SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K/A
AMENDMENT No. 3
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended June 30, 1999
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File No. 0-25831
NetWolves Corporation
(Exact name of registrant as specified in its charter)
New York 11-3430302
(State or other jurisdiction of (I.R.S. Employer Identification No.
incorporation or organization)
200 Broadhollow Road, Melville, New York 11747
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (516) 393-5016
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.0033 per share
(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 [ ]
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].
State the aggregate market value of the voting stock held by non-affiliates of
the registrant. (The aggregate market value shall be computed by reference to
the price at which the stock was sold, or the average bid and asked prices of
such stock, as of a specified date within 60 days prior to the date of filing).
As of September 30, 1999 - approximately $127,095,190.
Indicate the number of shares outstanding of each of the registrant's classes of
common stock, as of the latest practicable date (applicable only to corporate
registrants). Common Stock, par value $.0033 per share; outstanding as of
September 30, 1999 - 6,176,016.
<PAGE>
ITEM 1. BUSINESS
General
NetWolves Corporation ("NetWolves" or the "Company") designs, develops and
sells products which provide a secure, integrated, modular internet gateway. The
products connect business networks comprised of multiple computers sharing both
small and large geographic areas to the Internet. The primary product, the
FoxBox, is multi-functional. It supports secure access to the Internet for 3 to
400 users through a single dedicated connection or up to 8 users simultaneously
through a non-dedicated connection, provides advanced electronic mail functions
for unlimited users and delivers firewall security to protect the computers of a
private network from access by other users. 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. In furtherance of this objective, the Company has
entered into agreements with Anicom, Inc. and Comdisco, Inc., and has acquired
The Sullivan Group ("TSG"), Inc.
In January 1999, NetWolves entered into a distribution agreement with
Anicom, Inc. appointing Anicom, Inc. as the exclusive master distributor of its
products in North America subject to certain minimum purchase requirements.
Anicom is one of the largest distributors in the United States of multimedia
wiring systems with customers including Cisco Systems and Fast Com and intends
to sell the Company's products to its 75 offices located in the United States.
In addition, Anicom will maintain inventory of the FoxBox from all 75 locations
and intends to distribute the FoxBox nationwide. The Company delivered its first
significant order, approximately $1,700,000, in March/April 1999.
In January 1999, the Company entered into an agreement with 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 which includes Amoco
Oil, British Petroleum, Chevron, Chrysler, Exxon, General Motors, Mobil Oil
Shell, 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
approximately 40,000 retail locations throughout the United States. NetWolves is
customizing an Internet solution specifically to deliver distance learning to
these locations utilizing its FoxBox technology.
<PAGE>
In July 1999, the Company entered into a merger agreement pursuant to which
it acquired the outstanding capital stock of The Sullivan Group in exchange for
180,000 restricted shares of the Company's common stock. The five principal
officers and employees of The Sullivan Group were retained under long-term
employment contracts. To finance the anticipated sales to be generated from the
application of the FoxBox technology to The Sullivan Group's client base, in
July 1999, the Company entered into an agreement with Comdisco, Inc. under which
Comdisco has provided the Company access to a credit facility for up to 40,000
locations. This credit facility is intended to be utilized in connection with
Comdisco installing the FoxBox in up to 40,000 locations over a four year
period. Comdisco also has agreed to provide management, installation and
technology services with respect to the sale of the FoxBox to The Sullivan
Group's clients.
NetWolves, LLC was an Ohio limited liability company formed on February 13,
1998, which was merged into Watchdog Patrols, Inc. 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, Watchdog changed its name to NetWolves Corporation
and the former NetWolves LLC members owned 61.2% of the outstanding common stock
of NetWolves Corporation. NetWolves LLC was not affiliated with Watchdog prior
to the merger.
Products and Services
The FoxBox is a multi-services internet communications gateway that offers
a combined internet access and firewall security solution. The FoxBox includes
the following products or services which would have to be purchased separately
to achieve the same functionality: an exchange server, a web server, a firewall
which protects the computers of a private network from access by other users, a
router, internet hardware and software setup, and product training. The FoxBox
costs substantially less than purchasing its functionality in separate products,
which costs would exceed $30,000. Further, its "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,
and a common interface. This facilitates expansion and support of the converging
voice and data industries. NetWolves currently offers five FoxBox models: FoxBox
DDR, at a suggested wholesale price of $3,400; FoxBox ISDN, at a price of
$4,400; FoxBox 56K, for $5,500; FoxBox T1, for $7,100; and FoxBox S2E, for
$4,100.
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 files from one file to another.
<PAGE>
-- 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.
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 9.1 gigabyte SCSI hard drive provides extra storage for shared
files and Web data.
<PAGE>
-- 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 a high end firewall
security protection, without requiring the purchase of additional components.
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 (or 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 receiver of information.
<PAGE>
All packets of data entering the FoxBox from the Internet are first checked
for validity against a series of stateful packet filters. The 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 ISDN 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 S2E 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 e-mail standards.
For e-mail between a FoxBox and the Internet, NetWolves uses the standard simple
mail transfer protocol (SMTP), which is the standard for e-mail transmission on
the Internet. SMTP is accomplished using a product called Sendmail, version
8.8.8, which is the standard SMTP server on the Internet. Sendmail manages the
sending of e-mail from a FoxBox to any other host 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
-- Microsoft Internet Mail
-- Netscape Navigator Mail
-- Eudora
-- Pegasus
The FoxBox supports several e-mail gateways, including:
-- Microsoft Exchange Server
-- Lotus cc: Mail
-- GroupWise Mail
-- Others with SMTP gateways
<PAGE>
Graphical User Interface for Administration/Management
A Web-based graphical user interface, or GUI 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.
Anicom
In January 1999, NetWolves entered into an agreement with Anicom. The
agreement appoints Anicom as NetWolves' exclusive master distributor of its
products throughout North America for a five year period. There are minimum
purchase requirements under the agreement to maintain exclusivity though there
are no specific purchase commitments beyond its initial order which was
delivered in March/April 1999. NetWolves has also reserved the right to make
direct sales or leases of its products to customers, distributors and Anicom
resellers during the term of the agreement provided that it pays a stipulated
commission to Anicom of such sales. The agreement further provides for Anicom to
maintain inventory of NetWolves' products and to distribute these products
throughout its 75 locations in the United States. The agreement provides for
certain rights of termination, including the option of NetWolves to terminate
during the first two years of the agreement on 30 days prior written notice
provided that, as a condition to the effectiveness of such termination,
NetWolves shall pay Anicom a stipulated fee. Anicom's only rights to terminate
are in the event of bankruptcy or insolvency proceedings against NetWolves or in
the event the products covered the agreement cease to be manufactured by or on
behalf of NetWolves. In the event of termination by Anicom, Anicom has the
right, but not the obligation, to direct NetWolves to repurchase from Anicom any
portion of any new undamaged and unused products sold within a one year period
and owned by and remaining in Anicom's inventory. For the fiscal year ended June
30, 1999, the Company shipped approximately $1,700,000 of product to Anicom
which accounted for approximately 95% of the Company's revenue for such fiscal
year. The Company does not believe the loss of Anicom would have a material
effect on its operations since its current business strategy is the direct sales
of its products to customers and does not intend to rely on Anicom substantially
in future business operations.
Additionally, 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.
The Sullivan Group
In January 1999, NetWolves entered into an agreement with The Sullivan
Group ("TSG"), a leading consulting organization serving the needs of the
automotive aftermarket, convenience store and oil industry for more than ten
years. Its senior management comprises former high-level executives from the
<PAGE>
industry it serves. TSG provides its clients with competitive and comparative
industry intelligence generally categorized as benchmarking studies,
best-in-class performance and emerging industry trends. TSG also employs its
Profit Coach System , a profit-driven management process used to provide
information to its clients. Through its division, The Duffy-Vinet Institute, it
also maintains an extensive library of training modules.
Under the January 1999 agreement with NetWolves, NetWolves was appointed
the exclusive provider of multi-services internet gateway products, which is
intended to enable TSG to sell its proprietary training programs to
approximately 40,000 retail locations throughout the United States. This
combined technology is intended to facilitate simultaneous interactive distance
learning at all sites. The agreement is for a period of five years with an
automatic five year renewal unless previously terminated. NetWolves also agreed
to customize its FoxBox to serve the needs of TSG.
