SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
[x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIESEXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1999
OR
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
For the transition period from to
Commission file number 333-75137
PACIFIC SOFTWORKS, INC.
(Name of Small Business Issuer in Its Charter)
California 77-0390628
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
703 Rancho Conejo Boulevard
Newbury Park, California 91320
(Address of Principal Executive Offices) (Zip Code)
Issuer's Telephone Number: (805) 499-7722
Securities registered under Section 12(b) of the Exchange Act:
None
Securities registered under Section 12(g) of the Exchange Act:
Common Stock, $0.001 Par Value
(Title of class)
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
Check if disclosure of delinquent filers in response to Item 405 of
Regulation S-B is not contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB
The issuer's revenues for the most recent fiscal year were $ 2,242,544.
The aggregate market value of the voting and non-voting common equity
held by non-affiliates, based upon the average bid and asked prices of the
Common Stock on January 31, 2000 was $ 8,328,045. Shares of Common Stock held
by each officer and director and by each person who owns 5% or more of the
outstanding Common Stock have been excluded in that such persons may be deemed
to be affiliates. This determination of affiliate status is not necessarily a
conclusive determination for other purposes.
The number of shares outstanding of the issuer's Common Stock, as of
February 28, 2000 was 4,402,500.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of Pacific Softwork's definitive proxy statement furnished to
shareholders in connection with the Annual Meeting of Shareholders to be held on
May 26, 2000 are incorporated by reference with respect to Part III of Form 10-
KSB.
<PAGE> 2
PART I
ITEM 1. DESCRIPTION OF BUSINESS
GENERAL DEVELOPMENT OF BUSINESS
Pacific Softworks, Inc., "PASW" or the "Company"), was incorporated
in California in November 1992
and is a developer and licensor of Internet and Web related software and
software development tools. Its products enable Internet and Web based
communications, based on a set of rules known as protocols, and are embedded
into systems and "information appliances" developed or manufactured by others.
Our operations are conducted principally from offices in Southern California,
and sales offices in England and Japan.
We refined our strategic focus during 1999 in order to enhance our
positioning and flexibility in the rapidly growing market for Internetworking
technology and to improve the utilization of our assets and competencies. In
conjunction with this strategy, we elected to change our name to PASW, Inc. in
the first quarter of 2000, subject to shareholder approval. Key elements of our
business strategy involve the segregation of our core technology into separate
business units and identifying strategic investment opportunities and/or
associations with other operating companies.
Establishing separate business units for our core technology will
facilitate our ability to develop and commercialize the underlying
technology and will also allow for either private or public investment,
joint ventures or mergers that are beneficial to such development and
commercialization. Accordingly, we have transferred the operating
assets and technology that represented the historical business of the
Company into two wholly owned subsidiaries. The technology and
personnel responsible for the Internet and Web related software and
software development tools now operate as Pacific Softworks. The
technology and personnel responsible for the embedded Web browser and
server now operate as PSI Web Technologies, Inc. During 1999 we also
established iApplianceNet.com ("iApplianceNet") a development stage
company and a wholly-owned subsidiary, to provide Internet-active
merchandise and service store displays and the infrastructure that
supports them.
We have also commenced a program of identifying strategic
investment opportunities and/or associations with operating companies that are
compatible and complementary to our plan of operations. In accordance with this
program, the Company made an investment in FSPNetwork, Inc. ("FSPN") in December
1999 and signed a letter of intent to invest in RedFlag, Inc. ("RedFlag") in
early 2000. The goal of this strategy is to both increase shareholder value and
to create an operating group of companies that have mutually beneficial
technology and businesses. Future investments and/or associations, if any,
will focus on companies that:
- - have a strong Internet/Web presence that are synergistic with our
core businesses and that can utilize our Internet and web technology in
the implementation of their internet
strategies;
- - have a strong Internet/Web presence that are synergistic with the
businesses of companies in which we have an investment/and or
affiliation ("PSI network companies") and that can utilize the
technology of the PSI network companies in the implementation of their
internet strategies;
- - present cross licensing opportunities for our technology;
- - are past the start-up phase of operations, have revenues and earnings and
are near term candidates for an initial public offering; and
- - can benefit from our financial and operational resources in securing
both private and public investment capital.
<PAGE> 2
DESCRIPTION OF BUSINESS
We operate through three wholly-owned subsidiaries: Pacific
Softworks, PSI Web Technologies, Inc. and iApplianceNet.com.
Pacific Softworks ("Pacific")
Pacific develops and licenses Internet and Web related software and
software development tools. The products enable Internet and Web-based
communications, based on a set of rules known as protocols, and are embedded
into systems and "information appliances" developed or manufactured by others.
Information appliance manufacturers and software developers have
included our products within the following applications and information
appliances:
Applications Information Appliances
- - Office automation - Internet fax, copiers, laser
printers, scanners
- - Medical - Patient monitors, imaging systems
- - Multimedia - DVD players, projectors, digital
cameras
- - Industrial controls - Vending machines, traffic
controls, scoring systems,
security controls
- - Networking - Routers, switches, network
controls, cable modems
- - Set-top boxes - Set-top boxes, Internet TV
- - Wireless - Telephones, personal digital
assistants, pagers,
electronic organizers
- - Navigation systems - Navigational controls, air traffic
controls
- - Defense and aerospace - Engine controls, smart weapons
- - Satellite - Satellite positioning, uplink and
downlink of streaming video
Rapid advances are enabling wired and wireless information appliances to assume
many of the tasks now handled by personal computers. We believe that Web
browsing enabled by embedded software in information appliances used by
businesses and individuals will be a major market.
Approximately 94% of all Internet access is now made through PCs. By 2002, that
percentage is expected to decrease to 64%. By 2002 the number of information
appliances sold is expected to exceed the number of PCs sold. We believe our
Internet and Web related software development tools offer significant benefits
to our customers including:
- accelerated product development and market entry,
- portability across multiple hardware and software system
environments, and
- comprehensive embedded solutions that enable information
appliances to connect with the Internet and use the Web.
Transmission Control Protocol/Internet Protocol
Transmission Control Protocol/Internet Protocol ("TCP/IP"), is a suite
of communications protocols that has been adopted as a standard and enables the
communications that take place on the Internet. As a standard, TCP/IP enables
Internet users to adopt or acquire pre-made, "off the shelf" products, such as
those of Pacific, and eliminates the need by those users to develop a
proprietary communications infrastructure of their own. The TCP/IP stack is
a collection of components consisting of various layers of protocols and
programs that operate together to transfer data over the Internet. These
protocols include the Internet Protocol, various messaging and addressing
protocols, and Transmission Control Protocol.
Embedded systems consist of a microprocessor and related software
incorporated into a product and dedicated to performing a specific set of tasks.
The market for embedded Internet applications continues to grow substantially as
customers deploy TCP/IP based networks. TCP/IP and related technologies are
emerging as the building blocks for next-generation wired and wireless networks.
<PAGE> 3
We believe that key elements defining the TCP/IP market today
include the following:
- TCP/IP is a commodity type product that remains a key component
of the Internet. Generic public domain software for TCP/IP is available at low
cost.
- The competitive market for TCP/IP products currently focuses on
selling value-added applications, such as file transfer protocols designed to
send large files over the Internet, email, and management tools that enhance
the embedded protocol stack.
- The market is migrating away from proprietary protocols to
standard Internet protocols.
- Manufacturers continue to implement Internet and Web embedded
software in a growing number of consumer and industrial information appliances.
- International market growth will ultimately outpace market growth in the
United States.
- As more powerful microprocessors become available and decrease in price,
embedded systems are being used in a wider range of applications and are
facilitating the development of a new generation of information appliances.
Emerging embedded Internet applications for interactive entertainment, network
computers, remote management and other uses may offer significant additional
opportunities for embedded systems and information appliances.
- Manufacturers of products using embedded technology must bring
complex applications for embedded systems to market rapidly and economically.
Developing embedded applications has evolved from a relatively modest
programming task to a complex engineering effort. As more powerful and
affordable microprocessors have become available, products based on them have
become richer in features and functions.
- More sophisticated software solutions are required to develop
these more complex applications, frequently including a real-time operating
system and Internet and Web products that provide
developers with far more features, higher performance and greater productivity
than those necessary or feasible for programming prior generations of
microprocessors.
- As embedded applications increase in complexity, the costs
associated with providing software development, support and training of
engineers are rising rapidly.
In this environment, time-to-market, conformance to standards and
product reliability are critical issues for companies developing information
appliances and other devices which may be connected to the Internet.
Pacific Softworks Products
FUSION products have been designed with the developer in mind. The
FUSION solution assists system developers by adding compliant Internet protocols
and applications to their products. FUSION products are very flexible and
portable, are not dependent on any particular hardware or software and are
designed for easy integration.
FastTrackTM development products provide a pre-built "drop-in solution"
that facilitates quick and easy protocol implementation within our customer's
products. FUSION FastTrackTM solutions provide users with a complete suite of
networking tools to ease the development and porting of new projects. Customers
do not face the uncertainty of trying to determine which components will work
with FUSION. FastTrackTM is integrated with the processor, operating system,
compiler, debugger and development board to assure a simplified and
reliable drop-in solution that moves a customer's project to more rapid
completion. Our customers user need only add its application and then transfer
our software to the targeted hardware or device.
FUSION protocols products are not dependent on any particular processor. They
have been and are currently being developed and integrated by us and our
customers under the FastTrackTM product line for several families of processors
including those of:
- Advanced Micro Devices - MIPS Technologies
- Advanced Risc Machines - Motorola Corporation
<PAGE> 4
- Analog Devices - NEC
- ARC - Philips
- Hitachi - Siemens
- Hyperstone - ST Microsystems
- Intel Corporation - Texas Instruments
- LSI Logic
Product Descriptions
FUSION TCP/IP. This product enables data to be transported over the
Internet and is not dependent on any particular processor, operating system or
compiler. FUSION is high performance, small, tunable and can be readily
incorporated in a customer's information appliances and other embedded products.
FusOS, Operating System. This product is our FUSION operating system.
Customers may choose to use FusOS or remove it from our Internet product and
replace it with any commercial operating system of their choice.
FUSION RIP, Routing Information Protocol. RIP routers send broadcast
messages onto a network and contain routing information about the network. This
information is shared among all the RIP-capable routers in a network thereby
allowing each router to understand where it exists in a network and where its
routes lead. RIP specifies how routers exchange routing table information.
Industry standards describe
and prescribe the specifications required to implement RIP. Our FUSION RIP is a
high-performance portable software engine that implements IP forwarding and
route generation consistent with industry standards. With RIP, routers
periodically exchange entire tables of routing data.
Because this is inefficient, RIP is gradually being replaced by a newer
protocol called Open Shortest Path First Protocol, or OSPF.
FUSION OSPF, Open Shortest Path First Protocol. Unlike RIP, which
transfers entire tables of routing data, OSPF transfers only routing information
which has changed since the previous transfer. As a result, use of this protocol
reduces the amount of data to be transmitted and conserves system resources.
FUSION OSPF has been designed specifically for use in high performance multi-
protocol routers.
FUSION PPP, Point-to-Point Protocol. This application links one device
to another over telephone lines and cable. FUSION PPP provides a means for
transmitting packets of data known as datagrams over serial point-to-point
links.
FUSION SNMP, Simple Network Management Protocol. SNMP helps to manage
and control devices over the Internet. FUSION SNMP is a set of protocols that
interfaces transparently into FUSION TCP/IP.
FUSION FTP, File Transfer Protocol. This application software allows the
efficient sharing of files, programs or data between devices over the Internet.
FUSION FTP also provides a secure way to allow or deny access to specific files
or directories among diverse systems.
FUSION TFTP, Trivial File Transfer Protocol. This product is a subset of FUSION
FTP that allows the efficient transfer of files among diverse host systems
without the extended features and potential overhead or
consumption of computing resources associated with FTP. FUSION TFTP is
designed with small size and easy implementation in mind for devices with
minimal memory.
FUSION Telnet. This product is a general, bi-directional oriented
communications application which allows a standard method of interfacing or
connecting terminal devices and terminal-oriented processes to each other.
FUSION Telnet software can be used for terminal-to-terminal and/or application-
to-application communications.
FUSION SMTP, Simple Mail Transfer Protocol. This product is a protocol
used for sending email messages
<PAGE> 5
between or among servers on a network. SMTP is independent of any
transmission protocol or operating system and only requires a reliable data
stream. We have designed FUSION SMTP to be small, efficient and easy to
implement in virtually any environment.
FUSION POP3, Post Office Protocol Version 3. This software provides
messaging capability within products or systems that do not have the memory or
other resources to use SMTP or where there is no continuous Internet connection.
POP3 is typically used to access and retrieve e-mail that is being held on a
mail server. Most email applications, sometimes called an "e-mail client", use a
POP Protocol. POP3 is independent of any transport protocol or operating system.
We have designed FUSION POP3 to be a small, efficient messaging client that is
easy to implement in environments where memory and system resources are sparse.
FUSION BOOTP, Bootstrap Protocol. BOOTP provides a secure way to allow
or deny access to specific files or directories among diverse systems. This
Internet protocol enables a diskless device to discover its own IP address, the
IP address of a BOOTP server on the network and a file to be loaded into memory
to activate or boot the device. This application software allows the efficient
sharing of files, programs or data among diverse host systems.
FUSION DHCP, Dynamic Host Configuration Protocol. This protocol assigns
dynamic addresses to devices linked to the Internet. With dynamic addressing, a
device can have a different address every time it connects to the Internet. DHCP
also supports a mix of fixed and dynamic Internet addresses. Dynamic addressing
simplifies network administration because the software keeps track of the
addresses rather
than requiring an administrator to manage the task. This means that a device can
be added to the Internet without the difficulties associated with manually
assigning it a unique address. Many Internet service providers use dynamic
addressing for dial-up users.
Over the next 12 to 18 months we intend to introduce and market the
products described below:
FUSION 5. This product is our major TCP/IP upgrade. FUSION 5 will
contain major enhancement, significant improvements to our existing version and
compliance with changing industry standards.
FUSION IPsec. This product is the FUSION IP security protocol suite
which provides privacy and authentication services at the Internet Protocol
layer. IPsec will use advanced encryption technology and is designed to provide
secure financial and e-commerce transactions from information appliances over
the Internet.
FUSION Satellite IP. FUSION Satellite IP is being designed to handle
communication over satellite links for uplink and downlink modes and will adapt
to the delays inherent in satellite communications. We expect FUSION Satellite
IP to add the power and scalability required for Internet protocols to work in a
slow-start or delayed environment such as in satellites and set-top boxes.
FUSION Mobile IP. We are designing this product for use within wireless and
cellular applications. Internet protocols do not currently operate efficiently
in wireless environments. We are designing Mobile IP to handle information
processing delays and interruptions associated with Internet protocols in
wireless applications.
FUSION MultiLink PPP. MultiLink PPP will allow users to broadcast data
simultaneously to multiple devices within different operating environments and
will allow users to transfer more data by combining available links. MultiLink
PPP will extend the features and capabilities of PPP over multiple links or
channels. We expect to design both FUSION PPP and MultiLink PPP modules for use
within any major embedded processor.
Marketing, Sales and Distribution
In North America, Europe and Japan, we market our products and services
primarily through our own direct sales organization, which consists of
salespersons and field application engineers. As of December 31, 1999, we had
three domestic salespersons and field application engineers located in North
America, one salesperson in Europe and one
<PAGE> 6
salesperson and one field engineer in Japan.
Products are distributed in Japan through a wholly owned subsidiary,
Network Research Corporation Japan. Network Research has an exclusive license
for distribution of our products in Japan.
We have appointed international distributors to serve customers in
regions not serviced by our direct sales force. We also collaborate with
semiconductor and software vendors and work closely with a number of system
integrators worldwide. We believe these relationships enable us further to
broaden the geographic and market scope for our products.
