UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended June 30, 2000
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
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Commission File No. 0-25831
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NetWolves Corporation
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(Exact name of registrant as specified in its charter)
New York 11-2208052
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(State or other jurisdiction of (I.R.S. Employer Identification No.
incorporation or organization
200 Broadhollow Road, Melville, New York 11747
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(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (631) 393-5016
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Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.0033 par value
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(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 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
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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not 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-K or any amendment to this
Form 10-K [X ].
The aggregate market value of the voting stock held by non-affiliates of the
registrant, based upon the closing sale price of the Common Stock on September
29, 2000 as reported on the Nasdaq, was approximately $49,076,000. Shares of
Common Stock held by each executive 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 affiliates status
is not necessarily a conclusive determination for other purposes.
As of September 29, 2000, the Registrant had outstanding 8,742,613 shares of
Common Stock.
Documents incorporated by reference: None
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NETWOLVES CORPORATION AND SUBSIDIARIES
FORM 10-K
FOR THE YEARS ENDED JUNE 30, 2000 AND 1999 AND FOR THE PERIOD
FROM FEBRUARY 13, 1998 (INCEPTION) TO JUNE 30, 1998
PART I
ITEM 1 Business ...................................................... 1
ITEM 2 Properties .................................................... 10
ITEM 3 Legal Proceedings ............................................. 11
ITEM 4 Submission of Matters to a Vote of Security Holders ........... 11
PART II
ITEM 5 Market for Registrant's Common Equity and Related Stockholder
Matters ...................................................... 12
ITEM 6 Selected Consolidated Financial Data .......................... 13
ITEM 7 Management's Discussion and Analysis of Financial Condition and
Results of Operations ........................................ 14
ITEM 7a Quantitative and Qualitative Disclosure About Market Risk ..... 18
ITEM 8 Financial Statements and Supplementary Data ................... 18
ITEM 9 Changes In and Disagreements with Accountants on Accounting and
Financial Disclosure ......................................... 18
PART III
ITEM 10 Directors and Executive Officers of the Registrant ............ 19
ITEM 11 Executive Compensation ........................................ 20
ITEM 12 Security Ownership of Certain Beneficial Owners and Management. 22
ITEM 13 Certain Relationships and Related Transactions ................ 22
PART IV
ITEM 14 Exhibits, Financial Statements Schedules, and Reports on Form
8-K .......................................................... 23
SIGNATURES .............................................................. 24
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ITEM 1. BUSINESS
This Annual Report on Form 10-K, the exhibits hereto and the information
incorporated by reference herein contain "forward looking statements" within the
meaning of Section 27A of the Securities Act of 1933, as amended (the
"Securities Act") and Section 21E of the Securities Exchange Act of 1934, as
amended (the "Exchange Act"), and such forward looking statements involve risks
and uncertainties. When used in this report, the word "expects", "anticipates"
and "estimates" and similar expressions are intended to identify forward looking
statements. Such statements are subject to risks and uncertainties that could
cause actual results to differ materially from those projected. These risks and
uncertainties include those discussed below and those discussed in "Management's
Discussion and Analysis of Financial Condition and Results of Operations" or
incorporated by reference herein. NetWolves Corporation undertakes no obligation
to publicly release any revisions to these forward looking statements to reflect
events or circumstances after the date this Report is filed with the Securities
and Exchange Commission or to reflect the occurrence of unanticipated events.
Overview
NetWolves Corporation ("NetWolves" or the "Company") designs, develops,
manufactures and sells Internet infrastructure security products designed to
provide secure, manageable Internet access. The Company was founded to introduce
a new innovative Internet security and access device called the "FoxBox-TM".
NetWolves' state-of-the-art enabling technology for the Internet connects people
and computer networks securely to the Internet. NetWolves designs Internet
solutions that provide the services that companies desire without confusion,
complication, limitation and the exorbitant cost associated with traditional
offerings.
NetWolves' multi-services internet communications gateway products are
designed to meet all business needs packaged together, (e-mail, firewall
security, router, Web hosting, Intranet, FTP, etc.), complete with advanced
integrated hardware and software, a simple to use interface, and room for
expansion. As companies combine data and communications to reduce costs,
NetWolves' value-added expansion technologies such as Virtual Private Networking
("VPN"), a process for encrypting data for secure transmission over public
networks, will provide significant cost-efficient services in an all-in-one,
enterprise-wide gateway solution.
NetWolves differentiates itself from its competitors through its
proprietary patent pending technology which provides a centralized, remote
network monitoring, managing and security software ("Mother"). Mother allows the
secure, remote management and monitoring of multiple all-in-one gateway servers
located worldwide. This monitoring can be performed in real-time, and from one
or numerous central sites. This advanced new technology also allows a network
administrator to create a configuration template with all the configuration
information and changes required for all-in-one units. This template can be
applied to each unit, all via a secure configuration mechanism from the central
monitoring location, without compromising network security. It is this Mother
system which forms the basis of the Company's recent agreement with the General
Electric Company.
NetWolves products are designed for our partners' present and future needs.
The Company's initial target markets are the end users in the small and
mid-sized businesses and large organizations with satellite offices. Larger end
users to whom the product is intended to be marketed are companies with
multi-state locations, government agencies and educational markets. NetWolves
products are designed to service numerous markets, including the financial,
medical, legal, travel, hospitality, entertainment, hotel and auto and petroleum
industries.
The Company's strategy is to establish the FoxBox as the standard for
enterprise-wide network connectivity worldwide. To achieve its objectives
worldwide, NetWolves seeks to form relationships with leading companies in their
respective areas to deliver application-specific Internet solutions to
organizations worldwide.
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In January 1999, the Company entered into an agreement with Sales &
Management Consulting, Inc. (d/b/a The Sullivan Group), a leading consulting
organization serving the needs of the automobile aftermarket, convenience stores
and oil industry. It maintains an extensive library of training modules
available to its client base of Amoco Oil, British Petroleum, ExxonMobil, Tosco
and Unocal. Pursuant to its agreement, The Sullivan Group appointed NetWolves as
its exclusive provider in the United States of a delivery system whereby The
Sullivan Group intends to sell its proprietary training programs that enhance
profitability to retail locations throughout the United States. NetWolves is
customizing an Internet solution specifically to deliver distance learning to
these locations utilizing its FoxBox technology. In July 1999, the Company
acquired The Sullivan Group and the five principal officers and employees of The
Sullivan Group were retained under long-term employment contracts.
In February 2000, and in exchange for 1,775,000 restricted shares of the
Company's common stock, NetWolves acquired ComputerCOP Corp., whose assets
included ComputerCOP technology, inventory and $20.5 million in cash intended to
fund future growth. The shares issued by the Company in connection acquisition
are subject to a Voting Trust Agreement, wherein the Company's chief executive
officer has been granted the right to vote all Trust Shares for two years,
subject to earlier termination on the sale of the shares based on certain
parameters.
Agreement with General Electric
On June 29, 2000, NetWolves and General Electric Company ("GE") entered
into a six year agreement for the master purchase, license and support services
of NetWolves' security, remote monitoring and configuration management system.
GE, after extensive due diligence in looking for the all-in-one small office
solution for network management, interconnectivity and security management,
chose the FoxBox for deployment throughout their enterprise. In addition to
agreeing to sell the FoxBox to GE, NetWolves will receive (a) a one-time
installation fee for each FoxBox unit installed and (b) a monthly service and
maintenance fee for which GE pays NetWolves upon installation for the first
twelve months. GE will be using the FoxBox for interconnectivity of worldwide
offices. The FoxBox will enable GE's offices to interact with each other,
utilizing NetWolves advanced firewall security. NetWolves believes that this
agreement further validates the Company's technology and innovations within the
firewall and network security markets. Network security is one of the most
formidable challenges facing Fortune 500 companies, and with its new "Mother
System," NetWolves can offer the appropriate solutions.
In connection with the Company entering into the agreement, the Company
issued GE a warrant to purchase 500,000 shares of common stock that may be
exercised ratably upon the Company receiving orders (as defined in the
agreement) of an amount equal to or in excess of, in the aggregate, $2,000,000,
$3,000,000, $4,000,000 and $5,000,000.
The Company issued 200,000 shares of common stock to GE in June 2000.
Industry background
Small to medium sized enterprises, branch offices of large corporations,
government offices, telecommuters, education market businesses and consumers are
increasingly accessing the Internet for a wide variety of uses. These include
data, video and voice communications, information gathering and commerce.
Because it is an affordable means of achieving global reach and brand awareness,
the Internet is a particularly attractive vehicle for small and medium size
businesses as they endeavor to access and share information with a large number
of geographically dispersed customers, employees and business partners.
According to International Data Corporation's ("IDC") 1999 U.S. Small Business
Survey, of the 87.4 million devices estimated by IDC to have Internet access in
1998, approximately 60% were used by small businesses and home offices. IDC
estimates that the proportion of small businesses, those with less than 100
people, accessing the Internet in the United States will increase from
approximately 50% in 1998 to approximately 65% by 2001, to a total of 4.7
million businesses.
Many branch offices, mobile workers, and telecommuters, all of whom connect
electronically to the corporation and each other, characterize today's large
business enterprise. Because of the confidential nature of business
communications and data, these connections must be secure. Virtual private
networks provide secure Internet connections between the business enterprise and
employees and their business partners. Communicating using the Internet and
virtual private networks offer significant cost savings over alternative
solutions such as private leased lines or frame relay networks. TeleChoice Inc.,
an independent market researcher, estimates that virtual private networks can
cut telecommunication costs by as much as 90% over private leased line networks,
and, for this reason, their use is expected to grow rapidly.
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The market for Internet security products includes a variety of
applications to address these issues, such as firewall, web site access
filtering and Internet Protocol, including proxy servers, intrusion detection,
virus detection, address management and VPN. According to IDC, the market for
Internet security products increased over 45% in 1998 to $3.2 billion and is
expected to grow at a compounded annual growth rate of 21% to $8.3 billion by
2003.
NetWolves' FoxBox product line provides significant additional
functionality over existing server applications, including VPN and web site
access filtering for content. The product offers full functionality that is
administered through a simple, web-based interface. The FoxBox provides
integrated Internet applications with scalability and flexibility that overcomes
concerns about costly product upgrades and replacement as the Internet changes.
Historically, to create an Internet presence, an organization needed access
to complex network technologies and one or more costly general-purpose servers,
which often require a technically skilled staff to maintain. The expense and
technical complexity of these network technologies and general purpose servers
often discourage their adoption by small- to medium-sized organizations, due to
their limited budgets and technology skills. NetWolves' FoxBox "server
appliance" is a new category of low-cost servers that work with other network
devices to provide services to network users. Server appliances are a type of
network infrastructure device that is designed to facilitate the exchange of
information over a computing network. Server appliances differ from
general-purpose servers because they are specifically designed and tailored to
deliver one or more network-based applications, as opposed to general-purpose
servers. Dataquest Incorporated, an independent research firm, expects the
server appliance market to grow from $2.2 billion in 1999 to approximately $15.8
billion in 2003, representing a 64% compound annual growth rate.
Participation in the emerging global Internet-based economy and realization
of the benefits and efficiencies facilitated by new Internet-enabled business
applications are becoming increasingly important for the small office market.
The small office market includes small businesses, remote and branch offices of
large corporations, and home offices.
The FoxBox server appliances and FoxOS software product line enable small
office business organizations to establish a presence on the Internet, and do so
in an easy, cost-effective manner. As the number of Internet users and
businesses increases, the Company believes the demand for server appliances will
continue to grow.
Products and Services
The FoxBox offers a combined Internet access and firewall security solution
for small to medium sized businesses. The FoxBox costs substantially less than
purchasing its functionality in separate products. In addition, the FoxBox's
"all-in-one" solution significantly reduces costly network administration
overhead, since there are less divergent components to administer in the FoxBox.
Each of the features in the FoxBox is designed to work together using integrated
hardware and software with a common interface. This facilitates expansion and
support of the converging voice and data industries.
The FoxBox is configured using its web-based graphical user interface
("GUI"). The FoxBox is designed for basic network connectivity, although it is
often customized to handle large-scale applications for vertical market
solutions. NetWolves develops custom software applications that are fully
integrated with commodity off-the-shelf hardware components ("COTS") in the
FoxBox products. NetWolves outsources the manufacturing function that enables
NetWolves to maximize its research and development efforts.
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Standard FoxBox Features
The FoxBox offers the following features:
-- It can securely connect any number of users in a small geographic area
(LAN) simultaneous to the Internet through a single dial-up or
dedicated connection.
-- Up to eight users at one time can connect to the Web/Internet on
non-dedicated connections.
-- Hierarchical caching, which are rules that tell a computer to look for
the data stored on a series of a computer before accessing the
internet for data, gives the FoxBox more efficient web viewing and
greater ability to transfer data from one file to another.
-- Any number of users can send and receive e-mail individually, while
sharing one internet service provider account.
-- A firewall protects the LAN from Internet-borne attacks.
-- An advanced network address translation module allows the creation of
powerful address translation rules for greater firewall flexibility.
-- Files that store events for review at a later date ensure appropriate
use of internet resources.
-- Scalability allows internet usage to grow as a company expands.
-- A network file server centrally stores programs and data for
accessability to multiple users simultaneously and share data and
programs from a central location.
-- It can be used as a stand-alone firewall to protect the resources of a
private network from users outside on a public network.
-- It allows a company to publish and host a web site.
Optional FoxBox Features
The FoxBox also offers the following optional features:
-- High speed tape backup/restore module (SCSI) allows all stored data on
the FoxBox to be backed up onto a DAT tape, which is a standardized
tape for file back up.
-- Fast SCSI hard drive provides extra storage for shared files and Web
data at faster access speeds.
-- Extra 10.2 GB EIDE hard drive provides extra storage for shared files
and Web data.
-- E-Mail Archive module allows all inbound and outbound e-mail to be
saved for archival/compliance purposes.
-- Advanced access control module allows control over who can access the
web and the sites to which they have access.
-- Virtual Private Networking (VPN) module provides a process for
encrypting data for secure transmission over public networks.
Firewall and Security Functions
NetWolves believes that security is an essential element of any Internet
connectivity solution. For this reason, the FoxBox includes high-end firewall
security protection, without requiring the purchase of additional components.
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The FoxBox is designed to protect a company's private data and systems from
outside intruders with its firewall security system, incorporating three
separate firewall technologies:
-- Stateful packet filters verify that all incoming data packets coming
from the Internet have been requested by an authorized user on the
LAN.
-- Proxy applications prevent unauthorized Internet applications from
accessing the LAN.
-- Network Address Translation ("NAT"), which are conversions of public
addresses to and from private addresses, makes the network invisible
to outside Internet users by hiding the internal network's addresses
of each sender or reveiver of information.
All packets of data entering the FoxBox from the Internet are first checked
for validity against a series of stateful packet filters. Data is then forwarded
to proxy applications that further inspect the contents of the packets for
potential security violations. If the data is determined to be valid by both the
stateful packet filters and proxy applications, it is allowed to enter the
secure LAN.
The FoxBox DDR and FoxBox Pro I dial-on-demand units come with a
preconfigured firewall and network address translation rules that allow these
products to securely connect the LAN to the Internet. The FoxBox 56K, FoxBox T1
and FoxBox Pro Plus are designed with fully configurable firewalls and network
address translation rules that give the network administrator greater
flexibility in allowing or denying incoming and outgoing data.
E-Mail Services
A key feature of the FoxBox is its advanced and powerful management of
electronic mail. With only one Internet account, an unlimited number of users
can send and receive e-mail. In addition, the FoxBox supports Internet e-mail
standards. For e-mail between a FoxBox and the Internet, NetWolves uses the
standard simple mail transfer protocol (SMTP) protocol, which is the standard
for e-mail transmission on the Internet. For LAN users, the FoxBox supports a
number of different protocols. If the FoxBox is used as the LAN's e-mail server,
two common client-server e-mail protocol standards are supported:
-- POP-3 - a process for retrieving e-mail from its stored location to
the viewer.
-- IMAP - a method of viewing electronic mail at its stored location.
The FoxBox supports several e-mail clients, including:
-- Microsoft Exchange-TM
-- Microsoft Internet Mail-TM
-- Netscape Navigator Mail-TM
-- Eudora-TM
-- Pegasus-TM
The FoxBox supports several e-mail gateways, including:
-- Microsoft Exchange Server-TM
-- Lotus cc:Mail-TM
-- GroupWise Mail-TM
-- Others with SMTP gateways
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Web Based Administrative Interface ("AI")
A Web-based Administrative Interface allows the network administrator to
configure the various subsystems of the FoxBox. The FoxBox is completely
transparent to the Internet user. Likewise, because the FoxBox is easy to setup,
it will feel transparent to the administrator. This is especially true should
changes be required following initial installation. Since all administration of
the FoxBox is performed through a Web browser, the administrator can be on any
workstation on the LAN.
NetWolves' Distance Learning Solution
NetWolves is committed to the evolution of our core product, the FoxBox, as
well as new solutions for emerging markets in the new millennium. NetWolves'
distance learning solution, which delivers cost-effective, interactive training
programs through the FoxBox Intranet delivery system, is part of the evolution.
This system sets the standard for delivery of training and education in many
vertical market industries such as oil and petroleum, health care, retail, and
auto dealerships.
NetWolves Web Site Monitoring Software: ComputerCop Software
A national study commissioned by Congress that details the online
victimization of America's children has shown that 1 in 5 children online have
been invited to engage in cybersex, and 1 in 4 have been exposed to pornography.
Despite parental concerns, only one third of families were using filtering,
monitoring and blocking software, including technology offered by Internet
service providers. This statistic is understandable, since most blocking,
monitoring and filtering software is laborious to install, and some parents are
not aware that it is available.
The result is a CD that a parent can just put in the computer without any
installation or detection. Within a matter of minutes ComputerCOP scans the hard
drive for offensive images and inappropriate words to show parents what their
children have been exposed to online. This software has been approved by the
NCMEC, Pedowatch.org and has been featured on the television show, America's
Most Wanted.