Initial deliveries are scheduled to commence in the quarter ending December
31, 1999. While deliveries will be made against specific purchase orders yet to
be received, NetWolves has agreed to deliver to TSG's customers approximately
40,000 units over a five calendar year period ranging from 350 units in 1999 and
4,150 units in 2000 to 14,000 in 2003. It is intended that the units will be
leased over a 48 month term at a monthly rate of $200 per unit.
In July 1999, the Company entered into a merger agreement pursuant to which
it acquired the outstanding capital stock of TSG in exchange for 180,000
restricted shares of its common stock. The five principal officers and employees
of TSG were retained under three-year employment contracts. The merger provides
for the Company to make working capital advances to its TSG subsidiary of up to
$4,750,000 through November 15, 1999. Through September 30, 1999, $2,600,000 in
advances have been made. Under the agreement, NetWolves has the right to provide
no additional advances, in which event its equity interest in TSG would be
reduced. See Note 4 of Notes to Consolidated Financial Statements.
To finance the anticipated sales to be generated from the application of
the FoxBox technology to TSG's client base, in July 1999, the Company entered
into an agreement with Comdisco under which Comdisco has provided the Company
access a credit facility to be utilized in connection with Comdisco installing
the FoxBox in up to 40,000 locations over a four year period. Under the
agreement, the Company intends to lease the FoxBox to its customers for 48
months at a monthly fee estimated under the agreement at $200 . Comdisco will
then acquire all of the right, title and interest in the equipment with the
exception of intellectual property rights, software upgrades and software
application and content and take an assignment of the lease from the Company,
without recourse. At the time of assignment, Comdisco will pay the Company 95%
of the present value of the rental stream using an interest rate commensurate
with each customer's credit rating and prevailing market rates.
Research and Development
The internet and the computer hardware and software industry are
characterized by rapid technological change, which requires ongoing development
<PAGE>
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' research and development organization 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. As of September 30, 1999, the Company's research and development
group consists of nineteen 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.
For the year ended June 30, 1999, the Company expended approximately
$418,000 for research and development expenses. The Company intends to increase
its investment in product development and believes that its future services 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 is Boca Research, Inc., a
hardware assembly and engineering firm located in Boca Raton, Florida. In
September 1999, the Company entered into a strategic alliance agreement with
Boca Research. Under the terms of the agreement, Boca Research has agreed to
manufacture the FoxBox on a non-exclusive basis and has provided 250 FoxBox
units for immediate delivery. The two-year agreement also provides (a) for Boca
Research to provide certain engineering services to the Company necessary to
enable Boca Research to manufacture a thin client unit for use by TSG and (b)
the purchase of a minimum of 2,000 thin client units by the Company during the
two year agreement. The agreement further contemplates the parties negotiating
in good faith a joint marketing agreement wherein the Company would license Boca
the right to manufacture equipment comprising the FoxBox technology on an OEM,
private label basis in certain limited sales channels. To date, no marketing
agreement has been executed.
While the Company maintains a relationship with Boca Research which existed
prior to its September 1999 agreement, 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
<PAGE>
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.
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 criteria,
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 strategy of marketing and sales plan for it to enter into
agreements with providers of products in a wide variety of markets, including
financial, medical, legal, travel, hospitality, entertainment, hotel and the
auto industries in order to leverage their existing client base for sales of the
Company's products. With this objective, the Company has entered into the
aforesaid agreements with Anicom, Inc. and Comdisco, Inc. and is seeking
additional strategic alliances both domestically and on a worldwide basis,
including the proposed marketing agreement with Boca Research. The Company
intends to hire sales and marketing consultants in five (5) regional areas, New
York, Tampa, Chicago, Washington D. C. and Los Angeles. These persons will
perform several important functions including managing the master distribution
agreements between the Company and its partners and also customizing solutions
for the various market segments.
The Company has implemented marketing initiatives to support the sales and
distribution of its products and services, and to communicate corporate
direction. The Company's sales and marketing employees are responsible for
<PAGE>
collateral development, lead generation and awareness of the Company and its
products. Marketing programs include public relations, seminars, industry
conferences and trade shows, advertising and direct mail. The Company's
marketing employees also contribute to both the product direction and strategic
planning processes by providing 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. The Company does not currently have any
patents or pending patent applications. Notwithstanding the efforts the Company
takes to protect its proprietary rights, existing trade secret, copyright, and
trademark laws afford only limited protection. In addition, effective protection
of copyrights, trade secrets, trademarks and other proprietary rights may be
unavailable or limited in certain foreign countries. The Company believes that,
because of the rapid rate of technological change in the computer industry,
factors such as the knowledge, ability and experience of the Company's
employees, product and service offering development, and quality of customer
support services are more important than any available trade secret or copyright
protection.
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 products are intended to be licensed generally pursuant to
licensing 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. The first year of maintenance is bundled with
standard licensing agreements. 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
The Company faces competition from the manufacturers of several different
types of products used as multi-service packaged solutions for Internet
gateways. Its major competitors are Whistle, which was recently acquired by IBM,
Team Internet and Free Gate. 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.
<PAGE>
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
price and overall cost of ownership including administrative and maintenance
costs. However, equally important are other factors, including but not limited
to, 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.
Employees
As of September 30, 1999, the Company employed 38 full-time employees.
Approximately, 19 of these employees are involved in research and development,
13 in sales and marketing, and 6 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.
<PAGE>
Officers of the Registrant
Served as
Name Age Officer Since Position
- ---- --- ------------- --------
Walter M Groteke 29 June 1998 Chairman of the Board,
President and
Chief Executive Officer
Daniel G. Stephens 28 June 1998 Vice Chairman of the Board
and Chief Information
Officer
Walter R. Groteke 52 August 1998 Vice President - Sales
and Marketing
ITEM 2. PROPERTIES
The Company maintains approximately 250 square feet of office space in
Melville, New York at a monthly rental of approximately $1,600, which currently
accommodates the Company's headquarters for administrative and financial
functions. The lease expired in January and is currently on a month-to-month
basis. The Company has a three year lease expiring in August 2001 for
approximately 4,100 square feet of space in Tampa, Florida, which currently
accommodates the Company's research and development facilities. The annual rent
is approximately $28,500. The Company also maintains leased facilities in Tampa
under a three year lease expiring in June 2002 for approximately 6,340 square
feet that is used for administrative, sales and marketing purposes. The annual
rent is approximately $163,500. The Company believes that its present facilities
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
There are no material legal proceedings, other than ordinary routine
litigation incidental to the business, to which the Company or any of its
subsidiaries is ai party or of which any of their property is the subject.
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.
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
(a) NetWolves' common stock has traded on the OTC Bulletin Board under the
symbol "WOLV" since December 1998. Prior to the December 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>
1999
Third Quarter . . . . . . . . . . $31.25 $16.50
Second Quarter. . . . . . . . . . 22.25 9.75
First Quarter . . . . . . . . . . 16.00 4.50
1998
Fourth Quarter. . . . . . . . . . $4.875 $3.25
Third Quarter . . . . . . . . . . 7.75 4.50
Second Quarter (since June 17, 1998) . . . 5.00 1.625
</TABLE>
As of September 30, 1999, there were approximately 183 holders of record of
the common stock. On September 30, 1999, the closing sales price of NetWolves
common stock was $26.00 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. In this regard, the
Company will be submitting for shareholder approval a proposal giving the Board
of Directors discretion to approve a two-for-one or three-for-one stock split.
The transfer agent and registrar of NetWolves' Common Stock is American
Stock Transfer and Trust Co., 40 Wall Street, New York, New York 10005.
(b) (i) In May and June 1999 in connection with a private offering of 80
units, with each unit consisting of 10,000 shares of common stock at $7.50 per
share, the Company issued 800,000 shares of its common stock to approximately 80
accredited investors for an aggregate of $6,000,000. Joseph Gunnar & Co., LLC
acted as the placement agent for this offering for which they received a 9%
commission and unallocated expenses of $160,000, They also received 80,000
warrants exercisable for four years commencing in May 2000 at an exercise price
of $9.375 per share. This was a transaction by the Company not involving any
public offering which was exempt from the registration requirements under the
Securities Act pursuant to Section 4(2) and Rule 506 of Regulation D thereof.
<PAGE>
(ii) In July 1999, 60,000 shares of the Company's common stock were issued
to Internet Technologies, Inc. for services rendered in connection with
negotiations and structuring the private offering with Joseph Gunnar & Co., LLC
More specifically, Internet Technologies, Inc. assisted the Company in preparing
their presentation to Joseph Gunnar & Co. and in negotiating the price and other
financial terms of the offering, including the underwriters compensation. They
were also instrumental in the Company not having to provide any registration
rights to the participants in the offering. The value of the shares issued to
Internet Technologies in this transaction was $1,245,000, which was charged to
equity in the fourth quarter of fiscal 1999. This was a transaction by the
Company not involving any public offering which was exempt from the registration
requirements under the Securities Act pursuant to Section 4(2) thereof.