Revenue from international sales represented approximately 53% and 58%
of Pacific's total revenue in fiscal 1999 and 1998. Our international operations
are subject to various risks, including:
- foreign government regulation,
- foreign currency fluctuations which could reduce our revenue in
dollar terms or make our products more expensive,
- more prevalent software piracy,
- longer payment cycles,
- unexpected changes in regulatory requirements, tariffs, import
and export restrictions and other barriers and restrictions,
- greater difficulty in accounts receivable collection,
- potentially adverse tax consequences including restrictions on
repatriation of earnings,
- the burdens of complying with a variety of foreign laws,
- difficulties in staffing and managing foreign operations,
- political and economic instability,
- changes in diplomatic and trade relationships, and
- possible recessionary environments in economies outside the
United States.
These factors may have a material adverse effect on our international
sales and, consequently, our business, operating results and financial
condition.
We have experienced and expect to continue to experience significant
seasonality of revenue resulting primarily from customer buying patterns and
product development cycles. The strongest demand for products is generally
experienced in the fourth quarter of each fiscal year and the weakest demand in
the first quarter of each fiscal year.
Quarterly revenue has typically decreased in the first quarter of each
fiscal year from the fourth quarter of the prior fiscal year.
Competition
The embedded Internet and Web-based software industry is highly
competitive and is characterized by rapidly advancing technology. We believe
that competition in our markets is based on:
- product capabilities,
- price/performance characteristics,
- product portability,
- ease of use, and
- support services and corporate reputation.
We compete with other independent software vendors, including Wind River
Systems, Inc., Integrated Systems, Inc., Mentor Graphics, Inc. (through its
acquisition of Microtec/ Ready Systems), Microware Systems Corporation and
Microsoft Corporation. In addition, hardware or other software vendors could
seek to expand their product offerings by designing and selling products
that directly compete with or adversely affect sales of our products.
<PAGE> 7
Many of our existing and potential competitors have substantially
greater financial, technical, marketing and sales resources than we have. We are
aware of ongoing efforts by competitors to emulate the performance and features
of our products and we can provide no assurance that competitors will not
develop equivalent or superior technology.
Because we are been substantially dependent on our TCP/IP family of
Internet products and services, the effects of competition could be more adverse
on us than would be the case if we had a broader product offering. In addition,
competitive pressures could cause us to reduce the prices of our products, which
would result in reduced profit margins. There can be no assurance that we will
be able to compete effectively against our current and future competitors. If we
are unable to compete successfully, our business, financial condition
and operating results would be materially adversely affected.
Proprietary Rights
Our success is heavily dependent upon our proprietary technology. To
protect our software, documentation and other written materials, we rely on a
combination of:
- copyright protection,
- trade secret and trademark laws,
- nondisclosure agreements,
- other contractual restrictions on copying or distribution, and
- technical measures.
As a part of the confidentiality procedures, we generally enter into
nondisclosure agreements with employees and consultants and limit access to and
distribution of software, documentation and other proprietary information. End
user licenses of our software are frequently in the form of source license
agreements, which are signed by licensees and which we believe may be
enforceable under the laws of many jurisdictions.
We believe that, due to the rapid pace of innovation within our
industry, factors such as the technological and creative skills of our personnel
are more important than are the various legal protections of our technology.
Manufacturing and Backlog
Our manufacturing operation consists of assembling, packaging and
shipping the software products and documentation needed to fulfill each order.
We manufacture our source code and duplicate compact disks in our California
facility. We use outside vendors to print documentation and manufacture
packaging materials. We believe that backlog is not a meaningful indicator of
revenue that can be expected in future periods.
Employees
As of December 31, 1999, Pacific employed 16 persons full-time,
including seven in sales and marketing and nine in product development,
engineering and support, including two consulting engineers. Of these employees,
thirteen are located in North America, two are located in Japan and one is
located in Europe. None of our employees are represented by a labor union or is
subject to a collective bargaining agreement. We have never experienced a work
stoppage. We believe that relations with our employees are good.
PSI Web Technologies, Inc
PSI Web Technologies develops and licenses the FUSION WebPilot Micro
BrowserTM and the FUSION Embedded Web Server. The Internet and Web server
products provide an integrated suite of critical functions which feature:
<PAGE> 8
- a small sized, fast, efficient, high performance embedded
Internet protocol stack,
- an extensive range of Internet and Web applications,
- custom-built software code optimized for embedded systems,
- mature software code for the Internet products that have been
tested and used in a wide variety of products by companies
including Alcatel Telcom, AT&T/Lucent Technologies, Hewlett-
Packard, Honeywell, Hughes Aircraft, Intel, Cisco and SGS Thomson,
- code developed for embedded systems and information appliances
with fine tuning capabilities built into the code to optimize Internet
connectivity for specific applications,
- multiple interface software support for most of the major
communication chip sets, and
- pre-built, ready to add "drop-in solutions" for easy integration
of customer application software across multiple processor
platforms.
FUSION WebPilot Micro BrowserTM
The FUSION WebPilot Micro BrowserTM is an embedded browser aimed at
applications like set-top boxes, wired and wireless telephones, other hand-held
information appliances, kiosks and other remote Internet information appliances.
This application has been designed for limited memory environments and is
independent of the operating system, processor or compiler. It has been designed
to be applicable across diverse computer systems and environments.
Unlike other browsers based on Windows(R), the FUSION WebPilot Micro
BrowserTM is designed for applications where space and computing resources are
limited. Unlike other browsers, the FUSION WebPilot Micro
BrowserTM is not a modified or simplified version of existing PC code.
Our browser has also been designed specifically for embedded applications. We
believe that our product is the only embeddable Web browser that currently can
make this claim. Our product will provide full browsing capabilities in an
embedded environment without needing a full PC-type operating system such as
Microsoft Windows(R) NT. In addition to browsing capabilities, the FUSION
WebPilot Micro BrowserTM will include email and e-commerce applications.
The FUSION WebPilot Micro BrowserTM has its own embedded windowing and
graphical support. These features allow users to create custom designs and
custom fonts and icons. We believe that these features are particularly
important in addressing foreign languages such as Japanese and in developing
branded presentation screens for customers.
The FUSION WebPilot Micro BrowserTM has been designed to permit
incorporation of various add-on modules. Our browser will have a functionality
and presentation similar to those of the much larger PC-based browsers such as
Internet ExplorerTM and NetscapeTM but will have substantially reduced memory
requirements. We commenced actively marketing the FUSION WebPilot
Micro BrowserTM during the first quarter of 2000.
FUSION Embedded Web Server.
This application software provides Web servers with the capability to
monitor and manage any Internet connected device through the Web. Examples of
devices which could incorporate this product include:
- - video cameras,
- - vending machines,
- - utility power meters,
- - medical equipment, and
- - other remote devices.
The FUSION Web Server is compatible with the FUSION WebPilot Micro
BrowserTM and other standard browsers including Netscape, Mosaic and Internet
Explorer.
<PAGE> 9
Marketing, Sales and Distribution
PSI Web Technologies is in the process of planning for an
independent marketing, sales and distribution department. Until such time as
this department has been properly organized and staffed, PSI Web Technologies
will utilize personnel presently employed by Pacific Softworks.
Competition
The embedded Internet and Web-based software industry is highly
competitive and is characterized by rapidly advancing technology. We believe
that competition in our markets is based on:
- product capabilities,
- price/performance characteristics,
- product portability,
- ease of use, and
- support services and corporate reputation.
Like Pacific, PSI Web Technologies competes with other independent
software vendors, including Wind River Systems, Inc., Integrated Systems, Inc.,
Mentor Graphics, Inc. (through its acquisition of Microtec/ Ready Systems),
Microware Systems Corporation and Microsoft Corporation. In addition, hardware
or other software vendors could seek to expand their product offerings by
Designing and selling products that directly compete with or adversely affect
sales of our products.
Many of our existing and potential competitors have substantially
greater financial, technical, marketing and sales resources than we have. We are
aware of ongoing efforts by competitors to emulate the performance and features
of our products and we can provide no assurance that competitors will not
develop equivalent or superior technology.
There can be no assurance that we will be able to compete effectively
against our current and future competitors. If we are unable to compete
successfully, our business, financial condition and operating results would be
materially adversely affected.
Proprietary Rights
Our success is heavily dependent upon proprietary technology. To protect our
software, documentation and other written materials, we rely on a combination
of:
- copyright protection,
- trade secret and trademark laws,
- nondisclosure agreements,
- other contractual restrictions on copying or distribution, and
- technical measures.
As a part of the confidentiality procedures, we generally enter into
nondisclosure agreements with employees and consultants and limit access to and
distribution of software, documentation and other proprietary information. End
user licenses of our software are frequently in the form of source license
agreements, which are signed by licensees and which we believe may be
enforceable under the laws of many jurisdictions.
We believe that, due to the rapid pace of innovation within our industry,
factors such as the technological and
<PAGE> 10
creative skills of our personnel are more important than are the various legal
protections of our technology.
Manufacturing and Backlog
Our manufacturing operation consists of assembling, packaging and
shipping the software products and documentation needed to fulfill each order.
We manufacture our source code and duplicate compact disks in our California
facility. We use outside vendors to print documentation and manufacture
packaging materials. We believe that backlog is not a meaningful indicator of
revenue that can be expected in future periods.
Employees
As of December 31, 1999, PSI Web Technologies employed six persons full-time in
product development, engineering and support, including one consulting engineer.
All of these employees are located in North America. None of our employees are
represented by a labor union or is subject to a collective bargaining agreement.
We have never experienced a work stoppage. We believe that relations with our
employees are good.
iApplianceNet.com
iApplianceNet.com is a development stage company that has been
established to design, manufacturer and operate interactive merchandise
displays, enabling consumer goods manufacturers and retailers to manage real-
time product information into and from their retail store outlets. The
proprietary network has been designed to provide companies with the ability to
manage "point of purchase" product information, including real-time sales and
marketing messages, from a centralized data management location. In addition,
our network delivers measurement data that can be used strategically by
manufacturers and retailers for their inventory management systems. Systems and
software packages are both customizable and scalable to the global needs of our
clients.
iApplianceNet's goal is to manage the design, manufacturing and operation of
complex technology, so that our clients can focus on extracting the maximum
value from the advertisement displayed in the store and the information gathered
from the marketplace.
iApplianceNet has developed a working prototype of its initial product
and has established a strategic partnership with HMG Worldwide ("HMG",
NASDAQ-HMGC), an established company in the point-of-purchase industry.
Their clients include, among others, Proctor & Gamble, Coke, L'Eggs, and
Pillsbury. Recently, through
their acquisition of EgoMedia, an Internet site developer, HMG also has
creative assets in the area of content development. iApplianceNet and HMG
have signed a Joint Sales and Marketing Agreement, in which the two companies
will co-develop and market POP displays.
Additional capital is necessary to properly fund the capital needs of
iApplianceNet before such time as iApplianceNet can access the public capital
markets directly. Accordingly, iApplianceNet is in the process of securing
private investment capital. The final amount of capital and the dilution to
PASW are not known at this time.
Employees
As of December 31, 1999, iApplianceNet employed seven persons in
product development, including one part time person. All of these employees are
located in North America. None of our employees are represented by a labor
union or is subject to a collective bargaining agreement. We have never
experienced a work stoppage. We believe that
relations with our employees are good.
<PAGE> 11
Strategic Investments
FSPNetwork, Inc.
On October 25, 1999 PASW and FSPNetwork, Inc ("FSPN"), a
private firm and a developer of software for the banking industry, signed a
Letter of Intent to enter into discussions with the intent of entering a
strategic relationship to jointly develop certain Internet applications with
financial institutions. The Company indicated that subject to entering into a
definitive agreement it would invest up to $1,000,000 in FSPN and under certain
conditions up to an additional $2,000,000. On October 25, 1999 PASW
loaned FSPN $250,000 through a promissory note bearing interest at the rate of
ten (10%) percent per annum and due in ninety days. The loan was for general
corporate purposes.
On December 3, 1999 the Company loaned FSPN an additional $750,000 and converted
the $250,000 note, evidenced by a $1,000,000 convertible promissory note. The
convertible promissory note is unsecured, carries interest
at 10% per annum and is due 12 months from issuance unless previously converted
into capital stock of FSPN. The convertible note will automatically convert into
shares equivalent to no less than 5% of the outstanding capital stock of FSPN
concurrent with FSPN's closing of its next equity financing. If converted, the
accrued interest on the convertible promissory note will revert to a 6% rate for
purposes of calculating the number of shares of FSPN issuable.
FSPNetwork and Hewlett-Packard Company have established a business
alliance that provides a fully customizable, 100 percent private-branded portal
with Internet access. The portal will enable banks and financial institutions to
provide their retail and commercial customers with highly personalized Internet
environments that include e-commerce and transactional capabilities. The portal
also can be integrated with existing customer relationship management (CRM)
systems for one-to-one message-based marketing.
The portal enables financial-service institutions to offer a branded
portal experience, market directly and unobtrusively to customers, screen
competing advertising within the portal environment, and significantly increase
the convenience of access to online banking services. An e-banking link is put
directly on the customer's home page so that every Web transaction is completed
within the bank's branded Web environment. In addition, a virtual banker guides
the customer through the site and delivers individually targeted messages to the
customer. Local and national content can be customized and fully deployed within
weeks. The institution's commercial customers can also participate in the local
portal community with customized e-commerce sites hosted in the institution's
name.
FSPNetwork's portal is optimized for HP technology and leverages HP's
portfolio of UNIX(R) and Windows NT(R) system servers, storage products,
financing and software, such as HP OpenView. HP also is the preferred provider
of consulting and integration services as banks roll out these services to their
customers and integrate existing and new CRM systems.
RedFlag, Inc.
In January 2000, the Company signed a letter of intent to acquire up to
45% of RedFlag, Inc.("RedFlag"). RedFlag, a privately held company, designs
complex graphical application software that will enable the Company's operating
subsidiaries to provide products that include not only the Internet and Web-
component software, but the front- and back-end application software.
As part of the agreement, PASW has the right to acquire up
to 45 percent of the shares of RedFlag in exchange for shares of
PASW in the next 18 months, based on a pre-determined revenue schedule
for RedFlag. The purchase price will range between $100,000 for 10% of RedFlag
to $6,400,00 for 45% of RedFlag. The total amount of the purchase price will
depend on their level of sales for the next 18 months. The number of shares of
PASW will be based on the closing bid price of the stock on the date
of the exchange, subject to a floor of $4.00 and a ceiling of $12.00 per share.
<PAGE> 12
The companies will work together to develop complete end-to-end
networking and application software for the in-store display, banking and other
key market areas, using low-cost hardware to provide the interactive experience
at the point-of-purchase. These complete solutions will be compatible with both
Red Hat Linux and Microsoft Windows.
In addition to developing high-traffic portal sites and business-to-
business application services and software, RedFlag is now marketing is first
software product, "Business Analyst." Business Analyst is a unique product that
is available to business users on the Web. The program analyzes all of a
company's financial data, then, using red, yellow and green "flags," pinpoints
the company's strengths and weaknesses. It then offers solutions to these
problems by analyzing financial operations, interactions, obligations, assets
and liabilities, and converts all of this data into easy-to-read charts, graphs
and reports.
Business Analyst is offered by RedFlag as part of a suite of services
through major banking portals, allowing banks to offer its business customers
online banking services and advice. RedFlag has a team of professional software
engineers with expertise in Internet and Web communications, site architecture
and navigation experts, Web designers, programmers, database engineers, and
provides an end-to-end portal solution with customized applications.
