UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the quarterly period ended September 30, 2001
[ ] Transition Report under Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the transition period from _________ to __________.
Commission File No. 333-3074
NEXLAND, INC.
-------------
(Exact name of registrant as specified in its charter)
DELAWARE 37-1356503
-------- ----------
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification Number)
1101 BRICKELL AVENUE, NORTH TOWER, SUITE 200, MIAMI, FLORIDA 33131
- ------------------------------------------------------------ -----
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (305-358-7771)
(1) Registrant 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 [X] Yes
[ ] No
As of November 12, 2001, there were 36,153,385 shares outstanding of
issuer's common stock.
PART I
FINANCIAL INFORMATION
Item 1. Financial Statements
2
NEXLAND, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
FOR THE NINE MONTH PERIOD
ENDED SEPTEMBER 30, 2001
3
TABLE OF CONTENTS
Financial Statements:
Condensed Consolidated Balance Sheets at September 30, 2001
(Unaudited) and December 31, 2000..............................5
Condensed Consolidated Statements of Operations for the three
months ended September 30, 2001 and 2000 and the nine months
ended September 30, 2001 and 2000 (Unaudited)..................6
Condensed Consolidated Statements of Cash Flows for the nine
months ended September 30, 2001 and 2000 (Unaudited)...........7
Notes to Condensed Consolidated Financial Statements................8-9
4
NEXLAND, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
- --------------------------------------------------------------------------------
ASSETS
September 30, December 31,
2001 2000*
------------- ------------
Current assets:
Cash $ 97,584 $ 59,523
Accounts receivables 130,160 119,131
Inventory 216,137 75,949
Advance to related party supplier 553,000 -
-------- --------
Total current assets 996,881 254,603
-------- --------
Property and equipment, net 38,832 32,072
------- -------
Other assets:
Deposits and other assets 32,995 30,000
------- -------
Total other assets 32,995 30,000
------- -------
Total assets $ 1,068,708 $ 316,675
============ =========
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Accounts payable $ 281,124 $ 56,876
Accrued professional fees 242,955 219,194
Accrued expenses 287,435 73,424
Due to related party supplier 566,191 401,819
Loan payable 702,000 -
Other liabilities 97,356 97,356
------- -------
Total current liabilities 2,177,061 848,669
---------- --------
Long-term debt 255,000 -
---------- --------
Total liabilities 2,432,061 848,669
---------- --------
Stockholders' deficit:
Preferred stock, $0.0001 par value;
10,000,000 shares authorized; no
shares outstanding - -
Common stock, $0.0001 par value;
50,000,000 shares authorized;
36,153,385 and 36,027,368 shares
issued and outstanding, respectively 3,617 3,603
Additional paid-in capital 3,692,668 3,001,613
Unearned compensation (145,839) (333,336)
Accumulated deficit (4,913,799) (3,203,874)
----------- ----------
Total stockholders' deficit (1,363,353) (531,994)
----------- -----------
Total liabilities and stockholders'
deficit $ 1,068,708 $ 316,675
=========== ===========
Note: * The balance sheet at December 31, 2000 has been derived from the audited
fial statements at that date but does not include all of the information
aotnotes required by generally accepted accounting principles for complete fial
statements.
See notes to condensed consolidated financial statements.
5
NEXLAND, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
- --------------------------------------------------------------------------------
For the three months ended For the nine months ended
September 30, September 30,
-------------------------- -------------------------
2001 2000 2001 2000
Sales $ 739,847 $ 319,574 $ 2,275,018 $ 760,454
Cost of sales 285,647 144,909 1,110,131 322,104
----------- ---------- ----------- --------
Gross profit 454,200 174,665 1,164,887 438,350
----------- ---------- ----------- --------
Operating expenses:
Selling, general and
administrative 903,731 743,239 2,785,332 2,778,776
Depreciation 4,266 1,500 9,917 3,614
---------- ---------- --------- ---------
Total operating
expenses 907,997 744,739 2,795,249 2,782,390
---------- ---------- --------- ---------
Loss from operations (453,797) (570,074) (1,630,362) (2,344,040)
---------- ---------- ---------- ----------
Other income (expense):
Interest expense (3,428) (5,400) (79,563) (16,472)
---------- ---------- ----------- -----------
Total other income
(expense) (3,428) (5,400) (79,563) (16,472)
---------- ---------- ----------- ----------
Net loss $ (457,225) $ (575,474) $(1,709,925)$(2,360,512)
========== ========== =========== ==========
Net loss per common
share, basic and
diluted $ (0.01) $ (0.01) $ (0.05) $ (0.07)
========= ========= =========== ===========
Weighted-average
number of common
shares 36,153,385 35,079,382 36,117,923 34,558,126
========== ========== ========== ===========
See notes to condensed consolidated financial statements.
6
NEXLAND, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
- --------------------------------------------------------------------------------
For the nine months ended
September 30,
----------------------------
2001 2000
Cash flows from operating activities:
Net loss $ (1,709,925) $ (2,265,512)
Adjustments to reconcile net
loss to net cash used in
operating activities:
Compensation expenses in connection with:
Employment agreement 187,497 104,165
Severance - 1,125,000
Stock options issued 424,854 -
Contributed research and development
services 142,747 199,000
Common stock issued for services 88,590 378,929
Interest expense on convertible debentures 76,819
Provision for bad debts 21,623 -
Provision for inventory obsolecense 44,034 -
Depreciation expense 9,917 3,614
(Increase) decrease in:
Accounts receivable (32,652) (78,992)
Inventory (184,222) (99,300)
Deposits and other assets (555,995) (45,000)
(Decrease) increase in:
Accounts payable and accrued expenses 626,394 483,881
-------- --------
Net cash used in operating activities (860,319) (194,215)
-------- ---------
Cash flows from investing activities:
Purchase of property and equipment (16,677) (26,375)
-------- --------
Net cash used by investing activities (16,677) (26,375)
-------- --------
Cash flows from financing activities:
Loan proceeds 702,000 -
Proceeds from exercise of warrants and options 17 304,844
Proceeds from issuance of convertible debentures 255,000 -
Costs on issuance of convertible debentures (41,960) -
-------- --
Net cash provided by financing activities 915,057 304,844
-------- --------
Net increase in cash 38,061 84,254
Cash, beginning of period 59,523 4,231
-------- --------
Cash, end of period $ 97,584 $ 88,485
========= ========
Supplemental cash flow disclosure:
Interest paid $ 79,580 $ -
========= ========
See notes to condensed consolidated financial statements.
7
NEXLAND, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 1 - FINANCIAL STATEMENTS
- ------------------------------
In the opinion of the Company, the accompanying unaudited condensed consolidated
financial statements have been prepared in accordance with generally accepted
accounting principles for interim financial information and Regulation S-X.
In the opinion of management, all adjustments, (consisting only of normal
recurring accruals), which are necessary for a fair presentation for the periods
presented have been included. Certain information and footnote disclosures
normally included in the consolidated financial statements prepared in
accordance with generally accepted accounting principles have been omitted. The
condensed consolidated balance sheet information as of December 31, 2000 was
derived from the audited consolidated financial statements included in the
Company's Form 10-K.
It is suggested that these condensed consolidated financial statements be read
in conjunction with the Company's Annual Report on Form 10-K for the year ended
December 31, 2000. The results of operations for the nine months ended September
30, 2001 are not necessarily indicative of the results to be expected for the
full year.
The consolidated financial statements of the Company for the year ended December
31, 2000 were prepared on a going-concern basis. For the year ended December 31,
2000, the Company incurred a net annual loss of $2,876,244 and had deficits of
$3,203,874. These losses raise substantial doubt about the ability of the
Company to continue as a going concern. Management believes that resources
available from private and public sources in 2001 will ensure the continuation
of the operations of the Company.
NOTE 2 - EARNINGS PER SHARE
- ---------------------------
Net loss per share of common stock is based on the weighted average number of
common shares outstanding during each period. Diluted loss per share of common
stock is computed on the basis of the weighted average number of common shares
and dilutive options and warrants outstanding. All outstanding options and
warrants have an anti - dilutive effect and are excluded from the calculation.
