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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 JUNE 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
-------- ----------
(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 August 4, 2000 there were 6,249,593 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
<TABLE><CAPTION>
Page No.
<S> <C> <C>
PART I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
Balance Sheets as of June 30, 2000 (unaudited) and December 31, 1999................................3
Statements of Operations for the three and six months ended June 30, 2000 and 1999 (unaudited)......4
Statement of Stockholders' Equity for the six months ended June 30, 2000 (unaudited)
and for the year ended December 31, 1999............................................................5
Statements of Cash Flows for the six months ended June 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..................................................................................14
Item 6. Exhibits and Reports on Form 8-K...................................................................14
SIGNATURES..................................................................................................15
</TABLE>
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<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.
BALANCE SHEETS
<TABLE><CAPTION>
June 30, 2000 December 31, 1999
(Unaudited) (Audited)
----------- ---------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 6,339,000 $ 3,023,000
Accounts receivable - net of allowance for doubtful accounts
of $60,000 and $40,000 respectively 324,000 65,000
Prepaid expenses and other current assets 169,000 155,000
Due from officer 0 88,000
------------ ------------
Total current assets 6,832,000 3,331,000
Equipment and fixtures 449,000 425,000
Capitalized software costs - net 576,000 500,000
Security deposits 82,000 82,000
Net assets of discontinued operations 89,000 258,000
------------ ------------
$ 8,028,000 $ 4,596,000
============ ============
LIABILITIES
Current liabilities:
Accounts payable $ 205,000 $ 320,000
Accrued expenses and other current liabilities 541,000 546,000
Deferred revenue 120,000 58,000
------------ ------------
Total current liabilities 866,000 924,000
Notes payable - related parties 451,000 525,000
Notes payable - others 343,000 975,000
Interest payable - related parties 20,000 1,000
Interest payable - others 13,000 2,000
------------ ------------
1,693,000 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 -164,401 and 491,803 shares issued and outstanding, respectively 2,000 5,000
Common stock - $.01 par value; authorized 25,000,000 shares;
6,233,199 and 4,935,211 shares issued and outstanding, respectively 62,000 50,000
Additional paid-in capital 29,783,000 23,941,000
Accumulated deficit (23,451,000) (21,693,000)
Unearned portion of compensatory stock options (61,000) (134,000)
------------ ------------
6,335,000 2,169,000
------------ ------------
$ 8,028,000 $ 4,596,000
============ ============
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS
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<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.
STATEMENTS OF OPERATIONS
UNAUDITED
<TABLE><CAPTION>
Three Months Ended June 30, Six Months Ended June 30,
--------------------------------------------------------
2000 1999 2000 1999
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Revenues:
Licenses $ 317,000 $ 43,000 $ 474,000 $ 113,000
Services 35,000 29,000 70,000 63,000
----------- ----------- ----------- -----------
Total revenues 352,000 72,000 544,000 176,000
Cost of revenues:
Amortization of software development costs 63,000 135,000 124,000 270,000
Cost of licenses 23,000 13,000 29,000 30,000
Cost of services 38,000 67,000 66,000 115,000
----------- ----------- ----------- -----------
124,000 215,000 219,000 415,000
----------- ----------- ----------- -----------
Gross profit (loss) 228,000 (143,000) 325,000 (239,000)
----------- ----------- ----------- -----------
Operating expenses:
Product development 325,000 385,000 618,000 773,000
Selling and marketing 689,000 885,000 1,177,000 1,659,000
General and administrative 456,000 492,000 973,000 1,005,000
----------- ----------- ----------- -----------
1,470,000 1,762,000 2,768,000 3,437,000
----------- ----------- ----------- -----------
Loss from continuing operations before interest (1,242,000) (1,905,000) (2,443,000) (3,676,000)
Interest income (expense) - net (1,435,000) 29,000 (1,402,000) 94,000
----------- ----------- ----------- -----------
Loss from continuing operations $(2,677,000) $(1,876,000) $(3,845,000) $(3,582,000)
Income (loss) from discontinued operations 59,000 (1,000) 2,087,000 (125,000)
----------- ----------- ----------- -----------
Net loss $(2,618,000) $(1,877,000) $(1,758,000) $(3,707,000)
=========== =========== =========== ===========
Per common share information - basic and diluted
Loss from continuing operations $ (0.44) $ (0.43) $ (0.67) $ (0.82)