ITEM 2. DESCRIPTION OF PROPERTY
Pacific Softworks, PSI Web Technologies and iApplianceNet sublease office
space from PASW at a leased facility located in Newbury Park,
California consisting of approximately 11,500 square feet of office space. The
lease for this facility expires in September 2000. The monthly lease payment for
the facility is approximately $8,500. iApplianceNet also leases additional
office space in Santa Monica, California, consisting of approximately 1,306
square
feet of office space. The lease for this facility expires in 2002 and
has a monthly lease payment of approximately $2,550. In Japan we have
subleased space of approximately 700 square feet at a monthly rate of
approximately $2,000 on a month to month basis.
We believe that these facilities are adequate for our current
needs and for expected personnel additions over the next 18 months.
ITEM 3. LEGAL PROCEEDINGS
In April 1999 we were notified that a merchant banker, Golenberg & Co.,
has asserted rights under a June 1998 letter agreement to purchase 10% of our
then outstanding common stock for $400,000. In June 1999 counsel
for Golenberg & Co. reiterated this demand and advised us that these
claims were being evaluated for possible legal action. To date no action has
been taken by Golenberg & Co.
The Company is not a party to any other pending legal proceedings
that management believes could have a material adverse effect on its financial
position.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There have been no matters submitted to a vote of security holders during
the quarter ended December 31, 1999.
<PAGE> 13
EXECUTIVE OFFICERS AND DIRECTORS
Name Age
Position
Glenn P. Russell............... 44 Chairman
William E. Sliney.............. 61 President and Chief Financial
Officer
Mark Sewell..................... 37 Vice President,
Business Development
Sandra J. Garcia................ 37 Vice President, Sales
Robert G.J. Burg II........... 42 Director
Wayne T. Grau................. 50 Director
Reuben Sandler, Ph.D....... 62 Director
Joseph Lechman................ 32 Secretary
Glenn P. Russell. Mr. Russell has been our chairman since 1992.
He also served as president and chief executive officer from 1992 to December
1999. Before 1992 he had various sales and marketing positions at IBM, Unisys
and Network Research Corporation, a predecessor of PASW.
Mr. Russell is also an officer and director of Luke Systems
International, a distributor of electronic components. Luke Systems
International is controlled by Mr. Russell's spouse. Mr. Russell devotes
substantially all of his time to PASW. Mr. Russell was educated in
the United Kingdom.
William E. Sliney. Mr. Sliney has been our president since
December 1999 and chief financial officer since April 1999. Before joining us,
Mr. Sliney was the chief financial officer for Legacy Software Inc. from 1995 to
1998. From 1993 to 1994, Mr. Sliney was chief executive officer for Gumps. Mr.
Sliney received his masters in business administration from the University of
California at Los Angeles.
Mark Sewell. Mr. Sewell, previously a resident of the United
Kingdom, was the general manager for our European operations from 1996 to 1999
and our Vice President, Business Development commencing in 1999. For over two
years prior to 1996, he was the business and support manager for the Asia
Pacific region of PictureTel, Inc. He received his masters degree in electrical
and electronic engineering from the University of Canterbury.
Sandra J. Garcia. Ms. Garcia joined us in 1993 as our regional
sales manager and became vice president, North American sales in 1996 and became
Vice President, Sales in 1999. Ms. Garcia graduated with a degree in business
administration from Santa Barbara College.
Robert G. J. Burg II. Mr. Burg was a director of PASW
from January 1999 through January 2000. He has been the president of
Profile Sports, a corporate sports and outing entertainment business, since
1998. For more than five years before that he served as president, senior vice
president and in other managerial positions at Royal Grip, Inc., a manufacturer
and distributor of golf grips and sports headwear. Mr. Burg received a Bachelor
of Arts degree from the University of Colorado. He currently serves on the
boards of directors of EMD/Empyrean Diagnostics, Ltd. and
Royal Precision, Inc.
Wayne T. Grau. Mr. Grau has been a director of PASW
since January 1999. He has been the president and chief executive officer of
Fielding Electric, Inc. since 1981. Mr. Grau is currently a member of the Los
Angeles Chapter membership committee of the National Electrical Contractors
Association, a trustee for the Joint Apprenticeship Training Committee and a
trustee for the Los Angeles Electrical Training Trust.
Reuben Sandler, Ph.D. Dr. Sandler has been a director of PASW
since January 1999. He was the president and chief information officer
for MediVox, Inc., a medical software development company, since June 1997
through March 1999. Since March 1999, he has been President and Chief Executive
Officer of Intelligent Optical Systems, Inc. From 1989 to 1996, he was an
executive vice president for R&D Laboratories, Inc.. Dr. Sandler received
<PAGE> 14
a Ph.D. from the University of Chicago and is the author of four books on
mathematics. He currently serves on the boards of directors of MediVox, Inc. and
Alliance Medical Corporation and is an advisor to the board of directors of R&D
Laboratories, Inc.
Joseph Lechman. Mr. Lechman has been our secretary since March
1999. He is a principal in the law firm of Gose & Lechman and has been
practicing law in Ventura County, California since 1991. Mr. Lechman received
his Bachelor of Arts degree in business administration from California State
University at Fullerton. He received his Juris Doctorate from Pepperdine
University School of Law and obtained a masters of law in taxation from the
New York University School of Law. He was admitted to the State Bar of
California in 1990.
<PAGE> 15
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock and warrants began trading on the
NASDAQ SmallCap Market under the symbol "PASW" and "PASWW" on July 29, 1999,
respectively. The following table sets forth the high and low bid prices as
reported on NASDAQ for the periods indicated below.
Year ending December 31,1999
Quarter High Low
09/30/99 Common Stock 10.125 6.625
09/30/99 Warrants 2.063 1.875
12/31/99 Common Stock 9.875 4.625
12/31/99 Warrants 2.875 1.733
Number of Holders of Common Stock
At December 31, 1999, there were approximately six stockholders of record
of the Company's Common Stock. Based on information obtained from the Company's
transfer agent, the Company believes that the number of beneficial owners of its
Common Stock is approximately 895.
Dividends
The Company has never paid cash dividends on its Common Stock. The Company
currently intends to retain earnings for use in its business and, therefore,
does not anticipate paying cash dividends on its Common Stock in the foreseeable
future.
Recent Sales of Unregistered Securities
Set forth below is a description of all sales of unregistered
securities during the fourth quarter of 1999 (sales of unregistered securities
during the first three quarters of 1999 were previously reported on the
Company's Form SB2).
In conjunction with a management reorganization, on December
1,1999 the Board of Directors approved the issuance of warrants and options
to acquire 1,480,000 shares of the Company's common stock to a team of strategy
consultants led by Kaz Hashimoto, formerly CEO of Cygnus Solutions. The
warrants and options provide
for the purchase of PASW common stock at $5.75 per share (the fair
market value at the date of issuance) for a period of five years and are
exercisable only if the closing price of the Company's common stock is $10.00
per share or more for 15 consecutive trading days.
Use of Proceeds from Registered Securities
The Company's registration statement on Form SB2 became effective
July 29, 1999 (file number 333-75137). On July 29, 1999 the Company completed an
initial public offering of 950,000 units consisting of 950,000 common shares and
950,000 warrants priced at $5.25 per unit. Each warrant entitles the holder to
purchase one share of common stock for $7.50 for a 24 month period subject to
the right to redeem warrants at $0.05 per warrant if the closing bid price of
the common stock equals or exceeds $8.00 per share for 15 consecutive trading
days. The managing underwriter was Spencer Edwards, Inc.
A total of 1,267,500 units were registered for the Company and
200,000 shares of Common Stock were registered for selling shareholders for
aggregate proceeds of $6,754,125 and $1,050,000, respectively. A total of
<PAGE> 16
1,092,500 units were sold for the account of the Company for total
aggregate proceeds of $5,735,625. As of December 31, 1999 a total of 111,500
shares of common stock were sold for the account of selling shareholders for
total aggregate proceeds of $818,017.
A total of 1,267,500 shares of common stock were registered for
the Company and are included with the aggregate proceeds of the units. A total
of 1,092,500 shares of common stock were issued pursuant to the exercise of the
units and are included with aggregate proceeds of the units.
A total of 1,267,500 warrants were registered for the Company and
are included with the aggregate proceeds of the units. A total of 1,092,500
warrants were issued pursuant to the exercise of the units and are included with
aggregate proceeds of the units. An additional 1,267,500 shares of common stock
were registered for issuance upon exercise of the warrants for aggregate
proceeds of $9,506,250. As of December 31, 1999 a total of 10,000 shares
of common stock issuable upon exercise of warrants were issued for aggregate
proceeds of $74,480.
Actual expenses incurred in connection with the issuance and
distribution of the above securities during the period from the effective date
through December 31, 1999 were $1,339,282, representing Underwriting discounts
and commissions of $573,563, Underwriter expenses of $172,069 and other expenses
of $695,825.
No payments were direct or indirect payments to: i) directors,
officers or general partners of the Company or its associates; ii) persons
owning 10% or more of any class of equity security; or iii) affiliates of the
Company.
Net proceeds from the offering were $4,471,343 after expenses and
including the proceeds from the underwriter's overallotment of units and the
exercise of 10,000 warrants in December 1999.
From July 29, 1999 (the effective date of the Company's
registration statement) through December 31, 1999, the Company has utilized the
net proceeds from this offering as follows:
Web product research and development $ 620,000
Enhancements of existing products 570,000
Marketing and sales 200,000
Intellectual property protection 40,000
Repayment of indebtedness 460,000
Strategic investment 1,000,000
Working capital and other general
corporate purposes 106,000
Un-utilized proceeds 1,475,000
$ 4,471,000
The $1,000,000 utilized for strategic investment represents an
investment by the Company in FSPNetwork, Inc ("FSPN"). This investment was not
anticipated prior to the effective date of the initial public offering and was
therefor not identified as an expected use of proceeds.
No use of proceeds involved direct or indirect payments to: i)
directors, officers or general partners of the Company or its associates; ii)
persons owning 10% or more of any class of equity security; or iii) affiliates
of the Company. None of the offering proceeds have been used for the
construction of plant, buildings or facilities or other purchase or installation
of machinery or equipment or for purchases of real estate or the acquisition of
other businesses.
The un-utilized portion of the proceeds are presently being invested in
highly liquid, short-term investments.
<PAGE> 17
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
Cautionary Note Regarding Forward-Looking Statements
Except for historical information contained herein, the statements in
this report (including without limitation, statements indicating that the
Company "expects," "estimates," anticipates," or "believes" and all other
statements concerning future financial results, product offerings, proposed
acquisitions or combinations or other events that have not yet occurred) are
forward-looking statements that are made pursuant to the safe harbor provisions
of the Private Securities Litigation Reform Act of 1995, Section 21E of the
Securities Exchange Act of 1934, as amended, and Section 27A of the Securities
Act of 1933, as amended. Forward-looking statements involve known and unknown
factors, risks and uncertainties, which may cause the Company's actual results
in future periods to differ materially from forecasted results. See "Factors
That May Affect Future Results."
Overview
Following the completion of our initial public offering effective
July 29, 1999, we refined our strategic focus in order to enhance our
positioning and flexibility in the rapidly growing market for Internetworking
technology and to improve the utilization of our assets and competencies. In
conjunction with this strategy, we elected to change our name to PASW, Inc. in
the first quarter of 2000, subject to shareholder approval. Key elements of our
business strategy involve the segregation of our core technology into separate
business units and identifying strategic investment opportunities and/or
associations with other operating companies.
Establishing separate business units for our core technology will
facilitate our ability to develop and commercialize the underlying technology
and will also allow for either private or public investment, joint ventures or
mergers that are beneficial to such development and commercialization.
Accordingly, we have transferred the operating
assets and technology that represented the historical business of the
Company into two wholly owned subsidiaries. The technology and personnel
responsible for the Internet and Web related software and software development
tools now operate as Pacific Softworks. The technology and personnel responsible
for the embedded Web browser and server now operate as PSI Web Technologies,
Inc. During 1999 we also established iApplianceNet.com ("iApplianceNet") a
development stage company and a wholly-owned subsidiary, to provide Internet-
active merchandise and service store displays and the infrastructure that
supports them.
We have also commenced a program of identifying strategic
investment opportunities and/or associations with operating companies that are
compatible and complementary to our plan of operations. In accordance with this
program, the Company made an investment in FSPNetwork, Inc. ("FSPN") in December
1999 and signed a letter of intent to invest in RedFlag, Inc. ("RedFlag") in
early 2000. The goal of this strategy is to both increase shareholder value and
to create an operating group of companies that have mutually beneficial
technology and businesses. Future investments and/or associations, if any,
will focus on companies that:
- - have a strong Internet/Web presence that are synergistic with our core
businesses and that can utilize our Internet and web technology in the
implementation of their internet strategies;
- - have a strong Internet/Web presence that are synergistic with the
businesses of companies in which we have an investment/and or affiliation ("PSI
network companies") and that can utilize the technology of the PSI network
companies in the implementation of their internet strategies;
- - present cross licensing opportunities for our technology;
- - are past the start-up phase of operations, have revenues and earnings and are
near term candidates for an initial public offering; and
- - can benefit from our financial and operational resources in securing
both private and public investment capital.
<PAGE> 18
Results of Operations
The following table sets forth, for the periods indicated, the
percentage relationship to net revenue of certain
items in the consolidated statements of operations and comprehensive
income:
Year ended December 31,
1998 1999
Net revenue 100.00% 100.00%
Cost of revenue 3.59 7.47
Gross profit 96.41 92.53
Selling, general and administrative 69.47 120.68
Research and development 30.55 72.49
Depreciation and amortization 2.11 3.47
Former officer consulting and
administrative expense 11.28 11.47
Total operating expenses 113.41 208.11
Net loss from operations (17.00) (115.58)
Other income 0 5.70
Net loss (17.00) (109.88)
Foreign currency translation adjustment (0.34) 0.64
Comprehensive loss (17.34)% (109.24)%
The following table sets forth, for the periods indicated, the
percentage of net revenue by principal geographic area to total revenue:
Year ended December 31,
1998 1999
United States 42% 47%
United Kingdom and Europe 40 30
Japan and Asia 17 22
Other 1 1
Total 100% 100%
Net Revenue
Net revenue decreased 20% from 1998 to 1999. This decrease was composed
of a 27% decrease in sales, offset by a 38% increase in royalties from
operations in Japan. Revenue results primarily from fees for licenses of
software products, fees for customer support, training, maintenance and
engineering services and royalties. The decrease in revenue for 1999 was
attributable primarily to increased competition, related discounting on older
product categories, delayed introductions of new products and substantially
lower revenue from Europe. The FUSION WebPilot Micro BrowserTM was originally
anticipated to offset declining revenues from the older product categories
commencing in the fourth quarter of 1999. Due to development delays, the
FUSION WebPilot Micro BrowserTM did not reach the market until the first
quarter of 2000.
The decrease in international sales from 58% to 53% of total sales for
1998 and 1999 is principally due to a decline in European sales as a result. We
expect international sales to continue to represent a significant portion of net
revenue although the percentage may fluctuate from period to period.
We generally price our foreign licenses in dollars. An increase in the
relative value of the dollar against Japanese and European currencies may reduce
our revenue in dollar terms or could make our products more expensive. As a
result, an increase in the relative value of the dollar against other currencies
may cause our products to be less competitive in foreign markets. To pay
expenses and for other corporate purposes we maintain a small portion of our
funds outside of
<PAGE> 19
the United States in local currency. We actively monitor our foreign currency
exchange exposure and to date this exposure has not had a material impact on the
results of operations. To date, we have not utilized derivative instruments to
hedge such exposure.
Cost of Revenue
Cost of revenue includes direct and indirect costs for the production
and duplication of manuals and media for software products, as well as those
relating to packaging, shipping and delivery of the products to our customers.