(iii) On June 30, 1999, an aggregate of 180,000 shares of the Company's
common stock were issued to the five principals of the acquired company as
partial consideration for the acquisition of The Sullivan Group, Inc. pursuant
to a merger agreement with the Company. The shareholders are restricted from
selling, transferring or pledging such shares for an 18 month period. The value
of the shares issued to the Sullivan Group principals in this transaction was
$4,095,000. This was a transaction by the Company not involving any public
offering which was exempt from the registration requirements under the
Securities Act pursuant to Section 4(2) thereof.
(iv) From September 29, 1999 through November 4, 1999, an aggregate of
282,500 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 $4,237,500. This
was a transaction by the Company not involving any public offering which was
exempt from the registration requirements under the Securities Act pursuant to
Section 4(2) and Rule 506 of Regulation D thereof.
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data has been derived from the
consolidated financial statements included elsewhere in this report and should
be read in conjunction with such financial statements.
<TABLE>
<CAPTION>
Period from
February 13, 1998
(inception) to Year ended
June 30, 1998 June 30, 1999
------------------ -------------
<S> <C> <C>
Statements of Operations Data:
Net sales $ 29,621 $1,789,144
Cost of sales 5,681 582,724
--------- ----------
Gross profit 23,940 1,206,420
Operating expenses 149,510 8,666,381
--------- ----------
Loss before other income (expense)
and benefit from income taxes (125,570) (7,459,961)
Interest income (expense), net 2,666 48,154
Other income 3,490 488,793
---------- ----------
Loss before benefit from income taxes (119,414) (5,955,327)
Benefit from income taxes 20,000 -
---------- -----------
Net loss $ (99,414) $(6,923,014)
========== ===========
Basic and diluted net loss per share $ (0.04) $ (1.48)
========== ===========
Weighted average common shares
outstanding 2,810,102 4,691,651
==========
June 30,
--------
1998 1999
---- ----
Financial position:
Cash and cash equivalents $1,118,416 $ 5,585,981
Marketable securities, available
for sale 1,063,828 606,000
Working capital 2,918,327 5,799,246
Total assets 2,959,451 12,811,934
Long-term debt, net of current maturities 0 266,537
Minority interest 0 704,500
Total shareholders' equity 2,928,003 11,099,802
</TABLE>
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Forward-looking statements
This Form 10-K includes, without limitation, certain statements containing
the words "believes", "anticipates", "estimates", and words of a similar nature,
constitute "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. This Act provides a "safe harbor" for
forward-looking statements to encourage companies to provide prospective
information about themselves so long as they identify these statements as
forward looking and provide meaningful, cautionary statements identifying
important factors that could cause actual results to differ from the projected
results. All statements other than statements of historical fact made in this
Form 10-K are forward-looking. In particular, the statements herein regarding
industry prospects and future results of operations or financial position are
forward-looking statements. Forward-looking statements reflect management's
current expectations and are inherently uncertain. The Company's actual results
may differ significantly from management's expectations.
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 3 to 400
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. In January 1999 the Company was able to
secure two Agreements which have the potential to generate significant revenues
over the term of the agreement. The first of which would be TSG ("Sullivan")
agreement whereby Sullivan appointed the Company as its exclusive provider of
the Company's multi-service Internet delivery system (known as "FoxBox") to be
used in conjunction with Sullivan's proprietary interactive distance learning
training programs. The period of the agreement is for a term of five years. In
July 1999, the Company acquired TSG and in July 1999 secured a credit facility
with Comdisco, Inc. to finance the anticipated sales to be generated from the
application of the FoxBox technology to TSG's client base in up to 40,000
locations over a four year period. Under the agreement, the Company intends to
lease the FoxBox to its customers for 48 months at a monthly fee estimated under
the agreement at $200 . Comdisco will then acquire all of the right, title and
<PAGE>
interest in the equipment with the exception of intellectual property rights,
software upgrades and software application and content and take an assignment of
the lease from the Company, without recourse. At the time of assignment,
Comdisco will pay the Company 95% of the present value of the rental stream
using an interest rate commensurate with each customer's credit rating and
prevailing market rates. The second agreement is with Anicom, Inc. ("Anicom").
The Company entered into a five-year exclusive master distribution agreement
with Anicom, Inc. to distribute the FoxBox throughout North America.
The Company has a limited operating history in which to base an evaluation
of the business and prospects. The Company's prospects must be considered in
light of the risks frequently encountered by companies in their early stages,
particularly for companies in the rapidly evolving technology industry. Certain
risks for the Company include, but are not limited to unproven business model,
capital requirements and growth management. To counter this risk, the Company
must, among other things, increase its customer base, continue to develop its
distribution network, successfully execute its business and marketing plan, and
expand the operating infrastructure. There can be no assurance that the Company
will be successful in addressing such risk, and the failure to do so could have
a material adverse effect on the Company's financial condition and results of
operations. Since inception the Company has incurred significant losses and as
of June 30, 1999 had an accumulated deficit of approximately $7 million. The
Company believes that its success depends in large part on its ability to create
market awareness and acceptance for the FoxBox, raise additional operating
capital to grow operations, build technology and non-technology infrastructures,
expand the sales force and distribution network, and continue new product R&D.
Results of Operations
For the year ended June 30, 1999 compared to the period from February 13, 1998
(inception) through June 30, 1998
The net sales from operations were $1,789,144 and $29,621 for the periods
June 30, 1999 and June 30, 1998, respectively. Sales in 1999 almost entirely
relate to the initial stocking order of 500 FoxBox units sold to Anicom in
March/April 1999. $58,429 of dividend and interest income was generated through
June 30, 1999 as compared to $6,156 for the period ended June 30, 1998. The
increase is primarily attributable to the relative short time for which the
securities were held in the prior period. Additionally, the Company had a gain
of $478,518 on the sale of marketable securities.
NetWolves had gross profit of 67% for the period ended June 30, 1999. As of
yet, the Company has not had a full year of production in order to have a basis
of comparison. However, the Company believes that gross profit greater than 67%
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 goods sold." 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.
Additionally, this allows the Company to focus its core R&D efforts on
developing cutting edge Software. 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.
<PAGE>
Operating expenses were $8,666,381 and $149,510 for the periods June 30,
1999 and June 30, 1998, respectively. The operating expenses for June 30, 1999
consisted primarily of $6,053,754 of general and administrative costs relating
to the establishment of the infrastructure and the continued operations of the
business. $418,109 of costs were incurred relating to research and development,
and $2,194,518 related to selling and marketing. Included in the above mentioned
operating expenses are $5,162,750 of compensation for services in the form of
the Company's common stock and options. Operating expenses for the period June
30, 1998 were limited and provide an inadequate basis for comparability
purposes.
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 which generated
$5.4 million (net of $.6 million of expenses) to be used in operations.
In July 1999 the Company secured a credit facility with Comdisco, Inc. to
finance the anticipated sales to be generated from the application of the FoxBox
technology to TSG's client base in up to 40,000 locations over a four year
period. Under the agreement, the Company intends to lease the FoxBox to its
customers for 48 months at a monthly fee estimated under the agreement at $200.
Comdisco will then acquire all of the right, title and interest in the equipment
with the exception of intellectual property rights, software upgrades and
software application and content and take an assignment of the lease from the
Company, without recourse. At the time of assignment, Comdisco will pay the
Company 95% of the present value of the rental stream using an interest rate
commensurate with each customer's credit rating and prevailing market rates. The
agreement with Comdisco also provides for certain payments if the customer
elects to purchase the FoxBox instead of leasing the equipment. If a customer
elects to purchase the FoxBox and elects not to have the equipment serviced by
Comdisco, Comdisco will remit to the Company an amount equal to the purchase
price of the equipment less $1,400. If the customer elects to have Comdisco
service the equipment, the full purchase price will by paid by Comdisco to the
Company.
NetWolves had cash and cash equivalents of $5.6 million and $1.1 million at
June 30, 1999 and June 30, 1998, respectively. In September 1999, the Company
completed a private placement of 100,000 shares of common stock to one
accredited investor for $1.4 million (net of $100,000 of expenses). Management
believes that the Company has adequate capital resources to meet its working
capital need for at least the next twelve months based upon its current
operating level. 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.