Remote Monitoring and Configuration Management Product - "Mother"
The "Mother System" technology offers many innovations. First, it allows
the secure, remote management and monitoring of multiple all-in-one gateway
servers that may be located worldwide. This monitoring can be done in real-time
and from one or numerous central sites. Additionally, this new technology allows
a network administrator to create a configuration template with all the
configuration information and changes required for all- in-one units. This
template can be applied to each unit, all via a secure configuration mechanism
from the central monitoring location, without compromising network security.
The "Mother System" technology combined with the Company's core product,
the FoxBox, and a centralized monitoring office makes available to network
administrators and organizations what the Company believes to be the complete
solution to managing, monitoring and securing their networks.
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Engineering and Development
The Internet and the computer hardware and software industry are
characterized by rapid technological change, which requires ongoing development
and maintenance of products. It is customary for modifications to be made to
products as experience with its use grows or changes in manufacturer's hardware
and software so require.
NetWolves' engineering and development group is comprised of a core team of
engineers who specialize in different areas of product development. NetWolves
engineering team has experience in a variety of industries, including
information security, designing networking protocols, building interfaces,
designing databases, and computer telephony. Their expertise is used in the
design of the FoxBox and seeking improved methods for the FoxBox to meet
customer needs. We have engineering staff in two sites. Our main development
activities are based in Tampa, Florida, and are responsible for hardware design
and development, key architecture and software development, documentation and
quality assurance. We have an additional engineering and development facility in
Melville, New York, with responsibilities encompassing software research and
development as well as a new product development. As of September 30, 2000, the
Company's engineering and development group consists of 30 employees. The
Company seeks to recruit highly qualified employees and its ability to attract
and retain such employees will be a principal factor in its success in achieving
and maintaining a leading technological position.
Engineering and development expenses were approximately $1,334,000,
exclusive of capitalized software development costs of approximately $170,000,
for the year ended June 30, 2000. The Company intends to increase its investment
in product development and believes that its future product offerings will
depend, in part, on its ability to develop, manufacture and market new products
and enhancements to existing products on a cost-effective and timely basis.
Manufacturing and Testing
The manufacturer currently used by the Company in the production of
FoxBoxes is Haller Industries, Inc. ("Haller"), a hardware assembly and
engineering firm located in Tampa, Florida. In July of 2000, Netwolves
negotiated the foundations for the development of a strategic alliance with
Haller. The formation of this alliance is based primarily on Haller providing
quality products and services to Netwolves based on a predetermined production
schedule providing rapid response to special modifications of our core product
as required by our customers and the normal evolutionary software enhancements
created by Netwolves.
While the Company has no long-term agreement with Haller, it believes that
alternative manufacturers are available in the event the Company seeks to change
or expand upon manufacturers of its products.
Production Process
The process used to produce NetWolves products begins with hardware
configuration, installing the appropriate version of FoxBox software,
configuring client-specific software components, followed by a 24-hour "burn-in"
process. Raw/prefabricated materials, components, and subassemblies required for
production include mother boards, CPU's, cases, Ethernet cards, network
communication cards, hard drives, memory, CPU fans and power supplies. The
Company believes that these materials are available from several companies and
that alternative sources of supply are currently available.
Testing
A majority of testing is performed as part of the manufacturing process. In
addition, NetWolves performs quality testing via the Internet on a periodic
basis to verify that the assembled products meet all production quality
criteria. Also, randomly chosen FoxBox units are shipped from the production
assembly facility back to NetWolves for additional testing.
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In addition to testing the product on a regular basis, NetWolves researches
the status of existing components used in the FoxBox to determine if they are
being phased out or prices have changed. If it concludes that a certain
component must be substituted, trial testing is performed on a new component to
determine if it meets product component criteria. If it meets this criterion,
which includes cost effectiveness, longer life expectancy and product
efficiency, a plan to develop and use the component is implemented.
Customer Service and Technical Support
The Company maintains an experienced staff of customer service personnel to
provide technical support to its customers. Each member of the customer service
staff is certified through an ongoing in-house training and testing program to
provide support for each individual product. The Company's customer service
staff provides product support via telephone and e-mail 24 hours per day, seven
days per week. The Company generally provides software and documentation
updates, including maintenance releases, operating system upgrades and major
functional upgrades, as part of its customer support services.
Sales and Marketing
The Company's marketing and sales strategy plan is for it to enter into
multi-national reseller agreements with value added resellers (ISP's, CLEC's,
ILEC's, systems integrators, interconnects) of internet access devices,
including: firewalls, caching servers, hosting servers, email servers, web
access filtering systems, and file servers with the intent of capturing end user
sales of its FoxBox security and internet access functionality systems. The
Company has also embarked on direct end user sales efforts to the Fortune 1000
and has placed 15 sales representatives and two regional sales managers in major
market areas across the United States while currently negotiating international
distribution with a number of Western European and Latin American companies. The
Company is also seeking to enter into agreements and partnerships with providers
of services, and software and hardware products in a variety of markets that
enhance the functionality of its core FoxBox product line. These markets include
education, financial, medical, legal, travel, hospitality, petroleum and the
auto industries. The Company intends to recruit sales representatives and sales
engineering consultants in two regional areas, Eastern and Western United
States, managed by regional managers in Atlanta and Denver. Regional managers
have recently been put in place and fifteen (15) sales representatives have been
recruited in the Atlanta, Chicago, Los Angeles, New York, San Antonio, Tampa,
and Washington D. C. areas. Sales engineers are being recruited with two
currently in place at this time. They will perform important functions including
systems analysis and customizing solutions for various end user and value added
reseller prospects.
The Company has implemented marketing initiatives to support the sales,
technical support, and distribution of its products and services, and to
communicate and promote corporate initiatives and direction. The Company's sales
and marketing management employees are responsible for collateral development,
lead generation, customer and technical support, systems analysis, and market
awareness of the Company and its products. Marketing programs include public
relations, seminars, industry conferences and trade shows, coop advertising,
telemarketing and direct mail. The Company's marketing employees also contribute
to both the product development direction and strategic planning processes by
providing product/market research and conducting surveys and focus groups.
Licensing and Intellectual Property
The Company considers certain features of its products, including its
methodology and technology to be proprietary. The Company relies on a
combination of trade secret, copyright and trademark laws, contractual
provisions and certain technology and security measures to protect its
proprietary intellectual property. We generally enter into confidentiality
agreements with our employees, consultants, business partners and major
customers. NetWolves owns numerous copyrighted works of authorship in computer
programs, including but not limited to portions of the FoxOS (operating system),
ESCN (distance learning), products related to FoxOS and ESCN, and various
proprietary enhancements to publicly available open source system software; as
well as traditional media, including, but not limited to, marketing materials,
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documentation and white papers. Applications for registration of those
copyrights have been filed with respect to some of these works, and further
applications are expected to be filed in the near future.
On June 21, 2000, the Company filed a patent application with the U.S.
Patent and Trademark Office for technology that provides secure, centralized
remote management and monitoring of networks using the Internet. This "Mother
System" has enabled the Company to expand application of its FoxBox to Fortune
500 organizations with multiple worldwide locations such as General Electric.
Notwithstanding the efforts the Company takes to protect its proprietary
rights, existing trade secret, copyright, and trademark laws afford only limited
protection. Despite our efforts to protect our proprietary rights and other
intellectual property, unauthorized parties may attempt to copy aspects of our
products, obtain and use information that we regard as proprietary or
misappropriate our copyrights, trademarks, trade dress and similar proprietary
rights. In addition, the laws of some foreign countries do not protect
proprietary rights to as great an extent as do the laws of the United States.
Our means of protecting our proprietary rights may not be adequate. In addition,
our competitors might independently develop similar technology or duplicate our
products or circumvent any patents or our other intellectual property rights.
The Company does not intend to sell or transfer title of its products to
its clients, though this structure may change as the Company expands its
operations. The Company intends to license products pursuant to licensing and
maintenance agreements for which extended payment terms may be offered. In the
case of extended payment term agreements, the customer is contractually bound to
equal monthly fixed payments. In the case of extended payment term agreements,
maintenance may be bundled for the length of the payment term. Thereafter, in
both instances, the customer may purchase maintenance annually.
Competition
Current and potential competitors in our markets include, but are not
limited to, the following, all of whom sell world-wide or have a presence in
most of the major markets for such products: security appliance suppliers such
as Cobalt Networks, Inc. (to be acquired by Sun Microsystems, Inc.), Watchguard
Technologies, Inc., SonicWALL, Inc., enterprise firewall software vendors such
as Check Point Software and Axent Technologies; network equipment manufacturers
such as Cisco Systems, Lucent Technologies, Nortel Networks, 3COM and Nokia;
computer or network component manufacturers such as Intel Corporation; operating
system software vendors such as Microsoft Corporation, Novell, Inc. and Sun
Microsystems, Inc. The Company expects competition to intensify as more
companies enter the market and compete for market share. In addition, companies
currently in the server market may continue to change product offerings in order
to capture further market share. Many of these companies have substantially
greater financial and marketing resources, research and development staffs,
manufacturing and distribution facilities. There can be no assurance that the
Company's current and potential competitors will not develop products that may
or may not be perceived to be more effective or responsive to technological
change than that of the Company, or that current or future products will not be
rendered obsolete by such developments. Furthermore, increased competition could
result in price reductions, reduced margins or loss of market share, any of
which could have a material adverse effect on the Company's business operating
results and financial condition.
The Company believes that an important competitive factor in its market is
the cost effective integration of many services in a single unit. In this
regard, the Company believes that it compares favorably to its competitors in
the markets it serves in price and overall cost of ownership including
administrative and maintenance costs. However, equally important are other
factors, including but not limited to, product quality and scope of performance,
product reliability, availability, upgradability, and technical service and
support. The Company's ability to compete will depend upon, among other factors,
its ability to anticipate industry trends, invest in product research and
development, and effectively manage the introduction of new or upgraded products
into targeted markets.
9
<PAGE>
Employees
As of September 30, 2000, the Company employed approximately 100 full-time
employees (12 of which are covered by employment agreements). Approximately 30
of these employees are involved in research and development, 39 in sales and
marketing, and 31 in finance and general administration. In addition, the
Company has retained independent contractors on a consulting basis who support
engineering and marketing functions. To date, the Company believes it has been
successful in attracting and retaining skilled and motivated individuals.
Competition for qualified management and technical employees is intense in the
computer industry. The Company's success will depend in large part upon its
continued ability to attract and retain qualified employees. The Company has
never experienced a work stoppage and its employees are not covered by a
collective bargaining agreement. The Company believes that it has good relations
with its employees.
ITEM 2. PROPERTIES
The Company currently maintains leased facilities in the locations listed
below.
<TABLE>
<CAPTION>
CURRENT
ANNUAL
SQUARE TERM OF LEASE
FUNCTION LOCATION FEET LEASE COSTS
-------- -------- ------ ------- -------
<S> <C> <C> <C> <C>
NetWolves 200 Broadhollow Road 600 11/30/00 $ 18,000
Corporation - Melville, NY 11747
Corporate
Headquarters
NetWolves 2502 Rocky Point Drive 6,341 06/30/02 $ 163,000
Technologies Tampa, FL 33607
Corporation
Corporate
Headquarters
NetWolves 6011 Benjamin Road 4,062 08/31/01 $ 18,000
Technologies Tampa, FL 33634
Corporation
Research Facility
ComputerCOP Corp. One Corporate Drive 4,318 06/30/05 $ 90,000
Corporate Bohemia, NY 11716
Headquarters
TSG Global 320 Soundview Road 1,800 12/31/04 $ 79,000
Education Web, Inc. Guilford, CT 06437
Corporate
Headquarters
</TABLE>
In September 2000, the Company entered into a five year lease agreement in
Tampa, Florida covering approximately 20,000 sq. ft. of space at approximately
$390,000 annually to which it intends to relocate its corporate headquarters and
research and development facilities in Tampa in or about November 2000. The
Company believes that combining its Tampa operations into one facility will
increase efficiency of operations. The Company intends to sublease its other
facilities in Tampa, Florida.
10
<PAGE>
The Company believes that its present facilities and its new facility in
Tampa are adequate to meet its current business requirements and that suitable
facilities for expansion will be available, if necessary, to accommodate further
physical expansion of corporate operations and for additional sales and support
offices.
ITEM 3. LEGAL PROCEEDINGS
On April 19, 2000, an action was commenced against the Company in the U.S.
District Court for the Northern District of Illinois by Anicom, Inc. The action
is based upon NetWolves' alleged failure to deliver approximately 74,842 shares
of its common stock to Anicom, Inc. ("Anicom"), upon exercise by Anicom of the
Company's warrants. The action seeks specific performance as well as any damages
that may result from a diminution in value of NetWolves common stock. Anicom has
moved for summary judgment in this action which has been opposed by the Company.
The parties are awaiting judicial decision. The Company intends to vigorously
defend itself against this action and believes it will be meritorous.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year.
11
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
(a) On April 20, 2000, NetWolves' common stock commenced trading on the
NASDAQ SmalllCap market under the trading symbol "WOLV". From December 1998 to
April 20, 2000, NetWolves' common stock was traded on the OTC Bulletin Board
under the same symbol. Prior to the December 1998 name and symbol change, the
Company's stock traded under the symbol "WDGT", Watchdog Patrols, Inc. The
following table sets forth the high and low closing prices for the common stock
for the calendar quarters indicated:
<TABLE>
<CAPTION>
High Low
---- ---
<S> <C> <C>
2000
Third Quarter (through September 29) $ 11.00 $ 4.625
Second Quarter (April 20 through June 30) 15.875 7.50
Second Quarter (April 3 through April 19) 16.75 10.00
First Quarter 23.125 17.00
1999
Fourth Quarter $ 25.25 $ 18.50
Third Quarter 31.50 16.50
Second Quarter 22.75 9.75
First Quarter 17.00 5.00
1998
Fourth Quarter $ 5.125 $ 3.00
Third Quarter 8.00 4.50
</TABLE>
As of September 29, 2000, there were approximately 206 holders of record of
the common stock. On September 29, 2000, the closing sales price of NetWolves
common stock was $8.00 per share.
NetWolves has not paid any cash dividends on its Common Stock and does not
presently intend to do so. Future dividend policy will be determined by its
Board of Directors on the basis of NetWolves' earnings, capital requirements,
financial condition and other factors deemed relevant.
The transfer agent and registrar of NetWolves' Common Stock is American
Stock Transfer and Trust Co., 40 Wall Street, New York, New York 10005.
12
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
The following consolidated financial data set forth below should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and our consolidated financial statements and notes
thereto. The selected consolidated statement of operations data for the years
ended June 30, 2000 and 1999 and for the period from February 13, 1998
(inception) to June 30, 1998 and the selected consolidated balance sheet data as
of June 30, 2000 and 1999 are derived from, and are qualified by reference to,
the audited consolidated financial statements included elsewhere in this annual
report on Form 10-K. The selected consolidated balance sheet data as of June 30,
1998 is derived from our audited consolidated financial statements that are not
included in this annual report on Form 10-K. The historical results presented
below are not necessarily indicative of future results.
<TABLE>
<CAPTION>
Period from
February 13, 1998
Year ended June 30, (inception) to
2000 1999 June 30, 1998
---- ---- ------------------
<S> <C> <C> <C>
Consolidated Statements of Operations Data:
Net sales $ 1,423,690 $ 1,789,144 $ 29,621
Cost of sales 959,039 582,724 5,681
------------ ----------- ----------
Gross profit 464,651 1,206,420 23,940
Operating expenses 25,446,357 8,666,381 149,510
------------ ----------- ----------
Loss before other income (expense) and
benefit from income taxes (24,981,706) (7,459,961) (125,570)
Investment income (expense), net 611,746 58,884 6,501
Other income (expense) 68,012 478,063 (345)
------------ ----------- ----------
Loss before income taxes (24,301,948) (6,923,014) (119,414)
(Provision for) benefit from income taxes (25,000) - 20,000
------------ ----------- ----------
Net loss $(24,326,948) $(6,923,014) $ (99,414)
============ =========== ==========
Basic and diluted net loss per share $ (3.46) $ (1.48) $ (0.04)
============ =========== ==========
Weighted average common shares
outstanding 7,034,994 4,691,651 2,810,102
============ =========== ==========
</TABLE>
<TABLE>
<CAPTION>
June 30,
------------------------------------
2000 1999 1998
---- ---- ----
<S> <C> <C> <C>
Consolidated Balance Sheet Data:
Cash and cash equivalents $ 20,204,309 $ 5,585,981 $1,118,416
Marketable securities, available for sale 99,500 606,000 1,063,828
Working capital 19,459,099 5,799,246 2,918,327
Total assets 25,543,130 12,811,934 2,959,451
Long-term debt, net of current maturities 418,102 266,537 -
Minority interest 305,761 704,500 -
Total shareholders' equity 22,807,629 11,099,802 2,928,003
</TABLE>
13
<PAGE>
Fourth Quarter Adjustment/Correction
The Company had estimated without independent appraisal a total purchase
price excluding cash payments of approximately $32,690,000 on the acquisition of
ComputerCOP Corporation in its filing of Form 10-Q for the period ended March
31, 2000. Based on a recent appraisal, the total consideration paid for such
acquisition has been determined to be $26,776,460. The effects of this change
include a reduction in stockholders equity of approximately $5,910,000
corresponding reduction in the value of the software and inventory acquired in
the same amount. Further, the amortization of the software acquired for the year
ended June 30, 2000, reflects the basis using the appraised value.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Forward-looking statements
Certain statements in this "Management's Discussion and Analysis of
Financial Condition and Results of Operations" are forward looking statements.
These statements relate to future events or our future financial performance and
involve known and unknown risks, uncertainties and other factors that may cause
our or our industry's actual results, levels of activity, performance or
achievements to be materially different from any future results, levels of
activity, performance or achievements expressed or implied by the
forward-looking statements. These risks and other factors include those listed
under "Risk Factors That May Affect Future Operating Results" and elsewhere in
this annual report on Form 10-K. In some cases, you can identify forward-looking
statements by terminology such as "may", "will", "should", "expects", "plans",
"anticipates", "believes", "estimates", "predicts", "potential", "continue" or
the negative of these terms or other comparable terminology. These statements
are only predictions. Actual events or results may differ materially. In
evaluating these statements, you should specifically consider various factors,
including the risks outlined under "Risk Factors That May Affect Future
Operating Results". These factors may cause our actual results to differ
materially from any forward-looking statement.