Cost of revenue also includes license and other direct purchase costs of third-
party software that we distribute or integrate into our products. Cost of
revenue has increased from 3.59% to 7.47% of total sales for 1998 and 1999 is
principally due to certain costs associated with manuals and media charged
against the lower revenue. As a result, gross profit margins for products have
revenue decreased from 96.41% to 92.53 % of total sales for 1998 and 1999
Selling, General and Administrative Expense
Selling, general and administrative expense increased $770,267 or 40%
from $1,936,117 to $2,706,384, or from 69% to 121% of net revenues for 1998 and
1999. Because of a 20% decrease in net revenue, these expenses as a percentage
of revenue increased by 51% in 1999. The increase was principally attributable
to increases in the sales and marketing staffs which were expanded after
receipts of funds from the Company's initial public offering in July 1999 and
an increase in administrative costs for expenses associated with the Company
becoming a public company.
Research and Development Expense
Research and development expense increased $774,031 or 91% from $851,568 to
$1,625,599, or 31% to 72% of net revenues from 1998 to 1999. Because of a 20%
decrease in net revenue, research and development expense as a percentage of
revenue increased by 42%. The increase in research and development expense in
1999 was principally attributable to continued development of the Company's
FastTrack product lines and the FUSION WebPilot Micro Browser (tm) begun in
1998.
Depreciation and Amortization Expense
Depreciation and amortization expense increased $18,978 or 32% from
$58,850 to $77,828 from 1998 to 1999. This increase in 1999 was attributable to
the acquisition of capital equipment associated with the Company's expanded
development and administrative efforts.
Former Officer's Consulting and Administrative Expense
Former officer's consulting and administrative expense decreased from
$314,286 for 1998 to $257,143 in 1999. This expense was incurred in connection
with our buyout of a former officer's employment agreement in March 1996. At
that time, the former officer also entered into a covenant not to compete and
into a consulting agreement. Under the consulting agreement, he agreed to make
himself available to provide financial consulting to the Company as requested.
To date, we have not called upon him to render any significant services. The
decrease in expense for 1999 is due to the expiration of these agreements in
September 1999.
Provision for Taxes
Commencing in 1995 the Company elected to be treated as a subchapter S
corporation for income tax purposes Through 1998 all federal tax liabilities
were recognized at the individual stockholder level. In February 1999 the
Company terminated the subchapter S election and became subject to taxation at
the corporate level. Our historical financial statements do not reflect any
income tax provision or benefit. Had the Company been subject to taxation as
a C corporation, it would have received pro forma income tax benefits totaling
$177,750 in 1998, based on a combined
<PAGE> 20
federal and state tax rate of 37.5%. Income tax expense or benefit in
future periods will be recorded at the corporate level.
Liquidity and Capital Resources
At December 31, 1999 the Company had working capital of $2,522,666 and
cash and cash equivalents of $1,661,708. Included with working capital is a
$1,000,000 note receivable which is expected to be converted into an equity
position during 2000. As discussed below, a private placement in February 1999
and our initial public offering in July1999 provided $500,000 and $4,369,169 in
cash, respectively, after expenses. We expect that our cash and financing needs
in 2000 will continue to be met by cash on hand, cash generated by operations,
the possible exercise of warrants, and direct private or public funding of our
operating subsidiaries.
The Company currently has 1,082,500 public warrants outstanding
that were issued as a component of the unit in our July 1999 initial public
offering. The warrants have an exercise price of $7.50 and are callable under
certain circumstances. In March 2000 we met the criteria that will allow us to
call the warrants for $0.05 per warrant upon 30 days notice. This call
provision has the effect of forcing the exercise of the warrants. We have not
announced any plans to call the warrants. In the event these warrants are
exercised, additional working capital of $8,118,750 would be available.
In December1999 the Board of Directors approved the issuance of warrants and
options to acquire 1,480,000 shares of the Company's common stock to a team of
strategy consultants led by Kaz Hashimoto, formerly CEO of Cygnus Solutions. The
warrants and options provide for the purchase of PASW common stock at $5.75 per
share (the fair market value at the date of issuance) for a period of five years
and are exercisable only if the closing price of our common stock is $10.00 per
share or more for 15 consecutive trading days. In the event these warrants and
options are exercised, additional working capital of $8,510,000 would be
available.
Additional capital is necessary to properly fund the capital needs of
iApplianceNet before such time as iApplianceNet can access the public capital
markets directly. Accordingly, iApplianceNet is in the process of securing
private investment capital. The final amount of capital and the dilution to
PASW are not known at this time. The Company may seek direct investment
in other operating subsidiaries as deemed necessary to properly fund their
development.
If these sources of financing are insufficient or unavailable, or if we
experience an increase in operating cash requirements, we would slow the rate at
which we bring additional products to market, reducing the related marketing and
development activities.
To date, we have satisfied operating cash requirements principally through
internally generated funds. Our operating activities have used net cash of
($419,480) and ($2,209,272) for 1998 and 1999. Cash generated by or used in
operating activities in each period principally reflected the loss from
operations for each period and the related change in working capital components.
The principal cause of the increase in the cash used by operations in 1999 was
the continued decline in sales of mature products, compounded by increased
selling, general and administrative and research and development expenses as a
result of a push to introduce a new product: the FUSION WebPilot Micro
BrowserTM.. Due to development delays, the FUSION WebPilot Micro BrowserTM did
not reach the market until the first quarter of 2000, leaving the 1999
operations with the expense of development and no offsetting revenue.
Our investing activities during 1999 used net cash of $1,236,635,
consisting of $236,635 of capital additions and a $1,000,000 loan to in
FSPNetwork, Inc. as discussed below.
Our financing activities during 1999 generated net cash of $4,869,169,
representing the net proceeds from a private placement in January 1999 and our
initial public offering in July1999, as discussed below.
Our investing activities during 1998 used net cash of $71,888 for
capital expenditures. Our financing activities
<PAGE> 21
during 1998 generated net cash of $94,500. This net cash primarily
resulted from our acquisition of the minority interest in our Japanese
subsidiary for $5,500, that was offset by $150,000 of short-term borrowings of
which $50,000 was repaid during the period.
Short-Term Borrowings
During 1999 we hired additional operating personnel and expanded our
pace of operation in anticipation of the proceeds from our initial public
offering. As of July 1, 1999 we have fully utilized our $250,000 bank line of
credit. In order to meet our ongoing working capital needs we also obtained in
July 1999 a commitment for a short-term loan from Spencer Edwards, Inc., our
underwriter. The loan commitment provided for advances of up to $200,000 as
needed for general corporate purposes and working capital. The loan carried
interest at 10% per year from the date of the advance and was payable on the
earlier of October 6, 1999 or our receipt of the proceeds from our offering.
A total of $175,000 was advanced under this commitment. The bank line of
credit and underwriter loan were paid in full following the completion of
our offering.
Private Placement
In February 1999 we sold 100,000 units to one investor at a price of
$5.00 per share for total proceeds of $500,000. Each unit consisted of one share
of common stock and one common stock purchase warrant entitling the holder to
purchase one share of common stock at $6.00 per share. These warrants expire
March 1, 2001.
Initial Public Offering
On July 29, 1999 we successfully completed an initial public offering of 950,000
units consisting of 950,000 common shares and 950,000 warrants priced at $5.25
per unit. Net proceeds from the offering were $4,339,125. Each warrant will
entitle the holder to purchase one share of common stock at an exercise price of
$7.50 for a period of two years commencing from the initial issuance. Under the
letter of intent, the underwriter also had the right to purchase up to an
additional 142,500 units for the sole purpose of covering over-allotments.
On September 13, 1999 we received $650,869 from the sale of 142,500 units
representing the proceeds of the sales of the underwriter's overallotment
option. In December 1999, 10,000 warrants were exercised generating proceeds
of $75,000.
Strategic Investments - FSPNetwork, Inc.
On October 25, 1999 PASW and FSPNetwork, Inc ("FSPN"), a
private firm and a developer of software for the banking industry, signed a
Letter of Intent to enter into discussions with the intent of entering a
strategic relationship to jointly develop certain Internet applications with
financial institutions. The Company indicated that subject to entering into a
definitive agreement it would invest up to $1,000,000 in FSPN and under certain
conditions up to an additional $2,000,000. On October 25, 1999 PASW
loaned FSPN $250,000 through a promissory note bearing interest at the rate of
ten (10%) percent per annum and due in ninety days. The loan was for general
corporate purposes.
On December 3, 1999 the Company loaned FSPN an additional $750,000 and converted
the $250,000 note, evidenced by a $1,000,000 convertible promissory note. The
convertible promissory note
is unsecured, carries interest at 10% per annum and is due 12 months from
issuance unless previously converted into capital stock of FSPN. The convertible
note will automatically convert into shares equivalent to no less than 5% of the
outstanding capital stock of FSPN concurrent with FSPN's closing of its next
equity financing. If converted, the accrued interest on the convertible
promissory note will revert to a 6% rate for purposes of calculating the
number of shares of FSPN issuable.
<PAGE> 22
Strategic Investments -ApplianceWare, Inc.
On September 3, 1999 the Company entered into a Letter of Intent to
acquire a 100% interest in privately-held ApplianceWare, Inc. a California
corporation. We have determined that this acquisition is not in the best
interests of the Company and have terminated the letter of intent.
Corporate Strategy Consultants
On December 1, 1999 the Board of Directors approved a management
reorganization in order to provide Glenn Russell, CEO and Chairman of the Board,
the resources necessary to enhance the Company's positioning in the rapidly
growing market for Internetworking Technology and to improve the utilization of
its assets and competencies. In conjunction with the management reorganization,
the Board of Directors approved and the Company issued warrants to acquire
1,480,000 shares of the Company's common stock to a team of strategy consultants
led by Kaz Hashimoto, formerly CEO of Cygnus Solutions. The warrants provide
for the purchase of our common stock at $5.75 per share (the fair market value
at the date of issuance) for a period of five years and are exercisable only if
the closing price of the Company's common stock is $10.00 per share or more for
15 consecutive trading days. As additional consideration to the team of
strategy consultants, the company agreed to pay a fee equal to 10% of any profit
realized on its investment in FSPN.
Subsequent Events
Strategic Investment - RedFlag, Inc.
In January 2000, the Company signed a letter of intent to acquire up to
45% of RedFlag, Inc.("RedFlag"). RedFlag, a privately held company, designs
complex graphical application software that will enable the Company's operating
subsidiaries to provide products that include not only the Internet and Web-
component software, but the front- and back-end application software.
As part of the agreement, the Company has the right to acquire up to 45
percent of the shares of RedFlag in exchange for shares of PSI Technologies in
the next 18 months, based on a pre-determined revenue schedule for RedFlag. The
purchase price will range between $100,000 for 10% of RedFlag to $6,400,00 for
45% of RedFlag. The total amount of the purchase price will depend on their
level of sales for the next 18 months. The number of shares of PASW
will be based on the closing bid price of the stock on the date of the exchange,
subject to a floor of $4.00 and a ceiling of $12.00 per share.
The companies will work together to develop complete end-to-end
networking and application software for the in-store display, banking and other
key market areas, using low-cost hardware to provide the interactive experience
at the point-of-purchase. These complete solutions will be compatible with both
Red Hat Linux and Microsoft Windows.
In addition to developing high-traffic portal sites and business-to-
business application services and software, RedFlag is now marketing is first
software product, "Business Analyst." Business Analyst is a unique product that
is available to business users on the Web. The program analyzes all of a
company's financial data, then, using red, yellow and green "flags," pinpoints
the company's strengths and weaknesses. It then offers solutions to these
problems by analyzing financial operations, interactions, obligations, assets
and liabilities, and converts all of this data into easy-to-read charts, graphs
and reports.
Business Analyst is offered by RedFlag as part of a suite of services
through major banking portals, allowing banks to offer its business customers
online banking services and advice. RedFlag has a team of professional software
engineers with expertise in Internet and Web communications, site architecture
and navigation experts, Web designers, programmers, database engineers, and
provides an end-to-end portal solution with customized applications.
<PAGE> 23
Factors That May Affect Future Results
This report, including Management's Discussion and Analysis or
Plan of Operation, contains forward looking statements and other prospective
information relating to future events. These forward-looking statements and
other information are subject to certain risks and uncertainties that could
cause results to differ materially from historical or anticipated results,
including the following:
We have reported losses for our last two years and if we do not become
profitable our business could be adversely affected.
We reported losses of $473,760 and $2,464,067 for the years ending
December 31, 1998 and 1999. These losses include about $314,000 and $248,000
paid to a former officer for consulting and administrative expenses. We also
have an accumulated deficit of $ 2,445,615 as of December 31, 1999. We can
provide no assurance that we will be profitable in the future and if we do not
become profitable our business could be adversely affected.
Because we expect that our operating results will continue to fluctuate, the
results of any period should not be relied upon as an indication of future
performance.
From time to time we have experienced material period-to-period
fluctuations in revenue and operating results. We anticipate that these periodic
fluctuations in revenue and operating results will occur in the future. We
attribute these fluctuations to a variety of business conditions that affect our
operating subsidiaries, including:
- the volume and timing of orders received during the quarter,
- the timing and acceptance of new products and product
enhancements by us and our competitors,
- unanticipated sales and buyouts of run-time licenses,
- stages of product life cycles,
- purchasing patterns of customers and distributors,
- market acceptance of products sold by our customers, and
- competitive conditions in our industry.
As a result of the factors described above we believe that
quarterly revenue and operating results are likely to vary significantly in the
future and that quarter-to-quarter comparisons of our operating results may not
be meaningful. You should therefore not rely on the results of one quarter as
an indication of future performance.
Because our operating subsidiaries depend on a small number of large
orders, the loss or deferral of orders may have a negative impact on revenue.
Although none of our operating subsidiaries' customers has
accounted for 10% or more of total revenue in any fiscal year, a significant
portion of software license revenue in each quarter is derived from a small
number of relatively large orders. While we believe that the loss of any
particular customer is not likely to have a material adverse effect on our
business, our operating results could be materially adversely affected if our
operating subsidiaries were unable to complete one or more substantial license
sales in any future period.
Any decrease in the market acceptance of our operating subsidiaries
Internet and web products or lack of acceptance of new products would decrease
our revenue.
Our future results depend heavily on continued market acceptance
of our operating subsidiaries products in existing and new markets. Revenue from
licenses of the suite of Internet and Web products and sales of services
accounted for all revenue in the year ended December 31, 1998 and 1999. Although
research and development expenditures for 1998 and 1999 have resulted in several
new products we cannot give any assurances that these products will be accepted
in the marketplace.
The pricing strategy for new web products is based on flexible up-front
fees with ongoing royalties and may not result in increased revenue.
Historically our operating subsidiaries have charged a one-time
fee for a source code license and have
<PAGE> 24
occasionally also charged royalties for each copy of our software embedded in a
customers' products. The strategy for new products is to seek flexible up-front
fees with ongoing royalties measured against a customers' units of production
or run times. Our operating subsidiaries may be unsuccessful in implementing
this change to product pricing. Any increase in the portion of revenue
attributable to royalties will depend on our successful negotiation of royalty
agreements and on the successful commercialization by customers of their
underlying products.
Because our operating subsidiaries lack the name recognition, customer
base and resources of other companies in the Internet software market, they may
be unable to compete successfully which would reduce our revenue.
The markets for the products of our operating subsidiaries are
intensely competitive and are likely to become even more competitive. Increased
competition could result in:
- pricing pressures, resulting in reduced margins,
- decreased volume, resulting in reduced revenue, or
- the failure of products to achieve or maintain market
acceptance.
