As Filed with the Securities and Exchange Commission on July 22, 1998
REGISTRATION NO.
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM SB-2
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
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NETWORK-1 SECURITY SOLUTIONS, INC.
(Name of small business issuer in its charter)
Delaware 7372 11-3027591
(State or Other (Primary Standard (I.R.S. Employer
Jurisdiction of Industrial Identification Number)
Incorporation or Classification Code
Organization) Number)
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Network-1 Security Solutions, Inc.
70 Walnut Street
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Wellesley Hills, Massachusetts 02481
(781) 239-8280
(Address and Telephone Number of Registrant's Principal Executive Offices)
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AVI A. FOGEL
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President and Chief Executive Officer
Network-1 Security Solutions, Inc.
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70 Walnut Street
Wellesley Hills, Massachusetts 02481
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(781) 239-8280
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(Name, Address and Telephone Number of Agent for Service of Process)
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Copies of Communications to:
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SAM SCHWARTZ, ESQ. ROBERT J. MITTMAN, ESQ.
Bizar Martin & Taub, LLP Tenzer Greenblatt LLP
1350 Avenue of the Americas The Chrysler Building
New York, New York 10019 405 Lexington Avenue
Telephone: (212) 265-8600 New York, New York 10174
Telecopier: (212) 581-8958 Telephone: (212) 885-5000
Telecopier: (212) 885-5001
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Approximate Date of Proposed Sale to the Public: As soon as practicable
after the effective date of this Registration Statement.
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. / /
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. / /
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. / /
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. / /
-----------------
The Registrant hereby amends this Registration Statement on such date or
dates as may be necessary to delay its effective date until the Registrant shall
file a further amendment which specifically states that this Registration
Statement shall thereafter become effective in accordance with Section 8(a) of
the Securities Act of 1933 or until the Registration Statement shall become
effective on such date as the Commission, acting pursuant to said Section 8(a),
may determine.
CALCULATION OF REGISTRATION FEE
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
Proposed Proposed
Maximum Maximum Amount of
Title of Each Class of Amount to be Offering Price Aggregate Registration
Securities Being Registered Registered Per Share (1) Offering Price (1) Fee
- ----------------------------------------------------------------------------------------------------------------------
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Common Stock, par value $.01 per share 2,156,250(2) $ 8.00 $17,250,000 $5,088.75
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Underwriter's Warrants(3), each to purchase
one share of Common Stock.................. 187,500 $ .001 $ 187.50 $ .06
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Common Stock, par value $.01 per share
issuable upon exercise of Underwriter's
Warrants(4)................................ 187,500 $13.20(4) $ 2,475,000 $ 730.13
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Total...................................... $5,818.94
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(1) Estimated solely for the purpose of calculating the registration fee
pursuant to Rule 457(o) of the Securities Act of 1933, as amended.
(2) Includes 281,250 shares of Common Stock issuable upon exercise of an
option granted to the Underwriter to cover over-allotments of shares, if any.
(3) Pursuant to Rule 416, this Registration Statement also registers such
indeterminate number of shares as may become issuable pursuant to the
anti-dilution provisions of the Underwriter's Warrants.
(4) No fee due pursuant to Rule 457(g).
CROSS-REFERENCE SHEET
Form SB-2 Item Number and Caption Heading In Prospectus
- --------------------------------- ---------------------
1. Front of Registration Statement and Outside
Front Cover of Prospectus....................... Outside Front Cover of Prospectus
2. Inside Front and Outside Back Cover Pages of
Prospectus...................................... Inside Front and Outside Back Cover
3. Summary Information and Risk Factors............ Prospectus Summary; Risk Factors
4. Use of Proceeds................................. Use of Proceeds
5. Determination of Offering Price................. Risk Factors; Underwriting
6. Dilution........................................ Dilution; Risk Factors
7. Selling Security Holders........................ Not Applicable
8. Plan of Distribution............................ Outside Front Cover Page of Prospectus
9. Legal Proceedings............................... Business
10. Directors, Executive Officers, Promoters
and Control Persons............................. Risk Factors; Management
11. Security Ownership of Certain Beneficial
Owners and Management........................... Principal Stockholders
12. Description of Securities....................... Description of Securities
13. Interest of Named Experts and Counsel........... Legal Matters; Experts
14. Disclosure of Commission Position on
Indemnification for Securities Act Liabilities.. Description of Securities
15. Organization Within Last Five Years............. Business; Certain Transactions
16. Description of Business......................... Business
17. Management's Discussion and Analysis or
Plan of operation............................... Management's Discussion and Analysis of
Financial Condition and Results of Operations
18. Description of Property......................... Prospectus Summary; Risk Factors; Discussion
and Analysis of Financial Results of Operations; Business
19. Certain Relationships and Related Transactions.. Certain Transactions
20. Market for Common Equity and Related
Stockholder Matters............................. Risk Factors; Dilution; Management;
Shares Eligible for Future Sale
21. Executive Compensation.......................... Management
22. Financial Statements............................ Financial Statements
23. Change in and Disagreements with Accountants
on Accounting and Financial Disclosure.......... Not Applicable
Information contained herein is subject to completion or amendment. A
registration statement relating to these securities has been filed with the
Securities and Exchange Commission. These securities may not be sold nor may
offers to buy be accepted prior to the time the registration statement becomes
effective. This prospectus shall not constitute an offer to sell or the
solicitation of an offer to buy nor shall there be any sale of these securities
in any State in which such offer, solicitation or sale would be unlawful prior
to registration or qualification under the securities laws of any such State.
PRELIMINARY PROSPECTUS DATED JULY 22, 1998
SUBJECT TO COMPLETION
1,875,000 Shares
NETWORK-1 SECURITY SOLUTIONS, INC.
Common Stock
Prior to this offering, there has been no public market for the Common Stock
and there can be no assurance that any such market will develop. It is
anticipated that the Common Stock will be quoted on the Nasdaq SmallCap Market
under the symbol "________." For a discussion of the factors considered in
determining the initial public offering price, see "Underwriting."
THE SECURITIES OFFERED HEREBY ARE SPECULATIVE AND INVOLVE A HIGH DEGREE OF
RISK AND IMMEDIATE SUBSTANTIAL DILUTION AND SHOULD NOT BE PURCHASED BY
INVESTORS WHO CANNOT AFFORD THE LOSS OF THEIR ENTIRE INVESTMENT. SEE
"RISK FACTORS" COMMENCING ON PAGE 7 AND "DILUTION" ON PAGE 22.
----------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS
THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES
COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS
PROSPECTUS. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE.
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- -----------------------------------------------------------------------------------------------------------------
Price Underwriting Proceeds
to Discounts and to
Public Commissions (1) Company (2)
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Per Share........................................... $8.00 $.72 $7.28
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Total (3)........................................... $15,000,000 $1,350,000 $13,650,000
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(1) In addition, the Company has agreed to pay to the Underwriter a 3%
nonaccountable expense allowance and to sell to the Underwriter warrants
(the "Underwriter's Warrants") to purchase up to 187,500 shares of Common
Stock. The Company has also agreed to indemnify the Underwriter against
certain liabilities under the Securities Act of 1933, as amended. See
"Underwriting."
(2) Before deducting expenses estimated at $958,000, including the
Underwriter's nonaccountable expense allowance in the amount of $450,000
($517,500 if the Underwriter's over-allotment option is exercised in
full).
(3) The Company has granted the Underwriter an option, exercisable within 45
days from the date of this Prospectus, to purchase up to an additional
281,250 shares of Common Stock on the same terms as set forth above,
solely for the purpose of covering over-allotments, if any. If the
Underwriter's over-allotment option is exercised in full, the price to
public, underwriting discounts and commissions, and proceeds to Company
will be $17,250,000, $1,552,500 and $15,697,500, respectively. See
"Underwriting."
The shares of Common Stock are being offered, subject to prior sale, when,
as and if delivered to, and accepted by the Underwriter and subject to approval
of certain legal matters by counsel and to certain other conditions. The
Underwriter reserves the right to withdraw, cancel or modify the offering and to
reject any order in whole or in part. It is expected that delivery of
certificates representing the shares will be made against payment therefor at
the offices of the Underwriter, 650 Fifth Avenue, New York, New York 10019, on
or about , 1998.
----------------------
Whale Securities Co., L.P.
The date of this Prospectus is , 1998
[PRODUCT PICTURES TO BE INSERTED ON INSIDE COVER PAGE]
FireWall/Plus is a trademark of the Company. All other trademarks or
tradenames referred to in this Prospectus are the property of their respective
owners.
CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS ON
NASDAQ, IN THE OVER-THE-COUNTER MARKET OR OTHERWISE WHICH STABILIZE, MAINTAIN OR
OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK. SPECIFICALLY, THE UNDERWRITER
MAY OVER-ALLOT IN CONNECTION WITH THE OFFERING AND MAY BID FOR AND PURCHASE
SHARES OF COMMON STOCK IN THE OPEN MARKET. FOR A DESCRIPTION OF THESE
ACTIVITIES, SEE "UNDERWRITING."
2
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by reference to the more
detailed information and financial statements, including the notes thereto,
appearing elsewhere in this Prospectus. Except as otherwise indicated, all
information in this Prospectus, including per share data and information
relating to the number of shares outstanding, (i) has been adjusted to reflect a
1-for-1.61083 reverse stock split of the Common Stock effected on July 20, 1998,
(ii) gives effect to the conversion of the outstanding shares of Series B
Convertible Preferred Stock into 310,399 shares of Common Stock upon the
consummation of this offering, and the issuance of an aggregate of 48,125 shares
of Common Stock upon the consummation of this offering in connection with the
acquisition of CommHome Systems Corp. (the "CommHome Acquisition") and
satisfaction of certain indebtedness of CommHome, and (iii) assumes no exercise
of the Underwriter's over-allotment option to purchase up to 281,250 additional
shares of Common Stock. See "Business -- CommHome System Corp. Acquisition,"
"Certain Transactions" and Note J to Notes to Financial Statements.
Certain statements contained herein under "Prospectus Summary," "Risk
Factors," "Use of Proceeds," "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and "Business" including, without
limitation, statements concerning the Company's strategy and growth plans,
contain certain forward-looking statements concerning the Company's operations,
economic performance and financial condition. Because such statements involve
risks and uncertainties, actual results may differ materially from those
expressed or implied by such forward looking statements. Factors that could
cause such differences include, but are not limited to, those discussed under
"Risk Factors."
The Company
Network-1 Security Solutions, Inc. (the "Company") develops, markets,
licenses and supports a family of network security software products designed to
provide comprehensive security to computer networks, including Internet based
systems and internal networks and computing resources. The Company's
FireWall/Plus family of security software products enables an organization to
protect its computer networks from internal and external attacks and to secure
organizational communications over such internal networks and the Internet. The
Company also offers its customers a full range of consulting services in network
security and network design and support in order to build, maintain and enhance
customer relationships and increase the demand for its software products.
The FireWall/Plus family of security solutions is designed to protect
against Internet and intranet (internal networks utilizing Internet technology
and applications based upon TCP/IP - the Internet network transport protocol)
based security threats and to address security needs that arise from within
internal networks that often utilize other network transport protocols besides
TCP/IP including, among others, Novell's IPX, Digital Equipment's DECnet and
IBM's SNA. The Company's FireWall/Plus family of firewall products operates on
the Microsoft Windows NT operating system platform. FireWall/Plus's proprietary
Interceptor Shim and filter engine software technology, with its unique ability
to handle and filter all commonly used network transport protocols, provides
organizations with a highly secure and flexible security solution. Additionally,
unlike most other firewall solutions which focus on an enterprise's connection
to the Internet, the FireWall/Plus solution can be deployed throughout the
enterprise; at the perimeter to control access
3
to and from the Internet, between internal networks and on application servers
and desktop PCs to protect data residing on such servers and PCs. FireWall/Plus
for Windows NT received the 1997 Internet and Electronic Commerce Conference
award for "Best Intranet Solution" and the 1997 ENT Readers Choice Award for
"Best NT Firewall."
As a result of the explosive growth in network computing and Internet use
(as well as use of intranets and extranets), protection of an organization's
network and data has become a significant economic concern for businesses.
According to the 1997 Annual Information Week/Ernst & Young LLP Information
Security Survey of information technology managers and professionals, 42% of the
respondents reported malicious acts from external sources, as compared to 16% in
the prior year, and 43% of the respondents reported malicious acts by employees
as compared to 29% in the prior year. According to FBI estimates, U.S. companies
suffer estimated losses of $5 to $10 billion per year as a result of
unauthorized access to information and data. According to the 1998 Computer
Security Institute/FBI Computer Crime and Security Survey, 44% of the
respondents reported unauthorized access by employees. The Company believes that
securely segmenting internal network areas and computing resources from
unauthorized access will become paramount to insuring the integrity of both the
internal network and an organization's intranet and extranet (intranets which
allow access for one or more users outside of the internal network) resources.
In a Windows NT based environment, it is typical for multiple network
transport protocols to co-exist, as Windows NT comes pre-equipped with TCP/IP,
IPX (Novell), NetBEUI (LAN Manager) and AppleTalk. In addition, certain
applications require the use of non-TCP/IP protocols to operate between
subnetworks within a network. The Company believes that multiple network
transport protocols will remain prevalent in computing environments because of
the large installed base of non-TCP/IP based computer systems and applications.
As a result, the Company believes that its FireWall/Plus technology offers
significant advantages as a security product for computer networks because of
its unique ability to filter all commonly used network transport protocols and
reside in multiple locations throughout an organization's network.
The Company intends to pursue an aggressive growth strategy and to focus its
efforts on marketing its FireWall/Plus family of network security products. Key
elements of the Company's strategy are to:
- Provide comprehensive network security solutions by developing,
marketing and supporting a family of network security products to
address a broad range of security issues confronting computer networks
and computing, including concerns arising from allowing access to the
Internet as well as concerns relating to the security of internal
networks.
- Emphasize internal network security because of the ability of
FireWall/Plus to filter a multitude of network transport protocols
which are common in many organizations. The Company intends to devote a
significant portion of the proceeds of this offering for sales and
marketing toward educating potential end users and third-party
distributors as to the need to protect networks and computing resources
from unauthorized access and attacks from within an internal network
and the capabilities and benefits of the Company's products.
4
- Implement a marketing plan which includes a multi-channel distribution
strategy which emphasizes establishing and maintaining third-party
distributor relationships with systems integrators, VARs, OEMs and
resellers in the United States and internationally.
- Increase sales of FireWall/Plus by leveraging relationships with
consulting clients.
Since its inception, the Company has incurred significant losses. The future
success of the Company is largely dependent upon its FireWall/Plus family of
software products achieving market acceptance. There can be no assurance that
the Company will be able to successfully implement its marketing strategy,
achieve significant market acceptance of its FireWall/Plus products or achieve
profitable operations.
The Company was incorporated under the laws of the State of Delaware in July
1990. The Company's executive offices are located at 70 Walnut Street, Wellesley
Hills, Massachusetts 02481 and its telephone number at that address is (781)
239-8280. The Company intends to relocate its executive offices to a new
facility in the Boston, Massachusetts area following the consummation of this
offering. The Company's website can be found on the Internet at:
http://www.network-1.com.
The Offering
Common Stock offered....................... 1,875,000 shares
Common Stock to be outstanding
after the offering......................... 4,508,369 shares(1)
Use of Proceeds........................... The Company intends to use the
net proceeds of this offering
for sales and marketing;
repayment of indebtedness;
software development; purchase
of computer equipment; payment
of trade payables; establishing
a new office facility; and the
balance for working capital and
general corporate purposes.
Risk Factors.............................. The securities offered hereby
involve a high degree of risk
and immediate substantial
dilution to new investors and
should not be purchased by
investors who cannot afford the
loss of their entire
investment. See "Risk Factors"
and "Dilution."
Proposed Nasdaq SmallCap Market
symbol.................................... / /
(1) Does not include: (i) 187,500 shares of Common Stock reserved for issuance
upon exercise of the Underwriter's Warrants; (ii) 423,908 shares of Common
Stock reserved for issuance upon exercise of stock options granted under
the Company's 1996 Stock Option Plan (the "Stock Option Plan"); (iii)
326,092 shares of Common Stock reserved for issuance upon exercise of stock
options available for future grant under the Stock Option Plan; and (iv)
630,886 shares of Common Stock reserved for issuance upon exercise of other
outstanding warrants and options. See "Management-Stock Option Plan,"
"Description of Securities-Warrants and Options" and "Underwriting."
5
Summary Financial Information
The summary financial information set forth below is derived from and should
be read in conjunction with the audited financial statements, including the
notes thereto, and "Management's Discussion and Analysis of Financial Condition
and Results of Operations," contained elsewhere in this Prospectus.
Year Ended Three Months
December 31, Ended March 31,
---------------------------------------------------------------------
1996 1997 1997 1998
------------ ------------ ----------- ------------
Statement of Operations Data:
Total revenues $ 1,027,000 $ 2,369,000 $ 479,000 $ 339,000
Loss from operations (4,239,000) (1,837,000) (559,000) (473,000)
Net loss (4,499,000) (2,390,000) (590,000) (697,000)
Loss per share (1) (2.46) (1.29) (.30) (.41)
Weighted average number of
shares outstanding 1,825,163 1,855,244 1,942,872 1,706,037
December 31,
1997 March 31, 1998
---------------- ----------------------------------------------------
Actual Actual Pro Forma(2) As Adjusted(2)(3)
---------------- ------------- ------------------ -------------------
Balance Sheet Data:
Cash and cash equivalents $ 60,000 $ 67,000 $ 1,416,000 $ 10,766,000
Working capital (deficit) (661,000) (2,283,000) (1,518,000) 8,702,000
Total assets 2,404,000 2,094,000 3,443,000 12,718,000
Total liabilities 2,479,000 2,666,000 3,250,000 783,000
Accumulated deficit (7,470,000) (8,167,000) (8,181,000) (9,516,000)
Total stockholders' equity (deficit) (75,000) (572,000) 193,000 11,935,000
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(1) See Notes A and B to Notes to Financial Statements for an explanation of
shares used in net loss per share calculations.