Overview
The Company is a corporation with a limited operating history, formed in
February 1998, when it commenced field trial and limited sales of its primary
product, "The FoxBox". Additionally, efforts were made to obtain operating
capital and convert the Company to a public entity. This was successfully
accomplished through a reverse merger with Watchdog Patrols, Inc., a publicly
traded (OTCBB), non-reporting corporation. Operating expenses have increased
significantly since the Company's inception. This reflects the cost associated
with the formation of the Company as well as increased efforts to promote market
awareness for the FoxBox (Multi-services Internet communications gateway),
solicit new customers, recruit personnel, build operating infrastructure and
continued product development. The FoxBox is a multi-functional product that
connects business networks [Local Area Networks (LANs) and Wide Area Networks
(WANs)] to the Internet. It supports secure access to the Internet for users
through a single connection, provides advanced electronic mail functions for
unlimited users and delivers firewall security. The Company's initial target
markets are the end users in small and mid-size businesses and large
organizations with satellite offices. Since inception the Company has entered
into certain significant agreements/acquisitions as detailed below.
In January 1999, the Company entered into an agreement with Sales &
Management Consulting, Inc. (d/b/a The Sullivan Group), a leading consulting
organization serving the needs of the automobile aftermarket, convenience stores
and oil industry. It maintains an extensive library of training modules
available to its client base of Amoco Oil, British Petroleum, ExxonMobil, Tosco
and Unocal. Pursuant to its agreement, The Sullivan Group appointed NetWolves as
its exclusive provider in the United States of a delivery system whereby The
Sullivan Group intends to sell its proprietary training programs to retail
locations throughout the United States. NetWolves is customizing an Internet
solution specifically to deliver distance learning to these locations utilizing
its FoxBox technology. In July 1999, the Company acquired The Sullivan Group and
the five principal officers and employees of The Sullivan Group were retained
under long-term employment contracts.
14
<PAGE>
In February 2000, and in exchange for 1,775,000 restricted shares of the
Company's common stock, NetWolves acquired ComputerCOP Corp., whose assets
included ComputerCOP technology, inventory and $20.5 million in cash intended to
fund future growth. The shares issued by the Company in connection acquisition
are subject to a Voting Trust Agreement, wherein the Company's chief executive
officer has been granted the right to vote all Trust Shares for two years,
subject to earlier termination on the sale of the shares based on certain
parameters.
On June 29, 2000, NetWolves and General Electric Company ("GE") entered
into a six year agreement for the master purchase, license and support services
of NetWolves' security, remote monitoring and configuration management system.
GE, after extensive due diligence in looking for the all-in-one small office
solution for network management, interconnectivity and security management,
chose the FoxBox for deployment throughout their enterprise. In addition to
selling the FoxBox to GE, NetWolves will receive (a) a one-time installation fee
for each FoxBox unit installed and (b) a monthly service and maintenance fee for
which GE pays NetWolves upon installation for the first twelve months. GE will
be using the FoxBox for interconnectivity of worldwide offices. The FoxBox will
enable GE's offices to interact with each other, utilizing NetWolves advanced
firewall security. NetWolves believes that this agreement further validates the
Company's technology and innovations within the firewall and network security
markets. Network security is one of the most formidable challenges facing
Fortune 500 companies, and with its new "Mother System," NetWolves can offer the
appropriate solutions.
In connection with the Company entering into the agreement, the Company
issued GE a warrant to purchase 500,000 shares of common stock that may be
exercised ratably upon the Company receiving orders (as defined in the
agreement) of an amount equal to or in excess of, in the aggregate, $2,000,000,
$3,000,000, $4,000,000 and $5,000,000.
The Company issued 200,000 shares of common stock to GE in June 2000.
Results of Operations
Years ended June 30, 2000 ("Fiscal 2000") and 1999 ("Fiscal 1999")
Revenue
Revenue decreased to $1,423,690 in Fiscal 2000 from $1,789,144 in Fiscal 1999.
The 20% decrease in revenue was primarily the result of a decrease in sales of
the Company's FoxBox product partially offset by an increase in management and
consulting revenue. The decrease in sales of the Company's FoxBox product is
primarily the result of a one-time stocking order for 500 FoxBox units sold to
Anicom, Inc. in March/April 1999. While the Company did sell units to various
customers during Fiscal 2000, the levels of such sales were significantly below
the 500 units sold to Anicom, Inc. in the previous period. The Company's selling
efforts during the period were primarily designed to enhance future growth. The
increase in consulting revenue is primarily attributable to the Company entering
into an agreement to provide management and consulting services to certain
franchisees of BP Amoco commencing in December 1999. While the Company expects
to generate revenue from its management and consulting services in the future,
it expects to significantly increase its revenue derived from the sale of its
core product, the FoxBox. Through June 30, 2000 the Company has not generated
any revenue from the its ComputerCOP technology and any future revenue will be
dependent upon the signing of agreements similar to the Gateway agreement.
Cost of revenue and gross profit
Cost of revenue for sale of the Company's FoxBox include manufacturing
costs, which we have outsourced, packaging and shipping costs and warranty
expenses. Cost of revenue in connection with management and consulting services
include direct expenses of employees and consultants utilized in the generation
of management and consulting revenue. Cost of revenue increased to $959,039 in
Fiscal 2000 from $582,724 in Fiscal 1999.
15
<PAGE>
Overall gross profit decreased to 33% in Fiscal 2000 from 67% in Fiscal
1999. This was primarily attributable to revenue from management and consulting
services, which have significantly reduced margins. The gross profit on the sale
of the Company's FoxBox decreased to 57% in Fiscal 2000 from 67% in Fiscal 1999.
This is primarily the result of competitive pricing pressure on the Company's
core product line. The Company believes that greater gross profits are
achievable at increased production levels. These results will depend, in part,
on the effects of economies-of-scale, the use of third-party assemblers and the
ability to competitively purchase rapidly evolving commodity hardware, which is
a significant component of cost of revenue. The use of non-proprietary hardware
is one of many inherent design features of the FoxBox which facilitates an
efficient and cost effective production cycle. There can be no assurance that
the Company will be successful in increasing its margins due to one or more
factors. These factors include, but are not limited to increases/decreases in
direct labor and material cost, as well as increased competition and general
economic conditions in the future. Engineering and development
Engineering and development expenses, which are expensed as incurred,
consist primarily of salaries and related expenses for personnel utilized in
designing, maintaining and enhancing our products as well as material costs for
test units and prototypes. Costs associated with the development of software
products are generally capitalized once technological feasibility is reached.
Engineering and development expenses increased to $1,334,341 in Fiscal 2000 from
$418,109 in Fiscal 1999. In addition, the company capitalized approximately
$170,000 in software development costs during Fiscal 2000. The increase in
engineering and development costs was primarily the result of the employment of
additional engineering and development personnel. We expect to incur significant
engineering and development costs in the future as we continue to maintain our
existing product line as well as develop new products and features, as evidenced
by the development of Mother.
Sales and marketing
Sales and marketing expenses consist primarily of salaries, commissions and
related expenses for personnel engaged in marketing, sales and customer support
functions, as well as costs associated with trade shows, promotional activities,
advertising and public relations. Sales and marketing expenses increased to
$4,916,718 in Fiscal 2000 from $2,194,518 in Fiscal 1999. The increase in sales
and marketing expenses was primarily the result of the employment of additional
sales personnel and an increase in marketing efforts to effectuate brand
awareness designed for future growth. Included in sales and marketing expenses
for Fiscal 2000 and Fiscal 1999 are $2,539,362 and $1,467,750, respectively, of
non-cash compensation for services in the form of the Company's common stock,
options and warrants. The Company intends to continue to aggressively promote
its current and future products and, therefore, expects sales and marketing
costs to increase in absolute dollars in the future.
General and administrative
General and administrative expenses consist primarily of salaries and
related expenses for executive, finance, facilities and human resources
personnel, recruiting expenses and professional fees. General and administrative
expenses increased to $15,179,218 in Fiscal 2000 from $6,053,754 in Fiscal 1999.
The increase was primarily due to a full year of operations of the Company's
training and consulting segment as well as the employment of additional
administrative personnel, payment of professional fees for services rendered and
equity compensation given to various financial consultants. Included in general
and administrative expenses for Fiscal 2000 and Fiscal 1999 are $6,152,718 and
$3,695,000, respectively, of non-cash compensation for services in the form of
the Company's common stock, options and warrants. We expect general and
administrative costs to increase in absolute dollars in the future.
Impairment charges
On June 30, 2000, the Company recorded a writedown of its training content
and goodwill (training and consulting segment) relating to the acquisition of
SMCI in the amount of $4,016,080. This writedown eliminates all remaining
intangible assets relating to the acquisition. The intangible assets were
determined to be impaired because of the current financial condition of TSG and
TSG's inability to generate future operating income without substantial sales
volume increases which are uncertain. Moreover, anticipated future cash flows of
TSG indicate that the recoverability of the asset is not reasonably assured.
16
<PAGE>
Other income (expenses)
Other income (expenses) consists primarily of portfolio income and
increased to $679,758 in Fiscal 2000 from $536,947 in Fiscal 1999. The increase
was primarily due to an increase in interest income in Fiscal 2000 due to the
increase average cash balance from the ComputerCOP Corp. acquisition compared
with a realized gain on the sale of marketable securities in Fiscal 1999.
For the year ended June 30, 1999 ("Fiscal 1999") compared to the period
from February 13, 1998 (inception) through June 30, 1998 ("Fiscal 1998")
Revenue
Revenue increased to $1,789,144 in Fiscal 1999 from $29,621 in Fiscal 1998.
The increase in revenues was almost entirely related to a one time stocking
order of 500 FoxBox units sold to Anicom in March/April 1999.
Cost of revenue and gross profit
Cost of revenue increased to $582,724 in Fiscal 1999 from $5,681 in Fiscal
1998 and gross profit decreased to 67% in Fiscal 1999 from 82% in Fiscal 1998.
Engineering and development
Engineering and development expenses increased to $418,109 in Fiscal 1999
compared to none in Fiscal 1998. The increase was primarily the result of the
employment of engineering and development personnel in the Company's first full
year of operation.
Sales and marketing
Sales and marketing expenses increased to $2,194,518 in Fiscal 1999 from
$44,463 in Fiscal 1998. The increase in sales and marketing expenses was
primarily the result of the employment of additional sales personnel, equity
compensation given to various sales and marketing individuals and an increase
marketing efforts to effectuate brand awareness. Included in sales and marketing
expenses for Fiscal 1999 is $1,467,750 in non-cash compensation for services in
the form of the Company's common stock, options and warrants.
General and administrative
General and administrative expenses increased to $6,053,754 in Fiscal 1999
from $105,047 in Fiscal 1998. The increase was primarily due to the employment
of additional administrative personnel, equity compensation given to various
individuals and payment of professional fees for services rendered. Included in
general and administrative expenses for Fiscal 1999 is $3,695,000 in non-cash
compensation for services in the form of the Company's common stock, options and
warrants.
Other income (expenses)
Other income (expenses) consist increased to $536,947 in Fiscal 1999 from
$6,156 in Fiscal 1998. The increase was primarily due to a realized gain on the
sale of marketable securities.
17
<PAGE>
Liquidity and Capital Resources
On June 17, 1998 the Company executed a reverse merger with Watchdog
Patrols, Inc. a publicly traded non-reporting company engaged in the activity of
providing armed and unarmed security guard services for the New
York/Metropolitan Area. This merger made available to the Company, approximately
$2.3 million of cash, cash equivalents and marketable securities to be used as
operating capital. On November 22, 1998 the Company sold substantially all the
assets of the security guard business, consisting primarily of uniforms,
vehicles, computer systems and furniture to a third party. This generated an
additional $600,000 of cash flow to the Company. On June 29, 1999 NetWolves
concluded a private offering of 800,000 shares of common stock that generated
$5.4 million (net of $.6 million of expenses).
From September 29, 1999 through November 4, 1999, an aggregate of 287,500
shares of the Company's common stock were issued to 17 accredited investors at a
price of $15 per share for an aggregate sum of approximately $4.2 million. In
February 2000, NetWolves acquired ComputerCOP Corp., whose assets included
ComputerCOP technology, inventory and $20.5 million in cash.
NetWolves had cash and cash equivalents of $ 20.3 million and $5.6 million
at June 30, 2000 and June 30, 1999, respectively. Management believes that the
Company has adequate capital resources to meet its working capital needs for at
least the next twelve months based upon its current operating level. To the
extent necessary, the Company intends to raise additional monies from the sale
of its capital stock to fund its growth over the next 24 to 36 months, however,
there can be no assurance that the Company will have sufficient capital to
finance its planned growth.
Currently the Company's source of liquidity is equity financing which is
used to fund losses from operation activities.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Management does not believe that there is any material market risk exposure
with respect to derivative or other financial instruments that would require
disclosure under this item.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements of the Company and its subsidiaries are included
herein:
-- Reports of Independent Public Accountants
-- Consolidated Balance Sheets at June 30, 2000 and 1999
-- Consolidated Statements of Operations, Cash Flows and Shareholders'
Equity for the years ended June 30, 2000 and 1999 and the period from
February 13, 1998 (inception) to June 30, 1998
-- Notes to Consolidated Financial Statements
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
None
18
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The directors and executive officers of the Company and their ages are as
follows:
<TABLE>
<CAPTION>
Name Age Position
---- --- --------
<S> <C> <C>
Walter M. Groteke 30 Chairman of the Board, President and
Chief Executive Officer
Walter R. Groteke 53 Vice President - Sales and Marketing
and Director
Peter Castle 32 Treasurer, Secretary, Vice President-Finance
Ed Lavin 56 Director
James A. Cannavino 55 Director
</TABLE>
Principal Occupations of Officers and Directors
Walter M. Groteke, a co-founder of the Company, has been Chairman of the
Board, Chief Executive Officer and a director of the Company since June 1998.
Mr. Groteke is responsible for planning, developing and establishing policies
and business objectives for the Company. From June 1995 until 1997, Mr. Groteke
was regional business development manager for Techmatics, Inc., an information
systems Department of Defense contractor. From May 1993 to June 1995, Mr.
Groteke was senior account manager for NYNEX's strategic account management
program.
Walter R. Groteke has been a director of the Company since February 1999
and Vice President - Sales and Marketing since August 1998. From 1995 through
July 1998, Mr. Groteke was a regional and district sales manager for GTE Florida
and GTE Communications Corporation. Mr. Groteke founded Hawk Telecom in 1975 and
was President until its sale in 1994. Mr. Groteke is the father of Walter M.
Groteke.
Peter C. Castle has been Vice President - Finance since January 2000,
Controller from August 1998 until December 1999 and Treasurer and Secretary
since August 1999. From 1996 through July 1998 Mr. Castle was the Southeast
Regional Finance Manager for Magellan Health Service, Inc. a $1.6 billion
managed behavioral care company based in Georgia. Prior to that Mr. Castle was
the Controller for Physician's Care Network of NY, Inc.
James A. Cannavino has been a director of the Company since April, 2000.
Mr. Cannavino is President and Chief Executive Officer of CyberSafe, Inc., a
corporation specializing in network security. Additionally, he is Chairman of
Direct Insite Corp. (f/k/a Computer Concepts Corp.) He was the President and
Chief Executive Officer of Perot Systems Corporation through July 1997, and
prior to that was a Senior Vice President at IBM, responsible for strategy and
development. He also served on the IBM Corporate Executive Committee and
Worldwide Management Council, and on the board of IBM's integrated services and
solutions company. Mr. Cannavino currently serves on the boards of National
Center for Missing and Exploited Children, 7th Level, Inc. and Marist College.
Ed Lavin has been a director of the Company since February 1999. Mr. Lavin
has been Chairman and Chief Executive Officer of Staples Communications, a
subsidiary of Staples Corporation since March, 1999. Mr. Lavin began his career
at ADT from 1967 to 1972. In 1970 he was promoted into ADT's National Accounts
Division. Mr. Lavin then joined the L. M. Ericcson Company of Sweden from 1973
to 1979 where he served as Vice President of Sales in the United States. Mr.
Lavin immigrated to Canada in 1980 to form Canadian Telecommunications Group and
was Chairman and CEO of Canadian Telecommunications Group (CTG) from 1980 to
1986. Mr. Lavin moved to TIE Communications where he served as president from
1987 to 1990. TIE Communications acquired Centel Communications, which was later
merged with WilTel Communications where he served as CEO from 1990 to 1993. In
November 1993, Mr. Lavin founded Quest America, a telecommunications consulting
company based in Boston, Massachusetts. On April 10, 1996, Mr. Lavin led a group
that acquired Executone Information Systems' Network Division. The purchaser was
a group financed by Bain Capital, Inc. of Boston, Massachusetts. The company
name was later changed to Claricom, Inc. In March 1999, Claricom successfully
merged its business with Staples Corporation.
19
<PAGE>
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth the annual and long-term compensation with
regard to the Chairman/Chief Executive Officer and each of the other executive
officers of the Company who received more than $100,000 for services rendered
during the fiscal year ended June 30, 2000.
<TABLE>
<CAPTION>
Summary Compensation Table
Annual Compensation
------------------------------------------------------------------
Name and Other annual
Principal Position Fiscal Year Salary (1) Bonus compensation (2)
------------------ ----------- ---------- ----- ----------------
<S> <C> <C> <C> <C>
Walter M. Groteke 2000 $ 130,000 $ - $ -
Chairman and Chief Executive Officer 1999 101,250 - -
1998 - - -
Daniel G. Stephens 2000 130,000 - -
Vice Chairman and Chief Information 1999 101,250 - -
Officer 1998 - - -
Walter R. Groteke 2000 154,740 - -
Vice President 1999 - - -
1998 - - -
<FN>
(1) Represents compensation received under employment agreements. Mr. Stephens
resigned as an officer and director of the Company in July 2000.
