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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, 2000
[ ] 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
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(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
781-522-3400
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(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 November 1, 2000 there were 6,361,462 shares of Common Stock, $.01 par
value per share, and 156,204 shares of Series D Convertible Preferred Stock,
$.01 par value per share, outstanding.
Transitional Small Business Disclosure Format (check one): Yes No X
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<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.
INDEX
Page No.
PART I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
Balance Sheets as of September 30, 2000 (unaudited) and
December 31, 1999.....................................................3
Statements of Operations for the three and nine months
ended September 30, 2000 and 1999 (unaudited).........................4
Statement of Stockholders' Equity for the nine months ended
September 30, 2000 (unaudited) and for the year ended
December 31, 1999.....................................................5
Statements of Cash Flows for the nine months ended September
30, 2000 and 1999 (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....................................................13
Item 2. Changes in Securities and Use of Proceeds............................13
Item 3. Defaults Upon Senior Securities......................................13
Item 4. Submission of Matters to a Vote of Security Holders..................13
Item 5. Other Information....................................................13
Item 6. Exhibits and Reports on Form 8-K.....................................13
SIGNATURES....................................................................14
<PAGE>
<TABLE><CAPTION>
NETWORK-1 SECURITY SOLUTIONS, INC.
BALANCE SHEETS
SEPTEMBER 30, 2000 DECEMBER 31, 1999
(UNAUDITED) (AUDITED)
------------ ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 5,896,000 $ 3,023,000
Accounts receivable - net of allowance for doubtful accounts
of $59,000 and $40,000 respectively 354,000 65,000
Prepaid expenses and other current assets 151,000 155,000
Due from officer 0 88,000
------------ ------------
Total current assets 6,401,000 3,331,000
Equipment and fixtures 435,000 425,000
Capitalized software costs - net 615,000 500,000
Security deposits 82,000 82,000
Net assets of discontinued operations 46,000 258,000
------------ ------------
$ 7,579,000 $ 4,596,000
============ ============
LIABILITIES
Current liabilities:
Accounts payable $ 253,000 $ 320,000
Accrued expenses and other current liabilities 663,000 546,000
Deferred revenue 214,000 58,000
------------ ------------
Total current liabilities 1,130,000 924,000
Notes payable - related parties 451,000 525,000
Notes payable - others 343,000 975,000
Interest payable - related parties 28,000 1,000
Interest payable - others 21,000 2,000
------------ ------------
1,973,000 2,427,000
------------ ------------
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 - none issued and outstanding
Series C - none issued and outstanding
Series D -156,204 and 491,803 shares issued and outstanding, respectively 2,000 5,000
Common stock - $.01 par value; authorized 25,000,000 shares;
6,361,462 and 4,935,211 shares issued and outstanding, respectively 64,000 50,000
Additional paid-in capital 30,149,000 23,941,000
Accumulated deficit (24,565,000) (21,693,000)
Unearned portion of compensatory stock options (44,000) (134,000)
------------ ------------
5,606,000 2,169,000
------------ ------------
$ 7,579,000 $ 4,596,000
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SEE NOTES TO FINANCIAL STATEMENTS
-3-
</TABLE>
<PAGE>
<TABLE><CAPTION>
NETWORK-1 SECURITY SOLUTIONS, INC.