Any of these occurrences could have a material adverse effect on
our business, financial condition and operating results. Each of our operating
subsidiaries' products faces intense competition from multiple competing
vendors. Principal competitors include Wind River Systems, Inc., Integrated
Systems, Inc., Mentor Graphics, Inc., Microware Systems Corporation and
Microsoft Corporation. Many current and potential competitors have:
- longer operating histories,
- greater name recognition,
- access to larger customer bases, or
- substantially greater resources.
As a result, principal competitors may respond more quickly to
new or changing opportunities and technologies. For all of the reasons stated
above, our operating subsidiaries may be unable to compete successfully against
our current and future competitors.
If Pacific Softworks is unable to raise market awareness of the FUSION
brand, we may experience declining operating results.
If Pacific Softworks fail to promote its brand successfully or if
they incur significant expenses promoting and maintaining their FUSION brand
names, we may experience a material adverse effect on our business, financial
condition and operating results. Due in part to the still emerging nature of the
market for Internet and embedded software products and the substantial resources
available to many competitors, Pacific Softworks may have a time limited
opportunity to achieve and maintain market share.
We believe that developing and maintaining awareness of the FUSION brand
names will be critical to achieving widespread acceptance of Pacific Softworks'
products. We believe that brand recognition will become increasingly important
as competition increases. Successfully promoting and positioning Pacific
Softworks' brand will depend largely on the effectiveness of marketing
efforts and the ability to develop reliable and useful products at
competitive prices. As a result, Pacific Softworks may need to expand its
financial commitment to creating and maintaining brand awareness among
potential customers.
We may incur substantial costs in connection with intellectual property
infringement claims that others may bring against us which could adversely
affect our profitability.
In addition to technology developed internally, we and our
operating subsidiaries use code libraries developed and maintained by third
parties and have acquired or licensed technologies from other companies.
Internally developed technology, code libraries, or the technology acquired or
licensed may infringe on the intellectual property rights of others. These
persons may bring claims against us or our operating subsidiaries alleging
infringement of their intellectual property rights. If we infringe or others
bring claims against us alleging infringement, our business, financial
condition and operating results could be materially and adversely affected.
<PAGE> 25
We may be a party to litigation in the future to protect our
intellectual property or as a result of our alleged infringement of the
intellectual property of others. These claims and any resulting litigation could
subject us to significant liability for damages and invalidation of our
proprietary rights. Litigation, regardless of its success, would likely be time-
consuming and expensive to prosecute or defend and would divert management
attention from our business. Any potential intellectual property litigation
could also force us or our operating subsidiaries to do one or more of the
following:
- cease selling, incorporating, or using products or services that
incorporate the challenged intellectual property,
- obtain from the holder of the infringed intellectual property
right a license to sell or use the relevant technology, which license
may not be available on reasonable terms, or at all, and
- redesign those products or services that incorporate the
infringed intellectual property.
Any of these events could have a material adverse effect on our
business, financial condition and operating results.
Because our ownership is concentrated, our officers and directors will
be able to control all matters requiring stockholder approval including delaying
or preventing a change in our corporate control or taking other actions of which
individual shareholders may disapprove.
Our officers and directors beneficially own approximately 73% of the
outstanding common stock. Our officers and directors will be able to exercise
control over all matters requiring stockholder approval and other investors will
have minimal influence over the election of directors or other stockholder
actions. As a result, our officers and directors could approve or cause the
Company to take actions of which you disapprove or that are contrary to your
interests. This ability to exercise control over all matters requiring
stockholder approval could prevent or significantly delay another company from
acquiring or merging with us at prices and terms that you might find to be
attractive.
Issuance of our authorized preferred stock could discourage a change in
control, could reduce the market price of our common stock and could result in
the holders of preferred stock being granted voting rights that are superior to
those of the holders of common stock.
The Company is authorized to issue preferred stock without
obtaining the consent or approval of stockholders. The issuance of preferred
stock could have the effect of delaying, deferring, or preventing a change in
control. Management also has the right to grant superior voting rights to the
holders of preferred stock. Any issuance of preferred stock could materially and
adversely affect the market price of the common stock and the voting rights of
the holders of commonstock. The issuance of preferred stock may also result in
the loss of the voting control of holders of common stock to the
holders of preferred stock.
You may experience dilution if we are compelled to litigate or
arbitrate claims that have been asserted by Golenberg & Co. for the right to
purchase 10% of the Company.
In April 1999 we were notified that a merchant banker, Golenberg & Co.,
has asserted rights under a June 1998 letter agreement to purchase 10% of our
then outstanding common stock for $400,000. In June 1999 counsel for Golenberg
& Co. reiterated this demand and advised us that these claims were being
evaluated for possible legal action. Investors could be significantly diluted
if Golenberg & Co. successfully brings a lawsuit against us.
Trading in our common stock and warrants may be limited and could
negatively affect the ability to sell your securities.
A public market for our common stock and our warrants has only
existed since July 29, 1999, the date of our initial public offering. We do not
know how liquid the market for our stock and warrants will remain and if the
market becomes illiquid, it may negatively affect your ability to resell your
securities.
<PAGE> 26
ITEM 7. FINANCIAL STATEMENTS
The Consolidated Financial Statements of the Company are attached as
follows:
Index to Financial Statements F-1
Pacific Softworks, Inc. Financial Statements as of and
for the year ended December 31, 1999 and 1998 F-3 through F-23
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT
The information required by Item 9 is contained in the Company's
definitive Proxy Statement with respect to the Company's Annual Meeting of
Stockholders, to be filed with the Securities and Exchange Commission no later
than 120 days after the end of the Company's fiscal year, and is incorporated
herein by reference thereto.
ITEM 10. EXECUTIVE COMPENSATION
The information required by Item 10 is contained in the Company's
definitive Proxy Statement with respect to the Company's Annual Meeting of
Stockholders, to be filed with the Securities and Exchange Commission no later
than 120 days after the end of the Company's fiscal year, and is incorporated
herein by reference thereto.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
The information required by Item 11 is contained in the Company's
definitive Proxy Statement with respect to the Company's Annual Meeting of
Stockholders, to be filed with the Securities and Exchange Commission no later
than 120 days after the end of the Company's fiscal year, and is incorporated
herein by reference thereto.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 12 is contained in the Company's
definitive Proxy Statement with respect to the Company's Annual Meeting of
Stockholders, to be filed with the Securities and Exchange Commission no later
than 120 days after the end of the Company's fiscal year, and is incorporated
herein by reference thereto.
<PAGE> 27
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit No. Description
Page
3.1 Articles of Incorporation of the Registrant, as amended to date (1)
3.2 Bylaws of the Registrant (1)
4.2 Specimen Warrant (1)
4.3 Form of Warrant Agreement (1)
4.4 Specimen Common Stock Certificate (1)
4.5 Form of Lock Up Agreement (1)
4.6 Form of Underwriter's Option for Purchase of Units (1)
10.1 Form of Indemnification Agreements (1)
10.2 1998 Equity Incentive Program (1)
10.3 Security and Loan Agreement, dated September 15, 1998 between Bank of
America National Trust and Savings Association and Pacific Softworks (1)
10.4 Form of Invention Assignment and Proprietary Information Agreement (1)
10.5 Sublease, dated April 7, 1998 between SHR Perceptual Management
and Pacific Softworks for the premises at 703 Rancho Conejo Blvd.,
Newbury Park, California (1)
10.6 Consulting Agreement dated March 8, 1996 between Kenneth Woodgrift and
Pacific Softworks (1)
10.7 Letter from Golenberg & Co, merchant bankers, to Glenn Russell
dated June 18, 1998 and Letter from Pacific Softworks to Glenn
Golenberg dated January 27, 1999 (1)
10.8 Letter of intent regarding investment in FSPNetwork
dated October 25, 1999 (2).
10.9 Convertible 10% promissory note due form FSPNetwork dated
October 25, 1999*
10.10 Letter of intent regarding investment in RedFlag, Inc. dated
January 13, 2000*
21.1 Subsidiaries of the Registrant*
24.1 Power of Attorney (1)
27.1 Financial Data Schedule*
(1) As filed on Form SB2 effective July 29, 1999.
(2) As filed on Form 10-QSB on November 12, 1999.
* Filed herewith
(b) Reports on Form 8-K
Filed December 15, 1999 regarding an investment in Financial Services
Provider Network, Inc. ("FSPN").
<PAGE> 28
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
Pacific Softworks, Inc.
(Registrant)
Date: March 28, 2000 By: William E. Sliney
President
In accordance with the Exchange Act, this report has been signed below
by the following persons on behalf of the Registrant and in the capacities and
on the dates indicated.
Signature Title Date
President and Chief Financial
William E. Sliney Officer 03/28/00
Glenn P. Russell Chairman of the Board 03/28/00
Wayne T. Grau Director 03/28/00
Ruben Sandler, Ph.D Director 03/28/00
<PAGE> 29
PACIFIC SOFTWORKS, INC. AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 1998
<PAGE> F-1
PACIFIC SOFTWORKS, INC. AND SUBSIDIARY
INDEX TO FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1999
Pacific Softworks, Inc. and Subsidiary as of and for the
years ended December 31, 1999 and 1998:
Page
Independent Auditors' Report F-3
Consolidated Balance Sheet F-4
Consolidated Statements of Operations F-5
Consolidated Statements of Comprehensive Income (Loss) F-6
Consolidated Statements of Stockholders' Equity F-7
Consolidated Statements of Cash Flows F-8/9
Notes To Consolidated Financial Statements F-10
<PAGE> F-2
INDEPENDENT AUDITORS' REPORT
TO THE STOCKHOLDERS AND BOARD OF DIRECTORS
PACIFIC SOFTWORKS, INC. AND SUBSIDIARIES
We have audited the accompanying consolidated balance sheets of PACIFIC
SOFTWORKS, INC. AND SUBSIDIARIES as of December 31, 1999 and 1998, and the
related consolidated statements of operations, comprehensive income (loss),
stockholders' equity and cash flows for the years then ended. These
consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining,
on a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of PACIFIC
SOFTWORKS, INC. AND SUBSIDIARIES as of December 31, 1999 and 1998, and the
consolidated results of their operations and cash flows for the years then
ended, in conformity with generally accepted accounting principles.
MERDINGER, FRUCHTER, ROSEN & CORSO, P.C.
Certified Public Accountants
Los Angeles, California
February 2, 2000
<PAGE> F-3
PACIFIC SOFTWORKS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION> December 31,
ASSETS 1999 1998
CURRENT ASSETS
<S> <C> <C>
Cash and cash equivalents $ 1,661,708 $224,031
Accounts receivable, net of allowance for doubtful
accounts of $72,986 and $86,400 175,751 268,902
Related party receivable - 43,000
Note receivable 1,000,000 -
Prepaid expenses and other current assets 75,753 15,523
Total current assets 2,913,212 551,456
PROPERTY AND EQUIPMENT, less accumulated
depreciation and amortization of $426,589 and $348,761 241,003 82,196
OTHER ASSETS 13,193 9,674
TOTAL ASSETS $ 3,167,408 $ 643,326
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable and accrued expenses $ 390,546 $ 180,469
Related party payable - 3,705
Accrued taxes payable - 21,705
Customer deposits - 23,100
Total current liabilities 390,546 328,979
DEFERRED REVENUE 149,872 106,874
COMMITMENTS AND CONTINGENCIES - -
STOCKHOLDERS' EQUITY
Preferred stock, $.01 par value; 10,000,000 shares
authorized, no shares issued and outstanding - -
Common stock, $.001 par value; 50,000,000 shares
authorized; 4,402,500 and 3,200,000 shares
issued and outstanding 4,403 3,200
Additional paid-in capital 5,042,624 174,658
Retained earnings (deficit) (2,445,615) 18,452
Cumulative adjustment for foreign currency translation 25,578 1,163
2,626,990 207,473
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 3,167,408 $ 643,326
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
<PAGE> F-4
PACIFIC SOFTWORKS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
For the Years Ended
December 31,
1999 1998
<S> <C> <C>
REVENUE
Sales $ 1,817,654 $ 2,479,589
Royalties and other 424,890 307,808
Total 2,242,544 2,787,397
COST OF REVENUE
Purchases and royalty fees 167,486 100,336
GROSS PROFIT 2,075,058 2,687,061
OPERATING EXPENSES
Selling, general and administrative 2,706,384 1,936,117
Research and development 1,625,599 851,568
Depreciation and amortization 77,828 58,850
Former officer's consulting and
administrative expenses 257,143 314,286
Total operating expenses 4,666,954 3,160,821
LOSS FROM OPERATIONS (2,591,896) (473,760)
OTHER INCOME (EXPENSES)
Interest income 14,389 -
Other income 119,941 -
Interest expense (6,501) -
Total other income (expense) 127,829 -
LOSS BEFORE INCOME TAXES (2,464,067) (473,760)
INCOME TAX EXPENSE - -
NET LOSS $(2,464,067) $(473,760)
LOSS PER SHARE - Basic and Diluted $(0.62) $(0.14)
WEIGHTED AVERAGE COMMON SHARES
Basic and diluted 3,946,392 3,340,000
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
<PAGE> F-5
PACIFIC SOFTWORKS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
<TABLE>
<CAPTION>
For the Years Ended
December 31,
1999 1998
COMPREHENSIVE INCOME (LOSS)
<S> <C> <C>
Net loss $(2,464,067) $( 473,760)
Foreign currency translation adjustment 14,415 (9,399)
COMPREHENSIVE LOSS $(2,449,652) $( 483,159)
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
<PAGE> F-6
PACIFIC SOFTWORKS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
Cumulative
Foreign
Additional Currency Total
Common Stock Paid-in Retained Translation Stockholders'
Shares Amount Capital Earnings Adjustment Equity
<S> <C> <C> <C> <C> <C> <C>
Balance of January 1, 1998 3,200,000 $ 3,200 $ 174,658 $ 492,212 $ 20,562 $ 690,632
Foreign currency
translation adjustment - - - - (9,399) (9,399)
Net loss - - - ( 473,760) - (473,760)
Balance at
December 31, 1998 3,200,000 3,200 174,658 18,452 11,163 207,473
Private placement of
common stock 100,000 100 499,900 - - 500,000
Initial public
offering, net 950,000 950 3,642,350 - - 3,643,300
Sale of over
allotment, net 142,500 143 650,726 - - 650,869
Exercise of warrants 10,000 10 74,990 - - 75,000
Foreign currency translation
adjustment - - - - 14,415 14,415
Net loss - - - (2,464,067) - (2,464,067)
Balance at
December 31, 1999 4,402,500 $ 4,403 $ 5,042,624 $(2,445,615) $ 25,578 $ 2,626,990
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
<PAGE> F-7
PACIFIC SOFTWORKS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
For the Years Ended
December 31,
1999 1998
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $(2,464,067) $ (473,760)
Adjustments to reconcile net income
(loss) to net cash provided by
operating activities:
Depreciation and amortization 77,828 58,850
Bad debt (recovery) (13,414) 50,000
(Increase) decrease in assets:
Accounts receivable 106,565 18,788
Related party receivable 43,000 (43,000)
Other receivables - 2,125
Prepaid expenses and other current assets (60,230) 20,589
Deposits and trademark (3,519) (8,486)
Increase (decrease) in liabilities:
Accounts payable and accrued expenses 210,077 (38,558)
Related party payable (103,705) 3,705
Accrued taxes payable (21,705) 1,104
Customer deposits (23,100) 23,100
Deferred revenue 42,998 (33,937)
Net cash used in operating activities (2,209,272) (419,480)
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of fixed assets (236,635) ( 71,888)
Acquisition of note receivable (1,000,000) -
Net cash used in investing activities (1,236,635) ( 71,888)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from private placement 500,000 -
Proceeds from initial public offering 3,643,300 -
Proceeds from over allotment 650,869 -
Exercise of warrants 75,000 -
Acquisition of stock in subsidiary - (5,500)
Proceeds of borrowings 459,295 150,000
Repayment of borrowings (459,295) ( 50,000)
Net cash provided by financing activities 4,869,169 94,500
EFFECT OF EXCHANGE RATE CHANGES ON CASH 14,415 ( 4,053)
NET INCREASE (DECREASE) IN CASH 1,437,677 ( 400,921)
CASH AND CASH EQUIVALENTS - BEGINNING 224,031 624,952
CASH AND CASH EQUIVALENTS - ENDING $ 1,661,708 $ 224,031
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE> F-8
PACIFIC SOFTWORKS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid during the year for -
Interest paid $ 6,501 $ 482
Income taxes paid $ - $ -
CASH FLOW STATEMENT
SCHEDULE OF NON-CASH ACTIVITIES:
During 1999, the Company issued warrants to purchase the following:
a) 80,000 units valued at $107,481 for services rendered by various consultants,
attorneys and others in connection with its IPO;
b) 1,180,000 units valued at $1,736,323 for services rendered by various
consultants in connection with its restructuring;
c) 7,654 units valued at $14,147 to an executive search firm.