<PAGE>
Year 2000 Issues
Background. Some computers, software, and other equipment include
programming code in which calendar year data is abbreviated to only two digits.
As a result of this design decision, some of these systems could fail to operate
or fail to produce correct results if "00" is interpreted to mean 1900, rather
than 2000. These problems are widely expected to increase in frequency and
severity as the year 2000 approaches and are commonly referred to as the
"Millennium Bug" or "Year 2000 problem.
Assessment. The Year 2000 problem could affect computers, software, and
other equipment which NetWolves Corporation uses, operates, or maintains.
Accordingly, NetWolves Corporation has reviewed its internal computer programs
and systems to ensure that the programs and systems are Year 2000 compliant.
NetWolves Corporation presently believes that its computer systems are Year 2000
compliant. However, while the estimated cost of these efforts is not expected to
be material to its overall financial position, or any year's results of
operations, there can be no assurance to this effect.
Products Sold to Consumers. NetWolves Corporation believes that it has
substantially identified and resolved all potential Year 2000 problems with the
software products it develops and markets. However, it also believes that is not
possible to determine with complete certainty that all Year 2000 problems
affecting its products have been identified or corrected due to the complexity
of these products and the fact that these products interact with other third
party vendor products and operate with other systems which are not under its
control.
NetWolves Corporation recognizes the significance of the Year 2000 issue as
it relates to internal systems, including IT and non-IT systems. To that extent
NetWolves Corporation has achieved the following:
Internal Information Technology Infrastructure. NetWolves Corporation
believes that it has identified, modified upgraded, or replaced substantially
all of the major computers, software applications, and related equipment used in
connection with its internal operations in order to minimize the possibility of
a material disruption to its business. While most of the upgrades were planned
as part of a general enhancement to its infrastructure, the timing of the
upgrades also result in Year 2000 compliance.
Systems Other than Information Technology Systems. In addition to computers
and related systems, the operation of office and facilities equipment, such as
fax machines, photocopiers, telephone switches, security systems, elevators, and
other common devices may be affected by the Year 2000 problem. NetWolves
Corporation has assessed and remediated the effect of the Year 2000 problem on
its office and facilities equipment under its control, and the total costs
associated with completing the required modifications, upgrades, or replacements
of these internal systems were not material.
<PAGE>
Suppliers. NetWolves Corporation has initiated communications, including
surveys, with business critical third party suppliers of the major computers,
software, and other equipment which it uses, operates, or maintains to identify
and, to the extent possible, to resolve issues involving the Year 2000 problem.
NetWolves Corporation has received vendor certification that all of its business
critical information technology systems, including internal communications
systems, accounting and finance systems, customer service systems, and sales and
marketing tracking systems, are Year 2000 compliant. Accordingly, NetWolves
Corporation does not anticipate any significant Year 2000 problems with these
systems; however, it cannot ensure that these suppliers will resolve any or all
of their Year 2000 problems with these systems before the occurrence of a
material disruption to its business or that of its customers. NetWolves
Corporation believes that its primary exposure is presently with respect to
public utilities and telecommunications suppliers. Any failure of these third
parties to resolve Year 2000 problems with their systems in a timely manner
could have a material adverse affect on NetWolves Corporation business,
financial condition, and results of operation.
Additionally, NetWolves Corporation has initiated communications, including
surveys, with all other vendors or businesses that supply any service to
NetWolves Corporation. While it has limited or no control over responses to its
inquiries and the actions of these third party suppliers, NetWolves Corporation
does not view this category of services to be business critical and in the event
of a Year 2000 problem with a particular vendor, believes that those goods or
services could easily be obtained from other sources.
Banking Relationships. NetWolves Corporation has confined its banking
relationships to top tier financial institutions who have represented that their
respective systems are Year 2000 compliant.
Any failure of these banks to resolve Year 2000 problems with their systems
in a timely manner would result in financial inconvenience and, depending upon
the duration of the failure, could have a material adverse affect on NetWolves
Corporation financial condition and results of operation.
Most Likely Consequences of Year 2000 Problems. NetWolves Corporation
believes that it has identified all Year 2000 problems that could materially
adversely affect its business operations. However, it does not believe that it
is possible to determine with complete certainty that all Year 2000 problems
which effect it have been identified or corrected.
The number of devices that could be affected and the interactions among
these devices are simply too numerous. In addition, one cannot accurately
predict how many Year 2000 problem- related failures will occur or the severity,
duration, or financial consequences of these perhaps inevitable failures. In
addition, NetWolves Corporation is unable to determine with any degree of
certainty the changes in buying habits of its current and potential customers
due to their concerns over Year 2000 issues. As a result, NetWolves Corporation
expects that it could likely experience a significant number of operational
inconveniences and inefficiencies that may divert management's time and
attention and its financial and human resources from its ordinary business
activities. In addition, NetWolves Corporation may experience a lesser number of
serious system failures that may require significant efforts by it or its
customers to prevent or alleviate material business disruptions.
<PAGE>
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 and the report
thereon of Hays and Co. are included herein:
-- Report of Independent Public Accountants
-- Consolidated Balance Sheets at June 30, 1999 and 1998
-- Consolidated Statements of Operations, Cash Flows and Shareholders'
Equity for the year ended June 30, 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
<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:
Name Age Position
---- --- --------
Walter M Groteke 29 Chairman of the Board, President and
Chief Executive Officer
Daniel G. Stephens 28 Vice Chairman of the Board and
Chief Information Officer
Walter R. Groteke 52 Vice President - Sales and Marketing
and Director
Ed Lavin 55 Director
Louis Libin 40 Director
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.
Daniel G. Stephens, a co-founder of the Company, has been Vice Chairman of
the Board and Chief Information Officer since June 1998. Mr. Stephens directs
research and development, information systems and technical support services for
the Company. From May 1994 until 1997, Mr. Stephens was a senior systems
engineer for Techmatics, Inc. In this capacity, he advised the Department of
Justice on development of a nationwide series network infrastructure to support
a law- enforcement database.
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.
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
<PAGE>
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.
Louis Libin has been a director of the Company since February 1999. From
1997 to date, Mr. Libin has been a director, Chief Technology Officer and Senior
Vice President of e.TV Commerce, Inc., a Jacksonville, Florida network
distribution technology company. Mr. Libin is also a director and the Chief
Technology Officer of Compu-DAWN, Inc., a leading public safety software company
in the United States. Louis Libin is the founder of Broadcast Communications,
Inc. (Broad Comm), a broadcast project management group. Mr. Libin is a
world-renowned expert in wireless communications systems. At the International
Telecommunications Union in Geneva, Switzerland, Mr. Libin represents the United
States on satellite and transmission issues and is currently Chairman of the
expert group on interactive data services. Mr. Libin has over 15 years
experience in engineering, communications, and management. From 1983 to 1986,
Mr. Libin was employed by the Radio Corporation of American ("RCA") as a project
manager. In 1986, RCA was acquired by the General Electric Corporation ("G.E.").
From 1987 to 1997, Mr. Libin served as the Director of Technology for NBC/G.E.,
specializing in a broadcast transmission systems and is also an officer as
Corporate Secretary or Assistant Corporate Secretary for all G.E. wholly-owned
subsidiaries that deal in broadcast, with responsibility for technical
developments and all Federal Communications Commission ("FCC") issues and
licenses. From 1981 to 1982, Mr. Libin was employed by the Loral Corporation as
Electronic Design Engineer and designed Radio Frequency ("RF") systems for the
military. From 1979 to 1980 he worked for Burroughs Computer Systems, Inc. (now
UNISYS) as a Field Engineer and from 1980 to 1981 for the Chryon corporation as
Design Engineer.
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 $100,000 for services rendered
during the first year of the Company's operations as NetWolves, which was the
fiscal year ended June 30, 1999.
<PAGE>
<TABLE>
<CAPTION>
Summary Compensation Table
Annual Compensation
Name and Fiscal Other Annual
Principal Position Year Salary($) (1) Bonus($) Compensation($)(2)
- ------------------ ------- ------------- -------- ------------------
<S> <C> <C> <C> <C>
Walter M. Groteke 1999 $101,250 - -
Chairman and Chief 1998 - - -
Executive Officer
Daniel G. Stephens 1999 101,250 - -
Vice Chairman and Chief 1998 - - -
Information Officer
Kevin Sherlock 1999 100,000 - -
Chief Operating Officer 1998 - - -
- -----------
<FN>
(1) Represents compensation received under employment agreements. Mr. Sherlock
ceased being an officer or director of the Company effective August 1,
1999.