(2) Other annual compensation excludes certain perquisites and other non-cash
benefits provided by the Company since such amounts do not exceed the
lesser of $50,000 or 10% of the total annual base salary disclosed in the
table for the respective officer.
</FN>
</TABLE>
Aggregate Option Exercises in Last Fiscal Year and Fiscal Year-End Option Values
The following table sets forth information concerning options exercised
during the year ended June 30, 2000 by the named executive officers and the
value of unexercised options held by them as of June 30, 2000.
<TABLE>
<CAPTION>
Number of Securities Value of Unexercised
Underlying Unexercised In-The-Money
Shares Options at Fiscal Options at Fiscal
Acquired on Value Year End (#) Year End ($)
Name Exercise (#) Realized ($) Exercisable Unexercisable Exercisable Unexercisable
---- ------------ ----------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Walter M. Groteke........ 0 0 0 200,000 0 $724,000
Daniel G. Stephens....... 0 0 0 200,000 0 $724,000
Walter R. Groteke........ 0 0 0 200,000 0 $724,000
Peter C. Castle.......... 0 0 0 40,000 0 $ 10,000
<FN>
-------
(1) Based upon the closing price of common stock of $5.25 on June 30, 2000.
</FN>
</TABLE>
Employment Agreements
Walter M. Groteke and Daniel G. Stephens entered into employment agreements
in June 1998 in connection with the acquisition of Watchdog Patrols, Inc.
("Watchdog Patrols"). Pursuant to these agreements, Messrs. Groteke and Stephens
were employed as Chief Executive Officer and Information Officer, respectively,
for a term of three years. Mr. Stephens resigned as an officer and director of
the Company effective July 15, 2000 and receives no salary from the Company. The
current base salary for Mr. Groteke is $150,000.
The employment agreement with Mr. Groteke further provides for certain
payments following death or disability for certain fringe benefits such as
reimbursement for reasonable expenses and participation in medical plans, and
for accelerated payments in the event of change of control of the Company.
Walter M. Groteke, Daniel G. Stephens and Walter R. Groteke also entered
into warrant agreements with the Company in 1998 whereby they are entitled to
receive warrants to purchase 200,000, 200,000 and 150,000 shares, respectively,
of the Company's common stock at $1.63 per share under certain terms and
conditions. The warrants fully vested at June 30, 2000.
20
<PAGE>
Stock Option Plans
In June 1998, the Company adopted a 1998 Long Term Incentive Plan (the
"1998 Incentive Plan") in order to motivate qualified employees of the Company,
to assist the Company in attracting employees and to align the interests of such
persons with those of the Company's shareholders.
The 1998 Incentive Plan provides for a grant of "incentive stock options,"
"non-qualified stock options," restricted stock, performance grants and other
types of awards to officers, key employees, consultants and independent
contractors of the Company and its affiliates.
The 1998 Incentive Plan, which will be administered by the Board of
Directors, authorizes the issuance of a maximum of 282,500 shares of common
stock, which may be either newly issued shares, treasury shares, reacquired
shares, shares purchased in the open market or any combination thereof. If any
award under the 1998 Incentive Plan terminates, expires unexercised, or is
cancelled, the shares of common stock that would otherwise have been issuable
pursuant thereto will be available for issuance pursuant to the grant of new
awards. As of June 30, 2000, the Company had granted options to purchase 265,833
shares of common stock (net of cancellations) under the 1998 Incentive Plan to
its officers and key employees.
In July 2000, the Company adopted a 2000 Long Term Incentive Plan (the
"2000 Incentive Plan") in order to motivate qualified employees of the Company,
to assist the Company in attracting employees and to align the interests of such
persons with those of the Company's shareholders.
The 2000 Incentive Plan provides for a grant of "incentive stock options,"
"non-qualified stock options," restricted stock, performance grants and other
types of awards to officers, key employees, consultants and independent
contractors of the Company and its affiliates.
The 2000 Incentive Plan, which is administered by the Board of Directors,
authorizes the issuance of a maximum of 1,500,000 shares of common stock, which
may be either newly issued shares, treasury shares, reacquired shares, shares
purchased in the open market or any combination thereof. As with the 1998
Incentive Plan, if any award under the 2000 Incentive Plan terminates, expires
unexercised, or is cancelled, the shares of common stock that would otherwise
have been issuable pursuant thereto will be available for issuance pursuant to
the grant of new awards. As of June 30, 2000, the Company had granted options to
purchase 217,500 shares of common stock under the 2000 Incentive Plan to its
officers and key employees. As of September 30, 2000, approximately 1,015,000
options have been granted under the Plan including 450,000 options to Walter M.
Groteke, 100,000 options to Walter R. Groteke and 75,000 options to Peter C.
Castle.
21
<PAGE>
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth the beneficial ownership of shares of voting
stock of the Company, as of August 31, 2000, of (i) each person known by the
Company to beneficially own 5% or more of the shares of outstanding common
stock, based solely on filings with the Securities and Exchange Commission, (ii)
each of the Company's executive officers and directors and (iii) all of the
Company's executive officers and directors as a group. Except as otherwise
indicated, all shares are beneficially owned, and investment and voting power is
held by, the persons named as owners.
<TABLE>
<CAPTION>
Name and Address Amount and Nature
of Shares Ownership of Beneficial Owner Percentage
------------------- ------------------- ----------
<S> <C> <C>
Computer Concepts Corp. 2,000,000 (1) 22.8%
Greenleaf Capital Partners, LLC 861,360 9.9%
Walter M. Groteke 2,653,064 (2) 30.2%
Daniel G. Stephens 428,064 (3) 4.9%
Walter R. Groteke 175,000 (4) 2.0%
Peter C. Castle 120,833 (5) 1.4%
James A. Cannavino 200,000 (6) 2.2%
Ed Lavin 50,000 *%
Kirlin Securities, Inc. 500,000 (7) 5.4%
Executive officers and
directors as a group 3,447,086 (7) 36.9%
<FN>
* less than one percent (1%) unless otherwise indicated.
(1) The voting rights to these shares are held by Mr. Walter M. Groteke
pursuant to the terms of a voting agreement.
(2) Includes 2,000,000 shares owned by Computer Concepts Corp. covered by a
voting agreement and options to purchase 225,000 shares of common stock at
$5.00 per share. Does not include warrants to purchase 200,000 shares at an
option price of $1.63 per share and options to purchase 225,000 shares of
common stock at $5.00 per share.
(3) Does not includes warrants to purchase 200,000 shares at $1.63 per share
and options to purchase 50,000 shares o f common stock at $5.00 per share.
(4) Includes options to purchase 50,000 shares at $5.00 per share. Does not
include 200,000 warrants at $1.63.
(5) Includes options to purchase 50,833 shares of common stock at $5.00 per
share and options to purchase 65,000 shares of common stock at $12.00 per
share. Does not include options to purchase 64,167 shares of common stock
at $5.00 per share.
(6) Represents a warrant issued to Mr. Cannavino for joining the Board of
Directors to purchase 200,000 shares at an exercise price of $10 per share.
(7) Represents warrants currently exercisable by Kirlin Securities, Inc. and
its affiliates to purchase 500,000 shares of common stock at $1.63 per
share. Kirlin Securities, Inc. has demand registration rights on the shares
of common stock issuable upon exercise of the warrants.
(8) The natural person or persons who exercise sole or shared voting and
dispositive powers over the shares held of record by these entities are as
follows: Greenleaf Capital Partners, LLC - Mr. Phillip LoRusso and Mr.
Edmund McCormick; Kirlin Securities, Inc. - Mr. Anthony Kirincic.
</FN>
</TABLE>
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None
22
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) See Index to Financial Statements at beginning of attached financial
statements.
(b) Reports on Form 8-K
Report on Form 8-K dated July 7, 1999, as amended.
(c) Exhibits
3.1 Certificate of Incorporation, as amended.*
3.2 By-Laws. *
4.1 Specimen common stock certificate.*
4.2 Form of warrant to investment banking firm. *
4.3 Form of warrant to employees.*
10.2 Agreement between The Sullivan Group and NetWolves Corporation dated
January 5, 1999.*
10.3 Employment Agreement between NetWolves Corporation and Walter M.Groteke
dated June 17, 1998.*
10.4 Warrant Agreement between NetWolves Corporation and Walter M. Groteke dated
June 17, 1998.*
10.5 Warrant Agreement between NetWolves Corporation and Daniel G. Stephens, Jr.
dated June 17, 1998.*
10.6 1998 Stock Option Plan*
10.7 2000 Stock Option Plan
10.8 Form of Indemnification Agreement*
10.9 Agreement and Plan of Merger dated as of July 7, 1999 among NetWolves
Corporation, TSG Global Education Web, Inc. and Sales and Management
Consulting, Inc., d/b/a The Sullivan group and Duffy-Vinet Institute. **
10.10Exchange Agreement dated as of February 10, 2000 by and among NetWolves
Corporation, Computer Concepts Corp. and ComputerCOP Corporation with
Exhibits.****
27 Financial Data Schedule
------
* Previously filed as exhibits to Report on Form 10, as amended.
** Previously filed as an exhibit to Report on Form 8-K dated July 7, 1999, as
amended.
*** Previously filed as an exhibit to Report on Form 10/A, Amendment No. 1.
**** Previously filed as an exhibit to Report on Form 8-K dated February 10,
2000.
23
<PAGE>
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Company has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized on the 11th day of October, 2000.
NetWolves Corporation
By: /s/ Walter M. Groteke
Walter M. Groteke
Chairman of the Board, President
and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below on October 11, 2000 by the following persons in the
capacities indicated:
/s/ Walter M. Groteke Chairman of the Board and President
----------------------------
Walter M. Groteke Chief Executive Officer
/s/ Walter R. Groteke Vice President - Sales and Marketing
---------------------------- and Director
Walter R. Groteke
/s/ Peter C. Castle
---------------------------- Secretary and Treasurer
Peter C. Castle Principal Financial Officer and
Principal Accounting Officer
/s/ James A. Cannavino
---------------------------- Director
James A. Cannavino
/s/ Ed Lavin Director
----------------------------
Ed Lavin
24
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED JUNE 30, 2000 AND 1999 AND THE PERIOD
FROM FEBRUARY 13, 1998 (INCEPTION) TO JUNE 30, 1998
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED JUNE 30, 2000 AND 1999 AND THE PERIOD
FROM FEBRUARY 13, 1998 (INCEPTION) TO JUNE 30, 1998
CONTENTS
INDEPENDENT AUDITORS' REPORT .......................................... F-1
INDEPENDENT AUDITORS' REPORT .......................................... F-2
CONSOLIDATED BALANCE SHEETS
June 30, 2000 and 1999 .............................................. F-3
CONSOLIDATED STATEMENTS OF OPERATIONS
Years ended June 30, 2000 and 1999 and the period from
February 13, 1998 (inception) to June 30, 1998 ..................... F-4
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
For the period from February 13, 1998 (inception) to June 30, 1998
and the years ended June 30, 1999 and 2000 ......................... F-5-F-6
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended June 30, 2000 and 1999 and the period from
February 13, 1998 (inception) to June 30, 1998 ..................... F-7 -F-8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ............................ F-9-F-35
<PAGE>
Board of Directors and Shareholders
NetWolves Corporation
Melville, New York
INDEPENDENT AUDITORS' REPORT
We have audited the accompanying consolidated balance sheet of NetWolves
Corporation and subsidiaries (the "Company") as of June 30, 2000 and, and the
related consolidated statements of operations, shareholders' equity and cash
flows for the year ended June 30, 2000. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of NetWolves
Corporation and subsidiaries as of June 30, 2000, and the consolidated results
of their operations and their consolidated cash flows for the year then ended in
conformity with generally accepted accounting principles.
/s/ Richard A. Eisner & Company, LLP
New York, New York
August 24, 2000
With respect to Notes
4, 10, 15 and 16,
October 10, 2000.
F-1
<PAGE>
Board of Directors and Shareholders
NetWolves Corporation
Melville, New York
INDEPENDENT AUDITOR'S REPORT
We have audited the accompanying consolidated balance sheet of NetWolves
Corporation and subsidiaries (the "Company") as of June 30, 1999, and the
related consolidated statements of operations, shareholders' equity and cash
flows for the year ended June 30, 1999 and the period from February 13, 1998
(inception) to June 30, 1998. These financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of NetWolves
Corporation and subsidiaries as of June 30, 1999, and the consolidated results
of its operations and cash flows for the year ended June 30, 1999 and the period
from February 13, 1998 (inception) to June 30, 1998 in conformity with generally
accepted accounting principles.
/s/ Hays & Company
August 12, 1999
New York, New York
F-2
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
<TABLE>
<CAPTION>
June 30,
------------------------
2000 1999
------------ ---------
<S> <C> <C>
ASSETS
Current assets
Cash and cash equivalents $20,204,309 $ 5,585,981
Marketable securities, available for sale 99,500 606,000
Accounts receivable, net of allowance for doubtful accounts of
$44,747 and $40,000 at June 30, 2000 and 1999, respectively 248,861 76,907
Inventories 633,453 118,354
Prepaid expenses and other current assets 284,614 153,099
----------- -----------
Total current assets 21,470,737 6,540,341
Property and equipment, net 590,906 224,691
Software 3,427,688 -
Intangible assets - 6,024,121
Other assets 53,799 22,781
----------- -----------
$25,543,130 $12,811,934
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Accounts payable and accrued expenses $ 1,792,030 $ 453,336
Deferred compensation - 100,000
Loans and advances from TSG officer - 144,348
Deferred revenue 11,173 -
Current maturities of long-term debt 208,435 43,411
----------- -----------
Total current liabilities 2,011,638 741,095
Long-term debt, net of current maturities 418,102 266,537
----------- -----------
Total liabilities 2,429,740 1,007,632
----------- -----------
Minority interest 305,761 704,500
Commitments and contingencies
Shareholders' equity
Common stock, $.0033 par value; 10,000,000 shares
authorized; issued and outstanding; 8,592,613 - June 30,
2000 and 6,063,870 - June 30, 1999 28,356 20,011
Additional paid-in capital 56,076,197 17,726,374
Unamortized value of equity compensation (1,851,893) -
Accumulated deficit (31,349,376) (7,022,428)
Accumulated other comprehensive income (loss) (95,655) 375,845
----------- -----------
Total shareholders' equity 22,807,629 11,099,802
----------- -----------
$25,543,130 $12,811,934
=========== ===========
<FN>
See notes to financial statements.
