UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q/A
AMENDMENT NO. 2
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1999
------------------
Commission file number 000-25831
NetWolves Corporation
(Exact name of registrant as specified in its charter)
New York 11-3439392
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
200 Broadhollow Road, Melville, New York 11747
(Address of principal executive offices)
(516) 393-5016
(Registrant's telephone number, including area code)
None
(Former name, former address and former fiscal year, if changed since
last report)
Indicate by checkmark 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 the number of shares outstanding of each of issuer's classes of common
stock as of the latest practicable date:
<TABLE>
<CAPTION>
NUMBER OF SHARES OUTSTANDING ON
TITLE OF CLASS November 19, 1999
-------------- ---------------------------------
<S> <C>
Common Stock, $.0033 par value 6,346,370
</TABLE>
Registrant became subject to the filing requirements of the Securities Exchange
Act of 1934 on April 20, 1999, when it filed a Registration Statement on Form
10.
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
FORM 10-Q - SEPTEMBER 30, 1999
INDEX
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
September 30, 1999 and June 30, 1999 1
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND
COMPREHENSIVE INCOME (LOSS)
For the three months ended September 30, 1999 and September 30, 1998 2
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the three months ended September 30, 1999 and September 30, 1998 3
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 4 - 10
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 11 - 15
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK 15
PART II - OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS 16
ITEM 2 - CHANGES IN SECURITIES AND USE OF PROCEEDS 16
ITEM 3 - DEFAULTS UPON SENIOR SECURITIES 16
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 16
ITEM 5 - OTHER INFORMATION 16
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K 16
SIGNATURES 17
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
September 30, June 30,
1999 1999
------------- --------
(Unaudited)
<S> <C> <C>
ASSETS
Current assets
Cash and cash equivalents $5,376,269 $5,585,981
Marketable securities, available for sale,
at market value 527,500 606,000
Accounts receivable, net of allowance of $40,000 87,429 76,907
Inventories 64,790 118,354
Prepaid expenses and other current assets 171,760 153,099
----------- -----------
Total current assets 6,227,748 6,540,341
----------- -----------
Property and equipment, net 278,560 224,691
Intangible assets, net 5,522,111 6,024,121
Other assets 26,181 22,781
----------- -----------
$12,054,600 $12,811,934
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Accounts payable and accrued expenses $ 530,987 $ 453,336
Deferred compensation 100,000 100,000
Loans and advances from TSG officer 37,203 144,348
Current maturities of long-term debt 44,616 43,411
----------- -----------
Total current liabilities 712,806 741,095
Long term debt, net of current maturities 254,921 266,537
----------- -----------
Total liabilities 967,727 1,007,632
----------- -----------
Minority interest 692,072 704,500
Commitment and contingencies
Shareholders' equity
Common stock, $.0033 par value; 10,000,000 shares
authorized; issued and outstanding;
6,163,870 on September 30, 1999
and 6,063,870 on June 30, 1999 20,341 20,011
Additional paid-in capital 22,965,044 17,726,374
Unamortized value of warrant grants (2,290,417) -
Accumulated deficit (10,597,512) (7,022,428)
Accumulated other comprehensive income 297,345 375,845
----------- -----------
Total shareholders' equity 10,394,801 11,099,802
----------- -----------
$12,054,600 $12,811,934
=========== ===========
<FN>
See notes to condensed consolidated financial statements
</FN>
</TABLE>
1
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLDIATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME (LOSS)
(Unaudited)
<TABLE>
<CAPTION>
For the three months ended
September 30,
--------------------------
1999 1998
---- ----
<S> <C> <C>
Sales $ 137,951 $ 44,753
Cost of sales 96,169 16,299
----------- ----------
Gross profit 41,782 28,454
Operating expenses ----------- ----------
General and administrative 2,868,808 835,699
Research and development 184,718 13,104
Sales and marketing 606,007 1,001,156
----------- ----------
3,659,533 1,849,959
----------- ----------
Loss before other income (expense) (3,617,751) (1,821,505)
Other income (expense)
Investment income 45,730 15,716
Minority interest 7,428 -
Interest expense (10,491) -
----------- ----------
Net loss (3,575,084) (1,805,789)
Other comprehensive income (loss):
Marketable securities valuation adjustment 78,500 (41,186)
----------- ----------
Comprehensive income (loss) $(3,496,584) $(1,846,975)
=========== ==========
Basic and diluted net loss per share $ (.59) $ (.42)
=========== ==========
Weighted average common
shares outstanding 6,068,218 4,313,870
=========== ==========
</TABLE>
See notes to condensed consolidated financial statements
2
<PAGE>
