruiting fees,
office supplies and stationary, repairs and maintenance contracts, travel and
bad debt expenses, partially offset by higher salaries and depreciation.
Interest expense increased by $293,000 or 113%, from $260,000 for 1996 to
$553,000 for 1997, representing 25% and 23% of revenue for 1996 and 1997,
respectively. The increase in interest expense was due primarily to increased
amortization of debt discount as a result of the issuance of $1,500,000
principal amount promissory notes and warrants to purchase 210,628 shares of
Common Stock during 1997. Debt discount is amortized over the life of the debt
instrument.
No provision for or benefit from federal, state or foreign income taxes was
recorded for 1996 or 1997 because the Company incurred net operating losses for
each year and fully reserved its deferred tax assets as their future realization
could not be determined.
As a result of the foregoing, the net loss decreased by $2,109,000 or 47%,
from $4,499,000 for 1996 to $2,390,000 for 1997.
LIQUIDITY AND CAPITAL RESOURCES
The Company's capital requirements have been and will continue to be
significant, and its cash requirements have been exceeding its cash flow from
operations. At June 30, 1998, the Company had $634,000 of cash and cash
equivalents and a working capital deficit of $2,429,000. The Company has
financed its operations primarily through private sales of equity and debt
securities. Net cash used in operating activities was $708,000 and $848,000
during 1997 and the six months ended June 30, 1998, respectively. Net cash used
in operating activities for 1997 was primarily attributable to a net loss of
$2,390,000 and an increase in accounts receivable of $309,000 which was
partially offset by increases in accounts payable, accrued expenses and other
current liabilities of $744,000, and amortization of debt discount of $500,000
and depreciation and amortization of $481,000. Net cash used in operating
activities for the six months ended June 30, 1998 was primarily attributable to
a net loss of $1,990,000 and an increase in accounts receivable of $192,000,
partially offset by amortization of debt discount of $364,000, issuance of
Common Stock and warrants for services rendered of $583,000 and depreciation and
amortization of $346,000.
The Company's operating activities during 1996, 1997 and the six months
ended June 30, 1998 were financed primarily with $3,948,000 of net proceeds from
the sale of Common Stock with respect to a private placement completed in March
1996, $1,500,000 of net proceeds from the issuance of $1,500,000 principal
amount of notes and warrants to purchase 210,628 shares of Common Stock in 1997
and $1,750,000 of net proceeds from the issuance of $1,750,000 principal amount
of notes and warrants to purchase 325,919 shares of Common Stock during the six
months ended June 30, 1998. The Company intends to use a portion of the net
proceeds of this offering to repay the entire principal amount of $3,250,000 and
interest accrued on such outstanding notes. The Company will incur aggregate
non-cash
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charges estimated to be $668,000 upon repayment of the notes in the principal
amount of $3,250,000 relating to the amortization of debt discount. The Company
does not currently have a line of credit from a commercial bank or other
institution.
Simultaneously with the consummation of this offering, the Company, through
its wholly-owned subsidiary, will acquire CommHome in exchange for 35,000 shares
of the Company's Common Stock valued at $280,000 plus the assumption of
approximately $200,000 of liabilities, of which $105,000 will be satisfied with
the issuance of 13,125 shares of the Company's Common Stock. Upon consummation
of the acquisition, the Company will incur a charge for purchased research and
development of $469,000 representing the excess of the purchase price plus the
assumed liabilities over the fair value of the tangible assets acquired of
$1,000. See "Business--CommHome Systems Corporation Acquisition."
The Company is dependent on the proceeds of this offering to implement its
business plan and finance its working capital requirement. The Company
anticipates, based on currently proposed plans and assumptions relating to the
implementation of its business plan (including the timetable of, costs and
expenses associated with, and success of, its marketing efforts), that the net
proceeds of this offering, together with projected revenues from operations,
will be sufficient to satisfy the Company's operations and capital requirements
for approximately twelve months following the consummation of this offering.
There can be no assurance, however, that such funds will not be expended prior
thereto due to unanticipated changes in economic conditions or other unforeseen
circumstances. In the event the Company's plans change or its assumptions change
or prove to be inaccurate (due to unanticipated expenses, difficulties, delays
or otherwise) or the net proceeds of this offering and projected revenues
otherwise prove to be insufficient to fund the implementation of the Company's
business plan or working capital requirements, the Company could be required to
seek additional financing sooner than currently anticipated. The Company has no
current arrangements with respect to any additional financing. Consequently,
there can be no assurance that any additional financing will be available to the
Company when needed, on commercially reasonable terms or at all. Any inability
to obtain additional financing when needed would have a material adverse effect
on the Company, requiring it to curtail and possibly cease its operations. In
addition, any additional equity financing may involve substantial dilution to
the interests of the Company's then existing stockholders.
FLUCTUATIONS IN OPERATING RESULTS
The Company anticipates significant quarterly fluctuations in its operating
results in the future. The Company generally ships orders for commercial
products as they are received and, as a result, does not have any material
backlog. As a result, quarterly revenues and operating results depend on the
volume and timing of orders received during the quarter, which are difficult to
forecast. Operating results may fluctuate on a quarterly basis due to factors
such as the demand for the Company's products, purchasing patterns and budgeting
cycles of customers, the introduction of new products and product enhancements
by the Company or its competitors, market acceptance of new products introduced
by the Company or its competitors and the size, timing, cancellation or delay of
customer orders, including cancellation or delay in anticipation of new product
introduction or enhancement. In addition, the Company's consulting revenues tend
to fluctuate as projects, which may continue over several quarters, are
undertaken or completed. Therefore, comparisons of quarterly operating results
may not be meaningful and should not be relied upon, nor will they necessarily
reflect the Company's future performance. Because of the foregoing factors, it
is likely that in some future quarters the Company's operating results will be
below the expectations of public market analysts and investors. In such event,
the price of the Common Stock would likely be materially adversely affected.
Licensing of the Company's products generally involves a significant
commitment of capital by customers, with the attendant delays frequently
associated with large capital expenditures for complex technology. Accordingly,
the sales cycle for the Company's products can be lengthy and generally
commences at the time a prospective customer demonstrates an interest in
licensing a FIREWALL/PLUS
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solution, typically includes a 30-day free evaluation period and ends upon
execution of a purchase order by the customer. The length of the sales cycle
varies depending on the type and sophistication of the customer and the
complexity of the operating system and may extend for periods of six to nine
months. As a result of the Company's lengthy sales cycle, license of the
Company's products generally require the Company to make expenditures and use
significant resources prior to receipt, if any, of corresponding revenues.
YEAR 2000 ISSUE
The Company has assessed the potential software issues associated with the
Year 2000 and believes its software products are Year 2000 compliant and,
therefore, does not expect to incur material costs related thereto. With regard
to internal computing resources utilized in its operations, the Company does not
expect to incur material costs to make such resources year 2000 compliant.
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BUSINESS
OVERVIEW
The Company develops, markets, licenses and supports a family of network
security software products designed to provide comprehensive security to
computer networks, including Internet based systems and internal networks and
computing resources. The Company's FIREWALL/PLUS family of security software
products enables an organization to protect its computer networks from internal
and external attacks and to secure organizational communications over such
internal networks and the Internet. The Company also offers its customers a full
range of consulting services in network security and network design and support
in order to build, maintain and enhance customer relationships and increase the
demand for its software products.
The FIREWALL/PLUS family of security solutions is designed to protect
against Internet and intranet (internal networks utilizing Internet technology
and applications based upon TCP/IP--the Internet network transport protocol)
based security threats and to address security needs that arise from within
internal networks that often utilize other network transport protocols besides
TCP/IP including, among others, Novell's IPX, Digital Equipment's DECnet and
IBM's SNA. The Company's FIREWALL/PLUS family of firewall products operates on
the Microsoft Windows NT operating system platform. FIREWALL/PLUS' proprietary
Interceptor Shim and filter engine software technology, with its unique ability
to handle and filter all commonly used network transport protocols, provide
organizations with a highly secure and flexible security solution. Additionally,
unlike most other firewall solutions which focus on an enterprise's connection
to the Internet, the FIREWALL/PLUS solution can be deployed throughout the
enterprise; at the perimeter to control access to and from the Internet, between
internal networks and on application servers and desktop PCs to protect data
residing on such servers and PCs. The Company's FIREWALL/PLUS for Windows NT
received the 1997 Internet and Electronic Commerce Conference award for "Best
Intranet Solution" and the 1997 ENT Magazine Readers Choice Award for "Best NT
Firewall."
INDUSTRY BACKGROUND
A critical resource of every organization is its information and its ability
to distribute and access information throughout the enterprise. Computing has
moved from large centralized mainframes to distributed client/server
architecture consisting of interconnected personal computers dispersed
throughout an organization. Organizations utilize local area networks ("LANs")
to share information and applications internally. Many organizations have
connected LANs, including geographically dispersed networks, into wide area
networks ("WANs"). In addition, the explosive growth in telecommuting has
resulted in LANs and WANs frequently being accessed from remote locations via
traditional modem dial-up, Integrated Services Digital Network ("ISDN") and
recently introduced cable modems and Asymmetric Digital Subscriber Line ("ADSL")
modems. There is a growing use of establishing these remote connections to an
organization's central resources, via Internet links, rather than through
dedicated point-to point connections.
This evolution from mainframe computers supporting a number of terminals,
towards networks of interconnected personal computers has resulted in a wide
range of technologies from a multitude of vendors being used within internal
networks in order to satisfy different enterprise computing requirements. As a
result, heterogeneous networks utilizing a variety of network transport
protocols are commonplace within LANs and WANs. Although TCP/IP has become a
widely accepted network transport protocol due to the growth of the Internet and
the popularity of TCP/IP applications for use within internal networks, network
transport protocols such as IPX, DECnet, AppleTalk and SNA, among others, are
still utilized throughout networked environments, and the Company believes such
network transport protocols will continue to be utilized due to the large
investments in installed systems and applications using these protocols.
Further, computing environments often run one or more incompatible versions of
the same protocol suite for extended periods of time while converting to new
versions or to support older
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applications or systems which cannot use the newer versions of a given protocol
suite. In addition, Windows NT is shipped from Microsoft with four complete
network transport protocols (IP, IPX, AppleTalk and NetBEUI) for use with NT
when connected to a corporate network.
The Windows NT server market continues to grow and outpace sales of other
popular non-NT-based servers. According to recent studies by International Data
Corporation and Dataquest, in 1997, servers shipped with the Windows NT
operating system exceeded shipments of servers utilizing other operating
systems.
NETWORK SECURITY
Although open computing environments have many business advantages, their
accessibility makes an organization's critical software applications and
electronically stored data vulnerable to security threats. Open computing
environments are inherently complex, typically involving a variety of hardware,
operating systems, network transport protocols and applications supplied by a
multitude of vendors, making these networks difficult to manage, monitor and
protect from unauthorized access or attack. The security risk associated with
network computing is complicated by the increasing popularity of the Internet,
intranets and extranets (intranets which allow access to one or more users
outside of the internal network). By connecting an internal private network to
the Internet, unauthorized third parties are given a new means by which to
access an organization's private network. The combination of TCP/IP with other
commonly used network transport protocols within internal networks, increases
the network security challenge because of the various avenues of attack
available to both internal and external attackers.
As a result of the explosive growth in network computing and Internet use
(as well as use of intranets and extranets), protection of an organization's
network and data has become a significant economic concern for businesses.
According to the 1997 Annual Information Week/Ernst & Young LLP Information
Security Survey of information technology managers and professionals, 42% of the
respondents reported malicious acts from external sources, as compared to 16% in
the prior year, and 43% of the respondents reported malicious acts by employees
as compared to 29% in the prior year. According to FBI estimates, U.S. companies
suffer estimated losses of $5 to $10 billion per year as a result of
unauthorized access to information and data. According to the 1998 CSI/FBI
Computer Crime and Security Survey, 44% of the respondents reported unauthorized
access by employees. The Company believes that securely segmenting internal
network areas and computing resources from unauthorized access will become
paramount to insuring the integrity of both the internal network and an
organization's intranet and extranet resources.
FIREWALLS
A firewall is a security solution that enables an organization to protect
its computer resources from unauthorized access by internal and external users.
Firewalls enforce security access control policies between a trusted network and
an untrusted network. Only authorized traffic as defined by security policies is
allowed access through the firewall. Firewalls are predominantly utilized today
to provide security for a network's perimeter by preventing external breaches of
the internal network (trusted network) from untrusted external sources (the
public network).
Due to the significant growth in Internet connections, a number of companies
have introduced firewall products ("IP Firewalls") designed primarily to protect
an internal network using TCP/IP as the network transport protocol from Internet
based security threats or threats from within intranets. IP Firewalls can also
filter other network transport protocols used specifically with the IP routing
protocol (such as UDP and ICMP). In addition, a limited number of IP Firewalls
have limited filtering capabilities for a small number of non-IP based network
transport protocols.
Firewalls can also serve to provide access control between individual
sub-networks on an internal network or to control access between an internal
network and a selected outside party authorized to have access to the internal
network for limited purposes. IP Firewalls can accomplish this task to the
extent that
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TCP/IP is the network transport protocol being used within an internal network
as is the case with intranets and extranets. To the extent other network
transport protocols are utilized within such an internal network, IP Firewalls
will disallow all data utilizing any such network transport protocol from
passing through the firewall, thereby denying access entirely to a party which
is intended to have such access. This reduces the effectiveness of IP Firewalls
in a multi-protocol networked environment.
The Company's FIREWALL/PLUS family of security solutions is designed to
address security needs that arise from within internal networks utilizing
non-TCP/IP network transport protocols, including Novell's IPX, Digital
Equipment Corporation's DECnet and IBM's SNA, as well as to protect against
TCP/IP based Internet and intranet security threats addressed by IP Firewalls.
The Company's FIREWALL/PLUS suite of products consists of a firewall designed to
control access to an organization's internal network from the public networks
(the "ENTERPRISE VERSION"), a firewall controlling access between the network
and a trusted application server (the "SERVER VERSION") and a firewall
controlling access between the network and a trusted client workstation (the
"CLIENT VERSION").
The IP Firewall market is expected to continue to experience dramatic
growth. International Data Corporation estimates that 1996 unit shipments of
firewalls grew by more than 250%, compared with 1995, with 1996 revenues of
approximately $220 million. Unit sales of firewalls are expected to increase
from 36,610 units or approximately $220 million in 1996 to 1.1 million units or
$730 million in 2001. It is anticipated that unit prices of firewalls will
experience a decline in the future because of increased competition. The Company
believes that these projections do not take into account the need for firewalls
to protect computing environments that do not rely exclusively on TCP/IP as the
network transport protocol. While an organization generally requires a small
number of firewalls to restrict vulnerability to TCP/IP based threats from the
Internet, it may require numerous firewalls to protect internal networks from
attacks from within the organization.
The Company believes that securely segmenting internal network areas and
computing resources from unauthorized access will become paramount to insuring
the integrity of both the internal network and an organization's intranet and
extranet resources. The Company further believes that multiple network transport
protocols will remain prevalent in computing environments because of the large
installed base of non-IP based computer systems and applications. The
FIREWALL/PLUS security solution is positioned to address the security issues
faced by enterprises with multi-protocol networking environments seeking to
prevent unauthorized access and attacks from the Internet, intranets and
extranets and internal networks using network transport protocols other than
TCP/IP.
NETWORK-1 STRATEGY
The Company intends to pursue an aggressive growth strategy and to focus its
efforts on marketing its FIREWALL/PLUS family of network security products. Key
elements of the Company's strategy are:
- PROVIDE COMPREHENSIVE NETWORK SECURITY SOLUTIONS. The Company's strategy
is to develop, market and support a family of network security products to
address a broad range of security issues confronting computer networks and
computing, including concerns arising from allowing access to the Internet
as well as concerns relating to the security of internal networks. The
Company's comprehensive approach to network security is based on its
FIREWALL/PLUS technology, which offers robust security for data
communications utilizing TCP/IP as well as other network transport
protocols. The FIREWALL/PLUS family of firewall products currently
includes the FIREWALL/PLUS ENTERPRISE VERSION, FIREWALL/PLUS SERVER
VERSION and the FIREWALL/PLUS CLIENT VERSION.
- EMPHASIS ON INTERNAL NETWORK SECURITY. While FIREWALL/PLUS has the ability
to protect an organization's computer network from Internet, intranet and
extranet based security threats, the Company believes that its ability to
filter multiple network transport protocols offers significant advantages
as a security product for internal networks where multiple network
transport protocols are common. Accordingly, the Company will seek to
exploit this advantage by focusing significant marketing
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resources on the internal network security market. The Company intends to
devote a significant portion of the proceeds of this offering for sales
and marketing toward educating potential end users and third-party
distributors as to the need to protect networks and computing resources
from unauthorized access and attacks from within an internal network and
the capabilities and benefits of the Company's products.
- ESTABLISH AND MAINTAIN SUCCESSFUL THIRD PARTY DISTRIBUTION
RELATIONSHIPS. The Company's marketing plan includes a multi-channel
distribution strategy which emphasizes establishing and maintaining
third-party distributor relationships with systems integrators, VARs, OEMs
and resellers in the United States and internationally. The Company
intends to increase its internal sales and support organization following
the consummation of this offering primarily to provide additional support
to its third-party distributors.
- LEVERAGE CONSULTING CLIENTS. The Company has designed, planned, audited
and implemented numerous networks worldwide for a broad spectrum of
clients, including Fortune 500 companies, small companies with modest
requirements, federal, state and foreign governments and utilities, as
well as education and research institutions. The Company believes that its
consulting clients provide a base of potential customers for its software
products. In addition, the Company's consulting relationships may
facilitate its development and enhancement of software products as the
Company's consultants receive feedback and guidance directly from network
administrators and other technical personnel regarding products and
features needed in the marketplace. See "Business-- Consulting."
FIREWALL/PLUS TECHNOLOGY
The Company's network security solutions are based upon its proprietary
FIREWALL/PLUS technology which provides organizations with enterprise wide
security to protect against unauthorized access from the Internet as well as
security for internal sources of intrusion and breach. The following are key
aspects of the Company's FIREWALL/PLUS solution:
ENTERPRISE-WIDE DEPLOYMENT. Unlike most other firewall solutions which focus
on an enterprise's connection to the Internet, the FIREWALL/PLUS solution, as a
result of its unique architecture, may be used throughout the enterprise; at the
perimeter to control access to and from the Internet, between internal networks
and on application servers, including web servers, and desktop PCs to protect
data residing on such servers and PCs. While competing firewall solutions must
be installed on dedicated computers, FIREWALL/PLUS can operate on a Windows NT
desktop computer or application server without interfering with the normal
operation of such desktop computer or server. As a result, the FIREWALL/PLUS
security solution can be installed on existing strategic computing resources
within the enterprise without incurring the expense of additional computing
hardware.
MULTI-LAYER SECURITY. The architecture of Windows NT includes two operating
modes, the "user" and "kernel" modes. The FIREWALL/PLUS solution is implemented
in kernel mode to maximize performance and to provide maximum security from
network intrusion to the operating system environment. Using proprietary
kernel-level software code developed by the Company, FIREWALL/PLUS' Interceptor
Shim and security filter engine technology introduce a security layer between
the network hardware drivers and the Windows NT operating system. FIREWALL/PLUS
filters all network traffic before it reaches Windows NT. Incoming data packets
enter the network through the network interface card and its associated hardware
driver and are immediately passed to the Interceptor Shim, which directs them to
the FIREWALL/PLUS filter engine. The filter engine, using a proprietary
high-speed, real-time security policy enforcement language, checks the packet
and associated packet history against the security rule policy database to
determine whether the packet should be allowed to enter the system. The Company
believes that FIREWALL/PLUS' multi-layer approach to security strengthens
Windows NT by providing a layer of security that filters packets before entering
the Windows NT operating system.
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ADVANCED FILTERING SYSTEM. The Company's FIREWALL/PLUS family of products
includes an advanced filtering system which currently utilizes stateful
inspection and application layer filtering technology to provide security for
TCP/IP related network transport protocols and applications. Stateful filtering
involves the knowledge of states of protocols at specific transaction intervals
during the network connection between two communicating applications between
specific systems. Transaction states occur at routing, transport, session
control and application layers when two programs interoperate with each other
over a computer network connection. When these states are defined to
FIREWALL/PLUS, FIREWALL/PLUS can take actions on conditions that violate the
required or expected stateful actions of one or a simultaneous series of
protocols. Most firewalls have been based upon architectures incorporating
either packet filtering or proxy filtering. FIREWALL/PLUS adopts a hybrid
approach which incorporates frame, packet, application layer, proxy and stateful
inspection capabilities in the security management of network connections. The
Company believes that this hybrid approach allows the Company to offer a
firewall product that maximizes security without sacrificing performance.
MULTI-PROTOCOL CAPABILITY. A unique aspect of FIREWALL/PLUS is its ability
to provide multi-protocol filtering not available from network security products
offered by other firewall vendors. FIREWALL/PLUS has the advantage of filtering
not only TCP/IP, but also a multitude of other network transport protocols. The
Company believes that the ability of FIREWALL/PLUS to filter multiple network
transport protocols offers significant advantages as a security product for
internal networks where multiple network transport protocols are common.
FIREWALL/PLUS is capable of utilizing stateful inspection technology for
numerous network transport protocols once the various "states" of such protocols
are defined to FIREWALL/PLUS. The states of TCP/IP and several other of the more
commonly used protocols are capable of being defined. For those protocols not
capable of being defined, FIREWALL/PLUS performs frame, packet and application
filtering. In a Windows NT based environment, it is typical for all commonly
used multiple network transport protocols to co-exist, as Windows NT comes
pre-equipped with TCP/IP, IPX (Novell), NetBEUI (LAN Manager) and AppleTalk. In
addition, certain applications require the use of non-TCP/IP protocols to
operate between sub-networks on a network. FIREWALL/PLUS' multi-protocol
filtering capability is effective in supporting web servers on the Internet,
intranets and extranets and other information provision systems that access
information stored on mainframe computers via non-IP protocols. While some
commercially available routers allow basic packet filtering for multiple network
transport protocols, the Company believes its multi-protocol advanced filtering
capabilities offer superior features to routing solutions such as a graphical
user interface, extensive logging, reporting and alarming and security policy
time management.
TRANSPARENCY. FIREWALL/PLUS may be operated in a transparent mode. In this
mode, FIREWALL/PLUS has no network address (i.e. it is not visible on the
network) and therefore can not be identified for attack. The Company believes
that this feature provides additional security to the operating system because
when a firewall has a network address, it can be located and is more susceptible
to attack. FIREWALL/PLUS provides firewall protection while operating in
transparent mode, except that certain features such as remote management, proxy
support and virtual private networking are not functional.
CENTRALIZED MANAGEMENT. FIREWALL/PLUS allows for centralized management and
monitoring that allows a network manager to manage and monitor a system from a
local or remote location. Accordingly, large and geographically dispersed
firewalls may be managed from a single location.
CUSTOMIZED SECURITY POLICIES. FIREWALL/PLUS also allows customized security
policies for individual departments, applications and individual systems and
personnel within the network. Network managers may apply security rules to any
version of the FIREWALL/PLUS products so that individual systems, protocols,
applications, frames and many other network entities are either explicitly
denied or authorized access to specific applications and other network entities.
MULTI-PROTOCOL ENCRYPTION TUNNELS. Once firewalls are in place at multiple
sites on a WAN or the Internet, the ability to establish encrypted
communications links over these connections becomes possible,
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thereby reducing reliance on more costly dedicated telecommunications
alternatives. FIREWALL/PLUS provides for integrated data encryption to protect
communications over the Internet and other public networks from unauthorized
access. Encryption tunnels, known as virtual private networks ("VPNs"), may be
set up for any Windows NT based protocol to protect communications between
different locations of an organization's internal network or between different
locations and selected customers, suppliers or strategic partners. FIREWALL/PLUS
extends this ability such that VPNs may be formed between locations across the
Internet irrespective of the transport protocol being tunneled. The Company
currently resells VPN client solutions from Aventail Corporation in conjunction
with FIREWALL/PLUS.
PROXY SUPPORT. Proxy based firewalls filter network traffic by running a
separate software program that acts as a proxy for each application to be
allowed through the firewall. These firewall solutions require the customer to
purchase the proxies supplied by the vendor for the applications supported by
the vendor's architectural model. As a result, the customer may not find all the
required application proxies from a specific firewall vendor for all the
application suites being used or may find that the proxies offered by the
firewall vendor are not sufficient to support all the required security needs.
FIREWALL/PLUS includes several popular proxies in addition to frame, packet,
application layer, proxy and stateful inspection capabilities. These proxies
implement popular features for specific application types such as HTTP and FTP.
The Company currently licenses HTTP and FTP proxies from Network Associates,
Inc. FIREWALL/PLUS also allows the use of other third-party proxies in
conjunction with or in lieu of proxies offered by the Company. FIREWALL/PLUS'
architecture allows the Company to partner and include external or third-party
proxies quickly and easily to suit a variety of security requirements.
Additionally, custom-written proxies for a client-server architecture at a
customer site may easily be added to the FIREWALL/PLUS system by adjusting
security policy rule sets in the firewall database.
EASE OF USE. FIREWALL/PLUS was designed to be easily installed, configured
and managed by a network manager with minimal or no security skills.
FIREWALL/PLUS may be installed and configured by use of the graphical user
interface ("GUI") by simply pointing and clicking the mouse. To facilitate
implementation, FIREWALL/PLUS comes pre-programmed with a wide variety of
frequently used default security policies which require the customer to simply
select one of the rule-bases and save the selection. FIREWALL/PLUS does not
utilize significant server resources and may therefore co-exist on the same
server with other software applications on Windows NT. Unlike many other
competitive firewall products offered today, FIREWALL/PLUS need not run on a
separate dedicated server.
PRODUCTS
The Company's family of FIREWALL/PLUS products offers a broad range of
network security solutions. The FIREWALL/PLUS family of products includes the
FIREWALL/PLUS ENTERPRISE VERSION, FIREWALL/PLUS SERVER VERSION and FIREWALL/PLUS
CLIENT VERSION. The Company is currently shipping FIREWALL/PLUS Version 4.03.
The Company first introduced the FIREWALL/PLUS ENTERPRISE VERSION for Windows NT
in January 1997. As of August 31, 1998, the Company had licensed one or more of
its FIREWALL/PLUS family of software products to over 180 customers. Revenue
from FIREWALL/PLUS products accounted for 43%, 60% and 35% of the Company's
revenues for the years ended December 31, 1996, 1997 and the six months ended
June 30, 1998, respectively. Following the consummation of this offering, the
Company expects that sales of its FIREWALL/ PLUS products will account for an
increasing percentage of revenues, reflecting the Company's intent to emphasize
the development and marketing of its software products.
FIREWALL/PLUS ENTERPRISE VERSION. The FIREWALL/PLUS ENTERPRISE VERSION
secures an organization's internal network against unwarranted intrusions from
the Internet and is also used between major internal network components as well
as between general access internal networks and special purpose networks such as
process control, real-time and other sensitive access networks. The
FIREWALL/PLUS ENTERPRISE VERSION includes extensive centralized and remote
security management facilities, predefined security policy rules, multi-protocol
VPN capabilities, authentication and encryption facilities, real time connection
management and
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proxy services. The FIREWALL/PLUS ENTERPRISE VERSION supports Intel processors
and Digital Equipment Corporation Alpha processors that support Windows NT. The
FIREWALL/PLUS ENTERPRISE VERSION is available in scaleable models to support
varying numbers of simultaneous connections for small to mid-size companies and
in an unlimited session version, as well as a high-speed version. Additionally,
the FIREWALL/ PLUS ENTERPRISE VERSION is also available in a PREMIER VERSION
which includes the software installed on a high speed Alpha server running
Windows NT. Based on the number of concurrent connections, the nature of the
user's operating system and whether hardware is needed, the FIREWALL/PLUS
ENTERPRISE VERSION is currently priced to end users between $3,750 and $20,000
for software only versions and from $27,500 to $30,000 for PREMIER VERSIONS,
which include hardware and onsite technical support.
FIREWALL/PLUS SERVER VERSION. The FIREWALL/PLUS Server Version is designed
to improve internal security of a LAN or intranet or to protect highly sensitive
systems such as key escrow facilities, web servers, digital certificate servers,
database servers and authentication servers. As a server firewall, this solution
provides protection against unauthorized access to network resources by internal
users, where security breaches often originate. The FIREWALL/PLUS SERVER VERSION
co-exists on the server being protected and resides between the network users
and the protected data. FIREWALL/PLUS SERVER VERSION treats all information on
the server as secure and guarded, while treating network connections to the
server as unsecure. FIREWALL/PLUS can be configured using the FIREWALL/PLUS GUI
to allow access to certain users, to specific applications, during designated
times and under a variety of conditions. The FIREWALL/PLUS SERVER VERSION
incorporates all of the major features contained in the FIREWALL/PLUS ENTERPRISE
VERSION. Any other applications including web, file and print services, may be
run simultaneously on the server with the FIREWALL/PLUS SERVER VERSION installed
and operating. The FIREWALL/PLUS CLIENT VERSION is currently priced to end users
at $1,995.
FIREWALL/PLUS CLIENT VERSION. The FIREWALL/PLUS CLIENT VERSION is a full
featured firewall which has been specifically tailored to protect data residing
on Windows NT workstations without disrupting current system operations. These
workstations can run applications while the firewall maintains a high level of
security. When a network attack is detected, it is immediately defeated prior to
the attack being able to access the NT Workstation. The FIREWALL/PLUS CLIENT
VERSION is designed to protect sensitive individual desktop computers (such as a
network control station, a corporate executive's personal computer or the human
resources personnel system) or telecommuter systems where high speed remote
access lines are used (such as cable modems, ADSL and ISDN). The FIREWALL/PLUS
CLIENT VERSION is currently priced to end users at $995.
CUSTOMERS
The Company's customers represent a wide range of industries, both
commercial and government, which consider networked-data resources to be among
the most important assets within their organizations. As of August 31, 1998, the
Company had licensed one or more of its FIREWALL/PLUS family of products to over
180 customers. Customers for FIREWALL/PLUS products include The Sabre Group
Inc., Electronic Data Systems Corporation ("EDS"), Trusted Information Systems,
Inc. ("TIS"), TRW, Inc., United Technologies, Inc., National Semiconductor
Corp., Fairchild Semiconductor, Atlantic Richfield Company and related entities
("ARCO"), GTE, Inc., and Continental Airlines. During the year ended December
31, 1997, license revenues and royalties from TIS and EDS accounted for
approximately 21% and 13% of the Company's revenues, respectively. During the
six months ended June 30, 1998, license revenues from EDS and The Sabre Group,
Inc. accounted for 10% and 9% of the Company's revenues, respectively.
Examples of the varied uses of the Company's products by customers include:
- An industry leading system integrator uses ENTERPRISE VERSIONS of
FIREWALL/PLUS to secure access and communications to and from its
facilities management personnel and their customers to manage the networks
of one of the largest telecommunications companies. The FIREWALL/PLUS
ENTERPRISE VERSIONS are used as perimeter defenses on the company's
internal backbone, which supports more than 900 outside clients.
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- A leading travel service company utilizes multiple FIREWALL/PLUS
ENTERPRISE and SERVER VERSIONS internally to securely filter non-TCP/IP
network transport protocols between various segments of the internal
network. In addition, the company functions as a service company and
systems integrator dealing with many of the industry's largest travel
related companies and has installed multiple FIREWALL/PLUS ENTERPRISE
VERSIONS to interconnect to customer sites.
- A worldwide petrochemical company currently uses FIREWALL/PLUS ENTERPRISE
VERSION to secure data at multiple sites from internal and external
breaches. Disparate network transport protocols, including TCP/IP and
Novell's IPX, are securely and routinely sent from multiple data centers
(each using FIREWALL/PLUS) throughout the country to a center of
operations while FIREWALL/PLUS insures the integrity of the data.
The Company believes that the FIREWALL/PLUS security solution is a scaleable
product which satisfies customers' needs to secure the perimeter and internal
resources within their organizations. The Company further believes that
currently available IP Firewalls are not as flexible with respect to both
internal and external security as the FIREWALL/PLUS solution.
During the years ended December 31, 1996 and 1997 and the six months ended
June 30, 1998, license revenue from international customers (licenses to foreign
end users and international distributors) accounted for 7%, 16% and 2% of the
Company's revenues, respectively. All of the Company's revenues from
international licenses were denominated in U.S. dollars. The Company anticipates
that revenues from international customers will account for an increasing
percentage of the Company's revenues in the future.
SALES AND MARKETING
The Company is in the process of implementing a sales and marketing plan
which consists of a multi-channel distribution strategy and a promotion strategy
to create consumer awareness of the Company and its FIREWALL/PLUS products and
to educate the market about the need to implement network security products and
of the capabilities and benefits of the Company's FIREWALL/PLUS products.
MULTI-CHANNEL DISTRIBUTION
IN-HOUSE SALES FORCE. The Company's internal sales force consists of three
persons, consisting of a Vice President of International Sales and two sales
representatives. The Company's sales representatives are responsible for
soliciting potential customers and providing technical support to customers, as
well as supporting third-party distribution channels. To date, the Company's
internal sales force has not undertaken significant marketing efforts relating
to product commercialization.
Following the consummation of this offering, the Company intends to retain a
Vice-President of Sales to oversee the Company's domestic sales and marketing
efforts and a limited number of additional sales representatives in connection
with the expansion of the Company's marketing efforts. Although the Company's
in-house sales force will continue to solicit potential customers, its primary
responsibility is expected to be supporting third-party distribution channels.
THIRD-PARTY DISTRIBUTION CHANNELS. A key element of the Company's
distribution strategy is to establish and maintain relationships with
third-party distributors within the United States and internationally. By
engaging such third-party distributors, the Company is able to utilize the
end-user sales and support infrastructure of these channels.
The Company currently has relationships with 22 national, regional and local
systems integrators, VARs and resellers in the United States, including EDS,
Wang Laboratories, Inc. and BDM International, Inc. In November 1997, the
Company entered into a Master Software License Agreement with EDS pursuant to
which EDS has the non-exclusive right on a worldwide basis to use, market and
distribute the Company's FIREWALL/PLUS family of products including the right to
promote and resell such products in
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conjunction with providing systems integration, outsourcing or facilities
management services to its customers. The Company also currently has
relationships with international system integrators, VARs, resellers and
distributors in 25 countries, including Japan, Germany, Canada, United Kingdom,
Republic of China, Hong Kong, Russia, Taiwan, Korea, Singapore, Malaysia,
Indonesia, Thailand and Turkey.
The Company's agreements with distributors generally grant the distributor
the right to market the Company's products in specified territories on a
non-exclusive basis, are terminable on short notice and do not prohibit the
distributor from selling products that are competitive with the Company's
products.
The Company intends to continue to seek to establish relationships with
additional third-party distributors, principally larger system integrators and
VARs with the necessary resources to successfully distribute the Company's
FIREWALL/PLUS products. For the year ended December 31, 1997, TIS, EDS and ARCO
accounted for 21%, 15%, and 13%, respectively, of the Company's revenues and for
the six months ended June 30, 1998, The City of Hope, EDS and The Sabre Group,
Inc. accounted for 32%, 17% and 11%, respectively, of the Company's revenues.
The Company's five largest distributors accounted for an aggregate of
approximately 28% and 25% of the Company's revenues for the year ended December
31, 1997 and the six months ended June 30, 1998, respectively.
The Company also seeks to enter into OEM or licensing arrangements whereby
the Company grants to an OEM or other third party the right to incorporate
and/or bundle a specific technology of the Company with the OEM's or other
third-party's products. In June 1997, the Company entered into a license
agreement with TIS, which was subsequently acquired by Network Associates, Inc.,
pursuant to which the Company licensed to TIS on a non-exclusive basis the right
to incorporate and/or bundle the Company's Interceptor Shim software with TIS'
family of Gauntlet-TM- firewall products. The Company receives a royalty based
upon TIS sales, of which $500,000 was paid to the Company in June 1997 as a non-
refundable pre-paid royalty. As a result of such pre-paid royalty, royalties
from TIS accounted for 21% of the Company's revenues for the year ended December
31, l997. The Company expects that its arrangements with third-party
distributors and OEMs will account for an increased percentage of its revenues
in the future.
ADVERTISING AND PROMOTION
Following the consummation of this offering, the Company intends to
implement an advertising and promotion strategy to create consumer awareness of
the Company and its FIREWALL/PLUS products and to educate the market about
network security threats and FIREWALL/PLUS' ability to address customers' needs.
To date, the Company has engaged in limited advertising and promotion of its
products through its website, trade publications and published product reviews.
The Company intends to use a portion of the proceeds of this offering to
advertise and promote its products through print advertising, Internet website
advertising, direct marketing efforts and participation in trade shows and
seminars which target organization security and management information system
administrators and network system integrators.
The Company's website, www.network-1.com, which includes a description of
the Company's FIREWALL/PLUS family of products and enables visitors to the site
to download a 50-session FIREWALL/PLUS ENTERPRISE VERSION for a 30-day trial.
The Company intends to use a portion of the proceeds of this offering to add
content to the website, such as product information, including a user guide,
network security industry information and additional content specific to
distributors and end users; improve download capabilities for the trial version;
and enable purchases via the website.
CONSULTING
The Company has designed, planned, audited and implemented numerous networks
worldwide for a broad spectrum of clients, including Fortune 500 companies,
small companies with modest requirements, federal, state and foreign governments
and utilities, as well as education and research institutions. Mr. William
Hancock, the Company's Chief Technology Officer and a director, is an industry
expert who
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has authored networking and security books and has been a featured columnist as
well as a network and security editor for a number of industry journals. The
Company intends to expand its consulting activities following the consummation
of this offering by utilizing the expertise of Mr. Hancock to create
opportunities for consulting through speaking engagements at industry
conferences, seminars and trade shows.
Historically, the Company has offered a wide range of consulting services
designed to provide solutions to networking and security problems. Such
consulting services have included network surveys, network designs and traffic
modeling, security penetration studies, security breach investigation, network
and computer forensics services, hacker prosecutions (in connection with federal
and local law enforcement agencies) and network security technical audits among
other services. The Company generally provides its consulting clients with a
comprehensive report containing detailed findings and recommendations. The
Company offers its consulting services on a per hour or per project basis.
The Company's consulting clients have included, among others, EDS, MCI
Communications Corp., Kraft General Foods, Inc., Alcoa Aluminum Company of
America, TIA-CREF, Southwestern Bell Telephone Co., Chemical Bank Corp., Hewlett
Packard Co., American Airlines, Inc., Bechtel Corporation, ARCO, United
Technologies Sikorsky Aircraft, Bowne, Inc., and the U.S. Government, including
The Environmental Protection Agency.
Consulting services generated 35%, 25% and 47% of the Company's revenues for
the years ended 1996 and 1997 and the six months ended June 30, 1998,
respectively. Consulting revenues from ARCO accounted for 9% of the Company's
revenues for the year ended December 31, 1997 and consulting revenues from The
City of Hope accounted for 28% of the Company's revenues for the six months
ended June 30, 1998. Following the consummation of this offering, the Company
expects that consulting services will account for a decreasing percentage of
revenues as the Company continues to focus its efforts on developing and
marketing its network security software products.
CUSTOMER SERVICE AND SUPPORT
The Company believes that customer service and support is critical to
retaining customers and attracting prospective customers. The Company provides
customer service and support through its internal technical support staff of 4
persons located at its Grand Prairie, Texas office. Customers receive a 90-day
warranty, which includes technical assistance and product updates. To date, the
Company has not incurred any material warranty expense. Following the expiration
of the 90-day warranty, customers can elect to purchase the Company's annual
maintenance program at an average annual cost of 15% of the then current
purchase price. The maintenance program includes technical assistance and
support, product updates and general information relating to product
introductions and changes. Technical support is available 24 hours a day, 7 days
a week, by telephone and electronic mail. In addition, the Company provides
customers with fee-based on-site installation, support and training. The Company
provides its resellers with sales and technical support.
PRODUCT DEVELOPMENT
The Company believes that development of new products and enhancements to
existing products are essential for the Company to effectively compete in the
network security market. The Company's product development efforts are directed
toward enhancing its FIREWALL/PLUS family of security products, developing new
products and responding to emerging industry standards and other technological
changes. The Company intends to expand its existing product offerings and to
introduce new application products for the network security market. The
Company's new product development efforts are focused on enhancements to the
Company's current suite of products and new network security products, including
products that support Windows 95/98 operating systems. While the Company expects
that certain of its new products will be developed internally, the Company may,
based on timing and cost considerations, expand
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<PAGE>
its product offerings through acquisitions. In addition, the Company has relied
and will continue to rely on external development resources for the development
of certain of its products and components.
The Company currently has six employees devoted to research and product
development. However, historically, a substantial portion of the Company's
research and development activities have been undertaken by engaging third-party
consultants and independent contractors. During the years ended December 31,
1996 and 1997 and six months ended June 30, 1998, the Company's total product
development costs, including capitalized costs, were $1,642,000, $1,642,000 and
$333,000, respectively.
The Company intends to hire and retain approximately 17 additional software
engineers and developers on a full-time basis within twelve months following the
consummation of this offering and has allocated approximately $2,100,000 of the
net proceeds of this offering to software development.
The network security industry is characterized by rapid technological
change, changes in customer requirements, frequent new product introductions and
enhancements, new and continuously evolving network security threats and attack
methodologies and evolving industry standards in computer hardware and software
technology. As a result, the Company must continually change and improve its
products in response to such advances and changes in operating systems,
application software, computer and communications hardware, networking software,
programming tools and computer language technology. The introduction of products
embodying new technologies and the emergence of new industry standards may
render existing products obsolete or unmarketable.
The Company's future operating results will depend upon the Company's
ability to enhance its current products and to develop and introduce new
products on a timely basis that address the increasingly sophisticated needs of
the marketplace and that keep pace with technological developments, new
competitive product offerings and emerging industry standards. There can be no
assurance that the Company will be successful in developing and marketing new
products or product enhancements that respond to technological change and
evolving industry standards and customer requirements, that the Company will not
experience difficulties that could delay or prevent the successful development,
introduction and marketing of these products, or that any new products and
product enhancements will adequately meet the requirements of the marketplace
and achieve market acceptance. In the event that the Company does not respond
adequately to the need to develop and introduce new products or enhancements of
existing products in a timely manner in response to changing market conditions
or customer requirements, the Company's business, operating results and
financial condition will be materially adversely affected.
COMPETITION
The network security market in general, and the firewall product market in
particular, is characterized by intense competition and rapidly changing
business conditions, customer requirements and technologies. The Company
believes that the principal competitive factors affecting the market for network
security products include security effectiveness, name recognition, scope of
product offerings, product features, distribution channels, price, ease of use
and customer service and support. Currently, the Company's principal competitors
include AXENT Technologies Inc., Bay Networks, Inc., CheckPoint Software
Technologies, Ltd., Cisco Systems, Inc., Compaq Computer Corporation, Cyberguard
Corp., International Business Machines Corporation, ISS Group, Inc., Microsoft
Corporation, Network Associates, Inc. and Secure Computing Corporation. Due to
the rapid expansion of the network security market, the Company may face
competition from new entrants.
Most of the Company's current and potential competitors have longer
operating histories, greater name recognition, larger installed customer bases
and possess substantially greater financial, technical and marketing and other
competitive resources than the Company. As a result, the Company's competitors
may be able to adapt more quickly to new or emerging technologies and changes in
customer requirements or devote greater resources to the promotion and sale of
their products than the Company. While the Company believes that its firewall
products do not compete against manufacturers of other types of
41
<PAGE>
security products (such as encryption and authentication products), there can be
no assurance that potential customers will not perceive the products of such
other companies as substitutes for the Company's products. In addition, certain
of the Company's competitors may determine for strategic reasons to consolidate,
to substantially lower the price of their network security products or to bundle
their products with other products, such as hardware or other enterprise
software products. Accordingly, it is possible that new competitors and
alliances among competitors may emerge and rapidly acquire significant market
share. There can be no assurance that the Company's current and potential
competitors will not develop products that may be more effective than the
Company's current or future products or that the Company's products would not be
rendered obsolete or less marketable by evolving technologies or changing
consumer demands or that the Company will otherwise be able to compete
successfully. Increased competition for firewall products may result in price
reductions, reduced gross margins and adversely effect the Company's ability to
gain market share, any of which would adversely affect the Company's business,
operating results and financial condition.