</FN>
</TABLE>
F-3
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Period from
February 13,
Year ended June 30, 1998
(inception) to
2000 1999 June 30, 1998
------------ ------------ -------------
<S> <C> <C> <C>
Revenue
Product $ 132,825 $ 1,789,144 $ 29,621
Services 1,290,865 - -
------------ ------------ -----------
$ 1,423,690 $ 1,789,144 $ 29,621
============ ============ ============
Cost of revenue
Product 56,739 582,724 5,681
Services 902,300 - -
------------ ------------ -----------
959,039 582,724 5,681
------------ ------------ -----------
Gross profit 464,651 1,206,420 23,940
------------ ------------ -----------
Operating expenses
General and administrative (inclusive of $6.1
million and $3.7 million in non cash, equity
compensation for fiscal 2000 and 1999) 15,179,218 6,053,754 105,047
Engineering and development 1,334,341 418,109 -
Sales and marketing (inclusive of $2.5 million
and $1.5 in non cash, equity compensation
for fiscal 2000 and 1999) 4,916,718 2,194,518 44,463
Impairment charges 4,016,080 - -
------------ ------------ -----------
25,446,357 8,666,381 149,510
------------ ------------ -----------
Loss before other income (expense)
and income taxes (24,981,706) (7,459,961) (125,570)
Other income (expense)
Investment income 611,746 58,884 6,501
(Loss) gain on sale of marketable securities (35,000) 478,518 -
Minority interest 148,739 - -
Interest expense (45,727) (455) (345)
------------ ------------ -----------
Loss before income taxes (24,301,948) (6,923,014) (119,414)
(Provision for) benefit from income taxes (25,000) - 20,000
------------ ------------ -----------
Net loss $(24,326,948) $ (6,923,014) $ (99,414)
============ ============ ===========
Basic and diluted net loss per share $ (3.46) $ (1.48) $ (0.04)
============ ============ ===========
Weighted average common shares
outstanding $ 7,034,994 $ 4,691,651 $ 2,810,102
============ ============ ===========
<FN>
See Notes to financial statements
</FN>
</TABLE>
F-4
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
PERIOD FROM FEBRUARY 13, 1998 (INCEPTION) TO JUNE 30, 1998
AND FOR THE YEARS ENDED JUNE 30, 1999 AND 2000
<TABLE>
<CAPTION>
Accumulated
Additional other Unamortized Total
Common stock paid-in Accumulated comprehensive value of equity shareholders' Comprehensive
Shares Amount capital deficit income (loss) compensation equity income(loss)
------ ------ ---------- --------- --------------- ---------------- ------------ -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Initial capital contributions
to NetWolves, LLC 100 $ 64,245 $ - $ - $ - $ - $ 64,245
Reverse Acquisition,
June 17, 1998 (Note 3)
Exchange of NetWolves, LLC
membership interests (100) (64,245) - - - - (64,245)
Issuance of common stock
to owners of
NetWolves, LLC 2,640,322 8,713 55,532 - - - 64,245
Outstanding common stock
of Watchdog
Patrols, Inc. 1,673,548 5,523 2,956,627 - - - 2,962,150
Marketable securities
valuation adjustment - - - - 1,022 - 1,022 $ 1,022
Net loss, period from
February 13, 1998
(inception) to
June 30, 1998 - - - (99,414) - - (99,414) (99,414)
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Total comprehensive loss $ (98,392)
==========
Balance, June 30, 1998 4,313,870 14,236 3,012,159 (99,414) 1,022 - 2,928,003
Common stock and warrants
issued for services 770,000 2,541 5,160,209 - - - 5,162,750
Proceeds from sale
of warrants - - 300,000 - - - 300,000
Common stock issued in
private placement,
net of expenses 800,000 2,640 5,350,085 - - - 5,352,725
Adjustment to fair value
of Reverse Acquisition - - (190,485) - - - (190,485)
Common stock issued in
purchase business
combination (Note 4) 180,000 594 4,094,406 - - - 4,095,000
Marketable securities
valuation adjustment - - - - 374,823 - 374,823 $ 374,823
Net loss, year ended
June 30, 1999 - - - (6,923,014) - - (6,923,014) (6,923,014)
---------- ---------- ---------- ---------- ---------- ---------- ---------- -----------
Total comprehensive loss $(6,548,191)
===========
Balance, June 30, 1999 6,063,870 20,011 17,726,374 (7,022,428) 375,845 - 11,099,802
</TABLE>
F-5
(continued)
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
PERIOD FROM FEBRUARY 13, 1998 (INCEPTION) TO JUNE 30, 1998
AND FOR THE YEARS ENDED JUNE 30, 1999 AND 2000
<TABLE>
<CAPTION>
Accumulated
Additional other Unamortized Total
Common stock paid-in Accumulated comprehensive value of equity shareholders' Comprehensive
Shares Amount capital deficit income (loss) compensation equity income(loss)
------ ------ ---------- --------- --------------- ---------------- ------------ -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, June 30, 1999
Common stock 6,063,870 $ 20,011 $17,726,374 $(7,022,428) $ 375,845 $ - $11,099,802
Common stock issued
for services 212,500 701 2,200,299 - - - 2,201,000
Options and warrants
issued for services - - 8,342,973 - - (1,851,893) 6,491,080
Common stock issued in
private placement,
net of expenses 287,500 949 3,980,726 - - - 3,981,675
Common stock issued
upon exercise of
warrants (cashless) 114,855 379 (379) - - - -
Common stock and
warrants issued in
purchase business
combination (Note 4) 1,900,000 6,270 23,576,250 - - - 23,582,520
Common stock issued in
conversion of TSG
preferred stock 13,888 46 249,954 - - - 250,000
Marketable securities
valuation adjustment - - - - (471,500) - (471,500)$ (471,500)
Net loss, year ended
June 30, 2000 - - - (24,326,948) - - (24,326,948) (24,326,948)
---------- ---------- ----------- ---------- ---------- ----------- ---------- -----------
Total comprehensive loss (24,798,448)
===========
Balance, June 30, 2000 8,592,613 $ 28,356 $56,076,197 $(31,349,376) $(95,655) $(1,851,893) $22,807,629
========== ========== =========== ============ ======== =========== ===========
</TABLE>
F-6
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Period from
Year ended June 30, February 13, 1998
(inception) to
2000 1999 June 30, 1998
------------ ------------ --------------
<S> <C> <C> <C>
Cash flows from operating activities
Net loss $(24,326,948) $(6,923,014) $ (99,414)
Adjustments to reconcile net loss to net cash used
in operating activities
Depreciation 93,763 15,896 401
Amortization 2,968,786 - -
Writedown/realized loss (gain) on sale of
marketable services 35,000 (478,518) -
Provision for impairment 4,016,080 - -
Provision for doubtful accounts 4,747 35,000 5,000
Non-cash charge to operations with respect to
common stock and warrants issued for
services 8,692,080 5,162,750 -
Deferred income tax benefit - - (20,000)
Minority interest (148,739) - -
Changes in operating assets and liabilities
Accounts receivable (176,701) (34,883) (11,803)
Inventories (340,099) (95,944) (22,410)
Prepaid expenses and other current assets (75,515) (134,781) (18,318)
Accounts payable and accrued expenses 978,694 187,863 31,448
Deferred compensation (100,000) - -
Deferred revenue 11,173 - -
------------ ----------- ----------
Net cash used in operating activities (8,367,679) (2,265,631) (135,096)
------------ ----------- ----------
Cash flows from investing activities
Proceeds from the sale of marketable securities - 1,311,169 -
Issuance of notes receivable (56,000) - -
Proceeds from assets held for sale, net - 549,515 -
Finders fees paid in connection with acquisition
of ComputerCOP Corp. (550,000) - -
Appraisal fee paid in connection with
acquisition of ComputerCOP Corp. (40,000) - -
Cash acquired - ComputerCOP Corp. 20,500,000 - -
Purchases of property and equipment (459,978) (200,383) (5,350)
Advances to subsidiary, net of cash acquired of
$412,224, plus acquisition costs paid of $25,000 - (561,776) -
Capitalized software costs 170,913) - -
Payments of security deposits (31,018) (18,054) (4,727)
------------ ----------- ----------
Net cash provided by (used in) investing
activities 19,192,091 1,080,471 (10,077)
------------ ----------- ----------
<FN>
See notes to financial statements.
</FN>
</TABLE>
F-7
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Period from
Year ended June 30, February 13, 1998
(inception) to
2000 1999 June 30, 1998
------------ ------------ --------------
<S> <C> <C> <C>
Cash flows from financing activities
Proceeds from initial capital contribution - - 64,245
Repayment of long term debt (43,411) - -
Repayment of advances from TSG officer (144,348) - -
Cash acquired in Reverse Acquisition - - 1,460,366
Transaction costs paid in connection with Reverse
Acquisition - - (261,022)
Cash proceeds from issuance of common stock 4,312,500 6,000,000 -
Financing costs paid in connection with sale of
common stock (330,825) (647,275) -
Cash proceeds from sale of warrants - 300,000 -
------------ ----------- ------------
Net cash provided by financing activities 3,793,916 5,652,725 1,263,589
------------ ----------- ------------
Net increase in cash and cash equivalents 14,618,328 4,467,565 1,118,416
Cash and cash equivalents, beginning of period 5,585,981 1,118,416 -
------------ ----------- ------------
Cash and cash equivalents, end of period $ 20,204,309 $ 5,585,981 $ 1,118,416
============ =========== ============
Interest expense paid $ 45,727 $ 455 $ 345
============ =========== ============
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND
FINANCING ACTIVITIES
Reverse acquisition (Note 3)
Marketable securities acquired $ - $ - $ 1,062,806
Net assets held for sale - (190,485) 720,000
Deferred income tax liability - - (20,000)
Cash acquired, net of 261,022, of transaction
costs paid - - 1,199,344
------------ ----------- ------------
Outstanding common stock of Watchdog
Patrols, Inc. $ - $ (190,485) $ 2,962,150
============ =========== ============
Purchase acquisition (Note 4)
Accounts receivable $ - $ 70,221 $ -
Property and equipment - 35,255 -
Intangible assets - 6,024,121 -
Accrued expenses and other liabilities - (400,498) -
Long-term debt - (309,948) -
Acquisition costs - (82,875) -
Advances to subsidiary, net of cash acquired
of $412,224 - (536,776) -
Minority interest - (704,500) -
------------ ----------- ------------
Common stock issued in purchase acquisition $ - $ 4,095,000 $ -
============ =========== ============
Noncash conversion of preferred stock to common
stock (Note 4) $ 250,000 $ - $ -
============ =========== ============
Software ($2,907,520) and inventory ($175,000)
acquired through issuance of equity instruments $ 3,082,520 $ - $ -
============ =========== ============
<FN>
See notes to financial statements
</FN>
</TABLE>
F-8
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED JUNE 30, 2000 AND 1999 AND THE PERIOD
FROM FEBRUARY 13, 1998 (INCEPTION) TO JUNE 30, 1998
1 The Company
The consolidated financial statements include the accounts of NetWolves
Corporation and its three subsidiaries, NetWolves Technologies Corporation,
ComputerCOP Corporation and its majority owned TSG Global Education Web, Inc.
("TSG") (collectively "NetWolves" or the "Company").
NetWolves, LLC was an Ohio limited liability company formed on February 13,
1998, which was merged into Watchdog Patrols, Inc. ("Watchdog") on June 17,
1998. Watchdog, the legal surviving entity of the merger was incorporated under
the laws of the State of New York on January 5, 1970. As a result of the merger
and subsequent sale of Watchdog's business (Note 5), Watchdog changed its name
to NetWolves.
NetWolves is an Internet systems developer that has designed and developed a
multi-functional product that is a secure, integrated, modular Internet gateway.
The primary product, the FoxBox, supports secure access to the Internet for
multiple users through a single connection and, among other things, provides
electronic mail, firewall security and web site hosting and also contains a
network file server. Since inception, the Company has been developing its
business plan and building its infrastructure in order to effectively market its
products and shipped its first significant order in March 1999.
Additionally, in conjunction with TSG's acquisition of Sales and Management
Consulting, Inc. (d/b/a The Sullivan Group, see Note 4), the Company provides
consulting, educational and training services primarily to the oil and gas and
automotive industries throughout the United States.
Pursuant to an agreement dated February 10, 2000, the Company acquired all of
the outstanding capital stock of ComputerCOP Corporation, a New York corporation
and a subsidiary of Computer Concepts Corp. ("Computer Concepts"), in exchange
for 1,775,000 restricted shares of the Company's common stock valued at
$23,962,500 (Note 4). ComputerCOP Corp.'s assets included ComputerCOP
technology, inventory and $20.5 million in cash.
2 Significant accounting policies
Use of estimates
In preparing consolidated financial statements in conformity with generally
accepted accounting principles, management makes estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosures of
contingent assets and liabilities at the date of the consolidated financial
statements, as well as the reported amounts of revenue and expenses during the
reporting period. Actual results could differ from those estimates.
F-9
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED JUNE 30, 2000 AND 1999 AND THE PERIOD
FROM FEBRUARY 13, 1998 (INCEPTION) TO JUNE 30, 1998
2 Significant accounting policies (continued)
Principles of consolidation
The consolidated financial statements include the accounts of the Company and
its subsidiaries. All significant intercompany transactions and balances have
been eliminated in consolidation. The separate ownership of one of the Company's
subsidiaries is reflected in the Company's consolidated financial statements as
minority interest (Note 4). The minority interest includes common stock
representing 1.7% of the outstanding shares of the subsidiary and preferred
stock, until January 24, 2000, at which time the preferred stockholder elected
to convert the preferred stock into shares of NetWolves common stock (Note 4).
Revenue recognition
The Company records revenue in accordance with Statement of Position 97-2
"Software Revenue Recognition" ("SOP 97-2"), issued by the American Institute of
Certified Public Accountants (as modified by Statement of Position 98-9) and SEC
Staff Accounting Bulletin No. 101 ("SAB 101") regarding revenue recognition in
the financial statements. SOP 97-2 provides additional guidance with respect to
multiple element arrangements; returns, exchanges, and platform transfer rights;
resellers; services; funded software development arrangements; and contract
accounting. Accordingly, revenue from the sale of perpetual and term software
licenses are recognized, net of provisions for returns, at the time of delivery
and acceptance of software products by the customer, when the fee is fixed and
determinable and collectibility is probable. Maintenance revenue that is bundled
with an initial license fee is deferred and recognized ratably over the
maintenance period. Amounts deferred for maintenance are based on the fair value
of equivalent maintenance services sold separately. The Company recognizes
revenue from consulting and training fees when the services are provided.
Marketable securities
Marketable securities, which are all classified as "available for sale", are
valued at fair value. Unrealized gains or losses are recorded net of income
taxes as "accumulated other comprehensive income" in shareholders' equity,
whereas realized gains and losses are recognized in the Company's statements of
operations using the first-in, first-out method.
Inventories
Inventories consist of raw materials and finished goods. Inventories are valued
at the lower of cost or net realizable value using the first-in, first-out
method.
Property and equipment
Property and equipment are stated at cost. Costs assigned to property and
equipment of the acquired business (Note 4) were based on estimated fair value
at acquisition. Depreciation is provided on furniture and fixtures and machinery
and equipment over their estimated lives, ranging from 5 to 7 years, using the
straight-line method. Leasehold improvements are amortized over the lesser of
the term of the respective lease or the useful lives of the related assets.
Expenditures for maintenance and repairs are charged directly to the appropriate
operating accounts at the time the expense is incurred. Expenditures determined
to represent additions and betterments are capitalized.
F-10
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED JUNE 30, 2000 AND 1999 AND THE PERIOD
FROM FEBRUARY 13, 1998 (INCEPTION) TO JUNE 30, 1998
2 Significant accounting policies (continued)
Intangible assets
Intangible assets at June 30, 1999 consisted of intangible assets acquired in
connection with the Company's purchase business combination effective June 30,
1999 (Note 4). These assets consisted of training content (including a training
library, industry benchmarking data and the Profit Coach profitability analysis
module) which had a fair value of $1,000,000. The remaining portion of the
intangible asset (approximating $5,024,000) was allocated to goodwill. The
training content and the goodwill were being amortized over their estimated
useful lives of 3 years. On June 30, 2000, the Company recorded a loss on
impairment of the carrying value of the intangible assets at that date (Note 4).
Software costs
Costs associated with the development of software products are generally
capitalized once technological feasibility is established. Purchased software
technologies are recorded at cost. Software costs associated with technology
development and purchased software technologies are amortized using the greater
of the ratio of current revenue to total projected revenue for a product or the
straight-line method over its estimated useful life. Amortization of software
costs begins when products become available for general customer release. The
Company recorded approximately $960,000 in amortization expense for the year
ended June 30, 2000 relating to software costs. Costs incurred prior to
establishment of technological feasibility are expensed as incurred and
reflected as engineering and development costs in the accompanying consolidated
statements of operations. The Company capitalized approximately $170,000 of
software development costs and incurred approximately $802,000 in research and
development costs for the year ended June 30, 2000.
Impairment of long-lived assets
The Company reviews its long-lived assets, including software development costs,
intangible assets and property and equipment, for impairment whenever events or
changes in circumstances indicate that the carrying amount of the assets may not
be fully recoverable. To determine recoverability of its long-lived assets, the
Company evaluates the probability that future undiscounted net cash flows,
without interest charges, will be less than the carrying amount of the assets.
The Company has determined that as of June 30, 2000, there has been an
impairment in the carrying value of certain long-lived assets (Note 4).
Income taxes
The Company accounts for income taxes using the liability method which requires
the determination of deferred tax assets and liabilities based on the
differences between the financial and tax bases of assets and liabilities using
enacted tax rates in effect for the year in which differences are expected to
reverse. The net deferred tax asset is adjusted by a valuation allowance, if,
based on the weight of available evidence, it is more likely than not that some
portion or all of the net deferred tax asset will not be realized. The Company
and its subsidiaries file a consolidated Federal income tax return.
F-11
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED JUNE 30, 2000 AND 1999 AND THE PERIOD
FROM FEBRUARY 13, 1998 (INCEPTION) TO JUNE 30, 1998
2 Significant accounting policies (continued)
Stock options
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("SFAS 123") establishes a fair value-based method of accounting
for stock compensation plans. The Company has chosen to adopt the disclosure
requirements of SFAS 123 and continue to record stock compensation for its
employees and outside directors in accordance with Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25"). Under APB
25, charges are made to operations in accounting for stock options granted to
employees and outside directorswhen the option exercise prices are below the
fair market value of the common stock at the measurement date. Options granted
to non-employees are recorded in accordance with SFAS 123.
Basic and diluted net loss per share
The Company displays loss per share in accordance with Statement of Financial
Accounting Standards No.128, "Earnings Per Share" ("SFAS 128"). SFAS 128
requires dual presentation of basic and diluted earnings per share. Basic
earnings per share includes no dilution and is computed by dividing net income
(loss) available to common shareholders by the weighted average number of common
shares outstanding for the period. Loss per share does not include the impact of
potential shares issued upon exercise of options and warrants aggregating
approximately 3,057,000 which would be antidilutive.
The effect of the recapitalization on the NetWolves, LLC members has been given
retroactive application in the earnings per share calculation. The common stock
issued and outstanding with respect to the pre-merger Watchdog shareholders has
been included since the effective date of the merger. Outstanding stock options
and warrants have not been considered in the computation of diluted per share
amounts, since the effect of their inclusion would be antidilutive. Accordingly,
basic and diluted earnings per share amounts are identical.
Cash and cash equivalents
Generally, the Company considers highly liquid investments in debt securities
with original maturities of three months or less to be cash equivalents.
Concentrations and fair value of financial instruments
Financial instruments that potentially subject the Company to concentrations of
credit risk consist principally of cash investments and marketable securities.
At June 30, 2000, the Company's cash investments are held at primarily one
financial institution. The fair value of financial instruments approximates
their recorded values.
Reclassifications
Certain reclassifications have been made to the consolidated financial
statements shown for the prior periods in order to have them conform to the
current period's classifications.
F-12
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED JUNE 30, 2000 AND 1999 AND THE PERIOD
FROM FEBRUARY 13, 1998 (INCEPTION) TO JUNE 30, 1998
3 Reverse acquisition
On June 17, 1998, Watchdog acquired all of the outstanding common stock of
NetWolves, LLC (the "Reverse Acquisition"). For accounting purposes, the
acquisition has been treated as an acquisition of Watchdog by NetWolves, LLC and
as a recapitalization of NetWolves, LLC. The historical financial statements
prior to June 17, 1998 are those of NetWolves, LLC. The acquisition of Watchdog
has been recorded based on the fair value of Watchdog's net tangible assets,
which consist primarily of cash, marketable securities and certain assets held
for sale (Note 5), with an aggregate value of $2,962,150 (net of transaction
costs of $261,022). Since this transaction is in substance, a recapitalization
of NetWolves, LLC and not a business combination, pro forma information is not
presented.
As part of the Reverse Acquisition, the NetWolves, LLC membership interests were
converted into 2,640,322 shares of Watchdog common stock and warrants to
purchase an aggregate of 620,000 shares of Watchdog common stock at an exercise
price of $1.63 per share. Immediately prior to the Reverse Acquisition, there
were 1,673,548 shares of Watchdog common stock issued and outstanding. In
addition, certain pre-Reverse Acquisition shareholders of Watchdog received
warrants to purchase 500,000 shares of Watchdog common stock at an exercise
price of $1.63 per share. Additionally, two individuals, who provided consulting
services with respect to the Reverse Acquisition, received warrants to purchase
an aggregate of 87,500 shares of Watchdog common stock at an exercise price of
$2.00 per share. These warrants are described further in Note 10.