NOTE 3 - ADVANCES
- -----------------
In September 2001, the client received $702,000 as an advance from its factor on
future accounts receivable. The terms of the advance are the terms offered to
the Company's other factored receivables. The Company has recorded this advance
as a current liability.
The Company advanced its vendor and related party supplier in Taiwan $553,000
for the manufacture of certain quantities of product for a significant customer.
NOTE 4 - STOCK OPTIONS
- ----------------------
During the nine months ended September 30, 2001, the Company granted options to
purchase 2,069,000 shares of the Company's common stock to certain employees of
the Company. The Company also granted 1,266,179 options during the nine-month
ended September 30, 2001 to certain consultants. The weighted average fair value
of options granted during the six months ended June 30, 2001, is estimated on
the date of the grant, using an option-pricing model for public companies. The
weighted average grant-date fair value was from $0.25 to $0.45 for options whose
exercise price was equal to the market price on the date of the grant. All
options granted have an exercise price equal to the market price on the date of
grant.
8
NOTE 4 - STOCK OPTIONS (continued)
- ----------------------------------
The Company has elected to account for the stock options under Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and
related interpretations. Accordingly, no compensation expense has been
recognized on the employee stock options. The Company accounts for stock options
granted to consultants under Financial Accounting Standards Board Statement No.
123, "Accounting For Stock-Based Compensation," and has recorded a non-cash
charge of $424,854 to professional fees.
The fair value of each option is estimated on the date of grant using the fair
value-pricing model with the assumption:
Risk-free interest rate 6.0%
Expected life (years) various
Expected volatility various
Expected dividends None
Had the compensation expense for the employee stock options been determined
based on the fair value of the options at the grant date consistent with the
methodology prescribed under Statement of Financial Standards No. 123,
"Accounting for Stock Based Compensation", the Company's net loss for the nine
months ended September 30, 2001, would have been increased by $642,400.
The Company's net loss and loss per share would have been reduced to the pro
forma amounts indicated below:
September 30, 2001
------------------
Net loss
As reported $ (1,709,925)
================
Pro forma $ (2,352,325)
================
NOTE 5 - PRIOR PERIOD ADJUSTMENT
- --------------------------------
The balance of the accumulated deficit at the end of the year ended December 31,
2000 has been restated from the balance previously reported to reflect an
aggregate adjustment of $95,000 in the three months ended September 30, 2000.
This adjustment is for an understatement of rent expense of $18,000 and an
understatement of compensation expense of $77,000. Consequently, the net loss
for the period ended September 30, 2000 has been restated to reflect this
$95,000 increase.
9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
INTRODUCTORY STATEMENTS
FORWARD-LOOKING STATEMENTS AND ASSOCIATED RISKS
This filing contains forward-looking statements, including statements
regarding, among other things, (a) the growth strategies of Nexland, Inc. (the
"Company"), (b) anticipated trends in our Company's industry, (c) our Company's
future financing plans and (d) our Company's ability to obtain financing and
continue operations. In addition, when used in this filing, the words
"believes," "anticipates," "intends," "in anticipation of," and similar words
are intended to identify certain forward-looking statements. These
forward-looking statements are based largely on our Company's expectations and
are subject to a number of risks and uncertainties, many of which are beyond our
Company's control. Actual results could differ materially from these
forward-looking statements as a result of changes in trends in the economy and
our Company's industry, reductions in the availability of financing and other
factors. In light of these risks and uncertainties, there can be no assurance
that the forward-looking statements contained in this filing will in fact occur.
Our Company does not undertake any obligation to publicly release the results of
any revisions to these forward-looking statements that may be made to reflect
any future events or circumstances.
GOING CONCERN
Our Company's auditors stated that the consolidated financial
statements of our Company for the years ended December 31, 2000 and December 31,
1999 were prepared on a going-concern basis. For the years ended December 31,
2000 and 1999, respectively, our Company incurred a net annual loss of
$2,876,244 and $131,343, respectively, and our Company had deficits of
$3,203,874 and $327,630, respectively, in the corresponding periods. These
losses raise substantial doubt about the ability of our Company to continue as a
going concern. Management believes that resources will be available from private
and public sources in 2001 to continue the marketing of our Company's Internet
sharing devices. The financial statements do not include any adjustments
relating to the recoverability and classification of recorded assets, or the
amounts and classification of liabilities that might be necessary in the event
our Company cannot continue in existence. Management has established plans
intended to increase the sales of our Company's products. Management intends to
seek new capital from new equity securities offerings to provide funds needed to
increase liquidity, fund growth and implement our business plan; however, no
assurance can be given that our Company will be able to raise any additional
capital.
SIGNIFICANT PLANT OR EQUIPMENT PURCHASES
We do not currently anticipate any significant plant or equipment
purchases during the next twelve months.
CHANGES IN THE NUMBER OF EMPLOYEES
We currently have nineteen (19) employees in Miami and nine (9) in
Canada. If our Company is successful in increasing its sales level or in raising
significant new capital, we anticipate hiring six (6) additional personnel
within the next twelve (12) months. We believe that these personnel will be
adequate to accomplish the tasks set forth in our plan.
MANAGEMENT'S DISCUSSION AND ANALYSIS
RESULTS OF OPERATIONS
FOR THE THREE-MONTH AND NINE-MONTHS PERIODS ENDED SEPTEMBER 30, 2001
AND 2000
(1) REVENUES. For the three months ended September 30, 2001, our
Company had $739,847 in revenue consisting of sales of 4,639 units of our
Internet access "hardware routers" for small offices and home users as compared
to $319,574 in revenue consisting of sales of 1,632 units for the three months
ended September 30, 2000. During the three months ended September 30, 2001, the
average selling price per unit was $159 as compared to $195 for the
corresponding period in 2000. The decrease in the average selling price was due
to pricing discounts given to large volume customers. For the nine months ended
September 30, 2001, our Company had $2,275,018 in revenue consisting of sales of
10
15,566 units of our Internet access "hardware routers" as compared to $760,454
in revenue consisting of sales of 3,487 units for the nine months ended
September 30, 2000. During the nine months ended September 30, 2001 and the nine
months ended September 30, 2000, the average selling price per unit was $146.
(2) COST OF SALES. For the three months ended September 30, 2001, our
Company had $285,647 in cost of sales as compared to $144,909 in cost of sales
for the three months ended September 30, 2000. For the nine months ended
September 30, 2001, our Company had $1,110,131 in cost of sales as compared to
$322,104 in cost of sales for the nine months ended September 30, 2000. The
increase in cost of sales for the three months and nine months ended September
30, 2001 was due to the increase in the number of units sold.
(3) GROSS PROFIT. For the three months ended September 30, 2001, our
Company's gross profit was 61% as compared to 55% in gross profit for the three
months ended September 30, 2000. The gross profit increased for the three months
ended September 20, 2001 compared to the corresponding period in 2000 due to
lower costs and increased pricing on our new products. For the nine months ended
September 30, 2001, our Company's gross profit was 51% as compared to 58% in
gross profit for the nine months ended September 30, 2000. The gross profit
decreased for the nine months ended September 30, 2001 compared to the
corresponding period in 2000 due to lower sales prices given to large volume
customers.
(4) SELLING, GENERAL AND ADMINISTRATIVE EXPENSES.
THREE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000. Selling, general and
administrative expenses increased to $903,731 for the three months ended
September 30, 2001 as compared to $743,239 for the three months ended September
30, 2000. The increase of $160,492 is the result of the payroll costs increased
by approximately $181,000, professional fees decreased by approximately $18,000,
commissions to third parties increased approximately $43,000, and rent and other
office expenses decreased by approximately $33,000. Additionally, during the
same period, our Company had the following four transactions that resulted in
non-cash expenditures. (1) A company controlled by one of our Company's
principal shareholders incurred research and development costs on our Company's
behalf for the further development of the Internet access hardware routers. In
this connection, we recorded $73,000 as a capital contribution, which represents
the actual costs incurred by this company on our Company's behalf, substantially
consisting of technician salaries for subcontractors located in Taiwan. We have
no formal agreement with this company and we are in the preliminary phase of
evaluating the acquisition of this company during the next twelve months. During
the comparable period in 2000, our Company incurred approximately $199,000 of
research and development costs, a decrease of approximately $126,000 from the
same period in 2001. (2) Our Company recorded a charge of $62,499 in connection
with the issuance of common stock to our Chief Financial Officer to amortize his
unearned compensation in accordance with his employment agreement, the same as
the corresponding period in 2000, making no charge for the period. (3) Our
Company issued 600,000 options to consultants, recording a charge of $210,000.