PROPRIETARY RIGHTS
The Company's success is substantially dependent on its proprietary
technologies. The Company does not hold any patents and relies on copyright and
trade secret laws, non-disclosure agreements with employees, distributors and
customers, including "shrink wrap" license agreements that are not signed by the
customer, and technical measures to protect the ideas, concepts and
documentation of its proprietary technologies and know-how to protect its
intellectual property rights. Such methods may not afford complete protection,
and there can be no assurance that third parties will not independently develop
substantially equivalent or superior technologies or obtain access to the
Company's technologies, ideas, concepts and documentation. In addition, there
can be no assurance that any confidentiality agreements between the Company and
its employees, distributors or customers will provide meaningful protection for
the Company's proprietary information in the event of any unauthorized use or
disclosure. Any inability to protect its proprietary technologies could have a
material adverse effect on the Company. Furthermore, the Company may be subject
to additional risk as it enters into transactions in countries where
intellectual property laws are not well developed or are poorly enforced. Legal
protection of the Company's rights may be ineffective in such countries.
The Company also licenses from a third party certain proxy technology which
is incorporated into its FIREWALL/PLUS products. The Company is dependent in
part on its ability to continue to license such technology. Any inability of the
Company to be able to continue to utilize such technology either as a result of
the Company's breach or the termination of a license agreement or otherwise, in
the absence of similar available technologies, could have a material adverse
effect on the Company.
The Company received a U.S. trademark registration for the FIREWALL/PLUS
name in December 1996. Although the Company is not aware of any challenges to
the Company's rights to use this trademark, there can be no assurance that the
use of this mark would be upheld if challenged.
Although the Company believes that its technologies and products have been
developed independently and do not infringe upon the proprietary rights of
others, there can be no assurance that the Company's technologies and products
do not and will not so infringe or that third parties will not assert
infringement claims against the Company in the future. The Company is not aware
of any patent infringement charge or any violation of other proprietary rights
claimed by any third party relating to the Company or the Company's products. In
response to certain public statements made by CheckPoint Software Technologies,
Ltd. related to a patented technology referred to as "stateful inspection" (the
"Checkpoint Patent"), the Company retained patent counsel in April 1997 to
review the Checkpoint Patent as compared to the Company's intellectual property
and associated products. Based upon the opinion of the Company's intellectual
property counsel, the Company does not believe that the CheckPoint Patent will
have a material adverse effect on the Company. If, however, the Company's
technologies or products were deemed to infringe upon the Checkpoint Patent, or
if the Company's technologies or
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<PAGE>
products were deemed to infringe upon the proprietary rights of other third
parties, the Company could become liable for damages or be required to modify
its products or to obtain a license.
As the number of security products being offered continue to increase the
functionality of such products may further overlap, which could result in
increased infringement claims by software developers, including infringement
claims against the Company with respect to future products. There can be no
assurance that the Company would be able to modify its products or obtain a
license in a timely manner, upon acceptable terms and conditions, or at all, or
that the Company will have the financial or other resources necessary to defend
a patent infringement or other proprietary rights infringement action. Failure
to do any of the foregoing could have a material adverse effect on the Company,
including possibly requiring the Company to cease marketing its products.
COMMHOME SYSTEMS CORPORATION ACQUISITION
On September 11, 1998, the Company entered into a merger agreement with
CommHome, effective upon consummation of this offering, pursuant to which the
CommHome stockholders have agreed to exchange all of the outstanding common
stock of CommHome for 35,000 shares of Common Stock of the Company valued at
$280,000. Pursuant to the merger agreement, the Company has agreed to assume
approximately $200,000 of liabilities of CommHome, which include $55,000 and
$50,000 owed to Avi A. Fogel and Robert P. Olsen, respectively. Messrs. Fogel
and Olsen have agreed to accept 6,875 and 6,250 shares of Common Stock,
respectively, in full satisfaction of such indebtedness. Mr. Fogel, President,
Chief Executive Officer and a director of the Company, is also President, Chief
Executive Officer and a director of CommHome and owns 51% of the outstanding
shares of CommHome. Mr. Olsen, Vice President of Product Management of the
Company, is the former Vice President of Marketing of CommHome. See "Certain
Transactions."
CommHome, incorporated in June, 1997, is a development stage company that
has not achieved revenues from operations. At June 30, 1998, CommHome had a
stockholders' deficiency of $188,831 and an accumulated deficit of $188,861.
Upon consummation of the CommHome Acquisition, the Company will incur a charge
for purchased research and development of $469,000, representing the excess of
the purchase price plus the assumed liabilities over the fair value of the
tangible assets acquired of $1,000.
CommHome is engaged in the design and development of residential networking
solutions for high speed Internet access to the home. CommHome's designs are
intended to provide easy access to the Internet throughout the home. These
solutions include secure connections to high speed networking technologies, such
as ADSL and cable modem technology, and easy distribution at all phone
connections. It is currently expected that CommHome's designs will be
incorporated into the Company's future security products.
EMPLOYEES
As of August 31, 1998, the Company had 25 full time employees, including 5
in sales and marketing, 10 in product research and development and technological
support, 3 in consulting and 7 in administration and finance. None of the
Company's employees is represented by a labor union or is subject to a
collective bargaining agreement. The Company has not experienced any work
stoppages and considers its relationship with its employees to be good.
Competition with respect to the recruiting of highly qualified personnel in
the software industry is intense and many of the Company's competitors have
significantly greater resources than the Company. The Company's ability to
attract and assimilate new personnel will be critical to the Company's
performance and there can be no assurance that the Company will be successful in
attracting or retaining the personnel it requires to enhance its products,
develop new products and conduct its operations successfully.
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FACILITIES
The Company currently subleases on a month-to-month basis approximately 400
square feet of office space in Wellesley Hills, Massachusetts for its principal
executive offices. Following the consummation of this offering, the Company
intends to lease new principal executive offices in the Boston, Massachusetts
area. The Company's technical support, warehouse and distribution facilities are
located in Grand Prairie, Texas, where the Company leases approximately 7,500
square feet pursuant to a written lease which expires on July 31, 1999. The
Company also leases approximately 4,500 square feet of office space in New York,
New York under a sublease that expires on September 29, 1998, which the Company
does not intend to renew.
LEGAL PROCEEDINGS
The Company is not a party to any material legal proceedings.
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MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
The executive officers and directors of the Company are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
- ----------------------------------------------------- --- -----------------------------------------------------
<S> <C> <C>
Avi A. Fogel......................................... 44 President, Chief Executive Officer and Director
William Hancock...................................... 41 Chief Technology Officer and Director
Robert P. Olsen...................................... 44 Vice President of Product Management
Murray P. Fish....................................... 47 Chief Financial Officer
Joseph A. Donohue.................................... 43 Vice President of Engineering
Joseph D. Harris..................................... 45 Vice President of International Sales
Robert M. Russo...................................... 47 Vice President of Business Development and Secretary
Corey M. Horowitz.................................... 43 Chairman of the Board of Directors
Marcus J. Ranum...................................... 35 Director
Barry Rubenstein..................................... 55 Director
Irwin Lieber......................................... 59 Director
</TABLE>
AVI A. FOGEL has served as President, Chief Executive Officer and a director
since May 1998. From March 1998 until May 1998, Mr. Fogel served as a consultant
to the Company. From June 1997 until the consummation of this offering, Mr.
Fogel served as President and Chief Executive Officer of CommHome, a development
stage company engaged in the business of developing residential networking
solutions, which he co-founded in June 1997. From January 1997 to June 1997, Mr.
Fogel was engaged in pre-incorporation activities related to CommHome. Effective
upon the consummation of this offering, CommHome will be acquired by the
Company. From October 1995 to December 1996, Mr. Fogel was employed by Digital
Equipment Corp. as Vice President, Global Marketing. From July 1994 to October
1995, Mr. Fogel was Executive Vice President, Global Marketing and Business
Development of LANNET Data Communications, Ltd., a manufacturer of LAN switching
hubs located in Tel Aviv, Israel. From July 1990 to July 1994, Mr. Fogel served
as President and Chief Executive Officer of LANNET, Inc., the U.S. subsidiary of
LANNET Data Communications, Ltd.
WILLIAM HANCOCK co-founded the Company and has served as its Chief
Technology Officer since May 1998 and as a director since inception. From
inception until May 1998, Mr. Hancock served as Executive Vice President and
Secretary. Mr. Hancock is a leading international expert in computer and network
design and security with over 20 years of experience in computer science,
network technologies and electrical engineering. From June 1982 to July 1990,
Mr. Hancock was an independent computer and networking consultant to Fortune 500
companies, including Digital Equipment Corporation, AT&T and IBM. Mr. Hancock
participated in the operating system and network design teams at both Digital
Equipment Corporation and IBM. He was instrumental in the design and selection
of the Integrated System Digital Network plug connector and is the author of the
implementation of the RSA encryption algorithm for the CCITT X.32 network
standard. Mr. Hancock has been involved in the architecture and writing of the
networking and security standards for the International Organization for
Standardization. Mr. Hancock is a Certified Information Systems Security
Professional.
ROBERT P. OLSEN has served as Vice President of Product Management since May
1998. From March 1998 until May 1998, Mr. Olsen served as a consultant to the
Company. From July 1997 to December 1997, Mr. Olsen served as Vice President of
Marketing of CommHome. From July 1996 to July 1997, Mr. Olsen was Vice President
of Marketing for Netphone, Inc., a developer of computer servers. From December
1991 to June 1996, Mr. Olsen was Vice President of Marketing for Agile Networks,
Inc., a
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company engaged in the design manufacturing, marketing and support of ethernet
and ATM switches, which he co-founded.
MURRAY P. FISH has served as Chief Financial Officer since May 1998. From
August 1997 to May 1998, Mr. Fish was an independent financial consultant. From
April 1991 to August 1997, Mr. Fish served as President, Chief Executive Officer
and a director of RealWorld Corporation, a manufacturer of accounting software.
From March 1989 to April 1991, Mr. Fish served as Vice President and Controller
of Goldman Financial Group, Inc., a manufacturer of chemical and machine tools.
JOSEPH A. DONOHUE has served as Vice President of Engineering since July
1998. From April 1987 to July 1998, Mr. Donohue was employed by Stratus Computer
Inc., having held the positions of Director-- Windows/NT Software Development
from November 1997 to July 1998, Director--Proprietary OS from July 1994 to
November 1997 and Manager--Kernel Development from July 1993 to July 1994. From
April 1987 to July 1993, Mr. Donohue was employed by Stratus Computer, Inc. in
various engineering positions.
JOSEPH D. HARRIS has served as Vice President of International Sales since
August 1998. From November 1996 until August 1998, Mr. Harris served as Vice
President of Sales and Managing Director-- Asia Pacific of Proginet Corporation,
a developer of cross-platform database technologies. From October 1990 until
November 1996, Mr. Harris served as President and Chief Executive Officer of
KnowledgeNet Incorporated, a company also engaged in development of
cross-platform database technologies, which he founded. Mr. Harris also served
as Director of Architecture for System Software Associates, Inc., a developer of
business planning software, from January 1988 to October 1990.
ROBERT M. RUSSO co-founded the Company and has served as Vice President of
Business Development and Secretary since May 1998. Mr. Russo served as President
and a director of the Company from inception until May 1998, and as Chief
Operating Officer of the Company from December 1993 to May 1998. From May 1987
to June 1990, Mr. Russo served as Vice President of Sales and Marketing of
Essential Resources, Inc., a computer consulting and training company. From
December 1979 to February 1987, Mr. Russo served as President of the North
American Division of H&M Systems Software, Inc., a software developer.
COREY M. HOROWITZ became Chairman of the Board of Directors of the Company
in January 1996 and has been a member of the Board of Directors since April
1994. Mr. Horowitz is a private investor and President and sole shareholder of
CMH Capital Management Corp., a New York investment advisory and merchant
banking firm, which he founded in September 1991. From January 1986 to February
1991, Mr. Horowitz was a general partner in charge of mergers and acquisitions
at Plaza Securities Co., a New York investment partnership. From July 1984 to
December 1985, Mr. Horowitz was a general partner at Lafer Amster & Co., an
investment partnership. From August 1980 to June 1984, Mr. Horowitz was an
associate at the New York law firm of Skadden, Arps, Slate, Meagher & Flom.
MARCUS J. RANUM has served as a director of the Company since June 1998. Mr.
Ranum currently serves as President and Chief Executive Officer of Network
Flight Recorder, Inc., a development stage networking software company which he
founded in March 1996. From October 1994 to February 1996, Mr. Ranum served as
Chief Scientist and Executive Manager of V-One Corporation, a company engaged in
the development and marketing of network security products. From June 1994 to
October 1994, he served as a consultant in network security, software analysis
and testing, software development and related matters. From November 1992 to
June 1994, Mr. Ranum served as Senior Scientist of Trusted Information Systems,
Inc. From August 1991 to November 1993, Mr. Ranum served as a consultant to
Digital Equipment Corporation.
BARRY RUBENSTEIN has served as a director of the Company since August 1998.
During the period March 1996 until July 1998, Mr. Rubenstein served as a member
of the Company's advisory board. Since June 1994, Mr. Rubenstein has served as
President, a director and a shareholder of InfoMedia Associates,
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<PAGE>
Ltd., which is a general partner of the 21st Century Communications Partners,
L.P. and affiliated partnerships. Mr. Rubenstein also serves as Chief Executive
Officer of Wheatley Partners, L.L.C., the general partner of Wheatley Partners,
L.P. and a general partner of Wheatley Foreign Partners, L.P. He is also a
general partner of Applewood Associates, L.P., Seneca Ventures and Woodland
Venture Fund, each of which is an investment partnership. Prior to his
experience as an investor, Mr. Rubenstein served as a co-founder of several
technology companies, including Applied Digital Data Systems, Inc., Cheyenne
Software, Inc. and Novell, Inc. Mr. Rubenstein also serves as a director of
Infonautics, Inc., The Millbrook Press, Inc., Source Media, Inc. and USWeb
Corporation.
IRWIN LIEBER has served as a director of the Company since August 1998.
During the period March 1996 until July 1998, Mr. Lieber served as a member of
the Company's advisory board. Since 1979, he has served as Chairman and Chief
Executive Officer of GeoCapital LLC, an investment advisory firm which he
founded. Mr. Lieber is also a general partner of Applewood Associates, L.P., and
a principal of 21st Century Communications, L.P., each of which is an investment
partnership. Mr. Lieber also serves as President of Wheatley Partners, LLC, the
general partner of Wheatley Partners, L.P. and a general partner of Wheatley
Foreign Partners, both of which are investment partnerships. Mr. Lieber also
serves as a director of LeaRonal Inc. and Giga Information Group, Inc.
All Directors serve until the next annual meeting of stockholders and the
election and qualification of their successors. Executive officers are elected
by, and serve at the discretion of, the Board of Directors. Corey M. Horowitz
was elected a director pursuant to a stockholders' agreement which provided that
certain principal stockholders agreed to vote their shares to elect Mr. Horowitz
to the Board of Directors. The stockholders' agreement terminates upon the
effective date of the offering. There are no family relationships among any of
the Company's directors or executive officers.
The Company has agreed, for a period of five years from the date of this
Prospectus, if so requested by the Underwriter, to nominate and use its best
efforts to elect a designee of the Underwriter as a director of the Company or,
at the Underwriter's option, as a non-voting advisor to the Company's Board of
Directors. The Company's officers, directors and principal stockholders have
agreed to vote their shares of Common Stock in favor of such designee. The
Underwriter has not yet exercised and currently does not intend to exercise its
right to designate such a person.
BOARD COMMITTEES
In August 1998, the Board of Directors established an Audit Committee,
consisting of Irwin Lieber, Marcus Ranum and Avi Fogel, and a Compensation
Committee, consisting of Corey M. Horowitz and Barry Rubenstein. The Audit
Committee will review the qualifications of the Company's independent auditors,
make recommendations to the Board of Directors regarding the selection of
independent auditors, review the scope, fees and results of any audit, and
review non-audit services and related fees provided by the independent auditors.
The Compensation Committee will be responsible for determining compensation for
the executive officers of the Company, including bonuses and benefits, and will
administer the Company's compensation programs, including the Stock Option Plan.
The Board of Directors does not have a nominating committee. The selection
of nominees for the Board of Directors is made by the entire Board of Directors.
The Board of Directors may from time to time establish other committees to
facilitate the management of the Company.
DIRECTOR COMPENSATION
To date, directors of the Company have received no cash compensation for
their services as directors. The Company does not currently compensate directors
who are also employees of the Company for service on the Board of Directors. All
Directors are reimbursed for their expenses incurred in attending meetings of
the Board of Directors and its committees. Each non-employee director first
joining the Board of Directors in the future will be granted an option to
purchase 20,000 shares of Common Stock when such
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<PAGE>
director is first elected or appointed to the Board of Directors, with the
option shares vesting over a one year period in equal quarterly amounts, under
the Stock Option Plan. In addition, each non-employee director will receive an
automatic option grant to purchase 5,000 shares of Common Stock on each year
anniversary that such director is a member of the Board of Directors with the
option shares vesting over a one year period in equal quarterly amounts, under
the Stock Option Plan. All option grants to non-employee directors will be at a
per share exercise price equal to the fair market value of the Common Stock at
the time of grant. See "Management--Stock Option Plan."
EXECUTIVE COMPENSATION
The following table sets forth the compensation paid by the Company in all
capacities during the year ended December 31, 1997 to its then President and
Chief Operating Officer and to each of its executive officers whose compensation
for such year exceeded $100,000.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG TERM
COMPENSATION
AWARDS
-------------
ANNUAL COMPENSATION SHARES
YEAR ENDED ------------------------- UNDERLYING ALL OTHER
NAME AND PRINCIPAL POSITION(1) DECEMBER 31, SALARY ($) BONUS ($) OPTIONS(#) COMPENSATION
- --------------------------------------------- --------------- ---------- ------------- ------------- -----------------
<S> <C> <C> <C> <C> <C>
Robert Russo,................................ 1997 $ 145,000(2) -- -- --
President and Chief Operating Officer
William Hancock,............................. 1997 160,000(3) -- -- --
Executive Vice President
Peter Mearsheimer,........................... 1997 155,000(4) -- 21,728 --
Vice President of Sales
</TABLE>
- ------------------------
(1) Does not include the following executive officers who were employed by the
Company beginning in 1998 and are receiving annual compensation in excess of
$100,000: Avi A. Fogel, President and Chief Executive Officer; Robert P.
Olsen, Vice President of Product Management; Murray P. Fish, Chief Financial
Officer; Joseph D. Harris, Vice President of International Sales; and Joseph
A. Donohue, Vice President of Engineering. See "Employment Agreements."
(2) Includes $51,692 of deferred salary.
(3) Includes $6,154 of deferred salary.
(4) Includes $5,962 of deferred salary. Effective August 1998, Mr. Mearsheimer
was no longer employed by the Company.
The following table provides information relating to stock options awarded
to each of the executive officers during the year ended December 31, 1997. All
such options were awarded under the Stock Option Plan.
<TABLE>
<CAPTION>
OPTION GRANTS IN 1997
----------------------------------------------------------------
<S> <C> <C> <C> <C>
NUMBER OF % OF TOTAL
SHARES OPTIONS GRANTED TO EXERCISE
UNDERLYING EMPLOYEES PRICE PER EXPIRATION
NAME OPTIONS GRANTED IN 1997(1) SHARE (2) DATE
- ---------------------------------------------------- --------------- --------------------- ----------- -----------
Peter Mearsheimer(3)................................ 3,104 2% $ 6.44 5/12/2006
18,624 15% $ 4.83 9/15/2007
</TABLE>
- ------------------------
(1) The number of options granted to employees during 1997 used to compute this
percentage excludes options to purchase 35,075 shares of Common Stock due to
the termination of such options pursuant to their terms.
(2) Options were granted at an exercise price equal to the fair market value of
the Company's Common Stock on the date of grant, as determined by the Board
of Directors.
(3) Mr. Mearsheimer was no longer employed by the Company effective August 1998,
and his options expired in September, 1998.
48
<PAGE>
EMPLOYMENT AGREEMENTS
On May 18, 1998, the Company entered into an employment agreement with Avi
A. Fogel, pursuant to which Mr. Fogel serves as the Company's Chief Executive
Officer and President for a four year term at an annual base salary of $150,000
per year subject to annual increases in base salary of up to 20% at the
discretion of the Compensation Committee of the Board of Directors. Mr. Fogel is
eligible to receive an additional cash bonus of up to $50,000 as determined by
the Compensation Committee of the Board of Directors in its discretion. In
addition, upon execution of his employment agreement, Mr. Fogel received five
year options to purchase 294,879 shares of the Company's common stock at an
exercise price of $2.42 per share. The options granted to Mr. Fogel vested as to
34% of the shares covered thereby at the time of execution of his employment
agreement and vest as 22% of the shares covered thereby on each of the first
three anniversaries thereafter, subject to acceleration upon a change of control
of the Company. In the event Mr. Fogel's employment agreement is terminated
"other than for cause" (as defined in the agreement), he shall be entitled to
(i) the vesting of all options in the year of termination and 50% of the options
that would have vested in the year following termination and (ii) the lesser of
one year's base salary or the base salary for the balance of the term of the
agreement. Mr. Fogel has agreed not to disclose any confidential information of
the Company during the term of his employment or at any time thereafter or to
compete with the Company during the term of his agreement and for a period of
two years thereafter in the event of termination for cause.
On June 30, 1998, the Company entered into an employment agreement with Mr.
William Hancock pursuant to which Mr. Hancock agreed to continue to serve as the
Company's Chief Technology Officer for a three year term at an annual salary of
$160,000 per annum, subject to additional bonus compensation as determined by
the Compensation Committee of the Board of Directors in its discretion. In the
event Mr. Hancock's employment is terminated for cause (as defined in the
agreement), the Company will have the right to repurchase 50% of the securities
owned by him at the time at a purchase price of $1.00 per share. In the event
Mr. Hancock's employment agreement is terminated "other than for cause" (as
defined in the agreement), he shall be entitled to receive the lesser of six
months base salary or the base salary for the balance of the term of the term of
the agreement. Mr. Hancock has agreed not to disclose any confidential
information of the Company during the term of his employment or at anytime
thereafter or to compete with the Company during the term of his agreement and
for a period of two years thereafter in the event of termination for cause.
On May 18, 1998, the Company entered into an employment agreement with
Robert P. Olsen pursuant to which Mr. Olsen agreed to serve as the Company's
Vice President of Product Management for a three year term at an annual salary
of $120,000 per annum, subject to an additional cash bonus of $30,000 as
determined by the Compensation Committee of the Board of Directors in its
discretion. Upon execution of his employment agreement, Mr. Olsen received an
incentive stock option to purchase 58,976 shares of the Company's common stock
at an exercise price of $5.60 per share. The options granted to Mr. Olsen vested
as to 34% of the shares covered thereby upon execution of the agreement and 22%
of the shares covered thereby on each of the first three anniversaries
thereafter, subject to acceleration upon a change of control of the Company. In
the event Mr. Olsen's employment agreement is terminated "other than for cause"
(as defined in the agreement), he shall be entitled to (i) the vesting of all
options in the year of termination and 50% of the options that would have vested
in the year following termination and (ii) the lesser of one year base salary or
the base salary for the balance of the term of the agreement. Mr. Olsen has
agreed not to disclose any confidential information of the Company during the
term of his employment or at anytime thereafter or to compete with the Company
during the term of his agreement and for a period of two years thereafter in the
event of termination for cause.
On May 19, 1998, the Company entered into an employment agreement with
Murray P. Fish pursuant to which Mr. Fish agreed to serve as the Company's Chief
Financial Officer for a three year term at an annual salary of $120,000 per
annum, subject to an additional cash bonus of $30,000 as determined by
Compensation Committee of the Board of Directors in its discretion. Upon
execution of his employment
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<PAGE>
agreement, Mr. Fish received an incentive stock option to purchase 58,500 shares
of the Company's common stock at an exercise price of $5.60 per share. The
options granted to Mr. Fish vested as to 34% of the shares covered thereby upon
execution of the agreement and vest as to 22% on each of the first three
anniversaries thereafter, subject to acceleration upon a change of control of
the Company. In the event Mr. Fish's employment agreement is terminated "other
than for cause" (as defined in the agreement), he shall be entitled to (i) the
vesting of all options in the year of termination and 50% of the options that
would have vested in the year following termination and (ii) the lesser of six
months base salary or the base salary for the balance of the term of the
agreement. Mr. Fish has agreed not to disclose any confidential information of
the Company during the term of his employment or at anytime thereafter or to
compete with the Company during the term of his agreement and for a period of
two years thereafter in the event of termination for cause.
On July 31, 1998, the Company entered into an employment agreement with
Joseph A. Donohue pursuant to which Mr. Donohue agreed to serve as the Company's
Vice President of Engineering for a three year term at an annual salary of
$120,000 per annum, subject to an additional cash bonus of $30,000 as determined
by the Compensation Committee of the Board of Directors in its discretion. Upon
execution of his employment agreement, Mr. Donohue received an incentive stock
option to purchase 62,500 shares of the Company's common stock at an exercise
price of $7.20 per share. The options granted to Mr. Donohue vested as to 34% of
the shares covered thereby upon execution of the agreement and 22% of the shares
covered thereby on each of the first three anniversaries thereafter, subject to
acceleration upon a change of control of the Company. In the event Mr. Donohue's
employment agreement is terminated "other than for cause" (as defined in the
agreement), he shall be entitled to (i) the vesting of all options in the year
of termination and 50% of the options that would have vested in the year
following termination and (ii) the lesser of six months base salary or the base
salary for the balance of the term of the agreement. Mr. Donohue has agreed not
to disclose any confidential information of the Company during the term of his
employment or at anytime thereafter or to compete with the Company during the
term of his agreement and for a period of two years thereafter in the event of
termination for cause.
On August 24, 1998, the Company entered into an employment agreement with
Joseph D. Harris pursuant to which Mr. Harris agreed to serve as the Company's
Vice President of International Sales for a three year term at an annual salary
of $120,000 per annum, subject to an additional cash bonus of $30,000 as
determined by Compensation Committee of the Board of Directors in its
discretion. Upon execution of his employment agreement, Mr. Harris received an
incentive stock option to purchase 40,000 shares of the Company's common stock
at an exercise price of $8.00 per share. The options granted to Mr. Harris
vested as to 25% of the shares covered thereby upon execution of the agreement
and vest as to 25% on each of the first three anniversaries thereafter, subject
to acceleration upon a change of control of the Company. In the event Mr.
Harris' employment agreement is terminated "other than for cause" (as defined in
the agreement), he shall be entitled to (i) the vesting of all options in the
year of termination and 50% of the options that would have vested in the year
following termination and (ii) the lesser of six months base salary or the base
salary for the balance of the term of the agreement. Mr. Harris has agreed not
to disclose any confidential information of the Company during the term of his
employment or at anytime thereafter or to compete with the Company during the
term of his agreement and for a period of two years thereafter in the event of
termination for cause.
On April 4, 1994, the Company entered into an employment agreement with
Robert M. Russo pursuant to which Mr. Russo agreed to then serve as the
Company's President and Chief Operating Officer for a three year term at a base
salary of $145,000 per annum, subject to an additional cash bonus as determined
by the Board of Directors in its discretion. In February 1996, the Company and
Mr. Russo agreed to extend the term of his employment agreement, upon the same
terms and conditions, expiring April 1999. In accordance with his agreement, Mr.
Russo has agreed not to disclose any confidential information of the Company
during the term of his employment or at anytime thereafter or to compete with
the Company during the term of his agreement and for a period of two years
thereafter in the event of
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termination for cause. In May 1998, Mr. Russo agreed to serve the Company for
the balance of the term of his employment agreement as its Vice President of
Business Development at a base salary of $120,000 per annum, subject to an
additional cash bonus of $30,000 as determined by the Compensation Committee of
the Board of Directors.
The Company's aggregate salary commitment pursuant to employment agreements
with the foregoing officers is $804,000, $820,000, $790,000, $470,000 and
$56,000 for the years ending December 31, 1998, 1999, 2000, 2001 and 2002,
respectively.
STOCK OPTION PLAN
On March 7, 1996, the Board of Directors and stockholders of the Company
approved the adoption of the Stock Option Plan. The Stock Option Plan, as
amended, is intended to assist the Company in securing and retaining key
employees, directors and consultants by allowing them to participate in the
ownership and growth of the Company through the grant of incentive and
non-qualified options (collectively, the "Options"). Under the Stock Option
Plan, key employees (including officers and employee directors) are eligible to
receive grants of incentive stock options. Employees (including officers),
directors of the Company or any affiliates and consultants are eligible to
receive grants of non-qualified options. Incentive stock options granted under
the Stock Option Plan are intended to be "Incentive Stock Options" as defined by
Section 422 of the Internal Revenue Code of 1986, as amended.
The Stock Option Plan has been administered by the Board of Directors and
following the consummation of this offering will be administered by the
Compensation Committee of the Board of Directors of the Company. The
Compensation Committee of the Board of Directors will consist of members who
have been determined by the Board of Directors to be "disinterested persons"
within the meaning of Rule 16b-3(c)(2)(i) promulgated under the Exchange Act or
any future corresponding rule.
The Compensation Committee will determine who shall receive Options, the
number of shares of Common Stock that may be purchased under the Options, the
time and manner of exercise of Options and exercise prices. The term of Options
granted under the Stock Option Plan may not exceed 10 years (five years in the
case of an incentive stock option granted to an optionee owning more than 10% of
the voting stock of the Company) (a "10% Holder"). The exercise price for
incentive stock options shall not be less than 100% of the "fair market value"
of the shares of Common Stock at the time the Option is granted; provided,
however, that with respect to an incentive stock option, in the case of a 10%
Holder, the purchase price per share shall be at least 110% of such fair market
value. The exercise price for non-qualified options is set by the Compensation
Committee in its discretion. The aggregate fair market value of the shares of
Common Stock as to which an optionee may exercise incentive stock options may
not exceed $100,000 in any calendar year. Payment for shares purchased upon
exercise of Options is to be made in cash, check or other instrument, and at the
discretion of the Committee, may be made by delivery of other shares of Common
Stock of the Company. If any Option granted under the Plan expires or terminates
for any reason without having been exercised in full, then the unpurchased
shares subject to the Option will once again be available for additional Option
grants.
Under certain circumstances involving a change in the number of outstanding
shares of Common Stock including a stock split, consolidation, merger or payment
of stock dividend, the class and aggregate number of shares of Common Stock in
respect of which Options may be granted under the Stock Option Plan, the class
and number of shares subject to each outstanding Option and the exercise price
per share will be proportionately adjusted.
An aggregate of 750,000 shares of Common Stock has been reserved for
issuance upon exercise of the Options to be granted under the Stock Option Plan.
As of the date of this Prospectus, the Company has granted Options to purchase
509,829 shares of Common Stock under the Plan, of which Options to purchase
58,976, 58,500, 62,500 and 40,000 shares of Common Stock have been granted to
Messrs. Olsen, Fish, Donohue and Harris, respectively. The Options granted to
Messrs. Olsen and Fish are exercisable at
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a price of $5.60 per share, the Options granted to Mr. Donohue are exercisable
at a price of $7.20 per share and the Options granted to Mr. Harris are
exercisable at $8.00 per share. In addition, each of the non-employee directors,
Messrs. Horowitz, Rubenstein, Lieber and Ranum have been granted Options to
purchase 20,000 shares of Common Stock. The Options granted to Messrs. Horowitz,
Rubenstein and Lieber are exercisable at $8.00 per share and the Options granted
to Mr. Ranum are exercisable at $7.20 per share.
401(K) PLAN
The Company maintains the "Network-1 Security Solutions 401(k) Plan", a
defined contribution pension plan with a cash or deferred arrangement as
described in Section 401(k) of the Internal Revenue Code of 1986, as amended
(the "401(k) Plan"). The 401(k) Plan is intended to qualify under Section 401(a)
of the Code, so that contributions, and income earned thereon, are not taxable
to employees until withdrawn. All regular full-time Company employees over the
age of 21 are eligible to participate in the 401(k) Plan. The 401(k) Plan
provides that each participant may make elective pre-tax salary deferrals up to
15% of his or her annual compensation, subject to statutory limits. The Company
also may make discretionary annual matching contributions in amounts determined
by the Compensation Committee of the Board of Directors, subject to statutory
limits. The Company's policy is to base its contributions on Company
profitability. The Trustee of the 401(k) Plan invests each employee's account at
the direction of the employee, who may choose among several investment
alternatives, which do not include shares of the Company's Common Stock. The
Company did not make any contributions to the 401(k) Plan during 1997.
LIMITATION ON LIABILITY AND INDEMNIFICATION MATTERS
The Company's Certificate of Incorporation limits the liability of directors
to the maximum extent permitted by Delaware law. Delaware law provides that
directors of a corporation will not be personally liable for monetary damages
for breach of their fiduciary duties as directors, except for liability (i) for
any breach of their duty of loyalty to the corporation or its stockholders, (ii)
for acts or omissions not in good faith or that involve intentional misconduct
or a knowing violation of law, (iii) for unlawful payments of dividends or
unlawful stock repurchases or redemptions as provided in Section 174 of the
Delaware General Corporation Law or (iv) for any transaction from which the
director derived an improper personal benefit.
The Company's Bylaws provide that the Company shall indemnify its directors,
officers, employees and agents to the fullest extent permitted by law. The
Company's Bylaws also permit the Company to secure insurance on behalf of any
officer, director, employee or other agent for any liability arising out of his
or her actions in such capacity. The Company currently maintains liability
insurance for its officers and directors.
At present, there is no pending material litigation or proceeding involving
any director, officer, employee or agent of the Company where indemnification
will be required or permitted. The Company is not aware of any threatened
litigation or proceeding that might result in a material claim for such
indemnification.
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PRINCIPAL STOCKHOLDERS
The following table sets forth certain information, as of the date of this
Prospectus (after giving effect to the Pro Forma Adjustments and the CommHome
Acquisition) and as adjusted to reflect the sale by the Company of 1,875,000
shares of Common Stock offered hereby, relating to the beneficial ownership of
shares of Common Stock by: (i) each person or entity who is known by the Company
to own beneficially five percent or more of the outstanding shares of Common
Stock; (ii) each director or person who has agreed to become a director of the
Company; (iii) by the executive officers; and (iv) by all directors and
executive officers of the Company as a group.
<TABLE>
<CAPTION>
NUMBER OF PERCENT OF SHARES
SHARES OF BENEFICIALLY OWNED (1)
BENEFICIALLY ----------------------------------
NAME AND ADDRESS OF BENEFICIAL OWNER OWNED BEFORE OFFERING AFTER OFFERING
- ---------------------------------------------------------------------- ----------- ----------------- ---------------
<S> <C> <C> <C>
Corey M. Horowitz (2)................................................. 902,982 32.7% 19.5%
CMH Capital Management Corp.
Pisces Investors, L.P.
Security Partners, L.P.
Applewood Associates, L.P. (3)........................................ 571,963 21.7 12.7
Robert Russo.......................................................... 298,319 11.3 6.6
William Hancock....................................................... 235,057 8.9 5.2
Barry Rubenstein (4).................................................. 150,112 5.6 3.3
Avi A. Fogel (5)...................................................... 125,054 4.6 2.7
Irwin Lieber (6)...................................................... 77,944 2.9 1.7
Robert P. Olsen (7)................................................... 26,302 1.0 *
Joseph A. Donohue (8)................................................. 21,250 * *
Murray P. Fish (9).................................................... 19,890 * *
Joseph D. Harris (10)................................................. 10,000 * *
Marcus Ranum (11)..................................................... 5,000 * *
All directors and executive officers as group (11 persons)............ 1,871,910 61.4 38.0%
</TABLE>
- ------------------------
* Less than 1%.
(1) Unless otherwise indicated, the Company believes that all persons named in
the table have sole voting and investment power with respect to all shares
of Common Stock beneficially owned by them. A person is deemed to be the
beneficial owner of securities that can be acquired by such person within 60
days from the date of this Prospectus upon the exercise of options, warrants
or convertible securities. Each beneficial owner's percentage ownership is
determined by assuming that options, warrants or convertible securities that
are held by such person (but not those held by any other person) and which
are exercisable within 60 days of the date of this Prospectus have been
exercised and converted. Assumes a base of 2,633,369 shares of Common Stock
outstanding prior to this offering and a base of 4,508,369 shares of Common
Stock outstanding immediately after this offering, before any consideration
is given to outstanding options, warrants or convertible securities.
(2) Includes (i) 374,906 shares of Common Stock held by Mr. Horowitz, (ii) 5,000
shares of Common Stock subject to currently exercisable stock options owned
by Mr. Horowitz, (iii) 206,933 shares of Common Stock issuable upon
conversion of Series B Convertible Preferred Stock held by Pisces Investors,
L.P., a limited partnership whose general partner is CMH Capital Management
Corp. ("CMH"), a corporation whose sole stockholder and officer is Mr.
Horowitz, (iv) 145,887 shares of Common Stock (including 62,080 shares of
Common Stock issuable upon conversion of Series B Convertible Preferred
Stock) owned by Security Partners, L.P. (CMH is the general partner of
Security Partners, L.P. and Mr. Horowitz is a limited partner), (v) 45,320
shares of Common Stock held by CMH, and (vi) 124,936 shares of Common Stock
subject to currently exercisable warrants held by CMH. Does not include
15,000 shares of Common Stock subject to stock options which are not
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<PAGE>
currently exercisable. Mr. Horowitz disclaims beneficial ownership of the
shares held by Pisces Investors, L.P. and Security Partners, L.P. except to
the extent of his equity interest therein. The address of CMH Capital
Management Corp. is 909 Third Avenue, New York, New York 10022 and the
address of Pisces Investors, L.P. and Security Partners, L.P. is c/o CMH
Capital Management Corp., 909 Third Avenue, New York, New York 10022.
(3) Does not include (i) 31,040, 23,280, 31,040, 4,656 and 3,104 shares of
Common Stock held by Barry Rubenstein, Irwin Lieber, Barry Fingerhut, Seth
Lieber and Jonathan Lieber, respectively, each of which is a general partner
of Applewood Associates L.P., (ii) an aggregate of 109,328 shares of Common
Stock subject to currently exercisable warrants and options held by Barry
Rubenstein (54,664 shares) and Irwin Lieber (54,664 shares). Each of Messrs.
Rubenstein, I. Lieber, Fingerhut, S. Lieber and J. Lieber disclaim
beneficial ownership of the shares held by Applewood Associates, L.P.,
except to the extent of their equity interest therein. Applewood Associates,
L.P.'s business address is 80 Cuttermill Road, Great Neck, New York 11021.
(4) Includes (i) 54,664 shares of Common Stock subject to currently exercisable
warrants and options owned by Mr. Rubenstein, and (ii) 41,128 and 23,280
shares of Common Stock held by Woodland Venture Fund and Seneca Ventures,
respectively. Barry Rubenstein and Woodland Services Corp. are the general
partners of Woodland Venture Fund and Seneca Ventures. Barry Rubenstein is
also President and sole director of Woodland Services Corp. Does not include
(i) 571,963 shares of Common Stock held by Applewood Associates, L.P., of
which Mr. Rubenstein is a general partner, and (ii) 15,000 shares of Common
Stock subject to stock options which are not currently exercisable. Mr.
Rubenstein disclaims beneficial ownership of the shares of Common Stock held
by Applewood Associates, L.P., except the extent of his equity interest
therein. The address of Woodland Venture Fund and Seneca Ventures is c/o
Barry Rubenstein, 68 Wheatley Road, Brookville, New York 11545.
(5) Includes (i) 100,259 shares of Common Stock subject to currently exercisable
stock options, (ii) 17,920 shares of Common Stock to be issued to Mr. Fogel
in connection with the CommHome Acquisition and (iii) 6,875 shares of Common
Stock to be issued to Mr. Fogel in satisfaction of indebtedness owed to Mr.
Fogel by CommHome. Does not include 194,620 shares subject to stock options
which are not currently exercisable.
(6) Includes 54,664 shares of Common Stock subject to currently exercisable
warrants and options owned by Mr. Lieber. Does not include (i) 571,963
shares of Common Stock held by Applewood Associates, L.P., of which Mr.
Lieber is a general partner, and (ii) 15,000 shares of Common Stock subject
to stock options which are not currently exercisable. Mr. Lieber disclaims
beneficial ownership of the shares of Common Stock held by Applewood
Associates L.P., except to the extent of his equity interest therein.
(7) Includes (i) 20,052 shares of Common Stock subject to currently exercisable
stock options issued to Mr. Olsen pursuant to the Stock Option Plan, (ii)
6,250 shares of Common Stock to be issued to Mr. Olsen in satisfaction of
indebtedness owed to Mr. Olsen by CommHome. Does not include 38,924 shares
of Common Stock subject to stock options which are not currently
exercisable.
(8) Includes 21,250 shares of Common Stock subject to stock options issued to
Mr. Donohue pursuant to the Stock Option Plan. Does not include 41,250
shares of Common Stock subject to stock options which are not currently
exercisable.
(9) Includes 19,890 shares of Common Stock subject to stock options issued to
Mr. Fish pursuant to the Stock Option Plan. Does not include 38,610 shares
of Common Stock subject to stock options which are not currently
exercisable.
(10) Includes 10,000 shares of Common Stock subject to stock options issued to
Mr. Harris pursuant to the Stock Option Plan. Does not include 30,000 shares
of Common Stock subject to stock options which are not currently
exercisable.
(11) Includes 5,000 shares of Common Stock subject to stock options issued to
Mr. Ranum pursuant to the Stock Option Plan. Does not include 15,000 shares
of Common Stock subject to stock options which are not currently
exercisable.
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<PAGE>
CERTAIN TRANSACTIONS
In February and April 1997, the Company issued an aggregate principal amount
of $1,000,000 of notes bearing interest at the rate of 6% per annum, and
warrants to purchase an aggregate of 139,679 shares of the Company's Common
Stock at an exercise price of $6.44 per share in private financings (the
"February and April 1997 Private Financings"). The principal amount of the notes
issued in connection with the February and April 1997 Private Financings, plus
accrued interest thereon, will be repaid from the proceeds of this offering. In
connection with the February and April 1997 Private Financings, the Company
issued a note in the principal amount of $250,000 and warrants to purchase
34,920 shares of Common Stock to Applewood Associates, L.P. ("Applewood"), a
principal stockholder of the Company, and a note in the principal amount of
$50,000 and warrants to purchase 6,984 shares of Common Stock to Herb Karlitz.
Barry Rubenstein, a director and a principal stockholder of the Company, and
Irwin Lieber, a director of the Company, are general partners of Applewood. Herb
Karlitz is the brother-in-law of Corey M. Horowitz, Chairman of the Board of
Directors and a principal stockholder of the Company. In connection with the
February and April 1997 Private Financings, Robert Russo, Vice President of
Business Development and Secretary of the Company, delivered to the Company for
cancellation 39,110 shares of Common Stock in consideration of $630, and William
H. Hancock, Chief Technology Officer and a director of the Company, delivered to
the Company for cancellation 54,009 shares of Common Stock in consideration of
$870.
On August 30, 1996 the Company entered into an agreement (the "CMH Advisory
Agreement"), as amended, with CMH Capital Management Corp. ("CMH"), a
corporation wholly-owned by Corey M. Horowitz, Chairman of the Board of
Directors and a principal stockholder of the Company, pursuant to which CMH
agreed to render advisory services to the Company in consideration of fees of
$12,500 per month for a period of two years and the issuance of warrants to
purchase 31,040 shares of the Company's Common Stock at an exercise price of
$8.05 per share and 31,040 shares of the Company's Common Stock at an exercise
price of $6.44 per share (collectively, the "CMH Advisory Warrants"). In
addition, the Company agreed that in the event it completes a merger or sale of
substantially all of its assets prior to January 15, 2001, CMH would be entitled
to a cash fee equal to 2% of the value of the total consideration received in
connection with such transaction. CMH agreed that the monthly fee of $12,500
would accrue until the Company completed a financing of a minimum of $5,000,000.
On May 14, 1998, CMH agreed with the Company to convert accrued fees of $200,000
into 31,250 shares of Common Stock of the Company in full satisfaction of the
Company's monthly fee obligation to CMH under the CMH Advisory Agreement.