(2) Gives effect to (i) the conversion of the outstanding shares of Series B
Convertible Preferred Stock into 310,399 shares of Common Stock upon
consummation of this offering, (ii) the issuance of $1,350,000 principal
amount promissory notes and warrants to purchase up to 251,423 shares of
Common Stock in private financings completed from April 1998 through May
1998, (iii) the issuance of 596,741 shares of Common Stock in exchange for
the cancellation of outstanding warrants and options to purchase 789,521
shares of Common Stock on July 8, 1998, (iv) the repurchase and
cancellation of 62,080 shares of Common Stock in connection with a private
financing in May 1998, and (v) the issuance in May 1998 of an aggregate of
34,146 shares of Common Stock for services rendered to the Company
(collectively, the "Pro Forma Adjustments"). See "Certain Transactions" and
"Description of Securities."
(3) Gives effect to (i) the sale of 1,875,000 shares of Common Stock offered
hereby and the application of the estimated net proceeds therefrom, (ii)
aggregate non-cash charges estimated to be $870,000 relating to the
amortization of the debt discount on $3,250,000 principal amount promissory
notes upon the repayment of such notes, plus accrued interest thereon, upon
consummation of this offering and (iii) the issuance of an aggregate of
48,125 shares of Common Stock, upon consummation of this offering, in
connection with the CommHome Acquisition and the satisfaction of an
aggregate of $105,000 of indebtedness of CommHome owed to certain officers
of the Company, and a charge related to the CommHome Acquisition for
purchased research and development of $465,000 (such adjustment, together
with the adjustment described in (ii) above, collectively the "Additional
Adjustments"). See "Use of Proceeds,""Business - CommHome Systems Corp.
Acquisition" and "Capitalization."
6
RISK FACTORS
An investment in the shares of Common Stock offered hereby is speculative
and involves a high degree of risk and should not be purchased by anyone who
cannot afford the loss of their entire investment. Each prospective investor
should carefully consider the following risk factors as well as the other
information set forth in this Prospectus in evaluating an investment in the
shares of Common Stock offered hereby. This Prospectus contains forward-looking
statements based upon current expectations that involve risks and uncertainties.
The Company's actual results and the timing of certain events may differ
materially from those discussed in such forward-looking statements as a result
of certain factors, including, but not limited to, those set forth in the
following risk factors and elsewhere in this Prospectus.
Limited Relevant Operating History; Significant and Continuing Losses;
Explanatory Paragraph in Independent Public Accountant's Report. Although the
Company was organized in July 1990, it was engaged primarily in providing
network consulting and training services through 1994 and did not commence
marketing of its first FireWall/Plus product until June 1995. Accordingly, the
Company has a limited relevant operating history as a software developer upon
which an evaluation of its prospects and future performance can be made. Such
prospects must be considered in light of the risks, expenses and difficulties
frequently encountered in the operation and expansion of a new business and the
shift from research and product development to commercialization of products
based on rapidly changing technologies in a highly specialized and emerging
market. Since inception, the Company has incurred significant net losses,
including net losses of $4,499,000, $2,390,000 and $697,000 for the years ended
December 31, 1996, December 31, 1997 and the three months ended March 31, 1998,
respectively. At March 31, 1998, the Company had an accumulated deficit of
$8,167,000 and since March 31, 1998 the Company has continued to incur
significant losses. The Company will also incur aggregate non-cash charges
during the three months ended June 30, 1998 and upon consummation of this
offering of approximately $1,335,000 relating to (i) the amortization of debt
discount with respect to $3,250,000 principal amount promissory notes which will
be repaid in full, together with accrued interest thereon, upon consummation of
this offering and (ii) purchased research and development in connection with the
CommHome Acquisition. In addition, the Company will incur non-cash charges of
$900,000 over a four-year period related to stock options issued in May 1998 to
Avi A. Fogel, President and Chief Executive Officer of the Company. Inasmuch as
the Company intends to increase its level of activities following the
consummation of this offering and will be required to make significant up-front
capital expenditures in connection with its sales and marketing and continuing
research and product development efforts, the Company anticipates that losses
will continue until such time, if ever, as the Company is able to attain sales
levels sufficient to support its operations. There can be no assurance that the
Company will ever achieve profitable operations. The Company's independent
auditors have included an explanatory paragraph in their report on the Company's
financial statements for the years ended December 31, 1996 and December 31,
1997, stating that certain factors raise substantial doubt about the Company's
ability to continue as a going concern. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations," "Certain
Transactions" and Financial Statements.
Significant Capital Requirements; Working Capital Deficit; Dependence on
Proceeds for Plan of Operation; Continuing Need for Additional Financing. The
Company's capital requirements have been and will continue to be significant,
and its cash requirements have been exceeding its cash flow from operations. At
March 31, 1998, the Company had a working capital deficit of $2,283,000. As
7
a result, the Company has been substantially dependent on private sales of
equity and debt securities to fund its operations. The Company is dependent on
the proceeds of this offering to implement its business plan and finance its
working capital requirements. The Company anticipates, based on currently
proposed plans and assumptions relating to the implementation of its business
plan (including the timetable of, costs and expenses associated with, and
success of, its marketing efforts), that the net proceeds of this offering,
together with projected revenues from operations, will be sufficient to satisfy
the Company's operations and capital requirements for approximately twelve
months following the consummation of this offering. There can be no assurance,
however, that such funds will not be expended prior thereto due to unanticipated
changes in economic conditions or other unforeseen circumstances. In the event
the Company's plans change or its assumptions change or prove to be inaccurate
(due to unanticipated expenses, difficulties, delays or otherwise) or the net
proceeds of this offering and projected revenues otherwise prove to be
insufficient to fund the implementation of the Company's business plan or
working capital requirements, the Company could be required to seek additional
financing sooner than currently anticipated. The Company has no current
arrangements with respect to any additional financing. Consequently, there can
be no assurance that any additional financing will be available to the Company
when needed, on commercially reasonable terms or at all. Any inability to obtain
additional financing when needed would have a material adverse effect on the
Company, requiring it to curtail and possibly cease its operations. In addition,
any additional equity financing may involve substantial dilution to the
interests of the Company's then existing stockholders. See "Use of Proceeds" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
Uncertainty of Market Acceptance of Products. The future success of the
Company is largely dependent upon market acceptance of its FireWall/Plus family
of software products. The network security market is at an early stage of
development and is rapidly evolving. Accordingly, demand for the Company's
products and market acceptance are subject to a high level of uncertainty. While
the Company believes that its FireWall/Plus family of software products offers
advantages over competing products for network security, sales of FireWall/Plus
products since introduction (June 1995) through March 31, 1998 have been only
$2,437,000. There can be no assurance that FireWall/Plus will gain market
acceptance. Revenues from such products depend on a number of factors, including
the influence of market competition, technological changes in the network
security market, the Company's ability to design, develop and introduce
enhancements on a timely basis, and the ability of the Company to successfully
establish and maintain distribution channels. Moreover, there are commercially
available competitive products, offered by companies with significantly greater
resources than the Company, which have comparable or more favorable price
characteristics and which may be perceived to have performance characteristics
comparable to the Company's products. In addition, the Company anticipates the
introduction of additional competitive products, particularly if the demand for
network security products continues to increase. Existing and future competition
may make it more difficult to achieve market acceptance for FireWall/Plus.
Additionally, potential customers may be reluctant to purchase the Company's
products due to significant investments in other network security products.
Consequently, although the Company intends to utilize a significant portion of
the proceeds of this offering to expand its marketing and sales activities,
there can be no assurance that such funds will be sufficient, that the Company's
increased marketing efforts and expenditures will result in significant levels
of revenue or that the FireWall/Plus family of products will achieve significant
market acceptance. Moreover, a highly publicized breach of network security
involving the Company's products could adversely affect public
8
perception of, and confidence in, the Company's products. See "Use of Proceeds,"
"Business - Sales and Marketing" and "Business -- Competition."
Limited Marketing Capabilities and Experience; Dependence Upon Third-Party
Marketing Arrangements. The Company has not yet undertaken significant marketing
efforts relating to product commercialization, has limited marketing experience
and has limited financial, personnel and other resources to undertake extensive
marketing activities independently. Accordingly, the Company has relied and
intends to continue to rely to a large extent on arrangements with third parties
for the marketing and distribution of its products, including arrangements with
VARs, systems integrators, resellers, distributors and OEMs. The Company has
only recently entered into marketing arrangements with most of its distributors
and, to date, most of such arrangements have generated limited revenues. For the
year ended December 31, 1997 and the three months ended March 31, 1998, the
Company's five largest distributors accounted for an aggregate of approximately
28% and 40% of the Company's revenues, respectively. Trusted Information
Systems, Inc. (as a result of a non-refundable pre-paid royalty) and Electronic
Data Systems Corporation ("EDS") accounted for 21% and 14%, of the Company's
revenues, respectively, for the year ended December 31, 1997, and The Sabre
Group, Inc. and Omnicon Systems, Inc. accounted for 24% and 13% of the Company's
revenues, respectively, for the three months ended March 31, 1998. The Company's
prospects will be dependent upon its ability to develop and maintain strategic
marketing relationships with additional third parties and upon the marketing and
distribution efforts of its third-party distributors. While the Company believes
that the third parties with which it enters into marketing arrangements have an
economic incentive to commercialize the Company's products, the time and
resources devoted to these activities will be contributed and controlled by such
third parties. Many of the Company's third-party distributors represent various
product lines, including those competing with the Company's products. A decline
in the prospects of key distributors could have an adverse effect on the
Company. There can be no assurance that the Company will be able, for financial
or other reasons, to finalize any additional third-party distribution or
marketing arrangements, maintain its existing marketing and distribution
arrangements or that any such arrangements will result in the successful
commercialization of the Company's products. See "Business - Sales and
Marketing."
Competition. The network security market in general, and the firewall
product market in particular, is characterized by intense competition and
rapidly changing business conditions, customer requirements and technologies.
The Company believes that the principal competitive factors affecting the market
for network security products include security effectiveness, scope of product
offerings, name recognition, product features, distribution channels, price,
ease of use and customer service and support. Currently, the Company's principal
competitors include AXENT Technologies Inc., Bay Networks, Inc., CheckPoint
Software Technologies, Ltd., Cisco Systems, Inc., Compaq Computer Corporation,
Cyberguard Corp., International Business Machines Corporation, ISS Group, Inc.,
Microsoft Corporation, Network Associates, Inc. and Secure Computing
Corporation. Due to the rapid expansion of the network security market, the
Company may face competition from new entrants to the firewall product market.
Most of the Company's current and potential competitors have longer operating
histories, greater name recognition, larger installed customer bases and possess
substantially greater financial, technical and marketing and other competitive
resources than the Company. As a result, the Company's competitors may be able
to adapt more quickly to new or emerging technologies and changes in customer
requirements or to devote greater resources to the promotion and sale of their
products than the Company. While the Company believes that its firewall products
do not compete against manufacturers of other types of security products (such
as encryption
9
and authentication products), there can be no assurance that potential customers
will not perceive the products of such other companies as substitutes for the
Company's products. In addition, certain of the Company's competitors may
determine for strategic reasons to consolidate, to substantially lower the price
of their network security products or to bundle their products with other
products, such as hardware or other enterprise software products. Accordingly,
it is possible that new competitors and alliances among competitors may emerge
and rapidly acquire significant market share. There can be no assurance that the
Company's current and potential competitors will not develop products that may
be more effective than the Company's current or future products or that the
Company's products would not be rendered obsolete or less marketable by evolving
technologies or changing consumer demands or that the Company will otherwise be
able to compete successfully. Increased competition for firewall products may
result in price reductions and reduced gross margins and may adversely effect
the Company's ability to gain market share, any of which would adversely affect
the Company's business, operating results and financial condition. See "Business
- - Competition."
Rapid Technological Change; Potential Product Obsolescence. The network
security industry is characterized by rapid technological advances, increasingly
sophisticated and changing customer requirements, frequent new product
introductions and enhancements, new and continuously evolving network security
threats and attack methodologies and evolving industry standards in computer
hardware and software technology. As a result, the Company must continually
change and improve its products in response to such advances and changes in
operating systems, application software, computer and communications hardware,
networking software, programming tools and computer language technology. The
introduction of products embodying new technologies and the emergence of new
industry standards may render existing products obsolete or unmarketable. The
Company's future operating results will depend upon the Company's ability to
enhance its current products and to develop and introduce new products on a
timely basis that address the increasingly sophisticated needs of the
marketplace and that keep pace with technological developments, new competitive
product offerings and emerging industry standards. There can be no assurance
that the Company will be successful in developing and marketing new products or
product enhancements that respond to technological change and evolving industry
standards and customer requirements, that the Company will not experience
difficulties that could delay or prevent the successful development,
introduction and marketing of these products, or that any new products and
product enhancements will adequately meet the requirements of the marketplace
and achieve market acceptance. In the event that the Company does not respond
adequately to the need to develop and introduce new products or enhancements of
existing products in a timely manner in response to changing market conditions
or customer requirements, the Company's business, operating results and
financial condition will be materially adversely affected. See "Business -
Product Development."
Unproven Market for Internal Network Security Products. Many of the
Company's competitors in the firewall market have largely devoted their
resources to the development and marketing of perimeter firewall products ("IP
Firewalls") designed primarily to protect an internal network from internet
based security threats or threats from within intranets. While TCP/IP is a
dominant network transport protocol, network environments often use other
network transport protocols such as Novell's IPX, Digital Equipment's DECnet and
IBM's SNA. The Company believes that the ability of the FireWall/Plus technology
to filter all commonly used network transport protocols and reside in multiple
locations throughout the enterprise network offers significant advantages as a
security product for internal networks. However, the Company's limited sales to
date have not established that, in fact, this is a significant marketing
advantage. The Company's future
10
success depends in large part on the Company's ability to successfully market
its technology and the increased awareness and demand in the market for the need
to address security threats that arise from within internal networks which may
require substantial marketing efforts and the expenditure of significant funds.
Furthermore, firewall vendors and other vendors of network security products
with substantially greater financial, technical and marketing resources than the
Company may modify existing security products or develop new products which
would address the internal network security market. The Company's failure to
successfully implement marketing efforts emphasizing the internal network
security market would have a material adverse effect on its business, financial
condition and results of operations in the future. See "Business - Network-1
Strategy" and "Business - FireWall/Plus Technology."
Significant Fluctuations in Quarterly Operating Results. The Company
anticipates significant quarterly fluctuations in its operating results in the
future. The Company generally ships orders for commercial products as they are
received and, as a result, does not have any material backlog. As a result,
quarterly revenues and operating results depend on the volume and timing of
orders received during the quarter, which are difficult to forecast. Operating
results may also fluctuate on a quarterly basis due to factors such as the
demand for the Company's products, purchasing patterns and budgeting cycles of
customers, the introduction of new products and product enhancements by the
Company or its competitors, market acceptance of new products introduced by the
Company or its competitors and the size, timing, cancellation or delay of
customer orders, including cancellation or delay in anticipation of new product
introduction or enhancement. Therefore, comparisons of quarterly operating
results may not be meaningful and should not be relied upon, nor will they
necessarily reflect the Company's future performance. Because of the foregoing
factors, it is likely that in some future quarters the Company's operating
results will be below the expectations of public market analysts and investors.
In such event, the price of the Common Stock would likely be materially
adversely affected. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
Proposed Expansion; Management of Growth; Need for Qualified Personnel.
Following the consummation of this offering, the Company intends to use a
substantial portion of the proceeds to expand its current level of operations
and expects to significantly increase the number of its employees. This growth
will result in an increase in responsibilities placed upon the Company's
management and will place added pressures on the Company's operating and
financial resources. The Company's success will be dependent in part on its
ability to manage its growth, recruit additional management personnel, expand
its sales and marketing personnel and research and development staff, improve
its operational and financial systems, expand its customer support functions and
train, motivate and manage additional employees, monitor operations and control
costs. Competition with respect to the recruiting of highly qualified personnel
in the software industry is intense and many of the Company's competitors have
significantly greater resources than the Company. The Company's ability to
attract and assimilate new personnel will be critical to the Company's
performance and there can be no assurance that the Company will be successful in
attracting and retaining the personnel it requires to enhance its products,
develop new products and conduct its operations successfully. Moreover, the
Company may seek to expand its operations by acquiring businesses, technologies
or products which it believes are complimentary with its business. Except for
the CommHome Acquisition, the Company has no definitive plans with respect to
and is not currently involved in negotiations relating to any acquisitions. The
consummation of any such
11
acquisition would place additional burden on management and financial resources.
See "Business - CommHome Systems Corp. Acquisition."
Limited Protection of Proprietary Rights; Reliance on Trade Secrets. The
Company's success is substantially dependent on its proprietary technologies.
The Company does not hold any patents and relies on copyright and trade secret
laws, non-disclosure agreements with employees, distributors and customers,
including "shrink wrap" license agreements that are not signed by the customer,
and technical measures to protect the ideas, concepts and documentation of its
proprietary technologies and know-how to protect its intellectual property
rights. Such methods may not afford complete protection, and there can be no
assurance that third parties will not independently develop substantially
equivalent or superior technologies or obtain access to the Company's
technologies, ideas, concepts and documentation. In addition, there can be no
assurance that any confidentiality agreements between the Company and its
employees, distributors or customers will provide meaningful protection for the
Company's proprietary information in the event of any unauthorized use or
disclosure. Furthermore, the Company may be subject to additional risk as it
enters into transactions in countries where intellectual property laws are not
well developed or are poorly enforced. Legal protection of the Company's rights
may be ineffective in such countries. The inability of the Company to protect
its proprietary technologies could have a material adverse effect on the
Company. The Company also licenses from a third-party certain proxy technology
which is incorporated into its FireWall/Plus products. The Company is dependent
in part on its ability to continue to license such technology and any inability
of the Company to be able to continue to utilize such technology either as a
result of the Company's breach or the termination of the license agreement or
otherwise, in the absence of similar available technologies, could have a
material adverse effect on the Company.