(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 $50,000 or 10% of the total annual base salary disclosed in the
table for the respective officer.
</FN>
</TABLE>
The following table sets forth information concerning options exercised
during the year ended June 30, 1999 by the named executive officers and the
value of unexercised options held by them as of June 30, 1999:
<TABLE>
<CAPTION>
Value of Unexercised
Number of Unexercised In-The-Money
Shares Options/SARs at Options/SARs at
Acquired on Value Fiscal Year End Fiscal Year End (1)
Name Exercise (#) Realized($) Exercisable Unexercisable Exercisable Unexercisable
---- ------------- ----------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Walter M. Groteke. . . . 0 0 0 200,000 0 $4,224,000
Daniel G. Stephens . . . 0 0 0 200,000 0 $4,224,000
Kevin Sherlock . . . . . 0 0 0 200,000 0 $4,224,000
- ------
<FN>
(1) Based upon the closing price of common stock of $22.75 on June 30, 1999.
</FN>
</TABLE>
Employment Agreements
Walter M. Groteke, Daniel G. Stephens and Kevin F. Sherlock entered into
employment agreements in June 1998 in connection with the acquisition of
Watchdog Patrols, Inc. ("Watchdog Patrols"). Pursuant to these agreements,
Messrs. Groteke, Stephens and Sherlock were employed as Chief Executive Officer,
Chief Information Officer and Chief Operating Officer, respectively, for a term
of three years. While Mr. Sherlock ceased being an officer and director of the
Company effective August 1, 1999, he continues to be employed under the terms of
his employment agreement, as amended. The current base salary for each person is
$130,000.
<PAGE>
The employment agreements with Messrs. Groteke, Stephens and Sherlock
further provide 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, Kevin F. Sherlock and Walter R.
Groteke also have entered into warrant agreements with the Company 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 are fully vested two years from their
respective dates of employment subject to acceleration under certain events.
These events include the sale or disposition of substantially all of the capital
stock or assets of the Company.
Stock Option Plan
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"
within the meaning of the Section 422 of the Internal Revenue Code of 1986, as
amended, "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 August 31, 1999, the Company had granted options to purchase
243,500 shares of common stock under the 1998 Incentive Plan to its officers and
key employees.
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, 1999, 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.
<PAGE>
<TABLE>
<CAPTION>
Amount and Nature
Name and Address of of Shares Percentage
Beneficial Owner (5) Beneficially Owned Ownership
- -------------------- -------------------- -----------
<S> <C> <C>
Greenleaf Capital Partners, LLC 861,360 13.9%
Walter M. Groteke 528,064 (1)(2) 8.6 %
Daniel G. Stephens 528,064 (1)(2) 8.6 %
Kevin F. Sherlock 528,064 (2)(3) 8.6 %
Walter R. Groteke 150,000 (1) 2.4 %
Internet Technologies, Inc. 320,000 5.2 %
Ed Lavin 50,000 *
Louis Libin 66,000 1.1 %
Kirlin Securities, Inc. 500,000 (4) 8.1 %
Executive officers and
directors as a group 1,322,128 21.4 %
* less than one percent (1%) unless otherwise indicated.
<FN>
(1) Does not include unvested warrants to purchase 200,000 shares at an option
price of $1.63 per share.
(2) Messrs. Walter M. Groteke, Daniel G. Stephens and Kevin F. Sherlock have
agreed that the shares owned by them may not be sold until June 17, 2000
without the prior written consent of Kirlin Securities.
(3) Does not include unvested warrants to purchase 150,000 shares at an option
price of $1.63 per share. Does not include unvested, performance based
warrants to purchase 50,000 shares each at an option price of $5.00 per
share.
(4) Represents warrants currently exercisable by Kirlin Securities 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.
(5) 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; Internet Technologies, Inc. - Mr. Louis McElwee; Kirlin
Securities, Inc. - Mr. Anthony Kirincic.
</FN>
</TABLE>
<PAGE>
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
On June 17, 1998, NetWolves, LLC merged into a subsidiary of Watchdog
Patrols, Inc., which thereafter changed its name to NetWolves Corporation. The
merger provided for exchange of securities of NetWolves, LLC for the securities
of the Company. The total capital contribution to NetWolves LLC by its members
was $64,245. As part of such exchange, principals of NetWolves, LLC received
2,640,322 shares of NetWolves Corporation for a per share cost of approximately
$.02. Messrs. Walter M. Groteke, Daniel G. Stephens, Jr. , Kevin F. Sherlock and
Keith A. Darling each received 528,064 shares and Mr. Marc Jacques received
475,258 shares. Messrs. Groteke, Stephens, Sherlock, Darling and Jacques also
each received 200,000 warrants in connection with the merger, exercisable at a
price of $1.63 per share. The exercise price was based upon the public trading
price of Watchdog Patrols Inc's common stock at the time of the acquisition.
Howard Habberstadt and Joseph Ariola acted as finders for the merger transaction
for which they received 75,000 warrants and 12,500 warrants, respectively,
exercisable at a price of $2.00 per share. The exercise price for the warrants
issued to Messrs. Habberstad and Ariola was determined through arms-length
negotiations between the parties.
Greenleaf Capital Partners LLC was a shareholder of Watchdog Patrols, Inc.
prior to the merger, having acquired 1,141,360 shares at an aggregate purchase
price of $2,200,000. Greenleaf Capital received demand registration rights in
connection with the merger. Pursuant to these rights, Greenleaf Capital or any
member or members of Greenleaf Capital owning at least 20% of the outstanding
shares of common stock owned by Greenleaf Capital, has the right to request in
writing that NetWolves register such shares under a registration statement to be
filed with the Securities and Exchange Commission. The Company is thereafter
required to file such registration statement within sixty (60) days after
receipt of the request. The Company is further obligated to maintain the
effectiveness of the registration statement until the securities covered
thereunder have been sold.
<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. *
10.1 Merger and Reorganization Agreement dated June 15, 1998 among
Watchdog Patrols, Inc., Watchdog Acquisition Corp. and NetWolves,
LLC. *
10.2 Agreement between The Sullivan Group and NetWolves Corporation dated
January 5, 1999. *
10.3 Distribution Agreement between NetWolves Corporation and Anicom, Inc.
dated as of January 18, 1999. *
10.4 Employment Agreement between NetWolves Corporation and Daniel G.
Stephens, Jr. dated June 17, 1998.*
10.5 Employment Agreement between NetWolves Corporation and Walter M.
Groteke dated June 17, 1998.*
10.6 Employment Agreement between NetWolves Corporation and Kevin F.
Sherlock dated June 17, 1998.*
10.7 Warrant Agreement between NetWolves Corporation and Walter M. Groteke
dated June 17, 1998.*
10.8 Warrant Agreement between NetWolves Corporation and Daniel G.
Stephens, Jr. dated June 17, 1998.*
10.9 Warrant Agreement between NetWolves Corporation and Kevin F. Sherlock
dated June 17, 1998.*
10.10 Stock Option Plan.*
10.11 Form of Indemnification Agreement*
10.12 Settlement Agreement and Mutual Release with Keith Darling.*
10.13 Settlement Agreement and Mutual Release with Mark Jacques.*
10.14 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. **
10.15 Master Program Agreement dated July 26, 1999 between NetWolves
Corporation and Comdisco, Inc.****
10.16 First Amendment to Employment Agreement of Kevin F. Sherlock dated
September 2, 1999.***
10.17 Strategic Alliance Agreement dated as of September 10, 1999 between
Boca Research, Inc. and NetWolves Technologies, Inc.****
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-K/A, Amendment
No. 1 .
**** Previously filed as an exhibit to Report on Form 10-K/A, Amendment
No. 2.