In connection with the Reverse Acquisition, in the fourth quarter of fiscal
1999, the Company reduced the fair value of Watchdog's net tangible assets (the
assets held for sale) and, accordingly, recorded an adjustment to additional
paid-in capital of $190,485.
4 Purchase acquisitions
ComputerCOP Corporation
Pursuant to an agreement dated February 10, 2000, the Company acquired all of
the outstanding capital stock of ComputerCOP Corporation, a New York corporation
and a subsidiary of Computer Concepts, in exchange for 1,775,000 restricted
shares of the Company's common stock valued at $23,962,500. ComputerCOP
Corporation's assets included ComputerCOP technology, inventory and $20.5
million in cash. In connection with the transaction, the Company incurred
finders fees of approximately of $960,000 and issued 125,000 restricted shares
of the Company's common stock valued at $2,405,000 and a five year warrant to
purchase 300,000 shares of the Company's common stock valued at $2,928,000. In
addition, a warrant to purchase 600,000 shares of the Company's common stock did
not vest in accordance with its term and were cancelled on March 31, 2000 (Note
10). In addition, the Company incurred professional fees relating to the
acquisition aggregating $350,000. The fair value of the shares issued
(approximately $24.0 million) and finders fees and other acquisition costs
(approximately $6.6 million) have been allocated as follows: cash of
$20,500,000, ComputerCOP software technology of $4,217,520 and inventory of
$175,000, with a portion of the finders fees and other acquisition costs charged
as a cost of raising capital.
Additionally, Computer Concepts purchased 225,000 shares of the Company's common
stock from three other officers of the Company for $4.5 million.
F-13
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED JUNE 30, 2000 AND 1999 AND THE PERIOD
FROM FEBRUARY 13, 1998 (INCEPTION) TO JUNE 30, 1998
4 Purchase acquisitions (continued)
ComputerCOP Corporation (continued)
All of the shares issued by the Company in connection with the ComputerCOP
Corporation acquisition as well as all the shares sold by the three officers
(the "Trust Shares") are subject to a Voting Trust Agreement, wherein the
Company's chief executive officer has been granted the right to vote all Trust
Shares for two years, subject to earlier termination on the sale of those shares
based on certain parameters.
Sales and Management Consulting, Inc.
On July 7, 1999 (effective June 30, 1999), NetWolves and Sales and Management
Consulting, Inc. (d/b/a The Sullivan Group) ("SMCI") executed a merger agreement
(the "Merger") pursuant to which NetWolves acquired the outstanding capital
stock of SMCI. Under the terms of the Merger, TSG Global Education Web, Inc.
("TSG") (a subsidiary of NetWolves), with 4,150,000 shares of common stock
outstanding prior to the Merger, purchased all of the outstanding shares of
SMCI's common stock in exchange for 180,000 shares of NetWolves' restricted
common stock. The shareholders are restricted from selling, transferring or
pledging such shares for an eighteen- month period. Upon consummation of the
Merger SMCI merged into TSG and TSG was the surviving entity.
Concurrent with the Merger, the shareholders of SMCI purchased 70,000 shares of
TSG common stock at $.35 per share for aggregate cash proceeds of $24,500. This
represents 1.7% of the outstanding common stock of TSG. Additionally, TSG issued
250,000 shares of TSG Series A Non-Voting Cumulative (8%) Convertible Preferred
Stock to one of the SMCI shareholders, which was issued in partial settlement of
outstanding liabilities owed to the former shareholder. The preferred
stockholder was entitled to preferential liquidation rights and was also
entitled to cumulative dividends to be included in minority interest expense
that accrued at the rate of 8% per annum commencing on June 30, 1999. On January
24, 2000, the preferred stockholder elected to convert the preferred stock into
13,888 shares of NetWolves common stock (the fair market value at the time of
conversion). The TSG common and preferred stock (until conversion on January 24,
2000) have been reflected as minority interest in the accompanying consolidated
financial statements.
The purchase price approximated $4,095,000 (exclusive of acquisition costs of
$82,875), which consisted of 180,000 shares of NetWolves restricted common stock
valued at $22.75 per share (fair value of the common stock was based on its
quoted market price on the effective date of the acquisition). Additionally,
certain officers of TSG have options to acquire up to 175,000 (4%) additional
shares of TSG's common stock based upon meeting certain performance levels. The
acquisition has been accounted for with an effective date of June 30, 1999 using
the purchase method of accounting. Accordingly, assets and liabilities were
recorded at their fair values as of June 30, 1999.
F-14
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED JUNE 30, 2000 AND 1999 AND THE PERIOD
FROM FEBRUARY 13, 1998 (INCEPTION) TO JUNE 30, 1998
4 Purchase acquisitions (continued)
Sales and Management Consulting, Inc. (continued)
An allocation of the fair value of the assets acquired and liabilities assumed
is as follows:
<TABLE>
<CAPTION>
<S> <C>
Purchase price
NetWolves common stock issued $ 4,095,000
Acquisition costs 82,875
------------
$ 4,177,875
============
Allocation of purchase price
Fair value of tangible assets and liabilities
Current assets $ 70,221
Non-current assets 35,255
Current liabilities (443,909)
Non-current liabilities (266,537)
Advances to TSG, net of cash acquired of $412,224 (536,776)
------------
(1,141,746)
------------
Minority interest
Common stock and additional paid-in capital (454,500)
Preferred stock (250,000)
------------
(704,500)
------------
Intangible assets acquired 6,024,121
------------
$ 4,177,875
============
</TABLE>
On June 30, 2000, the Company recorded a writedown of its training content and
goodwill (training and consulting segment) relating to the acquisition of SMCI
in the amount of $4,016,080. This writedown eliminates all remaining intangible
assets relating to the acquisition. The intangible assets were determined to be
impaired because of the current financial condition of TSG and TSG's inability
to generate future operating income without substantial sales volume increases
which are uncertain. Moreover, anticipated future cash flows of TSG indicate
that the recoverability of the asset is not reasonably assured.
At the time of the Merger and in accordance with TSG's newly formed stock option
plan, the SMCI shareholders (who are all employees of TSG) received 605,000
five-year options to purchase TSG common stock at an exercise price of $.35 per
share. The options were issued in proportion to the SMCI shareholders' ownership
interest. The intrinsic value of these options (plus the 70,000 shares of TSG
common stock) totalled $430,000, which has been reflected in the allocation of
the purchase price. Additionally, the SMCI shareholders are entitled to an
additional 175,000 options to purchase TSG common stock (with an exercise price
at fair value at the time of grant), subject to TSG meeting specific earnings
targets over the three years ending June 30, 2000, 2001 and 2002. These options
will be accounted for as compensation expense in accordance with APB 25 in such
future periods. To date, these earnings targets have not been met. All of the
shareholders of SMCI entered into 3-year employment agreements with TSG (Note
15).
In accordance with the Merger, NetWolves made $4,750,000 of non-interest bearing
open account working capital advances to TSG.
F-15
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED JUNE 30, 2000 AND 1999 AND THE PERIOD
FROM FEBRUARY 13, 1998 (INCEPTION) TO JUNE 30, 1998
4 Purchase acquisitions (continued)
Sales and Management Consulting, Inc. (continued)
Also, in accordance with the Merger, the Board of Directors of TSG consists of
three members designated by NetWolves and two members designated by the SMCI
shareholders. A four-fifths majority of the TSG Board is required for specified
significant actions including: sale or merger of the business, changes to the
TSG capital structure, declaration of dividends and repayment of the working
capital advances made by NetWolves. A simple majority of the TSG Board is
required for all general operating matters.
Prior to the Merger negotiations, in January 1999, the Company entered into an
agreement with SMCI whereby SMCI appointed the Company as its sole provider of a
multi-service Internet delivery system (known as "FoxBox") to be used in
conjunction with SMCI's proprietary interactive distance learning training
programs.
The following unaudited pro forma financial information has been prepared
assuming that the acquisition of SMCI had taken place at the beginning of the
period presented. The pro forma information is not necessarily indicative of the
combined results that would have occurred had the acquisition taken place at the
beginning of the period, nor is it necessarily indicative of the results that
may occur in the future. The results of operations for the year ended June 30,
2000 are included in the Statements of Operations in the accompanying
consolidated financial statements.
<TABLE>
<CAPTION>
Year ended
June 30, 1999
--------------
(Unaudited)
<S> <C>
Revenue $ 2,904,000
Net loss $(7,907,000)
Basic and diluted net loss per share $ (1.62)
</TABLE>
5 Net assets held for sale
In November 1998, the Company sold substantially all of the business assets
related to Watchdog's uniformed security guard services operations to W
Acquisition Corp. (the "Purchaser") for $600,000. The Purchaser acquired all
inventory, furniture and equipment, customer lists, trade rights, contracts,
goodwill and rights to the name "Watchdog Patrols, Inc." (the "Assets"). The
Company retained responsibility for settling most other working capital
assets/liabilities, including accounts receivable, other current assets,
accounts payable and accrued expenses (the "Retained Assets and Liabilities").
The Retained Assets and Liabilities were all directly related to the uniformed
security guard business and were not used or settled by the Company in the
normal course of business. Accordingly, the resultant net proceeds have been
included in the net assets held for sale. In connection with the settlement of
the Retained Assets and Liabilities, the Company reduced the estimated fair
value of such items by $190,485 in the fourth quarter of 1999.
F-16
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED JUNE 30, 2000 AND 1999 AND THE PERIOD
FROM FEBRUARY 13, 1998 (INCEPTION) TO JUNE 30, 1998
6 Marketable securities, available for sale
The following is a summary of marketable securities, available for sale:
<TABLE>
<CAPTION>
Gross
Amortized unrealized Fair
cost gain (loss) value
---------- ----------- -----
<S> <C> <C> <C>
June 30, 2000
Bonds $ 195,155 $ (95,655) $ 99,500
========= ========== =========
June 30, 1999
Equity securities $ 35,000 $ 415,000 $ 450,000
Bonds 195,155 (39,155) 156,000
--------- ---------- ---------
$ 230,155 $ 375,845 $ 606,000
========= ========== =========
</TABLE>
Proceeds from sales of marketable securities and realized gains on such sales
aggregated $1,311,169, and $478,518, respectively, for the year ended June 30,
1999. There were no sales of marketable securities during the year ended June
30, 2000 and the Company recognized a realized loss of $35,000 on the expiration
of a warrant to purchase restricted common stock of an unrelated publicly traded
company.
The maturities of the Company's investments in debt securities at June 30, 2000
are as follows:
<TABLE>
<CAPTION>
Amortized Fair
cost value
---------- -----
<S> <C> <C>
Due in one year or less $ - $ -
Due after one year through five years 97,375 29,000
Due after six year through ten years 97,780 70,500
--------- --------
$ 195,155 $ 99,500
========= ========
</TABLE>
F-17
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED JUNE 30, 2000 AND 1999 AND THE PERIOD
FROM FEBRUARY 13, 1998 (INCEPTION) TO JUNE 30, 1998
7 Property and equipment, net
Property and equipment consist of the following:
<TABLE>
<CAPTION>
June 30,
----------------------------------------
2000 1999
---- ----
<S> <C> <C>
Machinery and equipment $ 510,849 $ 121,462
Furniture and fixtures 145,839 92,685
Leasehold improvements 44,278 26,841
------------ ------------
700,966 240,988
Less: accumulated depreciation and amortization (110,060) (16,297)
------------ ------------
Property and equipment, net $ 590,906 $ 224,691
============ ============
8 Accounts payable and accrued expenses
Accounts payable and accrued expenses consist
of the following:
June 30,
----------------------------------------
2000 1999
---- ----
Trade accounts payable $ 1,083,526 $ 286,868
Finders fee payable 300,000 -
Other accrued operating expenses 153,794 68,909
Accrued advertising 106,172 -
Compensated absences 95,793 50,354
Commissions payable 32,410 36,204
Payroll/sales taxes payable 20,335 11,001
------------ ------------
$ 1,792,030 $ 453,336
============ ============
9 Long-term debt
Long-term debt consists of the following:
June 30,
----------------------------------------
2000 1999
---- ----
Notes payable to DVI $ 266,537 $ 309,948
Finders fee payable 360,000 -
------------ ------------
626,537 309,948
Less current maturities of long-term debt (208,435) (43,411)
------------ ------------
Long-term debt, net of current maturities $ 418,102 $ 266,537
============ ============
</TABLE>
F-18
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED JUNE 30, 2000 AND 1999 AND THE PERIOD
FROM FEBRUARY 13, 1998 (INCEPTION) TO JUNE 30, 1998
9 Long-term debt (continued)
The notes payable (the "DVI Notes") to the Duffy-Vinet Institute, Inc. ("DVI")
were assumed by the Company in connection with the Merger (Note 4). The DVI
Notes are secured by all of the assets SMCI had acquired from DVI in 1992. These
assets consist of furniture, fixtures and equipment (with a net book value of
$12,000) and a portion of the intangible assets acquired from SMCI including a
library of master tapes and completed training programs. At the time of the
Merger, the fair value of the liability (totaling $309,948) was determined by
calculating the present value of the future payments to be made using an implied
interest rate of 11%. At June 30, 1999, the DVI Notes required 66 monthly
payments of $6,280, including interest.
In connection with the Company's purchase of ComputerCOP Corporation, the
Company incurred finder fees of $960,000, $360,000 of which are payable at
$10,000 per month over 36 months commencing on March 1, 2000. As of June 30,
2000, no payments were made on such note however such payments have been
subsequent to the year end. Payment had not yet been remitted and applied to the
note. As of une 30, 2000, no payments were made on such note, however, such
payments have been made subsequent to the year end.
Aggregate maturities of long-term debt are as follows:
<TABLE>
<CAPTION>
Year ending June 30,
<S> <C>
2001 $ 208,435
2002 174,039
2003 140,293
2004 67,270
2005 36,500
Thereafter -
----------
$ 626,537
==========
</TABLE>
10 Shareholders' equity
Common stock issuances
In July 2000, the Certificate of Incorporation of the Company was amended to
increase the authorized shares of common stock from 10,000,000 to 50,000,000
shares and to authorize issuance of 2,000,000 shares of preferred stock.
For the year ended June 30, 1999, the Company issued 1,750,000 shares of its
common stock as follows:
-- 150,000 unregistered shares were issued to the Company's Vice President of
Sales and Marketing (who is also a Director of the Company) for services
rendered during the six months ended December 31, 1998, which resulted in a
charge to operations of approximately $769,000. Management determined the
fair value of the common stock based on its quoted market price at the time
of issuance.
-- 260,000 unregistered shares were issued to Internet Technologies, Inc., a
consultant to the Company ("Internet Technologies"), for services rendered
during the nine months ended March 31, 1999, which resulted in a charge to
operations of approximately $1,333,000. Management determined the fair
value of the common stock based on its quoted market price at the time of
issuance. Internet Technologies has demand registration rights on 200,000
of these shares.
F-19
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED JUNE 30, 2000 AND 1999 AND THE PERIOD
FROM FEBRUARY 13, 1998 (INCEPTION) TO JUNE 30, 1998
10 Shareholders' equity (continued)
Common stock issuances (continued)
-- 100,000 unregistered shares were issued to a financial consultant and
100,000 unregistered shares were issued to the Company's legal counsel for
services rendered during the three months ending March 31, 1999, which
resulted in an aggregate charge to operations of $1,025,000. Management
determined the fair value of the common stock based on its quoted market
price at the time of issuance.
-- 100,000 unregistered shares were issued in conjunction with the appointment
of two new Directors of the Company effective February 1, 1999 (50,000
shares each), which resulted in an aggregate charge to operations of
approximately $513,000. Management determined the fair value of the common
stock based on its quoted market price at the time of issuance.
-- On June 29, 1999, the Company completed a private placement. The Company
sold 800,000 shares of unregistered common stock at $7.50 per share (a
total of $6,000,000) exclusive of commission and other fees totalling
$647,275. The placement agent received 80,000 warrants, exercisable at
$9.375 each; the warrants vest one year after the closing of the private
placement and expire four years after vesting. Additionally, 60,000 shares
were issued to Internet Technologies for services rendered in connection
with the private placement. Internet Technologies also has the right to
receive up to 60,000 additional shares based upon the completion of a
second private placement, if any.
-- 180,000 unregistered shares were issued in connection with the Merger (Note
4) on June 30, 1999 valued at $22.75 per share, totaling $4,095,000.
For the year ended June 30, 2000, the Company issued 2,528,743 shares of its
common stock as follows:
-- On September 29, 1999, the Company sold 100,000 shares of unregistered
common stock to an accredited investor at $15 per share (a total of
$1,500,000) exclusive of commissions totalling $105,000.
-- During November 1999, the Company sold 187,500 shares of unregistered
common stock to an accredited investor at $15 per share (a total of
$2,812,500) exclusive of commissions and fees of approximately 7%.
-- On November 20, 1999, 12,500 shares were issued to a financial consultant
for services rendered during the three moths ending December 31, 1999,
which resulted in a charge to operations of $275,000. Management determined
the fair value of the common stock based on its quoted market price at the
time of the issuance.
-- During January 2000, the preferred stockholder elected to convert the
preferred stock into 13,888 shares of NetWolves common stock (at fair
market value at the time of conversion).
F-20
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED JUNE 30, 2000 AND 1999 AND THE PERIOD
FROM FEBRUARY 13, 1998 (INCEPTION) TO JUNE 30, 1998
10 Shareholders' equity (continued)
Common stock issuances (continued)
-- Pursuant to an agreement dated February 10, 2000, the Company acquired all
of the outstanding capital stock of ComputerCOP Corp., a New York
corporation and a subsidiary of Computer Concepts, in exchange for
1,775,000 restricted shares of the Company's common stock. In addition, the
Company issued 125,000 restricted shares of the Company's common stock as
finders fees. The fair value of the common stock issued to Computer
Concepts and common stock issued as finders fees is included in the value
of the ComputerCOP software and inventory, less the cash acquired of 20.5
million
-- In June 2000, the Company issued General Electric Company ("GE"), 200,000
shares of common stock valued at $1,926,000 which is included in Sales and
Marketing expenses in the Consolidated Statements of Operations. Management
determined the fair value of the common stock based on its quoted market
price at the time of issuance (Note 14).