On August 8, 1997, CMH loaned the Company $100,000 at an interest rate of 8%
per annum. As further consideration for such loan, the Company agreed to reduce
the exercise price of all of the CMH Advisory Warrants to $3.22 per share. In
addition, the Company agreed to reduce the exercise price of warrants to
purchase 124,159 shares of Common Stock at an exercise price of $3.22 per share
previously issued to Corey M. Horowitz on November 29, 1995 to $1.61 per share.
On September 26, 1997, the Company issued to Applewood and CMH, principal
stockholders of the Company, notes in the principal amounts of $350,000 and
$50,000, respectively, bearing interest at the rate of 8% per annum, which,
together with accrued and unpaid interest thereon, will be repaid from the
proceeds of this offering and warrants to purchase 62,080 and 8,869 shares of
Common Stock, respectively (the "September 1997 Private Financing"). In
connection with the September 1997 Private Financing, Robert Russo, Vice
President of Business Development and Secretary of the Company, William Hancock,
Chief Technology Officer and a director of the Company, and Kenneth Conquest,
then Vice President of Engineering of the Company, delivered to the Company for
cancellation 112,373, 86,112 and 10,103 shares of Common Stock, respectively,
for an aggregate consideration of $3,360.
On November 21, 1997, CMH loaned the Company $50,000 at an interest rate of
8% per annum pending the Company's receipt of a certain accounts receivable. As
additional consideration for the loan, the Company agreed to further reduce the
exercise price of the CMH Advisory Warrants to $1.61 per share from $3.22 per
share. The aforementioned loan was repaid in full by the Company on December 12,
1997.
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<PAGE>
From March 2, 1998 through May 14, 1998, the Company issued an aggregate
principal amount of $1,750,000 of notes, bearing interest at the rate of 8% per
annum, and warrants to purchase up to 325,919 shares of Common Stock at an
exercise price of $4.83 per share (the "1998 Private Financing"). In connection
with the 1998 Private Financing, Applewood purchased a $1,300,000 principal
amount note and warrants to purchase 242,111 shares of Common Stock, CMH
purchased a $50,000 note and warrants to purchase 9,312 shares of Common Stock,
Mr. Horowitz purchased a $50,000 principal amount note and warrants to purchase
9,312 shares of Common Stock and Herb Karlitz purchased a $25,000 principal
amount note and warrants to purchase 4,656 shares of Common Stock, at purchase
prices of $1,300,000, $50,000, $50,000, and $25,000, respectively. In connection
with the 1998 Private Financing, Messrs. Russo and Hancock delivered to the
Company for cancellation 38,800 and 23,280 shares of Common Stock, respectively,
for an aggregate consideration of $1,000.
As part of the 1998 Private Financing, in consideration of Applewood's
investment of $1,000,000 in May 1998, the Company, CMH and Applewood entered
into an advisory agreement, which amended the CMH Advisory Agreement, pursuant
to which the Company agreed to increase the cash fee payable to CMH, if the
Company completes a merger or sale of all or substantially all its assets at any
time up to January 15, 2001, from 2% to 3% of the value of the total
consideration received by the Company, and CMH agreed to share such
consideration with Applewood. As further consideration for Applewood's
$1,000,000 investment in May 1998, each of CMH, Mr. Horowitz, Pisces Investors,
L.P., Security Partners, L.P., Messrs. Russo, Hancock and Conquest agreed that
for a period of 24 months from the consummation of this offering, they would not
sell in the public market any securities of the Company owned by them without
the consent of Applewood, unless 60% of the securities owned by Applewood and
affiliated parties have been sold.
On July 8, 1998, the Company entered into an exchange agreement with certain
holders of outstanding warrants and options to which the Company issued an
aggregate of 596,741 shares of its Common Stock in exchange for cancellation of
outstanding warrants and options to purchase 789,521 shares of the Company's
Common Stock. Pursuant to such agreement, Applewood exchanged warrants to
purchase 339,111 shares of Common Stock, at exercise prices of $4.83 and $6.44
per share, for 261,565 shares of Common Stock, Mr. Horowitz and CMH, exchanged
warrants to purchase an aggregate of 151,652 shares of Common Stock, at exercise
prices ranging from $1.61 to $4.83, for 131,207 shares of Common Stock and Herb
Karlitz exchanged warrants to purchase 11,640 shares of Common Stock, at
exercise prices of $4.83 and $6.44 per share, for 8,572 shares of Common Stock.
On September 11, 1998, the Company entered into a merger agreement with
CommHome Systems Corporation ("CommHome"), effective upon consummation of this
offering, pursuant to which the CommHome stockholders have agreed to exchange
all of the outstanding common stock of CommHome for 35,000 shares of Common
Stock of the Company valued at $280,000. The Company will assume liabilities of
CommHome on the effective date of the merger of approximately $200,000, which
include $55,000 and $50,000 owed to Avi A. Fogel and Robert P. Olsen,
respectively. Messrs. Fogel and Olsen have agreed to accept 6,875 and 6,250
shares, respectively, of the Company's Common Stock in full satisfaction of such
indebtedness. Avi A. Fogel, President, Chief Executive Officer and a director of
the Company, is also President, Chief Executive Officer and a director of
CommHome and owns 51% of the outstanding shares of CommHome. Mr. Olsen, Vice
President of Product Management of the Company, is the former Vice President of
Marketing of CommHome.
Upon consummation of this offering, 333,334 shares of Series B Preferred
Stock owned by Pisces Investors, L.P. ("Pisces") and 100,000 shares of Series B
Preferred Stock owned by Security Partners, L.P. ("Security Partners") will
automatically convert into 206,933 shares and 62,080 shares of Common Stock,
respectively. CMH is the general partner of Pisces and Security Partners. Mr.
Horowitz and Herb Karlitz are limited partners of Security Partners. In
addition, Robert Graifman, the brother-in-law of Mr. Horowitz, is a limited
partner of Pisces and Security Partners.
The Company believes that the aforementioned transactions with its officers,
directors and principal stockholders and their affiliates were on terms no less
favorable than could have been obtained from
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unaffiliated third parties. However, the Company lacked sufficient disinterested
independent directors at the time of certain of such transactions. All future
transactions, including loans, between the Company and its officers, directors
and stockholders beneficially owning 5% or more of the Company's outstanding
voting securities, or affiliates of such persons, will be for bona fide business
purposes and will be on terms no less favorable to the Company than could be
obtained in arm's length transactions from unaffiliated third parties. Further,
all such transactions and loans and any forgiveness of indebtedness owed by such
persons to the Company must be approved by a majority of the Company's
independent directors who do not have an interest in the transactions and who
have access, at the Company's expense, to the Company's or independent legal
counsel.
DESCRIPTION OF SECURITIES
The authorized capital stock of the Company consists of 25,000,000 shares of
Common Stock, par value $.01 per share, and 5,000,000 shares of Preferred Stock,
par value $.01 per share. As of the date of this Prospectus (after giving effect
to the Pro Forma Adjustments and the Offering Adjustments), the Company has
outstanding 2,633,369 shares of Common Stock, held of record by 79 stockholders.
Upon consummation of this offering, there will be 4,508,369 shares of Common
Stock and no shares of Preferred Stock outstanding.
COMMON STOCK
Holders of Common Stock are entitled to one vote per share on all matters
submitted to a vote of stockholders. There are no cumulative voting rights for
the election of directors, which means that the holders of more than 50% of such
outstanding shares voting for the election of directors can elect all of the
directors of the Company standing for election. Subject to the rights of any
outstanding class or series of Preferred Stock created by the authority of the
Board of Directors, holders of Common Stock are entitled to received dividends
as and when declared by the Board of Directors out of funds legally available
therefor. Subject to the rights of any outstanding class or series of Preferred
Stock created by the authority of the Board of Directors, in the event of the
liquidation, dissolution or winding up of the Company, the holder of each share
of Common Stock is entitled to share equally in the balance of any of the
Company's assets available for distribution to stockholders. Outstanding shares
of Common Stock do not have subscription or conversion rights and there are no
redemption or sinking fund provisions applicable thereto. Holders of Common
Stock have no preemptive rights to purchase pro-rata portions of new issues of
Common Stock or Preferred Stock of the Company. The outstanding shares of Common
Stock are, and the shares of Common Stock offered by the Company hereby will be,
when issued and sold hereunder, fully paid and non-assessable.
PREFERRED STOCK
Upon the consummation of this offering, all 500,000 shares of Series B
Preferred Stock outstanding will be converted into 310,399 shares of Common
Stock (See Note F(1) to Notes to Financial Statements for a description of the
Series B Convertible Preferred Stock). The Board is authorized, subject to any
limitations prescribed by Delaware law, to provide for the issuance of
additional shares of Preferred Stock in one or more series, to establish from
time to time the number of shares to be included in each such series, to fix the
rights, preferences and privileges of the shares of each wholly unissued series
and any qualifications, limitations or restrictions thereon, and to increase or
decrease the number of shares of any such series (but not below the number of
shares of such series then outstanding), without any further vote or action by
the stockholders. The Board may authorize the issuance of Preferred Stock with
voting or conversion rights that could adversely affect the voting power or
other rights of the holders of Common Stock. Thus, the issuance of Preferred
Stock may have the effect of delaying, deferring or preventing a change in
control of the Company. The Company has no current plan to issue any shares of
Preferred Stock.
57
<PAGE>
WARRANTS AND OPTIONS
As of the date of this Prospectus, the Company has outstanding warrants to
purchase 336,007 shares of Common Stock (excluding the Underwriter's Warrants to
purchase 187,500 shares of Common Stock) and options to purchase 294,879 shares
of Common Stock (excluding options to purchase 509,829 shares of Common Stock
issued pursuant to the Stock Option Plan). All outstanding warrants are
currently exercisable and outstanding options are currently exercisable to
purchase 100,259 shares of Common Stock (excluding currently exercisable options
issued pursuant to the Stock Option Plan). The outstanding warrants are
exercisable at prices ranging from $1.61 to $9.66 and expire between February
2002 and May 2008. The outstanding options are exercisable at $2.42 per share
and expire May 2003.
The warrants also entitle the holder to certain registration rights with
respect to the shares of Common Stock issuable upon exercise of such warrants.
No warrantholder has any stockholder rights with respect to the shares issuable
upon exercise of warrants held by such holder until such warrants are exercised
and the purchase price is paid for the shares. Each of the warrants and options
also provides, among other things, for the adjustment of the price per share and
number of shares issuable upon exercise of such warrants and options upon a
merger or consolidation of the Company, reclassification of the Company's
securities, a stock split, subdivision or combination of the Company's
securities, the payment of a dividend in Common Stock of the Company or of
certain other dividends or distributions with respect to the Common Stock of the
Company.
REGISTRATION RIGHTS OF CERTAIN HOLDERS
The holders of 1,040,614 shares of Common Stock (including warrants
exercisable to purchase 62,856 shares of Common Stock) have been granted certain
demand registration rights, including the right to request on up to two
occasions that the Company file a registration statement with respect to such
shares under the Securities Act and use its best efforts to effect any such
registration. In addition, the holders of 1,462,757 shares of Common Stock
(including warrants exercisable to purchase 336,007 shares) are entitled to
piggyback registration rights with respect to such shares. If the Company
proposes to register any of its securities, either for its own account or for
the account of other stockholders, the Company is required to notify these
holders and, subject to certain conditions and limitations, to include in such
registration all of the shares of Common Stock requested to be included by such
holders. All holders of registration rights have agreed to waive such rights in
connection with this offering and not to exercise any such rights for one year
from the date of this Prospectus, without the Underwriter's prior written
consent.
In connection with this offering, the Company has agreed to grant the
Underwriter certain demand and piggyback registration rights with respect to the
shares of Common Stock issuable upon exercise of the Underwriter's Warrants. See
"Underwriting."
DELAWARE ANTI-TAKEOVER LAW
The Company is subject to the provisions of Section 203 of the Delaware
General Corporation Law (the "Anti-Takeover Law") regulating corporate
takeovers. The Anti-Takeover Law prevents certain Delaware corporations,
including those whose securities are listed on the Nasdaq SmallCap Market from
engaging, under certain circumstances, in a "business combination" (which
includes a merger or sale of more than 10% of the corporation's assets) with any
"interested stockholder" (a stockholder who owns 15% or more of the
corporation's outstanding voting stock) for three years following the date that
such stockholder became an "interested stockholder" unless the business
combination is approved in a prescribed manner. A Delaware corporation may "opt
out" of the Anti-Takeover Law with an express provision in its original or
amended certificate of incorporation or an express provision in its Bylaws
resulting from a stockholders' amendment approved by at least a majority of the
outstanding voting shares. The Company has not "opted out" of the provisions of
the Anti-Takeover Law.
TRANSFER AGENT
The Transfer Agent for the Company's Common Stock is American Stock Transfer
and Trust Company, 40 Wall Street, New York, New York 10005.
58
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
Upon the consummation of this offering, the Company will have 4,508,369
shares of Common Stock outstanding, of which the 1,875,000 shares being offered
hereby will be freely tradeable without restriction or further registration
under the Securities Act, except for any shares purchased by an "affiliate of
the Company" (in general, a person who has a controlling position with regard to
the Company), which will be subject to the resale limitations of Rule 144
promulgated under the Securities Act.
All of the remaining 2,633,369 shares of Common Stock currently outstanding
are "restricted securities" or owned by "affiliates" (as those terms are defined
in Rule 144) and thus may not be sold publicly unless they are registered under
the Securities Act or are sold pursuant to Rule 144 or another exemption from
registration. Of the 2,633,369 restricted shares, an aggregate of 2,002,481
shares will be eligible for sale, without registration, under Rule 144 (subject
to certain volume limitations prescribed by such rule and to the contractual
restrictions described below), commencing 90 days following the date of this
Prospectus and the balance of such shares will become eligible for sale at
various times commencing February 1999. The Company's principal stockholders,
officers and directors have agreed not to sell or otherwise dispose of any
shares of Common Stock in the public markets and all holders of registration
rights have agreed not to exercise any such rights to cause the Company to
register any shares of Common Stock for sale pursuant to the Securities Act, in
each case, for a period of 12 months following the date of this Prospectus,
without the Underwriter's prior written consent.
In general, under Rule 144 as currently in effect, beginning 90 days after
the date of this Prospectus, a person (or persons whose shares are aggregated)
who has beneficially owned restricted securities for at least one year
(including the holding period of any prior owner except an affiliate of the
Company) would be entitled to sell within any three-month period a number of
shares that does not exceed the greater of: (i) 1% of the number of shares of
Common Stock then outstanding (which will equal approximately 45,083 shares
immediately following the consummation of this offering); or (ii) the average
weekly trading volume of the Common Stock during the four calendar weeks
preceding the filing of a Form 144 with respect to such sale. Sales under Rule
144 are also subject to certain manner of sale provisions, notice requirements
and the availability of current public information about the Company. Under Rule
144(k), a person who is not deemed to have been an affiliate of the Company at
any time during the 90 days preceding a sale, and who has beneficially owned the
shares proposed to be sold for at least two years (including the holding period
of any prior owner except an affiliate of the Company), is entitled to sell such
shares without complying with the manner of sale, public information, volume
limitation or notice provisions of Rule 144. Unless otherwise restricted,
"144(k) shares" may therefore be sold immediately upon the consummation of this
offering.
Rule 701 permits resales of shares in reliance upon Rule 144 but without
compliance with certain restrictions, including the holding period requirement,
of Rule 144. Any employee, officer or director of or consultant to the Company
who purchased his or her shares pursuant to a written compensatory plan or
contract may be entitled to rely on the resale provisions of Rule 701. Rule 701
permits affiliates to sell their Rule 701 shares under Rule 144 without
complying with the holding period requirements of Rule 144. Rule 701 further
provides that non-affiliates may sell such shares in reliance on Rule 144
without having to comply with the holding period, public information, volume
limitation or notice provisions of Rule 144. In both cases, a holder of Rule 701
shares is required to wait until 90 days after the date of this Prospectus
before selling such shares.
Prior to this offering, there has been no market for the Common Stock and no
prediction can be made as to the effect, if any, that market sales of shares of
Common Stock or the availability of such shares for sale will have on the market
prices of the Common Stock prevailing from time to time. Nevertheless, the
possibility that substantial amounts of Common Stock may be sold in the public
market may adversely affect prevailing market prices for the Common Stock and
could impair the Company's ability to raise capital through the sale of its
equity securities.
59
<PAGE>
UNDERWRITING
Whale Securities Co., L.P. (the "Underwriter") has agreed, subject to the
terms and conditions contained in the Underwriting Agreement, to purchase the
1,875,000 shares of Common Stock offered hereby from the Company. The
Underwriter is committed to purchase and pay for all of the shares of Common
Stock offered hereby if any of such securities are purchased. The shares of
Common Stock are being offered by the Underwriter, subject to prior sale, when,
as and if delivered to and accepted by the Underwriter and subject to certain
legal matters by counsel and to certain other conditions.
The Underwriter has advised the Company that it proposes to offer the shares
of Common Stock to the public at the public offering price set forth on the
cover page of this Prospectus. The Underwriter may allow certain dealers who are
member of the National Association of Securities Dealers, Inc. (the "NASD")
concessions, not in excess of $ per share, of which not in excess of $ per
share may be reallowed to other dealers who are members of the NASD.
The Company has granted to Underwriter an option, exercisable for 45 days
following the date of this Prospectus, to purchase up to 281,250 shares at the
public offering price set forth on the cover page of this Prospectus, less
underwriting discounts and commissions. The Underwriter may exercise this option
in whole or, from time to time, in part, solely for the purpose of covering
over-allotments, if any, made in connection with the sale of the shares offered
hereby.
The Company has agreed to pay to the Underwriter a non-accountable expense
allowance equal to 3% of the gross proceeds derived from the sale of the shares
offered hereby, including any securities sold prior to the Underwriter's
over-allotment option, $50,000 of which has been paid as of the date of this
Prospectus. The Company has also agreed to pay all expenses in connection with
qualifying the shares offered under the laws of such states as the Underwriter
may designate, including expenses of counsel retained for such purpose by the
Underwriter.
The Company has agreed to sell to the Underwriter and its designees, for an
aggregate of $100 (the "Underwriter's Warrants") to purchase up to 187,500
shares of Common stock at an exercise price of $13.20 per share (165% of the
public offering price per share). The Underwriter's Warrants may not be assigned
or hypothecated for one year following the date of this Prospectus, except to
the officers and partners of the Underwriter and members of the selling group,
and are exercisable at any time, in whole or in part, during the four-year
period commencing one year from the date of this Prospectus (the "Warrant
Exercise Term"). During the Warrant Exercise Term, the holders of the
Underwriter's Warrants are given, at nominal cost, the opportunity to profit
from a rise in the market price of the Common Stock. To the extent that the
Warrants are exercised, dilution to the interests of the Company's stockholders
will occur. Further, the terms upon which the Company will be able to obtain
additional equity capital may be adversely affected, since the holders of the
Underwriter's Warrants can be expected to exercise them at a time when the
Company would, in all likelihood, be able to obtain any needed capital on terms
more favorable to the Company than in the Underwriter's Warrants. Any profit
realized by the Underwriter on the sale of the Underwriter's Warrants, the
underlying shares of Common Stock or the underlying warrants may be deemed
additional underwriting compensation. The Underwriter's Warrants contain a
cashless exercise provision. Subject to certain limitations and exclusions, the
Company has agreed that, upon the request of the holders of the majority of the
Underwriter's Warrants, the Company will (at its own expense), on one occasion
during the Warrant Exercise term, register the Underwriter's Warrants and the
securities underlying the Underwriter's Warrants under the Securities Act and
that it will include the Underwriter's Warrants and all such underlying
securities in any appropriate registration statement which is filed by the
Company under the Securities Act during the seven years following the date of
this Prospectus.
The Company has agreed, for a period of five years from the date of this
Prospectus, if so requested by the Underwriter, to recommend and use its best
efforts to elect a designee of the Underwriter as a director of the Company. The
Company's officers, directors and principal stockholders have agreed to vote
their
60
<PAGE>
shares of Common Stock in favor of such designee. The Underwriter has not yet
exercised and currently does not intend to exercise its right to designate such
a person.
All of the Company's officers, directors and securityholders have agreed not
to sell or otherwise dispose any of their securities in the public markets for a
period of twelve months from the date of this Prospectus without the
Underwriter's prior written consent.
The Underwriter has informed the Company that it does not expect sales of
the securities offered discretionary accounts to exceed 1% of the shares offered
hereby.
The Company has agreed to indemnify the Underwriter against certain civil
liabilities, including liabilities under the Securities Act.
Prior to this offering there has been no public market for the Common Stock.
Accordingly, the initial public offering price of the Common Stock will be
determined by negotiation between the Company and the Underwriter and may not
necessarily be related to the Company's asset value, net worth or other
established criteria of value. Factors to be considered in determining such
price include the Company's financial condition and prospects, an assessment of
the Company's management, market prices of similar securities of comparable
publicly-traded companies, certain financial and operating information of
companies engaged in activities similar to those of the Company and the general
condition of the securities market.
In order to facilitate the offering, the Underwriter may engage in
transactions that stabilize, maintain, or otherwise affect the price of the
Common Stock. Specifically, the Underwriter may over-allotment in connection
with the offering, creating a short position in the Common Stock for its own
account. In addition, to cover over-allotments or to stabilize the price of the
Common Stock, the Underwriter may bid for, and purchase, shares of Common Stock
in the open market. The Underwriter may also reclaim selling concessions allowed
to a dealer for distributing the Common Stock in the offering, if the
Underwriter repurchases previously distributed Common Stock in transactions to
cover short positions, in stabilization transactions or otherwise. Any of these
activities may stabilize or maintain the market price of the Common Stock above
independent market levels. The Underwriter is not required to engage in these
activities, and may end any of these activities at any time.
LEGAL MATTERS
The validity of the Common Stock offered hereby will be passed upon for the
Company by Bizar Martin & Taub, LLP. Certain legal matters in connection with
this offering will be passed upon for the Underwriter by Tenzer Greenblatt LLP.
Bizar Martin & Taub, LLP owns currently exercisable warrants to purchase 9,312
shares of the Company's Common Stock at an exercise price of $6.44 per share.
EXPERTS
The financial statements of the Company as of December 31, 1997 and 1996 and
for each of the years then ended appearing in this Prospectus and Registration
Statement have been audited by Richard A. Eisner & Company, LLP, independent
auditors, as set forth in their report thereon (which contains an explanatory
paragraph with respect to the Company's ability to continue as a going concern)
appearing elsewhere herein, and are included in reliance upon such report given
upon the authority of said firm as experts in accounting and auditing.
61
<PAGE>
ADDITIONAL INFORMATION
The Company has filed with the Securities and Exchange Commission (the
"Commission") a Registration Statement on Form SB-2 under the Securities Act
with respect to the Common Stock offered hereby. This Prospectus, which
constitutes a part of the Registration Statement, does not contain all of the
information set forth in the Registration Statement and the exhibits and
schedules thereto. For further information with respect to the Company and the
Common Stock offered hereby, reference is hereby made to the Registration
Statement and the exhibits and schedules filed as a part thereof. Statements
contained in this Prospectus as to the contents of any contract or any other
document referred to are not necessarily complete. In each instance, reference
is made to the copy of such contract or document filed as an exhibit to the
Registration Statement, and each such statement is qualified in all respects by
such reference. The Registration Statement, including exhibits and schedules
thereto, may be inspected and copied at the principal office of the Commission
at Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549 and at the
Commission's regional offices located at Seven World Trade Center, Suite 1300,
New York, New York 10048 and Citicorp Center, 500 West Madison Street, Suite
1400, Chicago, Illinois 60661. Copies of such materials may also be obtained at
prescribed rates from the Public Reference Section of the Commission, at 450
Fifth Street, N.W., Washington, D.C. 20549. In addition, registration statements
and certain other filings made with the Commission through its Electronic Data
Gathering, Analysis and Retrieval ("EDGAR") systems are publicly available
through the Commission's site on the Internet's World Wide Web, located at
http://www.sec.gov. The Registration Statement, including all exhibits thereto
and amendments thereof, has been filed with the Commission through EDGAR.
Upon consummation of this offering, the Company will become subject to the
reporting requirements of the Securities Exchange Act of 1934 and in accordance
therewith will file reports, proxy statements and other information with the
Commission. The Company intends to furnish its stockholders with annual reports
containing audited financial statements and such other reports as the Company
deems appropriate or as may be required by law.
62
<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
INDEX TO FINANCIAL STATEMENTS
Independent auditors' report............................................................................. F-2
Balance sheets as of December 31, 1996 and 1997 and June 30, 1998 (unaudited)............................ F-3
Statements of operations for the years ended December 31, 1996 and 1997 and for the six months ended June
30, 1997 and 1998 (unaudited).......................................................................... F-4
Statements of stockholders' equity (deficiency) for the years ended December 31, 1996 and 1997 and for
the six months ended June 30, 1998 (unaudited)......................................................... F-5
Statements of cash flows for the years ended December 31, 1996 and 1997 and for the six months ended June
30, 1997 and 1998 (unaudited).......................................................................... F-6
Notes to financial statements............................................................................ F-7
</TABLE>
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
Board of Directors and Stockholders
Network-1 Security Solutions, Inc.
Wellesley, Massachusetts
We have audited the accompanying balance sheets of Network-1 Security
Solutions, Inc. (the "Company") as of December 31, 1996 and 1997 and the related
statements of operations, stockholders' equity (deficiency) and cash flows for
each of the years then ended. These financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements enumerated above present fairly, in
all material respects, the financial position of Network-1 Security Solutions,
Inc. as of December 31, 1996 and 1997 and the results of its operations and its
cash flows for each of the years then ended in conformity with generally
accepted accounting principles.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note A to the
financial statements, the Company has incurred substantial losses from
operations, and as of December 31, 1997 has a working capital deficiency of
$661,000 and a stockholders' deficiency of $75,000. These factors raise
substantial doubt about the Company's ability to continue as a going concern.
Management's plans in regard to these matters are also described in Note A. The
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.
Richard A. Eisner & Company, LLP
New York, New York
June 17, 1998
With respect to Note F[3]
July 8, 1998
With respect to the third paragraph of Note A
July 17, 1998
With respect to Note J
September 11, 1998
F-2
<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------- JUNE 30,
1996 1997 1998
------------ ------------ ------------
<S> <C> <C> <C>
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents............................................. $ 217,000 $ 60,000 $ 634,000
Accounts receivable--net of allowance for doubtful accounts of $5,000,
$70,000 and $88,000, respectively................................... 191,000 435,000 609,000
Prepaid expenses and other current assets............................. 30,000 30,000 35,000
------------ ------------ ------------
Total current assets............................................ 438,000 525,000 1,278,000
Equipment and fixtures................................................ 518,000 400,000 323,000
Capitalized software costs--net....................................... 729,000 1,258,000 1,042,000
Security deposits..................................................... 193,000 131,000 136,000
Deferred offering costs............................................... 90,000 350,000
------------ ------------ ------------
$ 1,878,000 $ 2,404,000 $ 3,129,000
------------ ------------ ------------
------------ ------------ ------------
LIABILITIES
Current liabilities:
Accounts payable...................................................... $ 275,000 $ 776,000 $ 598,000
Accrued fee--related party............................................ 138,000
Accrued expenses and other current liabilities........................ 155,000 201,000 302,000
Notes payable--related parties, net of discount....................... 1,610,000
Notes payable--others, net of discount................................ 972,000
Interest payable--related parties..................................... 72,000
Interest payable--other............................................... 61,000
Current portion of capital lease obligations.......................... 24,000 8,000
Deferred revenue...................................................... 25,000 63,000 92,000
------------ ------------ ------------
Total current liabilities....................................... 479,000 1,186,000 3,707,000
Capital lease obligations--less current portion......................... 8,000
Notes payable--related parties, net of discount......................... 564,000
Notes payable--others, net of discount.................................. 670,000
Interest payable--related parties....................................... 24,000
Interest payable--others................................................ 35,000
------------ ------------ ------------
487,000 2,479,000 3,707,000
------------ ------------ ------------
Commitments and contingencies
STOCKHOLDERS' EQUITY (DEFICIENCY)
Preferred stock--$.01 par value; authorized 5,000,000 shares; Series
A--10% cumulative, none issued and outstanding
Series B--500,000 shares issued and outstanding....................... 5,000 5,000 5,000
Common stock--$.01 par value; authorized 25,000,000 shares; 2,004,951,
1,706,037 and 1,678,104 shares issued and outstanding................. 20,000 17,000 17,000
Additional paid-in capital.............................................. 6,446,000 7,373,000 9,432,000
Accumulated deficit..................................................... (5,080,000) (7,470,000) (9,460,000)
Unearned portion of compensatory stock options.......................... (572,000)
------------ ------------ ------------
1,391,000 (75,000) (578,000)
------------ ------------ ------------
$ 1,878,000 $ 2,404,000 $ 3,129,000
------------ ------------ ------------
------------ ------------ ------------
</TABLE>
See notes to financial statements
F-3
<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED SIX MONTHS ENDED
DECEMBER 31, JUNE 30,
---------------------- ----------------------
1996 1997 1997 1998
---------- ---------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C>
Revenues:
Licenses................................. $ 624,000 $1,132,000 $ 506,000 $ 412,000
Royalties................................ 500,000 500,000
Services................................. 403,000 737,000 421,000 490,000
---------- ---------- ---------- ----------
Total revenues......................... 1,027,000 2,369,000 1,427,000 902,000
---------- ---------- ---------- ----------
Cost of revenues:
Amortization of software development
costs.................................. 246,000 321,000 125,000 267,000
Cost of licenses......................... 193,000 176,000 52,000 128,000
Cost of services......................... 390,000 418,000 212,000 272,000
---------- ---------- ---------- ----------
Total cost of revenues................. 829,000 915,000 389,000 667,000
---------- ---------- ---------- ----------
Gross profit............................... 198,000 1,454,000 1,038,000 235,000
---------- ---------- ---------- ----------
Operating expenses:
Product development...................... 892,000 792,000 235,000 283,000
Selling and marketing.................... 1,614,000 926,000 524,000 351,000
General and administrative............... 1,931,000 1,573,000 919,000 1,153,000
---------- ---------- ---------- ----------
Total operating expenses............... 4,437,000 3,291,000 1,678,000 1,787,000
---------- ---------- ---------- ----------
Loss from operations....................... (4,239,000) (1,837,000) (640,000) (1,552,000)
Interest expense, including amortization of
debt discount............................ (260,000) (553,000) (141,000) (438,000)
---------- ---------- ---------- ----------
Net loss................................... $(4,499,000) $(2,390,000) $ (781,000) $(1,990,000)
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Loss per share--basic and diluted.......... $ (2.46) $ (1.29) $ (.40) $ (1.17)
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Weighted average number of shares
outstanding--basic and diluted........... 1,825,163 1,855,244 1,934,334 1,699,120
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
</TABLE>
See notes to financial statements
F-4
<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIENCY)
<TABLE>
<CAPTION>
COMMON STOCK PREFERRED STOCK ADDITIONAL
--------------------- -------------------- PAID-IN ACCUMULATED
SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT
---------- --------- --------- --------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE--DECEMBER 31, 1995...................... 1,164,133 $ 12,000 750,000 $ 7,000 $ 1,146,000 $ (581,000)
Issuance of common stock for cash--net.......... 698,397 7,000 4,141,000
Issuance of common stock and warrants for
services rendered............................. 18,262 683,000
Conversion of notes payable into common stock... 108,639 1,000 699,000
Redemption of preferred stock................... (250,000) (2,000) (248,000)
Exercise of warrants............................ 15,520 25,000
Net loss........................................ (4,499,000)
---------- --------- --------- --------- ----------- ------------
BALANCE--DECEMBER 31, 1996...................... 2,004,951 20,000 500,000 5,000 6,446,000 (5,080,000)
Issuance of common stock and warrants for
services rendered............................. 2,794 163,000
Warrants issued in connection with debt
financing..................................... 766,000
Repurchase and retirement of common shares...... (301,708) (3,000) (2,000)
Net loss........................................ (2,390,000)
---------- --------- --------- --------- ----------- ------------
BALANCE--DECEMBER 31, 1997...................... 1,706,037 17,000 500,000 5,000 7,373,000 (7,470,000)
Common stock options issued to Chief Executive
Officer....................................... 938,000
Amortization of compensatory stock options......
Issuance of common stock, warrants and options
for services rendered and payment of
liability..................................... 34,147 356,000
Warrants issued in connection with debt
financing..................................... 766,000
Repurchase and retirement of common shares...... (62,080) (1,000)
Net loss........................................ (1,990,000)
---------- --------- --------- --------- ----------- ------------
BALANCE--JUNE 30, 1998 (UNAUDITED).............. 1,678,104 $ 17,000 500,000 $ 5,000 $ 9,432,000 $(9,460,000)
---------- --------- --------- --------- ----------- ------------
---------- --------- --------- --------- ----------- ------------
<CAPTION>
UNEARNED
PORTION OF
COMPENSATORY
STOCK OPTIONS TOTAL
------------- -----------
<S> <C> <C>
BALANCE--DECEMBER 31, 1995...................... $ 584,000
Issuance of common stock for cash--net.......... 4,148,000
Issuance of common stock and warrants for
services rendered............................. 683,000
Conversion of notes payable into common stock... 700,000
Redemption of preferred stock................... (250,000)
Exercise of warrants............................ 25,000
Net loss........................................ (4,499,000)
------------- -----------
BALANCE--DECEMBER 31, 1996...................... 1,391,000
Issuance of common stock and warrants for
services rendered............................. 163,000
Warrants issued in connection with debt
financing..................................... 766,000
Repurchase and retirement of common shares...... (5,000)
Net loss........................................ (2,390,000)
------------- -----------
BALANCE--DECEMBER 31, 1997...................... (75,000)
Common stock options issued to Chief Executive
Officer....................................... $ (938,000)
Amortization of compensatory stock options...... 366,000 366,000
Issuance of common stock, warrants and options
for services rendered and payment of
liability..................................... 356,000
Warrants issued in connection with debt
financing..................................... 766,000
Repurchase and retirement of common shares...... (1,000)
Net loss........................................ (1,990,000)
------------- -----------
BALANCE--JUNE 30, 1998 (UNAUDITED).............. $ (572,000) $ (578,000)
------------- -----------
------------- -----------
</TABLE>
See notes to financial statements
F-5
<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
SIX MONTHS ENDED
DECEMBER 31, JUNE 30,
-------------------------- ------------------------
<S> <C> <C> <C> <C>
1996 1997 1997 1998
------------ ------------ ---------- ------------
<CAPTION>
(UNAUDITED)
<S> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss................................................ $ (4,499,000) $ (2,390,000) $ (781,000) $ (1,990,000)
Adjustments to reconcile net loss to net cash used in
operating activities:
Amortization of debt discount......................... 306,000 500,000 128,000 364,000
Issuance of common stock and warrants for services
rendered............................................ 683,000 163,000 95,000 583,000
Provision for doubtful accounts....................... (15,000) 65,000 36,000 18,000
Depreciation and amortization......................... 368,000 481,000 200,000 346,000
Changes in:
Accounts receivable................................. 131,000 (309,000) (330,000) (192,000)
Prepaid expenses and other current assets........... (15,000) (5,000)
Accounts payable, accrued expenses and other current
liabilities....................................... 196,000 744,000 147,000 (1,000)
Deferred revenue.................................... 25,000 38,000 (3,000) 29,000
------------ ------------ ---------- ------------
Net cash used in operating activities............. (2,820,000) (708,000) (508,000) (848,000)
------------ ------------ ---------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisitions of equipment and fixtures.................. (235,000) (42,000) (32,000) (3,000)
Capitalized software costs.............................. (750,000) (850,000) (506,000) (50,000)
Security deposit........................................ (164,000) 62,000 64,000 (5,000)
------------ ------------ ---------- ------------
Net cash used in investing activities............. (1,149,000) (830,000) (474,000) (58,000)
------------ ------------ ---------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of notes payable and warrants.... 700,000 1,550,000 1,000,000 1,750,000
Repayment of notes payable.............................. (400,000) (50,000)
Proceeds from exercise of options and warrants.......... 25,000
Net proceeds from sale of common stock.................. 4,148,000
Repayment of capital lease obligations.................. (23,000) (24,000) (8,000)
Purchase of treasury shares............................. (5,000) (1,000) (1,000)
Repayment of line of credit............................. (62,000)
Repayment of stockholder's loan......................... (48,000)
Redemption of preferred stock........................... (250,000)
Deferred offering costs................................. (90,000) (25,000) (261,000)
------------ ------------ ---------- ------------
Net cash provided by financing activities......... 4,090,000 1,381,000 974,000 1,480,000
------------ ------------ ---------- ------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS...... 121,000 (157,000) (8,000) 574,000
Cash and cash equivalents--beginning of period............ 96,000 217,000 217,000 60,000
------------ ------------ ---------- ------------
CASH AND CASH EQUIVALENTS--END OF PERIOD.................. $ 217,000 $ 60,000 $ 209,000 $ 634,000
------------ ------------ ---------- ------------
------------ ------------ ---------- ------------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest.............................................. $ 32,000 $ 1,000
Noncash transaction:
Issuance of stock in connection with repayment of
debt................................................ $ 700,000
</TABLE>
See notes to financial statements
F-6
<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED WITH RESPECT TO DATA AS OF JUNE 30, 1998 AND FOR
THE SIX-MONTH PERIODS ENDED JUNE 30, 1997 AND 1998)
NOTE A--THE COMPANY AND BASIS OF PRESENTATION
Network-1 Security Solutions, Inc. (the "Company"), formerly known as
Network-1 Software & Technology, Inc., develops, markets, licenses and supports
its proprietary network security software products designed to provide
comprehensive security to computer networks. The Company also provides
maintenance and network consulting and training services.
The accompanying financial statements have been prepared on a going concern
basis. As reflected in the accompanying financial statements, the Company has
incurred substantial losses from operations and as of December 31, 1997 has a
working capital deficiency of $661,000 and a stockholders' deficiency of
$75,000. Subsequent to December 31, 1997 through May 14, 1998, the Company
received $1,750,000 in short-term debt financing, a significant portion of which
was from principal stockholders of the Company. However, the Company will
require additional financing to satisfy its obligations and fund its operations
through December 31, 1998. Also, in May 1998, the Company signed a letter of
intent with an underwriter for the sale of its securities in an initial public
offering (the "Offering"). There is no assurance, however, that the Offering
will be consummated or that the Company will be able to obtain alternative
financing. As of June 30, 1998, the Company's working capital deficiency
increased to $2,429,000 and its stockholders' deficiency increased to $578,000.
The above factors give rise to substantial doubt as to the ability of the
Company to continue as a going concern. The financial statements do not include
any adjustments that might result from the outcome of this uncertainty.
On July 17, 1998, the stockholders approved a 1:1.610831 reverse split of
the outstanding shares of the Company's common stock. The accompanying financial
statements have been retroactively adjusted to reflect the split and all
references to numbers of common shares, options, warrants and per share amounts
have been restated to give effect to the split.
NOTE B--SIGNIFICANT ACCOUNTING POLICIES
[1] CASH EQUIVALENTS:
The Company considers all highly liquid short-term investments purchased with
a maturity of three months or less to be cash equivalents.
[2] REVENUE RECOGNITION:
In October 1997, the AICPA issued Statement of Position ("SOP") No. 97-2,
"Software Revenue Recognition," which the Company adopted, effective January
1, 1997. Such adoption had no effect on the Company's methods of recognizing
revenue from its license and service activities. Prior to 1997, the
Company's revenue recognition policy was in accordance with SOP No. 91-1,
"Software Revenue Recognition."
License revenue is recognized upon delivery of software or delivery of a
required software key. Service revenues consist of maintenance, consulting
and training services. Annual renewable maintenance fees are a separate
component of each contract, and are recognized ratably over the contract
term. Consulting and training revenues are recognized as such services are
performed.
F-7
<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED WITH RESPECT TO DATA AS OF JUNE 30, 1998 AND FOR
THE SIX-MONTH PERIODS ENDED JUNE 30, 1997 AND 1998)
NOTE B--SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
[3] EQUIPMENT AND FIXTURES:
Equipment and fixtures are stated at cost and are depreciated using the
straight-line method over their estimated useful lives of five years.
[4] SOFTWARE DEVELOPMENT COSTS:
Costs to maintain developed programs and development costs incurred to
establish the technological feasibility of computer software are expensed as
incurred. The Company capitalizes costs incurred in producing computer
software after technological feasibility of the software has been
established. Such costs are amortized based on current and estimated future
revenue of each product with an annual minimum equal to the straight-line
amortization over the remaining estimated economic life of the product. The
Company estimates the economic life of its software to be three years. At
each balance sheet date, the unamortized capitalized software costs of each
product are compared with the net realizable value of that product and any
excess capitalized costs are written off.
[5] INCOME TAXES:
The Company utilizes the liability method of accounting for income taxes.
Under such method, deferred tax assets and liabilities are recognized for
the future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and liabilities and
their respective tax bases. Deferred tax assets and liabilities are measured
using enacted tax rates in effect at the balance sheet date. The resulting
asset or liability is adjusted to reflect enacted changes in tax law.
[6] LOSS PER SHARE:
During 1997, the Company adopted Statement of Financial Accounting Standards
No. 128, "Earnings Per Share" ("SFAS No. 128"). SFAS No. 128 requires the
reporting of basic and diluted earnings/loss per share. Basic loss per share
is calculated by dividing net loss by the weighted average number of
outstanding common shares during the year. Diluted per share data includes
the dilutive effects of options, warrants and convertible securities. As all
potential common shares are anti-dilutive, they are not included in the
calculation of diluted loss per share. Loss per share for 1996 has been
presented to conform to SFAS No. 128.
[7] USE OF ESTIMATES:
The preparation of financial statements in conformity with generally accepted
accounting principles 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 revenues and expenses during the reporting
period. Actual results could differ from those estimates.
[8] FINANCIAL INSTRUMENTS:
The carrying amounts of accounts receivable, accounts payable, accrued
expenses, capitalized lease obligations and notes payable approximate their
fair value as the interest rates on the Company's
F-8
<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED WITH RESPECT TO DATA AS OF JUNE 30, 1998 AND FOR
THE SIX-MONTH PERIODS ENDED JUNE 30, 1997 AND 1998)
NOTE B--SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
indebtedness approximate current market rates and due to the short period to
maturity of these instruments.
[9] STOCK-BASED COMPENSATION:
In October 1995, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 123 ("SFAS No. 123"), "Accounting for
Stock-Based Compensation". SFAS No. 123 encourages, but does not require,
companies to record compensation cost for stock-based employee compensation
plans at fair value. The Company has elected to continue to account for its
employee stock-based compensation plans using the intrinsic value method
prescribed by Accounting Principles Board Opinion No. 25 ("APB No. 25"),
Accounting for Stock Issued to Employees" and to disclose the pro forma
effect on net loss per share had the fair value of options been expensed.
Under the provisions of APB No. 25, compensation cost for stock options is
measured as the excess, if any, of the estimated market value of the
Company's common stock at the date of the grant over the amount an employee
must pay to acquire the stock.
[10] INTERIM FINANCIAL STATEMENTS:
The accompanying balance sheet as of June 30, 1998, the statement of changes
in stockholders' equity for the six-month period then ended and the
statements of operations and cash flows for the six-month periods ended June
30, 1997 and 1998 are unaudited. In the opinion of management, all
adjustments (consisting only of normal recurring accruals) considered
necessary for a fair presentation have been included. The results of
operations for the six-month period ended June 30, 1998 are not necessarily
indicative of the results to be expected for the year ended December 31,
1998.