<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 9th day of
March, 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 March 9, 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/ Daniel G. Stephens Vice Chairman of the Board and
Daniel G. Stephens Chief Information Officer
/s/ Walter R. Groteke Vice President-Sales and Marketing
Walter R. Groteke and Director
/s/ Peter C. Castle Secretary and Treasurer
Peter C. Castle Principal Financial Officer and
Principal Accounting Officer
Director
___________________________
Ed Lavin
Director
__________________________
Louis Libin
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED JUNE 30, 1999 AND THE PERIOD FROM
FEBRUARY 13, 1998 (INCEPTION) TO JUNE 30, 1998
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED JUNE 30, 1999 AND THE PERIOD FROM
FEBRUARY 13, 1998 (INCEPTION) TO JUNE 30, 1998
CONTENTS
INDEPENDENT AUDITOR'S REPORT..................................... F-1
CONSOLIDATED BALANCE SHEETS
June 30, 1999 and 1998......................................... F-2
CONSOLIDATED STATEMENTS OF OPERATIONS
Year ended June 30, 1999 and the period from
February 13, 1998 (inception) to June 30, 1998................ F-3
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
For the period from February 13, 1998 (inception)
to June 30, 1998 and the year ended June 30, 1999............. F-4
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended June 30, 1999 and the period from
February 13, 1998 (inception) to June 30, 1998................ F-5 F-6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS....................... F-7 F-26
<PAGE>
Board of Directors and Shareholders
NetWolves Corporation
Melville, New York
INDEPENDENT AUDITOR'S REPORT
We have audited the accompanying consolidated balance sheets of NetWolves
Corporation and subsidiaries (the "Company") as of June 30, 1999 and 1998, 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 1998, 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.
As discussed in Note 17 to the consolidated financial statements, the Company
adjusted the value assigned to equity instruments issued in fiscal 1999.
Accordingly, the consolidated financial statements for the year ended June 30,
1999 have been restated to reflect this adjustment.
/s/ Hays & Company
August 12, 1999, except for Notes 14, 4, 16 and 17,
which are dated September 2, 1999, September
21, 1999, September 29, 1999 and February 8,
2000, respectively
New York, New York
F-1
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
June 30,
--------------------------
1999 1998
---- ----
<S> <C> <C>
ASSETS
Current assets
Cash and cash equivalents $ 5,585,981 $ 1,118,416
Marketable securities, available for sale 606,000 1,063,828
Accounts receivable, net of allowance for doubtful
accounts of $40,000 and $5,000 at June 30, 1999 and
1998, respectively 76,907 6,803
Net assets held for sale (Note 5) - 720,000
Inventories 118,354 22,410
Prepaid expenses and other current assets 153,099 18,318
----------- -----------
Total current assets 6,540,341 2,949,775
Property and equipment, net 224,691 4,949
Intangible assets 6,024,121 -
Other assets 22,781 4,727
----------- -----------
$12,811,934 $ 2,959,451
----------- -----------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Accounts payable and accrued expenses $ 453,336 $ 31,448
Deferred compensation 100,000 -
Loans and advances from TSG officer 144,348 -
Current maturities of long-term debt 43,411 -
----------- -----------
Total current liabilities 741,095 31,448
Long-term debt, net of current maturities 266,537 -
----------- -----------
Total liabilities 1,007,632 31,448
----------- -----------
Minority interest 704,500 -
Commitments and contingencies (Notes 5, 8, 9, 10, 12,
13, 14 and 16)
Shareholders' equity
Common stock, $.0033 par value; 10,000,000 shares authorized;
issued and outstanding: 6,063,870 June 30, 1999
and 4,313,870 June 30, 1998 20,011 14,236
Additional paid-in capital 17,726,374 3,012,159
Accumulated deficit (7,022,428) (99,414)
Accumulated other comprehensive income 375,845 1,022
----------- -----------
Total shareholders' equity 11,099,802 2,928,003
----------- -----------
$12,811,934 $ 2,959,451
=========== ===========
<FN>
The accompanying notes are an integral part of
these consolidated financial statements.
F-2
</FN>
</TABLE>
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Period from
February 13,
1998
Year ended (inception) to
June 30, 1999 June 30, 1998
------------- --------------
<S> <C> <C>
Sales $ 1,789,144 $ 29,621
Cost of sales 582,724 5,681
----------- -----------
Gross profit 1,206,420 23,940
----------- -----------
Operating expenses
General and administrative 6,053,754 105,047
Research and development 418,109 -
Sales and marketing 2,194,518 44,463
----------- -----------
8,666,381 149,510
----------- -----------
Loss before other income (expense)
and benefit from income taxes (7,459,961) (125,570)
Other income (expense)
Interest income 48,609 3,011
Gain on sale of marketable securities 478,518 -
Dividend income 10,275 3,490
Interest expense (455) (345)
----------- -----------
Loss before benefit from income taxes (6,923,014) (119,414)
Benefit from income taxes - 20,000
----------- -----------
Net loss $(6,923,014) $ (99,414)
----------- -----------
Basic and diluted net loss per share $ (1.48) $ (0.04)
----------- -----------
Weighted average common
shares outstanding 4,691,651 2,810,102
=========== ===========
<FN>
The accompanying notes are an integral part of
these consolidated financial statements.
</FN>
</TABLE>
F-3
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
PERIOD FROM FEBRUARY 13, 1998 (INCEPTION) TO JUNE 30, 1998
AND FOR THE YEAR ENDED JUNE 30, 1999
<TABLE>
<CAPTION>
Accumulated
Additional other Total
Common Stock paid-in Accumulated comprehensive shareholders' Comprehensive
Shares Amount capital deficit income equity income (loss)
------ ------ ---------- ----------- -------------- ------------- ------------
<S> <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
========= ======== =========== =========== ========= ===========
<FN>
The accompanying notes are an integral part of
these consolidated financial statements.
</FN>
</TABLE>
F-4
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Period from
February 13,
1998
Year ended (inception) to
June 30, 1999 June 30, 1998
------------- --------------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
<S> <C> <C>
Cash flows from operating activities
Net loss $(6,923,014) $ (99,414)
Adjustments to reconcile net loss to net cash used in
operating activities
Depreciation and amortization 15,896 401
Realized gain on sale of marketable securities (478,518) -
Provision for doubtful accounts 35,000 5,000
Common stock and warrants issued for services 5,162,750 -
Deferred income tax benefit - (20,000)
Changes in operating assets and liabilities
Accounts receivable (34,883) (11,803)
Inventories (95,944) (22,410)
Prepaid expenses and other current assets (134,781) (18,318)
Accounts payable and accrued expenses 187,863 31,448
----------- ------------
Net cash used in operating activities (2,265,631) (135,096)
----------- ------------
Cash flows from investing activities
Proceeds from the sale of marketable securities 1,311,169 -
Proceeds from assets held for sale, net 549,515 -
Purchases of property and equipment (200,383) (5,350)
Advances to subsidiary, net of cash acquired of
$412,224, plus acquisition costs paid of $25,000 (561,776) -
Payments of security deposits (18,054) (4,727)
----------- ------------
Net cash provided by (used in) investing activities 1,080,471 (10,077)
----------- ------------
Cash flows from financing activities
Proceeds from initial capital contribution - 64,245
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, net of
financing costs paid of $647,275 5,352,725 -
Cash proceeds from sale of warrants 300,000 -
----------- ------------
Net cash provided by financing activities 5,652,725 1,263,589
----------- ------------
Net increase in cash and cash equivalents 4,467,565 1,118,416
Cash and cash equivalents, beginning of period 1,118,416 -
----------- -------------
Cash and cash equivalents, end of period $ 5,585,981 $ 1,118,416
=========== ============
<FN>
The Accompanying notes are an integral part of
these consolidated financial statements.
</FN>
F-5
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Period from
February 13,
1998
Year ended (inception) to
June 30, 1999 June 30, 1998
------------- --------------
(continued)
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 $ -
=========== ============
<FN>
The Accompanying notes are an integral part of
these consolidated financial statements.
</FN>
</TABLE>
F-6
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED JUNE 30, 1999 AND THE PERIOD FROM
FEBRUARY 13, 1998 (INCEPTION) TO JUNE 30, 1998
1 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 Corporation ("NetWolves" or the "Company").
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. Accordingly, it is no longer reporting as a development
stage company.
Additionally, in conjunction with the 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.
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.
Risks and other factors
As a company that has developed a software product for use as a
multi-functional Internet communications device, NetWolves faces certain
risks. These include, among other items, the ability to continue to
implement its business plan, dependence on proprietary technology, rapid
technological change, challenges in recruiting personal and a highly
competitive market place.
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 plus preferred stock.
The subsidiary has issued 250,000 shares of non-voting Series A Cumulative
Convertible Preferred Stock with a $1 par value. The preferred stockholder
is entitled to preferential liquidation rights and is also entitled to
cumulative dividends to be included in minority interest expense that
accrue at the rate of 8% per annum commencing on June 30, 1999. On or after
January 1, 2000, the preferred stockholder may elect to convert the
preferred stock into NetWolves common stock (at fair market value at the
F-7
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED JUNE 30, 1999 AND THE PERIOD FROM
FEBRUARY 13, 1998 (INCEPTION) TO JUNE 30, 1998
2 Significant accounting policies (continued)
Principles of consolidation (continued)
time of conversion). However, within 15 days of receiving the conversion
notice, NetWolves may elect to make a cash redemption of the preferred
stock at par value (including any unpaid cumulative dividends) and thereby
terminate the conversion right.