The accompanying notes are an integral part of these consolidated financial
statements.
<PAGE> F-9
PACIFIC SOFTWORKS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
a) Nature of Operations
Pacific Softworks, Inc., incorporated in California in November 1992, develops
and licenses Internet and Web related software and software development tools.
Its products enable Internet and Web based communications, based on a set of
rules known as protocols, and are embedded into systems and "information
appliances" developed or manufactured by others. Information appliances are
Internet connected versions of everyday products such as telephones,
televisions, fax machines and other digitally based devices. The Company's
operations are conducted principally from its offices in Southern California,
and it maintains sales offices in England and Japan.
b) Basis of Consolidation
The consolidated financial statements include the accounts of Pacific Softworks,
Inc. ("PSI") and its wholly owned subsidiaries:
(1) Network Research Corp. Japan, Ltd. ("NRC");
(2) iApplianceNet.com ("iAppliance"), a California Corporation;
(3) Pacific Acquisition Corporation ("PAC"), a California Corporation; and
(4) Pacific Softworks Europe Limited ("Europe"), a United Kingdom
Corporation
All references herein to PSI or the "Company" include the consolidated results
of PSI and its subsidiaries.
All significant intercompany accounts and transactions have been eliminated in
consolidation.
In January of 1998, PSI purchased the remaining 21% of NRC stock held by a
third party, to increase its holdings to 100%. The purchase price was $5,000.
The acquisition has been accounted for as a purchase. All of NRC's operations
and assets are located in Japan.
iAppliance is a wholly owned subsidiary of PSI and was incorporated in
California in August 1999. The Company was inactive during the period ended
December 31, 1999 and began operations in January 2000.
PAC and Europe were formed in 1999. Both companies were inactive during
the period ended December 31, 1999.
c) Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
<PAGE> F-10
PACIFIC SOFTWORKS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999
NOTE 1 -SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
d) Revenue Recognition
The Company is a developer and licensor of software and generates revenue
primarily from the one-time sales of licensed software. Generally, revenue is
recognized upon shipment of the licensed software. For multiple element license
arrangements, the license fee is allocated to the various elements based on fair
value. When a multiple element arrangement includes rights to a post-contract
customer support, the portion of the license fee allocated to each function is
recognized ratably over the term of the arrangement.
e) Cash and Cash Equivalents
The Company considers all highly liquid investments purchased with original
maturities of three months or less to be cash equivalents.
f) Concentration of Credit Risk
The Company places its cash in what it believes to be credit-worthy financial
institutions. However, cash balances may exceed FDIC insured levels at
various times during the year.
g) Accounts Receivable
For financial reporting purposes, the Company utilizes the allowance method
of accounting for doubtful accounts. The Company performs ongoing credit
evaluations of its customers and maintains an allowance for potential credit
losses. The allowance is based on an experience factor and review of current
accounts receivable. Uncollectible accounts are written off against the
allowance accounts when deemed uncollectible.
h) Property and Equipment
Property and equipment are stated at cost. Depreciation is provided for in
amounts sufficient to relate the cost of depreciable assets to operations over
their estimated service lives, primarily on a straight-line basis. The
estimated lived used in determining depreciation are five to seven years
for furniture, fixtures and computer equipment. Purchased computer software
costs are amortized over five years.
Maintenance and repairs are charged to expense as incurred; additions and
betterments are capitalized. Upon retirement or sale, the cost and related
accumulated depreciation of the disposed assets are removed and any resulting
gain or loss is credited or charged to operations.
i) Research and Development
Costs incurred in research and development activities are charged to
operations as incurred. All research and development activities are incurred in
connection with the development of computer software products.
F-11
PACIFIC SOFTWORKS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
j) Fair Value of Financial Instruments
The Company's financial instruments consist of cash, accounts receivable,
note receivable, accounts payable and short-term debt. The carrying amounts
of cash, accounts receivable, note receivable, accounts payable and short-term
debt approximate fair value due to the highly liquid nature of these short-term
instruments at December 31, 1999 and 1998.
k) Long-Lived Assets
Long-lived assets to be held and used are reviewed for impairment whenever
events or changes in circumstances indicate that the related carrying amount
may not be recoverable. When required, impairment losses on assets to be
held and used are recognized based on the fair value of the assets and long-
lived assets to be disposed of are reported at the lower of carrying amount or
fair value less cost to sell.
l) Income Taxes
Until February 14, 1999, the Company was a subchapter S corporation.
Income was passed through to the stockholders who paid personally their
share of the applicable taxes. Therefore, no provision for income taxes was
made at December 31, 1998 and in 1999 through February 1999.
Subsequent to the termination of the Company's S Corporation election,
provisions for income taxes are based on taxes payable or refundable for the
current year and deferred taxes on temporary differences between the amount
of taxable income and pretax financial income and between the tax bases of
assets and liabilities and their reported amounts in the financial statements.
Deferred tax assets and liabilities are included in the financial statements at
currently enacted income tax rates applicable to the period in which the
deferred tax assets and liabilities are expected to be realized or settled as
prescribed by Statement of Financial Accounting Standards ("SFAS") No.
109, "Accounting for Income Taxes." As changes in tax laws or rates are
enacted, deferred tax assets and liabilities are adjusted through the provision
for income taxes.
m) Offering Costs
Offering costs consists primarily of professional fees. These costs are charged
against the proceeds of the sale of common stock in the periods in which they
occur.
n) Advertising Costs
Advertising costs, except for costs associated with direct-response advertising,
are charged to operations when incurred. The costs of direct-response
advertising, if any, are capitalized and amortized over the period during which
future benefits are expected to be received.
<PAGE> F-12
PACIFIC SOFTWORKS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
o) Translation of Foreign Currency
The Company translates the foreign currency financial statements of its
foreign subsidiaries in accordance with the requirements of SFAS 52,
"Foreign Currency Translation." Assets and liabilities are translated at
current exchange rates and related revenues and expenses are translated at
average exchange rates in effect during the period. Resulting translation
adjustments are recorded as a separate component in stockholders' equity.
Foreign currency transaction gains and losses are included in determining
net income.
p) Stock Based Compensation
The Company uses the intrinsic value method of accounting for stock-based
compensation in accordance with Accounting Principles Board Opinion
("APB") No. 25. See Note 8 for proforma disclosure of net income and
earnings per share under the fair value method of accounting for stock-based
compensation as proscribed by SFAS No. 123.
q) Earnings Per Share
SFAS No. 128, "Earnings Per Share" requires presentation of basic earnings
per share ("Basic EPS") and diluted earnings per share ("Diluted EPS").
The computation of basic earnings per share is computed by dividing earnings
available to common stockholders by the weighted average number of
outstanding common shares during the period. Diluted EPS gives effect to all
dilutive potential common shares outstanding during the period. The
computation of diluted EPS does not assume conversion, exercise or
contingent exercise of securities that would have an anti-dilutive effect on
losses.
The shares used in the computation of earnings per share were as follows:
December 31,
1999 1998
Basic 3,946,392 3,340,000
Diluted 3,946,392 3,340,000
Loss per share - Basic and Diluted $ ( 0.62) $( 0.14)
<PAGE> F-13
PACIFIC SOFTWORKS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999
NOTE 1 -SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
r) Impact of Year 2000 Issue
During the year ended December 31, 1999, the Company conducted an
assessment of issues related to the Year 2000 and determined that it was
necessary to modify or replace portions of its software in order to ensure that
its computer systems will properly utilize dates beyond December 31, 1999.
The Company completed Year 2000 systems modifications and conversions in
1999. Costs associated with becoming Year 2000 compliant were not
material. At this time, the Company cannot determine the impact the Year
2000 will have on its key customer or suppliers. If the Company's customers
or suppliers don't convert their systems to become Year 2000 compliant, the
Company may be adversely impacted. The Company is addressing these risks
in order to reduce the impact on the Company.
s) Recent Accounting Pronouncements
In June 1997, SFAS No. 131, "Disclosures About Segments of an Enterprise and
Related Information" was issued, which changes the way public companies
report information about segments. SFAS No. 131 is based on the selected
segment information and requires quarterly and entity-wide disclosures about
products and services, major customers, and the material countries in which the
entity holds assets and reports revenue. This statement is effective for the
Company's 1998 fiscal year.
SFAS No. 132, "Employers' Disclosures about Pension and Other Post
Employment Benefits," was issued in February 1998 and specifies amended
disclosure requirements regarding such obligations. SFAS No. 132 does not
effect the Company as of December 31, 1999 or 1998.
In March 1998, Statement of Position No. 98-1 was issued, which specifies the
appropriate accounting for costs incurred to develop or obtain computer software
for internal use. The new pronouncement provides guidance on which costs
should be capitalized, and over what period such costs should be amortized and
what disclosures should be made regarding such costs. This pronouncement is
effective for fiscal years beginning after December 15, 1998, but earlier
application is acceptable. Previously capitalized costs will not be adjusted.
The Company believes that it is already in substantial compliance with the
accounting requirements as set forth in this new pronouncement, and therefore
believes that adoption will not have a material effect on financial condition or
operating results.
In April 1998, Statement of Position No. 98-5 was issued which requires that
companies write-off defined previously capitalized start-up costs including
organization costs and expense future start-up costs as incurred. Adoption of
this statement does not have an effect on the Company's financial condition or
operating results.
<PAGE> F-14
PACIFIC SOFTWORKS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
s) Recent Accounting Pronouncements (Continued)
In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 133, "Accounting for Derivative Instruments and for Hedging Activities".
This new pronouncement requires that certain derivative instruments be
recognized in balance sheets at fair value and for changes in fair value to be
recognized in operations.
Additional guidance is also provided to determine when hedge accounting
treatment is appropriate whereby hedging gains and losses are offset by losses
and gains related directly to the hedged item. While the standard, as amended,
must be adopted in the fiscal year beginning after June 15, 2000, its impact on
the Company's consolidated financial statements is not expected to be material
as the Company has not historically used derivative and hedge instruments.
NOTE 2 -NOTE RECEIVABLE
On December 3, 1999, the Company acquired for cash a $1,000,000 promissory
note bearing interest at 10% from Financial Services Provider Network, Inc.
("FSPN"). The note is convertible into FSPN's capital stock at the time of
FSPN's next equity based round of venture financing ("Subsequent Equity").
The principal amount and the portion of interest accrued for the actual number
of days elapsed at a rate of 6% shall automatically convert into Subsequent
Equity during the period from December 3, 1999 to December 2, 2000 upon FSPN's
sale and issuance of Subsequent Equity, for an aggregate purchase price of at
least $1,000,000, at one or more closings, at the same price per share at which
such shares of Subsequent Equity are sold to other participants at such
closings; provided, however, if the "Pre-Money Valuation" (PMV - as defined
below) of FSPN in the sale and issuance of shares of Subsequent Equity shall
be greater than $20,000,000, then the debt shall automatically convert into
Subsequent Equity at the price per share at which the PMV would be equal to
$20,000,000. For purposes of this note, PMV shall mean the product obtained
by multiplying: (x) the price per share (on an as-if-converted basis into
common stock basis) of the Subsequent Equity, by (y) the aggregate number of
shares (on an as-if-converted into or exercised for common stock basis) of
all the issued and outstanding capital stock of FSPN and options, warrants
or other rights to purchase capital stock of FSPN (including only those
options, warrants or other rights issued and outstanding as of immediately
prior to the closing and excluding those securities into which this note
shall convert) immediately prior to the closing. Upon such conversion, this
note shall be canceled and accrued interest in excess of 6% for the number of
days elapsed shall be forfeited. If the note is not converted, principal and
accrued interest at 10% are due and payable on December 2, 2000.
<PAGE> F-15
PACIFIC SOFTWORKS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999
NOTE 3 - PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
December 31,
1999 1998
Furniture, fixtures and equipment $ 388,879 $ 216,421
Computer software 278,713 214,536
667,592 430,957
Less: accumulated depreciation and
amortization ( 426,589) ( 348,761)
Fixed assets - net $ 241,003 $ 82,196
Depreciation and amortization expense
recorded in the statement of
operations $ 77,828 $ 30,243
Unamortized computer software costs $ - $ -
Amortization of computer software costs $ - $ 28,607
NOTE 4 - NOTE PAYABLE
The Company had a note payable from its underwriter for $200,000, dated
July 6, 1999, bearing interest at 10% per annum and due at the earlier of
October 6, 1999 or upon the Company's receipt of funds from its IPO. The
loan was repaid in 1999.
NOTE 5 - DEFERRED REVENUE
The Company provides technical support for its products, usually over a twelve-
month term. Revenue is recognized as earned on a straight-line basis.
NOTE 6 - COMMITMENTS AND CONTINGENCIES
The Company occupies two facilities under terms of operating leases expiring
September 15, 2000 and August 31, 2002, respectively. Rent expense included
in the statement of operations totaled $137,643 and $106,592 in 1999 and 1998,
respectively. The Company leases an auto under the term of an operating lease,
expiring August 31, 2002. Auto lease expense included in the statements of
operations totaled $19,278 and $15,513 in 1999 and 1998, respectively.
Future minimum lease payments are as follows:
2000 $ 125,729
2001 40,866
2002 20,374
<PAGE> F-16
PACIFIC SOFTWORKS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999
NOTE 7 - CAPITAL STOCK
a) The Company is authorized to issue 10,000,000 shares of Preferred Stock, par
value $.01. Preferred shares may be issued from time to time in one or more
series. The number of shares in each series and the designation of each series
to be issued shall be determined from time to time by the board of directors of
the Company.
b) On January 30, 1998, the Company approved an increase in the number of
shares of common stock it is authorized to issue from 1,000,000 shares to
50,000,000 shares and the restated articles of incorporation were filed on June
5, 1998. In June of 1998, the Company effected a stock split and subsequently
effected a reverse stock split. The net result of these two stock transactions
was an effective 6.27205 shares for one stock split, increasing the outstanding
shares from 510,200 to 3,200,000.
All references in the accompanying financial statements to the number of shares
of common stock and per-share amounts for 1999 and 1998 have been restated
to reflect the effective stock split.
c) In February 1999 the Company sold 100,000 units to a single accredited
investor at a price of $5.00 per unit for total proceeds of $500,000. Each
unit consisted of one share of common stock and one common stock purchase
warrant, entitling the holder thereof to purchase one share of common stock
for two years at an exercise price of $6.00 per share.
d) In July 1999 the Company through its underwriter, sold 950,000 units and
an overallotment of 142,500 units at $5.25 per unit. The proceeds were as
follows:
950,000 Units 142,500 Units
950,000 at $5.25 per share $ 4,987,500 $ -
142,500 at $5.25 per share - 748,125
Underwriter's discount and expenses ( 613,375) ( 97,256)
Other offering costs ( 730,825) -
Net proceeds $ 3,643,300 $ 650,869
Each unit consists of one share of common stock and one common stock
purchase warrant, entitling the holder thereof to purchase one share of common
stock for two years at an exercise price of $7.50 per share.