There was no expense for the corresponding period in 2000. (4) Our Company
restated expenses for the three months ended September 2000, which includes
$18,000 of accrued rent and $77,000 in connection with the reduction of warrant
exercise prices. Our Company expects to increase selling, general and
administrative expenses in the future in proportion to our Company's anticipated
growth in sales.
NINE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000. Selling, general and
administrative expenses increased to $2,785,332 for the nine months ended
September 30, 2001 as compared to $2,778,776 for the nine months ended September
30, 2000. The increase of $6,556 is the result of an increase of payroll cost by
$539,000, an increase of rent and other office expenses by approximately
$72,000, and increase of professional fees by approximately $61,000, an increase
of commissions to third parties by approximately $162,000 and an increase of
insurance expense by approximately $47,000. During the nine month period ending
in September 30, 2001, the Company had the following four transactions that
resulted in non-cash expenditures. (1) A company controlled by one of our
Company's principal shareholders incurred research and development costs on our
Company's behalf for the further development of the Internet access hardware
routers. Our Company recorded as a capital contribution $326,000, as compared to
$199,000 for the corresponding period in 2000, an actual change of $127,000,
which represents the actual costs incurred by the company on our Company's
behalf, substantially consisting of technician salaries for subcontractors
located in Taiwan. Our Company has no formal agreement with this company and it
is in the preliminary phase of evaluating the acquisition of this company during
the next twelve months. (2) Our Company recorded a charge of $187,497 in
connection with issuance of common stock to our Chief Financial Officer to
amortize his unearned compensation in accordance with his employment agreement.
Our Company recorded an expense of $104,000 in the corresponding period in 2000,
a change of $83,000 for the period. (3) Our Company issued 126,000 shares of
common stock to a consultant for services rendered and recorded a non-cash
transaction of $88,578. (4) Our Company issued 1,266,179 options to consultants,
recording a charge of $424,854. For the nine months ended September 30, 2000,
our Company had five (5) transactions that resulted in non-cash expenditures and
a corresponding decrease of expenses in the comparable period in 2001: (A) our
Company issued 500,000 shares of common stock valued at $1,125,000, issued to
the former Chief Executive Officer in consideration of the termination of his
employment agreement on September 30, 2000; (B) a consulting expense of
approximately $139,000; (C) a penalty of $240,000 for the late filing of the S-1
11
Registration Statement; (D) the company recorded $18,000 of rent expense; and
(E) our Company recorded a warrant expense of $77,000 in connection with the
reduction of warrant exercise prices. Our Company expects to increase selling,
general and administrative expenses in the future in proportion to our Company's
anticipated growth in sales.
LIQUIDITY AND CAPITAL RESOURCES
Since inception, our Company has relied principally upon the proceeds
of private equity financings and loans to fund its working capital requirements
and capital expenditures. Our Company's net cash used in operating activities
for the nine months ended September 30, 2001 was ($860,000), compared to cash
used in operating activities of ($194,000) for the nine months ended September
30, 2000, a decrease of $666,000. This decrease resulted from decreases in our
Company's net loss, which included non-cash charges of: (i) $187,497 for
compensation in connection with an employment agreement; (ii) $424,854 for
compensation to consultants with options; (iii) $142,747 for contributed
research and development services (iv) $88,590 for expenses paid by issuance of
common stock to a consultant; (v) $76,819 for interest expense on convertible
debentures; (vi) $22,000 for provision for bad debts; (vii) $44,034 for
provision for inventory obsolescence; (viii) $9,917 for depreciation expense;
(ix) $772,869 for increases in accounts receivable, inventory and deposits and
other assets; and (x) $626,394 for increase in accounts payable and accrued
expenses.
Our Company's net cash used by investing activities for the nine
month period ended September 30, 2001 was $16,677 for purchase of
property and equipment.
Our Company's net cash provided by financing activities for the nine
month period ended September 30, 2001 was $915,057 resulting from proceeds
received from the issuance of debentures and for an advance of $702,000 from our
factor on future accounts receivables. Our Company sold $255,000 of debentures
with net proceeds of $213,040 after legal and consulting fees. Our Company's
short-term and long-term liquidity requirements are expected to result from
working capital needs to purchase inventory and pay other operating expenses.
Although our Company cannot accurately predict the precise timing of its future
capital, we estimate that we will need to expend approximately $2,000,000,
within the next twelve months. Our Company estimates that of that amount (i)
$1,000,000 will be for pre-assembled finished goods inventory from
subcontractors, (ii) $250,000 will be for sales and marketing forces, (iii)
$250,000 will be for professional fees and (iv) $500,000 will be for other
operating expenses, such as payroll, rent and office expenses.
Our Company has no assured available financial resources to meet its
September 30, 2001 working capital deficit of $1,180,000 and future operating
costs.
Our Company is seeking additional equity capital from private offerings
and public offerings. There is no assurance that we will be able to raise such
additional capital during the next twelve months. If we are unable to obtain the
necessary additional capital, our Company may be required to change its proposed
business plan and decrease its planned operations, which could have a material
adverse effect upon its business, financial condition, or results of operations.
The management of our Company has taken the following steps to improve
its cash flow:
(a) On January 31, 2001, we entered into a Factoring Agreement. The
agreement expires on January 31, 2002 or until terminated by either party with
proper notice given as defined. Our Company has assigned substantially all of
its accounts receivable to the factor, typically on a recourse basis. We may
request advances up to 75% of the eligible receivables. The factor charges our
Company a commission equal to .0667% per day for each uncollected receivable
from the invoice date to the payment date of such invoice, plus interest on
advanced funds equal to the greater of 10% or the interest publicly announced by
Citibank N.A., plus 2%.
(b) On March 19, 2001, we entered into an Equity Line of Credit
Agreement. Pursuant to the equity line of credit, an institutional investor
agreed, if requested by our Company, to purchase up to $5 million of our common
stock at 80% of the lowest closing bid price of our Company's common stock on
the Over-the-Counter Bulletin Board for the 10 days immediately following the
notice date. The timing of each sale and the number of shares of common stock to
be sold is at our discretion, subject to various conditions. The dollar amount
that we can request under any individual sale is subject to the average trading
volume of our common stock for the preceding 40-day trading period. The maximum
term of the equity line of credit is two years from the date of the agreement.
The agreement contains various representations, warranties and covenants by us,
including limitations on the ability to sell common stock or common stock
equivalents, all assets, merge or enter into certain other transactions. There
were no amounts outstanding on the equity line of credit at September 30, 2001.
12
(c) On March 19, 2001, we also entered into a Securities Purchase
Agreement with third-party investors and a Placement Agent Agreement to provide
up to $250,000 less certain fees and expenses of the placement agent by the
issuance of convertible debentures. The debentures bear interest at 6% per year
and convert into our Company's common stock. In connection with the issuance of
such debentures, the difference between the conversion price and the fair value
of the common stock to which the debentures are convertible, multiplied by the
number of shares into which the debt is convertible at the issuance date of the
debt are recorded as intrinsic value of the beneficial conversion feature and
charged to interest expense in our Company's statement of operations. We
recorded $76,819 of interest expense at September 30, 2001. Through September
30, 2001, we issued debentures of $255,000 from which we received net proceeds
of approximately $213,040. The debenture holders are entitled to convert all or
part of the principal amount plus accrued interest into shares of our Company's
common stock equal to either (i) an amount equal to 120% of the closing bid
price of our Company's common stock as of the date of the debenture issuance or
(ii) an amount equal to 80% of the lowest three closing bid prices of our
Company's common stock for the 10 days immediately preceding the date of
conversion of the debenture. On August 7, 2001, we filed a registration
statement on Form S-1 registering 13,000,000 shares of our Company's common
stock for the equity line of credit investor and the debenture holders. The
debentures are subordinate and junior in right of payment to all accounts
payable of our Company incurred in the ordinary course of business and/or bank
debt of our Company not to exceed $250,000. We have the right to require the
debenture holders to convert any unpaid principal and accrued interest on the
debentures upon the five (5) year anniversary of the debenture issuance.