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). 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 will recognize 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-8
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED JUNE 30, 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 consist of intangible assets acquired in
connection with the Company's purchase business combination effective June
30, 1999 (Note 4). These assets consist of training content (including a
training library, industry benchmarking data and the Profit Coach
profitability analysis module) with a fair value of $1,000,000. The
remaining portion of the intangible asset (approximating $5,024,000) is
allocated to goodwill. The training content and the goodwill will be
amortized over their estimated useful lives of 3 years.
Software development 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. Costs incurred prior to establishment of
technological feasibility are expensed as incurred and reflected as
research and development costs in the accompanying consolidated statements
of operations.
Start-up and organization costs
The Company accounts for start-up costs in accordance with Statement of
Position 98-5, "Reporting on the Costs of Start-up Activities" ("SOP
98-5"), issued by the American Institute of Certified Public Accountants.
SOP 98-5 requires the cost of start-up activities, including organization
costs, to be expensed as incurred.
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, 1999, there has been no impairment in
the carrying value of long-lived assets.
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-9
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED JUNE 30, 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 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 when 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 earnings 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. Diluted
earnings per share includes the potential dilution that could occur if
securities or other contracts to issue common stock were exercised or
converted into common stock.
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 investments 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, 1999, the Company's cash investments are
held at primarily one financial institution. In addition, the Company's
marketable securities consist primarily of an investment in warrants to
purchase restricted common stock of an unrelated company (Note 6). Unless
otherwise disclosed, the fair value of financial instruments approximates
their recorded values.
F-10
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED JUNE 30, 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 acquisition
On July 7, 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, 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 Cumulative (8%)
Convertible Preferred Stock to one of the SMCI shareholders, which was
issued in partial settlement of outstanding liabilities owed to the
shareholder. This TSG common and preferred stock has been reflected as
minority interest in the accompanying consolidated financial statements.
F-11
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED JUNE 30, 1999 AND THE PERIOD FROM
FEBRUARY 13, 1998 (INCEPTION) TO JUNE 30, 1998
4 Purchase acquisition (continued)
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).
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, and
operations of SMCI will be included in the Company's consolidated
statements of operations commencing July 1, 1999.
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>
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 APB25 in such future
periods. All of the shareholders of SMCI entered into 3-year employment
agreements with TSG (Note 14).
F-12
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED JUNE 30, 1999 AND THE PERIOD FROM
FEBRUARY 13, 1998 (INCEPTION) TO JUNE 30, 1998
4 Purchase acquisition (continued)
The Merger also provides for NetWolves to make up to $4,750,000 of
non-interest bearing open account working capital advances to TSG pursuant
to an agreed upon schedule through November 15, 1999. Through June 30,
1999, $949,000 has been advanced and an additional $1,651,000 has been
advanced from July 1, 1999 through September 21, 1999. Should NetWolves
decide not to make further working capital advances, the number of TSG
shares owned by NetWolves will be reduced in accordance with the agreement.
Based upon the $2,600,000 advanced through September 21, 1999 (should
NetWolves decide not to make any further advances), NetWolves could be
required to return 987,500 TSG shares to the treasury of TSG. This would
reduce NetWolves' current ownership interest from 4,150,000 shares to
3,162,500 (from 98.3% to 97.8%). Subject to NetWolves first refusal rights,
TSG has the right to sell any shares, ultimately returned by NetWolves, to
third parties at fair value, which could further reduce NetWolves'
ownership interest.
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.
Included in the consolidated entity's cash and cash equivalents balance at
June 30, 1999 is $412,224 of cash held by TSG to be used for working
capital purposes.
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 respective periods 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.
<TABLE>
<CAPTION>
Period from
February 13,
Year ended 1998 to June 30,
June 30, 1999 1998
------------- ----------------
(Unaudited) (Unaudited)
<S> <C> <C>
Revenue $ 2,904,000 $ 644,000
Net loss $(7,907,000) $ (328,000)
Basic and diluted net loss per share $ (1.62) $ (.11)
</TABLE>
F-13
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED JUNE 30, 1999 AND THE PERIOD FROM
FEBRUARY 13, 1998 (INCEPTION) TO JUNE 30, 1998
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.
The net assets held for sale are classified as a current asset and are
reflected at net realizable value based on the selling price of the Assets,
the net estimated liquidation value of the Retained Assets and Liabilities,
and the net negative cash flows from the operations of the security guard
business during the period from June 17, 1998 (the date of acquisition) to
the date of disposal in November 1998. Net assets held for sale consist of
the following:
<TABLE>
<CAPTION>
June 30,
-------------------------
1999 1998
----------- -------------
<S> <C> <C>
Sale of Assets $ - $ 600,000
Retained Assets and Liabilities
Accounts receivable - 500,000
Other current assets - 140,000
Accounts payable and accrued expenses - (460,000)
Cash out-flows from operations during holding period - (60,000)
----------- -------------
Net assets held for sale $ - $ 720,000
=========== =============
</TABLE>
F-14
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED JUNE 30, 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, 1999
Equity securities $ 35,000 $ 415,000 $ 450,000
Bonds 195,155 (39,155) 156,000
----------- ------------ ------------
$ 230,155 $ 375,845 $ 606,000
=========== ============ ============
June 30, 1998
Mutual funds/equity securities $ 569,131 $ (536) $ 568,595
Bonds 493,675 1,558 495,233
----------- ------------ ------------
$ 1,062,806 $ 1,022 $ 1,063,828
=========== ============ ============
</TABLE>
At June 30, 1999, the Company's equity securities consist solely of an
investment in warrants to purchase restricted common stock of an unrelated
publicly traded company. As of August 12, 1999, the estimated fair value of
the warrants decreased by approximately 33% from the June 30, 1999
estimated fair value.
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.
The maturities of the Company's debt securities at June 30, 1999 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 66,500
Due after six years through ten years 97,780 89,500
--------- ---------
$ 195,155 $ 156,000
========= =========
</TABLE>
F-15
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED JUNE 30, 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,
-------------------
1999 1998
--------- -------
<S> <C> <C>
Machinery and equipment $ 121,462 $ 3,350
Furniture and fixtures 92,685 2,000
Leasehold improvements 26,841 -
--------- -------
240,988 5,350
Less accumulated depreciation and amortization (16,297) (401)
--------- -------
Property and equipment, net $ 224,691 $ 4,949
========= =======
</TABLE>
8 Accounts payable and accrued expenses
Accounts payable and accrued expenses
consist of the following:
<TABLE>
<CAPTION>
June 30,
-------------------
1999 1998
--------- -------
<S> <C> <C>
Trade accounts payable $ 286,868 $ 11,448
Compensated absences 50,354 -
Other accrued expenses 68,909 20,000
Commissions payable 36,204 -
Payroll taxes payable 11,001 -
--------- --------
$ 453,336 $ 31,448
========= ========
</TABLE>
9 Long-term debt
Long-term debt consists of the following:
<TABLE>
<CAPTION>
June 30,
-------------------
1999 1998
--------- -------
<S> <C> <C>
Notes payable to DVI $ 309,948 $ -
Less current maturities of long-term debt (43,411) -
-------- -------
Long-term debt, net of current maturities $ 266,537 $ -
========= =======
</TABLE>
F-16
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED JUNE 30, 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.
Aggregate maturities of long-term debt are as follows:
<TABLE>
<CAPTION>
Year ending June 30,
<S> <C>
2000 $ 43,411
2001 48,434
2002 54,039
2003 60,293
2004 67,270
Thereafter 36,501
---------
$ 309,948
=========
</TABLE>
10 Shareholders' equity
Common stock issuances
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-17
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED JUNE 30, 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.
Another shareholder, Greenleaf Capital Partners, LLC (a pre-Merger shareholder
of Watchdog), has demand registration rights on its 1,141,360 shares of common
stock.
Stock option plan
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 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 is administered by the Board of Directors, which has sole
discretion and authority, consistent with the provisions of the 1998 Incentive
Plan, to determine which eligible participants will receive options, the time
when options will be granted and the terms of options granted.