Income (loss) from discontinued operations 0.01 (0.00) 0.36 (0.03)
----------- ----------- ----------- -----------
Net loss $ (0.43) $ (0.43) $ (0.31) $ (0.85)
=========== =========== =========== ===========
Weighted average number of common
shares outstanding 6,124,112 4,372,375 5,722,257 4,371,957
=========== =========== =========== ===========
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS
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<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE><CAPTION>
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 327,402 3,000 (327,402) (3,000)
Exercise of employee & non-employee
stock options 456,350 4,000 -- --
Exercise of Warrants 275,576 3,000 -- --
Conversion of Notes and Accrued Interest 238,660 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 - June 30, 2000 6,233,199 $ 62,000 164,401 $ 2,000
============ ============ ============ ============
</TABLE>
NETWORK-1 SECURITY SOLUTIONS, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
(CONTINUED)
<TABLE><CAPTION>
Paid-in Accumulated Compensatory
Capital Deficit Stock Options Total
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
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 -- -- 73,000 73,000
Conversion of Series D preferred stock -- -- -- --
Exercise of employee & non-employee
stock options 2,210,000 -- -- 2,214,000
Exercise of Warrants 883,000 -- -- 886,000
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 -- (1,758,000) -- (1,758,000)
------------ ------------ ------------ ------------
Balance - June 30, 2000 $ 29,783,000 $(23,451,000) $ (61,000) $ 6,335,000
============ ============ ============ ============
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS
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<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.
STATEMENTS OF CASH FLOWS FOR THE SIX MONTHS ENDED
<TABLE><CAPTION>
June 30,
----------------------------
2000 1999
(Unaudited) (Unaudited)
----------- -----------
<S> <C> <C>
Cash flows from operating activities:
Loss from continuing operations $(3,845,000) $(3,582,000)
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 73,000 240,000
Provision for doubtful accounts 20,000 (58,000)
Depreciation and amortization 186,000 367,000
Changes in:
Accounts receivable (279,000) 21,000
Prepaid expenses and other current assets (14,000) (113,000)
Accounts payable, accrued expenses and
other current liabilities (120,000) 312,000
Interest Payable 33,000 0
Deferred revenue 62,000 (26,000)
----------- -----------
Net cash used in continuing operations (2,366,000) (2,839,000)
Cash provided by (used in) discontinued operations 81,000 (293,000)
----------- -----------
Net cash used in operating activities (2,285,000) (3,132,000)
Cash flows from investing activities:
Acquisitions of equipment and fixtures (87,000) (379,000)
Capitalized software costs (200,000) (200,000)
Security deposit 0 (45,000)
Loan to officer 88,000 0
Proceeds from sale of professional services group 2,700,000
----------- -----------
Net cash provided by (used in) investing activities 2,501,000 (624,000)
----------- -----------
Cash flows from financing activities:
Proceeds from exercise of options and warrants 3,100,000
----------- -----------
Net cash provided by financing activities 3,100,000 0
----------- -----------
Net increase (decrease) in cash and cash equivalents 3,316,000 (3,756,000)
Cash and cash equivalents - beginning of period 3,023,000 6,423,000
----------- -----------
Cash and cash equivalents - end of period $ 6,339,000 $ 2,667,000
=========== ===========
Supplemental disclosures of noncash investing and financing activity:
Conversion of notes payable and accrued interest into
238,660 shares of common stock $ 726,000 $ --
=========== ===========
</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
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 six months ended June 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
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. Accordingly, the Company has a limited relevant operating
history as a software developer and has made only limited sales of its
CYBERWALLPLUS product, 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. 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 June 30,
2000, had an accumulated deficit of $23,451,000. In addition, since June 30,
2000, the Company has continued to incur significant operating losses. The
Company expects to incur substantial operating expenses 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 network
security software products since the introduction of FIREWALL/PLUS (June 1995),
a predecessor product line, through June 30, 2000 has only been $3,396,000,
including a non-refundable pre-paid royalty of $500,000 in 1997. From January
1999 through June 30, 2000, license revenue from CYBERWALLPLUS has only been
$669,000. 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, if ever, 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
six months ended June 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.
