U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1999
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ______ TO ______
COMMISSION FILE NUMBER 1-14896
NETWORK-1 SECURITY SOLUTIONS, INC.
----------------------------------
(EXACT NAME OF SMALL BUSINESS ISSUER AS
SPECIFIED IN ITS CHARTER)
DELAWARE 11-3027591
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(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
1601 TRAPELO ROAD, RESERVOIR PLACE, WALTHAM, MASSACHUSETTS 02451
----------------------------------------------------------------
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
781-522-3400
------------
(ISSUER'S TELEPHONE NUMBER)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes [X] No [ ]
As of October 31, 1999 there were 4,372,375 shares of Common Stock, $.01 par
value per share, and 562,836 shares of Series C Convertible Preferred Stock,
$.01 par value per share, outstanding.
Transitional Small Business Disclosure Format (check one):
Yes [ ] No [X]
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NETWORK-1 SECURITY SOLUTIONS, INC.
INDEX
<TABLE>
<CAPTION>
<S> <C>
Page No.
PART I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
Balance Sheets as of September 30, 1999 (unaudited) and December 31, 1998................................3
Statements of Operations for the three and nine months ended September 30, 1999 and 1998 (unaudited).....4
Statement of Stockholders' Equity (Deficiency) for the nine months ended September 30, 1999 (unaudited)
and for the year ended December 31, 1998 ................................................................5
Statements of Cash Flows for the nine months ended September 30, 1999 and 1998 (unaudited)...............6
Notes to Financial Statements............................................................................7
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION................................................8
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.......................................................................................14
Item 2. Changes in Securities and Use of Proceeds...............................................................14
Item 3. Defaults Upon Senior Securities.........................................................................14
Item 4. Submission of Matters to a Vote of Security Holders.....................................................14
Item 5. Other Information.......................................................................................14
Item 6. Exhibits and Reports on Form 8-K........................................................................15
SIGNATURES.......................................................................................................16
</TABLE>
<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
SEPTEMBER 30, 1999 DECEMBER 31, 1998
(UNAUDITED) (AUDITED)
------------ ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 1,319,000 $ 6,423,000
Accounts receivable - net of allowance for doubtful accounts
of $104,000 and $151,000 respectively 296,000 249,000
Prepaid expenses and other current assets 269,000 119,000
------------ ------------
Total current assets 1,884,000 6,791,000
Equipment and fixtures 633,000 415,000
Capitalized software costs - net 820,000 925,000
Security deposits 82,000 37,000
------------ ------------
$ 3,419,000 $ 8,168,000
============ ============
LIABILITIES
Current liabilities:
Accounts payable $ 235,000 $ 420,000
Accrued expenses and other current liabilities 684,000 406,000
Deferred revenue 76,000 103,000
------------ ------------
Total current liabilities 995,000 929,000
------------ ------------
Commitments and contingencies
STOCKHOLDERS' EQUITY
Preferred stock - $.01 par value; authorized 5,000,000 shares;
Series A -10% cumulative, none issued and outstanding
Series B - 500,000 shares, none issued and outstanding
Series C - 562,836 shares issued and outstanding 6,000 6,000
Common stock - $.01 par value; authorized 25,000,000 shares;
4,372,375 and 4,366,520 shares issued and outstanding 44,000 44,000
Additional paid-in capital 20,898,000 20,819,000
Unearned portion of compensatory stock options (177,000) (383,000)
Accumulated deficit (18,347,000) (13,247,000)
------------ ------------
2,424,000 7,239,000
------------ ------------
$ 3,419,000 $ 8,168,000
============ ============
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS
-3-
<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.