The Company received a U.S. trademark registration for the FireWall/Plus
name in December 1996. Although the Company is not aware of any challenges to
the Company's rights to use this trademark, there can be no assurance that the
use of this mark would be upheld if challenged. See "Business - Proprietary
Rights."
Potential Infringement on Intellectual Property Rights of Others.
Although the Company believes that its technologies and products have been
developed independently and do not infringe upon the proprietary rights of
others, there can be no assurance that the Company's technologies and
products do not and will not so infringe or that third parties will not
assert infringement claims against the Company in the future. The Company is
not aware of any patent infringement charge or any violation of other
proprietary rights claimed by any third party relating to the Company or the
Company's products. In response to certain public statements made by
CheckPoint Software Technologies, Ltd. related to a patented technology
referred to as "stateful inspection" (the "Checkpoint Patent"), the Company
retained patent counsel in April 1997 to review the Checkpoint Patent as
compared to the Company's intellectual property and associated products.
Based upon the opinion of the Company's intellectual property counsel, the
Company does not believe that the CheckPoint Patent will have a material
adverse effect on the Company. If, however, the Company's technologies or
products were deemed to infringe upon the Checkpoint Patent, or if the
Company's technologies or products were deemed to infringe upon the
proprietary rights of other third parties, the Company could become liable
for damages or be required to modify its products or to obtain a license. As
the number of and variety of security products being offered continue to
increase the functionality of such products may further overlap, which could
result in increased infringement claims by software developers, including
infringement claims against the Company with respect to
12
future products. There can be no assurance that the Company would be able to
modify its products or obtain a license in a timely manner, upon acceptable
terms and conditions, or at all, or that the Company will have the financial or
other resources necessary to defend a patent infringement or other proprietary
rights infringement action. Failure to do any of the foregoing could have a
material adverse effect on the Company, including possibly requiring the Company
to cease marketing its products. See "Business - Proprietary Rights."
Dependence on Sales of Limited Product Line; Non-Recurring Revenues. Since
1996, a substantial portion of the Company's sales have been derived from the
sale of its FireWall/Plus products. For the year ended December 31, 1997 and the
three months ended March 31, 1998, sales of FireWall/Plus products accounted for
approximately 60% and 58% of the Company's revenues, respectively. A decline in
sales of FireWall/Plus products would have a material adverse effect on the
Company. In addition, sales of the Company's products are generally
non-recurring in nature. There can be no assurance that the Company will not
remain dependent upon non-recurring sales of FireWall/Plus products to a limited
number of customers, which sales could constitute a considerable portion of the
Company's revenues. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
Dependence on Continued Growth of the Internet and Internal Networks. Since
the Company's products are designed to protect internal networks from
unauthorized access and attacks via the Internet and from within internal
networks, the Company's success is substantially dependent upon the widespread
acceptance and use of the Internet, intranets and extranets as effective means
of communication and commerce. Rapid growth in the use of and interest in the
Internet, intranets and extranets is a recent phenomenon, and there can be no
assurance that acceptance and use will continue to develop or that a
sufficiently broad base of consumers will adopt and continue to use the
Internet, intranets and extranets as means of communication and commerce. The
Internet may not be accepted as a viable commercial marketplace for a number of
reasons, including potentially inadequate development of the necessary network
infrastructure or delayed development of enabling technologies and performance
improvements. If use of the Internet does not continue to grow or grows more
slowly than expected, if the infrastructure for the Internet does not
effectively support growth that may occur, or if the Internet and online
services do not become a viable commercial marketplace, market demand for the
Company's products may not develop or be maintained. See "Business -- Industry
Background."
Focus on Windows NT Platform. Currently, the Windows NT operating system is
the principal platform for the Company's FireWall/Plus family of products.
According to a recent International Data Corporation survey, Windows NT
shipments are expected to assume a majority market share by 1999. While the
Windows NT platform is perceived to have security weaknesses, many of the
Company's competitors currently offer Windows NT based firewalls and the Company
believes that the use of Windows NT as the preferred operating system will
continue to grow dramatically over the next five years. In the event that demand
for Windows NT based firewalls declines, or other platforms become the preferred
platforms, and the Company is unable to adapt its products to the preferred
platforms on a timely basis, the Company's business, financial condition and
results of operations may be materially adversely affected. See "Business --
Industry Background" and "Business -- FireWall/Plus Technology."
Potential Liability Exposure. Since the Company's products are network
security products and are used to prevent unauthorized access to and attacks
upon critical enterprise information, the
13
Company may be exposed to potential liability claims for damage caused to a
network as a result of an actual or alleged failure of an installed product.
Although the Company's license agreements typically contain provisions that are
designed to limit the Company's exposure to potential product liability or
related claims, including provisions that limit the Company's liability for
special, consequential or incidental damages, there can be no assurance that
such provisions will be enforceable under the laws of applicable domestic or
foreign jurisdictions. The Company's consulting engagements often involve
development, implementation and maintenance of networking systems that are
critical to the operations of its clients' businesses. The Company's failure or
inability to meet a client's expectations in the performance of its services
could harm the Company's business reputation or result in a claim for
substantial damages against the Company, regardless of the Company's
responsibility for such failure or inability. In addition, in the course of
performing services, the Company's personnel often gain access to technologies
and content which include confidential or proprietary client information. Any
unauthorized disclosure or use of such information could result in a claim for
substantial damages. The Company currently maintains product liability insurance
coverage in the amount of $1,000,000 per occurrence ($2,000,000 in the
aggregate) that, subject to customary exclusions, covers claims resulting from
failure of the Company's products or services to perform the function or to
serve the purpose intended. There can be no assurance that the Company's
insurance will be sufficient to cover potential claims or that adequate levels
of coverage will be available in the future at reasonable cost. A partially or
completely uninsured successful claim against the Company could have a material
adverse effect on the Company. See "Business - Proprietary Rights."
Risk of Product Defects. Software products as complex as those offered by
the Company may contain undetected errors or result in failures when first
introduced or when new versions are released. In particular, the personal
computer hardware environment is characterized by a wide variety of non-standard
configurations that make pre-release testing for programming or compatibility
errors very difficult and time-consuming. Despite testing by the Company and by
current and potential customers, there can be no assurance that errors will not
be found in new products or enhancements after commencement of commercial
shipments. The occurrence of these errors could result in adverse publicity,
loss of or delay in market acceptance, claims by customers against the Company,
or could cause the Company to incur additional costs, any of which could have a
material adverse effect upon the Company's business, operating results and
financial condition. See "Business - Products" and "Business - Product
Development."
Lengthy Sales Cycle. Licensing of the Company's software products generally
involves a significant commitment of capital by customers, with the attendant
delays frequently associated with large capital expenditures. Accordingly, the
sales cycle for the Company's products can be lengthy and generally commences at
the time a prospective customer demonstrates an interest in purchasing a
FireWall/Plus solution, typically includes a 30-day free evaluation period and
ends upon execution of a purchase order by the customer. The length of the sales
cycle varies depending on the type and sophistication of the customer and the
complexity of the operating system and may extend for periods of six to nine
months. As a result of the Company's lengthy sales cycle, sales of the Company's
products generally require the Company to make expenditures and use significant
resources prior to receipt, if any, of corresponding revenues. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
Licensing in Foreign Markets. The Company relies on sales of software
licenses in foreign customers for a portion of its revenues. For the years ended
December 31, 1996 and 1997 and the
14
three months ended March 31, 1998, licensing of the Company's software products
to foreign customers accounted for approximately 6.7%, 15.6% and 2.7%,
respectively, of the Company's revenues. The Company is seeking to increase the
licensing of its products in foreign markets, but there can be no assurance that
the Company will be successful or that such markets will prove to be viable. To
the extent that the Company is able to successfully expand its licenses to
foreign markets, the Company will become increasingly subject to risks inherent
in foreign trade, including shipping delays, increased collection risks, trade
restrictions, export duties and tariffs and international political, regulatory
and economic developments, all of which could have an adverse effect on the
Company's operating margins and results of operations and exacerbate the risks
inherent in the Company's business. The Company may seek to limit its exposure
to the risk of currency fluctuations by engaging in foreign currency hedging
transactions that could expose the Company to substantial risk of loss. The
Company is not currently engaged in any currency hedging or other activities
involving derivative financial instruments. The Company has limited experience
in managing international transactions and has not yet formulated a strategy to
protect the Company against currency fluctuations. See "Business - Sales and
Marketing."
Dependence Upon Key Personnel; New Management. The success of the Company
will be largely dependent on the personal efforts of Avi A. Fogel, President and
Chief Executive Officer, William Hancock, Chief Technology Officer, and Robert
P. Olsen, Vice President of Product Management. Although the Company has entered
into employment agreements with each of Messrs. Fogel, Hancock and Olsen, the
loss of the services of any of such officers could have a material adverse
effect on the Company's business and prospects. Prior to the consummation of
this offering, the Company will obtain "key-man" life insurance on each of the
lives of Messrs. Fogel, Hancock and Olsen in the amounts of $2,000,000,
$3,000,000 and $2,000,000, respectively. Messrs. Fogel and Olsen as well as
Murray P. Fish, Chief Financial Officer, only joined the Company in May 1998. In
addition, Joseph A. Donohue, Vice President of Engineering, only joined the
Company in July 1998. There can be no assurance that such officers will become
sufficiently familiar with the Company's operations on a timely basis, or at
all. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and "Management."
Control by Management. Upon consummation of this offering, the Company's
officers and directors, will beneficially own, in the aggregate, approximately
34.8% of the outstanding Common Stock. Accordingly, such persons will continue
to exert significant influence over the outcome of all matters submitted to a
vote of the holders of Common Stock, including the election of directors,
amendments to the Company's Certificate of Incorporation and approval of
significant corporate transactions. Such consolidation of voting power could
also have the effect of delaying, deterring or preventing a change in control of
the Company that might be beneficial to other stockholders. See "Management" and
"Principal Stockholders."
Use of Proceeds to Repay Indebtedness and Trade Payables; Benefits to
Related Parties; Broad Discretion in Application of Proceeds. The Company has
allocated approximately $3,537,000 (27.9%) of the net proceeds of this offering
to repay outstanding indebtedness including $1,900,000 principal amount of
notes, plus accrued interest thereon, payable to Applewood Associates, L.P., a
principal stockholder of the Company, $200,000 principal amount of notes plus
accrued interest thereon, payable to CMH Capital Management Corp., whose sole
stockholder is Corey Horowitz, Chairman of the Board of Directors and a
principal stockholder of the Company, and $50,000 principal amount of a note
plus interest payable to Mr. Horowitz. Furthermore, the Company has allocated
approximately $500,000 to pay past due trade payables upon consummation of this
offering.
15
In addition, simultaneously with the consummation of this offering, the Company
is acquiring CommHome Systems Corp. ("CommHome"), of which Avi A. Fogel is
President and Chief Executive Officer and a principal stockholder, in exchange
for 35,000 shares of Common Stock and the assumption of up to $200,000 of
liabilities, of which $55,000 and $50,000 are owed to Mr. Fogel and Robert P.
Olsen, Vice President of Product Management, respectively. Messrs. Fogel and
Olsen have agreed to cancel such obligations in exchange for the issuance of
6,875 and 6,250 shares of Common Stock, respectively, upon the consummation of
this offering. Approximately $1,895,000 (14.9%) of the estimated net proceeds of
this offering has been allocated to working capital and general corporate
purposes. Management will have broad discretion as to the application of such
proceeds. Furthermore, to the extent cash flow from operations is insufficient
for such purposes, a portion of the proceeds allocated to working capital may be
utilized to pay a portion of the salary of the Company's officers (such
aggregate salaries estimated to be approximately $970,000) over the twelve
months following the consummation of this offering. See "Use of Proceeds,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Certain Transactions."
Immediate and Substantial Dilution. This offering involves an immediate and
substantial dilution of $5.35 per share (or 66.9%) between the adjusted net
tangible book value per share of Common Stock after this offering and the
initial public offering price per share. See "Dilution."
No Dividends. The Company has never paid any dividends on its Common Stock
and does not anticipate paying cash dividends in the foreseeable future. The
Company currently intends to retain all earnings for use in connection with the
operation and expansion of its business. The declaration and payment of future
dividends, if any, will be at the sole discretion of the Company's Board of
Directors and will depend upon a variety of factors, including future earnings,
if any, operations, capital requirements, the general financial condition of the
Company, the preferences of any series of Preferred Stock which may be
designated in the future, the general business conditions and future contractual
restrictions on payments of dividends, if any. See "Dividend Policy" and
"Description of Securities - Common Stock."
Shares Eligible for Future Sale; Registration Rights. Upon the consummation
of this offering, the Company will have 4,508,369 shares of Common Stock
outstanding, of which the 1,875,000 shares being offered hereby will be freely
tradeable without restriction or further registration under the Securities Act.
All of the remaining 2,633,369 shares of Common Stock outstanding are
"restricted securities," as that term is defined in Rule 144 promulgated under
the Securities Act, and in the future may be sold only pursuant to an effective
registration statement under the Securities Act, in compliance with the
exemption provisions of Rule 144, on various dates commencing 90 days following
the date of this Prospectus, or pursuant to another exemption under the
Securities Act. The Company has granted certain registration rights with respect
to an aggregate of 1,117,435 shares of Common Stock, and the Company has granted
the Underwriter demand and piggyback registration rights with respect to the
shares of Common Stock issuable upon exercise of the Underwriter's Warrants. No
prediction can be made as to the effect, if any, that sales of such securities
or the availability of such securities for sale will have on the market prices
prevailing from time to time. While all of the Company's securityholders,
including the Company's officers and directors, have agreed not to (i) sell or
otherwise dispose of any shares of Common Stock in any public market transaction
(including pursuant to Rule 144) or (ii) exercise any registration rights for a
period of twelve months following the date of this Prospectus without the
Underwriter's prior written consent, the possibility that a substantial number
of the Company's securities may be sold in the public market
16
may adversely affect prevailing market prices for the Common Stock and could
impair the Company's ability to raise capital through the sale of its equity
securities. See "Description of Securities" and "Shares Eligible for Future
Sale."
Significant Outstanding Options and Warrants; Potential Adverse Effect on
Market Price of Common Stock. Upon the consummation of this offering, there will
be outstanding options and warrants to purchase an aggregate of 1,242,294 shares
of Common Stock (including 187,500 shares of Common Stock issuable upon exercise
of the Underwriter's Warrants) at exercise prices ranging from $1.61 to $13.20
per share. To the extent that outstanding options and warrants are exercised,
dilution to the percentage ownership of the Company's stockholders will occur
and any sales in the public market of the Common Stock underlying such options
and warrants may adversely affect prevailing market prices for the Common Stock.
Moreover, the terms upon which the Company will be able to obtain additional
equity capital may be adversely effected since the holders of outstanding
options and warrants can be expected to exercise them at a time when the Company
would, in all likelihood, be able to obtain any needed capital on terms more
favorable to the Company than those provided in the outstanding options and
warrants. See "Management - Stock Option Plan," "Description of Securities -
"Warrants and Options" and "Underwriting."
No Assurance of Public Market; Arbitrary Determination of Offering Price;
Possible Volatility of Market Price of Common Stock. Prior to this offering,
there has been no public trading market for the Common Stock. There can be no
assurance that a regular trading market for the Common Stock will develop after
this offering or that, if developed, it will be sustained. The initial public
offering price of the Common Stock has been determined arbitrarily by
negotiation between the Company and the Underwriter and is not necessarily
related to the assets, book value or potential earnings of the Company or any
other recognized criteria of value and may not be indicative of the prices that
may prevail in the public market. In addition, the market price for the Common
Stock following this offering may be highly volatile as has been the case with
the securities of other companies in emerging businesses. Factors such as the
Company's operating results, announcements of the Company or its competitors,
introduction of new products or technologies by the Company or its competitors
and various factors affecting the network security industry generally or the
market for firewall products in particular may have a significant impact on the
market price of the Common Stock. Additionally, in recent years, the stock
market has experienced a high level of price and volume volatility and market
prices for the stock of many companies, particularly of small and emerging
growth companies, the common stock of which trade in the over-the-counter
market, have experienced wide price fluctuations which have not necessarily been
related to the operating performance of such companies. See "Underwriting."
Possible Delisting of Securities from Nasdaq System; Risks Relating to
Low-Priced Stocks. It is currently anticipated that the Common Stock will be
eligible for listing on Nasdaq upon the completion of this offering. In order to
continue to be listed on Nasdaq, however, the Company must maintain $2,000,000
in net tangible assets (total assets, other than goodwill, less total
liabilities), and a $1,000,000 market value of the public float. In addition,
continued inclusion requires two market-makers, a minimum bid price of $1.00 per
share and adherence to certain corporate governance provisions. The failure to
meet these maintenance criteria in the future may result in the delisting of the
Common Stock from Nasdaq, and trading, if any, in the Common Stock would
thereafter be conducted in the non-Nasdaq over-the-counter market. As a result
of such delisting, an investor could find it more difficult to dispose of or to
obtain accurate quotations as to the market value of the Common Stock.