STATEMENTS OF OPERATIONS
UNAUDITED
Three Months Ended September 30, Nine Months Ended September 30,
-------------------------------- -------------------------------
2000 1999 2000 1999
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Revenues:
Licenses $ 301,000 $ 73,000 $ 775,000 $ 186,000
Services 45,000 40,000 115,000 103,000
----------- ----------- ----------- -----------
Total revenues 346,000 113,000 890,000 289,000
Cost of revenues:
Amortization of software development costs 62,000 135,000 186,000 405,000
Cost of licenses 23,000 5,000 52,000 35,000
Cost of services 41,000 32,000 107,000 147,000
----------- ----------- ----------- -----------
126,000 172,000 345,000 587,000
----------- ----------- ----------- -----------
Gross profit (loss) 220,000 (59,000) 545,000 (298,000)
----------- ----------- ----------- -----------
Operating expenses:
Product development 333,000 326,000 951,000 1,099,000
Selling and marketing 757,000 562,000 1,934,000 2,221,000
General and administrative 389,000 394,000 1,362,000 1,399,000
----------- ----------- ----------- -----------
1,479,000 1,282,000 4,247,000 4,719,000
----------- ----------- ----------- -----------
Loss from continuing operations before interest (1,259,000) (1,341,000) (3,702,000) (5,017,000)
Interest income (expense) - net 78,000 40,000 (1,324,000) 134,000
----------- ----------- ----------- -----------
Loss from continuing operations $(1,181,000) $(1,301,000) $(5,026,000) $(4,883,000)
Income (loss) from discontinued operations 67,000 (92,000) 2,154,000 (217,000)
----------- ----------- ----------- -----------
Net loss $(1,114,000) $(1,393,000) $(2,872,000) $(5,100,000)
=========== =========== =========== ===========
Per common share information - basic and diluted
Loss from continuing operations $ (0.19) $ (0.30) $ (0.85) $ (1.12)
Income (loss) from discontinued operations 0.01 (0.02) 0.36 (0.05)
----------- ----------- ----------- -----------
Net loss $ (0.18) $ (0.32) $ (0.49) $ (1.17)
=========== =========== =========== ===========
Weighted average number of common
shares outstanding 6,285,824 4,372,375 5,911,484 4,372,097
=========== =========== =========== ===========
SEE NOTES TO FINANCIAL STATEMENTS
- 4 -
</TABLE>
<PAGE>
<TABLE><CAPTION>
NETWORK-1 SECURITY SOLUTIONS, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
Common Stock Preferred Stock
----------------------------- ------------------------------
Shares Amount Shares Amount
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
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 -- -- --
Conversion of Series C preferred stock 562,836 6,000 (562,836) (6,000)
Issuance of Series D preferred stock and
warrants, net of expense of $34,000 -- -- 491,803 5,000
Beneficial conversion feature of Series D
preferred stock and related imputed dividend -- -- -- --
Net Loss -- -- -- --
------------ ------------ ------------ ------------
Balance - December 31, 1999 4,935,211 50,000 491,803 5,000
Amortization of compensatory stock options -- -- -- --
Conversion of Series D preferred stock 335,599 3,000 (335,599) (3,000)
Exercise of employee & non-employee
stock options 468,370 5,000 -- --
Exercise of Warrants 384,091 4,000 -- --
Conversion of Notes and Accrued Interest 238,191 2,000 -- --
Compensation charge for issuance of non-
qualified stock options -- -- -- --
Beneficial conversion feature of Series D
preferred stock underlying notes payable
and related debt discount -- -- -- --
Net loss -- -- -- --
------------ ------------ ------------ ------------
Balance - September 30, 2000 6,361,462 $ 64,000 156,204 $ 2,000
============ ============ ============ ============
NETWORK-1 SECURITY SOLUTIONS, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY(continued)
Paid-in Accumulated Compensatory
Capital Deficit Stock Options Total
------------ ------------ ------------ ------------
Balance - December 31, 1998 $ 20,819,000 $(13,247,000) $ (383,000) $ 7,239,000
Amortization of compensatory stock options -- -- 249,000 249,000
Issuance of common stock and options for
services rendered and payment of liability 161,000 -- -- 161,000
Conversion of Series C preferred stock -- -- -- 0
Issuance of Series D preferred stock and
warrants, net of expense of $34,000 1,461,000 -- -- 1,466,000
Beneficial conversion feature of Series D
preferred stock and related imputed dividend 1,500,000 (1,500,000) -- 0
Net Loss -- (6,946,000) -- (6,946,000)
------------ ------------ ------------ ------------
Balance - December 31, 1999 23,941,000 (21,693,000) (134,000) 2,169,000
Amortization of compensatory stock options -- -- 90,000 90,000
Conversion of Series D preferred stock -- -- -- --
Exercise of employee & non-employee
stock options 2,252,000 -- -- 2,257,000
Exercise of Warrants 1,207,000 -- -- 1,211,000
Conversion of Notes and Accrued Interest 724,000 -- -- 726,000
Compensation charge for issuance of non-
qualified stock options 525,000 -- -- 525,000
Beneficial conversion feature of Series D
preferred stock underlying notes payable
and related debt discount 1,500,000 -- -- 1,500,000
Net loss -- (2,872,000) -- (2,872,000)
------------ ------------ ------------ ------------
Balance - September 30, 2000 $ 30,149,000 $(24,565,000) $ (44,000) $ 5,606,000
============ ============ ============ ============
SEE NOTES TO FINANCIAL STATEMENTS
- 5 -
</TABLE>
<PAGE>
<TABLE><CAPTION>
NETWORK-1 SECURITY SOLUTIONS, INC.
STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED
September 30,
---------------------------------
2000 1999
(Unaudited) (Unaudited)
----------- -----------
<S> <C> <C>
Cash flows from operating activities:
Loss from continuing operations $(5,026,000) $(4,883,000)
Adjustments to reconcile net loss from continuing operations
to net cash used in operating activities:
Interest charge from Preferred D sale 1,500,000
Interest accrued and converted to Series D Preferred Stock 18,000
Issuance of common stock and warrants for
services rendered 90,000 285,000
Provision for doubtful accounts 19,000 (70,000)
Depreciation and amortization 282,000 569,000
Changes in:
Accounts receivable (308,000) 69,000
Prepaid expenses and other current assets 4,000 (147,000)
Accounts payable, accrued expenses and
other current liabilities 50,000 38,000
Interest Payable 46,000
Deferred revenue 156,000 (27,000)
----------- -----------
Net cash used in continuing operations (3,169,000) (4,166,000)
Cash provided by (used in) discontinued operations 193,000 (211,000)
----------- -----------
Net cash used in operating activities (2,976,000) (4,377,000)
Cash flows from investing activities:
Acquisitions of equipment and fixtures (107,000) (382,000)
Capitalized software costs (300,000) (300,000)
Security deposit 0 (45,000)
Loan to officer 88,000
Proceeds from sale of professional services group 2,700,000
----------- -----------
Net cash provided by (used in) investing activities 2,381,000 (727,000)
----------- -----------
Cash flows from financing activities:
Proceeds from exercise of options and warrants 3,468,000
----------- -----------
Net cash provided by financing activities 3,468,000 0
----------- -----------
Net increase (decrease) in cash and cash equivalents 2,873,000 (5,104,000)
Cash and cash equivalents - beginning of period 3,023,000 6,423,000
----------- -----------
Cash and cash equivalents - end of period $ 5,896,000 $ 1,319,000
=========== ===========
Supplemental disclosures of noncash investing and financing activity:
Conversion of notes payable and accrued interest into
238,191 shares of common stock $ 726,000 $ --
=========== ===========
Compensation charge for non qualified stock options related
to employees of discontinued operations $ 525,000 $ --
=========== ===========
SEE NOTES TO FINANCIAL STATEMENTS
- 6 -
</TABLE>
<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
filed March 21, 2000 for the year ended December 31, 1999. 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, 2000
presented herein are not necessarily indicative of the results of
operations that may be expected for the year ending December 31, 2000.
c. Basic loss per share is calculated by dividing net loss by the weighted
average number of outstanding common shares during the period. Diluted per
share data includes the dilutive effects of options, warrants and
convertible securities. As all potential common shares are anti-dilutive to
the loss from continuing operations, 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 RISKS AND UNCERTAINTIES,
INCLUDING, BUT NOT LIMITED TO, THOSE DISCUSSED IN THE COMPANY'S ANNUAL REPORT ON
FORM 10-KSB FOR THE YEAR ENDED DECEMBER 31, 1999 IN THE SECTION ENTITLED "RISK
FACTORS THAT MAY AFFECT FUTURE RESULTS" AS WELL AS THOSE RISKS DISCUSSED
ELSEWHERE IN THIS REPORT.