NETWOLVES CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
For the three months ended
September 30,
--------------------------
1999 1998
---- ----
<S> <C> <C>
INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS
Cash flows from operating activities
Net loss $(3,575,084) $(1,805,789)
Adjustments to reconcile net loss to net
cash used in operating activities
Depreciation and amortization 516,719 3,541
Noncash charge to operations with respect to
common stock and warrants issued for
services 1,553,583 1,246,375
Minority interest (12,428) -
Changes in operating assets and liabilities
Accounts receivable (10,522) (44,809)
Inventories 53,564 (127,931)
Other assets - 993
Prepaid expenses and other current assets (73,661) -
Accounts payable and accrued expenses 77,651 78,900
---------- ----------
Net cash used in operating activities (1,470,178) (648,720)
---------- ----------
Cash flows from investing activities
Purchase of marketable securities - (3,034)
Proceeds from assets held for sale, net - 40,764
Issuance of note receivable (50,000) -
Purchase of property and equipment (68,578) (34,753)
Payments of security deposits (3,400) (4,211)
---------- ----------
Net cash used in investing activities (121,978) (1,234)
---------- ----------
Cash flows from financing activities
Repayment of advances from TSG officer (107,145) -
Repayment of long term debt (10,411) -
Cash proceeds from private sale of common stock 1,500,000 -
---------- ----------
Net cash provided by financing activities 1,382,444 -
---------- ----------
Net decrease in cash and cash equivalents (209,712) (649,954)
Cash and cash equivalents, beginning of period 5,585,981 1,118,416
---------- ----------
Cash and cash equivalents, end of period $5,376,269 $ 468,462
========== ==========
</TABLE>
See notes to condensed consolidated financial statements
3
<PAGE>
NETWOLVES CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
THREE MONTHS ENDED SEPTEMBER 30, 1999 and 1998
1 Interim financial information
The summary financial information contained herein is unaudited; however,
in the opinion of management, all adjustments (consisting only of normal
recurring accruals) necessary for a fair presentation of such financial
information have been included. The accompanying condensed consolidated
financial statements, footnotes and discussions of NetWolves Corporation
("NetWolves" or the "Company") should be read in conjunction with the
Company's consolidated financial statements, and notes thereto, for the
year ended June 30, 1999 and the period from February 13, 1998 (inception)
to June 30, 1998. The results of operations for the three months ended
September 30, 1999 are not necessarily indicative of the results to be
expected for the full year.
2 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, Watchdog changed its
name to NetWolves Corporation.
NetWolves is an Internet systems developer that has designed and developed
a multi-functional product that is a secure, integrated, modular Internet
gateway. The primary product, the FoxBox, supports secure access to the
Internet for multiple users through a single connection and, among other
things, provides electronic mail, firewall security and web site hosting
and also contains a network file server. Since inception, the Company has
been developing its business plan and building its infrastructure in order
to effectively market its products and shipped its first significant order
in March 1999.
Additionally, in conjunction with 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.
3 Significant accounting policies
Use of estimates
In preparing condensed 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
condensed 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.
4
<PAGE>
NETWOLVES CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
THREE MONTHS ENDED SEPTEMBER 30, 1999 and 1998
3 Significant accounting policies (continued)
Principles of consolidation
The condensed 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 condensed
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 that are included in minority interest expense and
accrue at the rate of 8% per annum, which commenced 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
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 recognizes revenue from consulting and training fees when the
services are provided.
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.
5
<PAGE>
NETWOLVES CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
THREE MONTHS ENDED SEPTEMBER 30, 1999 and 1998
3 Significant accounting policies (continued)
Basic and diluted net loss per share (continued)
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.
Intangible assets
Intangible assets at September 30, 1999 consist of 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 (approximately $5,024,000) is
allocated to goodwill. The training content and the goodwill will be
amortized over their estimated usseful lives of 3 years.
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.
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 have been included in the Company's condensed
consolidated statements of operations commencing July 1, 1999.