17
In addition, if the Common Stock were to become delisted from trading on
Nasdaq and the trading price of the Common Stock were to fall below $5.00 per
share, trading in the Common Stock would also be subject to the requirements of
certain rules promulgated under the Securities Exchange Act of 1934, as amended
(the "Exchange Act"), which require additional disclosure by broker-dealers in
connection with any trades involving a stock defined as a penny stock
(generally, any non-Nasdaq equity security that has a market price of less than
$5.00 per share, subject to certain exceptions). Such rules require the
delivery, prior to any penny stock transaction, of a disclosure schedule
explaining the penny stock market and the risks associated therewith and impose
various sales practice requirements on broker-dealers who sell penny stocks to
persons other than established customers and accredited investors (generally
defined as an investor with a net worth in excess of $1,000,000 or annual income
exceeding $200,000 individually or $300,000 together with a spouse). For these
types of transactions, the broker-dealer must make a special suitability
determination for the purchaser and have received the purchaser's written
consent to the transaction prior to the sale. The broker-dealer also must
disclose the commissions payable to the broker-dealer, current bid and offer
quotations for the penny stock and, if the broker-dealer is the sole
market-maker, the broker-dealer must disclose this fact and the broker-dealer's
presumed control over the market. Such information must be provided to the
customer orally or in writing before or with the written confirmation of trade
sent to the customer. Monthly statements must be sent disclosing recent price
information for the penny stock held in the account and information on the
limited market in penny stocks. The additional burdens imposed upon
broker-dealers by such requirements could, in the event the Common Stock were
deemed to be a penny stock, discourage broker-dealers from effecting
transactions in the Common Stock which could severely limit the market liquidity
of the Common Stock and the ability of purchasers in this offering to sell the
Common Stock in the secondary market.
Adverse Effect of the Authorization of Preferred Stock; Anti-Takeover
Provisions Affecting Stockholders. The Company's Certificate of Incorporation
authorizes the Company's Board of Directors to issue 5,000,000 shares of "blank
check" Preferred Stock and to fix the rights, preferences, privileges and
restrictions, including voting rights, of these shares, without further
stockholder approval. The rights of the holders of Common Stock will be subject
to and may be adversely affected by the rights of holders of any Preferred Stock
that may be issued in the future. The ability to issue Preferred Stock without
stockholder approval could have the effect of making it more difficult for a
third party to acquire a majority of the voting stock of the Company thereby
delaying, deferring or preventing a change in control of the Company. Moreover,
following the consummation of this offering, the Company will be subject to the
State of Delaware's "business combination" statute, which prohibits a
publicly-traded Delaware corporation from engaging in various business
combination transactions with any of its 15% stockholders for a period of three
years after the date of the transaction in which the person became an
"interested stockholder," unless certain approvals are obtained or other events
occur. The statute could prohibit or delay mergers or other attempted takeovers
or changes in control with respect to the Company and, accordingly, may
discourage attempts to acquire the Company. See "Description of Securities."
Tax Loss Carryforward. The Company's net operating loss carryforwards
("NOLs") expire in the years 2009 to 2012. Under Section 382 of the Internal
Revenue Code of 1986, as amended, utilization of prior NOLs is limited after an
ownership change, as defined in Section 382, to an annual amount equal to the
value of the corporation's outstanding stock immediately before the date of the
ownership change multiplied by the federal long-term date exempt tax rate. The
additional equity financing obtained by the Company in connection with recent
financings and this offering may result in an ownership change and, thus, in a
limitation on the Company's use of its prior NOLs. In the
18
event the Company achieves profitable operations, any significant limitation on
the utilization of its NOLs would have the effect of increasing the Company's
tax liability and reducing net income and available cash reserves. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and Note H to Notes to Financial Statements.
Limitations on Liability of Directors and Officers. The Company's
Certificate of Incorporation includes provisions to eliminate, to the full
extent permitted by Delaware General Corporation Law as in effect from time to
time, the personal liability of directors of the Company for monetary damages
arising from a breach of their fiduciary duties as directors. The Certificate of
Incorporation also includes provisions to the effect that the Company'shall, to
the maximum extent permitted from time to time under the law of the State of
Delaware, indemnify any director or officer to the extent that such
indemnification and advancement of expense is permitted under such law, as it
may from time to time be in effect. In addition, the Company's By-laws require
the Company to indemnify, to the fullest extent permitted by law, any director,
officer, employee or agent of the Company for acts which such person reasonably
believes are not in violation of the Company's corporate purposes as set forth
in the Certificate of Incorporation. See "Management - Limitation of Liability
and Indemnification Matters."
19
USE OF PROCEEDS
The net proceeds to the Company from the sale of the 1,875,000 shares of
Common Stock offered hereby, (after deducting underwriting discounts and
commissions and other expenses of the offering) are estimated to be
approximately $12,692,000 ($14,672,000 if the Underwriter's over-allotment
option is exercised in full). The Company expects to use the net proceeds
(assuming no exercise of the Underwriter's over-allotment option) during the
twelve months following this offering approximately as follows:
Approximate
Approximate Percentage of
Application of Net Proceeds Dollar Amount Net Proceeds
- --------------------------- ------------- ------------
Sales and marketing(1) $3,860,000 30.4 %
Repayment of outstanding indebtedness(2) 3,537,000 27.9
Software development(3) 2,100,000 16.6
Computer equipment(4) 500,000 3.9
Payment of trade payables(5) 500,000 3.9
Relocation of offices(6) 300,000 2.4
Working capital and general corporate purposes(7) 1,895,000 14.9
------------ ------
Total $12,692,000 100.0 %
------------ ------
------------ ------
- ----------
(1) Represents (i) approximately $2,460,000 for sales, marketing and
promotional activities related to the Company's software products and (ii)
approximately $1,400,000 for the salaries and related costs of up to 15
additional sales and marketing personnel. See "Business - Sales and
Marketing."
(2) Represents amounts to repay (i) $3,250,000 principal amount of promissory
notes (the "Notes") issued in private offerings from February 1997 through
May 1998, plus estimated accrued interest thereon at annual rates between
6% and 8%, including $1,900,000, $200,000 and $50,000 principal amount of
Notes held by Applewood Associates, L.P., a principal stockholder of the
Company, CMH Capital Management Corp., a corporation wholly-owned by Corey
M. Horowitz, Chairman of the Board of Directors and a principal stockholder
of the Company, and Mr. Horowitz, respectively, and (ii) approximately
$95,000 of certain liabilities assumed by the Company in connection with
the CommHome Acquisition and paid upon consummation of this offering. The
Company used the net proceeds from the issuance of the Notes for working
capital and general corporate purposes. See "Certain Transactions."
(3) Represents estimated costs associated with software development, including
the salaries of up to 17 additional software engineers and developers. See
"Business - Product Development."
(4) Represents expenditures to purchase hardware and software as well as
servers and test equipment for the Company's operations.
(5) Represents estimated past due trade payables to be paid upon the
consummation of this offering. See Financial Statements.
20
(6) Represents costs associated with relocating the Company's principal office
location to the Boston, Massachusetts area, including rent and related
costs. See "Business - Facility."
(7) Represents amounts which may be used to pay a portion of the compensation
for executive officers (such aggregate salaries are estimated to be
$970,000 during the twelve months following the consummation of this
offering), rent, trade payables, consulting fees and professional fees.
If the Underwriter's over-allotment option is exercised in full, the Company
will realize additional net proceeds of $1,980,000, which will be allocated to
working capital and general corporate purposes.
The allocation of the net proceeds from this offering set forth above
represents the Company's best estimate based upon its currently proposed plans
and assumptions relating to its operations and certain assumptions regarding
general economic conditions. If any of these factors change, the Company may
find it necessary or advisable to reallocate some of the proceeds within the
above-described categories or to use portions thereof for other purposes. The
Company may also use a portion of the net proceeds for the acquisition of
businesses, technologies, or products which it believes are complimentary to
those of the Company, although no such acquisitions are planned or being
negotiated as of the date of this Prospectus, except for the acquisition of
CommHome. See "Business - CommHome Systems Corp. Acquisition."
Based on currently proposed plans and assumptions relating to its
operations, and implementation of its business plan (including the timetable of
costs and expenses associated with, and success of, its marketing efforts)
the Company anticipates that the net proceeds of this offering, together with
projected revenues from operations, will be sufficient to fund the Company's
operations and capital requirements for approximately twelve months following
the consummation of this offering. There can be no assurance, however, that such
funds will not be expended prior thereto due to unanticipated changes in
economic conditions or other unforeseen circumstances. In the event the
Company's plans change or its assumptions change or prove to be inaccurate (due
to unanticipated expenses, difficulties, delays or otherwise) or the net
proceeds of this offering and projected revenues otherwise prove to be
insufficient to fund the implementation of the Company's business plan or
working capital requirements, the Company could be required to seek additional
financing sooner than currently anticipated. The Company has no current
arrangements with respect to any additional financing. Consequently, there can
be no assurance that any additional financing will be available to the Company
when needed, on commercially reasonable terms or at all.
Proceeds not immediately required for the purposes described above will be
invested principally in United States government securities, short-term
certificates of deposit, or other similar short-term, interest bearing
investments.
21
DILUTION
The difference between the initial public offering price per share of Common
Stock and the net tangible book value per share of Common Stock after this
offering constitutes the dilution to investors in this offering. Net tangible
book value per share is determined by dividing the net tangible book value of
the Company (total tangible assets less total liabilities) by the number of
outstanding shares of Common Stock.
At March 31, 1998, the negative net tangible book value of the Company was
($572,000) or $(.34) per share ($.07 per share, on a pro forma basis after
giving effect to the Pro Forma Adjustments(see footnote 2 of "Prospectus
Summary--Summary Financial Information")). After also giving effect to the sale
by the Company of the 1,875,000 shares of Common Stock offered hereby (after
deducting underwriting discounts and commissions and estimated expenses of this
offering) and the Additional Adjustments (see footnote 3 of "Prospectus Summary
- -- Summary Financial Information"), the adjusted net tangible book value of the
Company at March 31, 1998 would have been $11,935,000, or $2.65 per share,
representing an immediate increase in net tangible book value of $2.58 per share
to the existing stockholders and an immediate dilution of $5.35 per share to new
investors. The following table illustrates the foregoing information with
respect to dilution to new investors on a per share basis:
Initial public offering price .................................... $ 8.00
Pro forma net tangible book value before offering ................ $ .07
Increase attributable to new investors ........................... 2.58
--------
Adjusted net tangible book value after offering .................. 2.65
--------
Dilution per share to new investors .............................. $ 5.35
--------
--------
The following table sets forth, with respect to the Company's existing
stockholders (after giving effect to the Pro Forma Adjustments and the
Additional Adjustments) and new investors in this offering, a comparison of the
number of shares of Common Stock acquired from the Company, the percentage
ownership of such shares, the total consideration paid, the percentage of total
consideration paid and the average price per share.
Average
Price per
Shares Purchased Total Consideration Share
---------------------- ----------------------- ----------
Number Percent Amount Percent
--------- ------- ------------ ----------
Existing Stockholders............... 2,633,369 58.4% $ 7,215,000 32.5% $ 2.74
New Investors....................... 1,875,000 41.6 15,000,000 67.5 8.00
--------- ------ ------------ ------
Total............................... 4,508,369 100.0% $22,215,000 100.0%
--------- ------ ------------ ------
--------- ------ ------------ ------
The above tables assume no exercise of the Underwriter's over-allotment
option. If such option is exercised in full, the new investors will have paid
$17,250,000 for 2,156,250 shares of Common Stock, representing approximately
70.5% of the total consideration, for 45.0% of the total number of shares of
Common Stock outstanding. In addition, the above tables do not give effect to
shares issuable upon exercise of outstanding warrants and options to purchase
1,242,294 shares of Common Stock, including options to purchase 423,908 shares
of Common Stock issued under the Stock Option Plan and 187,500 shares of Common
Stock issuable upon exercise of the Underwriter's Warrants. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations,"
"Management -- Stock Option Plan," Description of Securities -- Warrants and
Options" and "Underwriting."
22
DIVIDEND POLICY
The Company has never declared or paid any cash dividends on its Common
Stock and does not intend to declare or pay cash or other dividends in the
foreseeable future. The Board of Directors currently expects to retain any
future earnings for use in the operation and expansion of its business. The
declaration and payment of any future dividends will be at the discretion of the
Board of Directors and will depend upon a variety of factors, including future
earnings, if any, operations, capital requirements, the general financial
condition of the Company, the preferences of any series of Preferred Stock which
may be designated in the future, the general business conditions and future
contractual restrictions on payment of dividends, if any.
CAPITALIZATION
The following table sets forth (i) the capitalization of the Company as of
March 31, 1998, (ii) the pro forma capitalization at such date after giving
effect to the Pro Forma Adjustments (see footnote 2 of "Prospectus
Summary--Summary Financial Information"), and (iii) the pro forma capitalization
as adjusted to give effect to the sale of the Common Stock offered hereby, the
anticipated application of the estimated net proceeds therefrom and the
Additional Adjustments (see footnote 3 of "Prospectus Summary -- Summary
Financial Information"). The information set forth below should be read in
conjunction with the Financial Statements and Notes thereto and "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
March 31, 1998
------------------------------------------------------
Actual Pro Forma As Adjusted
---------------- ---------------- ------------------
Short-term debt............................................... $ 1,621,000 $ 2,380,000 --
----------- ------------ ------------
----------- ------------ ------------
Stockholders' equity (deficit)(1):
Preferred Stock, $.01 par value, 5,000,000
shares authorized............................................
Series A Preferred Stock, no shares issued or outstanding,
actual, pro forma and as adjusted............................ -- -- --
Series B Preferred Stock, 500,000 shares
issued and outstanding, actual; no shares issued
and outstanding, pro forma and as adjusted................... 5,000 -- --
Common Stock, $.01 par value; 25,000,000 shares
authorized; 1,706,037 shares issued and outstanding,
actual; 2,585,244 shares issued and outstanding, pro forma;
4,508,369 shares issued and outstanding, as adjusted(2)...... 17,000 26,000 45,000
Additional paid-in capital.................................... 7,573,000 8,348,000 21,406,000
Accumulated deficit........................................... (8,167,000) (8,181,000) (9,516,000)
---------------- ---------------- ------------------
Total stockholders' equity (deficit)......................... (572,000) 193,000 11,935,000
---------------- ---------------- ------------------
Total capitalization......................................... $ (572,000) $ 193,000 $ 11,935,000
---------------- ---------------- ------------------
---------------- ---------------- ------------------
- ----------
(1) See Note F to Notes to Financial Statements.
(2) Does not include (i) 423,908 shares of Common Stock issuable upon exercise
of stock options (of which options to purchase 168,546 shares were granted
as of March 31, 1998) under the Stock Option Plan, (ii) 630,886 shares of
Common Stock issuable upon exercise of other outstanding options and
warrants, and (iii) 187,500 shares of Common Stock reserved for issuance
upon exercise of the Underwriter's Warrants.
23
SELECTED FINANCIAL DATA
The following selected financial data for the years ended December 31, 1996
and December 31, 1997 and at December 31, 1997 have been derived from the
Company's audited financial statements. The following selected financial data
for the three month periods ended March 31, 1997 and 1998 and at March 31, 1998
have been derived from unaudited financial statements which have been prepared
on the same basis as the audited financial statements and, in the opinion of
management, contain all adjustments, consisting only of normal recurring
adjustments, necessary to present fairly the information presented. The results
for the three month period ended March 31, 1998 are not necessarily indicative
of the results to be expected for any other interim period or the fiscal year.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations" and Financial Statements.
Statement of Operations Data: Year Ended December 31, Three Months Ended March 31,
--------------------------- ----------------------------
1996 1997 1997 1998
--------------------------- ----------------------------
Revenues:
Licenses ........................ $ 624,000 $ 1,632,000 $ 346,000 $ 195,000
Services ........................ 403,000 737,000 133,000 144,000
------------ ------------ ------------ ------------
Total revenues .................. 1,027,000 2,369,000 479,000 339,000
Cost of revenues ................ 737,000 790,000 181,000 252,000
------------ ------------ ------------ ------------
Gross profit .................... 290,000 1,579,000 298,000 87,000
------------ ------------ ------------ ------------
Operating expenses:
Product development ............. 984,000 917,000 97,000 208,000
Selling and marketing ........... 1,614,000 926,000 326,000 140,000
General and administrative ...... 1,931,000 1,573,000 434,000 212,000
------------ ------------ ------------ ------------
Total operating expenses......... 4,529,000 3,416,000 857,000 560,000
------------ ------------ ------------ ------------
Loss from operations ............ (4,239,000) (1,837,000) (559,000) (473,000)
Interest expense ................ (260,000) (553,000) (31,000) (224,000)
------------ ------------ ------------ ------------
Net loss ........................ $(4,499,000) $(2,390,000) $ (590,000) $ (697,000)
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
Loss per share (1) .............. (2.46) (1.29) (.30) (.41)
Weighted average number of shares
outstanding (1) ................ 1,825,163 1,855,244 1,942,872 1,706,037
Balance Sheet Data: December 31, 1997 March 31, 1998
----------------- ------------------------------------------------
Actual Actual Pro Forma As Adjusted
------------- ------------- --------------- --------------
Cash and cash equivalents .......... $ 60,000 $ 67,000 $ 1,416,000 $ 10,766,000
Working capital (deficit) .......... (661,000) (2,283,000) (1,518,000) 8,702,000
Total assets ....................... 2,404,000 2,094,000 3,443,000 12,718,000
Total liabilities .................. 2,479,000 2,666,000 3,250,000 783,000
Accumulated deficit ................ (7,470,000) (8,167,000) (8,181,000) (9,516,000)
Total stockholders' equity (deficit) (75,000) (572,000) 193,000 11,935,000
- ----------
(1) See Notes A and B to Notes to Financial Statements for an explanation of
shares used in pro forma net loss per share calculations.