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. 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 network software product (FIREWALL/PLUS) in June 1995. In
January 1999, the Company introduced its CYBERWALLPLUS family of network
security products and has made only limited sales of these products to date. The
Company's 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. The Company may not be able to
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, 2000, had an accumulated deficit of $24,565,000. In addition, since
September 30, 2000, the Company has continued to incur significant operating
losses. The Company expects to expend significant funds in the future to support
its product development activities, as well as continue to expand its domestic
and international sales activities and marketing capabilities.
The Company's software products have not yet achieved significant
market acceptance. The future success of the Company is largely dependent upon
the size of market acceptance of its CYBERWALLPLUS family of software products.
While the Company believes that its family of software products offer advantages
over competing products for network security, license revenue from all network
security software products since the introduction of FIREWALL/PLUS (June 1995),
a predecessor product line, through September 30, 2000 has only been $3,697,000,
including a non-refundable pre-paid royalty of $500,000 in 1997. From January
1999 through September 30, 2000, license revenue from CYBERWALLPLUS has only
been $966,000. CYBERWALLPLUS may not achieve significant market acceptance.
Revenue from such commercial products depends 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 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.
In February 2000, the Company completed the sale of its professional
services business for a sales price of $4.0 million which included $1.3 million
held in escrow subject to certain former employees of the Company remaining
employed by the purchaser for at least one year and the purchaser securing
certain minimum purchase orders within ninety (90) days of the closing. The sale
has been accounted for by the Company as a sale of a discontinued operation and
the Company recorded a gain on the sale of $2,028,000 in the first quarter of
2000.
- 8 -
<PAGE>
The Company's professional services business accounted for 77% and 62% of its
total revenues during the fiscal years ended December 31, 1999 and December 31,
1998, respectively. Accordingly, as a result of the sale of its professional
services business, the Company's cash flow from operations is likely to be
materially adversely effected until the Company generates sufficient revenue
from the licensing of its software products. In connection with the sale, the
Company agreed not to offer any professional consulting services competitive
with the purchaser until the second anniversary of the closing. Effective upon
the sale, the Company granted options to acquire 104,063 shares of Common Stock
at $2.91 per share to certain employees of the professional services business.
In connection therewith, the Company incurred a compensation charge of $525,000
based upon the intrinsic value of the portion of the options vesting at such
date. The balance of the options vest one year after the closing provided that
the employees are still employed by purchaser. An additional charge of $863,000
will be incurred at such date assuming all the options vest.
The Company completed a Series D Preferred Stock, warrant and
promissory note financing on December 22, 1999. At the Company's April 28, 2000
annual meeting, the stockholders of the Company approved the conversion feature
of the promissory notes into preferred stock and warrants. Accordingly, for the
nine months ended September 30, 2000, the Company incurred an interest charge of
$1,500,000 related to the excess of the market value of the common stock (on the
closing date of the December 1999 financing) issuable upon conversion of the
preferred stock and exercise of the warrants issuable upon conversion of the
notes.
During the third quarter, the Company entered into a contract with a
master reseller in China that provides for a minimum sales commitment to the
Company of $300,000 by September 2001. Revenue will be recognized for the
$300,000 minimum sales commitments to the Company as the master reseller
licenses software to end users but no later than the end of the one year
contract term (September 2001).
The Company has committed significant product and development resources
to its CYBERWALLPLUS 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 will use a portion of the proceeds from its
December 1999 private offering, the sale of its professional services business
and proceeds from option and warrant exercises during 2000 to significantly
increase its product development expenditures.