6
<PAGE>
NETWOLVES CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
THREE MONTHS ENDED SEPTEMBER 30, 1999 and 1998
4 Purchase acquisition (continued)
An allocation of the fair value of the assets acquired and liabilities
assumed at June 30, 1999 is as follows:
<TABLE>
<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 Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" in
such future periods. All of the shareholders of SMCI entered into 3-year
employment agreements with TSG.
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 September 30,
1999, $2,600,000 has been advanced and an additional $850,000 has been
advanced from October 1, 1999 through November 10, 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.
7
<PAGE>
NETWOLVES CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
THREE MONTHS ENDED SEPTEMBER 30, 1999 and 1998
4 Purchase acquisition (continued)
Based upon the $3,450,000 advanced through November 10, 1999 (should
NetWolves decide not to make any further advances), NetWolves could be
required to return 400,000 TSG shares to the treasury of TSG. This would
reduce NetWolves' current ownership interest from 4,150,000 shares to
3,750,000 (from 98.34% to 98.17%). 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
September 30, 1999 is approximately $1,300,000 of cash held by TSG to be
used for working capital purposes.
The following unaudited pro forma financial information for the three
months ended September 30, 1998 has been prepared assuming that the
acquisition of SMCI had taken place at the beginning of such period
presented. The pro forma information is not necesarily 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. Pro forma information for the three
months ended September 30, 1999 is not presented, since the results of SMCI
are reflected in the Company's consolidated results for the entire period.
<TABLE>
<CAPTION>
Three months
ended
September 30,
1998
-------------
(unaudited)
<S> <C>
Revenue $ 408,000
Net loss $(1,800,000)
Basic and diluted net loss per share $ (.41)
</TABLE>
5 Shareholders' equity
Common stock issuances
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 totaling $105,000.
Warrants
-- On July 26, 1999 and in connection with the Company entering into an
agreement with Comdisco, Inc. ("Comdisco"), Comdisco was granted a
five-year warrant to purchase 125,000 shares of the Company's
unregistered common stock, at an exercise price of $10 per share. The
warrants are immediately exercisable. The value of the warrants of
$2,390,000 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.
-- 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. The value of the warrants
of 1,704,000 will be amortized over a period of three months and has
been calculated using the Black-Scholes option-pricing model with the
following assumptions: no dividend yield, expected volatility of 65%,
risk-free interest rate of 5.84%, and an expected term of five years.
8
<PAGE>
NETWOLVES CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
THREE MONTHS ENDED SEPTEMBER 30, 1999 and 1998
6 Segment information
The Company reports segments in accordance with Financial Accounting
Standards Board Statement No. 131 "Disclosures about Segments of an
Enterprise and Related Information." The Company and its subsidiaries
operate in two separate business segments, the Technology segment and the
Training and consulting segment. These operating segments are
representative of the Company's management approach to its evaluation of
its operations. The accounting policies of the reportable operating
segments are the same as those described in the summary of significant
accounting policies. The Technology segment, which operates principally
domestically, is primarily engaged in the design, development, marketing
and support of information delivery hardware products and software. The
Training and consulting segment, which operates domestically, provides
consulting, educational and training services primarily to the oil and gas
and automotive industries throughout the United States.
<TABLE>
<CAPTION>
Three Months Ended
September 30,
-------------------
1999 1998
---- ----
<S> <C> <C>
Revenue
Technology $ 13,200 $ 44,753
Training and consulting 124,751 -
----------- -----------
Total $ 137,951 $ 44,753
=========== ===========
Operating income (loss)
Technology $(2,692,352) $(1,821,505)
Training and consulting (925,399) -
------------ -----------
Total $(3,617,751) $(1,821,505)
============ ===========
Identifiable assets
Technology $ 5,030,452
Training and consulting 7,024,148
------------
Total $12,059,600
============
</TABLE>
The Company had two major customers, both included in the Training and
consulting segment, which accounted for 57% and 24% of consolidated sales
for the three months ended September 30, 1999.
7 Commitments and contingencies
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.
9
<PAGE>
NETWOLVES CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
THREE MONTHS ENDED SEPTEMBER 30, 1999 and 1998
7 Commitments and contingencies (continued)
Comdisco, Inc. agreement
On July 26, 1999 the Company entered into an agreement with 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.
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 rights, title and interest in
the equipment with the exception of intellectual 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.
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 (Note 5).