24
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with the
Company's Financial Statements, including the Notes thereto, included elsewhere
in this Prospectus. Except for the historical information contained herein, this
discussion contains forward-looking statements that involve risks and
uncertainties, including, without limitation, those concerning the Company's
strategy and growth plans. Because such statements involve risks and
uncertainties, actual results may differ materially from those expressed or
implied by such forward-looking statements. Factors that could cause such
differences include, but are not limited to, those discussed under "Risk
Factors."
General
The Company develops, markets, licenses and supports a family of network
security software products designed to provide comprehensive security to
computer networks including Internet based systems and internal networks and
computing resources. The Company also offers to its customers a full range of
consulting services in network security, network design and support. From
inception (July 1990) through December 31, 1994, the Company was primarily
engaged in providing consulting and training services. In 1995, the Company
began to shift its focus from consulting and training to the development and
marketing of network security software products. The Company introduced its
first FireWall/Plus software product in June 1995. Accordingly, the Company has
a limited relevant operating history as a software developer upon which an
evaluation of its prospects and future performance can be made. Such prospects
must be considered in light of the risks, expenses and difficulties frequently
encountered in the operation and expansion of a new business and the shift from
research and product development to commercialization of products based on
rapidly changing technologies in a highly specialized and emerging market. The
Company will be required to significantly expand its product and development
capabilities, introduce new products, introduce enhanced features to existing
products, expand its in-house sales force, establish and maintain distribution
channels through third-party vendors, increase marketing expenditures, further
expand its management team and attract additional qualified personnel. In
addition, the Company must adapt to the demands of an emerging and rapidly
changing computer network security market, intense competition and rapidly
changing technology and industry standards. There can be no assurance that the
Company can successfully address such risks, and the failure to do so would have
a material adverse effect on the Company's business, results of operations and
financial condition.
To date, the Company has incurred significant losses and, at March 31, 1998,
had an accumulated deficit of $8,167,000. Inasmuch as the Company intends to
increase its level of activities following the consummation of this offering and
will be required to make significant up-front capital expenditures in connection
with its sales and marketing and continuing research and product development
efforts, the Company anticipates that losses will continue until such time, if
ever, as the Company is able to attain sales levels sufficient to support its
operations. There can be no assurance that the Company will ever achieve
profitable operations. The Company's independent auditors have included an
explanatory paragraph in their report on the Company's financial statements for
the year ended December 31, 1996 and December 31, 1997, stating that certain
factors raise substantial doubt about the Company's ability to continue as a
going concern.
25
The Company has only recently employed certain members of senior management,
including Avi A. Fogel, President and Chief Executive Officer, Robert P. Olsen,
Vice President of Product Management, Murray P. Fish, Chief Financial Officer,
and Joseph A. Donohue, Vice President of Engineering. In addition, the Company
intends to hire approximately 17 additional software engineers and developers
and 15 additional sales and marketing personnel within twelve months of
consummation of this offering, as well as expand its finance and administrative
staff and increase expenses for employee benefits, facilities, consulting,
insurance, and other general operating expenses. See "Business -- Sales and
Marketing," "Business -- Product Development" and "Management -- Employment
Agreements."
The Company's FireWall/Plus family of software products has not yet achieved
market acceptance. The future success of the Company is largely dependent upon
market acceptance of its FireWall/Plus family of software products. While the
Company believes that its FireWall/Plus family of software products offer
advantages over competing products for network security, license revenue from
FireWall/Plus products since their introduction (June 1995) through March 31,
1998 has only been $2,437,000. There can be no assurance that FireWall/Plus will
gain significant market acceptance. Revenue from such commercial products depend
on a number of factors, including the influence of market competition,
technological changes in the network security market, the Company's ability to
design, develop and introduce enhancements on a timely basis, and the ability of
the Company to successfully establish and maintain distribution channels. The
failure of FireWall/Plus to achieve significant market acceptance, as a result
of competition, technological change or other factors, would have a material
adverse effect on the Company's business, operating results and financial
condition.
The Company's revenues are generated primarily from product license fees for
the use of the Company's software products (license revenues) and service fees
for consulting services, maintenance and training (service revenues). Revenues
from licenses are recognized upon (i) delivery of the software or, if the
customer has evaluation software, delivery of the software key, and (ii)
issuance of the related license, assuming that no significant vendor obligations
or customer acceptance rights exist. In October 1997, the American Institute of
Certified Public Accountants issued Statement of Position ("SOP") No. 97-2,
Software Revenue Recognition, which the Company adopted, effective January 1,
1997. Such adoption had no effect on the Company's methods of recognizing
revenue from its license and maintenance activities. Prior to 1997, the
Company's revenue policy was in accordance with the preceding authoritative
guidance provided by SOP No. 91-1, Software Revenue Recognition.
The Company recognizes service revenue upon delivery of the service or
ratably over the period of service. Consulting and training fees are recognized
as such services are performed. Annual maintenance, which may be purchased in
conjunction with the licensing of a product, is offered for an annual fee
generally equal to 15% of the then current license fee and is recorded as
service revenue ratably over the contract term.
The Company markets and licenses its products and services primarily through
third parties, such as VARs, systems integrators, resellers, distributors and
OEMs, and to a lesser extent, through the Company's limited in-house sales
force. Licenses through distributors typically have a lower gross margin than
in-house generated licenses since distributors usually receive discounts.
Revenues from third-party distributors accounted for approximately 23% and 50%
of the Company's license
26
revenues for the years ended December 31, 1996 and 1997, respectively. The
Company expects that the percentage of license revenues generated from
third-party distributors to increase in future periods. Pricing is based upon
the number of concurrent connections, the nature of the user's operating system
and whether hardware is needed. Selling and marketing expenses are expected to
increase as a result of proposed expansion of distribution channels and
marketing programs and hiring of additional personnel.
The Company has committed significant product and development resources to
its FireWall/Plus family of products. The Company's anticipated levels of
expenditures for product development are based on its plans for product
enhancements and new product development. The Company capitalizes software
development costs, net of amortization, in accordance with Statement of
Financial Accounting Standards No. 86. These costs consist of salaries,
consulting fees and applicable overhead. The Company intends to use a portion of
the proceeds of this offering to significantly increase its product development
expenditures. See "Business - Product Development."
Results of Operations
Three Months Ended March 31, 1998 Compared to Three Months Ended March 31, 1997
Revenues decreased by $140,000 or 29%, from $479,000 for the three months
ended March 31, 1997 to $339,000 for the three months ended March 31, 1998, as a
result of decreased license revenues. License revenues decreased by $151,000 or
44%, from $346,000 for the three months ended March 31, 1997 to $195,000 for the
three months ended March 31, 1998, primarily due to a lack of financial
resources for marketing of its software products during the three months ended
March 31, 1998 and certain initial product licensing payments received from
international resellers during the three months ended March 31, 1997. Service
revenues increased by $11,000 or 8%, from $133,000 for the three months ended
March 31, 1997 to $144,000 for the three months ended March 31, 1998. The
increase in service revenues is attributable to a large consulting project
serviced during the three months ended March 31, 1998.
Cost of licenses consists of the costs of media, documentation, product
packaging, production, product royalties, amortization of software development
costs and the cost of hardware associated with "turn-key" solutions. Cost of
licenses increased by $72,000 or 69%, from $105,000 for the three months ended
March 31, 1997 to $177,000 for the three months ended March 31, 1998,
representing 30% and 91% of license revenues, respectively. The increase in cost
of licenses in dollar amount and as a percentage of license revenues resulted
primarily from increased amortization of software costs and hardware costs
associated with sales of FireWall/Plus Premier Version, which is a turn-key
solution and includes computer hardware and, therefore, has a lower gross
margin. Cost of licenses as a percentage of license revenues may fluctuate from
period to period due to changes in product mix, changes in the number or size of
transactions recorded in a given period or an increase or decrease in licenses
of products which would require the Company to pay royalties to third parties.
27
Cost of services consist of the costs of salary, fringe benefits and
overhead associated with consulting services. Cost of services decreased by
$1,000 or 1%, from $76,000 for the three months ended March 31, 1997 to $75,000
for the three months ended March 31, 1998, representing 57% and 52% of service
revenues, respectively.
Gross profit decreased from $298,000 for the three months ended March 31,
1997 to $87,000 for the three months ended March 31, 1998, representing 62% and
26% of revenues, respectively. The decrease in gross profit was due to decreased
license revenues and the increase in cost of sales as a result of increased
amortization of software costs and hardware costs associated with sales of
FireWall/Plus Premier Version.
Product development costs consist of salaries, benefits, travel and related
costs of the Company's product development personnel, including consulting fees,
the costs of computer equipment used in product and technology development and
third-party development contracts. Product development costs increased $111,000
or 114%, from $97,000 for the three months ended March 31, 1997 to $208,000 for
the three months ended March 31, 1998, representing 20% and 61% of revenues,
respectively. The increase in product development costs in dollar amount and as
a percentage of revenues was due primarily to the capitalization of $283,333 and
$0 of product development costs associated with the development and enhancement
of its FireWall/Plus family of products during the three months ended March 31,
1997 and the three months ended March 31, 1998, respectively. During the three
months ended March 31, 1998, all product development costs were expensed since
they were incurred after the release of FireWall/Plus Version 4.0. The Company
currently anticipates that product development costs will increase as the
Company hires additional software engineers and developers to support the
Company's growth. See "Business - Product Development."
Sales and marketing expenses consist primarily of salary costs, including
commissions, benefits, bonuses and travel, advertising, public relations,
consultants and trade shows. Selling and marketing expenses decreased by
$186,000 or 57%, from $326,000 for the three months ended March 31, 1997 to
$140,000 for the three months ended March 31, 1998, representing 68% and 41% of
revenues, respectively. The decrease in selling and marketing expenses was due
primarily to a decrease in marketing efforts during such period resulting from
the Company's lack of available funds.
General and administrative expenses include employee costs, including
salary, benefits, bonuses, travel and other related expenses associated with
management, finance and accounting operations, and legal and other professional
services provided to the Company. General and administrative expenses decreased
by $222,000 or 51%, from $434,000 for the three months ended March 31, 1997 to
$212,000 for the three months ended March 31, 1998, representing 91% and 63% of
revenue, respectively. The decrease in general and administrative expenses was
due primarily to reduced professional fees, recruitment fees and travel and
entertainment expenses. The Company currently anticipates that general and
administrative expenses will increase significantly as the Company hires
additional personnel to support its growth in future periods.
28
Interest expense increased by $193,000 or 623%, from $31,000 for the three
months ended March 31, 1997 to $224,000 for the three months ended March 31,
1998, representing 6% and 66% of revenues, respectively. The increase in
interest expense was due primarily to an increase in the amortization of debt
discount for the three months ended March 31, 1998 related to private financings
consisting of notes and warrants. Interest expense is expected to be
significantly reduced following consummation of the offering since the Company
intends to use approximately $3,442,000 of the proceeds of this offering to
repay outstanding debt.
No provision for or benefit from federal, state or foreign income taxes was
recorded for the three months ended March 31, 1997 or the three months ended
March 31, 1998 because the Company incurred net operating losses during each
period and fully reserved its deferred tax assets as their future realization
could not be determined.
As a result of the foregoing, the net loss increased by $107,000 or 18%,
from $590,000 for the three months ended March 31, 1997 to $697,000 for the
three months ended March 31, 1998.
Year Ended December 31, 1997 Compared to Year Ended December 31, 1996
Revenues increased by $1,342,000 or 131%, from $1,027,000 for the year ended
December 31, 1996 ("1996") to $2,369,000 for the year ended December 31, 1997
("1997"). License revenues increased by $1,008,000 or 162%, from $624,000 for
1996 to $1,632,000 for 1997, partially due to the receipt of a non-refundable
prepaid royalty of $500,000 from Trusted Information Systems, Inc. relating to
licensing certain of the Company's technology and an increase in software
licenses sold during 1997 as a result of introduction of FireWall/Plus for
Windows NT. Service revenues increased by $334,000 or 83%, from $403,000 for
1996 to $737,000 for 1997 primarily as a result of servicing a large consulting
project and an increase in the customer base which purchased maintenance
contracts during 1997. The Company's two largest customers, Trusted Information
Systems, Inc. and Electronic Data Systems Corporation ("EDS") accounted for 21%
and 14% of the Company's revenues, respectively, in 1997. The Company's revenues
from customers in the United States represented 93% of its revenues in 1996 and
84% of its revenues in 1997.
Cost of licenses increased $58,000 or 13%, from $439,000 for 1996 to
$497,000 for 1997, representing 70% and 30% of license revenues, respectively.
The increase in the cost of licenses resulted primarily from the increased
amortization of capitalized software costs related to the Company's
FireWall/Plus for Windows NT product, hardware costs associated with sales of
FireWall/Plus Premier Version and royalties paid to third parties from product
sales. The decrease in cost of revenues as a percentage of license revenues was
due primarily to the Company's receipt in June 1997 of a $500,000 prepaid
royalty related to the license of its technology and decreased hardware costs
for resale.
Cost of services decreased by $5,000 or 2%, from $298,000 for 1996 to
$293,000 for 1997, representing 74% and 40% of service revenues, respectively.
The decrease in cost of services as a percentage of service revenues was due
primarily to the increase in service revenues which did not require increased
personnel.
29
Gross profit increased from $290,000 for 1996 to $1,579,000 for 1997
representing 28% and 67% of revenues, respectively. The increase in gross profit
was due to increased license revenue of $1,008,000, including receipt of a
$500,000 prepaid royalty in June 1997 and a $334,000 increase in revenue from
software licenses.
Product development costs decreased by $67,000 or 7%, from $984,000 for 1996
to $917,000 for 1997, representing 96% and 39% of revenues, respectively. The
decrease in product development costs was due primarily to an increased portion
of time spent by developers on the development of the second release of the
FireWall/Plus Windows NT product and the capitalization of such costs. During
1996 and 1997, the Company capitalized $750,000 and $850,000, respectively, of
product development expenditures associated with the development and enhancement
of its FireWall/Plus family of products.
Sales and marketing expenses decreased by $688,000 or 43%, from $1,614,000
for 1996 to $926,000 for 1997, representing 157% and 39% of revenues,
respectively. The decrease in sales and marketing expenses in dollar amount and
as a percentage of revenues was due primarily to a $526,000 decrease in
advertising expenses and the reduction of trade shows and related travel due to
the Company's lack of funds for sales and marketing, as well as the Company's
receipt of $500,000 of prepaid royalties in June 1997 and a $508,000 increase in
revenues from software licenses.
General and administrative expenses decreased by $358,000 or 19%, from
$1,931,000 for 1996 to $1,573,000 for 1997, representing 188% and 66% of revenue
for 1996 and 1997, respectively. The decrease in general and administrative
expenses in dollar amount and as a percentage of revenue in 1997 was due
primarily to a charge of $683,000 related to the issuance of warrants and shares
of Common Stock to advisory board members and others for services rendered in
March 1996 and reduced professional fees, recruiting fees, office supplies and
stationary, repairs and maintenance contracts, travel and bad debt expenses.
Interest expense increased by $293,000 or 113%, from $260,000 for 1996 to
$553,000 for 1997, representing 25% and 23% of revenue for 1996 and 1997,
respectively. The increase in interest expense was due primarily to increased
amortization of debt discount as a result of the issuance of $1,500,000
principal amount promissory notes and warrants to purchase 210,628 shares of
Common Stock during 1997. Debt discount is amortized over the life of the debt
instrument.
No provision for or benefit from federal, state or foreign income taxes was
recorded for 1996 or 1997 because the Company incurred net operating losses for
each year and fully reserved its deferred tax assets as their future realization
could not be determined.
As a result of the foregoing, the net loss decreased by $2,109,000 or 47%,
from $4,499,000 for 1996 to $2,390,000 for 1997.
Liquidity and Capital Resources
The Company's capital requirements have been and will continue to be
significant, and its cash requirements have been exceeding its cash flow from
operations. At March 31, 1998, the Company had $67,000 of cash and cash
equivalents and a working capital deficit of $2,283,000 due to, among other
things, costs associated with financing its product development efforts. The
30
Company has financed its operations primarily through private sales of equity
and debt securities. Net cash used in operating activities was $708,000 and
$383,000 during 1997 and the three months ended March 31, 1998, respectively.
Net cash used in operating activities for 1997 was primarily attributable to a
net loss of $2,390,000 and an increase in accounts receivable of 309,000 which
was partially offset by increases in accounts payable, accrued expenses and
accrued fees of $744,000, and amortization of debt discount of $500,000 and
depreciation and amortization of $481,000. The Company's operating activities
during 1996, 1997 and the three months ended March 31, 1998 were financed
primarily with $3,948,000 of net proceeds from the sale of Common Stock with
respect to a private placement completed in March 1996, $1,500,000 of net
proceeds from the issuance of $1,500,000 principal amount of notes and warrants
to purchase 210,628 shares of Common Stock in 1997 and $400,000 of net proceeds
from the issuance of $400,000 principal amount of notes and warrants to purchase
74,495 shares of Common Stock for the three months ended March 31, 1998. Since
March 31, 1998, the Company has financed its activities with $1,350,000 of net
proceeds from the issuance of $1,350,000 principal amount of notes and warrants
to purchase 251,423 shares of Common Stock. The Company intends to use a portion
of the net proceeds of this offering to repay the entire principal amount of
$3,250,000 and interest accrued on such outstanding notes. The Company does not
currently have a line of credit from a commercial bank or other institution.
The Company is dependent on the proceeds of this offering to implement its
business plan and finance its working capital requirement. The Company
anticipates, based on currently proposed plans and assumptions relating to the
implementation of its business plan (including the timetable of, costs and
expenses associated with, and success of, its marketing efforts), that the net
proceeds of this offering, together with projected revenues from operations,
will be sufficient to satisfy the Company's operations and capital requirements
for approximately twelve months following the consummation of this offering.