RESULTS OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 2000 COMPARED TO NINE MONTHS ENDED
SEPTEMBER 30, 1999
Revenues increased by $601,000 or 208%, from $289,000 for the nine
months ended September 30, 1999 to $890,000 for the nine months ended September
30, 2000, primarily as a result of an increase in license revenues during the
nine months ended September 30, 2000. License revenues increased by $589,000 or
317%, from $186,000 for the nine months ended September 30, 1999 to $775,000 for
the nine months ended September 30, 2000, primarily due to the release of new
products and increased demand in security products. CYBERWALLPLUS Workstation
Enterprise Edition was released during the second quarter. Revenue for the nine
months ended September 30, 2000 included an enterprise license issued to BMC
Software, Inc. totaling $120,000 and an $80,000 license issued to a large
government supplier in the third quarter. In addition, management believes that
customers are becoming more aware of the potential impact of security breaches,
and that companies are allocating increasing resources to safeguard their
assets. Service revenues increased by $12,000 or 12%, from $103,000 for the nine
months ended September 30, 1999 to $115,000 for the nine months ended September
30, 2000. The Company's revenues from customers in the United States represented
87% of its revenues during the nine months ended September 30, 1999 and 90% of
its revenues during the nine months ended September 30, 2000, respectively.
Amortization of software development costs decreased by $219,000 or
54%, from $405,000 for nine months ended September 30, 1999 to $186,000 for the
nine months ended September 30, 2000, representing 218% and 24% of license
revenues, respectively. The decrease in amortization of software development
costs was due to the write-off in 1999 of unamortized capitalized software costs
associated with the Company's predecessor product line, FireWall/Plus, and other
technology discontinued or replaced.
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
- 9 -
<PAGE>
and product royalties. Cost of licenses increased by $17,000 or 49%, from
$35,000 for the nine months ended September 30, 1999 to $52,000 for the nine
months ended September 30, 2000, representing 19% and 7% of license revenues,
respectively. 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.
Cost of services consists of salaries, benefits and overhead associated
with the technical support of maintenance contracts. Cost of services decreased
by $40,000 or 27%, from $147,000 for the nine months ended September 30, 1999 to
$107,000 for the nine months ended September 30, 2000, representing 143% and 93%
of service revenues, respectively. The decrease in cost of services in dollar
amount and as a percentage of service revenues resulted primarily from a
reduction in personnel costs as a result of the closing of the Company's former
Texas facility in 1999. Cost of services as a percentage of service revenues may
fluctuate from period to period due to changes in support headcount and related
benefit costs.
Gross profit was $545,000 for the nine months ended September 30, 2000
compared to a gross loss of ($298,000) for the nine months ended September 30,
1999, representing 61% and (103%) of revenues, respectively. The increase in
gross profit was primarily due to the increase in license revenue and the
decrease in amortization of capitalized software 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. Product development expense decreased $148,000 or 13%, from
$1,099,000 for nine months ended September 30, 1999 to $951,000 for the nine
months ended September 30, 2000, representing 380% and 107% of revenues,
respectively. Total product development costs, including capitalized costs of
$300,000 in both periods, were $1,399,000 and $1,251,000 for the nine months
ended September 30, 1999 and September 30, 2000, respectively. The decrease in
total product development costs was due primarily to the reduction in the
expiration of computer equipment operating leases of $102,000, reduced
recruiting fees $20,000 and lower depreciation expense of $12,000. 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.