NOTE C--EQUIPMENT AND FIXTURES
Equipment and fixtures are summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------- JUNE 30,
1996 1997 1998
--------- --------- -----------
(UNAUDITED)
<S> <C> <C> <C>
Office and computer equipment.............. $ 669,000 $ 661,000 $ 664,000
Furniture and fixtures..................... 59,000 59,000 59,000
Leasehold improvements..................... 46,000 46,000 46,000
--------- --------- -----------
774,000 766,000 769,000
Less accumulated depreciation.............. (256,000) (366,000) (446,000)
--------- --------- -----------
$ 518,000 $ 400,000 $ 323,000
--------- --------- -----------
--------- --------- -----------
</TABLE>
F-9
<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED WITH RESPECT TO DATA AS OF JUNE 30, 1998 AND FOR
THE SIX-MONTH PERIODS ENDED JUNE 30, 1997 AND 1998)
NOTE D--CAPITALIZED SOFTWARE COSTS
<TABLE>
<CAPTION>
SIX
YEAR ENDED MONTHS
DECEMBER 31, ENDED
------------------------- JUNE 30,
1996 1997 1998
----------- ------------ ------------
<S> <C> <C> <C>
(UNAUDITED)
Balance, beginning of period (net of accumulated amortization)........... $ 225,000 $ 729,000 $ 1,258,000
Additions................................................................ 750,000 850,000 50,000
Amortization............................................................. (246,000) (321,000) (266,000)
----------- ------------ ------------
Balance, end of period (net of accumulated amortization)................. $ 729,000 $ 1,258,000 $ 1,042,000
----------- ------------ ------------
----------- ------------ ------------
</TABLE>
NOTE E--NOTES PAYABLE
Notes payable is summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1997 1998
------------ ------------
<S> <C> <C>
Notes payable on the earlier of a) January 1, 1999 b) the date
upon which the Company receives $6,000,000 net proceeds of
equity or debt financing from one or a series of transactions
c) a sale of all of the Company's assets or d) a merger or
consolidation of the Company:
Notes bearing interest at 6%, including $250,000 payable to a
related party (1).......................................... $ 650,000 $ 650,000
Notes bearing interest at 6% (2)............................. 350,000 350,000
Note bearing interest at 8%, payable to a related party
(3)........................................................ 100,000 100,000
Notes bearing interest at 8%, payable to related parties
(4)........................................................ 400,000 400,000
Notes payable (including $1,400,000 to related parties) on the
earlier of a) twelve months from issuance b) the date upon
which the Company receives $6,000,000 net proceeds of equity
or debt financing from one or a series of transactions c) a
sale of all of the Company's assets or d) a merger or
consolidation of the Company; bearing interest at 8% (5)..... 1,750,000
------------ ------------
1,500,000 3,250,000
Less unamortized debt discount................................... (266,000) (668,000)
------------ ------------
$1,234,000 $ 2,582,000
------------ ------------
------------ ------------
</TABLE>
F-10
<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED WITH RESPECT TO DATA AS OF JUNE 30, 1998 AND FOR
THE SIX-MONTH PERIODS ENDED JUNE 30, 1997 AND 1998)
NOTE E--NOTES PAYABLE (CONTINUED)
- ------------------------
(1) In connection with the issuance of the notes, including $250,000 issued to
an entity which is a principal stockholder of the Company, the Company
issued ten-year warrants valued at $290,000 to purchase 90,791 shares of the
Company's common stock at an exercise price of $6.44 per share, increasing
the effective interest rate on the notes to 91%.
(2) In connection with the issuance of the notes, the Company issued ten-year
warrants valued at $159,000 to purchase 48,888 shares of the Company's
common stock at an exercise price of $6.44 per share, increasing the
effective interest rate to 94%.
(3) In connection with the issuance of the note to a corporation wholly owned by
the Chairman of the Board and a principal stockholder of the Company, the
Company agreed to reduce the exercise price of previously issued warrants to
the noteholder from $6.44 per share (31,040 shares) and $8.05 per share
(31,040 shares) to $3.22 per share (see Note G[5]). In addition, the Company
agreed to reduce the exercise price of warrants to purchase 124,159 shares
of common stock at an exercise price of $3.22 per share previously issued to
the noteholder to $1.61 per share. The Company valued the modified warrants
at $45,000 in excess of the value ascribed to the original warrants,
increasing the effective interest rate to 96%. The warrants exercisable at
$3.22 per share were further reduced to $1.61 per share in connection with
the issuance in November 1997 of a note for $50,000 to the same corporation
referred to above which was repaid in December 1997. This modification was
valued at $22,000 in excess of the value ascribed to the warrants as
previously modified.
(4) In connection with the issuance of the notes to an entity which is a
principal stockholder of the Company and to the corporation referred to in
(3) above, the Company issued ten-year warrants valued at $168,000 to
purchase 70,949 shares of the Company's common stock at an exercise price of
$4.83 per share, increasing the effective interest rate to 86%.
(5) The Company issued notes for $400,000, $100,000 and $1,250,000 on March 2,
1998, April 24, 1998 and May 14, 1998, respectively. In connection with the
issuance of the notes, $1,400,000 of which are payable to the Chairman of
the Board and the entities referred to in (4) above, the Company issued
ten-year warrants valued at $766,000 to purchase 325,919 shares of the
Company's common stock at an exercise price of $4.83 per share, increasing
the effective interest rate to 92%.
The proceeds from the issuance of the notes were allocated to the debt and
the warrants based on their estimated fair values. The Company estimated the
fair value of these warrants using the Black-Scholes pricing model and has
accounted for this amount as a debt discount to be amortized over the life of
the debt.
Interest expense for the years ended December 31, 1996, 1997 and for the six
months ended June 30, 1997 and 1998 includes $325,000, $267,000, $44,000 and
$323,000, respectively, of interest and amortization of debt discount on notes
to related parties.
F-11
<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED WITH RESPECT TO DATA AS OF JUNE 30, 1998 AND FOR
THE SIX-MONTH PERIODS ENDED JUNE 30, 1997 AND 1998)
NOTE F--STOCKHOLDERS' EQUITY
[1] PREFERRED STOCK:
The Company has outstanding 500,000 shares of Series B convertible preferred
stock. Such stock is convertible on a 1.610831-to-1 basis into common shares
and automatically converts into common shares upon the completion of an
initial public offering of the Company's securities which results in gross
proceeds to the Company of a minimum of $4,000,000. The preferred stock has
identical voting rights as the Company's common stock and has a liquidation
preference of $1.00 per share.
[2] STOCK OPTIONS AND WARRANTS:
During 1996, the Board of Directors and stockholders approved the adoption of
the 1996 Stock Option Plan (the "1996 Plan"). The 1996 Plan, as amended,
provides for the granting of both incentive and non-qualified options to
purchase up to 750,000 shares of common stock of the Company.
The term of options granted under the 1996 Plan may not exceed ten years
(five years in the case of an incentive stock option granted to an optionee
owning more than 10% of the voting stock of the Company). The option price
for incentive stock options can not be less than 100% of the fair market
value of the shares of common stock at the time the option is granted (110%
for a 10% stockholder). The exercise price for non-qualified options is set
by the Compensation Committee in its discretion.
The following table summarizes the activity under the 1996 Plan:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------------
SIX MONTHS ENDED
1996 1997 JUNE 30, 1998
---------------------- ---------------------- -----------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
--------- ----------- --------- ----------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C>
Options outstanding at beginning of period......... 104,139 $ 6.44 184,687 $ 5.72
Granted............................................ 107,398 $ 6.44 159,700 $ 5.54 399,832 $ 5.70
Cancelled.......................................... (3,259) $ 6.44 (79,152) $ 6.30 (135,644) $ 5.60
--------- --------- ----------
Options outstanding at end of period............... 104,139 $ 6.44 184,687 $ 5.72 448,875 $ 5.74
--------- --------- ----------
--------- --------- ----------
Options exercisable at end of period............... 82,256 $ 6.44 184,687 $ 5.72 256,761 $ 5.33
--------- --------- ----------
--------- --------- ----------
</TABLE>
The following table presents information relating to stock options
outstanding at December 31, 1997:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING AND EXERCISABLE
- -----------------------------------
<S> <C> <C>
WEIGHTED
WEIGHTED AVERAGE
AVERAGE REMAINING
EXERCISE LIFE IN
SHARES PRICE YEARS
- --------- ----------- -----------
82,876... $ 4.83 9.75
101,811.. $ 6.44 9.03
- ---------
184,687.. $ 5.72 9.35
- ---------
- ---------
</TABLE>
F-12
<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED WITH RESPECT TO DATA AS OF JUNE 30, 1998 AND FOR
THE SIX-MONTH PERIODS ENDED JUNE 30, 1997 AND 1998)
NOTE F--STOCKHOLDERS' EQUITY (CONTINUED)
The following table presents information relating to stock options
outstanding at June 30, 1998 (unaudited):
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
- ----------------------------------- -------------------------------------
<S> <C> <C> <C> <C> <C>
WEIGHTED WEIGHTED
WEIGHTED AVERAGE WEIGHTED AVERAGE
AVERAGE REMAINING AVERAGE REMAINING
EXERCISE LIFE IN EXERCISE LIFE IN
SHARES PRICE YEARS SHARES PRICE YEARS
- --------- ----------- ----------- --------- ----------- -------------
130,989 $ 4.83 9.56 130,989 $ 4.83 9.56
197,828 $ 5.60 9.92 88,214 $ 5.60 9.92
37,558 $ 6.44 8.42 37,558 $ 6.44 8.42
82,500 $ 7.20 10.00
- --------- ---------
448,875 $ 5.74 9.70 256,761 $ 5.33 9.51
- --------- ---------
- --------- ---------
</TABLE>
The weighted average fair value at date of grant for options granted during
the years ended December 31, 1996 and 1997 and the six months ended June 30,
1997 and 1998 were $3.20, $2.76, $3.21 and $2.70 per option, respectively.
The fair value of options at date of grant was estimated using the
Black-Scholes option pricing model utilizing the following weighted average
assumptions:
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
-------------------- --------------------
<S> <C> <C> <C> <C>
1996 1997 1997 1998
--------- --------- --------- ---------
<CAPTION>
(UNAUDITED)
<S> <C> <C> <C> <C>
Risk-free interest rates................................ 6.43% 6.50% 6.59% 5.62%
Expected option life in years........................... 6 6 6 6
Expected stock price volatility......................... 40% 40% 40% 40%
Expected dividend yield................................. 0% 0% 0% 0%
</TABLE>
Had the Company elected to recognize compensation cost based on the fair
value of the options at the date of grant as prescribed by SFAS 123, net
loss for the years ended December 31, 1996 and 1997 and for the six-month
periods ended June 30, 1997 and 1998 would have been $(4,842,000),
$(2,830,000), $(1,007,000) and $(2,898,000) or $(2.65), $(1.53), $(.52) and
$(1.71), respectively, per share.
[3] The Company has the following warrants and options referred to in [4] below
to purchase common stock outstanding as of December 31, 1997:
<TABLE>
<CAPTION>
NUMBER
OF EXERCISE
SHARES PRICE
- --------- -----------
<S> <C>
186,239.. $ 1.61
62,856... 2.42
62,080... 3.22
70,949... 4.83
318,159.. 6.44
93,120... 9.66
- ---------
793,403
- ---------
- ---------
</TABLE>
F-13
<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED WITH RESPECT TO DATA AS OF JUNE 30, 1998 AND FOR
THE SIX-MONTH PERIODS ENDED JUNE 30, 1997 AND 1998)
NOTE F--STOCKHOLDERS' EQUITY (CONTINUED)
From March through May 1998, in connection with the issuance of notes (see
Note E[5]), the Company issued warrants to purchase 325,919 shares of the
Company's common stock at an exercise price of $4.83. The Company also
issued a warrant to purchase 6,208 shares of the Company's common stock at
an exercise price of $6.04 for services rendered.
On July 8, 1998, the Company entered into an agreement with certain of its
option and warrant holders pursuant to which the Company issued 596,741
shares of its common stock in exchange for cancellation of outstanding
warrants to purchase 789,521 shares of the Company's common stock.
[4] PRIVATE PLACEMENT:
During March 1996, the Company completed a private placement of its
securities. The Company issued 667,357 shares of its common stock for $6.44
a share, yielding gross proceeds of $4,300,000. In connection with the
private placement the Company incurred costs aggregating $352,000 including
$279,000 in commissions and expense allowance paid to the placement agent.
The Company also issued options to purchase 66,736 shares of common stock at
an exercise price of $6.44 per share expiring in March 2001 to the placement
agents in connection with the private placement. The investors in the
private placement were granted certain demand and piggyback registration
rights. The Company also sold 31,040 shares of stock in 1996 receiving
proceeds of $200,000.
NOTE G--COMMITMENTS AND CONTINGENCIES
[1] OPERATING LEASES:
The Company leases office facilities in Florida, New York and Texas under
operating leases expiring through 1999. Rental commitments for the remaining
term of the Company's noncancellable leases relating to office space
expiring at various dates through 1999 are as follows:
<TABLE>
<CAPTION>
YEAR ENDING
DECEMBER 31,
- ----------------
<S> <C>
1998............ $ 120,000
1999............ 31,000
----------
$ 151,000
----------
----------
</TABLE>
Rental expense for the years December 31, 1996 and 1997 and for the
six-month periods ended June 30, 1997 and 1998 aggregated $142,000,
$146,000, $71,000 and $71,000, respectively.
[2] SOFTWARE DISTRIBUTION AGREEMENTS:
[A] In June 1997, the Company entered into a software distribution agreement
pursuant to which the Company licensed, on a nonexclusive basis, the
right to incorporate and/or bundle certain technology of the Company,
with the customer's products. In connection therewith, the Company, which
is entitled to royalties based on the customer's sales, received a
$500,000, nonrefundable prepaid royalty, which is included in license
revenue for the year ended December 31, 1997 and the six months ended
June 30, 1997.
[B] In September 1997, the Company entered into a software distribution
agreement, pursuant to which the Company has the right to incorporate
certain technology into its software. The
F-14
<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED WITH RESPECT TO DATA AS OF JUNE 30, 1998 AND FOR
THE SIX-MONTH PERIODS ENDED JUNE 30, 1997 AND 1998)
NOTE G--COMMITMENTS AND CONTINGENCIES (CONTINUED)
Company is required to make certain royalty payments based on unit sales
as defined. The Company is obligated to pay a minimum of $100,000 in
royalties pursuant to the agreement for the period September 1997 to
March 30, 1999. As of December 31, 1997 and June 30, 1998, accrued
royalty payable was approximately $29,000 and $44,000, respectively.
[C] In July 1996, the Company entered into an agreement pursuant to which
certain technology was developed for the Company. The Company is required
to make certain royalty payments based on unit sales as defined, up to a
maximum royalty payment of $100,000. For the year ended December 31, 1997
and the six months ended June 30, 1998, royalties owed pursuant to such
agreement were de minimus.
[3] EMPLOYMENT AGREEMENTS:
In May 1998, the Company entered into an employment agreement with its
President and Chief Executive Officer which provides for a base salary of
$150,000, subject to annual increases of up to 20% by the Board of Directors
at their discretion. The agreement also provides for an annual bonus of up
to $50,000 as determined by the Board of Directors in its discretion. The
agreement expires in May 2002. In connection therewith, the Company granted
the President a five-year option to purchase 294,879 shares of the Company's
common stock at an exercise price of $2.42 per share. The option vests 34%
immediately and then 22% per year thereafter. As the estimated fair value of
the Company's common stock at the date of grant of the option ($5.60 per
share) was in excess of the exercise price the Company will incur aggregate
compensation expense of approximately $938,000 over the service period,
$366,000 of which was charged to expense during the six months ended June
30, 1998 based on the vesting provisions of the option.
The Company has employment agreements with six other officers providing for
aggregate annual salaries of $120,000 through April 1999 with respect to one
officer and aggregate annual salaries of $640,000 through May and August
2001 with respect to five officers. Certain of the agreements provide for
the granting of bonuses at the discretion of the Board of Directors, as well
as options to purchase shares of common stock.
Aggregate salary commitments pursuant to employment agreements are $804,000,
$820,000, $790,000, $470,000 and $56,000 for 1998, 1999, 2000, 2001 and
2002, respectively.
[4] SAVINGS AND INVESTMENT PLAN:
The Company has a Savings and Investment Plan which allows participants to
make contributions by salary reduction pursuant to Section 401(k) of the
Internal Revenue Code of 1986. The Company also may make discretionary
annual matching contributions in amounts determined by the Board of
Directors, subject to statutory limits. The Company did not make any
contributions to the 401(k) Plan during the years ended December 31, 1996
and 1997 and the six months ended June 30, 1998.
[5] FINANCIAL ADVISORY AGREEMENT:
In September 1996, as amended in January 1997, the Company entered into a
financial advisory agreement with a corporation owned by the Chairman of the
Board and a principal stockholder, which expires in January 1999. Pursuant
to such agreement, monthly fees of $12,500 were to be paid to such
F-15
<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED WITH RESPECT TO DATA AS OF JUNE 30, 1998 AND FOR
THE SIX-MONTH PERIODS ENDED JUNE 30, 1997 AND 1998)
NOTE G--COMMITMENTS AND CONTINGENCIES (CONTINUED)
corporation, and the Company issued two 7-year warrants, each to purchase up
to 31,040 shares of common stock at an exercise price of $6.44 and $8.05,
respectively. Such exercise prices were subsequently reduced to an exercise
price of $1.61 per share (see Note E[3]). The Company also agreed to pay
such corporation and another corporation which is a principal stockholder of
the Company, a cash fee equal to 3% of the total proceeds or other
consideration received in connection with a merger or sale of substantially
all of the Company's assets completed by January 2001. Expenses under the
agreement, including amortization of the value ascribed to the warrants,
included in general and administrative expenses, for the year ended December
31, 1997 and the six-month periods ended June 30, 1997 and 1998 amounted to
$253,000, $135,000 and $121,000, respectively.
On May 14, 1998, the Company terminated the monthly fee provision of the
financial advisory agreement and issued 31,250 shares of common stock to
this entity in satisfaction of amounts owed pursuant the agreement.
NOTE H--INCOME TAXES
The principal components of deferred tax assets and valuation allowance are
as follows:
<TABLE>
<CAPTION>
SIX MONTHS
YEAR ENDED ENDED
DECEMBER 31, JUNE 30,
1996 1997 1998
------------- ------------- -------------
<S> <C> <C> <C>
Deferred tax assets:
Net operating loss carryforwards............... $ 1,464,000 $ 2,122,000 $ 2,882,000
Common stock and warrants issued for
compensation and debt discount, not yet
deducted for tax purposes.................... 266,000 525,000 503,000
Other.......................................... 240,000 261,000 275,000
------------- ------------- -------------
1,970,000 2,908,000 3,660,000
Valuation allowance.............................. (1,970,000) (2,908,000) (3,660,000)
------------- ------------- -------------
Net deferred tax asset........................... $ 0 $ 0 $ 0
------------- ------------- -------------
------------- ------------- -------------
</TABLE>
The Company has recorded a valuation allowance for the full amount of its
deferred tax assets as the likelihood of its future realization cannot be
presently determined.
The difference between the tax benefit and the amount that would be computed
by applying the statutory federal income tax rate to loss before taxes is
attributable to the following:
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED
DECEMBER 31, JUNE 30,
-------------------- --------------------
1996 1997 1997 1998
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Income tax benefit--statutory rate.................. (34.0)% (34.0)% (34.0)% (34.0)%
Increase in valuation allowance on deferred tax
assets............................................ 34.0% 34.0% 34.0% 34.0%
--------- --------- --------- ---------
0% 0% 0% 0%
--------- --------- --------- ---------
--------- --------- --------- ---------
</TABLE>
F-16
<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED WITH RESPECT TO DATA AS OF JUNE 30, 1998 AND FOR
THE SIX-MONTH PERIODS ENDED JUNE 30, 1997 AND 1998)
NOTE H--INCOME TAXES (CONTINUED)
At December 31, 1997, the Company has available net operating loss
carryforwards to reduce future federal taxable income of approximately
$5,500,000 for tax reporting purposes which expire from 2009 through 2012.
Pursuant to the provisions of the Internal Revenue Code, future utilization of
these past losses is subject to certain limitations based on changes in the
ownership of the Company's stock that have occurred or are likely to occur.
NOTE I--OTHER MATTERS
[1] For the year ended December 31, 1997, approximately $500,000 (21%), $362,000
(15%) and $298,000 (13%) of the Company's revenues were from three
customers. For the six months ended June 30, 1998, approximately $285,000
(32%), $154,000 (17%) and $95,000 (11%) of the Company's revenues
respectively, were from one customer, the second customer referred to above,
and a third customer. No customer accounted for 10% or more of the Company's
revenue for the year ended December 31, 1996 and one customer accounted for
$500,000 in sales (35%) for the six months ended June 30, 1997.
[2] For the years ended December 31, 1996 and 1997 and for the six months ended
June 30, 1997 and 1998, export sales of the Company's products amounted to
approximately $69,000, $370,000, $237,000 and $16,000, respectively.
NOTE J--SUBSEQUENT EVENTS
In August, 1998 the Company formed a wholly owned subsidiary, Network-1
Acquisition Corp. (the "Purchaser"). Pursuant to an agreement and plan of merger
dated September 11, 1998 between the Company, the Purchaser and CommHome Systems
Corporation ("CommHome"), upon closing of the offering CommHome will be merged
with and into the Purchaser with the shareholders of CommHome receiving 35,000
shares of the Company's common stock. The Company's President is also the
President of CommHome and owns 51% of its outstanding common stock. The
Purchaser also agreed to assume liabilities of CommHome of up to $200,000
including $105,000 which is owed to two officers of the Company and which will
be satisfied by the issuance of 13,125 shares of the Company's common stock. The
Company will incur a charge of approximately $469,000 for purchased research and
development upon the acquisition which will be accounted for as a purchase.
CommHome is a development stage company and has had no revenues. The principal
activity has been the design of residential networking solutions. The Company
intends to incorporate CommHome's designs into its future security products.
F-17
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
NO DEALER, SALESPERSON OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS
PROSPECTUS IN CONNECTION WITH THIS OFFERING AND, IF GIVEN OR MADE, SUCH
INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED
BY THE COMPANY OR THE UNDERWRITER. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER
TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY SECURITY OTHER THAN THE
SECURITIES OFFERED BY THIS PROSPECTUS, OR AN OFFER TO SELL OR A SOLICITATION OF
AN OFFER TO BUY ANY SECURITIES BY ANYONE IN ANY JURISDICTION IN WHICH SUCH OFFER
OR SOLICITATION IS NOT AUTHORIZED OR IS UNLAWFUL. NEITHER THE DELIVERY OF THIS
PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE
ANY IMPLICATION THAT THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME
SUBSEQUENT TO THE DATE HEREOF.
------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
Prospectus Summary............................... 3
Risk Factors..................................... 7
Use of Proceeds.................................. 18
Dilution......................................... 20
Dividend Policy.................................. 21
Capitalization................................... 21
Selected Financial Data.......................... 22
Management's Discussion and Analysis of Financial
Condition and Results of Operations............ 23
Business......................................... 31
Management....................................... 45
Principal Stockholders........................... 53
Certain Transactions............................. 55
Description of Securities........................ 57
Shares Eligible for Future Sale.................. 59
Underwriting..................................... 60
Legal Matters.................................... 61
Experts.......................................... 61
Additional Information........................... 62
Index to Financial Statements.................... F-1
</TABLE>
------------------------
UNTIL , 1998 (25 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL
DEALERS EFFECTING TRANSACTIONS IN THE REGISTERED SECURITIES, WHETHER OR NOT
PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS.
THIS DELIVERY REQUIREMENT IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER
A PROSPECTUS WHEN ACTING AS AN UNDERWRITER AND WITH RESPECT TO THEIR UNSOLD
ALLOTMENTS OR SUBSCRIPTIONS.
1,875,000 SHARES
[LOGO]
COMMON STOCK
---------------------
PROSPECTUS
---------------------
WHALE SECURITIES CO., L.P.
, 1998
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 24. INDEMNIFICATION OF DIRECTORS AND OFFICERS
As permitted by Section 102(b)(7) of the Delaware General Corporation Law
(the "GCL"), Article VI of the Company's Amended and Restated Certificate of
Incorporation, filed as Exhibit 3.1 hereto, includes a provision that eliminates
any director's personal liability to the Company or its stockholders for
monetary damages for breach of fiduciary duty as a director. Such elimination of
personal liability does not apply to the following: (i) breach of the duty of
loyalty to the Company or its stockholders; (ii) acts or omissions not in good
faith or which involve intentional misconduct or a knowing violation of the law;
(iii) payment of an illegal dividend or an illegal redemption or purchase of the
Company's stock, pursuant to Section 174 of the GCL; or (iv) any transaction
from which the director derived an improper benefit. If the GCL is amended to
authorize corporate action further eliminating or limiting the personal
liability of directors, then the liability of a director of the Company shall be
eliminated or limited to the fullest extent permitted by the GCL, as so amended.
Any repeal or modification of this Article by the stockholders of the Company
shall not adversely affect any right or protection of a director of the Company
with respect to events occurring prior to the time of such repeal or
modification.
As permitted by Section 145 of the GCL, pursuant to Article VII of the
Company's Amended and Restated Certificate of Incorporation, the Company, to the
fullest extent permitted by the provisions of the GCL, as now or hereafter in
effect, indemnifies any director, officer, employee or agent of the Company and
certain other persons serving at the request of the Company in related
capacities against amounts paid and expenses incurred in connection with an
action or proceeding to which that person is or is threatened to be made a party
by reasons of such position, if such person shall have acted in good faith and
in a manner he reasonably believed to be in or not opposed to the best interests
of the Company and, in any criminal proceeding, if such person had no reasonable
cause to believe his conduct was unlawful; provided that, in the case of actions
brought by or in the right of the Company, no indemnification shall be made with
respect to any matter as to which such person shall have been adjudged to be
liable to the Company unless and only to the extent that the adjudicating court
determines that such indemnification is proper under the circumstances. The
indemnification provided by Article VII of the Company's Amended and Restated
Certificate of Incorporation does not limit or exclude any rights, indemnities
or limitations of liability to which any person may be entitled, whether as a
matter of law, under the Bylaws of the Company, by agreement, vote of the
stockholders or vote of disinterested directors of the Company or otherwise.
The Company believes that the indemnification provisions contained in
Article VI and Article VII of the Company's Amended and Restated Certificate of
Incorporation have assisted and will assist the Company in attracting and
retaining qualified individuals to serve as directors and officers.
The Underwriting Agreement, filed as Exhibit 1.1 hereto, provides for
indemnification by the Underwriter of the Company, its directors and officers,
and by the Company of the Underwriter, for certain liabilities, including
liabilities under the Act, and affords certain rights of contribution with
respect thereto.
ITEM 25. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The following table sets forth all expenses, other than underwriting
discounts and commissions, payable by the Company in connection with the sale of
the securities being registered.
II-1
<PAGE>
The foregoing, except for the SEC Registration Fee and NASD Filing Fee are
estimates.
<TABLE>
<S> <C>
SEC Registration Fee............................................................ $5,818.94
NASD Filing Fee................................................................. $2,472.52
NASDAQ SmallCap Listing Fee..................................................... $ 10,000
Boston Stock Exchange Listing Fee............................................... $ 7,500
Accounting Fees and Expenses.................................................... $ 110,000
Legal Fees and Expenses (other than Blue Sky)................................... $ 250,000
Blue Sky Fees and Expenses (including legal and filing fees).................... $ 50,000
Printing and Engraving Expenses................................................. $ 100,000
Directors' and Officers' Liability Insurance.................................... $ 70,000
Transfer Agent Fees and Expenses................................................ $ 2,500
Miscellaneous................................................................... $19,208.54
---------
Total........................................................................... $ 627,500
</TABLE>
ITEM 26. RECENT SALES OF UNREGISTERED SECURITIES
During the past three years, the Company has issued unregistered securities
to the persons described below. No underwriting discounts or commissions were
paid in connection with such issuance of securities, except in connection with
the Company's issuance of an aggregate 667,359 shares of Common Stock on March
14, 1996 and March 21, 1996 (the "March 1996 Private Offering," as further
described below under paragraph 5). In issuing the securities described below,
the Company relied upon the exemption from the registration requirements of the
Securities Act of 1933, as amended (the "Securities Act"), by reason of Section
4(2) thereof and Regulation D promulgated thereunder, based on the fact that
each investor was either an "accredited investor" as such term is defined in
Rule 501 of Regulation D promulgated under the Securities Act or such investor
had such knowledge and experience in financial and business matters that such
person was capable of evaluating the merits and risks of the investment. The
share amounts below reflect a stock split at the rate of 12,836.97-to-1 on March
2, 1994, and a reverse stock split at the rate of 1-for-1.61083 on July 20,
1998.
(1) On November 29, 1995, the Company issued to Corey M. Horowitz warrants to
purchase 124,159 shares of Common Stock at an exercise price of $3.22 per
share, expiring November 29, 2005, in consideration for a loan of $150,000.
(2) On November 29, 1995, the Company issued to the CAPCOR Employee Pension Plan
warrants to purchase 62,080 shares of Common Stock at an exercise price of
$3.22 per share, expiring November 29, 2005, in consideration for a loan of
$75,000.
(3) On March 14, 1996, the Company issued to each of Irwin Lieber, Barry
Rubenstein and Eli Oxenhorn warrants to purchase 31,040 shares of Common
Stock at an exercise price of $6.44 per share, expiring March 14, 2006, and
warrants to purchase 31,040 shares of Common Stock at an exercise price of
$9.67 per share, expiring March 14, 2006, in consideration for their
agreement to serve on the Company's advisory board.
(4) On March 14, 1996, the Company issued to Bizar Martin & Taub, LLP warrants
to purchase 9,312 shares of Common Stock at an exercise price of $6.44 per
share, expiring March 14, 2006, in consideration for services rendered.
II-2
<PAGE>
(5) On March 14, 1996 and March 21, 1996, in connection with the March 1996
Private Offering, the Company issued to 34 investors an aggregate 667,359
shares of Common Stock, in consideration for payment of $6.44 per share, for
an aggregate consideration of $4.3 million. GKN Securities Corp. served as
Placement Agent for the March 1996 Private Offering, and received a 4.5%
sales commission (or $193,500). The Company also issued to GKN Securities
Corp., related parties and Barington Capital Group, L.P. options to purchase
an aggregate 66,736 shares of Common Stock at an exercise price of $6.44 per
share, expiring March 14, 2001, in consideration of $100. The following
investors participated in the March 1996 Private Offering:
<TABLE>
<CAPTION>
NAME AMOUNT INVESTED NUMBER OF SHARES
- ---------------------------------------------------------- --------------- -----------------
<S> <C> <C>
ALSA, Inc................................................. $ 50,000 7,760
Applewood Associates, L.P................................. 2,000,000 310,399
Neil Bellet............................................... 25,000 3,880
Jay H. Bernstein.......................................... 50,000 7,760
Stanley H. Blum........................................... 50,000 7,760
Elliott Broidy............................................ 100,000 15,520
Eliot Brown............................................... 25,000 3,880
Kenneth D. Cole........................................... 25,000 3,880
Dalewood Associates, L.P.................................. 150,000 23,280
E&M RP Trust.............................................. 100,000 15,520
Craig Effron.............................................. 35,000 5,432
Steven Etra............................................... 50,000 7,760
Barry K. Fingerhut........................................ 200,000 31,040
Lloyd Goldman............................................. 25,000 3,880
Richard C. Kaufman &
Elaine J. Lenart JTRWOS................................... 50,000 7,760
Irwin Lieber.............................................. 150,000 23,280
Jonathan Lieber........................................... 20,000 3,104
Seth Lieber............................................... 30,000 4,656
Lyonshare Venture Capital................................. 50,000 7,760
Mariwood Investments...................................... 35,000 5,432
Jody Miller............................................... 25,000 3,880
Eli Oxenhorn.............................................. 200,000 31,040
Jonathan Robinson......................................... 25,000 3,880
Andrew Rosen.............................................. 25,000 3,880
Steven Rosen.............................................. 25,000 3,880
Barry Rubenstein.......................................... 200,000 31,040
Curtis Schenker........................................... 30,000 4,656
Seneca Ventures........................................... 150,000 23,280
Matthew Smith............................................. 10,000 1,552
David Thalheim............................................ 50,000 7,760
Michael Weissman.......................................... 25,000 3,880
Lance Wolfson............................................. 25,000 3,880
William Wolfson........................................... 25,000 3,880
Woodland Venture Fund..................................... 265,000 41,128
--------------- -------
Total..................................................... $ 4,300,000 667,359
</TABLE>
(6) On March 14, 1996, the Company issued to Corey M. Horowitz 24,832 shares of
Common Stock and 83,808 shares of Common Stock to Security Partners, L.P. in
consideration for conversion of outstanding debt in the aggregate principal
amount of $700,000.
II-3
<PAGE>
(7) On March 21, 1996, the Company issued to J. Robert Scott, Inc. 6,467 shares
of Common Stock in consideration for services rendered.
(8) On April 26, 1996, the Company issued to Michael Stansky and Jill Stansky as
Tenants of the Entirety, w/r/o/s, 3,880 shares of Common Stock, in
consideration for payment of $6.44 per share or aggregate consideration of
$25,000.
(9) On April 28, 1996, the Company issued to James J. Pallotta 7,760 shares of
Common Stock, in consideration for payment of $6.44 per share or aggregate
consideration of $50,000.
(10) On April 29, 1996, the Company issued to Robert Russo 2,483 shares of
Common Stock in consideration for services rendered as the Company's
President.
(11) On June 3, 1996, the Company issued to Navigator Fund, L.P. 17,615 shares
of Common Stock in consideration for payment of $6.44 per share or aggregate
consideration of $113,500.
(12) On June 3, 1996, the Company issued to Navigator Global Fund 1,785 shares
of Common Stock in consideration for payment of $6.44 per share or aggregate
consideration of $11,500.
(13) On October 3, 1996, the Company issued to each of Craig Bandes and Mona
Geller 7,760 shares of Common Stock, upon the exercise of stock options by
Bandes and Geller at an exercise price of $1.61 per share or aggregate
consideration of $25,000. The stock options had been issued pursuant to
Stock Option Agreements, dated April 4, 1994, in consideration for financial
advisory services rendered to the Company.
(14) On October 11, 1996, the Company issued to CMH Capital Management Corp.
("CMH") warrants to purchase 31,040 shares of Common Stock at an exercise
price of $8.05 per share, expiring October 11, 2003, in consideration for
financial advisory services.
(15) On October 22, 1996, the Company issued to Communica, Inc. and related
parties 9,312 shares of Common Stock in consideration for services rendered.
(16) The Company's Stock Option Plan provides for the grant of stock options to
key employees, directors, and consultants of the Company (the "Stock Option
Plan"). Under the Stock Option Plan, employees (including officers and
employee directors) are eligible to receive grants of incentive stock
options, which are intended to be "Incentive Stock Options" as defined by
Section 422 of the Internal Revenue Code of 1986, as amended. Employees
(including officers), directors of the Company or any affiliates or
consultants are eligible to receive grants of non-qualified options. An
aggregate of 750,000 shares of Common Stock has been reserved for issuance
upon exercise of outstanding options issued under the Stock Option Plan. The
Company believes that the Stock Option Plan grants described in this
paragraph are exempt from the registration requirements of the Securities
Act by reason of Rule 701 promulgated thereunder, because such options were
granted pursuant to a written compensatory benefit plan of the Company,
copies of which were provided to each participant, and the aggregate
offering price did not exceed the limit prescribed by Rule 701 in connection
with any such grant. As of September 10, 1998, pursuant to the Stock Option
Plan, options to purchase an aggregate of 509,829 shares of Common Stock
were outstanding, including options to purchase 14,590 shares of Common
Stock at an exercise price of $6.44 per share, options to purchase 86,911
shares of Common Stock at an exercise price of $4.83 per share, options to
purchase 197,828 shares of Common Stock at an exercise price of $5.60 per
share, options to purchase 82,500 shares of Common Stock at an exercise
price of $7.20 per share and options to purchase 128,000 shares of Common
Stock at an exercise price of $8.00 per share. No such outstanding options
had been exercised.
(17) On January 15, 1997, the Company issued to CMH warrants to purchase 31,040
shares of Common Stock at an exercise price of $6.44 per share, expiring
January 15, 2004, in consideration for financial advisory services to the
Company.
II-4
<PAGE>
(18) In February and April of 1997, the Company borrowed $1 million through the
issuance to ten (10) investors of unsecured promissory notes, bearing 6%
interest (the "February and April 1997 Private Financing"), and due at the
earlier of (i) one year from the date of issuance, (ii) the date upon which
the Company receives $4,000,000 net proceeds (after deduction of all related
offering expenses) of equity or debt financing from one transaction or a
series of transactions, (iii) a sale of all or substantially all of the
Company's assets or (iv) a merger or consolidation of the Company. In
addition, as part of the February and April 1997 Private Financing,
investors received receive ten (10) year warrants to purchase an aggregate
of 139,679 shares of Common Stock at an exercise price of $6.44 per share
(the "Warrants"), as follows:
(a) On February 24, 1997, the Company issued to Charles P. Stevenson, Jr.
warrants to purchase 13,968 shares of Common Stock in consideration
for a loan of $100,000;
(b) On February 24, 1997, the Company issued to Albert Kalimian warrants
to purchase 6,984 shares of Common Stock in consideration for a loan
of $50,000;
(c) On February 24, 1997, the Company issued to Raptur Management Co.
warrants to purchase 13,968 shares of Common Stock in consideration
for a loan of $100,000;
(d) On February 24, 1997, the Company issued to Douglas Lipton warrants
to purchase 6,984 shares of Common Stock in consideration for a loan
of $50,000;
(e) On February 24, 1997, the Company issued to Applewood Associates,
L.P. warrants to purchase 34,920 shares of Common Stock in
consideration for a loan of $250,000;
(f) On February 24, 1997, the Company issued to Lawrence Wein warrants to
purchase 3,492 shares of Common Stock in consideration for a loan of
$25,000;
(g) On February 24, 1997, the Company issued to Steven Heineman warrants
to purchase 3,492 shares of Common Stock in consideration for a loan
of $25,000;
(h) On February 24, 1997, the Company issued to Herb Karlitz warrants to
purchase 6,984 shares of Common Stock in consideration for a loan of
$50,000;
(i) On April 29, 1997, the Company issued to Navigator Fund, L.P.
warrants to purchase 42,882 shares of Common Stock in consideration
for a loan of $307,000; and
(j) On April 29, 1997, the Company issued to Navigator Global Fund
warrants to purchase 6,006 shares of Common Stock in consideration
for a loan of $43,000.
(19) On February 24, 1997, the Company issued to Alan Kaufman warrants to
purchase 9,312 shares of Common Stock at an exercise price of $6.44 per
share, expiring February 24, 2007, in consideration for services rendered.
(20) On August 8, 1997, the Company agreed to reduce the exercise prices of
warrants to purchase 31,040 shares of Common Stock, at an exercise price of
$8.05 per share, issued to CMH on October 11, 1996 and warrants to purchase
31,040 shares of Common Stock, at an exercise price of $6.44 per share,
issued to CMH on January 15, 1997, to an exercise price of $3.22 per share,
in consideration for a loan $100,000 made by CMH. In addition, the Company
agreed to reduce the exercise price of warrants to purchase 124,159 shares
of Common Stock, at an exercise price of $3.22 per share, issued to Corey M.
Horowitz on November 29, 1995, to an exercise price of $1.61 per share, in
consideration for that same loan.
(21) On September 26, 1997, the Company issued to Applewood Associates, L.P.
warrants to purchase 62,080 shares of Common Stock at an exercise price of
$4.83 per share, expiring September 26, 2007, in consideration for a loan of
$350,000.
II-5
<PAGE>
(22) On September 26, 1997, the Company issued to CMH warrants to purchase 8,869
shares of Common Stock at an exercise price of $4.83 per share, expiring
September 26, 2007, in consideration for a loan of $50,000.
(23) On November 12, 1997, the Company issued to Progressive Strategies, Inc.
2,793 shares of Common Stock in consideration for services rendered.
(24) On November 21, 1997, in consideration of a loan of $50,000, the Company
agreed to reduce the exercise prices to $1.61 of warrants to purchase 31,040
shares of Common Stock, originally issued to CMH at an exercise price of
$8.05 per share on October 11, 1996 and warrants to purchase 31,040 shares
of Common Stock, originally issued to CMH at an exercise price of $6.44 per
share on January 15, 1997.
(25) On February 17, 1998, the Company issued to Venture Strategies, Inc.
warrants to purchase 6,207 shares of Common Stock at an exercise price of
$6.04 per share, expiring February 17, 2002, in consideration for services
rendered.
(26) On March 2, 1998, the Company issued an aggregate of $400,000 of promissory
notes and ten year warrants to purchase up to 74,496 shares of Common Stock
at an exercise price of $4.83 per share to four (4) investors including
Applewood Associates, L.P. ($300,000 note and warrants to purchase 55,872
shares of common stock), CMH Capital Management Corp.($50,000 note and
warrants to purchase 9,312 shares of common stock), Robert Graifman ($25,000
note and warrants to purchase 4,656 shares of common stock) and Herb Karlitz
($25,000 note and warrants to purchase 4,656 shares of common stock).
(27) On April 24, 1998, the Company issued to each of Corey Horowitz and MBF
Capital Corp. ten (10) year warrants to purchase 9,312 shares of Common
Stock at an exercise price of $4.83 per share in consideration for a loan of
$50,000 by each party.
(28) On May 10, 1998, the Company issued 2,897 shares of Common Stock to High
Tech Ventures in consideration for services rendered.
(29) On May 14, 1998, the Company issued an aggregate of $1,250,000 of
promissory notes and ten (10) year warrants to purchase up to 232,799 shares
of Common Stock at an exercise price of $4.83 per share to Applewood
Associates, L.P. ($1,000,000 note and warrants to purchase 186,239 shares)
and Bentley One, Ltd. ($250,000 note and warrants to purchase 46,560
shares).
(30) On May 14, 1998, the Company issued 31,250 shares of Common Stock to CMH in
connection with advisory services rendered to the Company.
(31) On May 18, 1998, the Company issued a five (5) year option to Avi A. Fogel
to purchase up to 294,879 shares of the Common Stock at an exercise price of
$2.42 per share, in consideration for Mr. Fogel's execution of his
employment agreement. The shares underlying the option vest as follows: 34%
on the date of issuance of the option and 22% per year for each year
thereafter.