RISK FACTORS
Our Company is subject to various risks which may materially harm our
business, financial condition and results of operations. Certain risks are
discussed below.
WE HAVE HISTORICALLY LOST MONEY AND LOSSES MAY CONTINUE IN THE FUTURE
We have historically lost money. For the three months ended September
30, 2001 and the nine months ended September 30, 2001, we sustained losses of
$0.5 million and $1.7 million, respectively. For the year ended December 31,
2000 and the year ended December 31, 1999, we sustained losses of $2.9 million
and $0.1 million, respectively. Future losses are likely to occur. Our
independent auditors have noted that our Company may not have significant cash
or other material assets to cover its operating costs and to allow it to
continue as a going concern. Our ability to obtain additional funding will
determine our ability to continue as a going concern. Accordingly, we may
experience significant liquidity and cash flow problems if we are not able to
raise additional capital as needed and on acceptable terms. No assurances can be
given that we will be successful in reaching or maintaining profitable
operations.
WE NEED TO RAISE ADDITIONAL CAPITAL TO FINANCE OPERATIONS
We have relied on significant external financing to fund our
operations. Such financing has historically come from a combination of
borrowings from and sale of common stock to third parties and funds provided by
certain officers and directors. We may need to raise additional capital to fund
our anticipated operating expenses and future expansion. We cannot assure you
that financing whether from external sources or related parties will be
available if needed or on favorable terms. The sale of our common stock to raise
capital may cause dilution to our existing shareholders. Our inability to obtain
adequate financing will result in the need to curtail business operations. Any
of these events would be materially harmful to our business and may result in a
lower stock price.
WE HAVE BEEN THE SUBJECT OF A GOING CONCERN OPINION FROM OUR INDEPENDENT
AUDITORS
Our independent auditors have added an explanatory paragraph to their
audit opinions issued in connection with the 2000 and 1999 financial statements
which states that our Company may not have significant cash or other material
assets to cover its operating costs and to allow it to continue as a going
concern. Our ability to obtain additional funding will determine our ability to
continue as a going concern. Our financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
WE HAVE BEEN AND CONTINUE TO BE SUBJECT TO A WORKING CAPITAL DEFICIT AND
ACCUMULATED DEFICIT
We had a working capital deficit of $1.2 million at September 30, 2001.
We had a working capital deficit of $0.6 million and $0.2 million at December
31, 2000 and 1999, respectively. We had an accumulated deficit of $3.2 million
and $0.3 million at December 31, 2000 and 1999, respectively. Our ability to
13
obtain additional funding will determine our ability to continue as a going
concern. Accordingly, we may experience significant liquidity and cash flow
problems if we are not able to raise additional capital as needed and on
acceptable terms. No assurances can be given that we will be successful in
reaching or maintaining profitable operations.
OUR COMMON STOCK MAY BE AFFECTED BY LIMITED TRADING VOLUME AND MAY FLUCTUATE
SIGNIFICANTLY
There has been a limited public market for our common stock and there
can be no assurance that an active trading market for our common stock will
develop. As a result, this could adversely affect our shareholders' ability to
sell our common stock in short time periods, or possibly at all. Our common
stock has experienced, and is likely to experience in the future, significant
price and volume fluctuations, which could adversely affect the market price of
our common stock without regard to our operating performance. In addition, we
believe that factors such as quarterly fluctuations in our financial results,
announcements by our competitors and changes in the overall economy or the
condition of the financial markets could cause the price of our common stock to
fluctuate substantially.
WE HAVE BEEN IN BUSINESS FOR A SHORT PERIOD OF TIME
Because we have been in business for a short period of time, there is
limited information upon which investors can evaluate our business. We were
incorporated on December 4, 1994 but did not begin significant operations until
the third quarter of 1999. You should consider the likelihood of our future
success to be highly speculative in view of our limited operating history, as
well as the complications frequently encountered by other companies in the early
stages of development, particularly companies in the highly competitive
technology industry.
WE HAVE HAD A HISTORY OF A LIMITED CUSTOMER BASE AND THIS MAY CONTINUE
At present, our customer base consists primarily of Internet service
providers, telephone companies, and value-added resellers. Our ability to
operate depends on increasing our customer base and achieving sufficient gross
profit margins. We cannot assure you that we will be able to increase our
customer base or to operate profitably. If any of our major customers stop or
delay their purchases of our products, our revenue and profitability would be
adversely affected. We anticipate that sales of our products to relatively few
customers will continue to account for a significant portion of our revenue. In
1999, sales to three customers accounted for 60% of our revenue, while in 2000,
sales to 10 customers accounted for 53% of our revenue. If these customers
cancel or delay their purchase orders, our revenue may decline and the price of
our common stock may fall. We cannot assure you that our current customers will
continue to place orders with us, that orders by existing customers will
continue at the levels of previous periods or that we will be able to obtain
orders from new customers. Although our financial performance depends on large
orders from a few key customers and resellers, we do not have binding
commitments from any of them.
WE MAY BE HARMED BY IMPORT RESTRICTIONS
Our imported materials are subject to certain quota restrictions and
U.S. customs duties, which are a material part of our cost of goods. A decrease
in quota restrictions or an increase in customs duties could harm our business
by making needed materials scarce or by increasing the cost of such materials.
WE MAY BE EXPOSED TO INTERNATIONAL BUSINESS AND CURRENCY FLUCTUATIONS
Although we are not dependent on international sales for a substantial
amount of our revenue (10% of total revenue in 1999 and in 2000), we still face
the risks of international business and associated currency fluctuations, which
might adversely affect our operating results. These risks include potential
regulation of our technology by foreign governments, general geopolitical risks
associated with political and economic instability, changes in diplomatic and
trade relationships, and foreign laws affecting the Internet generally. Our
risks of doing business abroad also include our ability to develop and maintain
distribution relationships on favorable terms. To the extent we are unable to
favorably renew our distribution agreements or make alternative arrangements,
revenue may decrease from our international operations. In addition, delays in
deliveries from our component suppliers could cause our revenue to decline and
adversely affect our results of operations.
OUR COMMON STOCK MAY BE DEEMED TO BE "PENNY STOCK"
Our common stock may be deemed to be "penny stock" as that term is
defined in Rule 3a51-1 promulgated under the Securities Exchange Act of 1934.
Penny stocks are stock:
o With a price of less than $5.00 per share;
14
o That are not traded on a "recognized" national exchange;
o Whose prices are not quoted on the Nasdaq automated quotation
system (Nasdaq listed stock must still have a price of not less
than $5.00 per share); or
o In issuers with net tangible assets less than $2.0 million (if
the issuer has been in continuous operation for at least three
years) or $5.0 million (if in continuous operation for less than
three years), or with average revenues of less than $6.0 million
for the last three years.
Broker/dealers dealing in penny stocks are required to provide
potential investors with a document disclosing the risks of penny stocks.
Moreover, broker/dealers are required to determine whether an investment in a
penny stock is a suitable investment for a prospective investor. These
requirements may reduce the potential market for our common stock by reducing
the number of potential investors. This may make it more difficult for investors
in our common stock to resell shares to third parties or to otherwise dispose of
them. This could cause our stock price to decline.
OUR STOCK PRICE COULD DECLINE DUE TO FLUCTUATIONS IN THE DEMAND FOR OUR PRODUCTS
AND GENERAL ECONOMIC CONDITIONS
Fluctuations in consumer demand and the timing and amount of orders
from key customers contribute to the variability of our operating results. In
addition, any general economic downturn, whether real or perceived, could change
consumer spending habits and decrease demand for our products. As a result of
these and other factors, our operating results may fall below market analysts'
expectations in some future quarters, and our stock price may decline.
We are subject to all of the substantial risks inherent in an Internet
related business, any one of which may harm our ability to operate successfully.