Sales and marketing expenses consist primarily of salaries, including
commissions, benefits, bonuses, travel, advertising, public relations,
consultants and trade shows. Selling and marketing expenses decreased by
$287,000 or 13%, from $2,221,000 for the nine months ended September 30, 1999 to
$1,934,000 for the nine months ended September 30, 2000, representing 769% and
217% of revenues, respectively. The decrease in selling and marketing expenses
was due primarily to a decrease of $139,000 in personnel costs and travel
expenditures related to the outside sales team in 1999 which was replaced
primarily with an in-house sales team late in 1999, a decrease of $129,000 in
the use of outside consultants, a decrease of $145,000 in the international
sales program which was replaced by the in-house sales team, a decrease in
public relations costs of $142,000 and a decrease of $86,000 in marketing
materials and media, which was partially offset by increases in marketing
personnel costs of $180,000 related to the replaced outside consultants, sales &
international sales teams, an increase of $131,000 in the implementation of a
business development sales team, an increase in advertising expenses of $64,000
and in increase in trade show participation of $18,000. The Company currently
anticipates that selling and marketing expenses will increase as the Company
hires additional personnel to support its growth.
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 decreased by
$37,000 or 3%, from $1,399,000 for the nine months ended September 30, 1999 to
$1,362,000 for the nine months ended September 30, 2000, representing 484% and
153% of revenues, respectively. Increases in general and administrative wages
and benefits of $81,000, an increase of $90,000 in investor relations expenses,
and professional fees of $113,000 was offset by decreases in telecommunication
costs of $29,000, rent of $22,000, non-cash charges of $116,000 relating to the
amortization of the value of stock options granted to the Company's Chief
Executive Officer in May 1998 and $48,000 relating to external consultants, and
travel expenses of $44,000.
- 10 -
<PAGE>
The Company currently anticipates that general and administrative expenses will
increase as the Company hires additional personnel to support its growth in
future periods.
Net interest expense was $1,324,000 for the nine months ended September
30, 2000 compared with net interest income of $134,000 for the nine months ended
September 30, 1999, representing (149%) and 46% of revenues, respectively. The
Company completed a Series D Preferred Stock, warrant and promissory note
financing on December 22, 1999 in connection therewith the Company recorded
interest expense of $67,000 related to the prommissory notes for the nine months
ended September 30, 2000. In addition, at the Company's April 28, 2000 annual
meeting, the stockholders of the Company approved the conversion feature of the
promissory notes into preferred stock and warrants. Accordingly, in the second
quarter of 2000, the Company recorded an interest charge of $1,500,000 related
to the excess of the market value of the common stock (on the closing date of
the December financing) issuable upon conversion of the preferred stock and
exercise of the warrants issuable upon conversion of the notes.
Income from discontinued operations was $2,154,000 for the nine months
ended September 30, 2000 compared with a loss of $217,000 for the nine months
ended September 30, 1999. Income from discontinued operations for the nine
months ended September 30, 2000 was due primarily to proceeds from the sale of
the professional services group in February 2000 of $2,700,000 less the value of
net assets of the business and a non-cash charge of $525,000 relating to the
issuance of non-qualified options which were granted on November 8, 1999 at fair
market value but were contingent upon the closing of the transaction which
resulted in the charge for the nine months ended September 30, 2000. The balance
of the options vest one year after the closing provided that the employees are
still employed by the purchaser. An additional charge of $863,000 will be
incurred at such date assuming all the options vest. The $1.3 million of the
purchase price held in escrow includes (i) $300,000 conditioned upon the
purchaser having secured a minimum of $300,000 of purchase orders or commitments
for consulting services from certain customers within ninety (90) days of the
closing (Minimum Orders), and (ii) $1,000,000 conditioned upon the Company's
former employees remaining employed by purchaser for at least one (1) year from
the closing of the sale. During the three months ended June 30, 2000, the
Company recognized $59,000 of such escrow amount as gain on sale of discontinued
operations based on purchase orders or commitments for consulting services from
certain customers reported to the Company by the purchaser. The Company
currently is in negotiation with the purchaser with respect to the balance of
the $300,000 held in escrow with respect to the Minimum Orders. In connection
with such sale, the Company has agreed not to offer any professional or
consulting services competitive with those services offered by purchaser for a
period of two years from the closing date. The Company has agreed to pay an
aggregate 14% of the $1.0 million of the escrow proceeds to the former employees
provided that they remain with purchaser for at least one year. During the three
months ended September 30, 2000, the Company collected $67,000 in payment of
consulting services provided to the purchaser prior to the acquisition, which
had been fully reserved.