(32) On July 8, 1998, the Company issued an aggregate of 596,741 shares of its
Common Stock in exchange for the cancellation of outstanding warrants and
options to purchase an aggregate of 789,521 shares of Common Stock, as
follows:
(a) 261,565 shares of its Common Stock to Applewood Associates, L.P. in
exchange for warrants to purchase 339,111 shares of Common Stock;
(b) 14,070 shares of its Common Stock to CMH Capital Management Corp. in
exchange for warrants to purchase 18,181 shares of Common Stock;
(c) 117,138 shares of its Common Stock to Corey M. Horowitz in exchange
for warrants to purchase 133,471 shares of Common Stock;
II-6
<PAGE>
(d) 49,381 shares of its Common Stock to CAPCOR Employee Pension Plan in
exchange for warrants to purchase 62,080 shares of Common Stock;
(e) 9,824 shares of its Common Stock to Raptur Management Co. in exchange
for warrants to purchase 13,968 shares of Common Stock;
(f) 4,912 shares of its Common Stock to Douglas Lipton in exchange for
warrants to purchase 6,984 shares of Common Stock;
(g) 2,456 shares of its Common Stock to Lawrence Wein in exchange for
warrants to purchase 3,492 shares of Common Stock;
(h) 2,456 shares of its Common Stock to Steven Heineman in exchange for
warrants to purchase 3,492 shares of Common Stock;
(i) 8,572 shares of its Common Stock to Herb Karlitz in exchange for
warrants to purchase 11,640 shares of Common Stock;
(j) 9,824 shares of its Common Stock to Charles P. Stevenson, Jr. in
exchange for warrants to purchase 13,968 shares of Common Stock;
(k) 4,912 shares of its Common Stock to Albert Kalimian in exchange for
warrants to purchase 6,984 shares of Common Stock;
(l) 30,375 shares of its Common Stock to Navigator Fund, L.P. in exchange
for warrants to purchase 42,882 shares of Common Stock;
(m) 4,254 shares of its Common Stock to Navigator Global Fund in exchange
for warrants to purchase 6,006 shares of Common Stock;
(n) 3,625 shares of its Common Stock to Robert Graifman in exchange for
warrants to purchase 4,656 shares of Common Stock;
(o) 7,278 shares of its Common Stock to MBF Capital Corp. in exchange for
warrants to purchase 9,312 shares of Common Stock;
(p) 36,441 shares of its Common Stock to Bentley One, Ltd. in exchange
for warrants to purchase 46,560 shares of Common Stock;
(q) 6,897 shares of its Common Stock to Barington Capital Group, L.P. in
exchange for options to purchase 15,520 shares of Common Stock;
(r) 9,560 shares of its Common Stock to GKN Securities Corp. in exchange
for options to purchase 21,511 shares of Common Stock;
(s) 3,869 shares of its Common Stock to David M. Nussbaum in exchange for
options to purchase 8,707 shares of Common Stock;
(t) 3,869 shares of its Common Stock to Robert Gladstone in exchange for
options to purchase 8,707 shares of Common Stock;
(u) 3,869 shares of its Common Stock to Roger Gladstone in exchange for
options to purchase 8,707 shares of Common Stock;
(v) 593 shares of its Common Stock to Deborah L. Schondorf in exchange
for options to purchase 1,335 shares of Common Stock;
(w) 104 shares of its Common Stock to Neil Betoff in exchange for options
to purchase 233 shares of Common Stock;
II-7
<PAGE>
(x) 455 shares of its Common Stock to Richard Buonocore in exchange for
options to purchase 1,024 shares of Common Stock;
(y) 166 shares of its Common Stock to Brian K. Coventry in exchange for
options to purchase 372 shares of Common Stock;
(z) 276 shares of its Common Stock to Andrew G. Lazarus in exchange for
options to purchase 621 shares of Common Stock;
ITEM 27. EXHIBITS
The following is a list of all Exhibits filed as part of this Registration
Statement.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT
- ----------- --------------------------------------------------------------------------------------------------------
<C> <S>
1.1 Form of Underwriting Agreement*
1.2 Form of Underwriter's Warrant*
2.1 Merger Agreement, dated September 11, 1998, between the Company and CommHome Systems Corporation
3.1 Certificate of Incorporation of the Company, as amended*
3.2 By-laws of the Company, as amended**
4.1 Form of Common Stock Certificate
4.2 Company's Stock Option Plan, as amended*
5.1 Opinion of Bizar Martin & Taub, LLP
10.1 Employment Agreement, dated May 18, 1998, between the Company and Avi A. Fogel, and amendment, dated May
30, 1998*
10.2 Employment Agreement, dated May 18, 1998, between the Company and Robert P. Olsen*
10.3 Employment Agreement, dated May 19, 1998, between the Company and Murray P. Fish*
10.4 Employment Agreement, dated June 30, 1998, between the Company and William Hancock*
10.5 Employment Agreement, dated April 4, 1994, between the Company and Robert Russo, and amendment, dated
February 16, 1996**
10.6 Waiver, dated June 30, 1998, of salary increases by William Hancock and Robert Russo*
10.7 Lease and Service Agreement, dated June 5, 1998, between the Company and Alliance Wellesley L.P.*
10.8 Lease, dated June 29, 1994, between the Company and Greenview Limited Partnership*
10.9 Agreement, dated August 30, 1996, between the Company and CMH Capital Management Corp. ("CMH"), with
respect to advisory services, and amendments, dated January 15, 1997, and January 30, 1997.*
10.10 Agreement, dated May 14, 1998, between the Company, CMH and Applewood Associates, L.P. with respect to
advisory services*
10.11 Master Software License Agreement, dated November 10, 1997, between the Company and Electronic Data
System Corporation, and amendment, dated May 29, 1998*
10.12 Software Distribution Agreement, dated June 5, 1997, between the Company and Trusted Information
Systems, Inc.*
10.13 Software Distribution Agreement, dated September 26, 1997, between the Company and Trusted Information
Systems, Inc.*
</TABLE>
II-8
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT
- ----------- --------------------------------------------------------------------------------------------------------
<C> <S>
10.14 Reseller Agreement, dated April 17, 1998, between the Company and Aventail Software Corporation *
10.15 Agreement, dated January 31, 1997, among the Company, Robert Russo and William Hancock, in which Messrs.
Russo and Hancock surrendered shares of Common Stock*
10.16 Agreement, dated September 26, 1997, between the Company, Robert Russo, William Hancock, and Kenneth
Conquest, in which Messrs. Russo, Hancock, and Conquest surrendered shares of Common Stock*
10.17 Agreement, dated May 14, 1998, among the Company, Robert Russo and William Hancock, in which Messrs.
Russo and Hancock surrendered shares of Common Stock*
10.18 Agreement, dated May 14, 1998, between the Company and CMH, in connection with the issuance of shares
for advisory fees*
10.19 Exchange Agreement, dated July 8, 1998, between the Company and certain of its holders of outstanding
warrants and options*
10.20 Employment Agreement, dated July 31, 1998, between the Company and Joseph A. Donohue
10.21 Employment Agreement, dated August 24, 1998, between the Company and Joseph D. Harris
21.1 List of Subsidiaries of the Company
23.1 Consent of Richard A. Eisner & Company, LLP
23.2 Consent of Bizar Martin & Taub, LLP (included in Exhibit 5.1)
24.1 Power of Attorney (see signature page)*
27.1 Financial Data Schedule**
</TABLE>
- ------------------------
* Previously filed.
** Amendment to previously filed document filed herewith.
ITEM 28. UNDERTAKINGS
The Registrant will provide to the Underwriter specified in the Underwriting
Agreement certificates in such denominations and registered in such names as
required by the Underwriter to permit prompt delivery to each purchaser.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 (the "Securities Act") may be permitted to directors, officers and
controlling persons of the registrant pursuant to the foregoing provisions, or
otherwise, the registrant has been advised that in the opinion of the Securities
and Exchange Commission such indemnification is against public policy as
expressed in the Securities Act and is, therefore, unenforceable. In the event
that a claim from indemnification against such liabilities (other than the
payment by the registrant of expenses incurred or paid by a director, officer or
controlling person of the registrant in the successful defense of any action,
suit or proceeding) is asserted by such director, officer or controlling person
in connection with the securities being registered, the registrant will, unless
in the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question of whether
such indemnification by it is against public policy as expressed in the
Securities Act and will be governed by the final adjudication of such issue.
For purpose of determining any liability under the Securities of 1933, each
post-effective amendment that contains a Form of Prospectus shall be deemed to
be a new registration statement relating to the securities offered therein, and
the offering of such securities at that time shall be deemed to be the initial
bona fide offering thereof.
II-9
<PAGE>
For purposes of determining any liability under the Securities Act, the
information omitted from the Form of Prospectus filed as part of this
Registration Statement in reliance upon Rule 430A and contained in the Form of
Prospectus filed by Company pursuant to Rule 424(b)(1) or (4) or 497(h) under
the Securities Act shall be deemed to be part of this Registration Statement as
of the time it was declared effective.
II-10
<PAGE>
SIGNATURES
In accordance with the requirements of the Securities Act of 1933, the
registrant certifies that it has reasonable grounds to believe that it meets all
of the requirements of filing on Form SB-2 and authorized this registration
statement to be signed on its behalf by the undersigned, in the Township of
Wellesley, Commonwealth of Massachusetts on the 16th day of September, 1998.
NETWORK-1 SECURITY SOLUTIONS, INC.
By: /s/ AVI A. FOGEL
-----------------------------------------
Avi A. Fogel,
CHIEF EXECUTIVE OFFICER
POWER OF ATTORNEY
In accordance with the requirements of the Securities Act of 1933, this
registration statement was signed by the following persons in the capacities and
on the dates indicated:
NAME TITLE DATE
- ------------------------------ --------------------------- -------------------
President, Chief Executive
/s/ AVI A. FOGEL Officer and Director
- ------------------------------ (principal executive September 16, 1998
Avi A. Fogel officer)
*
- ------------------------------ Chief Technology Officer September 16, 1998
William H. Hancock and Director
Chief Financial Officer
* (principal financial
- ------------------------------ officer and principal September 16, 1998
Murray P. Fish accounting officer)
*
- ------------------------------ Vice President of Business September 16, 1998
Robert Russo Development
/s/ COREY M. HOROWITZ
- ------------------------------ Chairman of the Board of September 16, 1998
Corey M. Horowitz Directors
/s/ MARCUS RANUM
- ------------------------------ Director September 16, 1998
Marcus Ranum
*By: /s/ AVI A. FOGEL
------------------------
Avi A. Fogel,
AS ATTORNEY-IN-FACT
II-11
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT PAGE
- ----------- ------------------------------------------------------------------------------------------------- -----
<C> <S> <C>
1.1 Form of Underwriting Agreement*
1.2 Form of Underwriter's Warrant*
2.1 Merger Agreement, dated September 11, 1998, between the Company and CommHome Systems Corporation
3.1 Certificate of Incorporation of the Company, as amended*
3.2 By-laws of the Company, as amended**
4.1 Form of Common Stock Certificate
4.2 Company's Stock Option Plan, as amended*
5.1 Opinion of Bizar Martin & Taub, LLP
10.1 Employment Agreement, dated May 18, 1998, between the Company and Avi A. Fogel, and amendment,
dated May 30, 1998*
10.2 Employment Agreement, dated May 18, 1998, between the Company and Robert P. Olsen*
10.3 Employment Agreement, dated May 19, 1998, between the Company and Murray P. Fish*
10.4 Employment Agreement, dated June 30, 1998, between the Company and William Hancock*
10.5 Employment Agreement, dated April 4, 1994, between the Company and Robert Russo, and amendment,
dated February 16, 1996**
10.6 Waiver, dated June 30, 1998, of salary increases by William Hancock and Robert Russo*
10.7 Lease and Service Agreement, dated June 5, 1998, between the Company and Alliance Wellesley L.P.*
10.8 Lease, dated June 29, 1994, between the Company and Greenview Limited Partnership*
10.9 Agreement, dated August 30, 1996, between the Company and CMH Capital Management Corp. ("CMH"),
with respect to advisory services, and amendments, dated January 15, 1997, and January 30, 1997.*
10.10 Agreement, dated May 14, 1998, between the Company, CMH and Applewood Associates, L.P. with
respect to advisory services*
10.11 Master Software License Agreement, dated November 10, 1997, between the Company and Electronic
Data System Corporation, and amendment, dated May 29, 1998*
10.12 Software Distribution Agreement, dated June 5, 1997, between the Company and Trusted Information
Systems, Inc.*
10.13 Software Distribution Agreement, dated September 26, 1997, between the Company and Trusted
Information Systems, Inc.*
10.14 Reseller Agreement, dated April 17, 1998, between the Company and Aventail Software Corporation *
10.15 Agreement, dated January 31, 1997, among the Company, Robert Russo and William Hancock, in which
Messrs. Russo and Hancock surrendered shares of Common Stock*
10.16 Agreement, dated September 26, 1997, between the Company, Robert Russo, William Hancock, and
Kenneth Conquest, in which Messrs. Russo, Hancock, and Conquest surrendered shares of Common
Stock*
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT PAGE
- ----------- ------------------------------------------------------------------------------------------------- -----
<C> <S> <C>
10.17 Agreement, dated May 14, 1998, among the Company, Robert Russo and William Hancock, in which
Messrs. Russo and Hancock surrendered shares of Common Stock*
10.18 Agreement, dated May 14, 1998, between the Company and CMH, in connection with the issuance of
shares for advisory fees*
10.19 Exchange Agreement, dated July 8, 1998, between the Company and certain of its holders of
outstanding warrants and options*
10.20 Employment Agreement, dated July 31, 1998, between the Company and Joseph A. Donohue
10.21 Employment Agreement, dated August 24, 1998, between the Company and Joseph D. Harris
21.1 List of Subsidiaries of the Company
23.1 Consent of Richard A. Eisner & Company, LLP
23.2 Consent of Bizar Martin & Taub, LLP (included in Exhibit 5.1)
24.1 Power of Attorney (see signature page)*
27.1 Financial Data Schedule**
</TABLE>
- ------------------------
* Previously filed.
** Amendment to previously filed document filed herewith.
<PAGE>
Exhibit 2.1
AGREEMENT AND PLAN OF MERGER
AGREEMENT AND PLAN OF MERGER, dated as of September 11, 1998,
by and among CommHome Systems Corporation, a Delaware Corporation (the
"Company"), Network-1 Acquisition Corp., a Delaware corporation and wholly owned
subsidiary of Parent (the "Purchaser"), and Network-1 Security Solutions, Inc.,
a Delaware corporation (the "Parent").
WHEREAS, the Board of Directors of the Company, Purchaser and
Parent have each determined that it is in the best interests of their respective
stockholders for the Purchaser to acquire the Company upon the terms and subject
to the conditions set forth herein;
WHEREAS, in furtherance of such acquisition, the Board of
Directors of the Company, Purchaser and Parent have each approved the merger of
the Company with and into the Purchaser in accordance with the General
Corporation Law of the State of Delaware (the "GCL") and upon the terms and
subject to the conditions set forth herein;
WHEREAS, all of the issued and outstanding shares of stock of
any class of the Company consists of 1,290 shares of Common Stock, par value,
$.01 per share, (the "Issued Company Shares") which are owned and of record by
the persons named on Schedule A hereto (the "Company Shareholders");
WHEREAS, it is the intent of this Agreement that the merger of
the Company with and into Purchaser (the "Merger") constitute a reorganization
within the meaning of Section 368(a) of the Internal Revenue Code of 1986, as
amended; and
WHEREAS, the Company's Shareholders have voted a majority of
the Issued Company Shares in favor of the approval of this Agreement and the
transactions contemplated hereby, including the Merger.
NOW, THEREFORE, in consideration of the foregoing and the
mutual covenants and agreements herein contained, and intending to be legally
bound hereby, the Purchaser, the Company and the Parent hereby agree as follows:
ARTICLE I
THE MERGER
SECTION 1.01 The Merger. Upon the terms and subject to the
conditions hereof, and in accordance with the GCL, the Company shall be merged
with and into the Purchaser simultaneously with the Parent's consummation of its
initial public offering of its securities (the
<PAGE>
"IPO"). Following the Merger, the Purchaser shall continue as the surviving
corporation and the separate corporate existence of the Company shall cease.
SECTION 1.02 Effective Time. Subject to Section 1.01, the
Merger shall become effective upon filing with the Delaware Secretary of State
of a certificate of merger executed in accordance with the relevant provisions
of the GCL (the time the Merger becomes effective being the "Effective Time").
SECTION 1.03 Effects of the Merger. The Merger shall have the
effects set forth in the GCL. Without limitation, upon the effectiveness of the
Merger: (a) the separate existence of the Company shall cease; (b) the Purchaser
as the surviving corporation shall possess all of the rights, privileges,
powers, immunities, purposes and franchises, both public and private, of each of
the Company and the Purchaser; (c) all real and personal property, tangible and
intangible, of every kind and description belonging to the Company and the
Purchaser shall be vested in the Purchaser as the surviving corporation without
further act or deed, and the title to any real estate or any interest therein
vested in either the Company or the Purchaser shall not revert or in any way be
impaired by reason of the Merger; (d) the Purchaser as the surviving corporation
shall be liable for all the obligations and liabilities of each of the Company
and the Purchaser, and any claim existing or action or proceeding pending by or
against either the Company or the Purchaser may be enforced against the
Purchaser as if the Merger had not taken place; and (e) neither the rights of
creditors nor any liens upon or security interests in the property of either the
Company or the Purchaser shall be impaired by the Merger.
SECTION 1.04 Certificate of Incorporation and By-Laws. Without
further action by the Company or the Purchaser, the Certificate of Incorporation
and By-laws of the Purchaser as in effect at the Effective Time shall continue
to be the Certificate of Incorporation and By-Laws of the Purchaser as the
surviving corporation.
SECTION 1.05 Directors. The directors of the Purchaser at the
Effective Time shall be the initial directors of the Purchaser as the surviving
corporation, until their successors shall have been duly elected or appointed
and qualified.
SECTION 1.06 Officers. The officers of the Purchaser at the
Effective Time shall be the initial officers of the Company as the surviving
corporation, until their successors have been duly appointed.
SECTION 1.07 Conversion of Shares and Assumption of Debt.
(a) At the Effective Time, all of the Issued Company Shares
shall, by virtue of the Merger and without any action on the part of the holder
thereof, be converted into a number of shares of the Parent's Common Stock, par
value $.01 per share ("Common Stock"), determined by dividing (i) $280,000 by
(ii) the price for the Common Stock as set forth on the cover page of the
Parent's final prospectus relating to its IPO (the "IPO Price"). The shares of
Common Stock to be
2
<PAGE>
received by the Company Shareholders as set forth on Schedule A shall be
"restricted stock", shall not be registered under the Securities Act of 1933, as
amended (the"Act") and the Parent shall have no obligation to effect any
registration thereof. As a condition to the receipt of the certificate for the
Common Stock, each Company Shareholder shall execute a lock-up letter (of one
year's duration) in the form requested of all of the Parent's shareholders by
Whale Securities Co., L.P., (the "Underwriter") with respect to the IPO.
(b) At the Effective Time, the Purchaser shall assume and pay
the Company's indebtedness in the amount of $198,284.91 as set forth in Schedule
B hereto (collectively the "Assumed Indebtedness"). The Assumed Indebtedness
includes $55,000 owed to Avi A. Fogel ("Fogel Debt") and $50,000 owed to Robert
P. Olsen ("Olsen Debt"), such debt due Messrs. Fogel and Olsen shall be
satisfied by Parent's issuance of Common Stock having a value based on the IPO
Price equal to the debt owed to Messrs. Olsen and Fogel. All other Assumed
Indebtedness shall be paid in cash. The shares of Common Stock to be received by
Messrs. Olsen and Fogel shall be "restricted stock", shall not be registered
under the Securities Act of 1933, as amended (the"Act") and the Parent shall
have no obligation to effect any registration thereof. As a condition to the
receipt of the certificate for the Common Stock, each of Messrs. Fogel and Olsen
shall execute a release of the Fogel Debt and Olsen Debt, respectively, and the
lock-up letter (of one year's duration) in the form requested of all of the
Parent's securityholders by the Underwriter with respect to the IPO.
SECTION 1.08 Payment of Outstanding Obligation to Nachum
Sadan. Included in the Assumed Indebtedness, is $30,000 (the "Principal Sum")
owed to Nachum Sadan in connection with a loan from Nachum Sadam to the Company,
on June 25, 1997. At the Effective Time, the Purchaser shall wire the Principal
Sum plus interest at a rate of 5.5% per annum, as set forth in Schedule B
hereto, to such account as provided by Nachum Sadan.
SECTION 1.09 Shareholders' Approval. The Purchaser, acting
through its Board of Directors, shall in accordance with applicable law duly
call, give notice of, convene and hold a special meeting of its shareholders (or
obtain consent) for the purpose of considering and taking action upon this
Agreement and the transactions contemplated hereby. The Company represents to
the Purchaser that all required shareholder action has been taken by it upon the
execution of this Agreement and the Company has provided the Purchaser with
copies of all consents of Company Shareholders.
SECTION 1.10 Filing of Certificate of Merger. Upon the terms
and subject to the conditions hereof, as soon as practicable following the
satisfaction or waiver of the conditions set forth in Article VI hereof, the
Company and the Purchaser shall execute and file a Certificate of Merger in the
manner required by the GCL and the parties hereto shall take all such other and
further actions as may be required by law to make the Merger effective. Prior to
the filings referred to in this Section, a closing (the "Closing Date") will be
held at the offices of Bizar Martin & Taub, LLP, New York, New York (or such
other place as the parties may agree) for the purpose of confirming all of the
foregoing. At the closing, Purchaser shall deliver the Common Stock to the
Company's
3
<PAGE>
Attorney for delivery to the Company Shareholders and the Company Shareholders
shall deliver the Company Shares to the Purchaser's attorney for delivery to the
Purchaser, subject only to confirmation that the Effective Time has occurred.
From and after the Effective Time, the Company Shares shall cease to exist.
ARTICLE II
REPRESENTATIONS AND WARRANTIES
OF THE COMPANY
The Company represents and warrants to each of the Purchaser
and the Parent that, except as set forth in the Disclosure Schedule annexed
hereto (the "Company Disclosure Schedule"):
SECTION 2.01 Organization. The Company is a corporation duly
organized, validly existing and in good standing under the laws of the State of
Delaware and has all requisite corporate power and authority to own, lease and
operate its properties and to carry on its business as now being conducted,
except where the failure to be so existing and in good standing or to have such
power and authority would not in the aggregate have a material adverse effect on
the financial condition, results of operations or business of the Company taken
as a whole. The Company is duly qualified or licensed to do business and is in
good standing in each jurisdiction in which the property owned, leased or
operated by it or the nature of the business conducted by it makes such
qualification or licensing necessary, except in such jurisdictions where the
failure to be so duly qualified or licensed and in good standing would not in
the aggregate have a material adverse effect on the financial condition, results
of operations or business of the Company taken as a whole. Schedule 2.01 sets
forth each jurisdiction where the Company is qualified to do business as a
foreign corporation. The Company has heretofore made available to the Purchaser
accurate and complete copies of the Certificate of Incorporation and By-laws, as
currently in effect, of the Company. The Company has no subsidiaries and is not
a party to any partnership, agency or joint venture agreement.
For purposes of this Agreement, the term "subsidiary" shall
mean each corporation or other entity in which a corporation owns or controls,
directly through one or more subsidiaries, 50% or more of the stock or other
interests having general voting power in the election of directors or persons
performing similar functions.
SECTION 2.02 Capitalization. The authorized capital stock of
the Company consists of 2000 shares of Common Stock, par value $.01 per share,
and 1000 shares of Preferred Stock, par value $.01 per share, of which 1,290
shares of Common Stock (the "Company Shares"), were issued and outstanding as of
the date hereof. All of the issued and outstanding Company Shares are validly
issued, fully paid and non-assessable and free of preemptive rights. Except for
the Company Shares, there are no shares of capital stock of the Company issued
or outstanding or any subscriptions, options, warrants, calls, rights,
convertible securities or other agreements or commitments of any character
obligating the Company to issue, transfer, sell or pay any amount with respect
to any of its securities.
4
<PAGE>
SECTION 2.03 Authority Relative to this Agreement. The Company
has full corporate power and authority to execute and deliver this Agreement and
to consummate the transactions contemplated hereby. The execution and delivery
of this Agreement and the consummation of the transactions contemplated hereby
have been duly and validly authorized by the Board of Directors of the Company
and the Company Shareholders and no other corporate proceedings on the part of
the Company are necessary to authorize this Agreement or to consummate the
transactions so contemplated. This Agreement has been duly and validly executed
and delivered by the Company and constitutes a valid and binding agreement of
the Company, enforceable against the Company in accordance with its terms,
subject to the provisions of any bankruptcy, insolvency, moratorium or similar
law applicable to the rights of creditors generally.
SECTION 2.04 No Violations. Except for the filing and
recordation of a Certificate of Merger as required by the GCL, no filing with,
and no permit, authorization, consent or approval of, any public body or
authority is necessary for the consummation by the Company of the transactions
contemplated by this Agreement, except for filings, permits, authorizations,
consents or approvals, the failure to obtain which would not in the aggregate
have a material adverse effect on the financial condition, results of operations
or business of the Company taken as a whole or which would not prevent or delay
in any material respect the consummation of the transactions contemplated
hereby. Neither the execution and delivery of this Agreement by the Company nor
the consummation by the Company of the transactions contemplated hereby nor
compliance by the Company with any provisions hereof will: (i) conflict with or
result in any breach of any provision of the Certificate of Incorporation or
By-laws of the Company, (ii) result in a violation or breach of, or constitute
(with or without due notice or lapse of time or both) a default (or give rise to
any right of termination, cancellation or acceleration) under, any of the terms,
conditions or provisions of any note, bond, mortgage, indenture, license, lease,
contract, agreement or other instrument or obligation to which the Company is a
party or by which it or its properties or assets may be bound or (iii) violate
any order, writ, injunction, decree, statute, rule or regulation applicable to
the Company, or any of its properties or assets.
SECTION 2.05 Financial Statements. The Company Disclosure
Schedule sets forth a balance sheet of the Company as at June 30, 1998 (the
"Balance Sheet") together with statements of operations for the period June 18,
1997 (inception) through December 31, 1997, the six month period ended June 30,
1998, and for the period June 18, 1997 (inception) through June 30, 1998, and
has been reviewed by Richard A. Eisner & Company, LLP, certified public
accountants. The Balance Sheet shall show and the Company shall have no
indebtedness other than the Assumed Indebtedness. June 30, 1998 is hereinafter
referred to as the Balance Sheet Date. The Balance Sheet included in the Company
Disclosure Schedule fairly presents the financial position of the Company as at
the respective dates thereof, and the other related statements included therein
fairly present the results of operations of the Company for the respective
fiscal periods covered thereby. Each of the Company's financial statements
included in the Company Disclosure Schedule has been prepared in accordance with
generally accepted accounting principles consistently applied during the periods
covered by such statements, except as otherwise noted therein.
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SECTION 2.06 Properties.
(a) The Company has good and marketable title to, or in the
case of leased property has valid leasehold interests in (which leases are in
full force and effect and with respect to which no event of default has occurred
and is continuing), all properties and assets (whether real or personal, and
whether tangible or intangible) reflected on the Balance Sheet or acquired after
the Balance Sheet Date in the ordinary course of business consistent with past
practices.
(b) There is no violation of any law, regulation or ordinance
relating to the properties and assets of the Company or the operation of its
business, except such violations as would not, in the aggregate, have a material
adverse effect on the financial condition, results of operations or business of
the Company.
SECTION 2.07 No Undisclosed Liabilities and No Operations.
(a) There are no liabilities of the Company of any kind
whatsoever, whether accrued, contingent, absolute, determined, determinable or
otherwise, and there is no existing condition situation or set of circumstances
which could reasonably result in such a liability, other than:
(i) liabilities disclosed or provided for in the
Balance Sheet including the Assumed
Indebtedness; and
(ii) liabilities arising under this Agreement;
and
(b) The Company has not conducted any operations since the
Balance Sheet Date.
SECTION 2.08 Litigation. There are no actions, suits, or
proceedings pending against, or to the knowledge of the Company, threatened
against the Company before any court or arbitrator or any governmental body,
agency or official.
SECTION 2.09 Taxes. Except as disclosed in the financial
statements referred to in Section 2.05, the Company has: (i) duly filed with the
appropriate federal, state and local governments or governmental agencies, all
federal, state and local income tax returns and declarations of estimated tax
and all other material tax returns and reports required to be filed and has paid
in full when due all taxes, licenses and fees, including interest and penalties,
shown to be due thereon, and (ii) has established reserves in the Balance Sheet
that, in the aggregate, are adequate for the payment of taxes not yet due with
respect to the Company's operations through the Balance Sheet Date. All material
claims for federal, state and local taxes asserted against the Company have
either been paid or adequately provided for on the Balance Sheet. The federal
income tax returns required to be filed by the Company have either been examined
by the Internal Revenue Service or the period during which any assessments may
be made by the Internal Revenue Service has expired without waiver or extension
and any deficiencies or assessments asserted in writing by the Internal
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Revenue Service have either been paid, settled or adequately provided for in the
Balance Sheet. The Company has withheld from employees and paid over to the
proper governmental authorities all amounts required to be so withheld and paid
over.
SECTION 2.10 Absence of Certain Changes. Except for: (i)
transactions, changes, events, obligations and liabilities contemplated by this
Agreement; (ii) transactions, changes, events, obligations and liabilities
disclosed in the financial statements referred to in Section 2.05; and (iii)
transactions, changes, events, obligations and liabilities which individually or
in the aggregate, have not had a material adverse effect on the financial
condition, results of operations or business of the Company, since the Balance
Sheet Date:
(a) there have been no changes in the business, condition
(financial or otherwise), assets or liabilities of the Company;
(b) no liability or obligation of the Company has been paid,
discharged or incurred;
(c) there has been no damage, destruction, or loss, whether or
not covered by insurance, materially adversely affecting the business or
property of the Company;
(d) the Company has not sold, mortgaged, pledged or subjected
to any lien or other encumbrance or otherwise transferred any material assets or
properties used in the conduct of its business; and
(e) the Company has not entered into any transaction.
SECTION 2.11 Investment Matters. The Company has obtained the
acknowledgment of each of the Company Shareholders that (i) they are acquiring
the Common Stock for investment purposes only and not with a view to
distribution, (ii) they are either an "accredited investor" as that term is
defined in Regulation D promulgated under the Securities Act of 1933, as
amended, or a sophisticated investor and have had access to sufficient
information concerning the transactions contemplated by this Agreement,
including, without limitation, information concerning the Parent and its
business including the Registration Statement, (iii) aware that the Common Stock
to be issued to them is restricted securities and as such has not been
registered under the Act and cannot be offered for sale or sold without
registration under the Securities Act and all applicable state securities laws
or pursuant to an applicable exemption from registration and (iv) there can be
no assurance that the IPO will be completed or, if completed, that a trading
market for the Common Stock will develop, or if developed will be maintained.
SECTION 2.12 Full Disclosure. No representation, warranty or
covenant made by the Company in this Agreement contains any untrue statement of
a material fact, or omits to state a material fact necessary to make the
statements contained in this Agreement not misleading.
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ARTICLE III
REPRESENTATIONS AND WARRANTIES
OF THE PURCHASER
The Purchaser represents and warrants to the Company, except
as set forth in the Disclosure Schedule annexed hereto (the "Purchaser
Disclosure Schedule") as follows:
SECTION 3.01 Organization. The Purchaser is a corporation duly
organized, validly existing and in good standing under the laws of the State of
Delaware and has all requisite corporate power and authority to own, lease and
operate its properties and to carry on its business as now being conducted,
except where the failure to be so existing and in good standing or to have such
power and authority would not in the aggregate have a material adverse effect on
the financial condition, results of operations or business of the Purchaser
taken as a whole. The Purchaser is duly qualified or licensed to do business and
is in good standing in each jurisdiction in which the property owned, leased or
operated by it or the nature of the business conducted by it makes such
qualification or licensing necessary, except in such jurisdictions where the
failure to be so duly qualified or licensed and in good standing would not in
the aggregate have a material adverse effect on the financial condition, results
of operations or business of the Purchaser. Schedule 3.01 sets forth each
jurisdiction where the Purchaser is qualified to do business as a foreign
corporation. The Purchaser has heretofore made available to the Company accurate
and complete copies of the Certificate of Incorporation and By-laws, as
currently in effect, of the Purchaser. The Purchaser has no subsidiaries and is
not a party to any partnership, agency or joint venture agreement.
SECTION 3.02 Capitalization. The authorized capital stock of
the Purchaser consists of 1,000 shares of common stock, par value $.01 per share
(the "Purchaser Shares"), all of which were issued and outstanding as of the
date hereof and held of record and beneficially by the Parent. All of the issued
and outstanding Purchaser Shares are validly issued, fully paid and
non-assessable and free of preemptive rights. Except for the Purchaser Shares,
there are no shares of capital stock of the Purchaser issued or outstanding or
any subscriptions, options, warrants, calls, rights, convertible securities or
other agreements or commitments of any character obligating the Purchaser to
issue, transfer, sell or pay any amount with respect to any of its securities.
SECTION 3.03 Authority Relative to this Agreement. The
Purchaser has full corporate power and authority to execute and deliver this
Agreement and to consummate the transactions contemplated hereby. The execution
and delivery of this Agreement and the consummation of the transactions
contemplated hereby have been duly and validly authorized by the Board of
Directors of the Purchaser and, except for the approval by Purchaser's
shareholder, no other corporate proceedings on the part of the Purchaser are
necessary to authorize this Agreement or to consummate the transactions so
contemplated. Subject to the approval of the Purchaser's shareholder, this
Agreement has been duly and validly executed and delivered by the Purchaser and
constitutes a valid and binding agreement of the Purchaser, enforceable against
the Purchaser in
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accordance with its terms, subject to the provisions of any bankruptcy,
insolvency, moratorium or similar law applicable to the rights of creditors
generally.
SECTION 3.04 No Violations. Except for the filing and
recordation of a Certificate of Merger as required by the GCL, no filing with,
and no permit, authorization, consent or approval of, any public body or
authority is necessary for the consummation by the Purchaser of the transactions
contemplated by this Agreement, except for filings, permits, authorizations,
consents or approvals, the failure to obtain which would not in the aggregate
have a material adverse effect on the financial condition, results of operations
or business of the Purchaser taken as a whole or which would not prevent or
delay in any material respect the consummation of the transactions contemplated
hereby. Neither the execution and delivery of this Agreement by the Purchaser
nor the consummation by the Purchaser of the transactions contemplated hereby
nor compliance by the Purchaser with any provisions hereof will: (i) conflict
with or result in any breach of any provision of the Certificate of
Incorporation or By-laws of the Purchaser, (ii) result in a violation or breach
of, or constitute (with or without due notice or lapse of time or both) a
default (or give rise to any right of termination, cancellation or acceleration)
under, any of the terms, conditions or provisions of any note, bond, mortgage,
indenture, license, lease, contract, agreement or other instrument or obligation
to which the Purchaser is a party or by which it or its properties or assets may
be bound or (iii) violate any order, writ, injunction, decree, statute, rule or
regulation applicable to the Purchaser, or any of its properties or assets.
SECTION 3.05 Financial Representation. The Purchaser was
organized on August 27, 1998, has had no operations and has performed no other
acts other than those incident to its organization. Purchaser's only asset is
the $100 which the Parent paid for the 1,000 issued and outstanding shares of
the Purchaser's common stock, par value $.01 per share and the Purchaser has no
liabilities.
SECTION 3.06 Full Disclosure. No representation, warranty or
covenant made by the Purchaser in this Agreement contains any untrue statement
of a material fact, or omits to state a material fact necessary to make the
statements contained in this Agreement not misleading.
ARTICLE IV
REPRESENTATIONS AND WARRANTIES
OF THE PARENT
The Parent represents and warrants to the Company, except as
set forth in the Disclosure Schedule annexed hereto (the "Parent Disclosure
Schedule") as follows:
SECTION 4.01 Organization. The Parent is a corporation duly
organized, validly existing and in good standing under the laws of the State of
Delaware and has all requisite corporate power and authority to own, lease and
operate its properties and to carry on its business as now being conducted,
except where the failure to be so existing and in good standing or to have
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such power and authority would not in the aggregate have a material adverse
effect on the financial condition, results of operations or business of the
Parent taken as a whole. The Parent is duly qualified or licensed to do business
and is in good standing in each jurisdiction in which the property owned, leased
or operated by it or the nature of the business conducted by it makes such
qualification or licensing necessary, except in such jurisdictions where the
failure to be so duly qualified or licensed and in good standing would not in
the aggregate have a material adverse effect on the financial condition, results
of operations or business of the Parent and its subsidiary taken as a whole.
Schedule 4.01 sets forth each jurisdiction where the Parent is qualified to do
business as a foreign corporation. The Parent has heretofore made available to
the Purchaser accurate and complete copies of the Certificate of Incorporation
and By-laws, as currently in effect, of the Parent. Except for Purchaser, The
Parent has no subsidiaries and is not a party to any partnership, agency or
joint venture agreement.
SECTION 4.02 Capitalization. The authorized capital stock of
the Parent consists of 25,000,000 shares of Common Stock, par value $.01 per
share and 5,000,000 shares of Preferred Stock, par value $.01 per share, of
which 2,085,244 shares of Common Stock and 500,000 shares of Preferred Stock,
are issued and outstanding as of the date hereof. All of the issued and
outstanding securities of Parent have been validly issued, fully paid and
non-assessable and are free of preemptive rights. Except for the foregoing
shares of Common Stock and Preferred Stock, and except as disclosed in the
Registration Statement, there are no shares of capital stock of the Parent
issued or outstanding or any subscriptions, options, warrants, calls, rights,
convertible securities or other agreements or commitments of any character
obligating the Parent to issue, transfer, sell or pay any amount with respect to
any of its securities. The Common Stock when issued and delivered in accordance
with this Agreement, will be duly and validly issued and such Common Stock will
be fully paid and non-assessable.
SECTION 4.03 Authority Relative to this Agreement. The Parent
has full corporate power and authority to execute and deliver this Agreement and
to consummate the transactions contemplated hereby. The execution and delivery
of this Agreement and the consummation of the transactions contemplated hereby
have been duly and validly authorized by the Board of Directors of the Parent
and the Parent Shareholders and no other corporate proceedings on the part of
the Parent are necessary to authorize this Agreement or to consummate the
transactions so contemplated. This Agreement has been duly and validly executed
and delivered by the Parent and constitutes a valid and binding agreement of the
Parent, enforceable against the Parent in accordance with its terms, subject to
the provisions of any bankruptcy, insolvency, moratorium or similar law
applicable to the rights of creditors generally.
SECTION 4.04 No Violations. Except for the filing and
recordation of a Certificate of Merger as required by the GCL, no filing with,
and no permit, authorization, consent or approval of, any public body or
authority is necessary for the consummation by the Parent of the transactions
contemplated by this Agreement, except for filings, permits, authorizations,
consents or approvals, the failure to obtain which would not in the aggregate
have a material adverse effect on the financial condition, results of operations
or business of the Parent taken as a whole or which
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would not prevent or delay in any material respect the consummation of the
transactions contemplated hereby. Neither the execution and delivery of this
Agreement by the Parent nor the consummation by the Parent of the transactions
contemplated hereby nor compliance by the Parent with any provisions hereof
will: (i) conflict with or result in any breach of any provision of the
Certificate of Incorporation or By-laws of the Parent, (ii) result in a
violation or breach of, or constitute (with or without due notice or lapse of
time or both) a default (or give rise to any right of termination, cancellation
or acceleration) under, any of the terms, conditions or provisions of any note,
bond, mortgage, indenture, license, lease, contract, agreement or other
instrument or obligation to which the Parent is a party or by which it or its
properties or assets may be bound or (iii) violate any order, writ, injunction,
decree, statute, rule or regulation applicable to the Parent, or any of its
properties or assets.
SECTION 4.05 Financial Statements. The Parent Disclosure
Schedule sets forth balance sheets of the Parent as at December 31, 1996,
December 31, 1997 and June 30, 1998 (unaudited) (the "Parent Balance Sheet"),
together with statements of results of operations and cash flows for the two
fiscal years ended December 31, 1996 and December 31, 1997 and the six months
ended June 30, 1998 (unaudited), and the report of Richard A. Eisner & Company,
LLP, certified public accountants on the financial statements for the years
ended December 31, 1996 and December 31, 1997. June 30, 1998 is hereinafter
referred to as the "Balance Sheet Date." Except as set forth in the Parent
Disclosure Schedule (which is deemed to include the Registration Statement and
each subsequent Amendment to the Registration Statement which the Parent shall
deliver to the Company), each of the balance sheets (including the related
notes) included in the Parent Disclosure Schedule fairly presents the
consolidated financial position of the Parent as of the respective dates
thereof, and the other related statements (including the related notes) included
therein fairly present the consolidated results of operations and the cash flows
of the Parent for the respective fiscal periods covered thereby. Each of such
financial statements has been prepared in accordance with generally accepted
accounting principles consistently applied during the periods covered, except as
otherwise noted therein.
SECTION 4.06 Properties.
(a) The Parent has good and marketable title to, or in the
case of leased property has valid leasehold interests in (which leases are in
full force and effect and with respect to which no event of default has occurred
and is continuing), all properties and assets (whether real or personal, and
whether tangible or intangible) reflected on the Balance Sheet or acquired after
the Balance Sheet Date in the ordinary course of business consistent with past
practices.
(b) There is no violation of any law, regulation or ordinance
relating to the properties and assets of the Parent except such violations as
would not, in the aggregate, have a material adverse effect on the financial
condition, results of operations or business of the Parent.
SECTION 4.07 No Undisclosed Liabilities. There are no
liabilities of the Parent of any kind whatsoever, whether accrued, contingent,
absolute, determined, determinable or
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otherwise, and there is no existing condition or set of circumstances which
could reasonably result in such a liability, other than:
(a) liabilities disclosed or provided for in the Balance Sheet
or in the notes thereto or in the Parent Disclosure Schedule;
(b) liabilities incurred in the ordinary course of business
consistent with past practices since the Balance Sheet Date;
(c) liabilities arising under this Agreement; and
(d) liabilities which would not, in the aggregate, have a
material adverse effect on the Parent.
SECTION 4.08 Litigation. Except as set forth in the Parent
Disclosure Schedule, there are no actions, suits, or proceedings pending
against, or to the knowledge of the Parent, threatened against the Parent before
any court or arbitrator or any governmental body, agency or official.
SECTION 4.09 Taxes. Except as disclosed in the financial
statements referred to in Section 4.05, the Parent has (i) duly filed (or
appropriate extensions have been filed) with the appropriate federal, state and
local governments or governmental agencies, all federal, state and local income
tax returns and declarations of estimated tax and all other material tax returns
and reports required to be filed and have paid in full when due all taxes,
licenses and fees, including interest and penalties, shown to be due thereon,
and (ii) has established reserves in the Balance Sheet that, in the aggregate,
are adequate for the payment of taxes not yet due with respect to the Parent's
operations through the Balance Sheet Date. All material claims for federal,
state and local taxes asserted against the Parent have either been paid or
adequately provided for on the Balance Sheet. The federal income tax returns
required to be filed by the Parent have either been examined by the Internal
Revenue Service or the period during which any assessments may be made by the
Internal Revenue Service has expired without waiver or extension and any
deficiencies or assessments asserted in writing by the Internal Revenue Service
have either been paid, settled or adequately provided for in the Balance Sheet.
The Parent has withheld from employees and paid over to the proper governmental
authorities all amounts required to be so withheld and paid over.
SECTION 4.10 Absence of Certain Changes. Except for: (i)
transactions, changes, events, obligations and liabilities contemplated by this
Agreement; (ii) transactions, changes, events, obligations and liabilities
disclosed in the financial statements referred to in Section 4.05 or in the
Parent Disclosure Schedule; (iii) transactions, changes, events, obligations and
liabilities which individually or in the aggregate, have not had a material
adverse effect on the Parent, since the Balance Sheet Date:
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(a) there have been no changes in the business, condition
(financial or otherwise), operations, manner of conduct of business or
operations, assets or liabilities of the Parent, other than changes in the
ordinary course of business;
(b) no liability or obligation of the Parent has been paid,
discharged or incurred other than in the ordinary course of business;
(c) there has been no damage, destruction, or loss, whether or
not covered by insurance, materially adversely affecting the business or
property of the Parent;
(d) the Parent has not sold, mortgaged, pledged or subjected
to any lien or other encumbrance or otherwise transferred any material assets or
properties used in the conduct of its business; and
(e) the Parent has not entered into any transaction other than
in the ordinary course of business.
SECTION 4.11 Commitments for Financing. On May 14, 1998, the
Parent entered into a letter of intent with Whale Securities Co., L.P. with
respect to the IPO. On July 22, 1998, the Parent filed a Form SB-2 Registration
Statement with the Securities and Exchange Commission with respect to the IPO.
The Parent has not received any notice from Whale that the IPO Offering will not
go forward on the terms set forth in the Registration Statement.
SECTION 4.12 Full Disclosure. No representation, warranty or
covenant made by the Parent in this Agreement contains any untrue statement of a
material fact, or omits to state a material fact necessary to make the
statements contained in this Agreement not misleading.
ARTICLE V
COVENANTS
SECTION 5.01 Conduct of the Business of the Company, Purchaser
and Parent. Except as contemplated by this Agreement, during the period from the
date of this Agreement to the Effective Time, each of the Company, Purchaser and
Parent will conduct its respective operations according to its ordinary course
of business and consistent with past practice, and will each use its reasonable
efforts to preserve intact its business organization. Without limiting the
generality of the foregoing, and except as otherwise expressly provided in this
Agreement, prior to the Effective Time, the Company will not, without the prior
written consent of the Purchaser and Parent:
(a) amend its Certificate of Incorporation or By-laws;
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(b) authorize for issuance, issue, sell, deliver or agree or
commit to issue, sell or deliver (whether through the issuance or granting of
options, warrants, commitments, subscriptions, rights to purchase or otherwise)
any shares of stock of any class or any other securities, except as may be
required by option agreements in effect on the date hereof;
(c) split, combine or reclassify any shares of its capital
stock, declare, set aside or pay any dividend or other distribution (whether in
cash, stock or property or any combination thereof) in respect of its capital
stock, or redeem or otherwise acquire any of its securities;
(d) except in the ordinary course of business consistent with
past practices: (i) incur or assume any long-term or short-term debt; (ii)
assume, guarantee, endorse or otherwise become liable or responsible (whether
directly, contingently or otherwise) for the obligations of any other person; or
(iii) make any loans, advances or capital contributions to, or investments in,
any other person;
(e) except pursuant to written agreements in effect on the
date hereof, acquire, sell, lease, create liens with respect to or dispose of
any material assets outside the ordinary course of business or enter into any
material commitment or transaction outside the ordinary course of business;
(f) except as may be required by law, take any action to
initiate, terminate or amend any of its employee benefit plans; and
(g) take, or agree in writing or otherwise to take, any of the
foregoing actions or any action which would make any representation or warranty
of the Company contained in this Agreement untrue or incorrect in any material
respect as of the date when made or as of a future date.