These include, but are not limited to:
o Our inability to attract or retain customers;
o Our failure to anticipate and adapt to a developing market;
o Our inability to upgrade and develop competitive products; and
o Technical difficulties with product development.
In addition, we believe that many potential customers in our target
markets are not fully aware of the need for Internet security products and
services. Historically, only enterprises with substantial resources have
developed or purchased Internet security solutions. Also, there is a perception
that Internet security is costly and difficult to implement. Therefore, we will
not succeed unless we can educate our target markets about the need for Internet
security and convince potential customers of our ability to provide this
security in a cost-effective and easy-to-use manner. Although we have spent, and
will continue to spend, considerable resources educating potential customers
about the need for Internet security and the benefits of our products and
services, our efforts may be unsuccessful.
WE HAVE A SUBSTANTIAL AMOUNT OF STOCK THAT WILL BECOME AVAILABLE FOR RESALE
UNDER RULE 144, WHICH MAY HAVE AN ADVERSE EFFECT ON THE MARKET AND OUR ABILITY
TO OBTAIN EQUITY FINANCING
As of November 12, 2001, we have issued and outstanding 36,153,385
shares of common stock of which 32,804,652 shares are "restricted securities" as
that term is defined under Rule 144 promulgated under the Securities Act. Future
sales of the restricted shares may be made under Rule 144. Such sales may have
an adverse effect on the then prevailing market price of the common stock,
adversely affect our ability to obtain future financing in the capital markets,
and may create a potential market overhang.
OUR ARTICLES OF INCORPORATION ALLOW AUTHORIZATION AND DISCRETIONARY ISSUANCE OF
BLANK CHECK PREFERRED STOCK WHICH COULD DELAY, DETER, OR PREVENT A TAKEOVER,
MERGER OR CHANGE OF CONTROL AND MAY PREVENT YOU FROM REALIZING A PREMIUM RETURN
Our Articles of Incorporation authorize the issuance of "blank check,"
preferred stock. The Board of Directors is empowered, without shareholder
approval, to designate and issue additional series of preferred stock with
dividend, liquidation, conversion, voting or other rights, including the right
15
to issue convertible securities with no limitations on conversion. These
designations and issuances, could:
o Adversely affect the voting power or other rights of the holders
of our common stock.
o Substantially dilute the common shareholder's interest.
o Depress the price of our common stock.
o Delay, deter, or prevent a merger, takeover or change in control
without any action by the shareholders.
OUR BUSINESS PLAN CONTEMPLATES FUTURE INTERNATIONAL OPERATIONS BUT THERE ARE
NUMEROUS RISKS AND UNCERTAINTIES IN OFFERING PRODUCTS OUTSIDE OF THE UNITED
STATES
We intend to expand into international markets. We currently have a
technology sharing business relationship with Nexland France, which precludes us
from marketing in Europe. We cannot be sure that we will be able to successfully
sell our products or adequately maintain operations outside North or South
America. In addition, there are certain risks inherent in operating a business
internationally. These include:
o Unexpected changes in regulatory requirements;
o Ability to secure and maintain the necessary physical and
telecommunications infrastructure;
o Challenges in staffing and managing foreign operations; and
o Employment laws and practices in foreign countries.
Any of these could adversely affect our proposed international
operations. Furthermore, some foreign governments have enforced laws and
regulations on content distributed over the Internet that are more restrictive
than those currently in place in the United States. In addition, companies
located in Taiwan perform our manufacturing. The current political tension
between Taiwan and Mainland China may impair our ability to import product from
our manufacturers. Anyone or more of these factors could adversely affect our
contemplated future international operations, and consequently, our business.
WE MAY BE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS OR TO CONTINUE
USING INTELLECTUAL PROPERTY THAT WE LICENSE FROM OTHERS; WE MAY ALSO BE THE
SUBJECT OF INTELLECTUAL PROPERTY INFRINGEMENT CLAIMS
We rely and intend to rely on a combination of pending patents,
copyright, trademark, service mark, and trade secret laws and contractual
restrictions to establish and protect certain of our proprietary rights. We have
a patent pending for certain technology, which is included in our family of
Internet sharing products. There can be no assurance that we will be able to
obtain such protection. Despite our efforts to protect our proprietary rights,
we cannot assure you that unauthorized parties will not copy or otherwise obtain
and use our data or technology or will not independently develop similar or
competing technology. We cannot assure you that these precautions will prevent
misappropriation or infringement of our intellectual property. Monitoring
unauthorized use of our products is difficult, and we cannot assure you that the
steps we have taken will prevent misappropriation of our technology or
intellectual property, particularly in foreign countries where the laws may not
protect our proprietary rights as fully as in the United States.
Our industry is characterized by the existence of a large number of
patents and frequent claims and related litigation regarding patent and other
intellectual property rights. In particular, leading companies in the data
communications and networking markets have extensive patent portfolios with
respect to modem and networking technology. From time to time, third parties,
including these leading companies, have asserted and may assert exclusive
patent, copyright, trademark and other intellectual property rights to
technologies and related standards that are important to us. We expect that we
may increasingly be subject to infringement claims as the numbers of products
and competitors in the office market for shared Internet access solutions grow
and the functionality of products overlaps. As of the date of this filing, we
have not been the recipient of any such claims.
We may in the future initiate claims or litigation against third
parties for infringement of our proprietary rights to determine the scope and
validity of our proprietary rights. Any such claims, with or without merit,
16
could be time consuming, result in costly litigation and diversion of technical
and management personnel, or require us to develop non-infringing technology or
enter into royalty or licensing agreements. Such royalty or licensing
agreements, if required, may not be available on acceptable terms, if at all. In
the event of a successful claim of infringement and our failure or inability to
develop non-infringing technology or license the proprietary rights on a timely
basis, our business would be harmed.
BECAUSE OF THE UNCERTAINTY ASSOCIATED WITH UNPROVEN BUSINESS MODELS, WE MAY BE
UNABLE TO ACHIEVE WIDESPREAD MARKET ACCEPTANCE
Since our business model is relatively new and unproven, we may not be
able to anticipate or adapt to a developing market. In addition, our success
will depend upon the widespread commercial acceptance of shared Internet access
products in the office and home markets. Businesses have only recently begun to
deploy shared Internet access products, and the market for these products is not
fully developed. If single Internet access devices currently utilized by many
offices are deemed sufficient even though they do not enable shared access, then
the market acceptance of our products may be slower than expected. Potential
users of our products may have concerns regarding the security, reliability,
cost, ease of use and capability of our products. We cannot accurately predict
the future growth rate or the ultimate size of the office or home markets.
WE CANNOT BE CERTAIN THAT WE WILL BE ABLE TO COMPETE WITH SIGNIFICANT PRICING
PRESSURE BY OUR COMPETITORS
As a result of increased competition in our industry, we expect to
encounter significant pricing pressure. We cannot be certain that we will be
able to offset the effects of any price reductions we may be forced to give to
our customers or that we will have the resources to compete successfully.
OUR BUSINESS WILL BE ADVERSELY AFFECTED IF WE LOSE MARKET SHARE
We compete in a new, rapidly evolving and highly competitive market. We
expect competition to persist and intensify in the future. Our current and
potential competitors offer a variety of competitive products, including shared
Internet access products offered by RAMP Networks, Flowpoint, Intel, Netopia,
Watchguard, Netscreen, Nortel, Cisco, Sonicwall, Linksys, Cayman Systems and
others, and high-end networking equipment offered by companies such as 3Com and
Nortel.
Many of our competitors are substantially larger than we are and have
significantly greater financial, sales, marketing, technical, manufacturing and
other resources and more established distribution channels. These competitors
may be able to respond more quickly to new or emerging technologies and changes
in customer requirements or devote greater resources to the development,
promotion and sale of their products than we can. Furthermore, some of our
competitors may make strategic acquisitions or establish cooperative
relationships to increase their ability to rapidly gain market share by
addressing the needs of our prospective customers. These competitors may enter
our existing or future markets with solutions that may be less expensive,
provide higher performance or additional features or be introduced earlier than
our solutions. Given the market opportunity in the shared Internet access
market, we also expect that other companies may enter our market with better
products and technologies. If any technology is more reliable, faster, and less
expensive or has other advantages over our technology, then the demand for our
products and services would decrease, which would seriously harm our business.