No provision for or benefit from federal, state or foreign income taxes
was recorded for nine months ended September 30, 1999 or September 30, 2000
because the Company incurred net operating losses and fully reserved its
deferred tax assets as their future realization could not be determined.
As a result of the foregoing, the Company had a net loss for the nine
months ended September 30, 2000 of $2,872,000 compared with a net loss of
$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, 2000, the Company had $5,896,000 of cash and cash
equivalents and a working capital of $5,271,000. The Company has financed its
operations primarily through private sales of equity and debt securities, the
consummation of its IPO on November 17, 1998, the sale of its professional
services division on February 10, 2000 and cash received from the exercises of
employee and non-employee stock options. Net cash used in operating activities
from continuing operations was $4,166,000 during the nine months ended September
30, 1999 and net cash used in operating activities from continuing operations
was $3,169,000 during the nine months ended September 30, 2000. Net cash used in
operating activities from continuing operations for the nine months ended
September 30, 1999 was primarily attributable to a net loss from continuing
operations of $4,883,000 and by an increase in prepaid expenses and other
current assets of $147,000 which was partially offset by an increase in accounts
payable, accrued expenses and other current liabilities of $38,000, depreciation
and amortization of $569,000, and the issuance of Common Stock and warrants for
services rendered of $285,000. Net cash used in operating activities from
continuing operations for nine months ended September 30, 2000 was primarily
attributable to a net loss from continuing operations of $5,026,000 less the
non-cash interest charge of $1,500,000, an increase in accounts receivable of
$308,000, and a decrease in accounts payable, accrued expenses and other current
liabilities of $50,000, which
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was partially offset by the issuance of common stock and warrants for services
rendered of $90,000, depreciation and amortization expense of $282,000, an
increase in accrued interest payable of $46,000 and an increase in deferred
revenue of $156,000.
The Company's operating activities during the nine months ended
September 30, 1999 were financed primarily with the net proceeds from the IPO
consummated on November 17, 1998, which resulted in $7,931,000 of net proceeds.
The Company's operating activities during the nine months ended September 30,
2000 were financed primarily with the net proceeds from the $3.0 million private
financing of preferred stock, warrants and notes consummated on December 22,
1999. In addition, in February 2000, the Company sold its professional services
business and received proceeds of $2.7 million. The Company also received
$2,257,000 from the exercise of stock options in the first nine months of 2000
and $1,211,000 from the exercise of preferred stock warrants and service
warrants in the first nine months of 2000. The Company does not currently have a
line of credit from a commercial bank or other institution.
The Company anticipates, based on its 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 its current cash position ($5,896,000 at September 30, 2000),
together with its projected revenues, will be sufficient to satisfy the
Company's operations and capital requirements through September 2001. 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 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. 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.
Year 2000 Issue
The Company did not incur material costs with respect to potential
software issues associated with the Year 2000.
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PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS.
None.
Item 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
None.
Item 3. DEFAULTS UPON SENIOR SECURITIES.
None.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
Item 5. OTHER INFORMATION.
None.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K.
a). 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, 2000
b). Reports of Form 8-K.
No reports on Form 8-K were filed during the three (3) months ended
September 30, 2000.
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<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)
By: /s/ Murray P. Fish
-------------------
Murray P. Fish
Chief Financial Officer
(Principal Financial and Accounting Officer)
Date: November 14, 2000
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<PAGE>
EXHIBIT INDEX
Exhibit Number Description of Exhibit
--------------------- -------------------------------
27 Financial data schedule for
nine month period ended
September 30, 2000
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