There can be no assurance, however, that such funds will not be expended prior
thereto due to unanticipated changes in economic conditions or other unforeseen
circumstances. In the event the Company's plans change or its assumptions change
or prove to be inaccurate (due to unanticipated expenses, difficulties, delays
or otherwise) or the net proceeds of this offering and projected revenues
otherwise prove to be insufficient to fund the implementation of the Company's
business plan or working capital requirements, the Company could be required to
seek additional financing sooner than currently anticipated. The Company has no
current arrangements with respect to any additional financing. Consequently,
there can be no assurance that any additional financing will be available to the
Company when needed, on commercially reasonable terms or at all. Any inability
to obtain additional financing when needed would have a material adverse effect
on the Company, requiring it to curtail and possibly cease its operations. In
addition, any additional equity financing may involve substantial dilution to
the interests of the Company's then existing stockholders.
Fluctuations in Operating Results
The Company anticipates significant quarterly fluctuations in its operating
results in the future. The Company generally ships orders for commercial
products as they are received and, as a result, does not have any material
backlog. As a result, quarterly revenues and operating results depend on the
volume and timing of orders received during the quarter, which are difficult to
forecast. Operating results may fluctuate on a quarterly basis due to factors
such as the demand for the Company's products, purchasing patterns and budgeting
cycles of customers, the introduction of new products and product enhancements
by the Company or its competitors, market acceptance of
31
new products introduced by the Company or its competitors and the size, timing,
cancellation or delay of customer orders, including cancellation or delay in
anticipation of new product introduction or enhancement. In addition, the
Company's consulting revenues tend to fluctuate as projects, which may continue
over several quarters, are undertaken or completed. Therefore, comparisons of
quarterly operating results may not be meaningful and should not be relied upon,
nor will they necessarily reflect the Company's future performance. Because of
the foregoing factors, it is likely that in some future quarters the Company's
operating results will be below the expectations of public market analysts and
investors. In such event, the price of the Common Stock would likely be
materially adversely affected.
Licensing of the Company's products generally involves a significant
commitment of capital by customers, with the attendant delays frequently
associated with large capital expenditures. Accordingly, the sales cycle for the
Company's products can be lengthy and generally commences at the time a
prospective customer demonstrates an interest in licensing a FireWall/Plus
solution, typically includes a 30-day free evaluation period and ends upon
execution of a purchase order by the customer. The length of the sales cycle
varies depending on the type and sophistication of the customer and the
complexity of the operating system and may extend for periods of six to nine
months. As a result of the Company's lengthy sales cycle, license of the
Company's products generally require the Company to make expenditures and use
significant resources prior to receipt, if any, of corresponding revenues.
Year 2000 Issue
The Company has assessed the potential software issues associated with the
Year 2000 and believes its software products are Year 2000 compliant and,
therefore, does not expect to incur material costs related thereto. With regard
to internal computing resources utilized in its operations, the Company does not
expect to incur material costs to make such resources year 2000 compliant.
32
BUSINESS
Overview
The Company develops, markets, licenses and supports a family of network
security software products designed to provide comprehensive security to
computer networks, including Internet based systems and internal networks and
computing resources. The Company's FireWall/Plus family of security software
products enables an organization to protect its computer networks from internal
and external attacks and to secure organizational communications over such
internal networks and the Internet. The Company also offers its customers a full
range of consulting services in network security and network design and support
in order to build, maintain and enhance customer relationships and increase the
demand for its software products.
The FireWall/Plus family of security solutions is designed to protect
against Internet and intranet (internal networks utilizing Internet technology
and applications based upon TCP/IP - the Internet network transport protocol)
based security threats and to address security needs that arise from within
internal networks that often utilize other network transport protocols besides
TCP/IP including, among others, Novell's IPX, Digital Equipment's DECnet and
IBM's SNA. The Company's FireWall/Plus family of firewall products operates on
the Microsoft Windows NT operating system platform. FireWall/Plus's proprietary
Interceptor Shim and filter engine software technology, with its unique ability
to handle and filter all commonly used network transport protocols, provides
organizations with a highly secure and flexible security solution. Additionally,
unlike most other firewall solutions which focus on an enterprise's connection
to the Internet, the FireWall/Plus solution can be deployed throughout the
enterprise; at the perimeter to control access to and from the Internet, between
internal networks and on application servers and desktop PCs to protect data
residing on such servers and PCs. The Company's FireWall/Plus for Windows NT
received the 1997 Internet and Electronic Commerce Conference award for "Best
Intranet Solution" and the 1997 ENT Readers Choice Award for "Best NT Firewall."
Industry Background
A critical resource of every organization is its information and its ability
to distribute and access information throughout the enterprise. Computing has
moved from large centralized mainframes to distributed client/server
architecture consisting of interconnected personal computers dispersed
throughout an organization. Organizations utilize local area networks ("LANs")
to share information and applications internally. Many organizations have
connected LANs, including geographically dispersed networks, into wide area
networks ("WANs"). In addition, the explosive growth in telecommuting has
resulted in LANs and WANs frequently being accessed from remote locations via
traditional modem dial-up, Integrated Services Digital Network ("ISDN") and
recently introduced cable modems and Asymmetric Digital Subscriber Line ("ADSL")
modems. There is a growing use of establishing these remote connections to an
organization's central resources, via Internet links, rather than through
dedicated point-to point connections.
This evolution from mainframe computers supporting a number of terminals,
towards networks of interconnected personal computers has resulted in a wide
range of technologies from a multitude of vendors being used within internal
networks in order to satisfy different enterprise computing requirements. As a
result, heterogeneous networks utilizing a variety of network transport
33
protocols are commonplace within LANs and WANs. Although TCP/IP has become a
widely accepted network transport protocol due to the growth of the Internet and
the popularity of TCP/IP applications for use within internal networks, network
transport protocols such as IPX, DECnet, AppleTalk, and SNA among others, are
still utilized throughout networked environments, and the Company believes such
network transport protocols will continue to be utilized due to the large
investments in installed systems and applications using these protocols.
Further, computing environments often run one or more incompatible versions of
the same protocol suite for extended periods of time while converting to new
versions or to support older applications or systems which cannot use the newer
versions of a given protocol suite. In addition, Windows NT is shipped from
Microsoft with four complete network transport protocols (IP, IPX, AppleTalk and
NetBEUI) for use with NT when connected to a corporate network.
The Windows NT server market continues to grow and outpace sales of other
popular non-NT-based servers. According to recent studies by International Data
Corporation and Dataquest, in 1997, Windows NT server shipments exceeded
shipments of any other server.
Network Security
Although open computing environments have many business advantages, their
accessibility makes an organization's critical software applications and
electronically stored data vulnerable to security threats. Open computing
environments are inherently complex, typically involving a variety of hardware,
operating systems, network transport protocols and applications supplied by a
multitude of vendors, making these networks difficult to manage, monitor and
protect from unauthorized access or attack. The security risk associated with
network computing is complicated by the increasing popularity of the Internet,
intranets and extranets (intranets which allow access for one or more users
outside of the internal network). By connecting an internal private network to
the Internet, unauthorized third parties are given a new means by which to
access an organization's private network. The combination of TCP/IP with other
commonly used network transport protocols within internal networks, increases
the network security challenge because of the various avenues of attack
available to both internal and external attackers.
As a result of the explosive growth in network computing and Internet use
(as well as use of intranets and extranets), protection of an organization's
network and data has become a significant economic concern for businesses.
According to the 1997 Annual Information Week/Ernst & Young LLP Information
Security Survey of information technology managers and professionals, 42% of the
respondents reported malicious acts from external sources, as compared to 16% in
the prior year, and 43% of the respondents reported malicious acts by employees
as compared to 29% in the prior year. According to FBI estimates, U.S. companies
suffer estimated losses of $5 to $10 billion per year as a result of
unauthorized access to information and data. According to the 1998 CSI/FBI
Computer Crime and Security Survey, 44% of the respondents reported unauthorized
access by employees. The Company believes that securely segmenting internal
network areas and computing resources from unauthorized access will become
paramount to insuring the integrity of both the internal network and an
organization's intranet and extranet resources.
34
Firewalls
A firewall is a security solution that enables an organization to protect
its computer resources from unauthorized access by internal and external users.
Firewalls enforce security access control policies between a trusted network and
an untrusted network. Only authorized traffic as defined by security policies is
allowed access through the firewall. Firewalls are predominantly utilized today
to provide security for a network's perimeter by preventing external breaches of
the internal network (trusted network) from untrusted external sources (the
public network).
Due to the significant growth in Internet connections, a number of companies
have introduced firewall products ("IP Firewalls") designed primarily to protect
an internal network using TCP/IP as the network transport protocol from Internet
based security threats or threats from within Intranets. IP Firewalls can also
filter other network transport protocols used specifically with the IP routing
protocol (such as UDP and ICMP). In addition, a limited number of IP Firewalls
have limited filtering capabilities for a small number of non-IP based network
transport protocols.
Firewalls can also serve to provide access control between individual
subnetworks on an internal network or to control access between an internal
network and a selected outside party authorized to have access to the internal
network for limited purposes. IP Firewalls can accomplish this task to the
extent that TCP/IP is the network transport protocol being used within an
internal network as is the case with intranets and extranets. To the extent
other network transport protocols are utilized within such an internal network,
IP Firewalls will disallow all data utilizing any such transport protocol from
passing through the firewall, thereby denying access entirely to a party which
is intended to have such access. This reduces the effectiveness of IP Firewalls
in a multi-protocol networked environment.
The Company's FireWall/Plus family of security solutions is designed, like
other IP Firewalls, to protect against IP based Internet and intranet security
threats but also addresses security needs that arise from within internal
networks utilizing network transport protocols other than IP, including,
Novell's IPX, Digital Equipment Corporation's DECnet and IBM's SNA. The
Company's FireWall/Plus suite of products consists of a firewall designed to
control access to an organization's internal network from the public networks
(the "Enterprise Version"), a firewall controlling access between the network
and a trusted application server (the "Server Version") and a firewall
controlling access between the network and a trusted client workstation (the
"Desktop Version").
The IP Firewall market is expected to continue to experience dramatic
growth. International Data Corporation estimates that 1996 unit shipments of
firewalls grew by more than 250%, compared with 1995, with 1996 revenues of
approximately $220 million. Unit sales of firewalls are expected to increase
from 36,610 units or approximately $220 million in 1996 to 1.1 million units or
$730 million in 2001. It is anticipated that unit prices of firewalls will
experience a decline in the future because of increased competition. The Company
believes that these projections do not take into account the need for firewalls
to protect computing environments that do not rely exclusively on TCP/IP as the
network transport protocol. While an organization generally requires a small
number of firewalls to restrict vulnerability to TCP/IP-based threats from the
Internet, it may require numerous firewalls to protect internal networks from
attacks from within the organization.
35
The Company believes that securely segmenting internal network areas and
computing resources from unauthorized access will become paramount to insuring
the integrity of both the internal network and an organization's intranet and
extranet resources. The Company further believes that multiple network transport
protocols will remain prevalent in computing environments because of the large
installed base of non-IP based computer systems and applications. The
FireWall/Plus security solution is positioned to address the security issues
faced by enterprises with multi-protocol networking environments seeking to
prevent unauthorized access and attacks from the Internet, intranets and
extranets and internal networks using network transport protocols other than
TCP/IP.
Network-1 Strategy
The Company intends to pursue an aggressive growth strategy and to focus its
efforts on marketing its FireWall/Plus family of network security products. Key
elements of the Company's strategy are:
- Provide Comprehensive Network Security Solutions. The Company's
strategy is to develop, market and support a family of network security
products to address a broad range of security issues confronting
computer networks and computing, including concerns arising from
allowing access to the Internet as well as concerns relating to the
security of internal networks. The Company's comprehensive approach to
network security is based on its FireWall/Plus technology, which offers
robust security for data communications utilizing TCP/IP as well as
other network transport protocols. The FireWall/Plus family of firewall
products currently includes the FireWall/Plus Enterprise Version,
FireWall/Plus Server Version and the FireWall/Plus Desktop Solution.
- Emphasis on Internal Network Security. While FireWall/Plus has the
ability to protect an organization's computer network from Internet,
intranet and extranet based security threats, the Company believes that
its ability to filter multiple network transport protocols offers
significant advantages as a security product for internal networks
where multiple protocols are common. Accordingly, the Company will seek
to exploit this advantage by focusing significant marketing resources
on the internal network security market. The Company intends to devote
a significant portion of the proceeds of this offering for sales and
marketing toward educating potential end users and third-party
distributors as to the need to protect networks and computing resources
from unauthorized access and attacks from within an internal network
and the capabilities and benefits of the Company's products.
- Establish and Maintain Successful Third Party Distribution
Relationships. The Company's marketing plan includes a multi-channel
distribution strategy which emphasizes establishing and maintaining
third-party distributor relationships with systems integrators, VARs,
OEMs and resellers in the United States and internationally. The
Company intends to increase its internal sales and support organization
following the consummation of this offering primarily to provide
additional support to its third-party distributors.
36
- Leverage Consulting Clients. The Company has designed, planned,
audited and implemented numerous networks worldwide for a broad
spectrum of clients, including Fortune 500 companies, small companies
with modest requirements, federal, state and foreign governments and
utilities, as well as education and research institutions. The Company
believes that its consulting clients provide a base of potential
customers for its products. In addition, the Company's consulting
relationships may facilitate its development and enhancement of
software products as the Company's consultants receive feedback and
guidance directly from network administrators and other technical
personnel regarding products and features needed in the marketplace.
See "Business - Consulting."
FireWall/Plus Technology
The Company's network security solutions are based upon its proprietary
FireWall/Plus technology which provides organizations with enterprise wide
security to protect against unauthorized access from the Internet as well as
security for internal sources of intrusion and breach. The following are key
aspects of the Company's FireWall/Plus solution:
Enterprise-Wide Deployment. Unlike most other firewall solutions which focus
on an enterprise's connection to the Internet, the FireWall/Plus solution, as a
result of its unique architecture, may be used throughout the enterprise; at the
perimeter to control access to and from the Internet, between internal networks
and on application servers, including web servers, and desktop PCs to protect
data residing on such servers and PCs. While competing firewall solutions must
be installed on dedicated computers, FireWall/Plus can operate on a Windows NT
desktop computer or application server without interfering with the normal
operation of such desktop computer or server. As a result, the FireWall/Plus
security solution can be installed on existing strategic computing resources
within the enterprise without incurring the expense of additional computing
hardware.
Multi-layer Security. The architecture of Windows NT includes two operating
modes, the "user" and "kernel" modes. The FireWall/Plus solution is implemented
in kernel mode to maximize performance and to provide maximum security from
network intrusion to the operating system environment. Using proprietary
kernel-level software code developed by the Company, FireWall/Plus's Interceptor
Shim and security filter engine technology introduce a security layer between
the network hardware drivers and the Windows NT operating system. FireWall/Plus
filters all network traffic before it reaches Windows NT. Incoming data packets
enter the network through the network interface card and its associated hardware
driver and are immediately passed to the Interceptor Shim, which directs them to
the FireWall/Plus filter engine. The filter engine, using a proprietary
high-speed, real-time security policy enforcement language, checks the packet
and associated packet history against the security rule policy database to
determine whether the packet should be allowed to enter the system. The Company
believes that FireWall/Plus' multi-layer approach to security strengthens
Windows NT by providing a layer of security that filters packets before entering
the Windows NT operating system.
Advanced Filtering System. The Company's FireWall/Plus family of products
includes an advanced filtering system which currently utilizes stateful
inspection and application level filtering technology to provide security for
IP-related transport protocols and applications. Stateful filtering
37
involves the knowledge of states of protocols at specific transaction intervals
during the network connection between two communicating applications between
specific systems. Transaction states occur at routing, transport, session
control and application layers when two programs interoperate with each other
over a computer network connection. When these states are defined to
FireWall/Plus, FireWall/Plus can take actions on conditions that violate the
required or expected stateful actions of one or a simultaneous series of
protocols. Most firewalls have been based upon architectures incorporating
either packet filtering or proxy application gateway filtering. FireWall/Plus
adopts a hybrid approach which incorporates frame, circuit, packet, proxy
application and stateful inspection capabilities in the security management of
network connections. The Company believes that this hybrid approach allows the
Company to offer a firewall product that maximizes security without sacrificing
performance.
Multi-Protocol Capability. A unique aspect of FireWall/Plus is its ability
to provide multi-protocol filtering not available from network security products
offered by other firewall vendors. FireWall/Plus has the advantage of filtering
not only TCP/IP, but also a multitude of other network transport protocols. The
Company believes that the ability of FireWall/Plus to filter multiple network
transport protocols offers significant advantages as a security product for
internal networks where multiple network transport protocols are common.
FireWall/Plus is capable of utilizing stateful inspection technology for
numerous network transport protocols once the various "states" of such protocols
are defined to FireWall/Plus. The states of TCP/IP and several other of the more
commonly used protocols are capable of being defined. For those protocols not
capable of being defined, FireWall/Plus performs frame, packet and application
filtering. In a Windows NT based environment, it is typical for all commonly
used multiple network transport protocols to co-exist, as Windows NT comes
pre-equipped with TCP/IP, IPX (Novell), NetBEUI (LAN Manager) and AppleTalk. In
addition, certain applications require the use of non-IP protocols to operate
between subnetworks on a network. FireWall/Plus' multi-protocol filtering
capability is also critical in the support of web servers on the Internet,
intranets and extranets and other information provision systems that access
information stored on mainframe computers via non-IP protocols. While some
commercially available routers allow basic packet filtering for multiple
protocols, the Company believes its multi-protocol advanced filtering
capabilities offer superior features to routing solutions such as a graphical
user interface, extensive logging, reporting and alarming and security policy
time management.