We expect our competitors to continue to improve the performance of
their current products and introduce new products and technologies as industry
standards and customer requirements evolve. These new products and technologies
could supplant or provide lower cost alternatives to our products. To be
competitive, we must continue to invest significant resources in research and
development, sales and marketing, and customer support.
Increased competition is likely to result in price reductions, reduced
gross margins, longer sales cycles, and loss of market share, any of which would
seriously harm our business and results of operations.
The market for shared Internet access solutions is characterized by
rapidly changing technologies and short product life cycles. Our future success
will depend in large part upon our ability to:
o Identify and respond to emerging technological trends in the
market;
o Develop and maintain competitive products;
17
o Enhance our products by adding innovative features that
differentiate our products from those of our competitors;
o Bring products to market on a timely basis and at competitive
prices;
o Respond effectively to new technological changes or new product
announcements by others; and
o Respond to emerging broadband access technologies.
The technical innovations required for us to remain competitive are
inherently complex, require long development cycles, and are dependent, in some
cases, on sole source suppliers. We will be required to continue to invest in
research and development in order to attempt to maintain and enhance our
existing technologies and products, but we may not have the funds available to
do so. Even if we have sufficient funds, these investments may not serve the
needs of customers or be compatible with changing technological requirements or
standards. Most development expenses are incurred before the technical
feasibility or commercial viability of new or enhanced products can be
ascertained. Revenue from future products or product enhancements may not be
sufficient to recover the associated development costs.
WE HAVE LIMITED MARKETING AND SALES CAPABILITY
Because of our limited working capital in the past, we have not had the
resources to fully implement our marketing and sales strategy. In order to
increase our revenues, we intend to implement a marketing and sales force with
technical expertise and marketing capability. There can be no assurance that we
will be able to:
o Establish and develop such a sales force;
o Gain market acceptance for our products;
o Obtain and retain qualified sales personnel on acceptable terms;
and
o Meet our proposed marketing schedules or plans.
To the extent that we arrange with third parties to market our
products, the success of such products may depend on the efforts of such third
parties.
OUR EXECUTIVE OFFICERS, DIRECTORS AND PRINCIPAL SHAREHOLDERS, TOGETHER, MAY BE
ABLE TO EFFECTIVELY EXERCISE CONTROL OVER ALL MATTERS SUBMITTED TO A VOTE OF
SHAREHOLDERS
Our executive officers, directors, and principal shareholders
beneficially own, in the aggregate, approximately 81% of our outstanding shares
of common stock. These shareholders, if acting together, will be able to
effectively control most matters requiring approval by our shareholders. These
shareholders can designate the members of our Board of Directors and can decide
our operations and business strategy. You may disagree with these shareholders'
decisions. Even if you do not like the members of our Board of Directors, you
will not be able to remove them from office. Additionally, these members of our
Board of Directors would be able to significantly influence a proposed amendment
to our charter, a merger proposal, a proposed sale of assets or other major
corporate transaction or a non-negotiated takeover attempt. Their influence may
not be beneficial to you. If they prevent or delay a merger or takeover, you may
not realize the premium return that shareholders may realize in conjunction with
corporate takeovers. Moreover, there are no preemptive rights in connection with
our common stock. Finally, cumulative voting in the election of our Directors is
not provided for. Accordingly, the holders of a majority of the shares of common
stock, present in person or by proxy, will be able to elect all of our
Directors.
WE HAVE NOT PAID NOR DO WE EXPECT TO PAY DIVIDENDS IN THE NEAR FUTURE
It is not anticipated that we will pay any dividends on our common
stock in the future. The Board of Directors intends to follow a policy of
retaining earnings, if any, for use in our business operations. As a result, the
return on your investment in us will depend upon any appreciation in the market
price of the common stock.
18
THE INSIDE SHAREHOLDERS RECEIVED SHARES FOR LESS CONSIDERATION THAN YOU ARE
ASKED TO PAY
The number of shares of common stock issued to our present shareholders
for cash, property and consulting services was arbitrarily determined and was
not the product of arm's length transactions. The inside shareholders received
shares of our common stock from $0.0104 to $0.1223 per share, which is
substantially less than you might pay.
THE OFFICERS AND DIRECTORS MAY BE ENTITLED TO INDEMNIFICATION FOR SECURITIES
LIABILITIES BY OUR COMPANY RESULTING IN SUBSTANTIAL EXPENDITURES FOR US AND
PREVENTING ANY RECOVERY FROM OFFICERS AND DIRECTORS
Our Articles of Incorporation provide that we may indemnify any
Director, officer, agent, and/or employee as to those liabilities and on those
terms and conditions as are specified in the Delaware Business Corporation Act.
Further, we may purchase and maintain insurance on behalf of any such persons
whether or not the corporation would have the power to indemnify such person
against the liability insured against. The foregoing could result in substantial
expenditures by us and prevent any recovery from our Directors, officers,
agents, and employees for losses incurred by us as a result of their actions.
Further, we have been advised that in the opinion of the Securities and Exchange
Commission, indemnification is against public policy as expressed in the
Securities Act of 1933, as amended, and is, therefore, unenforceable.
WE HAVE EXPERIENCED NEGATIVE CASH FLOW WHICH COULD RESULT IN OUR INABILITY TO
FUND PROGRAMS AND CREATE A NEED FOR ADDITIONAL FINANCING
Since inception, we have experienced negative cash flow from operations
and we expect to continue to experience negative cash flow from operations for
the foreseeable future. Therefore, we have relied solely on limited revenues,
shareholder loans and the issuances of equity securities to fund our operations.
In particular, we may need to raise additional funds, especially if our
estimates of revenue, working capital and/or capital expenditure requirements
change or prove inaccurate or in order for us to respond to technological or
marketing hurdles or to take advantage of unanticipated opportunities. We cannot
be certain that additional financing, through the issuance of equity securities
or otherwise, will be available to us on favorable terms when required, or at
all. If adequate funds are not available, or are not available on acceptable
terms, we may not be able to take advantage of market opportunities, develop new
products or otherwise respond to competitive pressures which could adversely
affect our ability to achieve and sustain positive cash flow and profitability
in the future.
WE DEPEND ON CONTRACT MANUFACTURERS FOR SUBSTANTIALLY ALL OF OUR MANUFACTURING
REQUIREMENTS; THE INABILITY OF OUR CONTRACT MANUFACTURERS TO PROVIDE US WITH
ADEQUATE SUPPLIES OF HIGH QUALITY PRODUCTS OR THE LOSS OF ANY OF OUR CONTRACT
MANUFACTURERS WOULD CAUSE A DELAY IN OUR ABILITY TO FULFILL ORDERS WHILE WE
OBTAIN A REPLACEMENT MANUFACTURER
We have developed an outsourced contract manufacturing capability for
the production of our products. Our primary relationship with our contract
manufacturers has been accomplished through Smerwick, Ltd., our Hong Kong
affiliate located in Taiwan. We rely on contract manufacturers to procure
components, assemble, test and package our products. We rely primarily on one
contract manufacturer for all of our product manufacturing and assembly, and if
we cannot obtain its services, we may not be able to ship products.
We outsource all of our hardware manufacturing and assembly primarily
to one manufacturer and assembly house. We employ Smerwick, Ltd. to coordinate
all manufacturing and packaging with this manufacturer. We do not have a long
term manufacturing contract with this manufacturer. To date, this manufacturer
has produced products with acceptable quality, quantity and cost, but there can
be no assurance it will be able or willing to meet our future demands. Our
operations could be disrupted if we have to switch to a replacement vendor or if
our hardware supply is interrupted for an extended period. While we believe
there are alternative manufacturing companies available at competitive prices,
any interruption in the operations of one or more of these contract
manufacturers or delays in their shipment of products would adversely affect our
ability to meet scheduled product deliveries to our customers and could result
in a loss in customer orders and revenue.