SECTION 5.02 Access to Information.
(a) Between the date of this Agreement and the Effective Time,
the Company will give the Purchaser, the Parent and its authorized
representatives, access to its respective facilities, books and records as the
other may reasonably request, will permit the other to make such inspections as
it may reasonably require and will cause its officers to furnish the other with
such financial data and other information with respect to its business and
properties as the other may from time to time reasonably request.
(b) Each of Purchaser and the Parent will hold and will cause
its representatives to hold in strict confidence all documents and information
concerning the Company furnished in connection with the transactions
contemplated by this Agreement (except to the extent that such information can
be shown to have been: (i) in the public domain through no fault of the
disclosing party, or (ii) required to be disclosed by Parent in its Registration
Statement relating to its IPO or (iii) later lawfully acquired by the disclosing
party (or its affiliates) from other sources) and will not release or disclose
such information to any other person, except in connection with this Agreement
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to (i) its representatives and (ii) to the Underwriter (including its counsel)
of the Parent's IPO (it being understood that such persons shall be informed by
Purchaser of the confidential nature of such information and shall be directed
by Purchaser to treat such information confidentially); provided that each party
and its representatives may provide such documents or information in response to
judicial or administrative process or applicable governmental laws, rules,
regulations, orders or ordinances, but only that portion of the documents or
information which, on the advice of counsel, is legally required to be
furnished. If the transactions contemplated by this Agreement are not
consummated, such confidence shall continue to be maintained in accordance with
the terms and conditions above set forth.
SECTION 5.03 Best Efforts. Subject to the terms and conditions
herein provided, each of the parties hereto agrees to use its best efforts to
take, or cause to be done, all things necessary, proper or advisable under
applicable laws and regulations to consummate and make effective the
transactions contemplated by this Agreement. In case at any time after the
Effective Time any further action is necessary or desirable to carry out the
purposes of this Agreement, the proper officers and directors of each party to
this Agreement shall take all such necessary action.
SECTION 5.04 Consents. The Purchaser, Company and Parent each
will use its best efforts to obtain consents of all third parties and
governmental authorities necessary to the consummation of the transactions
contemplated by this Agreement, unless the failure to obtain such consents will
not, in the aggregate, have a material adverse effect on the financial
condition, results of operations or business in respect of either the Purchaser,
Company or Parent.
SECTION 5.05 Notification of Certain Matters. The Company,
Purchaser and Parent agree to give prompt notice to each other of (i) the
occurrence, or failure to occur, of any event which occurrence or failure to
occur would be likely to cause any representation or warranty contained in this
Agreement to be untrue or inaccurate in any material respect at any time from
the date hereof to the Effective Time (including any such occurrence or failure
of which either party is or becomes aware with respect to the other) and (ii)
any material failure on its part to comply with or satisfy any covenant,
condition or agreement to be complied with or satisfied by it hereunder;
provided, however, that the delivery of any notice pursuant to this Section 5.05
shall not limit or otherwise affect the remedies available hereunder to the
party receiving such notice.
ARTICLE VI
CONDITIONS TO CONSUMMATION
OF THE MERGER
SECTION 6.01 Conditions to Consummation of the Merger. The
obligations of the Purchaser and the Parent are, at Purchaser's and the Parent's
option, subject to the fulfillment of the conditions hereinafter set forth:
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(a) The Company shall have performed and complied with all of
the conditions and agreements required by this Agreement to be performed or
complied with by it prior to the Effective Time in all material respects.
(b) The Purchaser's shareholder shall have approved the Merger
in accordance with Delaware law. The approval of the Merger by the Company's
shareholders in accordance with Delaware law shall be in full force and effect.
(c) There shall have been no material change in the business,
properties or financial condition of the Company from such condition on the date
hereof.
(d) On the Closing Date (i) there shall be no injunction,
restraining order, or order of any nature issued by a court of competent
jurisdiction which directs that any transaction contemplated by this Agreement
shall not be consummated and (ii) there shall be no suit, action, investigation
or other proceeding pending or threatened by any governmental agency or private
party seeking to restrain or prohibit the consummation of any material
transaction contemplated hereby or the obtaining of any material amount of
damages from any party hereto or any officer or director of any such party, in
connection with the consummation of the transactions contemplated hereby.
(e) The Parent shall have consummated the IPO upon the terms
and provisions set forth in the Registration Statement.
(f) The Parent and the Purchaser shall have received a
certificate from an officer of the Company confirming the accuracy of each and
every representation and warranty of the Company and the fulfillment of each and
every condition of the Company herein.
(g) The Parent and the Purchaser shall have received the
opinion of Testa, Hurwitz & Thibeault, LLP, counsel to the Company, in form
reasonably satisfactory to the Parent and the Purchaser and their counsel,
confirming the accuracy of the representations and warranties of the Company and
the fulfillment of the conditions to closing on the part of the Company.
SECTION 6.02 Conditions to the Obligations of the Company. The
obligations of the Company are, at the Company's option, subject to the
fulfillment of the conditions hereinafter set forth.
(a) Purchaser and Parent shall have performed and complied
with all of the conditions and agreements required by this Agreement to be
performed or complied with by it prior to the Effective Time in all material
respects.
(b) The Purchaser's shareholder shall have approved the Merger
in accordance with Delaware law.
(c) The Parent shall have consummated the IPO.
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(d) There shall have been no material adverse change in the
business, properties or financial condition of the Parent from such condition on
the date hereof.
(e) On the Closing Date (i) there shall be no injunction,
restraining order, or order of any nature issued by a court of competent
jurisdiction which directs that any transaction contemplated by this Agreement
shall not be consummated and (ii) there shall be no suit, action, investigation
or other proceeding pending or threatened by any governmental agency or private
party seeking to restrain or prohibit the consummation of any material
transaction contemplated hereby or the obtaining of any material amount of
damages from any party hereto or any officer or director of any such party, in
connection with the consummation of the transaction contemplated hereby.
(f) The Company shall have received a certificate from an
officer of the Purchaser and Parent confirming the accuracy of each and every
representation and warranty of the Purchaser and Parent and the fulfillment of
each and every condition of the Purchaser and Parent herein.
(g) The Company shall have received the opinion of Bizar
Martin & Taub, LLP, counsel to the Purchaser and Parent, in form reasonably
satisfactory to the Company and its counsel, confirming the accuracy of the
representations and warranties of the Company and the fulfillment of the
conditions to closing on the part of the Company.
ARTICLE VI
TERMINATION; AMENDMENT; WAIVER
SECTION 7.01 Termination. This Agreement may be terminated and
the Merger contemplated hereby may be abandoned at any time notwithstanding
approval thereof by the shareholders of the Purchaser and the Company, but prior
to the Effective Time:
(a) by mutual written consent of the Purchaser, the Company
and the Parent;
(b) by the Purchaser, the Company or the Parent if the
Effective Time shall not have occurred on or before November 30, 1998; provided,
however, that the right to terminate this Agreement under this Section 7.01(b)
shall not be available to any party whose failure to fulfill any obligation
under this Agreement has been the cause of, or resulted in, the failure of the
Effective Time to occur on or before such date;
(c) by the Purchaser, the Company or the Parent if any United
States or state governmental authority or other agency or commission or United
States or state court of competent jurisdiction shall have enacted, issued,
promulgated, enforced or entered any statute, rule, regulation, injunction or
other order which is in effect and is permanent and non-appealable and has the
effect of prohibiting consummation of the Merger or the provision of the
financing necessary for such transactions; or
17
<PAGE>
(d) by the Purchaser: (i) if, prior to the Closing Date, the
Board of Directors of the Purchaser determines that it will not recommend
approval of the Merger by the stockholder of Purchaser (or if such
recommendation is withdrawn) or (ii) in the event of a breach by Company of any
material term or condition hereof.
Any unilateral termination of this Agreement permitted by this
Section 7.01 shall be effective upon the giving of the written notice by the
terminating party in the manner provided herein.
SECTION 7.02 Effect of Termination. In the event of the
termination and abandonment of this Agreement pursuant to Section 7.01 hereof,
this Agreement shall forthwith become void and have no effect, without any
liability on the part of any party or its directors, officers or shareholders.
Nothing contained in this Section 7.02 shall relieve any party from liability
for any breach of this Agreement; that with respect to breaches of this
Agreement the Purchaser shall not be responsible for, or have any liability in
respect of, any action or intended failure to act by the Company or the Company
Shareholders.
SECTION 7.03 Amendment. This Agreement may be amended by
action taken by all of the parties at any time before or after adoption of this
Agreement by the shareholders of the Purchaser and the Company, but, after any
such approval, no amendment shall be made which changes the amount or form of
consideration to be paid in the Merger or adversely affects the rights of the
shareholders of Purchaser and the Company hereunder without the approval of such
shareholders. It is acknowledged and agreed that an amendment which extends the
time by which the Effective Time must occur in order to obtain any required
third party or governmental consent or to comply with any judicial or
administrative ruling or order shall not be deemed to adversely affect such
rights. This Agreement may not be amended except by an instrument in writing
signed on behalf of the parties.
SECTION 7.04 Extension; Waiver. At any time prior to the
Effective Time, the parties may (i) extend the time for the performance of any
of the obligations or other acts of the other party hereto, (ii) waive any
inaccuracies in the representations and warranties contained herein or in any
document, certificate or writing delivered pursuant hereto or (iii) waive
compliance with any of the agreements or conditions contained herein. Any
agreements on the part of any party to any such extension or waiver shall be
valid only if set forth in an instrument in writing signed on behalf of such
party.
ARTICLE VIII
INDEMNIFICATION
SECTION 8.01 Indemnification. (a) Avi A. Fogel, the principal
stockholder of the Company, agrees to indemnify and defend Parent and Purchaser,
including their officers, directors, employees, agents and representatives, and
to hold such parties harmless from and against
18
<PAGE>
any and all damages, claims, losses and expenses (including reasonable
attorneys' fees) up to a maximum of $150,000 arising from or relating to (i) any
misrepresentation or breach of any representation and warranty hereunder by
Company; or (ii) any breach of any of the Company's covenants under this
Agreement.
(b) Purchaser and Parent agree to indemnify and defend the
Company Shareholders and to hold the Company Shareholders harmless from and
against any and all damages, claims, losses and expenses (including reasonable
attorneys' fees) arising from or relating to (i) any misrepresentation or breach
of any representation and warranty hereunder by Parent or Purchaser; or (ii) any
breach of any of Parent's or Purchaser's covenants under this Agreement.
ARTICLE IX
MISCELLANEOUS
SECTION 9.01 Survival. The representations, warranties,
covenants and agreements made herein or in any certificate or document executed
in connection herewith shall survive the execution and delivery of this
Agreement.
SECTION 9.02 Brokerage Fees and Commissions. The Purchaser and
Parent hereby represent and warrant to the Company with respect to the Purchaser
and Parent, and the Company hereby represents and warrants to the Purchaser and
Parent with respect to the Company, that no person or entity is entitled to
receive from the Purchaser or Parent or the Company, respectively, any
investment banking, brokerage or finder's fee or fees for financial consulting
or advisory services in connection with this Agreement or the transactions
contemplated hereby.
SECTION 9.03 Expenses. Each party hereto shall pay its own
expenses incidental to the preparing for, entering into and carrying out of this
Agreement and to the consummation of the Merger, whether or not the Merger shall
be consummated, except that the Assumed Liabilities shall include $25,000 for
the Company's fees and expenses (legal and accounting) related to the
transactions contemplated herein.
SECTION 9.04 Entire Agreement; Assignment. This Agreement
(including any other agreements referred to herein) (a) constitutes the entire
agreement among the parties with respect to the subject matter hereof and
supersedes all other prior agreements and understandings, both written and oral,
between the parties with respect to the subject matter hereof and (b) shall not
be assigned by operation of law or otherwise, provided that the Purchaser may
assign its rights and obligations to Parent or any subsidiary of the Purchaser,
but no such assignment shall relieve the Purchaser of its obligations hereunder
if such assignee does not perform such obligations.
SECTION 9.05 Validity. The invalidity or unenforceability of
any provision of this Agreement shall not affect the validity or enforceability
of any other provision of this Agreement, which shall remain in full force and
effect.
19
<PAGE>
SECTION 9.06 Notices. All notices, requests, claims, demands
and other communications hereunder shall be in writing and shall be given (and
shall be deemed to have been duly given upon receipt) by delivery in person, by
cable, telegram or telex, or by registered or certified mail (postage prepaid,
return receipt requested) to the respective parties as follows:
If to the Purchaser and/
or the Parent: Network-1 Security Solutions, Inc. and
Network-1 Acquisition Corp.
70 Walnut Street
Wellesley Hills, MA 02481
With a copy to: Bizar Martin & Taub, LLP
1350 Avenue of the Americas - 29th Floor
New York, New York 10019
Attn: Sam Schwartz, Esq.
If to the Company: CommHome Systems Corporation
22 Hollywood Drive
Chestnut Hill, MA 02167-3070
With a copy to: Testa, Hurwitz & Thiebult, LLP
High Street Tower
125 High Street
Boston, Massachusetts 02110
Attn: William J. Schnoor, Esq.
or to such other address as the person to whom notice is given may have
previously furnished to the others in writing in the manner set forth above.
SECTION 9.07 Governing Law. This Agreement shall be governed
by and construed in accordance with the laws of the Commonwealth of
Massachusetts as they are applied to contracts to be performed entirely within
such state, regardless of the laws that might otherwise govern under applicable
principles of conflicts of laws, provided, however, that the consummation and
effectiveness of the Merger shall be governed by and construed in accordance
with the laws of the State of Delaware.
SECTION 9.08 Descriptive Headings. The descriptive headings
herein are inserted for convenience of reference only and are not intended to be
part of or to affect the meaning or interpretation of this Agreement.
SECTION 9.09 Parties in Interest. This Agreement shall be
binding upon and inure solely to the benefit of each party hereto, and nothing
in this Agreement, express or implied, is intended to or shall confer upon any
other person any rights, benefits or remedies of any nature whatsoever under or
by reason of this Agreement.
20
<PAGE>
SECTION 9.10 Counterparts. This Agreement may be executed in
two or more counterparts, each of which shall be an original, but all of which
shall constitute one and the same agreement.
SECTION 9.11 Specific Performance. The parties hereto agree
that irreparable damage would occur in the event any of the provisions of this
Agreement were not to be performed in accordance with the terms hereto and that
the parties shall be entitled to specific performance of the terms hereof, in
addition to any other remedy at law or equity.
IN WITNESS WHEREOF, the undersigned has executed this
Agreement and Plan of Merger as of the 11th day of September, 1998.
NETWORK-1 SECURITY SOLUTIONS, INC.
By: /s/ Murray P. Fish
-----------------------------------------------
Name: Murray P. Fish
Title: Chief Financial Officer
NETWORK-1 ACQUISITION CORP.
By: /s/ Murray P. Fish
-----------------------------------------------
Name: Murray P. Fish
Title: Vice President
COMMHOME SYSTEMS CORPORATION
By: /s/ Avi A. Fogel
-----------------------------------------------
Name: Avi A. Fogel
Title: President and Chief Executive Officer
AS TO PARAGRAPH 1.07(b):
/s/ Avi A. Fogel
- ----------------------------------
Avi A. Fogel, Noteholder
/s/ Robert P. Olsen
- ----------------------------------
Robert P. Olsen, Noteholder
21
<PAGE>
SCHEDULE A
CommHome Systems Corp. Shareholders
<TABLE>
<CAPTION>
Number of
CommHome Systems Dollar Value of Network-
Name, address and Social Corporation Shares 1 Shares to be Received
Security Number Held Based on IPO Price
- ---------------------------------- ---------------------- ------------------------------
<S> <C> <C>
Avi Fogel 660 $143,255.80
22 Hollywood Drive
Chestnut Hill, MA 02167-3070
Nachum Sadan 400 86,821.71
140 Carroll Drive
Carlisle, MA 01741
Russell L. Rivin 60 13,023.26
29 Walnut Street
Holliston, MA 01746
Robert Quinn 60 13,023.26
40 Silver Hill Road
Weston, MA 02193
David Chhoeum 50 10,852.71
26 Eisenhower Road
Peabody, MA 01960
Uri Guttman 60 13,023.26
79 Everett Street
Arlington, MA 02174
----- -------
1,290 280,000
</TABLE>
<PAGE>
SCHEDULE B
CommHome Systems Corporation
List of Assumed Indebtedness
<TABLE>
<S> <C>
Notes Payable:
Avi Fogel $55,000.00
Robert Olsen 50,000.00
Nachum Sadan 32,709.32*
Accounts Payable:
Alliance Business Center 1,762.78
Berlin, Hamilton & Dahman, LLP 1,768.60
Testa, Hurwitz & Thibeault, LLP 29,965.96
B&C Consulting Services 250.00
Reimbursement of Officer Expenses 1,828.25
Estimated Merger Expenses:
Accounting 10,000.00
Legal 15,000.00
-----------
Total $198,284.91
-----------
-----------
</TABLE>
*Includes estimated interest, at a rate of 5.5% per annum, through an estimated
effective date of October 15, 1998.
<PAGE>
COMPANY DISCLOSURE STATEMENT
----------------------------
[SEE ATTACHED FINANCIAL STATEMENTS]
<PAGE>
COMMHOME SYSTEMS CORPORATION
(a development stage company)
FINANCIAL STATEMENTS
JUNE 30, 1998
<PAGE>
[LETTERHEAD OF RICHARD A. EISNER & COMPANY, LLP]
[LOGO]
Board of Directors and Stockholders
CommHome Systems Corporation
Wellesley, Massachusetts
We have reviewed the accompanying balance sheet of CommHome Systems Corporation
(a development stage company) as of June 30, 1998, and the related statements of
operations, stockholders' deficiency, and cash flows for the six months then
ended and for the periods from June 18, 1997 (inception) through December 31,
1997 and June 18, 1997 (inception) through June 30, 1998, in accordance with
Statements on Standards for Accounting and Review Services issued by the
American Institute of Certified Public Accountants. All information included in
these financial statements is the representation of the management of CommHome
Systems Corporation.
A review consists principally of inquiries of company personnel and analytical
procedures applied to financial data. It is substantially less in scope than an
audit in accordance with generally accepted auditing standards, the objective of
which is the expression of an opinion regarding the financial statements taken
as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to the accompanying financial statements in order for them to be in
conformity with generally accepted accounting principles.
/s/ Richard A. Eisner & Company, LLP
New York, New York
August 25, 1998
<PAGE>
COMMHOME SYSTEMS CORPORATION
(a development stage company)
BALANCE SHEET
JUNE 30, 1998
ASSETS
Current assets:
Cash $ 795
Security deposit 437
---------
$ 1,232
=========
LIABILITIES
Current liabilities:
Accounts payable $ 23,893
Accrued expenses and other current liabilities 28,000
Loan payable - stockholders 85,000
Loan payable - other 50,000
Interest payable - stockholder 2,400
Due to Network-1 Security Solutions, Inc. 770
---------
Total current liabilities 190,063
---------
Commitments and contingencies
STOCKHOLDERS' DEFICIENCY
Preferred stock - $.01 par value; authorized
1,000 shares; no shares issued and outstanding
Common stock - $.01 par value; authorized 2,000 shares;
1,290 shares issued and outstanding 13
Additional paid-in capital 17
Deficit accumulated during the development stage (188,861)
---------
(188,831)
---------
$ 1,232
=========
<PAGE>
COMMHOME SYSTEMS CORPORATION
(a development stage company)
STATEMENTS OF OPERATIONS
JUNE 18, JUNE 18,
1997 1997
(INCEPTION) SIX MONTHS (INCEPTION)
THROUGH ENDED THROUGH
DECEMBER 31, JUNE 30, JUNE 30,
1997 1998 1998
--------- -------- ---------
EXPENSES:
Research and development $ 26,901 $ 2,070 $ 28,971
Marketing 51,946 4,344 56,290
General and administrative 64,334 30,824 95,158
--------- -------- --------
Total expenses 143,181 37,238 180,419
Interest expense - net 1,317 900 2,217
Other expense 6,225 6,225
--------- -------- --------
NET LOSS $(144,498) $(44,363) $(188,861)
========= ======== =========
SEE ACCOUNTANTS' REVIEW REPORT AND NOTES TO FINANCIAL STATEMENTS
<PAGE>
COMMHOME SYSTEMS CORPORATION
(a development stage company)
STATEMENTS OF STOCKHOLDERS' DEFICIENCY
<TABLE>
<CAPTION>
DEFICIT
ACCUMULATED
COMMON STOCK ADDITIONAL DURING THE
---------------------- PAID-IN DEVELOPMENT
SHARES AMOUNT CAPITAL STAGE TOTAL
------ ------ ------- ------------ -------
<S> <C> <C> <C> <C> <C>
Issuance of common stock for cash on
July 31, 1997 ($.01 per share) 1,120 $ 11 $ 11
Issuance of common stock for cash in
December 1997 ($.05 per share) 430 4 $ 17 21
Repurchase of common shares in December 1997
($.01 per share) (260) (2) (2)
Net loss from June 18, 1997 (inception)
to December 31, 1997 $(144,498) (144,498)
------ ----- ----- --------- ---------
BALANCE - DECEMBER 31, 1997 1,290 13 17 (144,498) (144,468)
Net loss for the six months ended June 30, 1998 (44,363 (44,363)
------ ----- ----- --------- ---------
BALANCE - JUNE 30, 1998 1,290 $ 13 $ 17 $(188,861) $(188,831)
====== ===== ===== ========= =========
</TABLE>
SEE ACCOUNTANTS' REVIEW REPORT AND NOTES TO FINANCIAL STATEMENTS
<PAGE>
COMMHOME SYSTEMS CORPORATION
(a development stage company)
STATEMENTS OF CASH FLOWS
JUNE 18, JUNE 18,
1997 1997
(INCEPTION) SIX MONTHS (INCEPTION)
THROUGH ENDED THROUGH
DECEMBER 31, JUNE 30, JUNE 30,
1997 1998 1998
--------- --------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(144,498) $ (44,363) $ (188,861)
Adjustments to reconcile net loss to
net cash used in operating activities:
Depreciation 1,900 1,900 3,800
Realized loss on disposal of
computer equipment 6,225 6,225
Changes in:
Due to Network-1 770 770
Accounts payable, accrued
expenses and other current
liabilities 65,121 (10,828) 54,293
--------- --------- ---------
Net cash used in operating
activities (77,477) (46,296) (123,773)
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of computer equipment (10,025) (10,025)
Security deposit (2,200) 1,763 (437)
--------- --------- ---------
Net cash provided by (used in)
investing activities (12,225) 1,763 (10,462)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of notes payable 150,000 5,000 155,000
Repayment of notes payable (10,000) (10,000) (20,000)
Net proceeds from sale of common stock 30 30
--------- --------- ---------
Net cash provided by (used in)
financing activities 140,030 (5,000) 135,030
--------- --------- ---------
NET INCREASE (DECREASE) IN CASH 50,328 (49,533) 795
Cash - beginning of period 0 50,328 0
--------- --------- ---------
CASH - END OF PERIOD $ 50,328 $ 795 $ 795
========= ========= =========
SEE ACCOUNTANTS' REVIEW REPORT AND NOTES TO FINANCIAL STATEMENTS
<PAGE>
COMMHOME SYSTEMS CORPORATION
(a development stage company)
Notes to Financial Statements
June 30, 1998
NOTE A - THE COMPANY AND BASIS OF PRESENTATION
CommHome Systems Corporation (the "Company") is a development stage company
engaged in the design and development of residential networking solutions for
high speed internet access to the home.
The accompanying financial statements have been prepared on a going concern
basis. As reflected in the accompanying financial statements, the Company has
incurred substantial losses since inception and such losses are expected to
continue. As of June 30, 1998 the Company had a working capital deficiency and
a stockholders' deficiency of approximately $189,000. The Company intends to
merge with a wholly owned subsidiary of Network-1 Security Solutions, Inc.
("Network-1") effective upon the consummation of an initial public offering by
such entity. The Company's majority stockholder and chief executive officer is
the chief executive officer and a director of Network-1. Network-1, which filed
a registration statement with the Securities and Exchange Commission on July 22,
1998, develops, markets, licenses and supports its proprietary network security
software products designed to provide comprehensive security to computer
networks. There is no assurance, however, that the merger will take place. The
above factors give rise to substantial doubt as to the ability of the Company to
continue as a going concern. The financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
NOTE B - SIGNIFICANT ACCOUNTING POLICIES
(1) CASH EQUIVALENTS:
The Company considers all highly liquid short-term investments purchased
with a maturity of three months or less to be cash equivalents.
(2) SOFTWARE DEVELOPMENT COSTS:
Research and development costs incurred to establish the technological
feasibility of computer software are expensed as incurred.
(3) USE OF ESTIMATES:
The preparation of financial statements in conformity with generally
accepted accounting principles 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 revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
<PAGE>
COMMHOME SYSTEMS CORPORATION
(a development stage company)
Notes to Financial Statements
June 30, 1998
NOTE C - LOANS PAYABLE
One loan for $30,000 at June 30, 1998 bears interest at 5.5% per annum, the
other two loans are noninterest bearing. All the loans are due upon receipt by
the Company of proceeds of equity or debt financing. Interest expense to
stockholder for the period from June 18, 1997 through December 31, 1997 and for
the six months ended June 30, 1998 amounted to $1,500 and $900, respectively.
NOTE D - INCOME TAXES
At June 30, 1998, the Company has a deferred tax asset of $70,000 comprised of
net operating loss carryforwards available to reduce future federal taxable
income of approximately $175,000 expiring through 2018. Pursuant to the
Internal Revenue Code, future utilization of past losses are subject to certain
limitations based on changes in ownership of the Company's stock. The Company
has reserved the full amount of its deferred tax asset as the likelihood of
future realization cannot be presently determined.
<PAGE>
PURCHASER DISCLOSURE STATEMENT
NOT APPLICABLE
<PAGE>
PARENT DISCLOSURE STATEMENT
[See Attached Financial Statements]
<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
INDEX TO FINANCIAL STATEMENTS
Independent auditors' report............................................................................. F-2
Balance sheets as of December 31, 1996 and 1997 and June 30, 1998 (unaudited)............................ F-3
Statements of operations for the years ended December 31, 1996 and 1997 and for the six months ended June
30, 1997 and 1998 (unaudited).......................................................................... F-4
Statements of stockholders' equity (deficiency) for the years ended December 31, 1996 and 1997 and for
the six months ended June 30, 1998 (unaudited)......................................................... F-5
Statements of cash flows for the years ended December 31, 1996 and 1997 and for the six months ended June
30, 1997 and 1998 (unaudited).......................................................................... F-6
Notes to financial statements............................................................................ F-7
</TABLE>
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
Board of Directors and Stockholders
Network-1 Security Solutions, Inc.
Wellesley, Massachusetts
We have audited the accompanying balance sheets of Network-1 Security
Solutions, Inc. (the "Company") as of December 31, 1996 and 1997 and the related
statements of operations, stockholders' equity (deficiency) and cash flows for
each of the years then ended. These financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements enumerated above present fairly, in
all material respects, the financial position of Network-1 Security Solutions,
Inc. as of December 31, 1996 and 1997 and the results of its operations and its
cash flows for each of the years then ended in conformity with generally
accepted accounting principles.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note A to the
financial statements, the Company has incurred substantial losses from
operations, and as of December 31, 1997 has a working capital deficiency of
$661,000 and a stockholders' deficiency of $75,000. These factors raise
substantial doubt about the Company's ability to continue as a going concern.
Management's plans in regard to these matters are also described in Note A. The
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.
Richard A. Eisner & Company, LLP
New York, New York
June 17, 1998
With respect to Note F[3]
July 8, 1998
With respect to the third paragraph of Note A
July 17, 1998
With respect to Note J
September 11, 1998
F-2
<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------- JUNE 30,
1996 1997 1998
------------ ------------ ------------
<S> <C> <C> <C>
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents............................................. $ 217,000 $ 60,000 $ 634,000
Accounts receivable--net of allowance for doubtful accounts of $5,000,
$70,000 and $88,000, respectively................................... 191,000 435,000 609,000
Prepaid expenses and other current assets............................. 30,000 30,000 35,000
------------ ------------ ------------
Total current assets............................................ 438,000 525,000 1,278,000
Equipment and fixtures................................................ 518,000 400,000 323,000
Capitalized software costs--net....................................... 729,000 1,258,000 1,042,000
Security deposits..................................................... 193,000 131,000 136,000
Deferred offering costs............................................... 90,000 350,000
------------ ------------ ------------
$ 1,878,000 $ 2,404,000 $ 3,129,000
------------ ------------ ------------
------------ ------------ ------------
LIABILITIES
Current liabilities:
Accounts payable...................................................... $ 275,000 $ 776,000 $ 598,000
Accrued fee--related party............................................ 138,000
Accrued expenses and other current liabilities........................ 155,000 201,000 302,000
Notes payable--related parties, net of discount....................... 1,610,000
Notes payable--others, net of discount................................ 972,000
Interest payable--related parties..................................... 72,000
Interest payable--other............................................... 61,000
Current portion of capital lease obligations.......................... 24,000 8,000
Deferred revenue...................................................... 25,000 63,000 92,000
------------ ------------ ------------
Total current liabilities....................................... 479,000 1,186,000 3,707,000
Capital lease obligations--less current portion......................... 8,000
Notes payable--related parties, net of discount......................... 564,000
Notes payable--others, net of discount.................................. 670,000
Interest payable--related parties....................................... 24,000
Interest payable--others................................................ 35,000
------------ ------------ ------------
487,000 2,479,000 3,707,000
------------ ------------ ------------
Commitments and contingencies
STOCKHOLDERS' EQUITY (DEFICIENCY)
Preferred stock--$.01 par value; authorized 5,000,000 shares; Series
A--10% cumulative, none issued and outstanding
Series B--500,000 shares issued and outstanding....................... 5,000 5,000 5,000
Common stock--$.01 par value; authorized 25,000,000 shares; 2,004,951,
1,706,037 and 1,678,104 shares issued and outstanding................. 20,000 17,000 17,000
Additional paid-in capital.............................................. 6,446,000 7,373,000 9,432,000
Accumulated deficit..................................................... (5,080,000) (7,470,000) (9,460,000)
Unearned portion of compensatory stock options.......................... (572,000)
------------ ------------ ------------
1,391,000 (75,000) (578,000)
------------ ------------ ------------
$ 1,878,000 $ 2,404,000 $ 3,129,000
------------ ------------ ------------
------------ ------------ ------------
</TABLE>
See notes to financial statements
F-3
<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED SIX MONTHS ENDED
DECEMBER 31, JUNE 30,
---------------------- ----------------------
1996 1997 1997 1998
---------- ---------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C>
Revenues:
Licenses................................. $ 624,000 $1,132,000 $ 506,000 $ 412,000
Royalties................................ 500,000 500,000
Services................................. 403,000 737,000 421,000 490,000
---------- ---------- ---------- ----------
Total revenues......................... 1,027,000 2,369,000 1,427,000 902,000
---------- ---------- ---------- ----------
Cost of revenues:
Amortization of software development
costs.................................. 246,000 321,000 125,000 267,000
Cost of licenses......................... 193,000 176,000 52,000 128,000
Cost of services......................... 390,000 418,000 212,000 272,000
---------- ---------- ---------- ----------
Total cost of revenues................. 829,000 915,000 389,000 667,000
---------- ---------- ---------- ----------
Gross profit............................... 198,000 1,454,000 1,038,000 235,000
---------- ---------- ---------- ----------
Operating expenses:
Product development...................... 892,000 792,000 235,000 283,000
Selling and marketing.................... 1,614,000 926,000 524,000 351,000
General and administrative............... 1,931,000 1,573,000 919,000 1,153,000
---------- ---------- ---------- ----------
Total operating expenses............... 4,437,000 3,291,000 1,678,000 1,787,000
---------- ---------- ---------- ----------
Loss from operations....................... (4,239,000) (1,837,000) (640,000) (1,552,000)
Interest expense, including amortization of
debt discount............................ (260,000) (553,000) (141,000) (438,000)
---------- ---------- ---------- ----------
Net loss................................... $(4,499,000) $(2,390,000) $ (781,000) $(1,990,000)
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Loss per share--basic and diluted.......... $ (2.46) $ (1.29) $ (.40) $ (1.17)
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Weighted average number of shares
outstanding--basic and diluted........... 1,825,163 1,855,244 1,934,334 1,699,120
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
</TABLE>
See notes to financial statements
F-4
<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIENCY)
<TABLE>
<CAPTION>
COMMON STOCK PREFERRED STOCK ADDITIONAL
--------------------- -------------------- PAID-IN ACCUMULATED
SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT
---------- --------- --------- --------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE--DECEMBER 31, 1995...................... 1,164,133 $ 12,000 750,000 $ 7,000 $ 1,146,000 $ (581,000)
Issuance of common stock for cash--net.......... 698,397 7,000 4,141,000
Issuance of common stock and warrants for
services rendered............................. 18,262 683,000
Conversion of notes payable into common stock... 108,639 1,000 699,000
Redemption of preferred stock................... (250,000) (2,000) (248,000)
Exercise of warrants............................ 15,520 25,000
Net loss........................................ (4,499,000)
---------- --------- --------- --------- ----------- ------------
BALANCE--DECEMBER 31, 1996...................... 2,004,951 20,000 500,000 5,000 6,446,000 (5,080,000)
Issuance of common stock and warrants for
services rendered............................. 2,794 163,000
Warrants issued in connection with debt
financing..................................... 766,000
Repurchase and retirement of common shares...... (301,708) (3,000) (2,000)
Net loss........................................ (2,390,000)
---------- --------- --------- --------- ----------- ------------
BALANCE--DECEMBER 31, 1997...................... 1,706,037 17,000 500,000 5,000 7,373,000 (7,470,000)
Common stock options issued to Chief Executive
Officer....................................... 938,000
Amortization of compensatory stock options......
Issuance of common stock, warrants and options
for services rendered and payment of
liability..................................... 34,147 356,000
Warrants issued in connection with debt
financing..................................... 766,000
Repurchase and retirement of common shares...... (62,080) (1,000)
Net loss........................................ (1,990,000)
---------- --------- --------- --------- ----------- ------------
BALANCE--JUNE 30, 1998 (UNAUDITED).............. 1,678,104 $ 17,000 500,000 $ 5,000 $ 9,432,000 $(9,460,000)
---------- --------- --------- --------- ----------- ------------
---------- --------- --------- --------- ----------- ------------
<CAPTION>
UNEARNED
PORTION OF
COMPENSATORY
STOCK OPTIONS TOTAL
------------- -----------
<S> <C> <C>
BALANCE--DECEMBER 31, 1995...................... $ 584,000
Issuance of common stock for cash--net.......... 4,148,000
Issuance of common stock and warrants for
services rendered............................. 683,000
Conversion of notes payable into common stock... 700,000
Redemption of preferred stock................... (250,000)
Exercise of warrants............................ 25,000
Net loss........................................ (4,499,000)
------------- -----------
BALANCE--DECEMBER 31, 1996...................... 1,391,000
Issuance of common stock and warrants for
services rendered............................. 163,000
Warrants issued in connection with debt
financing..................................... 766,000
Repurchase and retirement of common shares...... (5,000)
Net loss........................................ (2,390,000)
------------- -----------
BALANCE--DECEMBER 31, 1997...................... (75,000)
Common stock options issued to Chief Executive
Officer....................................... $ (938,000)
Amortization of compensatory stock options...... 366,000 366,000
Issuance of common stock, warrants and options
for services rendered and payment of
liability..................................... 356,000
Warrants issued in connection with debt
financing..................................... 766,000
Repurchase and retirement of common shares...... (1,000)
Net loss........................................ (1,990,000)
------------- -----------
BALANCE--JUNE 30, 1998 (UNAUDITED).............. $ (572,000) $ (578,000)
------------- -----------
------------- -----------
</TABLE>
See notes to financial statements
F-5
<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
SIX MONTHS ENDED
DECEMBER 31, JUNE 30,
-------------------------- ------------------------
<S> <C> <C> <C> <C>
1996 1997 1997 1998
------------ ------------ ---------- ------------
<CAPTION>
(UNAUDITED)
<S> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss................................................ $ (4,499,000) $ (2,390,000) $ (781,000) $ (1,990,000)
Adjustments to reconcile net loss to net cash used in
operating activities:
Amortization of debt discount......................... 306,000 500,000 128,000 364,000
Issuance of common stock and warrants for services
rendered............................................ 683,000 163,000 95,000 583,000
Provision for doubtful accounts....................... (15,000) 65,000 36,000 18,000
Depreciation and amortization......................... 368,000 481,000 200,000 346,000
Changes in:
Accounts receivable................................. 131,000 (309,000) (330,000) (192,000)
Prepaid expenses and other current assets........... (15,000) (5,000)
Accounts payable, accrued expenses and other current
liabilities....................................... 196,000 744,000 147,000 (1,000)
Deferred revenue.................................... 25,000 38,000 (3,000) 29,000
------------ ------------ ---------- ------------
Net cash used in operating activities............. (2,820,000) (708,000) (508,000) (848,000)
------------ ------------ ---------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisitions of equipment and fixtures.................. (235,000) (42,000) (32,000) (3,000)
Capitalized software costs.............................. (750,000) (850,000) (506,000) (50,000)
Security deposit........................................ (164,000) 62,000 64,000 (5,000)
------------ ------------ ---------- ------------
Net cash used in investing activities............. (1,149,000) (830,000) (474,000) (58,000)
------------ ------------ ---------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of notes payable and warrants.... 700,000 1,550,000 1,000,000 1,750,000
Repayment of notes payable.............................. (400,000) (50,000)
Proceeds from exercise of options and warrants.......... 25,000
Net proceeds from sale of common stock.................. 4,148,000
Repayment of capital lease obligations.................. (23,000) (24,000) (8,000)
Purchase of treasury shares............................. (5,000) (1,000) (1,000)
Repayment of line of credit............................. (62,000)
Repayment of stockholder's loan......................... (48,000)
Redemption of preferred stock........................... (250,000)
Deferred offering costs................................. (90,000) (25,000) (261,000)
------------ ------------ ---------- ------------
Net cash provided by financing activities......... 4,090,000 1,381,000 974,000 1,480,000
------------ ------------ ---------- ------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS...... 121,000 (157,000) (8,000) 574,000
Cash and cash equivalents--beginning of period............ 96,000 217,000 217,000 60,000
------------ ------------ ---------- ------------
CASH AND CASH EQUIVALENTS--END OF PERIOD.................. $ 217,000 $ 60,000 $ 209,000 $ 634,000
------------ ------------ ---------- ------------
------------ ------------ ---------- ------------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest.............................................. $ 32,000 $ 1,000
Noncash transaction:
Issuance of stock in connection with repayment of
debt................................................ $ 700,000
</TABLE>
See notes to financial statements
F-6
<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED WITH RESPECT TO DATA AS OF JUNE 30, 1998 AND FOR
THE SIX-MONTH PERIODS ENDED JUNE 30, 1997 AND 1998)
NOTE A--THE COMPANY AND BASIS OF PRESENTATION
Network-1 Security Solutions, Inc. (the "Company"), formerly known as
Network-1 Software & Technology, Inc., develops, markets, licenses and supports
its proprietary network security software products designed to provide
comprehensive security to computer networks. The Company also provides
maintenance and network consulting and training services.
The accompanying financial statements have been prepared on a going concern
basis. As reflected in the accompanying financial statements, the Company has
incurred substantial losses from operations and as of December 31, 1997 has a
working capital deficiency of $661,000 and a stockholders' deficiency of
$75,000. Subsequent to December 31, 1997 through May 14, 1998, the Company
received $1,750,000 in short-term debt financing, a significant portion of which
was from principal stockholders of the Company. However, the Company will
require additional financing to satisfy its obligations and fund its operations
through December 31, 1998. Also, in May 1998, the Company signed a letter of
intent with an underwriter for the sale of its securities in an initial public
offering (the "Offering"). There is no assurance, however, that the Offering
will be consummated or that the Company will be able to obtain alternative
financing. As of June 30, 1998, the Company's working capital deficiency
increased to $2,429,000 and its stockholders' deficiency increased to $578,000.
The above factors give rise to substantial doubt as to the ability of the
Company to continue as a going concern. The financial statements do not include
any adjustments that might result from the outcome of this uncertainty.
On July 17, 1998, the stockholders approved a 1:1.610831 reverse split of
the outstanding shares of the Company's common stock. The accompanying financial
statements have been retroactively adjusted to reflect the split and all
references to numbers of common shares, options, warrants and per share amounts
have been restated to give effect to the split.
NOTE B--SIGNIFICANT ACCOUNTING POLICIES
[1] CASH EQUIVALENTS:
The Company considers all highly liquid short-term investments purchased with
a maturity of three months or less to be cash equivalents.
[2] REVENUE RECOGNITION:
In October 1997, the AICPA issued Statement of Position ("SOP") No. 97-2,
"Software Revenue Recognition," which the Company adopted, effective January
1, 1997. Such adoption had no effect on the Company's methods of recognizing
revenue from its license and service activities. Prior to 1997, the
Company's revenue recognition policy was in accordance with SOP No. 91-1,
"Software Revenue Recognition."
License revenue is recognized upon delivery of software or delivery of a
required software key. Service revenues consist of maintenance, consulting
and training services. Annual renewable maintenance fees are a separate
component of each contract, and are recognized ratably over the contract
term. Consulting and training revenues are recognized as such services are
performed.
F-7
<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED WITH RESPECT TO DATA AS OF JUNE 30, 1998 AND FOR
THE SIX-MONTH PERIODS ENDED JUNE 30, 1997 AND 1998)
NOTE B--SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
[3] EQUIPMENT AND FIXTURES:
Equipment and fixtures are stated at cost and are depreciated using the
straight-line method over their estimated useful lives of five years.
[4] SOFTWARE DEVELOPMENT COSTS:
Costs to maintain developed programs and development costs incurred to
establish the technological feasibility of computer software are expensed as
incurred. The Company capitalizes costs incurred in producing computer
software after technological feasibility of the software has been
established. Such costs are amortized based on current and estimated future
revenue of each product with an annual minimum equal to the straight-line
amortization over the remaining estimated economic life of the product. The
Company estimates the economic life of its software to be three years. At
each balance sheet date, the unamortized capitalized software costs of each
product are compared with the net realizable value of that product and any
excess capitalized costs are written off.
[5] INCOME TAXES:
The Company utilizes the liability method of accounting for income taxes.
Under such method, deferred tax assets and liabilities are recognized for
the future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and liabilities and
their respective tax bases. Deferred tax assets and liabilities are measured
using enacted tax rates in effect at the balance sheet date. The resulting
asset or liability is adjusted to reflect enacted changes in tax law.
[6] LOSS PER SHARE:
During 1997, the Company adopted Statement of Financial Accounting Standards
No. 128, "Earnings Per Share" ("SFAS No. 128"). SFAS No. 128 requires the
reporting of basic and diluted earnings/loss per share. Basic loss per share
is calculated by dividing net loss by the weighted average number of
outstanding common shares during the year. Diluted per share data includes
the dilutive effects of options, warrants and convertible securities. As all
potential common shares are anti-dilutive, they are not included in the
calculation of diluted loss per share. Loss per share for 1996 has been
presented to conform to SFAS No. 128.
[7] USE OF ESTIMATES:
The preparation of financial statements in conformity with generally accepted
accounting principles 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 revenues and expenses during the reporting
period. Actual results could differ from those estimates.
[8] FINANCIAL INSTRUMENTS:
The carrying amounts of accounts receivable, accounts payable, accrued
expenses, capitalized lease obligations and notes payable approximate their
fair value as the interest rates on the Company's
F-8
<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED WITH RESPECT TO DATA AS OF JUNE 30, 1998 AND FOR
THE SIX-MONTH PERIODS ENDED JUNE 30, 1997 AND 1998)
NOTE B--SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
indebtedness approximate current market rates and due to the short period to
maturity of these instruments.