8 Subsequent events
Private placement
In November 1999, the Company sold 182,500 shares of unregistered common
stock to a group of accredited investors at $15 per share (a total of
$2,737,500) exclusive of commissions and fees of approximately 7%.
9 Restatement of condensed consolidated financial statements
The Company has restated previously issued financial results for the
quarters ended September 30, 1999 and 1998. The restated financial results
primarily reflect an adjustment made to the values assigned to equity
instruments issued 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 quarter ended September
30, 1999 was increased from $2,794,941 to $3,575,084, the net loss for the
quarter ended September 30, 1998 was increased from $1,581,570 to
$1,805,789 and the value of the Company's acquisition of SMCI was increased
from $1,432,875 to $4,177,875.
10
<PAGE>
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Forward-looking statements
The Form 10-Q 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-Q 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 sales of the FoxBox (Multi- services Internet
communications gateway), 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 revenue the terms of the agreements. The
first of which would be the TSG ("Sullivan") agreements 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. Comdisco also has agreed to provide management, installation and
technology services for FoxBoxes sold to this client base. 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.
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Overview (continued)
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 an
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 and product
offerings, 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 risks, 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 September 30, 1999 had an accumulated deficit
of approximately $10.4 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
As a result of the July 1999 acquisition of TSG, NetWolves and its
subsidiaries operated in two business segments, the Technology segment and
the Training and consulting segment. The net sales from operations were
$137,951 and $44,753 for the three months ended September 30, 1999 and
September 30, 1998, respectively. Sales for the first quarter of fiscal
2000 were primarily attributable to the training and consulting business
segment. Although training and consulting revenue is currently derived from
traditional leader-lead training and benchmark studies, the Company's
strategic focus is on distance learning. The Company is currently "beta
testing" products utilizing the FoxBox technology to deliver distance
learning to existing clients in the petroleum industry. In fiscal 1999, the
Company delivered an initial stocking order of 500 FoxBoxes ($1.7 million)
to Anicom. As of July 1999 the Company has dedicated resources to train and
support the Anicom sales force in developing demand in the Anicom sales
channel. $45,730 of investment income was generated through September 30,
1999 as compared to $15,716 for the period ended September 30, 1998. The
increase is primarily attributable to the additional amounts of securities
held with respect to the prior period.
NetWolves had gross profit of 31% for the period ended September 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 31% 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.
Operating expenses were $3,659,533 and $1,849,959 for the three months
ended September 30, 1999 and September 30, 1998, respectively. The increase
in operating expense is primarily due to the continued growth of the
Company and the addition of the training and consulting business segment.
The operating expenses for September 30, 1999 consisted primarily of
$2,868,808 of
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Results of Operations (continued)
general and administrative costs relating to the establishment of the
infrastructure and the continued operations of the business. $184,718 of
costs were incurred relating to research and development, and $606,007
related to selling and marketing. Included in the above mentioned operating
expenses are $1,553,583 of non-cash 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). Additionally, on September 29, 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) to be used in
operations.
NetWolves had cash and cash equivalents of $5.3 million at September 30,
1999. In November 1999, the Company completed a private sale of an
additional 182,500 shares of common stock to accredited investors for $2.5
million (net of expenses of approximately 7%). Management believes that the
Company has adequate capital resources to meet its working capital needs
for at least the next twelve months based upon its current operating level.
However, there can be no assurance that the Company will have sufficient
capital to finance its planned growth. 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.
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 decisions, some of these systems could
fail to operate or fail to produce correct results if "00" is interpreted
to 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
complaint. NetWolves Corporation presently believes that its computer
systems are Year 2000 complaint. 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.
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Year 2000 Issues (continued)
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.
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 complaint. 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.
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Year 2000 Issues (continued)
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.
ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
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ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On September 29, 1999, the Company sold 100,000 shares of unregistered
common stock to an accredited investor at $15 per share.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
ITEM 5. OTHER INFORMATION
Not applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits: Exhibit 27 Financial Data Schedule (for electronic
submission only).
(b) Reports on Form 8-K: Report on Form 8-K dated July 7, 1999, as
amended.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
BY: NETWOLVES CORPORATION
/s/ Walter M. Groteke
--------------------------
Walter M. Groteke
Chief Executive Officer
/s/ Peter C. Castle
--------------------------
Peter C. Castle
Secretary -Treasurer
Date: March 9, 2000