We intend to introduce new products and product enhancements that will
require us to rapidly achieve volume production by coordinating our efforts with
those of our suppliers and contract manufacturers. The inability of our contract
manufacturers to provide us with adequate supplies of high quality products or
the loss of any of our contract manufacturers would cause a delay in our ability
to fulfill orders while we obtain a replacement manufacturer. In addition, our
inability to accurately forecast the actual demand for our products could result
in supply, manufacturing or testing capacity constraints. These constraints
could result in delays in the delivery of our products or the loss of existing
or potential customers.
19
Although we perform random spot testing on manufactured products, we
rely on our contract manufacturers for assembly and primary testing of our
products. Any product shortages or quality assurance problems could increase the
costs of manufacturing, assembling or testing our products.
IF WE FAIL TO DEVELOP AND EXPAND OUR DISTRIBUTION CHANNELS OUR BUSINESS WILL
SUFFER
Our product distribution strategy focuses primarily on continuing to
develop and expand our distribution channels through Internet service providers,
value-added resellers, and telephone companies. If we fail to develop and
cultivate relationships with these customers, or if they are not successful in
their sales efforts, our product sales may decrease and our operating results
may suffer. Many of our resellers also sell products that compete with our
products. We cannot assure you that our customers will market our products
effectively or continue to devote the resources necessary to provide us with
effective sales, marketing and technical support.
OUR FINANCIAL RESULTS MAY PERIODICALLY VARY DUE TO FACTORS WHICH MAY AFFECT OUR
STOCK
Our operating results may vary due to factors unrelated to the progress
of our business and beyond our control. These factors include:
o Continued market acceptance of our products;
o Fluctuations in demand for our products and services;
o Variations in the timing of orders and shipments of our products;
o Timing of new product and service introductions by us or our
competitors;
o Our ability to obtain sufficient supplies of sole or limited
source components for our products;
o Unfavorable changes in the prices of the components we purchase;
o Our ability to attain and maintain production volumes and quality
levels for our products; and
o Our ability to integrate new technologies we develop or acquire
into our products.
The amount and timing of our operating expenses generally will vary
from quarter to quarter depending on the level of actual and anticipated
business activities. Research and development expenses will vary as we develop
new products. General and administrative expense fluctuations in past periods
have been due primarily to the level of sales and marketing expenses associated
with new product introductions. In the past, we have experienced fluctuations in
operating results.
WE ARE SUBJECT TO VARIOUS RISKS PERTAINING TO THE INTERNET INDUSTRY
Our revenue growth is dependent on the continued growth of broadband
access services, which are currently in early stages of development, and if such
services are not widely adopted or we are unable to address the issues
associated with the development of such services, our sales will be adversely
affected.
Sales of our products depend on the increased use and widespread
adoption of broadband access services, such as cable, digital subscriber lines,
integrated services digital networks, frame relay and point-to-point digital
circuits. These broadband access services typically are more expensive with
respect to the required equipment and ongoing access charges than is the case
with Internet dial-up access providers. Our business, prospects, results of
operations and financial condition would be materially adversely affected if the
use of broadband access services does not increase as anticipated or if our
customers' access to broadband services is limited. Critical issues concerning
the use of broadband access services are unresolved and will likely affect the
use of broadband access services. These issues include:
o Security;
o Reliability;
20
o Capacity;
o Congestion;
o Cost;
o Ease of access; and
o Quality of service.
If the market for products that provide broadband access to the
Internet fails to develop, or if it develops at a slower pace than we
anticipate, our business, prospects, results of operations and financial
condition would be materially adversely affected.
The broadband access service market is new and is characterized by
rapid technological change, frequent enhancements to existing products, new
product introductions, changes in customer requirements and evolving industry
standards. We may be unable to respond quickly or effectively to these
developments. The introduction of new products by competitors, market acceptance
of products based on new or alternative technologies, or the emergence of new
industry standards, could render our existing or future products obsolete, which
would materially adversely affect our business, prospects, results of operations
and financial condition.
The emergence of new industry standards might require us to redesign
our products. If our products fail to comply with widely adopted industry
standards, our customers and potential customers may not purchase our products.
This would have a material adverse effect on our business, prospects, results of
operations and financial condition.
Governmental regulations affecting Internet security could affect our
revenue. Any additional governmental regulation of imports/exports or the
failure to obtain required export approval of our encryption technologies could
adversely affect our international and domestic sales. The United States and
various foreign governments have imposed controls, export license requirements
and restrictions on the import and export of certain technologies, including
encryption technology. In addition, from time to time governmental agencies have
proposed additional regulations on encryption technology, such as requiring the
escrow and governmental recovery of private encryption keys. Additional
regulation of encryption technology could delay or prevent the acceptance and
use of encryption products and public networks for secure communications. This,
in turn, could decrease demand for our products.
In addition, some foreign competitors are subject to less stringent
controls on exporting their encryption technologies. As a result, they may be
able to compete more effectively than we can in the United States and
internationally.
THE PURCHASE OF SHARES IN OUR COMPANY WILL BE SUBJECT TO VARIOUS INVESTMENT
RISKS
Because our officers, directors, principal shareholders and their
affiliates beneficially own approximately 81% of our stock ownership, they will
be able to elect the Board of Directors and control all matters requiring
shareholder approval.
The price of our common stock has been volatile and may continue to
experience volatility.
The trading price of our common stock may fluctuate widely as a result
of a number of factors, most of which are outside our control. Some of these
factors include:
o Quarterly variations in our operating results;
o Announcements by our Company about the performance of our
products and our competitors' announcements about performance of
their products; and
o Changes in earnings estimates by analysts, or the failure to meet
the expectations of analysts.
In addition, the stock market has experienced extreme price and volume
fluctuations, which have particularly affected the market prices of many
technology and computer software companies and which have in some cases, been
unrelated to the operating performance of these companies.
21
CHARTER AND BYLAW PROVISIONS OF OUR COMPANY LIMIT THE AUTHORITY OF OUR
SHAREHOLDERS, AND THEREFORE MINORITY SHAREHOLDERS MAY NOT BE ABLE TO
SIGNIFICANTLY INFLUENCE THE COMPANY'S GOVERNANCE OR AFFAIRS
Our Board of Directors has the authority to issue shares of preferred
stock and to determine the price, rights, preferences, privileges and
restrictions, including voting rights, of those shares without any further vote
or action by shareholders. The rights of the holders of common stock will be
subject to, and may be adversely affected by, the rights of the holders of any
preferred stock that may be issued in the future. The issuance of preferred
stock, while providing flexibility in connection with possible acquisitions and
other corporate purposes, could have the effect of making it more difficult for
a third party to acquire a majority of our outstanding voting stock.
Substantial future sales of our common stock in the public market could
cause our stock price to fall. If our shareholders sell substantial amounts of
our common stock in the public market, including shares sold pursuant to the
Equity Line of Credit, from the conversion of debentures or issued upon the
exercise of outstanding options, the trading price of our common stock could
fall. Such sales also might make it more difficult for us to raise capital in
the future at a time and price that we deem appropriate.
WE COULD FAIL TO ATTRACT OR RETAIN KEY PERSONNEL
Our success largely depends on the efforts and abilities of key
executives and consultants, including Gregory S. Levine, our President and a
Director of our Company, and Martin Dell'Oca, our Chief Financial Officer and a
Director of our Company. The loss of the services of any of these people could
materially harm our business because of the cost and time necessary to replace
and train such personnel. Such a loss would also divert management attention
away from operational issues. We have entered into employment agreements with
Mr. Levine and Mr. Dell'Oca, respectively. We do not maintain key-man life
insurance policies on any of these people.
WE MAY BE UNABLE TO MANAGE GROWTH
Successful implementation of our business strategy requires us to
manage our growth. Growth could place an increasing strain on our management and
financial resources. To manage growth effectively, we will need to:
o Implement changes in certain aspects of our business;
o Enhance our information systems and operations to respond to
increased demand;
o Attract and retain qualified personnel; and
o Develop, train and manage an increasing number of
management-level and other employees.
If we fail to manage our growth effectively, our business, financial
condition or operating results could be materially harmed, and our stock price
may decline.