<PAGE> F-17
PACIFIC SOFTWORKS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999
NOTE 8 - STOCK PLAN
On April 17, 1998, the Company adopted the 1998 Equity Incentive Program
(the "Plan"). The Plan provides for the granting of the following Stock Awards:
(i) Incentive Stock Options, (ii) Non-Statutory Stock Options, (iii) Stock
Appreciation Rights, (iv) Stock Bonuses, and (v) Rights to acquire Restricted
Stock. Persons eligible to receive Stock Awards are the employees, directors
and consultants of the Company and its Affiliates, as defined. Incentive Stock
Options may be granted only to employees. Stock awards other than Incentive
Stock Options may be granted to all eligible persons.
The maximum term of any options granted is ten years. Vesting requirements
may vary, and will be determined by the board of directors.
The number of shares reserved for issuance under the Plan is 440,200 shares.
NOTE 9 - STOCK OPTIONS
a) In 1998, the Company granted certain non-statutory options to purchase shares
of common stock to two employees. Each option is for 70,000 shares at an
exercise price of $1.25 per share. The options vest on January 1, 1999 and
expire December 31, 2003.
b) In 1999, the company granted certain non-statutory options to purchase shares
of common stock to three directors. Each option is for 15,000 shares at an
exercise price of $5.00 per share, vest immediately, and expire in 2003.
c) On May 1, 1999, the Company granted stock options to certain employees,
covering 283,000 shares. The options are exercisable for five years at a price
of $5.00 per share for 253,000 shares and $5.50 per share for 30,000 shares.
The options vest at a rate of 2% of the shares covered per month up to 36
months, at which time they will be fully vested.
d)On December 1, 1999, the president and chief financial officer of the Company
was granted options to purchase 300,000 shares of common stock of the
Company at an exercise price of $5.75 per share. These options expire on
November 30, 2004.
<PAGE> F-18
PACIFIC SOFTWORKS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999
NOTE 9 - STOCK OPTIONS (continued)
Plan and non-plan stock option activity is summarized as follows:
December 31,
1999 1998
Outstanding at beginning of period 140,000 -
Options granted at an exercise price of
$1.25 per share - 140,000
Options granted at an exercise price of
$5.00 per share 298,000 -
Options granted at an exercise price of
$5.50 per share 30,000 -
Options granted at an exercise price of
$5.75 per share 300,000 -
Outstanding at end of period 768,000 140,000
Exercisable at end of period 213,300 -
Weighted average exercise price of
options outstanding $ 4.63 $ 1.25
Weighted average remaining contractual
life of options outstanding 47 months 60 months
The Company accounts for its stock option transactions under the provisions of
APB No. 25. The following proforma information is based on estimating the
fair value of grants based upon the provisions of Statement of Financial
Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based
Compensation." The fair value of each option granted during the period ended
December 31, 1999 has been estimated as of the date of grant using the Black-
Scholes option pricing model with the following assumptions: risk free interest
rate of 5.5%, life of options of 2-5 years, volatility of 0% (except for the
options described in item (d) above for which the volatility is 44%) and
expected dividend yield of 0%. Under these assumptions, the weighted average
fair value of options granted during the period ending December 31, 1999 was
$2.05.
The Company's proforma net loss and net loss per share assuming compensation
cost was determined under SFAS No. 123 would have been the following:
Year Ended Year Ended
December 31, December 31,
1999 1998
Net Loss $(2,559,096) $( 513,360)
Net Loss Per Share $( 0.65) $( 0.15)
<PAGE> F-19
PACIFIC SOFTWORKS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999
NOTE 10 - WARRANTS
a) Warrants to purchase 80,000 units have been issued to certain professionals
who have rendered legal services, temporary accounting and administrative
services to the Company in connection with its IPO. Each of these units
consists of one share of the Company's common stock exercisable at any time
over a period of 60 months commencing July 29, 1999 at a price of $5.25 per
unit, and a common stock purchase warrant exercisable at a price of $7.50 per
share until 24 months after such common stock purchase warrants are registered.
These units are identical to the units sold in the IPO.
b)Upon completion of the IPO, the Company issued warrants to purchase 95,000
units to its underwriter. Each unit consists of one share of the Company's
common stock exercisable at $6.30 per unit for a period of four years, and a
common stock purchase warrant exercisable at a price of $7.50 per share until 24
months after such common stock purchase warrants are registered. $0 value has
been assigned to these warrants.
c)In August 1999, in connection with its IPO, the Company issued 200,000
common stock purchase warrants to an outside consultant that are exercisable at
a price of $5.75 per share, expiring in August 2001.
d)Warrants to purchase 1,180,000 shares have been issued to certain
professionals who have rendered consulting services, in connection with its
restructuring. Each of these warrants may be exercised at $5.75 per unit
until November 2004.
e) Warrants to purchase 7,674 shares have been issued to an executive search
firm. The warrants may be exercised at $5.75 per unit until November 2004. In
accordance with SFAS No. 123, the Company has valued these warrants at the
fair value of the warrants using the Black-Scholes pricing model.
In accordance with SFAS No. 123, the Company has valued the warrants, issued
under a), c), and d) above, at the fair value of the warrants using the Black-
Scholes pricing model; accordingly, as of December 31, 1999, the Company
recognized $107,481, $1,750,470, and $0 as offering costs, respectively, which
have been offset against additional paid-in capital.
The fair value of each warrant granted during the period ended December 31,
1999 has been estimated as of the date of grant using the Black-Scholes pricing
model with the following assumptions: risk-free interest rate, ranging from 5.5%
- - 6%, life of warrants ranging from 24 to 60 months, volatility of 0% and
expected dividend yield of 0%.
<PAGE> F-20
PACIFIC SOFTWORKS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999
NOTE 11 - RELATED PARTY TRANSACTIONS
a) As of December 31, 1998, the Company had advanced funds to its principal
stockholder in the amount of $43,000. The advances did not bear any interest
and were payable upon demand. The funds were repaid in 1999.
b) As of December 31, 1998, the Company had received advances from a company
controlled by the spouse of the principal stockholder of PSI. The advances
totaled $103,705. The advances did not bear any interest and were repayable
upon demand. This liability was satisfied in 1999.
c) In 1998, the company mentioned in item (b) above occupied space in premises
leased by PSI. The Company believes that the terms of occupancy are no less
favorable than those that could be obtained from unaffiliated third parties.
This party relocated during 1999.
d) During 1998 and 1999, the principal stockholder of the Company personally
guaranteed advances made to the Company pursuant to a line of credit provided
by Bank of America. Total availability under the line was $250,000. No
advances were outstanding as of December 31, 1998. The account was closed in
1999.
NOTE 12 - SEGMENT INFORMATION
The Company's assets are located principally in the United States.
Product sales are to the following geographic areas:
1999 1998
United States and the Americas 48% 43%
Europe 30% 40%
Asia and Australia 22% 17%
NOTE 13 - INCOME TAXES AND S CORPORATION STOCKHOLDER DISTRIBUTIONS
a) DistributionsThe Company has paid no distributions to its stockholders.
b) Tax Provision As a result of the Company's tax status as an S Corporation,
operating results as presented in the accompanying consolidated financial
statements do not include a provision for income taxes for the year ended
December 31, 1998 and in 1999 through February 14th.
As a result of the sale of common stock described in Note 7(c), the Company's S
Corporation election was terminated as of February 14, 1999.
<PAGE> F-21
PACIFIC SOFTWORKS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999
NOTE 13 - INCOME TAXES AND S CORPORATION STOCKHOLDER DISTRIBUTIONS (continued)
c) Proforma Income Taxes
Proforma income taxes (benefit), assuming that the Company had not been an S
Corporation in the period presented, are as follows:
1998
Federal $( 93,510)
State ( 30,674)
$( 124,184)
d) The components of the provision for income taxes are as follows:
December 31,
1999
Current Tax Expense
U.S. Federal $ -
State and Local -
Total Current -
Deferred Tax Expense
U.S. Federal $ -
State and Local _
Total Deferred -
Total Tax Provision from
Continuing Operations $ -
e)The reconciliation of the effective income tax rate to the Federal
statutory rate is as follows:
December 31,
1999
Federal Income Tax Rate ( 34.0)%
Deferred Tax Charge (Credit) -
Effect of Valuation Allowance 34.0%
State Income Tax, Net of Federal Benefit -
Effective Income Tax Rate 0.0%
At December 31, 1999, the Company had a net carryforward loss of
approximately $2,464,000. A valuation allowance equal to the tax benefit for
deferred taxes has been established due to the uncertainty of realizing the
benefit of the tax carryforward.
<PAGE> F-22
PACIFIC SOFTWORKS, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999
NOTE 13 - INCOME TAXES AND S CORPORATION STOCKHOLDER
DISTRIBUTIONS (continued)
Deferred tax assets and liabilities reflect the net tax effect of temporary
differences between the carrying amount of assets and liabilities for financial
reporting purposes and amounts used for income tax purposes. Significant
components of the Company's deferred tax assets (liabilities) are as follows:
December 31,
1999
Non-Current Deferred Tax Assets (Liabilities):
Loss Carryforwards $ 838,000
Less: Valuation Allowance ( 838,000)
Net Deferred Tax Assets (Liabilities) $ -
The net operating loss carryforward expires in 2019.
NOTE 14 - EARNINGS PER SHARE
Securities that could potentially dilute basic earnings per share in the future
that were note included in the computation of diluted earnings per share because
their effect would have been antidilutive are as follows:
December 31,
1999
Warrants $ 2,920,174
Options 768,000
Total Shares $ 3,688,174
NOTE 15 - ADVERTISING COSTS
Advertising costs incurred and recorded as expense in the statement of
operations were $243,059 and $213,670 for the years ended December 31, 1999
and 1998, respectively.
NOTE 16 - INTEREST COSTS
Interest costs incurred were $6,501 and $6,004 in 1999 and 1998, respectively,
all of which were charged to operations.
NOTE 17 - SUBSEQUENT EVENT
Company Name
The Company intends to change the name of the parent company Pacific
Softworks, Inc. to PASW, Inc. and the name of Pacific Acquisition
Corporation to Pacific Softworks, Inc.
<PAGE> F-23
THE SECURITIES REPRESENTED BY THIS CERTIFICATE HAVE
BEEN ACQUIRED FOR INVESTMENT AND HAVE NOT BEEN
REGISTERED UNDER THE SECURITIES ACT OF 1933. SUCH
SECURITIES MAY NOT BE SOLD OR TRANSFERRED IN THE
ABSENCE OF SUCH REGISTRATION OR AN EXEMPTION
THEREFROM UNDER SAID ACT.
FINANCIAL SERVICES PROVIDER NETWORK, INC.
CONVERTIBLE PROMISSORY NOTE
December ___, 1999 $1,000,000.00
FOR VALUE RECEIVED, Financial Services Provider Network, Inc., a
California corporation (the "Company"), hereby promises to pay to the
order of Pacific Softworks, Inc. (the "Holder") the aggregate principal
amount of One Million Dollars ($1,000,000.00) (the "Principal Amount"),
together with interest on the unpaid balance thereof from December ___,
1999 until the Repayment Date at the rate of ten percent (10%) per
annum calculated based on a year of 365 days, for the actual number of
days elapsed (the "Interest"). Unless earlier converted into shares of
capital stock of the Company with the same designation as Company
capital stock issued in the Company's next equity based round of
venture financing (the "Subsequent Equity") as described in Section 1
below, such principal and interest shall be due and payable twelve (12)
months from the date first set forth above (the "Repayment Date"), at
such place as the Holder shall indicate to the Company in writing, and,
except as set forth below, shall be payable in immediately available
funds in lawful money of the United States of America. If any
payment of principal or interest on this Note shall become due on a
Saturday, Sunday or public holiday, such payment shall be made on the
next succeeding business day.
1. Automatic Conversion Upon Financing. The Company and the Holder
agree that the Principal Amount and the portion of the Interest as
shall equal the interest accrued on the Principal Amount at the rate of
six percent (6%) per annum calculated based on a year of 365 days, for
the actual number of days elapsed, (the "Debt") shall automatically
convert into Subsequent Equity after the date hereof and before the
Repayment Date upon the Company's sale and issuance of Subsequent
Equity for an aggregate purchase price of at least One Million Dollars
($1,000,000) at one or more closings (the "Closing"), at the same price
per share (the "Conversion Price") at which such shares of Subsequent
Equity are sold to the other participants at the Closing; provided,
however, if the Pre-Money Valuation (as defined below) of the Company
in the sale and issuance of shares of Subsequent Equity shall be
greater than Twenty Million Dollars ($20,000,000.00), then the Debt
shall automatically convert into Subsequent Equity at the price per
share at which the Pre-Money Valuation of the Company would be equal to
Twenty Million Dollars ($20,000,000.00). For the purposes of this
Note, "Pre-Money Valuation" shall mean the product obtained by
multiplying: (x) the price per share (on an as-if-converted into Common
Stock basis) of the Subsequent Equity, by (y) the aggregate number of
shares (on an as-if-converted into or exercised for Common Stock basis)
of all of the issued and outstanding capital stock of the Company and
options, warrants or other rights to purchase capital stock of the
Company (including only those options, warrants or other rights issued
and outstanding as of immediately prior to the Closing and excluding
those securities into which this Note shall convert) immediately prior
to the Closing. Upon such conversion: (i) this Note shall be canceled,
and (ii) the Holder shall forfeit the portion of the Interest as shall
exceed the interest accrued on the Principal Amount at the rate of six
percent (6%) per annum calculated based on a year of 365 days, for the
actual number of days elapsed. The Holder, by acceptance hereof,
agrees to surrender this Note for conversion at the principal office of
the Company at the time of such Closing and agrees to execute all
appropriate documentation necessary to effect such conversion,
including, without limitation, a stock purchase agreement substan-
tially similar to that executed by the other investors in the
Subsequent Equity financing of the Company. If upon such conversion of
this Note a fraction of a share would result, the Company will pay in
lieu thereof in cash the amount of principal and accrued interest
represented by such fractional share calculated on the basis of the
purchase price per share of Subsequent Equity in such financing.
2. Corporate Transactions. From and after the date of issuance of this
Note, if at any time prior to the Repayment Date and prior to the date
of the Closing the Company is acquired by another entity by means of
merger, reorganization, consolidation or a transfer of more than 50% of
the voting power of the Company (a "Transaction"), unless the
stockholders of record of the Company prior to such Transaction will,
after such Transaction, hold at least 50% of the voting power of the
surviving entity, then, if the Adjusted Consideration, as defined
below, shall have a value greater than Twenty Million Dollars
($20,000,000), the Holder shall be entitled to receive such portion of
the consideration received in such Transaction after satisfying all
forms of Indebtedness, as defined below, to which the Company is
subject as shall equal a fraction: (x) the numerator of which is equal
to One Million Dollars ($1,000,000) divided by the per-share fair
market value of the most recent designation of Company capital stock
immediately prior to the date of such Transaction (the "Numerator") and
(y) the denominator of which is equal to the Numerator plus the number
of shares of capital stock of the Company (calculated on an as-if-
converted into Common Stock basis) outstanding immediately prior to the
date of such Transaction. For the purposes of this Section 2,
"Adjusted Consideration" shall mean the aggregate value of the
consideration received, after satisfying all forms of Indebtedness, as
defined below, to which the Company is subject, in a Transaction
divided by the percentage of the voting power of the Company sold in
such Transaction.