-- A total of 114,855 shares of the Company's common stock was issued to
outside consultants upon the exercise of warrants (cashless) previously
issued to these individuals.
Stock option plans NetWolves Corporation
In June 1998, the Company adopted the 1998 Long Term Incentive Plan (the "1998
Incentive Plan") in order to motivate qualified employees of the Company, to
assist the Company in attracting employees and to align the interests of such
persons with those of the Company's shareholders. The 1998 Incentive Plan, which
authorizes the issuance of a maximum of 282,500 shares of common stock, provides
for a grant of non-qualified stock options, restricted stock, performance grants
and other types of awards to officers, key employees, consultants and
independent contractors of the Company and its affiliates. The 1998 Incentive
Plan is administered by the Board of Directors, which has sole discretion and
authority to determine which eligible participants will receive options, the
time when options will be granted and the terms of options granted.
During the year ended June 30, 2000, the Company granted options to purchase
142,500 shares of common stock under the 1998 Incentive Plan to key employees at
exercise prices ranging from $9.00 to $30.75 per share that vest in equal
installments over three years commencing on the first anniversary of the date of
grant. The exercise prices represent the closing quoted price of the common
stock on the day immediately prior to the grants. All options expire in ten
years from the grant date.
F-21
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED JUNE 30, 2000 AND 1999 AND THE PERIOD
FROM FEBRUARY 13, 1998 (INCEPTION) TO JUNE 30, 1998
10 Shareholders' equity (continued)
Stock option plans NetWolves Corporation (continued)
In July 2000, the Company adopted a 2000 Long Term Incentive Plan (the "2000
Incentive Plan") in order to motivate qualified employees of the Company, to
assist the Company in attracting employees and to align the interests of such
persons with those of the Company's shareholders.
The 2000 Incentive Plan, which is a non-qualified plan administered by the Board
of Directors, authorizes the issuance of a maximum of 1,500,000 shares of common
stock, which may be either newly issued shares, treasury shares, reacquired
shares, shares purchased in the open market or any combination thereof. As with
the 1998 Incentive Plan, if any award under the 2000 Incentive Plan terminates,
expires unexercised, or is cancelled, the shares of common stock that would
otherwise have been issuable pursuant thereto will be available for issuance
pursuant to the grant of new awards. As of June 30, 2000, the Company had
granted options to purchase 217,500 shares of common stock under the 2000
Incentive Plan to its officers and key employees at exercise prices ranging from
$7.50 to $17.00 per share that vest in periods not exceeding three years from
the date of grant. The exercise prices represent the closing quoted price of the
common stock on the day immediately prior to the grants. All options expire in
five years from the grant date. As of September 30, 2000, approximately
1,015,000 options have been granted under the Plan at exercise prices ranging
from $5.00 to $9.00, including an aggregate of 625,000 to three officers and
shareholders of the Company.
Warrants
On June 17, 1998, in conjunction with the Reverse Acquisition, the Company
granted warrants to purchase 1,207,500 shares of its common stock as follows:
-- 620,000 ten-year warrants issued to the former members of NetWolves LLC at
an exercise price of $1.63 per share. Originally, an aggregate of 1,000,000
warrants were granted to six individuals; upon termination of two of these
individuals in January 1999, 380,000 warrants were cancelled resulting in
620,000 outstanding warrants. The warrants were originally issued as
performance-based warrants, vesting only upon achieving specified financial
targets. In January 1999, the vesting terms of 600,000 of the warrants were
amended so that the warrants would automatically vest in June 2000.
Accordingly, the modification changed the warrant to a fixed-warrant and a
new measurement date was established. The intrinsic value of the modified
warrants approximated $1,908,000, which will be charged to operations over
the 18-month vesting period (also see Note 15).
-- 500,000 five-year warrants issued to certain pre-Reverse Acquisition
shareholders of Watchdog at an exercise price of $1.63 per share. These
warrants became exercisable when granted. The pre-Reverse Acquisition
shareholders have demand registration rights on the shares of common stock
issuable upon exercise of these warrants.
F-22
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED JUNE 30, 2000 AND 1999 AND THE PERIOD
FROM FEBRUARY 13, 1998 (INCEPTION) TO JUNE 30, 1998
10 Shareholders' equity (continued)
Warrants (continued)
-- 87,500 five-year warrants issued to two individuals who provided consulting
services with respect to the Reverse Acquisition at an exercise price of
$2.00 per share. These warrants became exercisable when granted and were
exercised during fiscal 2000 (see Common Stock Issuances above).
For the year ended June 30, 1999, the Company granted warrants to purchase its
common stock as follows:
-- 200,000 ten-year warrants issued to the Company's Vice-President of Sales
and Marketing (who is also a Director of the Company) at an exercise price
of $1.63 per share. These warrants were issued for services rendered during
the six months ended December 31, 1998 and resulted in a charge to
operations of approximately $699,000, based upon the intrinsic value of the
warrants on the date of grant.
-- 100,000 two-year warrants were issued to two terminated employees (50,000
warrants each) at an exercise price of $5.00 per share (also see Note 15).
The warrants were to vest only upon the independent contractors' submission
of valid, legally binding purchase orders totaling $10,000,000 for the
period from January 1, 1999 to December 31, 1999 which did not occur and
accordingly, such warrants were canceled. The potential charge to
operations upon achieving specified performance criteria was approximately
$201,000. The value of the warrants had been calculated using the
Black-Scholes option-pricing model with the following assumptions: no
dividend yield, expected volatility of 65%, risk-free interest rate of
4.62%, and an expected term of two years.
-- 25,000 five year warrants were granted to a consultant in March 1999 for
services rendered, which resulted in a charge to operations of $189,000,
based on the fair value of the warrant at the time of grant.
-- 300,000 warrants were issued to Anicom, Inc. for cash consideration of
$300,000 (see Note 14).
-- 80,000 warrants were issued to the placement agent in connection with a
private placement of common stock (see "Common Stock Issuances" above).
F-23
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED JUNE 30, 2000 AND 1999 AND THE PERIOD
FROM FEBRUARY 13, 1998 (INCEPTION) TO JUNE 30, 1998
10 Shareholders' equity (continued)
Warrants (continued)
For the year ended June 30, 2000, the Company granted warrants to purchase its
common stock as follows:
-- On July 26, 1999 and in connection with the Company entering into an
agreement with Comdisco, Inc. ("Comdisco"), Comdisco was granted a
five-year warrant to purchase 125,000 shares of the Company's unregistered
common stock, at an exercise price of $10 per share. The warrants are
immediately exercisable. The value of the warrants of $2,390,000 are being
amortized over the initial term of the agreement (four years) and have been
calculated using the Black- Scholes option-pricing model with the following
assumptions: no dividend yield, expected volatility of 65%, risk-free
interest rate of 5.84%, and an expected term of five years.
-- On July 31, 1999, a financial consultant of the Company was granted a
five-year warrant to purchase 100,000 shares of common stock, at an
exercise price of $12 per share. The warrants are immediately exercisable
and the shares issuable pursuant to the warrants have piggyback
registration rights. The value of the warrants of $1,704,000 was being
amortized over a period of three months and has been calculated using the
Black- Scholes option-pricing model with the following assumptions: no
dividend yield, expected volatility of 65%, risk-free interest rate of
5.84%, and an expected term of five years.
-- On November 1, 1999, the Company granted a five-year warrant to purchase
24,000 shares of common stock, at an exercise price of $18 per share to a
public relations firm. The warrants vest ratably over twelve months and
resulted in a charge to operations of approximately $205,000 through May
31, 2000, at which time the remaining unvested warrants were canceled due
to termination of the public relations firm's services. The total value of
the warrants has been calculated using the Black-Scholes option- pricing
model with the following assumptions: no dividend yield, expected
volatility of 65%, risk-free interest rate of 5.97%, and an expected term
of five years.
-- In November 1999, a consultant was granted a five-year warrant to purchase
60,000 shares of common stock, at an exercise price of $18 per share for
services provided in connection with a private placement of the Company's
common stock.
-- During December 1999, the Company granted 65,000 ten-year warrants to the
Company's Vice President of Finance at an exercise price of $12 per share.
The warrants vest immediately and accordingly resulted in a charge to
operations of $422,500, based upon the intrinsic value of the warrants on
the date of grant.
-- In December 1999, a consultant was granted a ten-year warrant to purchase
100,000 shares of common stock, at an exercise price of $12 per share. The
warrants are immediately exercisable. The value of the warrants resulted in
a charge to operations of approximately $1,536,000 during the three months
ended December 31, 1999 and has been calculated using the Black-Scholes
option-pricing model with the following assumptions: no dividend yield,
expected volatility of 65%, risk-free interest rate of 5.97%, and an
expected term of ten years.
F-24
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED JUNE 30, 2000 AND 1999 AND THE PERIOD
FROM FEBRUARY 13, 1998 (INCEPTION) TO JUNE 30, 1998
10 Shareholders' equity (continued)
Warrants (continued)
-- In connection with the February 10, 2000 acquisition of ComputerCOP Corp.,
the Company issued a warrant to purchase an aggregate of 300,000 shares of
the Company's stock that are initially exercisable at $25 per share if
exercised on or before September 30, 2002 and $30 thereafter until they
expire on February 10, 2005. The fair value of this warrant of $2,928,000
has been allocated between the value of the software and the cost of
capital obtained and has been calculated using the Black-Scholes option
pricing model with the following assumptions: No dividend yield, expected
volatility of 65% risk free interest rate of 6.68% and an expected term
through February 10, 2005. In addition, the Company issued another warrant
to purchase an aggregate of 600,000 shares of the Company's common stock.
This warrant did not vest in accordance with its terms and was cancelled on
March 31, 2000.
-- On May 12, 2000, and in full settlement with a previously terminated
employee, the Company granted a one-year warrant to purchase 10,000 shares
of common stock, at an exercise price of $15 per share. The warrant is
immediately exercisable. The value of the warrant resulted in a charge to
operations of approximately $14,000 during the three months ended June 30,
2000 and has been calculated using the Black-Scholes option-pricing model
with the following assumptions: no dividend yield, expected volatility of
65%, risk-free interest rate of 6.33%, and an expected term of one year.
-- In June 2000, three consultants were granted three-year warrants to
purchase 100,000, 50,000 and 7,500, respectively, shares of common stock,
at exercise prices ranging from $15 to $17 per share. Two of the warrants
are immediately exercisable and one vests ratably over 18 months. The value
of the warrants resulted in a charge to operations of approximately
$395,000 for the three months ended June 30, 2000 and has been calculated
using the Black- Scholes option-pricing model with the following
assumptions: no dividend yield, expected volatility of 65%, risk-free
interest rate of 6.43%, and an expected term of three years.
-- On June 22, 2000 and in connection with the Company entering into an
agreement with GE, the Company issued a warrant to purchase 500,000 shares
of common stock. The warrant may be exercised with respect to any given
shares in whole or, from time to time in part, on or prior to the two-year
anniversary of the date of vesting of such shares. The warrant vests as
follows: GE may exercise the warrant to purchase, cumulatively, up to
100,000, 200,000, 350,000 and 500,000, respectively, shares of the
Company's common stock upon the Company receiving orders (as defined in the
agreement) of an amount equal to or in excess of, in the aggregate,
$2,000,000, $3,000,000, $4,000,000 and $5,000,000. The exercise price of
the warrant shall be the average (weighted by daily trading volume) of the
reported closing price of the Company's common stock over the 20
consecutive trading day period ending two trading days prior to the date GE
gives notice to exercise its conversion right. The fair value of the
warrant has been accrued at the date of issuance with the measurement of
such warrant costs adjusted at each reporting date until such milestone has
been achieved or the warrant expires. The value of the warrant for the
purchase of the first 100,000 shares of the Company's common stock resulted
in a charge to operations of $395,000 during the year ended June 30, 2000
and has been calculated using the Black-Scholes option-pricing model with
the following assumptions: no dividend yield, expected volatility of 65%,
risk-free interest rate of 6.48%, and an expected term of approximately two
years. GE has demand registration rights (subject to certain limitations as
defined in the agreement) covering at least 20% of the shares of common
stock issuable upon exercise of these warrant.
F-25
<PAGE>
10 Shareholders' equity (continued)
Summary of options and warrants
The Company has adopted the disclosure provisions of SFAS 123 and applies APB 25
in accounting for stock options granted to employees and, accordingly,
recognizes non-cash compensation charges related to the intrinsic value of
employee stock options. If the Company had elected to recognize compensation
expense based upon the fair value at the date of grant consistent with the
methodology prescribed by SFAS 123, the effect on the Company's net loss and net
loss per share would be as follows:
<TABLE>
<CAPTION>
Year Ended Period from
June 30 February 13, 1998
------------------------------ (inception)
2000 1999 to June 30, 1998
---- ---- ------------------
Net loss
<S> <C> <C> <C>
As reported $ (24,326,948) $ (6,923,014) $ (99,414)
Pro forma $ (24,950,773) $ (6,829,767) $ (99,414)
Basic and diluted net loss per share
As reported $ (3.46) $ (1.48) $ (.04)
Pro forma $ (3.55) $ (1.46) $ (.04)
</TABLE>
The weighted average fair value per share of common stock, options and warrants
granted to employees during the years ended June 30, 2000 and 1999, approximated
$10.97 and $5.02, respectively, are estimated on the date of grant using the
Black-Scholes option-pricing model with the following assumptions: no dividend
yield, expected volatility of 65%, risk-free interest rates ranging from 4.72%
to 6.69%, and expected lives ranging from 5 to 10 years.
The following is a summary of all of the Company's stock options and warrants
that were described in detail above (excluding the TSG stock options):
F-26
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED JUNE 30, 2000 AND 1999 AND THE PERIOD
FROM FEBRUARY 13, 1998 (INCEPTION) TO JUNE 30, 1998
10 Shareholders' equity (continued)
Summary of options and warrants (continued)
<TABLE>
<CAPTION>
Weighted
average
Number of exercise
Warrants price per
and Options share
----------- -----------
<S> <C> <C>
Outstanding at February 13, 1998 - $ -
Granted 1,587,500 $ 1.48
Exercised - $ -
Forfeited - $ -
----------
Outstanding at June 30, 1998 1,587,500 $ 1.65
Granted 924,000 $ 5.08
Exercised - $ -
Forfeited (396,000) $ 1.77
----------
Outstanding at June 30, 1999 2,115,500 $ 3.13
Granted 1,901,500 $ 18.86
Exercised (120,500) $ 1.90
Forfeited (839,667) $ 19.68
---------
Outstanding at June 30, 2000 3,056,833 $ 8.41
=========
</TABLE>
The following table summarizes information about all of the Company's options
and warrants outstanding at June 30, 2000:
<TABLE>
<CAPTION>
Options and Warrants Warrants and
outstanding at Options exercisable at
June 30, 2000 June 30, 2000
---------------------- ----------------------
Weighted
average Weighted Weighted
remaining average average
Range of Number of contractual exercise Number of exercise
exercise price shares life price shares price
-------------- --------- ----------- --------- ----------- ---------
<S> <C> <C> <C> <C> <C>
$ 1.63 1,237,000 6.08 $ 1.63 1,217,000 $ 1.63
$ 5.00 422,833 4.71 $ 5.00 65,833 $ 5.00
$ 7.50 50,000 4.92 $ 7.50 - $ -
$ 9.00-13.00 639,000 6.02 $10.84 478,834 $11.03
$ 15.00-20.00 408,000 5.09 $16.63 235,333 $15.95
$ 25.00 300,000 4.62 $25.00 300,000 $25.00
--------- ---------
3,056,833 2,297,000
========= =========
</TABLE>
During the year ended June 30, 2000, the Company granted 165,000 options and
warrants with a weighted average market value per share of $11.86 representing
in-the-money awards.
F-27
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED JUNE 30, 2000 AND 1999 AND THE PERIOD
FROM FEBRUARY 13, 1998 (INCEPTION) TO JUNE 30, 1998
11 Segment information
The Company reports segments in accordance with Financial Accounting Standards
Board Statement No. 131 "Disclosures about Segments of an Enterprise and Related
Information". The Company and its subsidiaries operate in three separate
business segments, the Technology segment, the Training and Consulting segment
and the Computer Software segment. These operating segments are representative
of the Company's management approach to its evaluation of its operations. The
accounting policies of the reportable operating segments are the same as those
described in the summary of significant accounting policies. The Technology
segment, which operates principally domestically, is primarily engaged in the
design, development, marketing and support of information delivery hardware
products and software. The Training and Consulting segment, which operates
domestically, provides consulting, educational and training services primarily
to the oil and gas and automotive industries throughout the United States. The
Software segment, which operates domestically, is primarily engaged in the
design, development, marketing and support of software products which are
designed to provide non computer literate owners the ability to identify threats
as well as objectionable material which may be viewed by users of the computer
on the Internet.
<TABLE>
<CAPTION>
Year Ended Period from
June 30 February 13, 1998
------------------------------ (inception)
2000 1999 to June 30, 1998
---- ---- ------------------
<S> <C> <C> <C>
Revenue
Technology $ 132,825 $ 1,789,144 $ 29,621
Training and consulting 1,290,865 - -
Computer software - - -
------------ ------------ -----------
Total $ 1,423,690 $ 1,789,144 $ 29,621
============ ============ ===========
Operating loss
Technology $(14,786,837) $ (7,459,961) $ (125,570)
Training and consulting (9,029,678) - -
Computer software (1,165,191) - -
------------ ------------ -----------
Total $(24,981,706) $ (7,459,961) $ (125,570)
============ ============ ===========
June 30,
---------------------------------
2000 1999
---- ----
Identifiable assets
Technology $ 21,231,907 $ 6,270,113
Training and consulting 708,678 6,541,821
Computer software 3,602,545 -
------------- ------------
Total $ 25,543,130 $ 12,811,934
============= ============
</TABLE>
The Company had two major customers, both included in the Training and
Consulting segment, which accounted for 46% and 24% of consolidated revenue for
the year ended June 30, 2000 and one customer that accounted for 40% of
consolidated accounts receivable at June 30, 2000.