In the second quarter of 2000, the Company introduced CYBERWALLPLUS
Workstation Enterprise Edition (CYBERWALLPLUS-WS) version of its CYBERWALLPLUS
family of network security products. CYBERWALLPLUS-WS is designed for running on
Windows NT 4.0 Workstations or Windows 2000 Professional and prevents
unauthorized network traffic from entering or leaving your workstation. In June
2000, the Company executed a license agreement with BMC Software, Inc. for the
sale of CYBERWALLPLUS-WS totaling $120,000.
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
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
SIX MONTHS ENDED JUNE 30, 2000 COMPARED TO SIX MONTHS ENDED JUNE 30, 1999
Revenues increased by $368,000 or 209%, from $176,000 for the six
months ended June 30, 1999 to $544,000 for the six months ended June 30, 2000,
primarily as a result of an increase in license revenues during the six months
ended June 30, 2000. License revenues increased by $361,000 or 320%, from
$113,000 for the six months ended June 30, 1999 to $474,000 for the six months
ended June 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 and included an enterprise license to BMC
Software, Inc. totaling $120,000. 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 $7,000 or 11%, from $63,000 for the six
months ended June 30, 1999 to $70,000 for the six months ended June 30, 2000.
The Company's revenues from customers in the United States represented 93% of
its revenues during the six months ended June 30, 1999 and 2000, 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 and product
royalties. Cost of licenses decreased by $1,000 or 3%, from $30,000 for the six
months ended June 30, 1999 to $29,000 for the six months ended June 30, 2000,
representing 27% and 6% 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.
Amortization of software development costs decreased by $146,000 or
54%, from $270,000 for six months ended June 30, 1999 to $124,000 for the six
months ended June 30, 2000, representing 239% and 26% of license revenues,
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<PAGE>
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 services consists of salaries, benefits and overhead associated
with technical support and maintenance contracts. Cost of services decreased by
$49,000 or 43%, from $115,000 for the six months ended June 30, 1999 to $66,000
for the six months ended June 30, 2000, representing 183% and 94% 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 consolidation of the Company's former Texas
facility. 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 $325,000 for the six months ended June 30, 2000
compared to a gross loss of ($239,000) for the six months ended June 30, 1999,
representing 60% and (136%) 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 $155,000 or 20%, from
$773,000 for the six months ended June 30, 1999 to $618,000 for the six months
ended June 30, 2000, representing 439% and 114% of revenues, respectively. Total
product development costs, including capitalized costs of $200,000 in both
periods, were $973,000 and $818,000 for the six months ended June 30, 1999 and
June 30, 2000, respectively. The decrease in total product development costs was
due primarily to the reduction in personnel costs as a result of the
consolidation of the Company's former Texas facility, the discontinuation in the
use of outside development consultants and the expiration of computer equipment
operating leases. 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
$482,000 or 29%, from $1,659,000 for the six months ended June 30, 1999 to
$1,177,000 for the six months ended June 30, 2000, representing 943% and 216% of
revenues, respectively. The decrease in selling and marketing expenses was due
primarily to a decrease of $180,000 in personnel costs and travel expenditures
related to the outside sales team in 1999 which was replaced primarily with an
inside sales team late in 1999, a decrease of $34,000 in the use of outside
consultants, a decrease of $137,000 in the international sales program which was
replaced by the inside sales team, a decrease of $32,000 in recruitment fees, a
decrease in public relations costs of $105,000, and a decrease of $48,000 in
costs associated with redesigning the Company's web-site which was partially
offset by increases in marketing personnel costs of $128,000 related to the
replaced outside services, an increase in trade show participation of $14,000
and an increase of $62,000 in the implementation of a business development sales
team. 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
$32,000 or 3%, from $1,005,000 for the six months ended June 30, 1999 to
$973,000 for the six months ended June 30, 2000, representing 571% and 179% of
revenues, respectively. Increases in general and administrative wages and
benefits of $63,000, investor relations expenses of $96,000, professional fees
of $66,000 and recruiting expenses of $27,000 was offset by decreases in
telecommunication costs of $36,000, rent of $18,000, non-cash charges of $91,000
relating to the amortization of the value of stock options granted to the
Company's Chief Executive Officer in May 1998 and $46,000 relating to external
consultants, and general office expenses including travel expenses of $112,000.