[9] STOCK-BASED COMPENSATION:
In October 1995, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 123 ("SFAS No. 123"), "Accounting for
Stock-Based Compensation". SFAS No. 123 encourages, but does not require,
companies to record compensation cost for stock-based employee compensation
plans at fair value. The Company has elected to continue to account for its
employee stock-based compensation plans using the intrinsic value method
prescribed by Accounting Principles Board Opinion No. 25 ("APB No. 25"),
Accounting for Stock Issued to Employees" and to disclose the pro forma
effect on net loss per share had the fair value of options been expensed.
Under the provisions of APB No. 25, compensation cost for stock options is
measured as the excess, if any, of the estimated market value of the
Company's common stock at the date of the grant over the amount an employee
must pay to acquire the stock.
[10] INTERIM FINANCIAL STATEMENTS:
The accompanying balance sheet as of June 30, 1998, the statement of changes
in stockholders' equity for the six-month period then ended and the
statements of operations and cash flows for the six-month periods ended June
30, 1997 and 1998 are unaudited. In the opinion of management, all
adjustments (consisting only of normal recurring accruals) considered
necessary for a fair presentation have been included. The results of
operations for the six-month period ended June 30, 1998 are not necessarily
indicative of the results to be expected for the year ended December 31,
1998.
NOTE C--EQUIPMENT AND FIXTURES
Equipment and fixtures are summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------- JUNE 30,
1996 1997 1998
--------- --------- -----------
(UNAUDITED)
<S> <C> <C> <C>
Office and computer equipment.............. $ 669,000 $ 661,000 $ 664,000
Furniture and fixtures..................... 59,000 59,000 59,000
Leasehold improvements..................... 46,000 46,000 46,000
--------- --------- -----------
774,000 766,000 769,000
Less accumulated depreciation.............. (256,000) (366,000) (446,000)
--------- --------- -----------
$ 518,000 $ 400,000 $ 323,000
--------- --------- -----------
--------- --------- -----------
</TABLE>
F-9
<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED WITH RESPECT TO DATA AS OF JUNE 30, 1998 AND FOR
THE SIX-MONTH PERIODS ENDED JUNE 30, 1997 AND 1998)
NOTE D--CAPITALIZED SOFTWARE COSTS
<TABLE>
<CAPTION>
SIX
YEAR ENDED MONTHS
DECEMBER 31, ENDED
------------------------- JUNE 30,
1996 1997 1998
----------- ------------ ------------
<S> <C> <C> <C>
(UNAUDITED)
Balance, beginning of period (net of accumulated amortization)........... $ 225,000 $ 729,000 $ 1,258,000
Additions................................................................ 750,000 850,000 50,000
Amortization............................................................. (246,000) (321,000) (266,000)
----------- ------------ ------------
Balance, end of period (net of accumulated amortization)................. $ 729,000 $ 1,258,000 $ 1,042,000
----------- ------------ ------------
----------- ------------ ------------
</TABLE>
NOTE E--NOTES PAYABLE
Notes payable is summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1997 1998
------------ ------------
<S> <C> <C>
Notes payable on the earlier of a) January 1, 1999 b) the date
upon which the Company receives $6,000,000 net proceeds of
equity or debt financing from one or a series of transactions
c) a sale of all of the Company's assets or d) a merger or
consolidation of the Company:
Notes bearing interest at 6%, including $250,000 payable to a
related party (1).......................................... $ 650,000 $ 650,000
Notes bearing interest at 6% (2)............................. 350,000 350,000
Note bearing interest at 8%, payable to a related party
(3)........................................................ 100,000 100,000
Notes bearing interest at 8%, payable to related parties
(4)........................................................ 400,000 400,000
Notes payable (including $1,400,000 to related parties) on the
earlier of a) twelve months from issuance b) the date upon
which the Company receives $6,000,000 net proceeds of equity
or debt financing from one or a series of transactions c) a
sale of all of the Company's assets or d) a merger or
consolidation of the Company; bearing interest at 8% (5)..... 1,750,000
------------ ------------
1,500,000 3,250,000
Less unamortized debt discount................................... (266,000) (668,000)
------------ ------------
$1,234,000 $ 2,582,000
------------ ------------
------------ ------------
</TABLE>
F-10
<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED WITH RESPECT TO DATA AS OF JUNE 30, 1998 AND FOR
THE SIX-MONTH PERIODS ENDED JUNE 30, 1997 AND 1998)
NOTE E--NOTES PAYABLE (CONTINUED)
- ------------------------
(1) In connection with the issuance of the notes, including $250,000 issued to
an entity which is a principal stockholder of the Company, the Company
issued ten-year warrants valued at $290,000 to purchase 90,791 shares of the
Company's common stock at an exercise price of $6.44 per share, increasing
the effective interest rate on the notes to 91%.
(2) In connection with the issuance of the notes, the Company issued ten-year
warrants valued at $159,000 to purchase 48,888 shares of the Company's
common stock at an exercise price of $6.44 per share, increasing the
effective interest rate to 94%.
(3) In connection with the issuance of the note to a corporation wholly owned by
the Chairman of the Board and a principal stockholder of the Company, the
Company agreed to reduce the exercise price of previously issued warrants to
the noteholder from $6.44 per share (31,040 shares) and $8.05 per share
(31,040 shares) to $3.22 per share (see Note G[5]). In addition, the Company
agreed to reduce the exercise price of warrants to purchase 124,159 shares
of common stock at an exercise price of $3.22 per share previously issued to
the noteholder to $1.61 per share. The Company valued the modified warrants
at $45,000 in excess of the value ascribed to the original warrants,
increasing the effective interest rate to 96%. The warrants exercisable at
$3.22 per share were further reduced to $1.61 per share in connection with
the issuance in November 1997 of a note for $50,000 to the same corporation
referred to above which was repaid in December 1997. This modification was
valued at $22,000 in excess of the value ascribed to the warrants as
previously modified.
(4) In connection with the issuance of the notes to an entity which is a
principal stockholder of the Company and to the corporation referred to in
(3) above, the Company issued ten-year warrants valued at $168,000 to
purchase 70,949 shares of the Company's common stock at an exercise price of
$4.83 per share, increasing the effective interest rate to 86%.
(5) The Company issued notes for $400,000, $100,000 and $1,250,000 on March 2,
1998, April 24, 1998 and May 14, 1998, respectively. In connection with the
issuance of the notes, $1,400,000 of which are payable to the Chairman of
the Board and the entities referred to in (4) above, the Company issued
ten-year warrants valued at $766,000 to purchase 325,919 shares of the
Company's common stock at an exercise price of $4.83 per share, increasing
the effective interest rate to 92%.
The proceeds from the issuance of the notes were allocated to the debt and
the warrants based on their estimated fair values. The Company estimated the
fair value of these warrants using the Black-Scholes pricing model and has
accounted for this amount as a debt discount to be amortized over the life of
the debt.
Interest expense for the years ended December 31, 1996, 1997 and for the six
months ended June 30, 1997 and 1998 includes $325,000, $267,000, $44,000 and
$323,000, respectively, of interest and amortization of debt discount on notes
to related parties.
F-11
<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED WITH RESPECT TO DATA AS OF JUNE 30, 1998 AND FOR
THE SIX-MONTH PERIODS ENDED JUNE 30, 1997 AND 1998)
NOTE F--STOCKHOLDERS' EQUITY
[1] PREFERRED STOCK:
The Company has outstanding 500,000 shares of Series B convertible preferred
stock. Such stock is convertible on a 1.610831-to-1 basis into common shares
and automatically converts into common shares upon the completion of an
initial public offering of the Company's securities which results in gross
proceeds to the Company of a minimum of $4,000,000. The preferred stock has
identical voting rights as the Company's common stock and has a liquidation
preference of $1.00 per share.
[2] STOCK OPTIONS AND WARRANTS:
During 1996, the Board of Directors and stockholders approved the adoption of
the 1996 Stock Option Plan (the "1996 Plan"). The 1996 Plan, as amended,
provides for the granting of both incentive and non-qualified options to
purchase up to 750,000 shares of common stock of the Company.
The term of options granted under the 1996 Plan may not exceed ten years
(five years in the case of an incentive stock option granted to an optionee
owning more than 10% of the voting stock of the Company). The option price
for incentive stock options can not be less than 100% of the fair market
value of the shares of common stock at the time the option is granted (110%
for a 10% stockholder). The exercise price for non-qualified options is set
by the Compensation Committee in its discretion.
The following table summarizes the activity under the 1996 Plan:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------------
SIX MONTHS ENDED
1996 1997 JUNE 30, 1998
---------------------- ---------------------- -----------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
--------- ----------- --------- ----------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C>
Options outstanding at beginning of period......... 104,139 $ 6.44 184,687 $ 5.72
Granted............................................ 107,398 $ 6.44 159,700 $ 5.54 399,832 $ 5.70
Cancelled.......................................... (3,259) $ 6.44 (79,152) $ 6.30 (135,644) $ 5.60
--------- --------- ----------
Options outstanding at end of period............... 104,139 $ 6.44 184,687 $ 5.72 448,875 $ 5.74
--------- --------- ----------
--------- --------- ----------
Options exercisable at end of period............... 82,256 $ 6.44 184,687 $ 5.72 256,761 $ 5.33
--------- --------- ----------
--------- --------- ----------
</TABLE>
The following table presents information relating to stock options
outstanding at December 31, 1997:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING AND EXERCISABLE
- -----------------------------------
<S> <C> <C>
WEIGHTED
WEIGHTED AVERAGE
AVERAGE REMAINING
EXERCISE LIFE IN
SHARES PRICE YEARS
- --------- ----------- -----------
82,876... $ 4.83 9.75
101,811.. $ 6.44 9.03
- ---------
184,687.. $ 5.72 9.35
- ---------
- ---------
</TABLE>
F-12
<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED WITH RESPECT TO DATA AS OF JUNE 30, 1998 AND FOR
THE SIX-MONTH PERIODS ENDED JUNE 30, 1997 AND 1998)
NOTE F--STOCKHOLDERS' EQUITY (CONTINUED)
The following table presents information relating to stock options
outstanding at June 30, 1998 (unaudited):
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
- ----------------------------------- -------------------------------------
<S> <C> <C> <C> <C> <C>
WEIGHTED WEIGHTED
WEIGHTED AVERAGE WEIGHTED AVERAGE
AVERAGE REMAINING AVERAGE REMAINING
EXERCISE LIFE IN EXERCISE LIFE IN
SHARES PRICE YEARS SHARES PRICE YEARS
- --------- ----------- ----------- --------- ----------- -------------
130,989 $ 4.83 9.56 130,989 $ 4.83 9.56
197,828 $ 5.60 9.92 88,214 $ 5.60 9.92
37,558 $ 6.44 8.42 37,558 $ 6.44 8.42
82,500 $ 7.20 10.00
- --------- ---------
448,875 $ 5.74 9.70 256,761 $ 5.33 9.51
- --------- ---------
- --------- ---------
</TABLE>
The weighted average fair value at date of grant for options granted during
the years ended December 31, 1996 and 1997 and the six months ended June 30,
1997 and 1998 were $3.20, $2.76, $3.21 and $2.70 per option, respectively.
The fair value of options at date of grant was estimated using the
Black-Scholes option pricing model utilizing the following weighted average
assumptions:
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
-------------------- --------------------
<S> <C> <C> <C> <C>
1996 1997 1997 1998
--------- --------- --------- ---------
<CAPTION>
(UNAUDITED)
<S> <C> <C> <C> <C>
Risk-free interest rates................................ 6.43% 6.50% 6.59% 5.62%
Expected option life in years........................... 6 6 6 6
Expected stock price volatility......................... 40% 40% 40% 40%
Expected dividend yield................................. 0% 0% 0% 0%
</TABLE>
Had the Company elected to recognize compensation cost based on the fair
value of the options at the date of grant as prescribed by SFAS 123, net
loss for the years ended December 31, 1996 and 1997 and for the six-month
periods ended June 30, 1997 and 1998 would have been $(4,842,000),
$(2,830,000), $(1,007,000) and $(2,898,000) or $(2.65), $(1.53), $(.52) and
$(1.71), respectively, per share.
[3] The Company has the following warrants and options referred to in [4] below
to purchase common stock outstanding as of December 31, 1997:
<TABLE>
<CAPTION>
NUMBER
OF EXERCISE
SHARES PRICE
- --------- -----------
<S> <C>
186,239.. $ 1.61
62,856... 2.42
62,080... 3.22
70,949... 4.83
318,159.. 6.44
93,120... 9.66
- ---------
793,403
- ---------
- ---------
</TABLE>
F-13
<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED WITH RESPECT TO DATA AS OF JUNE 30, 1998 AND FOR
THE SIX-MONTH PERIODS ENDED JUNE 30, 1997 AND 1998)
NOTE F--STOCKHOLDERS' EQUITY (CONTINUED)
From March through May 1998, in connection with the issuance of notes (see
Note E[5]), the Company issued warrants to purchase 325,919 shares of the
Company's common stock at an exercise price of $4.83. The Company also
issued a warrant to purchase 6,208 shares of the Company's common stock at
an exercise price of $6.04 for services rendered.
On July 8, 1998, the Company entered into an agreement with certain of its
option and warrant holders pursuant to which the Company issued 596,741
shares of its common stock in exchange for cancellation of outstanding
warrants to purchase 789,521 shares of the Company's common stock.
[4] PRIVATE PLACEMENT:
During March 1996, the Company completed a private placement of its
securities. The Company issued 667,357 shares of its common stock for $6.44
a share, yielding gross proceeds of $4,300,000. In connection with the
private placement the Company incurred costs aggregating $352,000 including
$279,000 in commissions and expense allowance paid to the placement agent.
The Company also issued options to purchase 66,736 shares of common stock at
an exercise price of $6.44 per share expiring in March 2001 to the placement
agents in connection with the private placement. The investors in the
private placement were granted certain demand and piggyback registration
rights. The Company also sold 31,040 shares of stock in 1996 receiving
proceeds of $200,000.
NOTE G--COMMITMENTS AND CONTINGENCIES
[1] OPERATING LEASES:
The Company leases office facilities in Florida, New York and Texas under
operating leases expiring through 1999. Rental commitments for the remaining
term of the Company's noncancellable leases relating to office space
expiring at various dates through 1999 are as follows:
<TABLE>
<CAPTION>
YEAR ENDING
DECEMBER 31,
- ----------------
<S> <C>
1998............ $ 120,000
1999............ 31,000
----------
$ 151,000
----------
----------
</TABLE>
Rental expense for the years December 31, 1996 and 1997 and for the
six-month periods ended June 30, 1997 and 1998 aggregated $142,000,
$146,000, $71,000 and $71,000, respectively.
[2] SOFTWARE DISTRIBUTION AGREEMENTS:
[A] In June 1997, the Company entered into a software distribution agreement
pursuant to which the Company licensed, on a nonexclusive basis, the
right to incorporate and/or bundle certain technology of the Company,
with the customer's products. In connection therewith, the Company, which
is entitled to royalties based on the customer's sales, received a
$500,000, nonrefundable prepaid royalty, which is included in license
revenue for the year ended December 31, 1997 and the six months ended
June 30, 1997.
[B] In September 1997, the Company entered into a software distribution
agreement, pursuant to which the Company has the right to incorporate
certain technology into its software. The
F-14
<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED WITH RESPECT TO DATA AS OF JUNE 30, 1998 AND FOR
THE SIX-MONTH PERIODS ENDED JUNE 30, 1997 AND 1998)
NOTE G--COMMITMENTS AND CONTINGENCIES (CONTINUED)
Company is required to make certain royalty payments based on unit sales
as defined. The Company is obligated to pay a minimum of $100,000 in
royalties pursuant to the agreement for the period September 1997 to
March 30, 1999. As of December 31, 1997 and June 30, 1998, accrued
royalty payable was approximately $29,000 and $44,000, respectively.
[C] In July 1996, the Company entered into an agreement pursuant to which
certain technology was developed for the Company. The Company is required
to make certain royalty payments based on unit sales as defined, up to a
maximum royalty payment of $100,000. For the year ended December 31, 1997
and the six months ended June 30, 1998, royalties owed pursuant to such
agreement were de minimus.
[3] EMPLOYMENT AGREEMENTS:
In May 1998, the Company entered into an employment agreement with its
President and Chief Executive Officer which provides for a base salary of
$150,000, subject to annual increases of up to 20% by the Board of Directors
at their discretion. The agreement also provides for an annual bonus of up
to $50,000 as determined by the Board of Directors in its discretion. The
agreement expires in May 2002. In connection therewith, the Company granted
the President a five-year option to purchase 294,879 shares of the Company's
common stock at an exercise price of $2.42 per share. The option vests 34%
immediately and then 22% per year thereafter. As the estimated fair value of
the Company's common stock at the date of grant of the option ($5.60 per
share) was in excess of the exercise price the Company will incur aggregate
compensation expense of approximately $938,000 over the service period,
$366,000 of which was charged to expense during the six months ended June
30, 1998 based on the vesting provisions of the option.
The Company has employment agreements with six other officers providing for
aggregate annual salaries of $120,000 through April 1999 with respect to one
officer and aggregate annual salaries of $640,000 through May and August
2001 with respect to five officers. Certain of the agreements provide for
the granting of bonuses at the discretion of the Board of Directors, as well
as options to purchase shares of common stock.
Aggregate salary commitments pursuant to employment agreements are $804,000,
$820,000, $790,000, $470,000 and $56,000 for 1998, 1999, 2000, 2001 and
2002, respectively.
[4] SAVINGS AND INVESTMENT PLAN:
The Company has a Savings and Investment Plan which allows participants to
make contributions by salary reduction pursuant to Section 401(k) of the
Internal Revenue Code of 1986. The Company also may make discretionary
annual matching contributions in amounts determined by the Board of
Directors, subject to statutory limits. The Company did not make any
contributions to the 401(k) Plan during the years ended December 31, 1996
and 1997 and the six months ended June 30, 1998.
[5] FINANCIAL ADVISORY AGREEMENT:
In September 1996, as amended in January 1997, the Company entered into a
financial advisory agreement with a corporation owned by the Chairman of the
Board and a principal stockholder, which expires in January 1999. Pursuant
to such agreement, monthly fees of $12,500 were to be paid to such
F-15
<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED WITH RESPECT TO DATA AS OF JUNE 30, 1998 AND FOR
THE SIX-MONTH PERIODS ENDED JUNE 30, 1997 AND 1998)
NOTE G--COMMITMENTS AND CONTINGENCIES (CONTINUED)
corporation, and the Company issued two 7-year warrants, each to purchase up
to 31,040 shares of common stock at an exercise price of $6.44 and $8.05,
respectively. Such exercise prices were subsequently reduced to an exercise
price of $1.61 per share (see Note E[3]). The Company also agreed to pay
such corporation and another corporation which is a principal stockholder of
the Company, a cash fee equal to 3% of the total proceeds or other
consideration received in connection with a merger or sale of substantially
all of the Company's assets completed by January 2001. Expenses under the
agreement, including amortization of the value ascribed to the warrants,
included in general and administrative expenses, for the year ended December
31, 1997 and the six-month periods ended June 30, 1997 and 1998 amounted to
$253,000, $135,000 and $121,000, respectively.
On May 14, 1998, the Company terminated the monthly fee provision of the
financial advisory agreement and issued 31,250 shares of common stock to
this entity in satisfaction of amounts owed pursuant the agreement.
NOTE H--INCOME TAXES
The principal components of deferred tax assets and valuation allowance are
as follows:
<TABLE>
<CAPTION>
SIX MONTHS
YEAR ENDED ENDED
DECEMBER 31, JUNE 30,
1996 1997 1998
------------- ------------- -------------
<S> <C> <C> <C>
Deferred tax assets:
Net operating loss carryforwards............... $ 1,464,000 $ 2,122,000 $ 2,882,000
Common stock and warrants issued for
compensation and debt discount, not yet
deducted for tax purposes.................... 266,000 525,000 503,000
Other.......................................... 240,000 261,000 275,000
------------- ------------- -------------
1,970,000 2,908,000 3,660,000
Valuation allowance.............................. (1,970,000) (2,908,000) (3,660,000)
------------- ------------- -------------
Net deferred tax asset........................... $ 0 $ 0 $ 0
------------- ------------- -------------
------------- ------------- -------------
</TABLE>
The Company has recorded a valuation allowance for the full amount of its
deferred tax assets as the likelihood of its future realization cannot be
presently determined.
The difference between the tax benefit and the amount that would be computed
by applying the statutory federal income tax rate to loss before taxes is
attributable to the following:
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED
DECEMBER 31, JUNE 30,
-------------------- --------------------
1996 1997 1997 1998
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Income tax benefit--statutory rate.................. (34.0)% (34.0)% (34.0)% (34.0)%
Increase in valuation allowance on deferred tax
assets............................................ 34.0% 34.0% 34.0% 34.0%
--------- --------- --------- ---------
0% 0% 0% 0%
--------- --------- --------- ---------
--------- --------- --------- ---------
</TABLE>
F-16
<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED WITH RESPECT TO DATA AS OF JUNE 30, 1998 AND FOR
THE SIX-MONTH PERIODS ENDED JUNE 30, 1997 AND 1998)
NOTE H--INCOME TAXES (CONTINUED)
At December 31, 1997, the Company has available net operating loss
carryforwards to reduce future federal taxable income of approximately
$5,500,000 for tax reporting purposes which expire from 2009 through 2012.
Pursuant to the provisions of the Internal Revenue Code, future utilization of
these past losses is subject to certain limitations based on changes in the
ownership of the Company's stock that have occurred or are likely to occur.
NOTE I--OTHER MATTERS
[1] For the year ended December 31, 1997, approximately $500,000 (21%), $362,000
(15%) and $298,000 (13%) of the Company's revenues were from three
customers. For the six months ended June 30, 1998, approximately $285,000
(32%), $154,000 (17%) and $95,000 (11%) of the Company's revenues
respectively, were from one customer, the second customer referred to above,
and a third customer. No customer accounted for 10% or more of the Company's
revenue for the year ended December 31, 1996 and one customer accounted for
$500,000 in sales (35%) for the six months ended June 30, 1997.
[2] For the years ended December 31, 1996 and 1997 and for the six months ended
June 30, 1997 and 1998, export sales of the Company's products amounted to
approximately $69,000, $370,000, $237,000 and $16,000, respectively.
NOTE J--SUBSEQUENT EVENTS
In August, 1998 the Company formed a wholly owned subsidiary, Network-1
Acquisition Corp. (the "Purchaser"). Pursuant to an agreement and plan of merger
dated September 11, 1998 between the Company, the Purchaser and CommHome Systems
Corporation ("CommHome"), upon closing of the offering CommHome will be merged
with and into the Purchaser with the shareholders of CommHome receiving 35,000
shares of the Company's common stock. The Company's President is also the
President of CommHome and owns 51% of its outstanding common stock. The
Purchaser also agreed to assume liabilities of CommHome of up to $200,000
including $105,000 which is owed to two officers of the Company and which will
be satisfied by the issuance of 13,125 shares of the Company's common stock. The
Company will incur a charge of approximately $469,000 for purchased research and
development upon the acquisition which will be accounted for as a purchase.
CommHome is a development stage company and has had no revenues. The principal
activity has been the design of residential networking solutions. The Company
intends to incorporate CommHome's designs into its future security products.
F-17
<PAGE>
Exhibit 3.2
AMENDMENT TO
AMENDED AND RESTATED BY-LAWS
OF
NETWORK-1 SECURITY SOLUTIONS, INC.
A DELAWARE CORPORATION
Article III, Section 6 of the Amended and Restated By-laws of Network-1
Security Solutions, Inc. (the "Corporation") is amended, as follows:
Section 6. SPECIAL MEETINGS. Special meetings of the stockholders of
the Corporation may be called, for any purpose or purposes, unless
otherwise prescribed by statute or by the Certificate of Incorporation, by
(i) the Chairman of the Board of Directors, (ii) the President, (iii) the
Board of Directors, or (iv) the holders of not less than 10% of the shares
entitled to vote at such meeting, and shall be called by the President or
Secretary at the request in writing of a majority of the stockholders
entitled to vote thereat. No business may be transacted at such meeting
other than specified in notice of such meeting.
<PAGE>
Exhibit 4.1
NUMBER SHARES
NETWORK-1 SECURITY SOLUTIONS, INC.
INCORPORATED UNDER THE LAWS OF THE STATE OF DELAWARE
COMMON STOCK CUSIP 64121N 10 9
SEE REVERSE FOR CERTAIN DEFINITIONS
THIS CERTIFIES THAT
is the owner of
FULLY PAID AND NON-ASSESSABLE SHARES OF COMMON STOCK OF
NETWORK-1 SECURITY SOLUTIONS, INC., transferable on the books of the
Corporation in person or by attorney upon surrender of this certificate duly
endorsed or assigned. This certificate and the shares represented hereby are
subject to the laws of the State of Delaware, and to the Certificate of
Incorporation and By-Laws of the Corporation, as now or hereafter amended.
This certificate is not valid until countersigned and registered by the
Transfer Agent and Registrar.
WITNESS the facsimile seal of the Corporation and the facsimile
signatures of its duly authorized officers.
Dated:
SEAL
/s/ Avi A. Fogel /s/ Robert Russo
------------------------- -------------------------
President Secretary
Countersigned and Registered:
AMERICAN STOCK TRANSFER & TRUST COMPANY
(NEW YORK, NY)
Transfer Agent
and Registrar,
Authorized Signature
<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.
THE CORPORATION WILL FURNISH, WITHOUT CHARGE, TO EACH STOCKHOLDER WHO SO
REQUESTS A COPY OF THE POWERS, DESIGNATIONS, PREFERENCES AND RELATIVE
PARTICIPATION, OPTIONAL OR OTHER SPECIAL RIGHTS OF EACH CLASS OF STOCK OR
SERIES THEREOF AND THE QUALIFICATIONS, LIMITATIONS OR RESTRICTIONS OF SUCH
PREFERENCES AND/OR RIGHTS APPLICABLE TO EACH CLASS OF STOCK OR SERIES
THEREOF. ANY SUCH REQUEST SHOULD BE ADDRESSED TO THE SECRETARY OF THE
CORPORATION AT ITS PRINCIPAL PLACE OF BUSINESS.
The following abbreviations when used in the inscription on the face of this
certificate, shall be construed as though they were written out in full
according to applicable laws or regulations:
TEN COM - as tenants in common UNIF TRANSFERS MIN ACT-_____________
(Cust)
Custodian___________
(Minor)
TEN ENT - as tenants by the under Uniform Transfers to Minors Act
entireties
JT TEN - as joint tenants
with right of
survivorship and
not as tenants ___________________________
in common (State)
Additional abbreviations may also be used though not in the above list
For value received, _______________ hereby sell, assign and transfer unto
PLEASE INSERT SOCIAL SECURITY OR OTHER
IDENTIFYING NUMBER OF ASSIGNEE
--------------------------------------
- --------------------------------------------------------------------------------
Please print or typewrite name and address including postal zip code of assignee
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------Shares
of the Common Stock evidenced by the within Certificate, and do hereby
irrevocably constitute and appoint----------------------------------------------
- --------------------------------------------------------------------------------
Attorney to transfer the said stock on the books of the within-named
Corporation with full power of substitution in the premises.
Dated, ---------------------------
NOTICE: The signature to this assignment must correspond with the name as
written upon the face of the Certificate, in every particular, without
alteration or enlargement, or any change whatever.
<PAGE>
Exhibit 5.1
[BIZAR MARTIN & TAUB, LLP LETTERHEAD]
September 16, 1998
Network-1 Security Solutions, Inc.
70 Walnut Street
Wellesley Hills, MA 02481
Re: Registration Statement on Form SB-2 (File No. 333-59617)
Gentlemen:
We have acted as special counsel to Network-1 Security Solutions, Inc.,
a Delaware corporation (the "Company"), in connection with the proposed public
offering of 1,875,000 shares (the "Firm Shares") of the Company's common stock,
$0.01 par value (the "Common Stock"), and up to an additional 281,250 shares
(the "Option Shares") of Common Stock subject to an over-allotment option
granted to the underwriter of such public offering. The Firm Shares and the
Option Shares are hereinafter referred to collectively as the "Shares". The
Company has filed a Registration Statement on Form SB-2 (File No. 333-59617) (as
amended, the "Registration Statement"), with the Securities and Exchange
Commission (the "Commission") pursuant to the Securities Act of 1933, as amended
(the "Act"), with respect to the public offering of the Shares. As such counsel,
you have requested our opinion as to the matters described herein relating to
the issuance of the Shares.
In connection with this opinion, we have examined and relied upon
copies, certified or otherwise identified to our satisfaction, of: (i) the
Company's Amended and Restated Certificate of Incorporation and Amended and
Restated By-laws, as amended to date; (ii) the minute books and other records of
corporate proceedings of the Company through the date hereof as made available
to us by officers of the Company; and (iii) an executed copy of the Registration
Statement, and each amendment thereto through the date hereof, together with the
exhibits and schedules thereto, in the form filed with the Commission; and we
have reviewed such matters of law and fact deemed necessary by us to deliver the
within opinion.
<PAGE>
September 16, 1998
Page 2
For purposes of this opinion we have assumed the authenticity of all
documents submitted to us as originals, the conformity to originals of copies,
and the authenticity of the originals of such copies. We have also assumed the
legal capacity of all natural persons, the genuineness of all signatures on all
documents examined by us, the authority of such persons signing on behalf of the
parties thereto other than the Company and the due authorization, execution and
delivery of all documents by the parties thereto other than the Company. As to
certain factual matters, we have, to the extent that relevant facts were not
independently established by us, relied on certificates of public officials and
statements and representations of officers and other representatives of the
Company.
Based upon and subject to the foregoing assumptions and the further
limitations set forth below, it is our opinion that the Shares when issued and
sold in the manner referred to in the Registration Statement, will be legally
and validly issued, fully paid and non-assessable.
This opinion is limited to the specific issues addressed herein, and no
opinion may be inferred or implied beyond that expressly stated herein. We
assume no obligation to revise or supplement this opinion should the corporate
laws of the State of Delaware or the federal laws of the United States be
changed by legislative action, judicial decision or otherwise.
We hereby consent to the filing of this opinion letter as an exhibit to
the Registration Statement and to the reference to our firm under the
heading "Legal Matters" in the prospectus constituting part of the Registration
Statement.
Very truly yours,
/s/ Bizar Martin & Taub, LLP
----------------------------
BIZAR MARTIN & TAUB, LLP
<PAGE>
Exhibit 10.5
September 10, 1998
Mr. Robert Russo
Network-1 Security Solutions, Inc.
909 Third Avenue, 9th Floor
New York, NY 10022
Re: Amendment to Employment Agreement
Dear Mr. Russo:
This letter shall serve to amend, as of June 1, 1998, Section 3 of the
Employment Agreement, dated April 4, 1994, as previously amended on February 16,
1996 (the "Agreement"), between you and Network-1 Security Solutions, Inc. (the
"Company"), as follows:
"3. COMPENSATION
(a) The Company shall pay to Executive an annual base salary (the
"Base Salary") during the term of employment of $120,000 per annum, payable
in such installments (but not less often than monthly) as is generally the
policy of the Company with respect to its executive officers, which Base
Salary shall be subject to such increases as the Compensation Committee of
the Board, in its sole discretion, may from time to time determine.
Executive's Base Salary and performance shall be reviewed at least annually
by the Board.
(b) In addition, to the Base Salary set forth in paragraph 3(a) above,
during the term of employment, Executive shall be eligible to receive bonus
compensation of up to $30,000 per annum, subject to the discretion of the
Compensation Committee of the Board."
All of the other terms and conditions of the Agreement shall remain in full
force and effect.
Very truly yours,
Network-1 Security Solutions, Inc.
By: /s/ Avi A. Fogel
----------------
Avi A. Fogel, President
Agreed and Accepted:
/s/ Robert Russo
- --------------------------
Robert Russo
<PAGE>
Exhibit 10.20
EMPLOYMENT AGREEMENT dated as of July 31, 1998, between
NETWORK-1 SECURITY SOLUTIONS, INC., a Delaware corporation with its principal
office located at 70 Walnut Street, Wellesley, Massachusetts 02481 (the
"Company"), and JOSEPH A. DONOHUE residing at 16 Celestial Way, Pepperell,
Massachusetts 01776 (the "Executive").
The Company desires to enter into this Agreement in order to
assure itself of the service of Executive, and Executive desires to accept
employment with the Company, upon the terms and conditions hereinafter set
forth.
NOW, THEREFORE, in consideration of the mutual covenants and
obligations hereinafter set forth, the parties agree as follows:
SECTION 1. Employment. The Company hereby employs Executive,
and Executive hereby accepts employment by the Company, upon the terms and
conditions hereinafter set forth.
SECTION 2. Term. The employment of Executive hereunder shall
be for a period commencing on the date hereof (the "Commencement Date") and
ending on the third anniversary of the Commencement Date (the "Term") or such
earlier date upon which the employment of the Executive shall terminate in
accordance with the provisions hereof. The period commencing on the Commencement
Date and ending on the date of termination of the Executive's employment
hereunder shall be called the "Term of Employment" for Executive, and the date
on which the Executive's employment hereunder shall terminate shall be called
the "Termination Date".
SECTION 2. Duties. During the Term of Employment, Executive
shall be employed as the Vice President of Engineering of the Company and shall
perform such duties as are consistent therewith as the Chief Executive Officer
and Board of Directors of the Company (the "Board") shall designate. Executive
shall use his best efforts to perform well and faithfully the foregoing duties
and responsibilities.
SECTION 4. Time to be Devoted to Employment. During the Term
of Employment, Executive shall devote all of his business time, attention and
energies to the business of the Company (except for vacations to which he is
entitled pursuant to Section 6(b) and periods of illness or incapacity). During
the Term of Employment, Executive shall not engage in any business activity
which, in the reasonable judgment of the Board, conflicts with the duties of
Executive hereunder, whether or not such activity is pursued for gain, profit or
other pecuniary advantage.
<PAGE>
SECTION 5. Compensation.
(a) The Company shall pay to Executive an annual base
salary (the "Base Salary") during the Term of Employment of $120,000 per annum,
payable in such installments (but not less often than monthly) as is generally
the policy of the Company with respect to its executive officers, which Base
Salary shall be subject to such increases as the Compensation Committee of the
Board, in its sole discretion, may from time to time determine. Executive's Base
Salary and performance shall be reviewed at least annually by the Board.
(b) In addition, to the Base Salary set forth in
paragraph 5(a) above, during the term of employment, Executive shall be eligible
to receive incentive compensation of up to $30,000 per annum (to be distributed
as directed by the Board of Directors) subject to the discretion of the
Compensation Committee of the Board.
(c) On the Commencement Date the Company shall grant to
the Executive an incentive stock option (the "Option") of ten (10) years'
duration for the purchase of 62,500 shares (the "Shares") of the Company's
Common Stock at an exercise price of $7.20 per share. The Option shall vest as
to 34% of the Shares covered thereby on the Commencement Date and an additional
22% of the Shares covered thereby on each anniversary of the Commencement Date,
conditioned only on the Executive's continued employment by the Company. The
form of Option is attached as Exhibit A hereto.
SECTION 6. Business Expenses; Benefits.
(a) The Company shall reimburse Executive, in accordance
with the practice from time to time for executive officers of the Company, for
all reasonable and necessary expenses and other disbursements incurred by
Executive for or on behalf of the Company in the performance of Executive's
duties hereunder. Executive shall provide such appropriate documentation of
expenses and disbursements as may from time to time be required by the Company.
(b) During the Term of Employment, Executive shall be
entitled to four (4) weeks vacation per year.
(a) During the Term of Employment, Executive shall be
entitled to participate in the group health, life and disability insurance
benefits, and retirement plan benefits made available from time to time for its
employees generally.
2
<PAGE>
SECTION 7. Involuntary Termination.
(a) If Executive is incapacitated or disabled (such
condition being hereinafter referred to as a "Disability") in a manner that
would qualify Executive for benefits under the disability policy of the Company
(the "Disability Policy"), the Term of Employment and employment of the
Executive under this Agreement shall cease (such termination, as well as a
termination under Section 7(b), being hereinafter referred to as an "Involuntary
Termination") and Executive shall be entitled to receive the benefits payable
under the Disability Policy and in accordance with Section 9 hereof.
(b) If Executive dies during the Term of Employment, the
Term of Employment and Executive's employment hereunder shall cease as of the
date of the Executive's death and Executive shall be entitled to receive the
benefits payable in accordance with Section 9 hereof.
SECTION 8. Termination by the Company.
(a) Termination For Cause. The Company may terminate the
Term of Employment and the employment of the Executive hereunder at any time for
Cause (as hereinafter defined) (such termination being referred to herein as a
"Termination For Cause") by giving Executive written notice of such termination,
effective immediately upon the giving of such notice to the Executive. As used
in this Agreement, "Cause" means the Executive's (a) commission of an act (i)
constituting a felony or (ii) involving fraud, moral turpitude, theft or
dishonesty which is not a felony and which materially adversely affects the
Company or could reasonably be expected to materially adversely affect the
Company, (b) repeated failure to be reasonably available to perform his duties,
which, if curable, shall not have been cured within 30 business days of written
notice thereof from the Company, (c) repeated failure to follow the lawful
directions of the Board, which, if curable, shall not have been cured within 30
business days of written notice thereof from the Company, (d) material breach of
any agreement with the Company (including any provisions of this or any
agreement between Executive and the Company) which, if curable, shall not have
been cured within 30 business days of written notice thereof from the Company or
(e) voluntary resignation (except as set forth in paragraph 9(d) hereof).
(b) Termination Other Than for Cause. The Company may
terminate this Agreement and the employment of Executive other than for cause as
defined in Section 8(a) above (such termination shall be defined as a
"Termination Other Than for Cause") by giving Executive written notice of such
termination, which notice
3
<PAGE>
shall be effective upon the giving of such notice or such later date set forth
therein.
SECTION 9. Effect of Termination.
(a) Upon the termination of the Term of Employment and
Executive's employment hereunder due to Termination for Cause (as defined in
Section 8(a) above), neither Executive nor his beneficiary or estate shall have
any further rights or claims against the Company under this Agreement, except to
receive (i) the unpaid portion, if any, of the Base Salary provided for in
Section 5(a), computed on a pro rata basis to the Termination Date (based on the
actual number of days elapsed over the actual number of days elapsed over the
year in which such termination occurs), (ii) any unpaid accrued benefits of
Executive, (iii) reimbursement for any expenses for which Executive shall not
have been reimbursed as provided in Section 6(a), and (iv) Executive's rights
under the vested portion of the Option.
(b) Upon the termination of Executive's employment
hereunder due to an Involuntary Termination, neither Executive nor his
beneficiary or estate shall have any further rights or claims against the
Company under this Agreement except the right to receive (i) the amounts set
forth in Section 9(a), and (ii)the vesting of all of the Options that would have
vested in the year of Involuntary Termination and one-half of the Options that
would have vested in the year following the year of Involuntary Termination.
(c) Upon the termination of Executive's employment upon
a Termination Other Than for Cause (as defined in Section 8(b) above), neither
Executive nor his beneficiary nor his estate shall have any rights or claims
against the Company except to receive (i) the amounts set forth in 9(b)
(including Options), and (ii) the lesser of (A) six months Base Salary as in
effect at the time of the Termination Other Than for Cause or (B) Executive's
Base Salary for the balance of the term of this Agreement.
(d) For purposes of this Section 9, if Executive is
asked to assume any duties or the material reduction of duties, either of which
is substantially inconsistent with the position of Vice President of Engineering
of the Company, Executive, upon 30 days notice to the Board of Directors setting
forth in reasonable detail the respects in which Executive believes such
assignment or duties are substantially inconsistent with the level of
Executive's position, may resign from the Company and such resignation will be
treated as a Termination Other Than For Cause pursuant to this Section 9.
SECTION 10. Insurance. The Company may, for its own benefit,
in its sole discretion, maintain "key-man" life and
4
<PAGE>
disability insurance policies covering Executive. Executive will cooperate with
the Company and provide such information or other assistance as the Company may
reasonably request in connection with the Company's obtaining and maintaining
such policies.
SECTION 11. Disclosure of Information. Executive will not,
either during the Term of Employment or at any time thereafter, divulge,
publish, communicate, furnish or make accessible to anyone any knowledge or
information with respect to the Company's confidential, secret or proprietary
products, technology, methods, plans, materials and processes, or with respect
to any other confidential, secret or proprietary aspects of the business,
activities or products of the Company including, without limitation, (a)
software programs, source code, object code, product development information,
research and development projects or other technical data pertaining to the
Company's products (whether or not subject to patent, trademark or copyright
protection) or (b) any customer or client lists, telephone leads, prospects
lists, sales figures and forecasts, purchase costs, financial projections,
advertising and marketing plans and business strategies and plans; except as
such items set forth in clauses (a) and (b) above may already be in the public
domain through no fault of Executive (all of the foregoing items set forth in
clauses (a) and (b) being referred to herein collectively as "Confidential
Property"). Upon the termination of the Term of Employment, Executive shall
return to the Company all property (including Confidential Property) of the
Company (or any subsidiary or affiliate thereof) then in the possession of
Executive and all books, records, computer tapes or discs and all other material
containing non-public information concerning the business, clients or affairs of
the Company or any subsidiary or affiliate thereof.
SECTION 12. Right to Inventions. Executive shall promptly
disclose, grant and assign to the Company for its sole use and benefit any and
all marks, designs, logos, inventions, improvements, technical information and
suggestions relating in any way to the business conducted by the Company, which
he may develop or which may be acquired by Executive during the Term of
Employment (whether or not during usual working hours), together with all
trademarks, patent applications, letters, patent, copyrights and reissues
thereof that may at any time be granted for or upon any such mark, design, logo,
invention, improvement or technical information (collectively, "Inventions"). In
connection therewith, Executive shall (at the Company's sole cost and expense)
take all actions reasonably necessary or desirable to assign and/or confirm the
assignment of any Invention to the Company.
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SECTION 13. Restrictive Covenant.
(a) The Company is in the business of developing,
marketing, licensing and supporting network software security products and also
provides consulting in network security, network design, troubleshooting and
engineering (the "Business"). Executive acknowledges and recognizes that the
Business has been conducted, and sales of its products have been made,
throughout the United States, and Executive further acknowledges and recognizes
the highly competitive nature of the industry in which the Business is involved.
Accordingly, in consideration of the premises contained herein, the
consideration to be received hereunder, stock options to be granted Executive,
Executive shall not, during the Non-Competition Period (as defined below): (i)
directly or indirectly engage, whether or not such engagement shall be as a
partner, stockholder, affiliate or other participant, in any Competitive
Business (as defined below), or represent in any way any Competitive Business,
whether or not such engagement or representation shall be for profit, (ii)
interfere with, disrupt or attempt to disrupt the relationship, contractual or
otherwise, between the Company and any other person or entity, including,
without limitation, any customer, supplier, employee or consultant of the
Company, (iii) induce any employee of the Company to terminate his employment
with the Company or to engage in any Competitive Business in any manner
described in the foregoing clause (i) (as well as an officer or director of any
Competitive Business), or (iv) affirmatively assist or induce any other person
or entity to engage in any Competitive Business in any manner described in the
foregoing clause (i) (as well as an officer or director of any Competitive
Business). Anything contained in this Section 13 to the contrary
notwithstanding, an investment by Executive in any publicly traded company in
which Executive and his affiliates exercise no operational or strategic control
and which constitutes less than 5% of the capital of such entity shall not
constitute a breach of this Section 13.
(b) As used herein, "Non-Competition Period" shall mean
the period commencing on the date hereof and terminating on the Termination
Date; provided, however, that if the Term of Employment shall have been
terminated pursuant to Section 8 (a), then "Non-Competition Period" shall mean
the period commencing on the date hereof and ending on the second anniversary of
the Termination Date. "Competitive Business" shall mean any business in any
State of the United States engaged in the development, marketing and licensing
of network software security products, or in any other line of business in which
the Company was engaged or had a formal plan to enter as of the Termination
Date.