3. Issuance of Stock on Conversion. As soon as practicable after
conversion of this Note into shares of Subsequent Equity as set forth
in Section 1 above, the Company at its expense will cause to be issued
in the name of and delivered to the Holder, a certificate or
certificates for the number of shares of securities to which the Holder
shall be entitled on such conversion (bearing such legends as may be
required by applicable state and federal securities laws in the opinion
of legal counsel for the Company), together with any other securities
and property, if any, to which the Holder is entitled on such
conversion under the terms of this Note. Such conversion shall be
deemed to have been made upon the Closing under Section 1, regardless
of whether the Note has been surrendered on such date. Notwithstanding
the foregoing, the Holder agrees to promptly surrender the Note prior
to or upon such conversion.
4. Events of Default. The occurrence of any of the following shall
constitute an "Event of Default" under this Note:(a) Failure to Pay.
The Company shall fail to pay (i) when due any principal payment on the
due date hereunder or (ii) any interest or other payment required
under the terms of this Note on the date due and such payment shall not
have been made within five (5) days of Company's receipt of the
Holder's written notice to Company of such failure to pay;(b) Voluntary
Bankruptcy or Insolvency Proceedings. The Company shall (i) apply for
or consent to the appointment of a receiver, trustee, liquidator or
custodian of itself or of all or a substantial part of its property,
(ii) be unable, or admit in writing its inability, to pay its debts
generally as they mature, (iii) make a general assignment for the
benefit of its or any of its creditors, (iv) be dissolved or
liquidated, (v) become insolvent (as such term may be defined or
interpreted under any applicable statute), (vi) commence a voluntary
case or other proceeding seeking liquidation, reorganization or other
relief with respect to itself or its debts under any bankruptcy,
insolvency or other similar law now or hereafter in effect or consent
to any such relief or to the appointment of or taking possession of its
property by any official in an involuntary case or other proceeding
commenced against it, or (vii) take any action for the purpose of
effecting any of the foregoing;(c) Involuntary Bankruptcy or
Insolvency Proceedings. Proceedings for the appointment of a receiver,
trustee, liquidator or custodian of the Company or of all or a
substantial part of the Company's property, or an involuntary case or
other proceedings seeking liquidation, reorganization or other relief
with respect to the Company or the Company's debts under any
bankruptcy, insolvency or other similar law now or hereafter in effect
shall be commenced and an order for relief entered or such proceeding
shall not be dismissed or discharged within thirty (30) days of
commencement; or (d) Judgments. A final judgment or order for the
payment of money in excess of One Hundred Thousand Dollars ($100,000)
(exclusive of amounts covered by insurance issued by an insurer) shall
be rendered against the Company and the same shall remain undischarged
for a period of thirty (30) days during which execution shall not be
effectively stayed, or any judgment, writ, assessment, warrant of
attachment, or execution or similar process shall be issued or levied
against a substantial part of the property of the Company and such
judgment, writ, or similar process shall not be released, stayed,
vacated or otherwise dismissed within thirty (30) days after issue or
levy.(e) Other Payment Obligations. The Company shall fail to make any
payment when due under the terms of any bond, debenture, note or other
evidence of indebtedness to be paid by the Company (excluding this
Note) ("Indebtedness"), provided that such payment exceeds an amount of
One Hundred Thousand Dollars ($100,000), and the failure to make such
payment shall continue for a period exceeding the greater of: (i) the
applicable grace period for such Indebtedness and (ii) thirty (30)
days.
5. Rights of Holder upon Default. Upon the occurrence or existence of
any Event of Default (other than an Event of Default, referred to in
Sections 4(b) and 4(c)) and at any time thereafter during the
continuance of such Event of Default, the Holder may, by written notice
to the Company, declare all unpaid Debt payable by the Company
hereunder to be immediately due and payable without presentment,
demand, protest or any other notice of any kind, all of which are
hereby expressly waived. Upon the occurrence or existence of any Event
of Default described in Sections 4(b) and 4(c), immediately and
without notice, all unpaid Debt payable by the Company hereunder shall
automatically become immediately due and payable, without presentment,
demand, protest or any other notice of any kind, all of which are
hereby expressly waived. In addition to the foregoing remedies, upon
the occurrence or existence of any Event of Default, the Holder may
exercise any other right power or remedy permitted to it by law, either
by suit in equity or by action at law, or both.
6. Cost of Collection. In the event of any default under this Note,
the Company shall pay the fees and expenses of one legal counsel for
the Holder incurred in connection with collection of any amounts owed
to Holder by the Company under this Note.
7. Subordination. The indebtedness represented by this Note is hereby
expressly subordinated in right of payment to the prior payment in full
of all of the Company's indebtedness to banks, insurance companies,
lease financing institutions or other lending institutions (other than
small business investment companies or venture capital firms) regularly
engaged in the business of lending money.
8. Waiver and Amendment. Any term of this Note may be amended and the
observance of any terms of this Note may be waived (either generally or
in a particular instance and either retroactively or prospectively)
with the written consent of the Company and the Holder. Any such
amendment or waiver by the Company and the Holder shall be conclusive
and binding upon the holder of this Note and of any Note issued upon
the transfer hereof or in exchange hereof or in lieu hereof whether or
not
notation of such consent and waiver is made upon this Note.
9. Transfer. Prior to due presentment for registration of transfer,
the Company may treat the person in whose name this Note is registered
as the owner and holder of this Note for the purpose of receiving
payment of principal of and interest on this Note and for all other
purposes whatsoever, whether or not this Note shall be overdue, and the
Company shall not be affected by notice to the contrary.
10. Usury Disclosure. Regardless of any provision contained in this
Note, the Agreement or any other document executed in connection
herewith, it is expressly stipulated and agreed that the intent of the
Holder and the Company is to comply at all times with all usury and
other laws relating to this Note. If the laws of the State of
California would now or hereafter render usurious, or are revised,
repealed or judicially interpreted so as to render usurious, the
indebtedness evidenced by this Note, or if any prepayment by the
Company results in the Company's having paid any interest in excess of
that permitted by law, then it is the Holder's and the Company's
express intent that all excess amounts theretofore collected by the
Holder be credited to the principal balance of this Note (or, if this
Note has been paid in full, refunded to the Company), and the
provisions of this Note immediately be deemed reformed and the amounts
therefor collectible hereunder reduced, without the necessity of
execution of any new document, so as to comply with the then applicable
law, but so as to permit the recovery of the fullest amount otherwise
called for hereunder.
11. Governing Law. This Note shall be construed and enforced in
accordance with the laws of the State of California.
12. Headings. The headings in this Note are for purposes of convenience
and reference only, and shall not be deemed to constitute a part
hereof.
IN WITNESS WHEREOF, the Company has caused this Note to be issued as of
the date first above written.
Financial Services Provider
Network, Inc.
a California corporation
VIA FACSIMILE TRANSMISSION
January 13, 2000
Mr. Robert Benedict
RedFlag, Inc.
1523 Cabrillo Avenue
Venice, CA 90291
Dear Robert:
This letter is intended to summarize our recent discussions between
Pacific Softworks, Inc. and RedFlag,
Inc.
1. Pacific Softworks, Inc. ("PSI") is desirous of entering into a
strategic relationship with RedFlag, Inc. ("RedFlag") to jointly
develop certain specific aspects of their respective businesses.
2. Assumptions are that as Red Flag increases its revenues, thereby
proving the corporate concept, it will result in related value
increases.
It is assumed that over the next 18 months RedFlag will have cumulative
revenues of approximately $15 million. It is also assumed that Robert
Benedict will draw a salary of approximately $1 million in 2000 and
that there will be a pre tax profit of approximately 50%.
3. In addition to the stock exchange between PSI and Red Flag, PSI is
prepared to assist RedFlag in marketing by a formal introduction to all
of PSI's customers and associates. There will be an immediate effort
to introduce RedFlag to FSPN, iApplianceNET.com, IBM, Alcatel, and
others. PSI will also make available its Internet and web technology
to be marketed, where appropriate, to RedFlag's customers.
4. Both parties believe that it is in the best interests of both PSI
and RedFlag to have substantial financial interest in each other's
companies. Therefore, PSI will purchase up to 12.5% of the outstanding
shares of RedFlag, on a fully diluted basis, for shares of PSI
on the following schedule:
Mr. Robert Benedict
January 13, 2000
Page Two
Red Flag Revenues % to be acquired Pacific's Price (1)
$ 1,000,000 10.0% $ 100,000 1 x Revenues
$ 3,000,000 10.0% $ 300,000 1 x Revenues
$ 9,000,000 12.5% $ 2,250,000 2 x Revenues
$15,000,000 12.5% 3,750,000 2 x Revenues
45.0% $6,400,000 (2)
(1) To protect both Red Flag and PSI, a collar will be placed on PSI
stock price which will be divided into the price in dollars that PSI
pays for Red Flag stock. The collar will be between $12 and $4.
Example: If PSI stock is selling at $20 per share at the time Red Flag
reaches $15 million in revenue, Red Flag would have the benefit of a
$12 maximum price placed on PSI's stock. It would receive at least
312,500 shares. If PSI's stock were selling at $4 or below, Red Flag
would receive 937,500 shares of PSI.
(2) If PSI stock averaged $6 per share, Red Flag would receive
1,066,667 shares of PSI
5. At a minimum, PSI would expect this investment to be subject to the
following terms and conditions:
A. RedFlag and PSI will endeavor to develop areas of common interest as
they relate to software and hardware requirements.
B. It is understood that PSI will give a limited, revocable, proxy, in
favor of Mr. Robert Benedict, (to the extent that his ownership in
RedFlag should fall below 50%), to vote the shares of RedFlag that will
be held by PSI. The limiting factors of the proxy will be maintenance
of certain (to be determined) financial ratios. The proxy will not
be in force as it relates to mergers, acquisitions, or bankruptcy.
C. PSI will have the right to appoint one Director to RedFlag' s Board
of Directors.
D. PSI and RedFlag will negotiate a first right of refusal for embedded
Internet technologies to be provided by PSI for use by RedFlag, or its
partners, in delivering RedFlag products and services. Said Internet
technologies will include, but will not be limited to, embedded Web
browsers, networking protocol stacks and thin client technologies.
E. The negotiation, execution and delivery of a definitive binding
written agreement and such other documentation as may be necessary or
appropriate, all in form and substance satisfactory to PSI and RedFlag,
and will include customary representations, warranties and
Mr. Robert Benedict
January 13, 2000
Page Three
any determined budgets, forecasts and financial systems and controls
(which may be negotiated as part of a definitive agreement) which shall
survive the closing of the Agreement as well as customary conditions
precedent and indemnification.
F. The completion by PSI and RedFlag and their respective accountants,
counsel and other experts of a customary due diligence investigation
with respect to the business and affairs (including business, financial
and legal matters) of PSI and RedFlag and the resolution, in a manner
satisfactory to the Parties of any and all issues raised as a result of
such investigation.
G. The receipt of all necessary and appropriate corporate stockholder,
and governmental approvals by the Parties to enter into, and consummate
the transactions contemplated by the Agreement.
H. The obtaining of such consents and approvals from third parties as
may be required in order lawfully to consummate a definitive agreement
without violating any contract or rights of third parties.
I. The occurrence prior to the Closing Date (as defined within the
definitive agreement) of no material adverse change in the financial
condition, business or prospects of any of the Parties and no
threatened litigation with respect to the transactions contemplated
hereby or otherwise with respect to any of the Parties.
6. The Parties represent that each has the necessary power and
authority to execute and deliver this Letter. By executing and
delivering this Letter each of the Parties represents that to their
knowledge none the Parties nor any stockholder of any of the Parties is
in violation of, breach of or default under any material contract,
agreement or understanding, whether oral or written, to which the
Parties or stockholders is a party.
7. This Letter is only an expression of mutual interest by the Parties
concerning some aspects of the proposed transactions described herein,
it being understood that all of the material terms of such proposed
transactions are not yet agreed upon between the Parties and still must
be agreed upon mutual satisfaction of all the Parties.
8. Except as explicitly otherwise set forth in this Letter
- - No liabilities or obligations of any kind whatsoever are intended to
be created hereby between the Parties;
- - This Letter is not intended to constitute a legally binding contract
or to consummate the proposed transactions described herein and
is not an agreement to enter into a legally binding agreement;
Mr. Robert Benedict
January 13, 2000
Page Four
- - Any binding legal obligation of any nature between the Parties shall
be only set forth in the definitive Agreement;
- - No party may claim any legal rights against the other by reason of
the execution of this Letter or by taking any action in reliance
thereon; and
- - Each Party shall bear its own costs in connection with this Letter
and the Agreement contemplated thereby.
9. The Parties intend in good faith to use their best efforts to
proceed promptly with the negotiation, execution and the delivery of
the definitive agreement and the closing transactions contemplated by
this Letter. This Letter shall terminate and, except as set
forth in Item 8, shall be of no further force or effect if the
Agreement has not been approved by PSI's and RedFlag' Boards of
Directors, all required regulatory agencies and, if required, submitted
to the stockholders of PSI and RedFlag for approval by February 29,
2000 or any other date that may be mutually acceptable to the Parties.
If the terms and conditions set forth in this Letter correctly set
forth our understanding, please execute this Letter in duplicate and
return one fully executed copy to me at your convenience.
If this Letter has not been executed and returned to us by January 17,
2000, it shall be deemed null and void.
Very truly yours,
Glenn P. Russell
Chairman of the Board
The foregoing correctly sets forth our understanding:
RedFlag, Inc.
Exhibit 21.1
Subsidiaries of Pacific Softworks
Name Incorporation DBA
Network Research Corp. Japan, Ltd. Japan None
iApplianceNet.com, Inc. California None
Pacific Acquisition Corporation California Pacific Softworks
Pacific Softworks Eurpope Limited United Kingdom None
WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
<TABLE> <S> <C>
Pacific Softworks
Financial Data Schedule
Years ended December 31, 1999 and 1998
PACIFIC SOFTWORKS, INC.
FINANCIAL DATA TABLE
YEAR ENDED DECEMBER 31, 1998 AND 1999
1998 1999
ITEM 5-02 (1) Cash 224,031 1,661,708
(2) Marketable securities 0 0
(3) (a) (1) Notes and accounts receivable - trade 355,302 1,248,737
(4) Allowance for doubtful accounts 86,400 72,986
(6) Inventory 0 0
(9) Total current assets 551,456 2,913,212
(13) Property, plant and equipment 430,957 667,592
(14) Accumulated depreciation 348,761 426,589
(18) Total assets 643,326 3,167,408
(21) Total current liabilities 328,979 390,546
(22) Bonds, Mortages and similar debt 0 0
(28) Preferred stock - mandatory redemption 0 0
(29) Preferred stock - no mandatory redemption 0 0
(30) Common stock 177,858 5,047,027
(31) Other stockholders' equity 11,163 25,578
(32) Total liabilities and stockholders' equity 643,326 3,167,408
ITEM 5-03 (b) 1 (a) Net sales of tangible products 2,479,589 1,817,654
(b) 1 Total revenues 2,787,397 2,242,544
(b) 2 (a) Cost of tangible goods sold 100,336 167,486
(b) 2 Total operating costs and expenses 3,110,821 4,666,954
(b) 3 Other costs and expenses 0 0
(b) 5 Provision for doubtful accounts and notes 50,000 0
(b) (8) Interest and amortization of debt discount 0 6,501
(b) (10) Income before income taxes (473,760) (2,464,067)
(b) (11) Income tax expense 0 0
(b) (14) Income/loss continuing operations (473,760) (2,464,067)
(b) (15) Discontinued operations 0 0
(b) (17) Extraordinary items 0 0
(b) (18) Cummulative effect - change in
accounting principles 0 0
(b) (19) Net income or loss (473,760) (2,464,067)
(b) (20) Earnings per share - primary ($0.14) ($0.62)
(b) (20) Earnings per share - fully diluted ($0.14) ($0.62)
</TABLE>