STATEMENTS OF OPERATIONS
UNAUDITED
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------------------------------------------
1999 1998 1999 1998
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Revenues:
Licenses $ 73,000 $ 102,000 $ 186,000 $ 514,000
Services 381,000 569,000 1,171,000 1,059,000
----------- ----------- ----------- -----------
Total revenues 454,000 671,000 1,357,000 1,573,000
Cost of revenues:
Amortization of software costs 135,000 135,000 405,000 402,000
Cost of licenses 5,000 33,000 35,000 161,000
Cost of services 406,000 230,000 1,180,000 502,000
----------- ----------- ----------- -----------
Total cost of revenues 546,000 398,000 1,620,000 1,065,000
----------- ----------- ----------- -----------
Gross (loss) profit (92,000) 273,000 (263,000) 508,000
Operating expenses:
Product development 327,000 160,000 1,103,000 443,000
Selling and marketing 614,000 339,000 2,438,000 690,000
General and administrative 400,000 647,000 1,430,000 1,800,000
----------- ----------- ----------- -----------
Total operating expenses 1,341,000 1,146,000 4,971,000 2,933,000
----------- ----------- ----------- -----------
Loss from operations (1,433,000) (873,000) (5,234,000) (2,425,000)
Interest income (expense) - net 40,000 (284,000) 134,000 (722,000)
=========== =========== =========== ===========
Net loss $(1,393,000) $(1,157,000) $(5,100,000) $(3,147,000)
=========== =========== =========== ===========
Loss per share - basic and diluted $ (0.32) $ (0.52) $ (1.17) $ (1.69)
=========== =========== =========== ===========
Weighted average number of shares
outstanding - basic and diluted 4,372,375 2,222,955 4,372,097 1,861,717
=========== =========== =========== ===========
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS
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<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIENCY)
<TABLE>
<CAPTION>
COMMON STOCK PREFERRED STOCK
----------------------- -------------------
SHARES AMOUNT SHARES AMOUNT
----------- ---------- --------- --------
<S> <C> <C> <C> <C>
Balance - December 31, 1997 1,706,037 $ 17,000 500,000 $5,000
Common stock options issued to Chief
Executive Officer
Amortization of compensatory stock options
Issuance of Series C preferred stock 562,836 6,000
Issuance of common stock, warrants and
options for services rendered and payment
of liability 51,256 1,000
Warrants issued in connection with debt
financing
Repurchase and retirement of common shares (62,080)
Conversion of warrants to stock at discount
as part of debt re-financing 596,741 6,000
Conversion of Series B Preferred Stock 310,399 3,000 (500,000) (5,000)
Acquisition of CommHome 64,167
Issuance of common stock for cash - initial
public offering 1,700,000 17,000
Net loss
----------- ---------- --------- --------
Balance - December 31, 1998 4,366,520 44,000 562,836 6,000
Amortization of compensatory stock options
Issuance of common stock and options for
services rendered and payment of liability 5,855
Net Loss
----------- ---------- --------- --------
Balance - September 30, 1999 (Unaudited) 4,372,375 $ 44,000 562,836 $6,000
=========== ========== ========= ========
</TABLE>
NETWORK-1 SECURITY SOLUTIONS, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIENCY)(Cont.)
<TABLE>
<CAPTION>
ADDITIONAL PORTION OF
PAID-IN ACCUMULATED COMPENSATORY
CAPITAL DEFICIT STOCK OPTIONS TOTAL
------------- -------------- ------------ ------------
<S> <C> <C> <C> <C>
Balance - December 31, 1997 $ 7,373,000 $ (7,470,000) $ (75,000)
Common stock options issued to Chief
Executive Officer 938,000 (938,000) 0
Amortization of compensatory stock options 555,000 555,000
Issuance of Series C preferred stock 2,949,000 2,955,000
Issuance of common stock, warrants and
options for services rendered and payment
of liability 499,000 500,000
Warrants issued in connection with debt
financing 766,000 766,000
Repurchase and retirement of common shares (1,000) (1,000)
Conversion of warrants to stock at discount
as part of debt re-financing (6,000) 0
Conversion of Series B Preferred Stock 2,000 0
Acquisition of CommHome 385,000 385,000
Issuance of common stock for cash - initial
public offering 7,914,000 7,931,000
0
Net loss (5,777,000) (5,777,000)
------------- -------------- ------------ ------------
Balance - December 31, 1998 20,819,000 (13,247,000) (383,000) 7,239,000
Amortization of compensatory stock options 206,000 206,000
Issuance of common stock and options for
services rendered and payment of liability 79,000 79,000
Net Loss (5,100,000) (5,100,000)
------------- -------------- ------------ ------------
Balance - September 30, 1999 (Unaudited) $20,898,000 $(18,347,000) $ (177,000) $ 2,424,000
============= ============== ============ ============
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS
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<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.
STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED
<TABLE>
<CAPTION>
SEPTEMBER 30,
----------------------------
1999 1998
(Unaudited) (Unaudited)
----------- -----------
<S> <C> <C>
Cash flows from operating activities:
Net loss $(5,100,000) $(3,147,000)
Adjustments to reconcile net loss to net cash used in
operating activities:
Amortization of debt discount 594,000
Issuance of common stock, options and
warrants for services rendered and payment of liability 285,000 703,000
Provision for doubtful accounts (47,000) 30,000
Depreciation and amortization 569,000 523,000
Changes in:
Accounts receivable 0 (262,000)
Prepaid expenses and other current assets (150,000) (6,000)
Accounts payable, accrued expenses and
other current liabilities 93,000 207,000
Deferred revenue (27,000) 10,000
----------- -----------
Net cash used in operating activities (4,377,000) (1,348,000)
----------- -----------
Cash flows from investing activities:
Acquisitions of equipment and fixtures (382,000) (47,000)
Capitalized software costs (300,000) (100,000)
Security deposit (45,000) (7,000)
----------- -----------
Net cash used in investing activities (727,000) (154,000)
----------- -----------
Cash flows from financing activities:
Proceeds from issuance of notes payable and
warrants 1,750,000
Repayment of capital lease obligations (8,000)
Purchase of Treasury Shares
Deferred Offering Costs (119,000)
----------- -----------
Net cash provided by financing activities 0 1,623,000
----------- -----------
Net increase (decrease) in cash and cash equivalents (5,104,000) 121,000
Cash and cash equivalents - beginning of period 6,423,000 60,000
----------- -----------
Cash and cash equivalents - end of period $ 1,319,000 $ 181,000
=========== ===========
Supplemental disclosures of cash flow information:
Cash paid during the period for Interest $ -- $ 1,000
=========== ===========
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS
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<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS
1. FINANCIAL STATEMENT PRESENTATION
a. The financial statements included herein have been prepared by the
Company, without audit, pursuant to the rules and regulations of the Securities
and Exchange Commission with respect to Form 10-QSB. Certain information and
footnote disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles have been condensed or
omitted pursuant to such rules and regulations, although the Company believes
that the disclosures made herein are adequate to make the information contained
herein not misleading. These interim financial statements and the notes thereto
should be read in conjunction with the financial statements included in the
Company's 10-KSB for the year ended December 31, 1998. In the Company's opinion,
all adjustments (consisting only of normal recurring adjustments) necessary for
a fair presentation of the information shown have been included.
b. The results of operations for the nine months ended September 30, 1999
presented herein are not necessarily indicative of the results of operations
that may be expected for the year ending December 31, 1999.
c. 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.
- 7 -
<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THIS QUARTERLY REPORT ON FORM 10-QSB CONTAINS FORWARD-LOOKING STATEMENTS WITHIN
THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED (THE
"SECURITIES ACT"), AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS
AMENDED (THE "EXCHANGE ACT"). ACTUAL RESULTS, EVENTS AND CIRCUMSTANCES
(INCLUDING FUTURE PERFORMANCE, RESULTS AND TRENDS) COULD DIFFER MATERIALLY FROM
THOSE SET FORTH IN SUCH STATEMENTS DUE TO VARIOUS FACTORS, RISKS AND
UNCERTAINTIES, INCLUDING BUT NOT LIMITED TO RISKS ASSOCIATED WITH THE COMPANY'S
FUTURE GROWTH AND OPERATING RESULTS, THE UNCERTAINTY OF OBTAINING SUFFICIENT
FINANCING TO FUND THE COMPANY'S OPERATIONS, MARKET ACCEPTANCE OF THE COMPANY'S
PRODUCTS, TECHNOLOGICAL CHANGE, COMPETITIVE FACTORS AND GENERAL ECONOMIC
CONDITIONS.
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 also offers to its customers a full range of
consulting services in network security, network design and support. In January
1999, the Company introduced its CYBERWALLPLUS(TM) family of network security
products. This suite of products was re-branded and modified from the original
suite (FireWall/Plus) - to focus more on internal, embedded and distributed
firewalling and intrusion prevention, than the FireWall/Plus suite - which
competed in the intensely competitive space of traditional IP perimeter
firewalls. 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, 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 September 30,
1999, had an accumulated deficit of $ 18,347,000. In addition, since September
30, 1999, the Company has continued to incur significant losses. Inasmuch as the
Company has increased its level of activities following the consummation of its
initial public offering in November 1998 and will be required to make
significant 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 is currently seeking additional financing which will be
necessary to continue its operations beyond December 31, 1999. Although the
Company is negotiating with several parties for such financing, there is no
assurance that any such necessary financing will in fact be completed when
needed, on commercially reasonable terms, or at all. The inability of the
Company to secure such financing on a timely basis would have a material adverse
effect on the Company, requiring it to curtail and possibly
- 8 -
<PAGE>
cease its operations. In addition, any additional financing may involve
substantial dilution to the interest of the Company's then existing
stockholders.