Transparency. FireWall/Plus may be operated in a transparent mode. In this
mode, FireWall/Plus has no network address (i.e. it is not visible on the
network) and therefore can not be identified for attack. The Company believes
that this feature provides additional security to the operating system because
when a firewall has a network address, it can be located and is more susceptible
to attack. FireWall/Plus provides firewall protection while operating in
transparent mode, except that certain features such as remote management, proxy
support and virtual private networking are not functional.
Centralized Management. FireWall/Plus allows for centralized management and
monitoring that allows a network manager to manage and monitor a system from a
local or remote location. Accordingly, large and geographically dispersed
firewalls may be managed from a single location.
38
Customized Security Policies. FireWall/Plus also allows customized security
policies for individual departments, applications and individual systems and
personnel within the network. Network managers may apply security rules to any
version of the FireWall/Plus products so that individual systems, protocols,
applications, frames and many other network entities are either explicitly
denied or authorized access to specific applications and other network entities.
Multi-Protocol Encryption Tunnels. Once firewalls are in place at multiple
sites on a WAN or the Internet, the ability to establish encrypted
communications links over these connections becomes possible, thereby reducing
reliance on more costly dedicated telecommunications alternatives. FireWall/Plus
provides for integrated data encryption to protect communications over the
Internet and other public networks from unauthorized access. Encryption tunnels,
known as virtual private networks ("VPNs"), may be set up for any Windows NT
based protocol to protect communications between different locations of an
organization's internal network or between different locations and selected
customers, suppliers or strategic partners. FireWall/Plus extends this ability
such that VPNs may be formed between locations across the Internet irrespective
of the transport protocol being tunneled. The Company currently resells VPN
client solutions from Aventail Corporation in conjunction with FireWall/Plus.
Proxy Support. Proxy based firewalls filter network traffic by running a
separate software program that acts as a proxy for each application to be
allowed through the firewall. These firewall solutions require the customer to
purchase the proxies supplied by the vendor for the applications supported by
the vendor's architectural model. As a result, the customer may not find all the
required application proxies from a specific firewall vendor for all the
application suites being used or may find that the proxies offered by the
firewall vendor are not sufficient to support all the required security needs.
FireWall/Plus includes several popular proxies in addition to frame,
circuit, packet, application and stateful inspection capabilities. These proxies
implement popular features for specific application types such as HTTP and FTP.
The Company currently licenses HTTP and FTP proxies from Network Associates,
Inc. FireWall/Plus also allows the use of other third-party proxies in
conjunction with or in lieu of proxies offered by the Company. FireWall/Plus'
architecture allows the Company to partner and include external or third-party
proxies quickly and easily to suit a variety of security requirements.
Additionally, custom-written proxies for a client-server architecture at a
customer site may easily be added to the FireWall/Plus system by adjusting
security policy rule sets in the firewall database.
Ease of Use. FireWall/Plus was designed to be easily installed, configured
and managed by a network manager with minimal or no security skills.
FireWall/Plus may be installed and configured by use of the intuitive graphical
user interface ("GUI") by simply pointing and clicking the mouse. To facilitate
implementation, FireWall/Plus comes pre-programmed with a wide variety of
frequently used default security policies which require the customer to simply
select one of the rule-bases and save the selection. FireWall/Plus does not
utilize significant server resources and may therefore co-exist on the same
server with other software applications on Windows NT. Unlike many other
competitive firewall products offered today, FireWall/Plus need not run on a
separate dedicated server.
39
Products
The Company's family of FireWall/Plus products offers a broad range of
network security solutions. The FireWall/Plus family of products includes the
FireWall/Plus Enterprise Version, FireWall/Plus Server Version and FireWall/Plus
Desktop Version. The Company is currently shipping FireWall/Plus Version 4.03.
The Company first introduced the FireWall/Plus Enterprise Version for Windows NT
in January 1997. As of June 30, 1998, the Company had licensed one or more of
its FireWall/Plus family of software products to over 150 customers. License
revenue from FireWall/Plus products accounted for 43%, 60% and 58% of the
Company's revenues for the years ended December 31, 1996, 1997 and the three
months ended March 31, 1998, respectively, reflecting the Company's emphasis on
the development and marketing of software products rather than consulting
services.
FireWall/Plus Enterprise Version. The FireWall/Plus Enterprise Version
secures an organization's internal network against unwarranted intrusions from
the Internet and is also used between major internal network components as well
as between general access internal networks and special purpose networks such as
process control, real-time and other sensitive access networks. The
FireWall/Plus Enterprise Version includes extensive centralized and remote
security management facilities, predefined security policy rules, multiprotocol
VPN capabilities, authentication and encryption facilities, real time connection
management and proxy services. The FireWall/Plus Enterprise Version supports
Intel processors and Digital Equipment Corporation Alpha processors that support
Windows NT. The FireWall/Plus Enterprise Version is available in scaleable
models to support varying numbers of simultaneous connections for small to
mid-size companies and in an unlimited session version, as well as a high-speed
version. Additionally, the FireWall/Plus Enterprise Version is also available in
a Premier Version which includes the software installed on a high speed Alpha
server running Windows NT. Based on the number of concurrent connections, the
nature of the user's operating system and whether hardware is needed, the
FireWall/Plus Enterprise Version is currently priced to end users between $3,750
and $20,000 for software only versions and from $27,500 to $30,000 for Premier
Versions, which include hardware and onsite technical support.
FireWall/Plus Server Solution. The FireWall/Plus Server Version is designed
to improve internal security of a LAN or Intranet or to protect highly sensitive
systems such as key escrow facilities, web servers, digital certificate servers,
database servers, authentication servers, etc. As a server firewall, this
solution provides protection against unauthorized access to network resources by
internal users, where security breaches often originate. The FireWall/Plus
Server Version co-exists on the server being protected and resides between the
network users and the protected data. FireWall/Plus Server Version treats all
information on the server as secure and guarded, while treating network
connections to the server as unsecure. FireWall/Plus can then be configured
using the FireWall/Plus GUI to allow access to certain users, to specific
applications, during designated times and under a variety of conditions. The
FireWall/Plus Server Version incorporates all of the major features contained in
the FireWall/Plus Enterprise Version. Any other applications including web, file
and print services, may be run simultaneously on the server with the
FireWall/Plus Server Version installed and operating. The FireWall/Plus Server
Version is currently priced to end users at $1,995.
40
FireWall/Plus Desktop Solution. The FireWall/Plus Desktop Version is a full
featured firewall which has been specifically tailored to protect data residing
on Windows NT workstations without disrupting current system operations. These
workstations can run applications while the firewall maintains a high level of
security. When a network attack is detected, it is immediately defeated prior to
the attack being able to access the NT Workstation. The FireWall/Plus Desktop
Version is designed to protect sensitive individual desktop computers (such as a
network control station, a corporate executive's personal computer or the human
resources personnel system) or telecommuter systems where high speed remote
access lines are used (such as cable modems, ADSL and ISDN). The FireWall/Plus
Desktop Version is currently priced to end users at $995.
Customers
The Company's customers represent a wide range of industries, both
commercial and government, which consider networked-data resources to be among
the most important assets within their organizations. As of June 30, 1998, the
Company had licensed one or more of its FireWall/Plus family of products to over
150 customers. Customers for the FireWall/Plus products include The Sabre Group
Inc., Electronic Data Systems Corporation ("EDS"), Trusted Information Systems,
Inc., TRW, Inc., United Technologies, Inc., National Semiconductor Corp.,
Fairchild Semiconductor, ARCO, GTE, Inc., and Continental Airlines. During the
year ended December 31, 1997, Trusted Information Systems, Inc. and EDS
accounted for approximately 21% and 14% of the Company's revenues, respectively.
Examples of the varied uses of the Company's products by customers include:
/ / An industry leading system integrator uses both the Enterprise and
Server Versions of FireWall/Plus to secure access and communications to and
from its facilities management personnel and their customers to manage the
networks of one of the largest telecommunications companies. The
FireWall/Plus Enterprise Versions are used as perimeter defenses on the
company's internal backbone, which supports more than 900 outside clients,
while the FireWall/Plus Server Versions are used to protect key internal
components on the customer's internal network.
/ / A leading travel service company utilizes FireWall/Plus' high speed
Premier Versions to protect one of the busiest websites on the Internet.
Multiple firewalls are also being used internally to securely filter DECnet,
which is the prevalent network transport protocol used in addition to TCP/IP,
between various segments of the internal network. Additionally, this customer
has begun to install multiple FireWall/Plus versions at its customers' sites.
/ / A worldwide petrochemical company currently uses FireWall/Plus
Enterprise Version to secure data at multiple sites from internal and
external breaches. Disparate protocols, including IP and Novell's IPX, are
securely and routinely sent from multiple data centers (each using
FireWall/Plus) throughout the country to a center of operations while
FireWall/Plus insures the integrity of the data.
41
The Company believes that the FireWall/Plus security solution is a scaleable
product which satisfies customers' needs to secure the perimeter and internal
resources within their organizations. The Company further believes that
currently available IP Firewalls are not as flexible with respect to both
internal and external security as the FireWall/Plus solution.
During the years ended December 31, 1996 and 1997 and the three months ended
March 31, 1998, license revenue from international customers (licenses to
foreign end users and international distributors) accounted for 6.7%, 15.6% and
2.7% of the Company's revenues, respectively. All of the Company's revenues from
international licenses were denominated in U.S. dollars. The Company anticipates
that revenues from international customers will account for an increasing
percentage of the Company's revenues in the future.
Sales and Marketing
The Company is in the process of implementing a sales and marketing plan
which consists of a multi-channel distribution strategy and a promotion strategy
to create consumer awareness of the Company and its FireWall/Plus products and
to educate the market about the need to implement network security products and
of the capabilities and benefits of the Company's FireWall/Plus products.
Multi-Channel Distribution
In-House Sales Force. The Company's internal sales force consists of three
persons, consisting of a Vice President of Sales of North America and two sales
representatives. The Company's sales representatives are responsible for
soliciting potential customers and providing technical support to customers, as
well as supporting third-party distribution channels. To date, the Company's
internal sales force has not undertaken significant marketing efforts relating
to product commercialization.
Following the consummation of this offering, the Company intends to retain a
Vice-President of International Sales to oversee the Company's international
sales and marketing efforts and a limited number of additional sales
representatives in connection with the expansion of the Company's marketing
efforts. Although the Company's in-house sales force will continue to solicit
potential customers, its primary responsibility is expected to be supporting
third-party distribution channels.
Third-Party Distribution Channels. A key element of the Company's
distribution strategy is to establish and maintain relationships with
third-party distributors within the United States and internationally. By
engaging such third-party distributors, the Company is able to utilize the
end-user sales and support infrastructure of these channels.
The Company currently has relationships with 22 national, regional and local
systems integrators, VARs and resellers in the United States, including EDS,
Wang Laboratories, Inc. and BDM International, Inc. In November 1997, the
Company entered into a Master Software License Agreement with EDS pursuant to
which EDS has the non-exclusive right on a worldwide basis to use, market and
distribute the Company's Fire Wall/Plus family of products including the right
to promote and resell such products in conjunction with providing systems
integration, outsourcing or facilities
42
management services to its customers. The Company also currently has
relationships with international system integrators, VARs, resellers and
distributors in 25 countries, including Japan, Germany, Canada, United Kingdom,
Republic of China, Hong Kong, Russia, Taiwan, Korea, Singapore, Malaysia,
Indonesia, Thailand and Turkey.
The Company's agreements with distributors generally grant the distributor
the right to market the Company's products in specified territories on a
non-exclusive basis, are terminable on short notice and do not prohibit the
distributor from selling products that are competitive with the Company's
products.
The Company intends to continue to seek to establish relationships with
additional third-party distributors, principally larger system integrators and
VARs with the necessary resources to successfully distribute the Company's Fire
Wall/Plus products. For the year ended December 31, 1997, Trusted Information
Systems, Inc. ("TIS") and EDS accounted for 21% and 14%, respectively, of the
Company's revenues and for the three months ended March 31, 1998, The Sabre
Group, Inc. and Omnicon Systems, Inc. accounted for 24% and 13%, respectively,
of the Company's revenues. The Company's five largest distributors accounted for
an aggregate of approximately 28% and 40% of the Company's revenues for the year
ended December 31, 1997 and the three months ended March 31, 1998, respectively.
The Company also seeks to enter OEM or licensing arrangements whereby the
Company grants to an OEM or other third party the right to incorporate and/or
bundle a specific technology of the Company with the OEM's or other
third-party's products. In June 1997, the Company entered into a license
agreement with TIS, which was subsequently acquired by Network Associates, Inc.,
pursuant to which the Company licensed to TIS which was on a non-exclusive basis
the right to incorporate and/or bundle the Company's Interceptor Shim software
with TIS' family of Gauntlet(TM) firewall products. The Company receives a
royalty based upon TIS sales, of which $500,000 was paid to the Company as a
non-refundable pre-paid royalty. As a result of such pre-paid royalty, license
revenue from TIS accounted for 21% of the Company's revenues for the year ended
December 31, l997.
The Company expects that its arrangements with third-party distributors and
OEMs will account for an increased percentage of its product sales in the
future.
Advertising and Promotion
Following the consummation of the offering, the Company intends to implement
an advertising and promotion strategy to create consumer awareness of the
Company and its FireWall/Plus products and to educate the market about network
security threats and FireWall/Plus's ability to address customers' needs. To
date, the Company has engaged in limited advertising and promotion of its
products through its website, trade publication and published product reviews.
The Company intends to use a portion of the proceeds of this offering to
advertise and promote its products through print advertising, Internet website
advertising, direct marketing efforts and participation in trade shows and
seminars which target organization security and management information system
administrators and network system integrators.
43
The Company's website, www.network-1.com, which includes a description of
the Company's FireWall/Plus family of products and enables visitors to the site
to download a 50-session FireWall/Plus Enterprise Version for a 30-day trial.
The Company intends to use a portion of the proceeds of this offering to add
content to the website, such as product information, including a user guide,
network security industry information and additional content specific to
distributors and end users; improve download capabilities for the trial version;
and enable purchases via the website.
Consulting
The Company has designed, planned, audited and implemented numerous
networks worldwide for a broad spectrum of clients, including Fortune 500
companies, small companies with modest requirements, federal, state and foreign
governments and utilities, as well as education and research institutions. Mr.
William Hancock, the Company's Chief Technology Officer and a director, is an
industry expert who has authored networking and security books and has been a
featured columnist as well as a network and security editor for a number of
industry journals. The Company intends to expand its consulting activities
following the consummation of this offering by utilizing the expertise of Mr.
Hancock to create opportunities for consulting through speaking engagements at
industry conferences, seminars and trade shows.
Historically, the Company has offered a wide range of consulting services
designed to provide solutions to networking and security problems. Such
consulting services have included network surveys, network designs and traffic
modeling, security penetration studies, security breach investigation, network
and computer forensics services, hacker prosecutions (in connection with federal
and local law enforcement agencies) and network security technical audits among
other services. The Company generally provides its consulting clients with a
comprehensive report containing detailed findings and recommendations. The
Company offers its consulting services on a per hour or per project basis.
The Company's consulting clients have included, among others, EDS, MCI
Communications Corp., Kraft General Foods, Inc., Alcoa Aluminum Company of
America, TIA-CREF, Southwestern Bell Telephone Co., Chemical Bank Corp., Hewlett
Packard Co., American Airlines, Inc., Bechtel Corporation, ARINC, ARCO Chemical
Company, United Technologies Sikorsky Aircraft, Bowne, Inc., and the U.S.
Government, including The Environmental Protection Agency.
Consulting services generated 24%, 21% and 27% of the Company's revenues
for the years ended 1996 and 1997 and the three months ended March 31, 1998,
respectively. The Company expects that consulting services will account for a
decreasing percentage of revenue as the Company continues to focus its efforts
on developing and marketing its network security software products.
Customer Service and Support
The Company believes that customer service and support is critical to
retaining customers and attracting prospective customers. The Company provides
customer service and support through its internal technical support staff of 5
persons located at its Grand Prairie, Texas office. Customers receive a 90-day
warranty, which includes technical assistance and product updates. To date, the
Company has not incurred any material warranty expense. Following the expiration
of the 90-day warranty, customers can elect to purchase the Company's annual
maintenance program at an average
44
annual cost of 15% of the then current purchase price. The maintenance program
includes technical assistance and support, product updates and general
information relating to product introductions and changes. Technical support is
available 24 hours a day, 7 days a week, by telephone and electronic mail. In
addition, the Company provides customers with fee-based on-site installation,
support and training. The Company provides its resellers with sales and
technical support.
Product Development
The Company believes that development of new products and enhancements to
existing products are essential for the Company to effectively compete in the
network security market. The Company's product development efforts are directed
toward enhancing its FireWall/Plus family of security products, developing new
products and responding to emerging industry standards and other technological
changes. The Company intends to expand its existing product offerings and to
introduce new application products for the network security market. The
Company's new product development efforts are focused on enhancements to the
Company's current suite of products and new network security products, including
products that support Windows 95/98 operating systems. While the Company expects
that certain of its new products will be developed internally, the Company may,
based on timing and cost considerations, expand its product offerings through
acquisitions. In addition, the Company has relied and will continue to rely on
external development resources for the development of certain of its products
and components.
The Company currently has 10 employees devoted to research and product
development. However, historically, a substantial portion of the Company's
research and development activities have been undertaken by engaging third-party
consultants and independent contractors. During the years ended December 31,
1996 and 1997 and three months ended March 31, 1998, the Company's product
development expenses were $984,000, $917,000 and $208,000, respectively.