F-18
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED JUNE 30, 1999 AND THE PERIOD FROM
FEBRUARY 13, 1998 (INCEPTION) TO JUNE 30, 1998
10 Shareholders' equity (continued)
Stock option plan (continued)
During the third and fourth quarters of the year ended June 30, 1999, the
Company granted options to purchase 219,000 shares of common stock under
the 1998 Incentive Plan to key employees at exercise prices ranging from
$5.00 to $16.25 per share that vest in equal installments over three to
five 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.
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 14).
. 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.
. 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.
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. The warrants vest in 5 years
subject to acceleration if specified financial targets are achieved.
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.
F-19
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED JUNE 30, 1999 AND THE PERIOD FROM
FEBRUARY 13, 1998 (INCEPTION) TO JUNE 30, 1998
10 Shareholders' equity (continued)
Warrants (continued)
. 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 14). The warrants 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.
The potential charge to operations upon achieving specified
performance criteria is approximately $201,000. The 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 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 13).
. 80,000 warrants were issued to the placement agent in connection with
a private placement of common stock (see "common stock issuances"
above).
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>
Period from
February 13,
Year ended 1998 (inception)
June 30, to June 30,
1999 1998
------------- ----------------
<S> <C> <C>
Net loss
As reported $ (6,923,014) $ (99,414)
Pro forma $ (6,829,767) $ (99,414)
Basic and diluted net loss per share
As reported $ (1.48) $ (.04)
Pro forma $ (1.46) $ (.04)
</TABLE>
F-20
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED JUNE 30, 1999 AND THE PERIOD FROM
FEBRUARY 13, 1998 (INCEPTION) TO JUNE 30, 1998
10 Shareholders' equity (continued)
Summary of options and warrants (continued)
The fair value of common stock options and warrants granted to employees
during the year ended June 30, 1999 has been calculated using the
Black-Scholes option-pricing model with the following assumptions: no
dividend yield, expected volatility of 65%, risk-free interest rates
ranging from 4.6% to 5.9%, 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 describe in detail above (excluding the TSG stock
options):
<TABLE>
<CAPTION>
Weighted
average
exercise
# of Options price
------------ ----------
<S> <C> <C>
Outstanding at February 13, 1998 (inception)
Granted 1,587,500 $ 1.65
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
---------
</TABLE>
The following table summarizes information about all of the Company's
options and warrants outstanding at June 30, 1999:
<TABLE>
<CAPTION>
Options outstanding
Number Weighted average Options
Options outstanding at remaining contractual exercisable
Exercise Price June 30, 1999 life (years) at June 30, 1999
-------------- ------------- --------------------- ----------------
<S> <C> <C> <C>
$ 1.630 1,320,000 7.1 500,000
$ 2.000 87,500 4.0 87,500
$ 5.000 574,500 5.1 25,000
$ 9.375 80,000 4.0 -
$ 10.250 - $16.250 53,500 9.8 -
--------- --------
2,115,500 612,500
========= ========
</TABLE>
F-21
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED JUNE 30, 1999 AND THE PERIOD FROM
FEBRUARY 13, 1998 (INCEPTION) TO JUNE 30, 1998
11 Benefit from income taxes
The benefit from income taxes consists of the following:
<TABLE>
<CAPTION>
Period from
February 13,
1998
Year ended (inception) to
June 30, 1999 June 30, 1998
------------- ---------------
<S> <C> <C>
Current Federal and states $ - $ -
Deferred Federal - 15,000
Deferred states - 5,000
------------ -----------
Benefit from income taxes $ - $ 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>
Period from
February 13,
1998
Year ended (inception) to
June 30, 1999 June 30, 1998
------------- --------------
<S> <C> <C>
Federal statutory tax rate (34.0)% (34.0)%
State and local taxes net of Federal tax effect (6.0) (5.0)
Stock and option compensation 17.8 -
Non-deductible reserves .2 -
Effect of graduated tax rates - 9.0
Permanent differences .3 1.9
Valuation allowance on deferred tax asset 21.7 11.4
------------ ---------------
Effective tax rate 0% (16.7)%
============ ===============
</TABLE>
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,
----------------------------
1999 1998
---- ----
<S> <C> <C>
Non-deductible reserves $ 16,000 $ 1,500
Accrual to cash conversion TSG 73,000 -
Net operating loss carry forward 1,100,000 32,000
Net assets held for sale - (20,000)
Valuation allowance on net deferred tax asset (1,189,000) (13,500)
----------- -----------
Deferred tax asset, net $ - $ -
=========== ===========
</TABLE>
F-22
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED JUNE 30, 1999 AND THE PERIOD FROM
FEBRUARY 13, 1998 (INCEPTION) TO JUNE 30, 1998
11 Benefit from income taxes (continued)
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, 1999, the Company has net tax operating loss carryforwards of
approximately $2,750,000 available to offset future income tax liabilities,
if any. The carryforward losses expire in the years 2011 through 2019 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 and, accordingly, are subject to restriction pursuant to
Section 382 of the Internal Revenue Code.
12 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 1999.
. TSG leases its office facilities from the TSG officer for annual lease
payments of approximately $75,000 through December 2004.
. The loans and advances from the TSG officer of $144,348 is 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.
13 Major customer - 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 is 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. The agreement
may be terminated by the Company with payment of a specified termination
fee or it may be terminated should Anicom fail to meet minimum order
requirements. 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.
F-23
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED JUNE 30, 1999 AND THE PERIOD FROM
FEBRUARY 13, 1998 (INCEPTION) TO JUNE 30, 1998
13 Major customer - Anicom, Inc. (continued)
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.
14 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, 1999, the approximate
future minimum annual lease payments (including the lease for office space
with the TSG officer, Note 12) are summarized as follows:
<TABLE>
<CAPTION>
Fiscal year ending June 30,
<S> <C>
2000 $ 323,000
2001 314,000
2002 275,000
2003 102,000
2004 39,000
---------------
$ 1,053,000
===============
</TABLE>
Total rent expense for the year ended June 30, 1999 and for the period from
February 13, 1998 (inception) to June 30, 1998 was $139,417 and $351,
respectively.
Employment agreements
In conjunction with the consummation of the Reverse Acquisition, the
Company entered into employment agreements with 5 executives who were the
principal pre-Reverse Acquisition owners of NetWolves, LLC. Two of these
executives were subsequently terminated 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).
F-24
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED JUNE 30, 1999 AND THE PERIOD FROM
FEBRUARY 13, 1998 (INCEPTION) TO JUNE 30, 1998
14 Commitments and contingencies (continued)
Employment agreements (continued)
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 will pay each terminated executive $50,000
in cash and enter into a Manufacturer's Representation Agreement ("MRA").
The MRA appoints the terminated executive as an independent non-exclusive
sales person to promote the sale of the Company's products. The MRA is for
a one-year term commencing January 1999 and provides for a 5% commission on
all net sales attributed to such representative. Additionally, each of the
terminated executives received 50,000 performance-based warrants (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.
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,
. 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.
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.
F-25
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED JUNE 30, 1999 AND THE PERIOD FROM
FEBRUARY 13, 1998 (INCEPTION) TO JUNE 30, 1998
14 Commitments and contingencies (continued)
Legal matters
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.
15 Quarterly results of operations
As a result of an adjustment to the accounting for certain stock option
compensation, the Company recorded an adjustment in the fourth quarter of
fiscal 1999, pertaining to the third quarter, which resulted in an increase
to the net loss of $449,000 or $.10 per share.
16 Subsequent events
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 in up to 40,000 locations over a four-year period. However, there
can be no assurances that the Company will actually require the use of the
credit facility.
In connection with the agreement, 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 will be amortized over
the initial term of the agreement (four years) 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.
Issuance of warrants
For services rendered, 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.
Private placement
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.
17 Restatement of consolidated financial statements
The Company has restated previously issued financial results for the year
ended June 30, 1999. The restated financial results primarily reflect an
adjustment made to the values assigned to equity instruments issued in
fiscal 1999 as compensation to employees and consultants and in connection
with the Company's acquisition of SMCI (Note 4). Management originally
determined the fair value of the equity instruments using the quoted market
price on the day of issuance less a discount due to its restricted nature.
Subsequently, management determined that it would be more objectively
verifiable to use the undiscounted quoted market price. As a result of this
adjustment, the net loss for the year ended June 30, 1999 was increased
from $5,955,327 to $6,923,014 and the value of the Company's acquisition of
SMCI was increased from $1,432,875 to $4,177,875.
F-26