The Company's software products have not yet achieved market acceptance.
The future success of the Company is largely dependent upon market acceptance of
its CYBERWALLPLUS(TM) family of software products. While the Company believes
that its CYBERWALLPLUS(TM) family Of software products offer advantages over
competing products for network security, license revenue from network security
software products since their introduction (June 1995) through September 30,
1999 has only been $2,848,000, including a non-refundable pre-paid royalty of
$500,000 in 1997. In addition, during the three and nine month periods ended
September 30, 1999 and the year ended December 31,1998 license revenues from
software products decreased as compared to the three and nine month periods
ended September 30, 1998 and the year ended December 31,1997, respectively.
Since its introduction in March 1999, license revenue from CYBERWALLPLUS(TM) has
been only $127,000. Service revenues from product maintenance were $103,000 for
the nine months ended September 30, 1999.
There can be no assurance that CYBERWALLPLUS(TM) 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
CYBERWALLPLUS(TM) 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.
During the quarter ended September 30, 1999, the Company's major
achievements included the following:
In August, the Company introduced its web-server embedded firewall product
architecture and has since then announced some of its initial successes with
several small and mid-sized customers (Koromaku Partners, NextLEC, NetPro
Solutions, FuturesGuide, and Fisher. Towne and Associates).
In August, the Company entered into a major consulting contract with Delphi
Automotive.
In September, the Company also entered into new relationships with partners
in Japan, Argentina and Canada.
The Company acquired 16 new CyberwallPLUS customers - and had over 20
previous Firewall/PLUS customers upgrade to CyberwallPLUS, either through
existing support agreements or new ones.
The Company announced the initial acceptance during the third quarter, of
the Company's Intranet firewall for Any Protocol - CyberwallPLUS - AP - by 3
major corporations National Semiconductors, Capital One and Consumer's Energy.
- 9 -
<PAGE>
RESULTS OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
1998
Revenues decreased by $216,000, from $1,573,000 for the nine months ended
September 30, 1998 to $1,357,000 for the nine months ended September 30, 1999,
primarily as a result of decreased license revenues as FirewallPLUS was
discontinued and new revenues from CyberwallPLUS have not reached the former
levels which was partially offset by higher consulting revenues .
License revenues decreased by $328,000 or 64%, from $514,000 for the nine
months ended September 30, 1998 to $186,000 for the nine months ended September
30, 1999, primarily due to lower product licensing revenue from FireWallPlus
which was replaced by its successor product line, CyberwallPLUS which was
announced in January 1999 and commenced shipping in March 1999. CyberwallPLUS
license revenue for the quarter ended September 30, 1999 increased by $30,000 or
70% from $43,000 for the three months ended June 30 ,1999 to $73,000 for the
three months ended September 30, 1999.
Service revenues increased by $112,000 or 11%, from $1,059,000 for the nine
months ended September 30, 1998 to $1,171,000 for the nine months ended
September 30, 1999. Service revenues from consulting increased by $105,000 or
11%, from $963,000 for the nine months ended September 30, 1998 to $1,068,000
for the nine months ended September 30, 1999. The increase in service revenues
was attributable to three large consulting projects serviced during the nine
months ended September 30, 1999. Service revenues from product maintenance
increased by $8,000 or 8%, from $95,000 for the nine months ended September 30,
1998 to $103,000 for the nine months ended September 30, 1999.
The Company's revenues from customers in the United States represented 99%
and 97% of the Company's revenues during the nine months ended September 30,
1998 and 1999, respectively.
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 decreased by $126,000 or 78%, from $161,000
for the nine months ended September 30, 1998 to $35,000 for the nine months
ended September 30, 1999, representing 31% and 19% of license revenues,
respectively. The decrease in cost of licenses in dollar amount was due to the
decrease in license revenue and a decrease in royalties due on third party
product sales. 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 $3,000 from
$402,000 for the nine months ended September 30, 1998 to $405,000 for the nine
months ended September 30, 1999, representing 78% and 218% of license revenues,
respectively.
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<PAGE>
Cost of services consist of salaries, benefits and overhead associated with
consulting services and maintenance. Cost of services increased by $678,000 or
135%, from $502,000 for the nine months ended September 30, 1998 to $1,180,000
for the nine months ended September 30, 1999, representing 47% and 101% of
service revenues, respectively. The increase in cost of services in dollar
amount resulted primarily from hiring additional employees, travelling costs
related to increases in employees and consulting time expended which was not
billable to the customer. Cost of services as a percentage of license revenues
may fluctuate from period to period due to changes in consultant headcount,
costs relating to hiring new consultants or an increase or decrease in number of
projects being worked.