FUTURE SALES BY OUR STOCKHOLDERS MAY ADVERSELY AFFECT OUR STOCK PRICE AND OUR
ABILITY TO RAISE FUNDS IN NEW STOCK OFFERINGS
Sales of our common stock in the public market following our most
recent offering could lower the market price of our common stock. Sales may also
make it more difficult for us to sell equity securities or equity-related
securities in the future at a time and price that our management deems
acceptable or at all. Of the 36,153,385 shares of common stock outstanding as of
November 10, 2001 (assuming no exercise of options), 3,348,733 shares are, or
will be, freely tradable without restriction, unless held by our "affiliates."
The remaining 32,804,652 shares of common stock held by existing stockholders
are "restricted securities" and may be resold in the public market only if
registered or pursuant to an exemption from registration. Some of these shares
may be resold under Rule 144. Immediately following the effective date of our
most recent prospectus, including the shares to be issued to Cornell Capital
Partners, L.P., and upon conversion of debentures, 13,673,814 shares of common
stock will be freely tradeable without restriction, unless held by our
"affiliates."
Upon completion of our most recent offering, and assuming all shares
registered in that offering are resold in the public market, there will be an
additional 13,673,814 shares of common stock outstanding. All of those shares of
common stock may be immediately resold in the public market upon effectiveness
of the accompanying registration statement and the sale to the investor under
the terms of the Equity Line of Credit Agreement.
22
In addition, we have issued options to purchase a total of 4,399,179
shares of our common stock at exercise prices ranging from $0.120 to $0.0927 per
share.
EXISTING SHAREHOLDERS MAY EXPERIENCE SIGNIFICANT DILUTION FROM OUR SALE OF
SHARES UNDER THE LINE OF CREDIT
The sale of shares pursuant to the Equity Line of Credit and from
conversion of debentures will have a dilutive impact on our stockholders. As a
result, our net income per share could decrease in future periods, and the
market price of our common stock could decline. In addition, the lower our stock
price is the more shares of common stock we will have to issue under the Equity
Line of Credit to draw down the full amount. If our stock price is lower, then
our existing stockholders would experience greater dilution.
THE INVESTOR UNDER THE LINE OF CREDIT WILL PAY LESS THAN THE THEN-PREVAILING
MARKET PRICE OF OUR COMMON STOCK
The common stock to be issued under the Equity Line of Credit will be
issued at a 20% discount to the lowest closing bid price for the 10 days
immediately following the notice date. These discounted sales could cause the
price of our common stock to decline.
THE SELLING STOCKHOLDERS IN OUR MOST RECENT OFFERING INTEND TO SELL THEIR SHARES
OF COMMON STOCK IN THE MARKET, WHICH SALES MAY CAUSE OUR STOCK PRICE TO DECLINE
The selling stockholders in our most recent offering intend to sell in
the public market the shares of common stock being registered in that offering.
That means that up to 13,673,814 shares of common stock, the number of shares
being registered in that offering, may be sold. Such sales may cause our stock
price to decline.
OUR COMMON STOCK HAS BEEN RELATIVELY THINLY TRADED AND WE CANNOT PREDICT THE
EXTENT TO WHICH A TRADING MARKET WILL DEVELOP
Our common stock is traded on the Over-the-Counter Bulletin Board. Our
common stock is thinly traded compared to larger more widely known companies in
our industry. Thinly traded common stock can be more volatile than common stock
trading in an active public market. We cannot predict the extent to which an
active public market for the common stock will develop or be sustained after our
most recent offering.
WE MAY NOT BE ABLE TO ACCESS SUFFICIENT FUNDS UNDER THE EQUITY LINE OF CREDIT
WHEN NEEDED
We are dependent on external financing to fund our operations. Our
financing needs are expected, in part, to be provided from the Equity Line of
Credit. No assurances can be given that such financing will be available in
sufficient amounts or at all when needed, in part, because the amount of
financing available will fluctuate with the price and volume of our common
stock. As the price and volume decline, then the amount of financing available
under the Equity Line of Credit will decline.
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PART II
ITEM 1. LEGAL PROCEEDINGS
The officers and directors of our Company believe that to the best of
their knowledge, neither our Company nor any of its officers and Directors are
parties to any legal proceeding or litigation. Further, the officers and
directors know of no threatened or contemplated legal proceedings or litigation.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. EXHIBITS
The following documents are incorporated herein by reference from the
Registrant's Form S-1 Registration Statement filed with the Securities and
Exchange Commission (the "Commission"), Commission file #333-3074 on April 1,
1996 and declared effective by the Commission August 16, 1996:
NUMBER DOCUMENT
- ------ --------
3.1 Articles of Incorporation.
3.2 Amended Articles of Incorporation.
3.3 Bylaws of the Company.
4.1 Specimen certificate for Common Stock.
4.2 Specimen certificate for Class A Redeemable Warrants.
4.3 Specimen certificate for Class B Redeemable Warrants.
The following documents are incorporated herein by reference from the
Registrant's Form 10-K Annual Report for the period ended December 31, 1997:
99.1 Stock Purchase Agreement.
99.2 Employment Agreement with Fred Schmid.
The following documents are incorporated herein by reference from the
Registrant's Form 10-K Annual Report for the period ended December 31, 1998:
3.3 Amended Articles of Incorporation dated December 31, 1997.
3.4 Amended Articles of Incorporation dated April 15, 1998.
24
The following documents are incorporated herein by reference from the
Registrant's Post Effective Amendment 1 to Form S-1 Registration Statement filed
with the Commission, Commission file #333-3074 on June 17,1998 and declared
effective by the Commission June 19,1998:
3.3 Amended Articles of Incorporation dated December 31, 1997.
3.4 Amended Articles of Incorporation dated April 15, 1998.
The following documents are incorporated herein by reference
from the Registrant's Form 8-K Report filed on December 3,
1999:
2. Acquisition Agreement and Exhibits attached thereto.
The following documents are incorporated by reference from the
Registrant's Post-Effective Amendment 2 to Form S-1 Registration Statement filed
with the Commission, Commission file #333-3074 on April 3, 2000.
10.1 March 14, 2000, Consulting Agreement between Nexland S.A. and the
Company.
10.2 November 17, 1999, Mutual Non-Competition Agreement between Nexland,
S.A. and the Company.
10.3 November 17, 1999 Co-Operation Agreement between Smerwick, Ltd. and
the Company.
The following documents are incorporated by reference from the
Registrant's Form 8K filed with the Commission, Commission file
#333-3074 on May 12, 2000.
10.4 Employment Contract of Enrique Dillon.
10.5 Employment Contract of Martin Dell'Oca.
Thefollowing documents are incorporated by reference from the
Registrant's Form 10-K filed with the Commission on May 14, 2001:
4.4 2000 Stock Incentive Plan
10.6 Promissory Note dated August 1, 2000, by the Company payable to
Israel D. Sultan
10.7 Conversion Agreement dated October 26, 2000, between Israel D.
Sultan and the Company.
10.8 Line of Credit Agreement dated March 19, 2001, between Cornell
Capital Partners, L.P. and the Company.
10.9 Registration Rights Agreement dated March 19, 2001, between Cornell
Capital Partners, L.P. and the Company.
10.10 Escrow Agreement dated March 19, 2001, between Cornell Capital
Partners, L.P., the Company, Butler Gonzalez LLP and First Union
National Bank.
10.11 Form of Convertible Debenture
10.12 Consulting Services Agreement dated March 19, 2001, between
Yorkville Advisors Management, L.L.C. and the Company.
10.13 Securities Purchase Agreement dated March 19, 2001, between the
investors on Schedule I attached thereto (the "Investors") and the
Company.
10.14 Registration Rights Agreement dated March 19, 2001, between the
Investors and the Company.
10.15 Placement Agent Agreement dated March 19, 2001, between May Davis
Group, Inc. ("May Davis") and the Company.
10.16 Escrow Agreement dated March 19, 2001, between May Davis, the
Company and First Union National Bank.
The following documents are provided herewith:
10.17 Employment Agreement, effective August 16, 2001, between the Company
and Robert W. Nelson.
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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.
Dated: November 13, 2001 NEXLAND, INC.
By: /s/ Martin Dell'Oca
----------------------------
Martin Dell'Oca
Chief Financial Officer
26