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 $1,402,000 for the six months ended June 30,
2000 compared with net interest income of $94,000 for the six months ended June
30, 1999, representing (258%) and 53% of revenues, respectively. The Company
completed a Series D Preferred Stock, warrant and promissory note financing on
December 22, 1999 which resulted in an interest charge of $51,000 for the six
months ended June 30, 2000. 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
-10-
<PAGE>
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 financing) issuable upon conversion of the preferred stock and exercise
of the warrants issuable upon conversion of the notes.
Income from discontinued operations was $2,087,000 for the six months
ended June 30, 2000 compared with a loss of $125,000 for the six months ended
June 30, 1999. Income from discontinued operations for the six months ended June
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 six months ended June 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 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. In
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.
No provision for or benefit from federal, state or foreign income taxes
was recorded for six months ended June 30, 1999 or June 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 six
months ended June 30, 2000 of $1,758,000 compared with a net loss of $3,707,000
for the six months ended June 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 June 30, 2000, the Company had $6,339,000 of cash and cash
equivalents and a working capital of $5,966,000. 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 $2,839,000 during the six months ended June 30,
1999 and net cash used in operating activities from continuing operations was
$2,366,000 during the six months ended June 30, 2000. Net cash used in operating
activities from continuing operations for the six months ended June 30, 1999 was
primarily attributable to a net loss from continuing operations of $3,582,000
and by an increase in prepaid expenses and other current assets of $113,000
which was partially offset by an increase in accounts payable, accrued expenses
and other current liabilities of $312,000, depreciation and amortization of
$367,000, and the issuance of Common Stock and warrants for services rendered of
$240,000. Net cash used in operating activities from continuing operations for
six months ended June 30, 2000 of $2,366,000 was primarily attributable to a net
loss from continuing operations of $3,845,000 less the non-cash interest charge
of $1,500,000, an increase in accounts receivable of $279,000, and a decrease in
accounts payable, accrued expenses and other current liabilities of $120,000,
which was partially offset by the issuance of common stock and warrants for
services rendered of $73,000, depreciation and amortization expense of $186,000,
an increase in accrued interest payable of $51,000 and an increase in deferred
revenue of $62,000.
The Company's operating activities during the six months ended June 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 six months ended June 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 $2,214,000 from
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the exercise of stock options in the first six months of 2000 and $886,000 from
the exercise of preferred stock warrants and service warrants in the first six
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 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 from the December 1999 financing, the sale of
its professional services business and the exercises of stock options and
warrants through June 30, 2000, together with projected revenues from
operations, will be sufficient to satisfy the Company's operations and capital
requirements through January 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.
On April 28, 2000, the Company's annual meeting of
stockholders was held. At the annual meeting, the following actions was
taken by the stockholders :
1. The following individuals listed below were elected
directors of the Company to serve until the next annual meeting of
stockholders and the election and qualification of their successors.
The number of votes cast for or withheld were as follows:
Nominee For Withheld
------- --- --------
Avi A. Fogel 5,316,566 4,100
William Hancock 5,316,566 4,100
Corey M. Horowitz 5,316,566 4,100
Emanuel Pearlman 5,316,566 4,100
Marcus J. Ranum 5,316,566 4,100
2. The conversion feature of certain outstanding promissory
notes in the principal amount of $1,500,000 (the"Notes") issued as part
of the December 1999 private financing was approved by the
stockholders. The Notes are convertible into 491,803 shares of
Preferred D Stock and warrants of 491,803 shares of stock. The number
of votes cast for, against or withheld were as follows:
For: 3,315,985 Against: 21,770 Withheld: 4,700
3. Richard A. Eisner & Company, LLP was ratified as
independent auditors of the Company for the year commencing January 1,
2000. The number of votes cast for or withheld were as follows:
For: 5,317,216 Against: 1,000 Withheld: 2,550
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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
six month period ended
June 30, 2000
b). Reports of Form 8-K.
No reports on Form 8-K were filed during the three (3) months
ended June 30, 2000:
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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: August 10, 2000
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<PAGE>
EXHIBIT INDEX
Exhibit Number Description of Exhibit
--------------------- -------------------------------
27 Financial data schedule for
six month period ended
June 30, 2000