Gross profit (loss) decreased from $508,000 for the nine months ended
September 30, 1998 to ($263,000) for the nine months ended September 30, 1999,
representing 32% and (19%) of revenues, respectively. The decrease in gross
profit was due to decreased license revenues and the increase in cost of
services as a result of increased hiring costs.
Product development consists of salaries, benefits, bonuses, 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 expenses
increased $660,000 or 149%, from $443,000 for the nine months ended September
30, 1998 to $1,103,000 for the nine months ended September 30, 1999,
representing 28% and 81% of revenues, respectively. Total product developments
costs, including capitalized costs of $100,000 and $300,000, were $543,000 and
$1,403,000 for the nine months ended September 30, 1998 and September 30, 1999,
respectively. The increase in total product development costs was due to the
salaries, related employment costs and operational costs of establishing the new
development team in Waltham, MA.
Sales and marketing expenses consist primarily of salaries, including
commissions, benefits, bonuses, travel, advertising, public relations,
consultants and trade shows. Selling and marketing expenses increased by
$1,748,000 or 253%, from $690,000 for the nine months ended September 30, 1998
to $2,438,000 for the nine months ended September 30, 1999, representing 44% and
180% of revenues, respectively. The increase in selling and marketing expenses
was due primarily to available funding for marketing as a result of the
Company's completion of its initial public offering and the release of its new
product line, CyberwallPLUS.
General and administrative expenses include employee costs, including
salary, benefits, bonuses, 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 decreased
by $370,000 or 21%, from $1,800,000 for the nine months ended September 30, 1998
to $1,430,000 for the nine months ended September 30, 1999, representing 114%
and 105% of revenues, respectively. The decrease in general and administrative
expenses was due primarily to decreases in non-cash compensation for services of
$414,000 which was partially offset by increased salaries and expenses related
to the hiring of the executive officers of the Company in May 1998, increased
professional fees and recruiting fees, telephone and the costs associated with
moving and setting up the new corporate headquarters.
Interest expense was $722,000 for the nine months ended September 30, 1998
and the Company had interest income of $134,000 for the nine months ended
September 30, 1999. The decrease in interest expense and the increase in
interest income was due to the conversion of the majority of the Company's debt
to equity concurrent with the consumation of the Company's initial public
offering, the utilization of a portion of the proceeds of the offering to pay
the remaining debt and the interest earned on the remaining proceeds of the
offering in 1999.
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<PAGE>
No provision for or benefit from federal, state or foreign income taxes was
recorded for the nine months ended September 30, 1998 or the nine months ended
September 30, 1999 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 $1,953,000 or 62%,
from $3,147,000 for the nine months ended September 30, 1998 to $5,100,000 for
the nine months ended September 30, 1999.
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 September 30, 1999, the Company had $1,319,000 of cash and cash
equivalents and a working capital of $889,000. The Company has financed its
operations primarily through net proceeds from the consummation of its initial
public offering in November 1998, and prior thereto by private sales of equity
and debt securities. Net cash used in operating activities was $1,348,000 and
$4,377,000 during the nine months ended September 30, 1998 and 1999,
respectively. Net cash used in operating activities for the nine months ended
September 30, 1998 was primarily attributable to a net loss of $3,147,000 and an
increase in accounts receivable of $262,000 which was offset by amortization of
debt discount of $594,000, issuance of Common Stock and warrants for services
rendered of $703,000 and depreciation and amortization of $523,000. Net cash
used in operating activities for the nine months ended September 30, 1999 was
primarily attributable to a net loss of $5,100,000 and an increase in prepaid
expenses and other current assets of $150,000 and a decrease in deferred revenue
of $27,000 which was partially offset by increases in accounts payable, accrued
expenses and other current liabilities of $93,000, issuance of Common Stock and
warrants for services rendered of $285,000 and depreciation and amortization of
$569,000.
The Company's operating activities during the nine months ended September
30, 1998 were financed primarily with $1,750,000 of proceeds from the issuance
of $1,750,000 principal amount of notes and warrants to purchase 325,919 shares
of Common Stock. The Company's operating activities for the nine months ended
September 30, 1999 were primarily financed with the proceeds from the initial
public offering consummated in November 1998. The Company does not currently
have a line of credit from a commercial bank or other institution.