F-28
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED JUNE 30, 2000 AND 1999 AND THE PERIOD
FROM FEBRUARY 13, 1998 (INCEPTION) TO JUNE 30, 1998
12 Income taxes
The provision for (benefit from) income taxes consists of the following:
<TABLE>
<CAPTION>
Year Ended Period from
June 30 February 13, 1998
------------------------------ (inception)
2000 1999 to June 30, 1998
---- ---- ------------------
<S> <C> <C> <C>
Current Federal and States $ 25,000 $ - $ -
Deferred Federal - - (15,000)
Deferred States - - (5,000)
----------- ----------- ------------
Provision for (benefit from)
income taxes $ 25,000 $ - $ (20,000)
=========== =========== ===========
</TABLE>
The following table summarizes the significant differences between the Federal
statutory tax rate and the Company's effective tax rate for financial reporting
purposes:
<TABLE>
<CAPTION>
Year Ended Period from
June 30 February 13, 1998
------------------------------ (inception)
2000 1999 to June 30, 1998
---- ---- ------------------
<S> <C> <C> <C>
Federal statutory tax rate (34.0)% (34.0)% (34.0)%
State and local taxes net of Federal
tax effect (6.0) (6.0) (5.0)
Stock and option compensation 9.2 17.8 -
Non-deductible reserves - .2 -
Effect of graduated tax rates - - 9.0
Impairment 5.7 - -
Permanent differences .1 .3 1.9
Valuation allowance on deferred tax
asset 25.1 21.7 11.4
----- ----- -----
Effective tax rate 0.1% 0.0% (16.7)%
===== ===== =====
</TABLE>
F-29
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED JUNE 30, 2000 AND 1999 AND THE PERIOD
FROM FEBRUARY 13, 1998 (INCEPTION) TO JUNE 30, 1998
12 Income taxes (continued)
The tax effects of temporary differences and carry forwards that give rise to
deferred tax assets or liabilities are summarized as follows:
<TABLE>
<CAPTION>
June 30,
----------------------------------------
2000 1999
---- ----
<S> <C> <C>
Non deductible reserves $ 17,000 $ 16,000
Accrual to cash conversion TSG - 73,000
Options and Warrants 3,721,000 -
Net operating loss carry forward 6,548,000 1,100,000
Impairment of long-lived assets 1,606,000 -
Valuation allowance on net deferred tax asset (11,892,000) (1,189,000)
----------- -----------
Deferred tax asset, net $ - $ -
=========== ===========
</TABLE>
The Company has provided for full valuation allowances on the net deferred tax
assets due to the uncertainty of future income tax estimates.
At June 30, 2000, the Company has net tax operating loss carryforwards of
approximately $16 million available to offset future income tax liabilities, if
any, that may be subject to Section 382 of the Internal Revenue Code. if any.
The carryforward losses expire in the years 2011 through 2020 and have not been
recognized in the accompanying consolidated financial statements as a result of
a valuation of the total potential tax asset. Approximately $700,000 of these
carryforwards were generated by SMCI prior to the Merger which are subject to
the separate return limitation year (SRLY) rules and are subject to the
restriction pursuant to Section 382 of the the Internal Revenue Code.
13 Related party transactions
In connection with the Merger, the Company has assumed obligations and entered
into commitments with one of the Company's shareholders, who is also a director
and treasurer of TSG, as follows:
-- Deferred compensation payable aggregating $100,000 at June 30, 1999,
represents unpaid salary to the TSG officer for services rendered prior to
the Merger. The deferred compensation is payable in six monthly
installments of $16,667 commencing in October 31, 1999.
-- TSG leases its office facilities from the TSG officer for annual lease
payments of approximately $75,000 through December 2004 which aproximates
fair market value. The Company paid approximately $75,000 (excluding sales
tax) in connection with this lease for the year ended June 30, 2000.
-- The loans and advances from the TSG officer of $144,348 was payable in four
equal monthly installments of $37,203 (including interest at 8%) commencing
on July 1, 1999.
In addition, in July 1999, another shareholder, who is also the President and
Chief Executive Officer of TSG, borrowed $50,000 at an interest rate of 6% per
annum. Interest on the loan is payable quarterly and the entire principal
balance is payable upon the third anniversary date of issuance.
F-30
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED JUNE 30, 2000 AND 1999 AND THE PERIOD
FROM FEBRUARY 13, 1998 (INCEPTION) TO JUNE 30, 1998
14 Major customers/significant agreements
General Electric Company
On June 29, 2000, NetWolves and General Electric Company ("GE") signed a
contract for the master purchase, license and support services of NetWolves'
security, remote monitoring and configuration management system. GE will be
using the FoxBox for interconnectivity of its worldwide offices.
The contract is for a term of six years and can be extended for four additional
one-year periods unless prior notice of non-renewal is given by either party as
defined in the agreement. The contract provides for the Company to receive a fee
upon shipment of each FoxBox, and an additional one-time configuration and
installation fee. Additionally, upon shipment of each unit, the Company is to
receive an annual support service fee and an annual configuration management fee
("Annual Fees"). The Annual Fees shall continue at the same rate per annum at
GE's discretion, provided that GE requests such services at any time during a
subsequent year. GE shall be required to pay such Annual Fees in full from the
expiration date of the prior year period and revenue generated from the Annual
Fees will be recognized over the service period.
On June 22, 2000 and in connection with the Company entering into the agreement
with GE, the Company issued a warrant to purchase 500,000 shares of common stock
(Note 10).
In June 2000, the Company issued 200,000 shares of common stock to GE.
Gateway, Inc. Agreement
In April, 2000, the Company was assigned an agreement with Gateway, Inc.
("Gateway") whereby Gateway agreed to install the ComputerCOP software on every
new Gateway consumer computer. The Company is to receive fifty percent (50%) of
all gross margins generated from sales of upgrades to the existing software
contained within the Gateway consumer computer.
Amoco Oil Company
On December 1, 1999, the Company entered into a three-year agreement (the
"Management Agreement") with Amoco Oil Company ("Amoco"), whereby the Company
was granted the exclusive right to service and support certain franchised
automotive maintenance and repair businesses located within Minnesota. In return
for the Company providing management services for the franchisees (as defined in
the agreement), the Company receives a monthly payment of $100,000 (the "Monthly
Payment"), which is then compared to the actual monthly fees billed to the
franchisees (the "Monthly Revenue"), with the difference between the Monthly
Payment and Monthly Revenue recorded as either a receivable or payable to Amoco.
For the year ended June 30, 2000, the Company recorded management fee revenue
from the Management Agreement of approximately $650,000 and has included a
liability to Amoco of $57,000 in accounts payable and accrued expenses at June
30, 2000 in the accompanying consolidated balance sheets. Such liability was
subsequently paid in August 2000.
The agreement also calls for the maintenance of a separate advertising fund to
be used to fund marketing and advertising costs for the franchisees. At June 30,
2000, this fund approximately $108,000 and is included in cash and cash
equivalents in the accompanying consolidated balance sheets.
F-31
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED JUNE 30, 2000 AND 1999 AND THE PERIOD
FROM FEBRUARY 13, 1998 (INCEPTION) TO JUNE 30, 1998
14 Major customers/significant agreements (continued)
Anicom, Inc.
In January 1999, the Company entered into a five-year exclusive master
distribution agreement with Anicom, Inc. ("Anicom") to distribute the FoxBox
throughout North America. Additionally, Anicom was entitled to receive a
commission on any sales or leases of the FoxBox unit made directly by the
Company that Anicom was not involved with and a commission on certain technical
support revenue earned by the Company. In accordance with the terms of the
agreement, the Company shipped approximately $1,700,000 of product to Anicom,
which accounted for approximately 95% of the Company's revenue for the year
ended June 30, 1999.
For cash consideration paid to the Company of $300,000, the Company issued
Anicom 300,000 warrants to purchase common stock of the Company at an exercise
price of $5 per share. The warrants issued to Anicom shall vest in equal
installments over three years, commencing on the first anniversary of the
agreement and shall expire in January 2004. Anicom also obtained piggyback
registration rights with respect to the issuable shares of common stock.
On April 10, 2000, the Company exercised its right to terminate its exclusive
distributorship agreement with Anicom pursuant to its terms (see Note 15
Commitments and Contingencies - Legal Matters, for further information).
15 Commitments and contingencies
Leases
The Company has entered into several leases for office space, office equipment
and vehicles. In addition, as a result of the Merger, TSG assumed several
leases, which are included below. At June 30, 2000, the approximate future
minimum annual lease payments (including the lease for office space with the TSG
officer, Note 13 and including the lease entered into during September 2000 see
Note 16) are summarized as follows:
<TABLE>
<CAPTION>
<S> <C>
Fiscal year ending June 30,
2001 $ 591,000
2002 671,000
2003 647,000
2004 570,000
2005 483,000
Thereafter 277,000
-----------
$ 3,239,000
===========
</TABLE>
Total rent expense for the years ended June 30, 2000 and 1999 and for the period
from February 13, 1998 (inception) to June 30, 1998 was $394,184, $139,417 and
$351, respectively.
F-32
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED JUNE 30, 2000 AND 1999 AND THE PERIOD
FROM FEBRUARY 13, 1998 (INCEPTION) TO JUNE 30, 1998
15 Commitments and contingencies (continued)
Employment agreements
In conjunction with the consummation of the Reverse Acquisition, the Company
entered into employment agreements with five executives who were the principal
pre-Reverse Acquisition owners of NetWolves, LLC. Two of these executives were
subsequently terminated, one resigned and one executive restructured his
employment contract as discussed below. Each of the agreements are substantially
identical and provide for the following significant terms:
-- employment term of three years commencing June 1999, with automatic
renewals for additional three-year terms unless terminated by the Company
for cause or terminated by the executive,
-- salary of $100,000, increasing up to $250,000, dependent on specified
revenue targets,
-- bonus of 2% of the Company's gross profit, and
-- 200,000 warrants for four of the executives and 180,000 warrants for the
fifth executive (see Note 10).
In January 1999, two of the five executives were terminated pursuant to a
Settlement Agreement and Mutual Release. In exchange for terminating the
employment agreements and cancellation of 380,000 warrants (in total) previously
issued, the Company paid each terminated executive $50,000 in cash and entered
into a Manufacturer's Representation Agreement ("MRA"). The MRA appointed the
terminated executives as independent, non-exclusive sales persons to promote the
sale of the Company's products. The MRA was for a one-year term commencing
January 1999 and provided for a 5% commission on all net sales attributed to
such representative. Additionally, each of the terminated executives received
50,000 performance-based warrants which were subsequently canceled (see Note
10).
On September 2, 1999, one of the five executives restructured his employment
agreement whereby the executive tendered his resignation as a Director and as
Chief Operating Officer of the Company effective August 1, 1999 with his
employment agreement terminating on June 15, 2001. In addition, 50,000 of the
executive's 200,000 warrants were cancelled.
Effective July 15, 2000, one of the five executives resigned as an officer and
director of the Company and no longer receives salary from the Company.
In connection with the Merger (Note 4), TSG entered into employment agreements
with 5 executives who were the principals of SMCI. Each of the agreements are
substantially identical and provide for the following significant terms:
-- employment terms of three years with automatic renewals for additional
one-year terms unless terminated by either party through written notice,
-- annual salaries of $150,000 for two individuals and $100,000 for three
individuals adjusted annually for cost of living increases,
F-33
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED JUNE 30, 2000 AND 1999 AND THE PERIOD
FROM FEBRUARY 13, 1998 (INCEPTION) TO JUNE 30, 1998
15 Commitments and contingencies (continued)
Employment agreements (continued)
-- two of the executives shall each receive 5% of pre-tax profits of TSG (up
to a maximum of 100% of each employee's base salary) and three of the
executives shall each receive 1.67% of pre-tax profits of TSG (up to a
maximum of 50% of each employee's base salary),
-- An aggregate of 605,000 incentive TSG stock options issued to the employees
(Note 4),
-- An aggregate of 175,000 contingently issuable incentive TSG stock options
to the employees (Note 4),
-- If within eighteen months of the Merger, TSG has not initiated an initial
public offering or acquired a publicly held shell, two executives shall
receive 10% of pre- tax profits of TSG up to $10 million and 5% of pre-tax
profits in excess of $10 million, not to exceed, in the aggregate, $1.5
million in compensation in any year.
In August 2000 the Company entered in to employment agreements with four
employees. One of the agreements is for a period of three years and grants the
employee warrants to purchase 250,000 shares of common stock of the Company at a
purchase price of $5.25 per share, subject to a vesting schedule as specified in
such agreement. Another agreement is for a thirty-month period and provides for
a monthly salary of $12,000, plus reimbursement of certain expenses of $3,000
per month. In addition, the agreement also grants the employee warrants to
purchase 350,000 shares of common stock of the Company at a purchase price of
$5.25 per share, subject to a vesting schedule as specified in such agreement.
Another agreement is for a period of three years and grants the employee
warrants to purchase 275,000 shares of common stock of the Company at a purchase
price of $5-1/8 per share, subject to a vesting schedule as specified in such
agreement; and the last agreement is for a period of three years and provides
for a monthly salary of $5,000, and the agreement also grants the employee
warrants to purchase 200,000 shares of common stock of the Company at a purchase
price of $5.25 per share, subject to a vesting schedule as specified in such
agreement.
Pension Plan
As of a result of the Merger, TSG has assumed the obligations of a defined
contribution plan that provides retirement benefits to qualified TSG employees.
Company contributions to the plan are discretionary. In addition, employees have
the option of deferring and contributing a portion of their annual compensation
to the plan in accordance with the provisions of the plan.
Comdisco, Inc. agreement
On July 26, 1999 the Company entered into an agreement with Comdisco, Inc.
("Comdisco") whereby Comdisco will provide management, installation and
technology services to the Company's proprietary Internet distribution system.
In addition, the agreement provides for the creation of a credit facility to be
utilized in connection with the sale and installation of the FoxBox over a
four-year period. However, there can be no assurances that the Company will
actually require the use of the credit facility.
F-34
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED JUNE 30, 2000 AND 1999 AND THE PERIOD
FROM FEBRUARY 13, 1998 (INCEPTION) TO JUNE 30, 1998
15 Commitments and contingencies (continued)
Legal matters
On April 19, 2000, an action was commenced against the Company in the U.S.
District Court for the Northern District of Illinois by Anicom, Inc. The action
is based upon NetWolves' alleged failure to deliver approximately 74,842 shares
of its common stock to Anicom, upon exercise by Anicom of the Company's
warrants. The action seeks specific performance as well as any damages that may
result from a diminution in value of NetWolves common stock. Anicom has moved
for summary judgment in this action which has been opposed by the Company. The
parties are awaiting judicial decision. The Company intends to vigorously defend
itself against this action and believes it will be meritorous.
Certain claims, suits and complaints arising in the normal course with respect
to the Company's uniformed security guard services operations have been filed or
are pending against the Company. Generally, these matters are all covered by a
general liability insurance policy. In the opinion of management, all such
matters are without merit or are of such kind, or involve such matters, as would
not have a significant effect on the financial position or results of operations
of the Company, if disposed of unfavorably.
16 Subsequent events
Lease agreement
In September 2000, the Company entered into a five year lease agreement in
Tampa, Florida covering approximately 20,000 sq. ft. of space at approximately
$390,000 annually to which it intends to relocate its corporate headquarters and
research and development facilities in Tampa in or about November 2000. The
Company believes that combining its Tampa operations into one facility will
increase efficiency of operations. The Company intends to sublease its other
facilities in Tampa, Florida.
F-35
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of NetWolves Corporation
The audit referred to in our report dated August 24, 2000 (with respect to Notes
4,10, 15 and 16 - October 10, 2000) on the consolidated financial statements of
NetWolves Corporation and subsidiaries, which appear in Part II, also include
Schedule II for the year ended June 30, 2000. This schedule is the
responsibility of the Company's management. Our responsibility is to express an
opinion based on our audit. In our opinion, the financial statement schedule
referred to above, when considered in relation to the basic financial statements
taken as a whole, presents fairly in all material respects the information set
forth therein, in compliance with the applicable accounting regulations of the
Securities and Exchange Commission.
/s/ Richard A. Eisner & Company, LLP
New York, New York
August 24, 2000
<PAGE>
Board of Directors and Shareholders
NetWolves Corporation
Melville, New York
INDEPENDENT AUDITOR'S REPORT
We have audited the consolidated financial statements of NetWolves Corporation
and subsidiaries (the "Company") as of June 30, 1999, and financial statements
for the year ended June 30, 1999 and the period from February 13, 1998
(inception) to June 30, 1998, and have issued our report thereon dated August
12, 1999; such consolidated financial statements and report are included
elsewhere in this Form 10-K. Our audits also included Schedule II for the year
ended June 30, 1999 and the period from February 13, 1998 (inception) to June
30, 1998. The financial statement schedule is the responsibility of the
Company's management. Our responsibility is to express an opinion based on our
audits. In our opinion, such financial statement schedule, when considered in
relation to the basic consolidated financial statements taken as a whole,
present fairly in all material respects the information set forth therein, in
compliance with the applicable accounting regulations of the Securities and
Exchange Commission.
/s/ Hays & Company
August 12, 1999
New York, New York
<PAGE>
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
<TABLE>
<CAPTION>
Additions
Balance at Charged to Deductions Balance
Beginning Costs and from at End
of Period Expenses Allowances of Period
<S> <C> <C> <C> <C>
Year ended June 30, 2000:
Allowance for doubtful accounts receivable $ 40,000 $ 30,000 $ 25,253 $ 44,747
Provision for impairment of intangible assets $ 0 $ 4,016,080 $ 0 $4,016,080
Year ended June 30, 1999:
Allowance for doubtful accounts receivable $ 0 $ 40,000 $ 0 $ 40,000
Provision for impairment of long lived assets $ 0 $ 0 $ 0 $ 0
Period from February 13, 1998 (inception) to
June 30, 1998:
Allowance for doubtful accounts receivable $ 0 $ 0 $ 0 $ 0
Provision for impairment of long lived assets $ 0 $ 0 $ 0 $ 0
</TABLE>