(c) Executive understands that the foregoing
restrictions may limit his ability to earn a livelihood in a business similar to
the business of the Company, but he
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nevertheless believes that he has received and will receive sufficient
consideration and other benefits as an employee of the Company and as otherwise
provided hereunder and pursuant to other agreements between the Company and
Executive to justify clearly such restrictions which, in any event (given his
education, skills and ability), Executive does not believe would prevent him
from earning a living.
SECTION 14. Enforcement; Severability; Etc. It is the desire
and intent of the parties that the provisions of this Agreement shall be
enforced to the fullest extent permissible under the laws and public policies
applied in each jurisdiction in which enforcement is sought. Accordingly, if any
particular provision of this Agreement shall be adjudicated to be invalid or
unenforceable, such provision shall be deemed amended to (a) delete therefrom
the portion thus adjudicated to be invalid or unenforceable, such deletion to
apply only with respect to the operation of such provision in the particular
jurisdiction in which such adjudication is made or (b) otherwise to render it
enforceable in such jurisdiction.
SECTION 15. Remedies. Executive acknowledges and understands
that the provisions of this Agreement are of a special and unique nature, the
loss of which cannot be adequately compensated for in damages by an action at
law, and that the breach or threatened breach of the provisions of this
Agreement would cause the Company irreparable harm. In the event of a breach or
threatened breach by Executive of the provisions of this Agreement, the Company
shall be entitled to an injunction restraining him from such breach. Nothing
contained in this Agreement shall be construed as prohibiting the Company from
or limiting the Company in pursuing any other remedies available for any breach
or threatened breach of this Agreement.
SECTION 16. Notices. All notices, claims, certificates,
requests, demands and other communications hereunder shall be in writing and
shall be deemed to have been duly given and delivered if personally delivered or
if sent by a nationally-recognized overnight courier, by telecopy, or by
registered or certified mail, return receipt requested and postage prepaid,
addressed as follows:
if to the Company, to: Network-1 Security Solutions, Inc.
70 Walnut Street
Wellesley, Massachusetts 02481
Attention: Avi Fogel, President
and Chief Executive Officer
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with copies to: Bizar Martin & Taub, LLP
1350 Avenue of the Americas
29th Floor
New York, NY 10019
Telecopier:(212) 581-8958
Telephone: (212) 265-8600
Attention: Sam Schwartz, Esq.
if to Executive, to: Joseph A. Donohue
16 Celestial Way
Pepperell, Massachusetts 01776
or to such other address as the party to whom notice is to be given may have
furnished to the other party or parties in writing in accordance herewith. Any
such notice or communication shall be deemed to have been received (a) in the
case of personal delivery, on the date of such delivery, (b) in the case of
nationally-recognized overnight courier, on the next business day after the date
when sent, (c) in the case of telecopy transmission, when received, and (d) in
the case of mailing, on the third business day following that on which the piece
of mail containing such communication is posted.
SECTION 17. Binding Agreement; Benefit. The provisions of this
Agreement will be binding upon, and will inure to the benefit of, the respective
heirs, legal representatives, successors and assigns of the parties.
SECTION 18. Governing Law. This Agreement will be governed by,
construed and enforced in accordance with, the laws of the State of
Massachusetts (without giving effect to principles of conflicts of laws).
SECTION 19. Waiver of Breach. The waiver by either party of a
breach of any provision of this Agreement must be in writing and shall not
operate or be construed as a waiver of any other breach.
SECTION 20. Entire Agreement; Amendments. This Agreement
contains the entire agreement between the parties with respect to the subject
matter hereof and supersedes all prior agreements or understandings between the
parties with respect thereto. This Agreement may be amended only by an agreement
in writing signed by the parties.
SECTION 21. Headings. The section headings contained in this
Agreement are for reference purposes only and shall not affect in any way the
meaning or interpretation of this Agreement.
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SECTION 22. Assignment. This Agreement is personal in its
nature and the parties shall not, without the consent of the other, assign or
transfer this Agreement or any rights or obligations hereunder; provided,
however, that the Company may assign this Agreement to any of its subsidiaries
and affiliates.
SECTION 23. Gender. Any reference to the masculine gender
shall be deemed to include the feminine and neuter genders unless the context
otherwise requires.
SECTION 24. Counterparts. This Agreement may be executed in
counterparts, and each such counterpart shall be deemed to be an original
instrument, but all such counterparts together shall constitute but one
agreement.
IN WITNESS WHEREOF, the parties hereto have executed and
delivered this Employment Agreement as of the date first written above.
NETWORK-1 SECURITY SOLUTIONS, INC.
By: /s/ Avi A. Fogel
-----------------------------------
Avi A. Fogel, President and
Chief Executive Officer
/s/ Joseph A. Donohue
-----------------------------------
Joseph A. Donohue
9
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INCENTIVE STOCK OPTION
To: Joseph A. Donohue
----------------------------------------------------------------------
Name
16 Celestial Way, Pepperell, MA 01463
----------------------------------------------------------------------
Address
Date of Grant: July , 1998
-----------------------------------------------------------
You are hereby granted an option (the "Option"), effective as of the
date hereof, to purchase 62,500 shares of Common Stock, par value $.01 per share
("Common Stock"), of Network-1 Security Solutions, Inc. (the "Company") at a
price of $7.20 per share pursuant to the Company's 1996 Stock Option Plan (the
"Plan") adopted by the Company's Board of Directors effective March 7, 1996.
Your option price is intended to equal at least the fair market value of the
Company's Common Stock as of the date hereof; provided, however, that if, at the
time this option is granted, you own stock possessing more than 10% of the total
combined voting power of all shares of stock of the Company or any parent or
subsidiary (an "Affiliate") of the Company (a "10% Shareholder"), your option
price is intended to be at least 110% of the fair market value of the Company's
Common Stock as of the date hereof.
This Option shall vest as follows: (i) as to 34% of the shares
underlying the Option on the date of this Option;(ii) as to the balance of 66%
of the shares underlying the Option, 22% of such shares on each of the first
three anniversary dates of the date of this Option, provided the Optionee is
then an employee of the Company; (iii) as to 50% of the remaining shares
underlying the Option if a Change in Control (as hereinafter defined) occurs
within one year of the date of this Option, provided the Optionee is then an
employee of the Company; (iv) as to all of the unvested portion of this Option
if a Change of Control (as hereinafter defined) occurs more than one year after
the date of this Option, provided the Optionee is then an employee of the
Company.
<PAGE>
The shares subject to this Option shall be adjusted for any change in
the outstanding shares of the Common Stock of the Company by reason of a stock
dividend, stock split, combination of shares, recapitalization, merger,
consolidation, transfer of assets, reorganization, conversion or what the
Compensation Committee deems in its sole discretion to be similar circumstances.
No fractional shares shall be issued or delivered.
This Option shall terminate and is not exercisable after the expiration
of ten years from the date of its grant (five years from the date of grant if,
at the time of the grant, you are a 10% Shareholder) (the "Scheduled Termination
Date"), except if terminated earlier as hereinafter provided (the "Termination
Date").
A "change of control" shall be deemed to have occurred upon the
happening of any of the following events:
(i) the acquisition by any person, entity or "group",
within the meaning of Section 13(d)(3) or 14(d)(2) of
the Securities Exchange Act of 1934, as amended(the
"Exchange Act"), of beneficial ownership (within the
meaning of Rule 13d-3 promulgated under the Exchange
Act) of forty (40%) percent or more of the combined
voting power of the then outstanding securities
entitled to vote generally in the election of
directors where such person, entity or group owned
less than 5% of such voting power on the date of this
Option; or
(ii) The shareholders of the Company approve a merger or
consolidation of the Company with any other
corporation, other than a merger or consolidation
which would result in the voting securities of the
Company outstanding immediately prior thereto
continuing to represent (either by remaining
outstanding or by being converted into voting
securities of the surviving entity) more than fifty
percent (50%) of the total voting power represented
by the voting securities of the Company or such
surviving entity outstanding
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immediately after such merger or consolidation, or
the shareholders of the Company approve a plan of
complete liquidation of the Company or an agreement
for the sale or disposition by the Company of all or
substantially all of the Company's assets (other than
to a subsidiary or subsidiaries).
(iii) Any other event deemed to constitute a "change in
control" by the Compensation Committee.
You may exercise your option as set forth in Section 7 of the Plan.
If the Company's Common Stock has not been registered under Section 12
of the Securities Exchange Act of 1934, the exercise of your option will not be
effective unless and until you execute and deliver to the Company a Stock
Restriction Agreement, in the form on file in the office of the Secretary of the
Company.
Your Option will, to the extent not previously exercised by you,
terminate thirty (30) days after the date on which your employment by the
Company or Affiliate of the Company is terminated, whether such termination is
voluntary or not, other than by reason of disability as defined in Section
22(e)(3) of the Internal Revenue Code of 1986, as amended (the "Code"), and the
regulations thereunder, or death, in which case your Option will terminate six
(6) months from the date of termination of employment due to disability or death
(but in no event later than the Scheduled Termination Date). After the date your
employment is terminated, as aforesaid, you may exercise this Option only for
the number of shares which you had a right to purchase and did not purchase on
the date your employment terminated. If you are employed by an Affiliate of the
Company, your employment shall be deemed to have terminated on the date your
employer ceases to be an Affiliate of the Company, unless you are on that date
transferred to the Company or another Affiliate of the Company. Your employment
shall not be deemed to have terminated if you are transferred from the Company
to an Affiliate, or vice versa, or from one Affiliate to another Affiliate.
Anything in this Option to the contrary notwithstanding, your
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<PAGE>
option will terminate immediately if your employment is terminated for cause (as
determined by the Company in its sole and absolute discretion). Your employment
shall be deemed to have been terminated for cause if you are terminated due to,
among other reasons, (i) your willful misconduct or gross negligence, (ii) your
material breach of any agreement with the Company or (iii) your failure to
render satisfactory services to the Company.
If you die while employed by the Company or an Affiliate of the
Company, your legatee(s), distributee(s), executor(s) or administrator(s), as
the case may be, may, at any time within six (6) months after the date of your
death (but in no event later than the Scheduled Termination Date), exercise the
Option as to any shares which you had a right to purchase and did not purchase
during your lifetime. If your employment with the Company, or an Affiliate is
terminated by reason of your becoming disabled (within the meaning of Section
22(e)(3) of the Code and the regulations thereunder), you or your legal guardian
or custodian may at any time within six (6) months after the date of such
termination (but in no event later than the Scheduled Termination Date),
exercise the Option as to any shares which you had a right to purchase and did
not purchase prior to such termination. Your legatee, distributee, executor,
administrator, guardian or custodian must present proof of his authority
satisfactory to the Company prior to being allowed to exercise this Option.
This Option is not transferable otherwise than by will or the laws of
descent and distribution, and is exercisable during your lifetime only by you,
including, for this purpose, your legal guardian or custodian in the event of
disability. Until the Option price has been paid in full pursuant to due
exercise of this Option and the purchased shares are delivered to you, you do
not have any rights as a shareholder of the Company. The Company reserves the
right not to deliver to you the shares purchased by virtue of the exercise of
this Option during any period of time in which the Company deems, in its sole
discretion, that such delivery would violate a federal, state, local or
securities exchange rule, regulation or law.
Notwithstanding anything to the contrary contained herein, this Option
is not exercisable until all of the following events occur and during the
following periods of time:
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(a) Until the Plan pursuant to which this Option is granted is approved
by the shareholders of the Company in the manner prescribed by the Code and the
regulations thereunder;
(b) Until this Option and the optioned shares are approved and/or
registered with such federal, state and local regulatory bodies or agencies and
securities exchanges as the Company may deem necessary or desirable; or
(c) During any period of time in which the Company deems that the
exercisability of this Option, the offer to sell the shares optioned hereunder,
or the sale thereof, may violate a federal, state, local or securities exchange
rule, regulation or law, or may cause the Company to be legally obligated to
issue or sell more shares than the Company is legally entitled to issue or sell.
The following two paragraphs shall be applicable if, on the date of
exercise of this Option, the Common Stock to be purchased pursuant to such
exercise has not been registered under the Securities Act of 1933, as amended,
and under applicable state securities laws, and shall continue to be applicable
for so long as such registration has not occurred:
(a) The optionee hereby agrees, warrants and represents that he will
acquire the Common Stock to be issued hereunder for his own account for
investment purposes only, and not with a view to, or in connection with, any
resale or other distribution of any of such shares, except as hereafter
permitted. The optionee further agrees that he will not at any time make any
offer, sale, transfer, pledge or other disposition of such Common Stock to be
issued hereunder without an effective registration statement under the
Securities Act of 1933, as amended, and under any applicable state securities
laws or an opinion of counsel acceptable to the Company to the effect that the
proposed transaction will be exempt from such registration The optionee shall
execute such instruments, representations, acknowledgements and agreements as
the Company may, in its sole discretion, deem advisable to avoid any violation
of federal, state, local or securities exchange rule, regulation or law.
(b) The certificates for Common Stock to be issued to the optionee
hereunder shall bear the following legend:
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<PAGE>
"The shares represented by this certificate have not been
registered under the Securities Act of 1933, as amended, or
under applicable state securities laws. The shares have been
acquired for investment and may not be offered, sold,
transferred, pledged or otherwise disposed of without an
effective registration statement under the Securities Act of
1933, as amended, and under any applicable state securities
laws or an opinion of counsel acceptable to the Company that
the proposed transaction will be exempt from such
registration."
The foregoing legend shall be removed upon registration of the legended shares
under the Securities Act of 1933, as amended, and under any applicable state
laws or upon receipt of any opinion of counsel acceptable to the Company that
said registration is no longer required.
The sole purpose of the agreements, warranties, representations and
legend set forth in the two immediately preceding paragraphs is to prevent
violations of the Securities Act of 1933, as amended, and any applicable state
securities laws.
It is the intention of the Company and you that this option shall, if
possible, be an "Incentive Stock Option" as that term is used in Section 422 of
the Code and the regulations thereunder. In the event this Option is in any way
inconsistent with the legal requirements of the Code or the regulations
thereunder for an "Incentive Stock Option" this Option shall be deemed
automatically amended as of the date hereof to conform to such legal
requirements, if such conformity may be achieved by amendment.
This Option shall be subject to the terms of the Plan in effect on the
date this Option is granted, which terms are hereby incorporated herein by
reference and made a part hereof. In the event of any conflict between the terms
of this Option and the terms of the Plan in effect on the date of this Option,
the terms of the Plan shall govern. This Option constitutes the entire
understanding between the Company and you with respect to the subject matter
hereof and no amendment, modification or waiver of this Option, in whole or in
part, shall be binding upon the Company unless in writing and signed by an
appropriate officer of the Company. This Option and the performances of the
parties hereunder
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<PAGE>
shall be construed in accordance with and governed by the laws of the State of
New York without regard to principles of conflict of law.
Please sign the copy of this Option and return it to the Company,
thereby indicating your understanding of and agreement with its terms and
conditions.
NETWORK-1 SECURITY SOLUTIONS, INC.
By:
-----------------------------------------
Avi A. Fogel,
President and Chief Executive Officer
I hereby acknowledge receipt of a copy of the foregoing Stock Option
and the Network-1 Security Solutions, Inc. 1996 Stock Option Plan, and having
read such documents, hereby signify my understanding of, and my agreement with,
their terms and conditions.
- ------------------------------ ---------------------------------
Joseph A. Donohue (Date)
7
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Exhibit 10-21
EMPLOYMENT AGREEMENT dated as of August 24, 1998, between NETWORK-1
SECURITY SOLUTIONS, INC., a Delaware corporation with its principal office
located at 70 Walnut Street, Wellesley, Massachusetts 02481 (the "Company"), and
JOSEPH HARRIS residing at 22123 Cambridge Drive, Kildeer, Illinois 60047 (the
"Executive").
The Company desires to enter into this Agreement in order to
assure itself of the service of Executive, and Executive desires to accept
employment with the Company, upon the terms and conditions hereinafter set
forth.
NOW, THEREFORE, in consideration of the mutual covenants and
obligations hereinafter set forth, the parties agree as follows:
SECTION 1. Employment. The Company hereby employs Executive,
and Executive hereby accepts employment by the Company, upon the terms and
conditions hereinafter set forth.
SECTION 2. Term. The employment of Executive hereunder shall
be for a period commencing on the date hereof (the "Commencement Date") and
ending on the third anniversary of the Commencement Date (the "Term") or such
earlier date upon which the employment of the Executive shall terminate in
accordance with the provisions hereof. The period commencing on the Commencement
Date and ending on the date of termination of the Executive's employment
hereunder shall be called the "Term of Employment" for Executive, and the date
on which the Executive's employment hereunder shall terminate shall be called
the "Termination Date".
SECTION 3. Duties. During the Term of Employment, Executive
shall be employed as the Vice President of International Sales of the Company
and shall perform such duties as are consistent therewith as the Chief Executive
Officer and Board of Directors of the Company (the "Board") shall designate.
Executive shall use his best efforts to perform well and faithfully the
foregoing duties and responsibilities.
SECTION 4. Time to be Devoted to Employment. During the Term
of Employment, Executive shall devote all of his business time, attention and
energies to the business of the Company (except for vacations to which he is
entitled pursuant to Section 6(b) and periods of illness or incapacity). During
the Term of Employment, Executive shall not engage in any business activity
which, in the reasonable judgment of the Board, conflicts with the duties of
Executive hereunder, whether or not such activity is pursued for gain, profit or
other pecuniary advantage.
<PAGE>
SECTION 5. Compensation.
(a) The Company shall pay to Executive an annual base
salary (the "Base Salary") during the Term of Employment of $120,000 per annum,
payable in such installments (but not less often than monthly) as is generally
the policy of the Company with respect to its executive officers, which Base
Salary shall be subject to such increases as the Compensation Committee of the
Board, in its sole discretion, may from time to time determine. Executive's Base
Salary and performance shall be reviewed at least annually by the Board.
(b) In addition, to the Base Salary set forth in
paragraph 5(a) above, during the term of employment, Executive shall be eligible
to receive incentive compensation of $30,000 per annum (to be distributed as
directed by the Board of Directors) based upon achieving certain annual sales
goals subject to the discretion of the Compensation Committee of the Board.
(c) On the Commencement Date the Company shall grant to
the Executive an incentive stock option (the "Option") of ten (10) years'
duration for the purchase of 40,000 shares (the "Shares") of the Company's
Common Stock at an exercise price of $8.00 per share. The Option shall vest as
to 25% of the Shares covered thereby on the Commencement Date and an additional
25% of the Shares covered thereby on each anniversary of the Commencement Date,
conditioned only on the Executive's continued employment by the Company. The
form of Option is attached as Exhibit A hereto.
SECTION 6. Business Expenses; Benefits.
(a) The Company shall reimburse Executive, in accordance
with the practice from time to time for executive officers of the Company, for
all reasonable and necessary expenses and other disbursements incurred by
Executive for or on behalf of the Company in the performance of Executive's
duties hereunder. Executive shall provide such appropriate documentation of
expenses and disbursements as may from time to time be required by the Company.
(b) During the Term of Employment, Executive shall be
entitled to four (4) weeks vacation per year.
(a) During the Term of Employment, Executive shall be
entitled to participate in the group health, life and disability insurance
benefits, and retirement plan benefits made available from time to time for its
employees generally.
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SECTION 7. Involuntary Termination.
(a) If Executive is incapacitated or disabled (such
condition being hereinafter referred to as a "Disability") in a manner that
would qualify Executive for benefits under the disability policy of the Company
(the "Disability Policy"), the Term of Employment and employment of the
Executive under this Agreement shall cease (such termination, as well as a
termination under Section 7(b), being hereinafter referred to as an "Involuntary
Termination") and Executive shall be entitled to receive the benefits payable
under the Disability Policy and in accordance with Section 9 hereof.
(b) If Executive dies during the Term of Employment, the
Term of Employment and Executive's employment hereunder shall cease as of the
date of the Executive's death and Executive shall be entitled to receive the
benefits payable in accordance with Section 9 hereof.
SECTION 8. Termination by the Company.
(a) Termination For Cause. The Company may terminate the
Term of Employment and the employment of the Executive hereunder at any time for
Cause (as hereinafter defined) (such termination being referred to herein as a
"Termination For Cause") by giving Executive written notice of such termination,
effective immediately upon the giving of such notice to the Executive. As used
in this Agreement, "Cause" means the Executive's (a) commission of an act (i)
constituting a felony or (ii) involving fraud, moral turpitude, theft or
dishonesty which is not a felony and which materially adversely affects the
Company or could reasonably be expected to materially adversely affect the
Company, (b) repeated failure to be reasonably available to perform his duties,
which, if curable, shall not have been cured within 30 business days of written
notice thereof from the Company, (c) repeated failure to follow the lawful
directions of the Board, which, if curable, shall not have been cured within 30
business days of written notice thereof from the Company, (d) material breach of
any agreement with the Company (including any provisions of this or any
agreement between Executive and the Company) which, if curable, shall not have
been cured within 30 business days of written notice thereof from the Company or
(e) voluntary resignation (except as set forth in paragraph 9(d) hereof).
(b) Termination Other Than for Cause. The Company may
terminate this Agreement and the employment of Executive other than for cause as
defined in Section 8(a) above (such termination shall be defined as a
"Termination Other Than for Cause") by giving Executive written notice of such
termination, which notice
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<PAGE>
shall be effective upon the giving of such notice or such later date set forth
therein.
SECTION 9. Effect of Termination.
(a) Upon the termination of the Term of Employment and
Executive's employment hereunder due to Termination for Cause (as defined in
Section 8(a) above), neither Executive nor his beneficiary or estate shall have
any further rights or claims against the Company under this Agreement, except to
receive (i) the unpaid portion, if any, of the Base Salary provided for in
Section 5(a), computed on a pro rata basis to the Termination Date (based on the
actual number of days elapsed over the actual number of days elapsed over the
year in which such termination occurs), (ii) any unpaid accrued benefits of
Executive, (iii) reimbursement for any expenses for which Executive shall not
have been reimbursed as provided in Section 6(a), and (iv) Executive's rights
under the vested portion of the Option.
(b) Upon the termination of Executive's employment
hereunder due to an Involuntary Termination as a result of Executive's
Disability, neither Executive nor his beneficiary or estate shall have any
further rights or claims against the Company under this Agreement except the
right to receive (i) the amounts set forth in Section 9(a), and (ii)the vesting
of all of the Options that would have vested in the year of Involuntary
Termination and one-half of the Options that would have vested in the year
following the year of Involuntary Termination; provided, that, in the event of
Executive's death, his beneficiaries and estate shall, in addition to the
benefits provided in this Section 9(b), have the additional right to the
benefits set forth in Section 9(c)(ii) below.
(c) Upon the termination of Executive's employment upon
a Termination Other Than for Cause (as defined in Section 8(b) above), neither
Executive nor his beneficiary nor his estate shall have any rights or claims
against the Company except to receive (i) the amounts set forth in 9(b)
(including Options), and (ii) the lesser of (A) six months Base Salary as in
effect at the time of the Termination Other Than for Cause or (B) Executive's
Base Salary for the balance of the term of this Agreement.
(d) For purposes of this Section 9, if Executive is
asked to assume any duties or the material reduction of duties, either of which
is substantially inconsistent with the position of Vice President of
International Sales of the Company, Executive, upon 30 days notice to the Board
of Directors setting forth in reasonable detail the respects in which Executive
believes such assignment or duties are substantially inconsistent with the level
of Executive's position, may resign from the Company and such
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resignation will be treated as a Termination Other Than For Cause pursuant to
this Section 9.
SECTION 10. Insurance. The Company may, for its own benefit,
in its sole discretion, maintain "key-man" life and disability insurance
policies covering Executive. Executive will cooperate with the Company and
provide such information or other assistance as the Company may reasonably
request in connection with the Company's obtaining and maintaining such
policies.
SECTION 11. Disclosure of Information. Executive will not,
either during the Term of Employment or at any time thereafter, divulge,
publish, communicate, furnish or make accessible to anyone any knowledge or
information with respect to the Company's confidential, secret or proprietary
products, technology, methods, plans, materials and processes, or with respect
to any other confidential, secret or proprietary aspects of the business,
activities or products of the Company including, without limitation, (a)
software programs, source code, object code, product development information,
research and development projects or other technical data pertaining to the
Company's products (whether or not subject to patent, trademark or copyright
protection) or (b) any customer or client lists, telephone leads, prospects
lists, sales figures and forecasts, purchase costs, financial projections,
advertising and marketing plans and business strategies and plans; except as
such items set forth in clauses (a) and (b) above may already be in the public
domain through no fault of Executive (all of the foregoing items set forth in
clauses (a) and (b) being referred to herein collectively as "Confidential
Property"). Upon the termination of the Term of Employment, Executive shall
return to the Company all property (including Confidential Property) of the
Company (or any subsidiary or affiliate thereof) then in the possession of
Executive and all books, records, computer tapes or discs and all other material
containing non-public information concerning the business, clients or affairs of
the Company or any subsidiary or affiliate thereof.
SECTION 12. Right to Inventions. Executive shall promptly
disclose, grant and assign to the Company for its sole use and benefit any and
all marks, designs, logos, inventions, improvements, technical information and
suggestions relating in any way to the business conducted by the Company, which
he may develop or which may be acquired by Executive during the Term of
Employment (whether or not during usual working hours), together with all
trademarks, patent applications, letters, patent, copyrights and reissues
thereof that may at any time be granted for or upon any such mark, design, logo,
invention, improvement or technical information (collectively, "Inventions"). In
connection therewith, Executive shall (at the Company's sole cost and expense)
take all actions reasonably necessary or desirable to
5
<PAGE>
assign and/or confirm the assignment of any Invention to the
Company.
SECTION 13. Restrictive Covenant.
(a) The Company is in the business of developing,
marketing, licensing and supporting network software security products and also
provides consulting in network security, network design, troubleshooting and
engineering (the "Business"). Executive acknowledges and recognizes that the
Business has been conducted, and sales of its products have been made,
throughout the United States, and Executive further acknowledges and recognizes
the highly competitive nature of the industry in which the Business is involved.
Accordingly, in consideration of the premises contained herein, the
consideration to be received hereunder, stock options to be granted Executive,
Executive shall not, during the Non-Competition Period (as defined below): (i)
directly or indirectly engage, whether or not such engagement shall be as a
partner, stockholder, affiliate or other participant, in any Competitive
Business (as defined below), or represent in any way any Competitive Business,
whether or not such engagement or representation shall be for profit, (ii)
interfere with, disrupt or attempt to disrupt the relationship, contractual or
otherwise, between the Company and any other person or entity, including,
without limitation, any customer, supplier, employee or consultant of the
Company, (iii) induce any employee of the Company to terminate his employment
with the Company or to engage in any Competitive Business in any manner
described in the foregoing clause (i) (as well as an officer or director of any
Competitive Business), or (iv) affirmatively assist or induce any other person
or entity to engage in any Competitive Business in any manner described in the
foregoing clause (i) (as well as an officer or director of any Competitive
Business). Anything contained in this Section 13 to the contrary
notwithstanding, an investment by Executive in (a) any company not engaged in a
Competitive Business or (ii) any company engaged in a Competitive Business
provided Executive or his affiliates exercise no operational or strategic
control and such investment constitutes less than 5% of the equity of such
entity, shall not constitute a breach of this Section 13.
(b) As used herein, "Non-Competition Period" shall mean
the period commencing on the date hereof and terminating on the Termination
Date; provided, however, that if the Term of Employment shall have been
terminated pursuant to Section 8 (a), then "Non-Competition Period" shall mean
the period commencing on the date hereof and ending on the second anniversary of
the Termination Date. "Competitive Business" shall mean any business in any
State of the United States engaged in the development, marketing and licensing
of network software security products, or
6
<PAGE>
in any other line of business in which the Company was engaged or had a formal
plan to enter as of the Termination Date.
(c) Executive understands that the foregoing
restrictions may limit his ability to earn a livelihood in a business similar to
the business of the Company, but he nevertheless believes that he has received
and will receive sufficient consideration and other benefits as an employee of
the Company and as otherwise provided hereunder and pursuant to other agreements
between the Company and Executive to justify clearly such restrictions which, in
any event (given his education, skills and ability), Executive does not believe
would prevent him from earning a living.
SECTION 14. Enforcement; Severability; Etc. It is the desire
and intent of the parties that the provisions of this Agreement shall be
enforced to the fullest extent permissible under the laws and public policies
applied in each jurisdiction in which enforcement is sought. Accordingly, if any
particular provision of this Agreement shall be adjudicated to be invalid or
unenforceable, such provision shall be deemed amended to (a) delete therefrom
the portion thus adjudicated to be invalid or unenforceable, such deletion to
apply only with respect to the operation of such provision in the particular
jurisdiction in which such adjudication is made or (b) otherwise to render it
enforceable in such jurisdiction.
SECTION 15. Remedies. Executive acknowledges and understands
that the provisions of this Agreement are of a special and unique nature, the
loss of which cannot be adequately compensated for in damages by an action at
law, and that the breach or threatened breach of the provisions of this
Agreement would cause the Company irreparable harm. In the event of a breach or
threatened breach by Executive of the provisions of this Agreement, the Company
shall be entitled to an injunction restraining him from such breach. Nothing
contained in this Agreement shall be construed as prohibiting the Company from
or limiting the Company in pursuing any other remedies available for any breach
or threatened breach of this Agreement.
SECTION 16. Notices. All notices, claims, certificates,
requests, demands and other communications hereunder shall be in writing and
shall be deemed to have been duly given and delivered if personally delivered or
if sent by a nationally-recognized overnight courier, by telecopy, or by
registered or certified mail, return receipt requested and postage prepaid,
addressed as follows:
7
<PAGE>
if to the Company, to: Network-1 Security Solutions, Inc.
70 Walnut Street
Wellesley, Massachusetts 02481
Attention: Avi Fogel, President
and Chief Executive Officer
with copies to: Bizar Martin & Taub, LLP
1350 Avenue of the Americas
29th Floor
New York, NY 10019
Telecopier:(212) 581-8958
Telephone: (212) 265-8600
Attention: Sam Schwartz, Esq.
if to Executive, to: Joseph Harris
22123 Cambridge Drive
Kildeer, Illinois 60047
or to such other address as the party to whom notice is to be given may have
furnished to the other party or parties in writing in accordance herewith. Any
such notice or communication shall be deemed to have been received (a) in the
case of personal delivery, on the date of such delivery, (b) in the case of
nationally-recognized overnight courier, on the next business day after the date
when sent, (c) in the case of telecopy transmission, when received, and (d) in
the case of mailing, on the third business day following that on which the piece
of mail containing such communication is posted.
SECTION 17. Binding Agreement; Benefit. The provisions of this
Agreement will be binding upon, and will inure to the benefit of, the respective
heirs, legal representatives, successors and assigns of the parties.
SECTION 18. Governing Law. This Agreement will be governed by,
construed and enforced in accordance with, the laws of the State of
Massachusetts (without giving effect to principles of conflicts of laws).
SECTION 19. Waiver of Breach. The waiver by either party of a
breach of any provision of this Agreement must be in writing and shall not
operate or be construed as a waiver of any other breach.
SECTION 20. Entire Agreement; Amendments. This Agreement
contains the entire agreement between the parties with respect to the subject
matter hereof and supersedes all prior agreements or understandings between the
parties with respect thereto. This Agreement may be amended only by an agreement
in writing signed by the parties.
8
<PAGE>
SECTION 21. Headings. The section headings contained in this
Agreement are for reference purposes only and shall not affect in any way the
meaning or interpretation of this Agreement.
SECTION 22. Assignment. This Agreement is personal in its
nature and the parties shall not, without the consent of the other, assign or
transfer this Agreement or any rights or obligations hereunder; provided,
however, that the Company may assign this Agreement to any of its subsidiaries
and affiliates.
SECTION 23. Gender. Any reference to the masculine gender
shall be deemed to include the feminine and neuter genders unless the context
otherwise requires.
SECTION 24. Counterparts. This Agreement may be executed in
counterparts, and each such counterpart shall be deemed to be an original
instrument, but all such counterparts together shall constitute but one
agreement.
IN WITNESS WHEREOF, the parties hereto have executed and
delivered this Employment Agreement as of the date first written above.
NETWORK-1 SECURITY SOLUTIONS, INC.
By: /s/ Avi A. Fogel
------------------------------------
Avi A. Fogel, President and
Chief Executive Officer
/s/ Joseph Harris
------------------------------------
Joseph Harris
<PAGE>
INCENTIVE STOCK OPTION
To: Joseph Harris
22123 Cambridge Drive, Kildeer, Illinois 60047
------------------------------------------------
Address
Date of Grant: August , 1998
You are hereby granted an option (the "Option"), effective as of the
date hereof, to purchase 40,000 shares of Common Stock, par value $.01 per share
("Common Stock"), of Network-1 Security Solutions, Inc. (the "Company") at a
price of $8.00 per share pursuant to the Company's 1996 Stock Option Plan (the
"Plan") adopted by the Company's Board of Directors effective March 7, 1996, as
amended, and approved by the stockholders of the Company. Your option price is
intended to equal at least the fair market value of the Company's Common Stock
as of the date hereof; provided, however, that if, at the time this option is
granted, you own stock possessing more than 10% of the total combined voting
power of all shares of stock of the Company or any parent or subsidiary (an
"Affiliate") of the Company (a "10% Shareholder"), your option price is intended
to be at least 110% of the fair market value of the Company's Common Stock as of
the date hereof.
This Option shall vest as follows: (i) as 25% of the shares underlying
this Option on the date of this Option;(ii) as to the balance of 75% of the
shares underlying this Option, 25% of such shares on each of the first three
anniversary dates of the date of this Option, provided you are then an employee
of the Company; (iii) as to 50% of the remaining shares underlying this Option
if a Change in Control (as hereinafter defined) occurs within one year of the
date of this Option, provided you are then an employee of the Company; (iv) as
to all of the unvested portion of this Option if a Change of Control (as
hereinafter defined) occurs more than one year after the date of this Option,
provided you are then an employee of the Company.
The shares subject to this Option shall be adjusted for any change in
the outstanding shares of the Common Stock of the Company by reason of a stock
dividend, stock split, combination of shares, recapitalization, merger,
consolidation, transfer of assets, reorganization, conversion or what the
Compensation Committee deems in its sole discretion to be similar circumstances.
No fractional shares shall be issued or delivered.
This Option shall terminate and is not exercisable after the expiration
of ten years from the date of its grant (five years from the date of grant if,
at the time of the grant, you are a 10%
<PAGE>
Shareholder) (the "Scheduled Termination Date"), except if terminated earlier as
hereinafter provided (the "Termination Date").
A "Change of Control" shall be deemed to have occurred upon the
happening of any of the following events:
(i) the acquisition by any person, entity or "group",
within the meaning of Section 13(d)(3) or
14(d)(2) of the Securities Exchange Act of 1934,
as amended(the "Exchange Act"), of beneficial
ownership (within the meaning of Rule 13d-3
promulgated under the Exchange Act) of forty
(40%) percent or more of the combined voting
power of the then outstanding securities entitled
to vote generally in the election of directors
where such person, entity or group owned less
than 5% of such voting power on the date of this
Option; or
(ii) The shareholders of the Company approve a merger
or consolidation of the Company with any other
corporation, other than a merger or consolidation
which would result in the voting securities of
the Company outstanding immediately prior thereto
continuing to represent (either by remaining
outstanding or by being converted into voting
securities of the surviving entity) more than
fifty percent (50%) of the total voting power
represented by the voting securities of the
Company or such surviving entity outstanding
immediately after such merger or consolidation,
or the shareholders of the Company approve a plan
of complete liquidation of the Company or an
agreement for the sale or disposition by the
Company of all or substantially all of the
Company's assets (other than to a subsidiary or
subsidiaries).
(iii) Any other event deemed to constitute a "Change in
Control" by the Compensation Committee.
You may exercise your option as set forth in Section 7 of the Plan.
If the Company's Common Stock has not been registered under Section 12
of the Securities Exchange Act of 1934, the exercise of your option will not be
effective unless and until you execute and deliver to the Company a Stock
Restriction Agreement, in the form on file in the office of the Secretary of the
Company.
2
<PAGE>
Your Option will, to the extent not previously exercised by you,
terminate thirty (30) days after the date on which your employment by the
Company or Affiliate of the Company is terminated, whether such termination is
voluntary or not, other than by reason of disability as defined in Section
22(e)(3) of the Internal Revenue Code of 1986, as amended (the "Code"), and the
regulations thereunder, or death, in which case your Option will terminate six
(6) months from the date of termination of employment due to disability or death
(but in no event later than the Scheduled Termination Date). After the date your
employment is terminated, as aforesaid, you may exercise this Option only for
the number of shares which you had a right to purchase and did not purchase on
the date your employment terminated. If you are employed by an Affiliate of the
Company, your employment shall be deemed to have terminated on the date your
employer ceases to be an Affiliate of the Company, unless you are on that date
transferred to the Company or another Affiliate of the Company. Your employment
shall not be deemed to have terminated if you are transferred from the Company
to an Affiliate, or vice versa, or from one Affiliate to another Affiliate.
If you die while employed by the Company or an Affiliate of the
Company, your legatee(s), distributee(s), executor(s) or administrator(s), as
the case may be, may, at any time within six (6) months after the date of your
death (but in no event later than the Scheduled Termination Date), exercise the
Option as to any shares which you had a right to purchase and did not purchase
during your lifetime. If your employment with the Company, or an Affiliate is
terminated by reason of your becoming disabled (within the meaning of Section
22(e)(3) of the Code and the regulations thereunder), you or your legal guardian
or custodian may at any time within six (6) months after the date of such
termination (but in no event later than the Scheduled Termination Date),
exercise the Option as to any shares which you had a right to purchase and did
not purchase prior to such termination. Your legatee, distributee, executor,
administrator, guardian or custodian must present proof of his authority
satisfactory to the Company prior to being allowed to exercise this Option.
This Option is not transferable otherwise than by will or the laws of
descent and distribution, and is exercisable during your lifetime only by you,
including, for this purpose, your legal guardian or custodian in the event of
disability. Until the Option price has been paid in full pursuant to due
exercise of this Option and the purchased shares are delivered to you, you do
not have any rights as a shareholder of the Company. The Company reserves the
right not to deliver to you the shares purchased by virtue of the exercise of
this Option during any period of time in which the Company deems, in its sole
discretion, that such delivery would
3
<PAGE>
violate a federal, state, local or securities exchange rule, regulation or law.
Notwithstanding anything to the contrary contained herein, this Option
is not exercisable until all of the following events occur and during the
following periods of time:
(a) Until this Option and the optioned shares are approved and/or
registered with such federal, state and local regulatory bodies or agencies and
securities exchanges as the Company may deem necessary or desirable; or
(b) During any period of time in which the Company deems that the
exercisability of this Option, the offer to sell the shares optioned hereunder,
or the sale thereof, may violate a federal, state, local or securities exchange
rule, regulation or law, or may cause the Company to be legally obligated to
issue or sell more shares than the Company is legally entitled to issue or sell.
The following two paragraphs shall be applicable if, on the date of
exercise of this Option, the Common Stock to be purchased pursuant to such
exercise has not been registered under the Securities Act of 1933, as amended,
and under applicable state securities laws, and shall continue to be applicable
for so long as such registration has not occurred:
(a) The optionee hereby agrees, warrants and represents that he will
acquire the Common Stock to be issued hereunder for his own account for
investment purposes only, and not with a view to, or in connection with, any
resale or other distribution of any of such shares, except as hereafter
permitted. The optionee further agrees that he will not at any time make any
offer, sale, transfer, pledge or other disposition of such Common Stock to be
issued hereunder without an effective registration statement under the
Securities Act of 1933, as amended, and under any applicable state securities
laws or an opinion of counsel acceptable to the Company to the effect that the
proposed transaction will be exempt from such registration. The optionee shall
execute such instruments, representations, acknowledgements and agreements as
the Company may, in its sole discretion, deem advisable to avoid any violation
of federal, state, local or securities exchange rule, regulation or law.
(b) The certificates for Common Stock to be issued to the optionee
hereunder shall bear the following legend:
"The shares represented by this certificate have not been
registered under the Securities Act of 1933, as amended, or
under applicable state securities laws. The shares have been
acquired for investment and may not be offered,
4
<PAGE>
sold, transferred, pledged or otherwise disposed of without an
effective registration statement under the Securities Act of
1933, as amended, and under any applicable state securities
laws or an opinion of counsel acceptable to the Company that
the proposed transaction will be exempt from such
registration."
The foregoing legend shall be removed upon registration of the legended shares
under the Securities Act of 1933, as amended, and under any applicable state
laws or upon receipt of any opinion of counsel acceptable to the Company that
said registration is no longer required.
The sole purpose of the agreements, warranties, representations and
legend set forth in the two immediately preceding paragraphs is to prevent
violations of the Securities Act of 1933, as amended, and any applicable state
securities laws.
It is the intention of the Company and you that this option shall, if
possible, be an "Incentive Stock Option" as that term is used in Section 422 of
the Code and the regulations thereunder. In the event this Option is in any way
inconsistent with the legal requirements of the Code or the regulations
thereunder for an "Incentive Stock Option" this Option shall be deemed
automatically amended as of the date hereof to conform to such legal
requirements, if such conformity may be achieved by amendment.
This Option shall be subject to the terms of the Plan in effect on the
date this Option is granted, which terms are hereby incorporated herein by
reference and made a part hereof. In the event of any conflict between the terms
of this Option and the terms of the Plan in effect on the date of this Option,
the terms of the Plan shall govern. This Option constitutes the entire
understanding between the Company and you with respect to the subject matter
hereof and no amendment, modification or waiver of this Option, in whole or in
part, shall be binding upon the Company unless in writing and signed by an
appropriate officer of the Company. This Option and the performances of the
parties hereunder shall be construed in accordance with and governed by the laws
of the State of New York without regard to principles of conflict of law.
5
<PAGE>
Please sign the copy of this Option and return it to the Company,
thereby indicating your understanding of and agreement with its terms and
conditions.
NETWORK-1 SECURITY SOLUTIONS, INC.
By:
-----------------------------------
I hereby acknowledge receipt of a copy of the foregoing Stock Option
and the Network-1 Security Solutions, Inc. 1996 Stock Option Plan, as amended,
and having read such documents, hereby signify my understanding of, and my
agreement with, their terms and
conditions.
- ----------------------------- ----------------------------------
(Signature) (Date)
6
<PAGE>
Exhibit 21.1
List of Subsidiaries of Network-1 Security Solutions, Inc.
Network-1 Acquisition Corp., which was incorporated in the State of Delaware on
August 27, 1998.
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
We consent to the inclusion of our report dated June 17, 1998 (July 8, 1998
with respect to Note F[3] July 17, 1998, with respect to the third paragraph
of Note A and September 11, 1998 with respect to Note J), which contains an
explanatory paragraph with respect to the Company's ability to continue as a
going concern, on the financial statements of Network-1 Security Solutions,
Inc. as of December 31, 1997 and 1996 and for each of the years then ended, in
Amendment No. 1 to its Registration Statement on Form SB-2 and to the
reference to our firm under the caption "Experts" in the Prospectus.
/s/ Richard A. Eisner & Company, LLP
New York, New York
September 15, 1998
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS FINANCIAL INFORMATION EXTRACTED FROM THE UNAUDITED
FINANCIAL STATEMENTS OF NETWORK-1 SECURITY SOLUTIONS, INC. FOR THE PERIOD
ENDED JUNE 30, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
<CASH> 634,000
<SECURITIES> 0
<RECEIVABLES> 697,000
<ALLOWANCES> 88,000
<INVENTORY> 15,000
<CURRENT-ASSETS> 1,278,000
<PP&E> 769,000
<DEPRECIATION> 446,000
<TOTAL-ASSETS> 3,129,000
<CURRENT-LIABILITIES> 3,707,000
<BONDS> 0
0
5,000
<COMMON> 17,000
<OTHER-SE> (600,000)
<TOTAL-LIABILITY-AND-EQUITY> 3,129,000
<SALES> 412,000
<TOTAL-REVENUES> 902,000
<CGS> 395,000
<TOTAL-COSTS> 667,000
<OTHER-EXPENSES> 1,769,000
<LOSS-PROVISION> 18,000
<INTEREST-EXPENSE> 438,000
<INCOME-PRETAX> (1,990,000)
<INCOME-TAX> 0
<INCOME-CONTINUING> (1,990,000)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,990,000)
<EPS-PRIMARY> (1.17)
<EPS-DILUTED> (1.17)
</TABLE>