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 its public offering, together with projected revenues from
operations, will be sufficient to satisfy the Company's operations and capital
requirements through December 1999. 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 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 in
need of additional financing sooner than currently anticipated. The Company is
currently seeking additional financing but the Company has no current agreement
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.
- 12 -
<PAGE>
During the quarter ended September 30, 1999 and subsequently, the Company
took certain steps to reorganize its operations in order to reduce expenses.
Such reorganization included the closing of its Texas office and consolidation
of its operations in Massachusetts, closing of certain sales offices and the
reduction of the number of employees from 46 to 31.
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.
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.
- 13 -
<PAGE>
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS.
In July 1999, the City of Hope filed a lawsuit against the Company in Los
Angeles Superior Court alleging breach of contract with respect to certain
network security consulting services provided by the Company to the City of Hope
and seeking return of $530,893 paid to the Company for such services, plus
consequential damages and other unspecified damages. Prior to the City of Hope's
commencement of the action, the Company had demanded from the City of Hope
payment in the amount of $218,766, representing outstanding invoices for
services rendered by the Company to City of Hope. In October, 1999, the parties
settled the dispute by agreeing to forego their respective claims against each
other and exchanging general releases.
Item 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
Use of Proceeds.
On November 12, 1998, the Company's registration statement on Form SB-2, as
amended (file number 333-59617), relating to its initial public offering (the
"Offering") was declared effective by the Securities and Exchange Commission.
Whale Securities Co., L.P. acted as the underwriter in connection with the
Offering which was consummated on November 17, 1998. In connection with the
Offering, the Company registered, issued and sold 1,700,000 shares of Common
Stock (excluding 255,000 shares of Common Stock subject to the underwriter's
over-allotment option which was not exercised), at an initial public offering
price of $6.00 per share resulting in net proceeds of $7,931,000, after payment
of underwriting discounts and commissions and offering expenses of $2,269,000.
Additionally, the Company registered 170,000 shares of Common Stock underlying
warrants to purchase Common Stock sold by the Company to the underwriter for
$100. The warrants are exercisable for a four-year period commencing on November
12, 1999 at a price of $9.30 per share. Since November 17, 1998 (the date of
consummation of the Offering) through September 30, 1999, the Company used the
net proceeds of the Offering as follows: $2,861,000 for sales and marketing,
$1,586,000 for software development, $546,000 for payment of past due trade
payables, $585,000 for repayment of outstanding indebtedness (including $132,000
for repayment of indebtedness to officers, directors and 10% or more
stockholders and affiliates), $200,000 for purchase of office,
telecommunications and computer equipment, $158,000 for expenses related to
establishing new executive offices and $1,822,000 for working capital and
general corporate purposes.
Item 3. DEFAULTS UPON SENIOR SECURITIES.
None.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
Item 5. OTHER INFORMATION.
None.
- 14 -
<PAGE>
Item 6. EXHIBITS AND REPORTS ON FORM 8-K.
Exhibits
The exhibits in the following table have been filed as part of this
Quarterly Report on Form 10-QSB:
Exhibit Number Description of Exhibit
-------------- ----------------------
27 Financial data schedule for nine month period ended
September 30, 1999
No reports on Form-8-K were filed during the nine months ended September
30, 1999.
- 15 -
<PAGE>
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
NETWORK-1 SECURITY SOLUTIONS, INC.
By: /s/ Avi A. Fogel
-------------------------------
Avi A. Fogel, President and Chief Executive Officer
(Principal Executive Officer)
Date: November 15, 1999
By: /s/ Murray P. Fish
-------------------------------
Murray P. Fish
Chief Financial Officer
(Principal Financial and Accounting Officer)
Date: November 15, 1999
- 16 -
<PAGE>
EXHIBIT INDEX
Exhibit Number Description of Exhibit
-------------- ----------------------
27 Financial data schedule for nine month period ended
September 30, 1999
- 17 -
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
UNAUDITED FINANCIAL STATEMENTS OF NETWORK-1 SECURITY SOLUTIONS, INC. FOR THE
PERIOD ENDED SEPTEMBER 30, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO
SUCH FINANCIAL STATEMENTS
</LEGEND>
<S> <C>
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<PERIOD-END> SEP-30-1999
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<SECURITIES> 0
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6,000
<COMMON> 44,000
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<SALES> 186,000
<TOTAL-REVENUES> 1,357,000
<CGS> 440,000
<TOTAL-COSTS> 1,620,000
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<LOSS-PROVISION> 10,000
<INTEREST-EXPENSE> 0
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