The Company intends to hire and retain approximately 17 additional software
engineers and developers on a full-time basis within twelve months following the
consummation of this offering and has allocated approximately $2,100,000 of the
net proceeds of this offering to software development.
The network security industry is characterized by rapid technological
change, changes in customer requirements, frequent new product introductions and
enhancements, new and continuously evolving network security threats and attack
methodologies and evolving industry standards in computer hardware and software
technology. As a result, the Company must continually change and improve its
products in response to such advances and changes in operating systems,
application software, computer and communications hardware, networking software,
programming tools and computer language technology. The introduction of products
embodying new technologies and the emergence of new industry standards may
render existing products obsolete or unmarketable.
The Company's future operating results will depend upon the Company's
ability to enhance its current products and to develop and introduce new
products on a timely basis that address the increasingly sophisticated needs of
the marketplace and that keep pace with technological developments, new
competitive product offerings and emerging industry standards. There can be no
assurance that the Company will be successful in developing and marketing new
products or product enhancements that respond to technological change and
evolving industry standards and customer requirements, that the Company will not
experience difficulties that could delay or prevent the
45
successful development, introduction and marketing of these products, or that
any new products and product enhancements will adequately meet the requirements
of the marketplace and achieve market acceptance. In the event that the Company
does not respond adequately to the need to develop and introduce new products or
enhancements of existing products in a timely manner in response to changing
market conditions or customer requirements, the Company's business, operating
results and financial condition will be materially adversely affected.
Competition
The network security market in general, and the firewall product market in
particular, is characterized by intense competition and rapidly changing
business conditions, customer requirements and technologies. The Company
believes that the principal competitive factors affecting the market for network
security products include security effectiveness, name recognition, scope of
product offerings, product features, distribution channels, price, ease of use
and customer service and support. Currently, the Company's principal competitors
include AXENT Technologies Inc., Bay Networks, Inc., CheckPoint Software
Technologies, Ltd., Cisco Systems, Inc., Compaq Computer Corporation, Cyberguard
Corp., International Business Machines Corporation, ISS Group, Inc., Microsoft
Corporation, Network Associates, Inc. and Secure Computing Corporation. Due to
the rapid expansion of the network security market, the Company may face
competition from new entrants.
Most of the Company's current and potential competitors have longer
operating histories, greater name recognition, larger installed customer bases
and possess substantially greater financial, technical and marketing and other
competitive resources than the Company. As a result, the Company's competitors
may be able to adapt more quickly to new or emerging technologies and changes in
customer requirements or devote greater resources to the promotion and sale of
their products than the Company. While the Company believes that its firewall
products do not compete against manufacturers of other types of security
products (such as encryption and authentication products), there can be no
assurance that potential customers will not perceive the products of such other
companies as substitutes for the Company's products. In addition, certain of the
Company's competitors may determine for strategic reasons to consolidate, to
substantially lower the price of their network security products or to bundle
their products with other products, such as hardware or other enterprise
software products. Accordingly, it is possible that new competitors and
alliances among competitors may emerge and rapidly acquire significant market
share. There can be no assurance that the Company's current and potential
competitors will not develop products that may be more effective than the
Company's current or future products or that the Company's products would not be
rendered obsolete or less marketable by evolving technologies or changing
consumer demands or that the Company will otherwise be able to compete
successfully. Increased competition for firewall products may result in price
reductions, reduced gross margins and adversely effect the Company's ability to
gain market share, any of which would adversely affect the Company's business,
operating results and financial condition.
46
Proprietary Rights
The Company's success is substantially dependent on its proprietary
technologies. The Company does not hold any patents and relies on copyright and
trade secret laws, non-disclosure agreements with employees, distributors and
customers, including "shrink wrap" license agreements that are not signed by the
customer, and technical measures to protect the ideas, concepts and
documentation of its proprietary technologies and know-how to protect its
intellectual property rights. Such methods may not afford complete protection,
and there can be no assurance that third parties will not independently develop
substantially equivalent or superior technologies or obtain access to the
Company's technologies, ideas, concepts and documentation. In addition, there
can be no assurance that any confidentiality agreements between the Company and
its employees, distributors or customers will provide meaningful protection for
the Company's proprietary information in the event of any unauthorized use or
disclosure. Any inability to protect its proprietary technologies could have a
material adverse effect on the Company. Furthermore, the Company may be subject
to additional risk as it enters into transactions in countries where
intellectual property laws are not well developed or are poorly enforced. Legal
protection of the Company's rights may be ineffective in such countries.
The Company also licenses from a third party certain proxy technology which
is incorporated into its FireWall/Plus products. The Company is dependent in
part on its ability to continue to license such technology. Any inability of the
Company to be able to continue to utilize such technology either as a result of
the Company's breach or the termination of a license agreement or otherwise, in
the absence of similar available technologies, could have a material adverse
effect on the Company.
The Company received a U.S. trademark registration for the FireWall/Plus
name in December 1996. Although the Company is not aware of any challenges to
the Company's rights to use this trademark, there can be no assurance that the
use of this mark would be upheld if challenged.
Although the Company believes that its technologies and products have been
developed independently and do not infringe upon the proprietary rights of
others, there can be no assurance that the Company's technologies and products
do not and will not so infringe or that third parties will not assert
infringement claims against the Company in the future. The Company is not aware
of any patent infringement charge or any violation of other proprietary rights
claimed by any third party relating to the Company or the Company's products. In
response to certain public statements made by CheckPoint Software Technologies,
Ltd. related to a patented technology referred to as "stateful inspection" (the
"Checkpoint Patent"), the Company retained patent counsel in April 1997 to
review the Checkpoint Patent as compared to the Company's intellectual property
and associated products. Based upon the opinion of the Company's intellectual
property counsel, the Company does not believe that the CheckPoint Patent will
have a material adverse effect on the Company. If, however, the Company's
technologies or products were deemed to infringe upon the Checkpoint Patent, or
if the Company's technologies or products were deemed to infringe upon the
proprietary rights of other third parties, the Company could become liable for
damages or be required to modify its products or to obtain a license.
47
As the number of security products being offered continue to increase the
functionality of such products may further overlap, which could result in
increased infringement claims by software developers, including infringement
claims against the Company with respect to future products. There can be no
assurance that the Company would be able to modify its products or obtain a
license in a timely manner, upon acceptable terms and conditions, or at all, or
that the Company will have the financial or other resources necessary to defend
a patent infringement or other proprietary rights infringement action. Failure
to do any of the foregoing could have a material adverse effect on the Company,
including possibly requiring the Company to cease marketing its products.
CommHome Systems Corp. Acquisition
Prior to the consummation of this offering, the Company will enter into a
merger agreement with CommHome Systems Corp. ("CommHome"), effective upon
consummation of this offering, pursuant to which the CommHome stockholders have
agreed to exchange all of the outstanding common stock of CommHome for 35,000
shares of Common Stock of the Company. Pursuant to the merger agreement, the
Company has agreed to assume up to $200,000 of liabilities of CommHome, which
include $55,000 and $50,000 owed to Avi A. Fogel and Robert P. Olsen,
respectively. Messrs. Fogel and Olsen have agreed to accept 6,875 and 6,250
shares of Common Stock, respectively, in full satisfaction of such indebtedness.
Mr. Fogel, President, Chief Executive Officer and a director of the Company, is
also President, Chief Executive Officer and owns 51% of the outstanding shares
of CommHome. Mr. Olsen, Vice President of Product Management of the Company, is
the former Vice President of Marketing of CommHome. See "Certain Transactions."
CommHome, incorporated in June 1997, is a development stage company engaged
in the design and development of residential networking solutions for high speed
Internet access to the home. CommHome's designs are intended to provide easy
access to the Internet throughout the home. These solutions include secure
connections to high speed networking technologies, such as ADSL and cable modem
technology, and easy distribution at all phone connections. It is currently
expected that CommHome's designs will be incorporated into the Company's future
security products.
Employees
As of June 30, 1998, the Company had 22 full time employees, including 5 in
sales and marketing, 10 in product research and development and technological
support and 7 in administration and finance. None of the Company's employees is
represented by a labor union or is subject to a collective bargaining agreement.
The Company has not experienced any work stoppages and considers its
relationship with its employees to be good.
Competition with respect to the recruiting of highly qualified personnel in
the software industry is intense and many of the Company's competitors have
significantly greater resources than the Company. The Company's ability to
attract and assimilate new personnel will be critical to the Company's
performance and there can be no assurance that the Company will be successful in
attracting or retaining the personnel it requires to enhance its products,
develop new products and conduct its operations successfully.
48
Facilities
The Company currently subleases on an interim basis approximately 400
square feet of office space in Wellesley Hills, Massachusetts for its principal
executive offices. Following the consummation of this offering, the Company
intends to lease new principal executive offices in the Boston, Massachusetts
area. The Company's technical support, warehouse and distribution facilities are
located in Grand Prairie, Texas, where the Company leases approximately 7,500
square feet pursuant to a written lease which expires on July 31, 1999. The
Company also leases approximately 4,500 square feet of office space in New York,
New York under a sublease that expires on September 29, 1998 which the Company
does not intend to renew.
Legal Proceedings
The Company is not a party to any material legal proceedings.
49
MANAGEMENT
Executive Officers and Directors
The executive officers and directors of the Company are as follows:
Name Age Position
Avi A. Fogel ............................... 44 President, Chief Executive Officer and
Director
William Hancock............................. 41 Chief Technology Officer and Director
Robert P. Olsen ............................ 44 Vice President of Product Management
Murray P. Fish.............................. 47 Chief Financial Officer
Peter Mearsheimer........................... 45 Vice President of North American Sales
Joseph A. Donohue........................... 43 Vice President of Engineering
Robert M. Russo............................. 47 Vice President of Business Development
and Secretary
Corey M. Horowitz........................... 43 Chairman of the Board of Directors
Marcus J. Ranum............................. 35 Director
Avi A. Fogel has served as President, Chief Executive Officer and a
director since May 1998. From March 1998 until May 1998, Mr. Fogel served as a
consultant to the Company. From June 1997 until the consummation of this
offering, Mr. Fogel served as President and Chief Executive Officer of CommHome,
a development stage company engaged in the business of developing residential
networking solutions, which he co-founded in June 1997. From January 1997 to
June 1997, Mr. Fogel was engaged pre-incorporation activities related to
CommHome. Effective upon the consummation of this offering, CommHome will be
acquired by the Company. From October 1995 to December 1996, Mr. Fogel was
employed by Digital Equipment Corp. as Vice President, Global Marketing. From
July 1994 to October 1995, Mr. Fogel was Executive Vice President, Global
Marketing and Business Development of LANNET Data Communications, Ltd., a
manufacturer of LAN switching hubs located in Tel Aviv, Israel. From July 1990
to July 1994, Mr. Fogel served as President and Chief Executive Officer of
LANNET, Inc., the U.S. subsidiary of LANNET Data Communications, Ltd.
William Hancock co-founded the Company and has served as its Chief
Technology Officer since May 1998 and as a director since inception. Since
inception until May 1998, Dr. Hancock served as Executive Vice President and
Secretary. Mr. Hancock is a leading international expert in computer and network
design and security with over 20 years of experience in computer science,
network technologies and electrical engineering. From June 1982 to July 1990,
Mr. Hancock was an independent computer and networking consultant to Fortune 500
companies, including Digital Equipment Corporation, AT&T and IBM. Mr. Hancock
participated in the operating system and network design teams at both Digital
Equipment Corporation and IBM. He was instrumental in the design and selection
of the Integrated System Digital Network plug connector and is the author of
50
the implementation of the RSA encryption algorithm for the CCITT X.32 network
standard. Mr. Hancock has been involved in the architecture and writing of the
networking and security standards for the International Organization for
Standardization. Mr. Hancock is a Certified Information Systems Security
Professional.
Robert P. Olsen has served as Vice President of Product Management since
May 1998. From March 1998 until May 1998, Mr. Olsen served as a consultant to
the Company. From July 1997 to December 1997, Mr. Olsen served as Vice President
of Marketing of CommHome. From July 1996 to July 1997, Mr. Olsen was Vice
President of Marketing for Netphone, Inc., a developer of computer servers. From
December 1991 to June 1996, Mr. Olsen was Vice President of Marketing for Agile
Networks, Inc., a company engaged in the design manufacturing, marketing and
support of ethernet and ATM switches, which he co-founded.
Murray P. Fish has served as Chief Financial Officer since May 1998. From
August 1997 to May 1998, Mr. Fish was an independent financial consultant. From
April 1991 to August 1997, Mr. Fish served as President, Chief Executive Officer
and a director of RealWorld Corporation, a manufacturer of accounting software.
From March 1989 to April 1991, Mr. Fish served as Vice President and Controller
of Goldman Financial Group, Inc., a manufacturer of chemical and machine tools.
Peter Mearsheimer has served as Vice President of North American Sales
since May, 1998 and Vice President of Sales from April 1996 to May 1998. Mr.
Mearsheimer was employed by Wall Data Incorporated, a network software company,
as the Eastern Area Sales Manager from April 1993 to March 1996. From January
1991 to March 1993, Mr. Mearsheimer served as a Regional Sales Manager for Eicon
Technology, Inc., a company engaged in the network software business.
Joseph A. Donohue has served as Vice President of Engineering since July
1998. From April 1987 to July 1998, Mr. Donohue was employed by Stratus Computer
Inc., having held the positions of Director - Windows/NT Software Development
from November 1997 to July, 1998, Director - Proprietary OS from July 1994 to
November 1997 and Manager - Kernel Development July 1993 to July 1994. From
April 1987 to July 1993, Mr. Donohue served Status Computer, Inc. in various
engineering positions.
Robert M. Russo co-founded the Company and has served as Vice President of
Business Development and Secretary since May 1998. Mr. Russo served as President
and a director of the Company from inception until May 1998, and as Chief
Operating Officer of the Company from December 1993 to May 1998. From May 1987
to June 1990, Mr. Russo served as Vice President of Sales and Marketing of
Essential Resources, Inc., a computer consulting and training company. From
December 1979 to February 1987, Mr. Russo served as President of the North
American Division of H&M Systems Software, Inc., a software developer.
Corey M. Horowitz became Chairman of the Board of Directors of the Company
in January 1996 and has been a member of the Board of Directors since April
1994. Mr. Horowitz is a private investor and President and sole shareholder of
CMH Capital Management Corp., a New York investment advisory and merchant
banking firm, which he founded in September 1991. From January 1986 to February
1991, Mr. Horowitz was a general partner in charge of mergers and acquisitions
at Plaza Securities Co., a New York investment partnership. From July 1984 to
51
December 1985, Mr. Horowitz was a general partner at Lafer Amster & Co., an
investment partnership. From August 1980 to June 1984, Mr. Horowitz was an
associate at the New York law firm of Skadden, Arps, Slate, Meagher & Flom.
Marcus J. Ranum has served as a director of the Company since June 1998.
Mr. Ranum currently serves as President and Chief Executive Officer of Network
Flight Recorder, Inc., a development stage networking software company which he
founded in March of 1996. From October 1994 to February 1996, Mr. Ranum has
served as Chief Scientist and Executive Manager of V-One Corporation, a company
engaged in the development and marketing of network security products. From June
1994 to October 1994, he served as a consultant in network security, software
analysis and testing, software development and related matters. From November
1992 to June 1994, he served as Senior Scientist of Trusted Information Systems,
Inc. From August 1991 to November 1993, Mr. Ranum served as a consultant to
Digital Equipment Corporation.
All Directors serve until the next annual meeting of stockholders and the
election and qualification of their successors. Executive officers are elected
by, and serve at the discretion of, the Board of Directors. Corey M. Horowitz
was elected a director pursuant to a stockholders' agreement which provided that
certain principal stockholders agreed to vote their shares to elect Mr. Horowitz
to the Board of Directors. The stockholders' agreement terminates upon the
effective date of the offering. There are no family relationships among any of
the Company's directors or executive officers.
The Company has agreed, for a period of five years from the date of this
Prospectus, if so requested by the Underwriter, to nominate and use its best
efforts to elect a designee of the Underwriter as a director of the Company or,
at the Underwriter's option, as a non-voting advisor to the Company's Board of
Directors. The Company's officers, directors and principal stockholders have
agreed to vote their shares of Common Stock in favor of such designee. The
Underwriter has not yet exercised its right to designate such a person.
Board Committees
Prior to the date of this Prospectus, the Board of Directors intends to
establish an Audit Committee and a Compensation Committee. The Audit Committee
will review the qualifications of the Company's independent auditors, make
recommendations to the Board of Directors regarding the selection of independent
auditors, review the scope, fees and results of any audit, and review non-audit
services and related fees provided by the independent auditors.
The Compensation Committee will be responsible for determining compensation
for the executive officers of the Company, including bonuses and benefits, and
will administer the Company's compensation programs, including the Stock Option
Plan.
The Board of Directors does not have a nominating committee. The selection
of nominees for the Board of Directors is made by the entire Board of Directors.
The Board of Directors may from time to time establish other committees to
facilitate the management of the Company.
52
Director Compensation
To date, directors of the Company have received no cash compensation for
their services as directors. The Company does not currently compensate directors
who are also employees of the Company for service on the Board of Directors. All
Directors are reimbursed for their expenses incurred in attending meetings of
the Board of Directors and its committees. Each non-employee director first
joining the Board of Directors in the future will be granted an option to
purchase 20,000 shares of Common Stock when such director is first elected or
appointed to the Board of Directors, with the option shares vesting over a one
year period in equal quarterly amounts, under the Stock Option Plan. In
addition, each non-employee director will receive an automatic option grant to
purchase 5,000 shares of Common Stock on each year anniversary that such
director is a member of the Board of Directors with the option shares vesting
over a one year period in equal quarterly amounts, under the Stock Option Plan.
All option grants to non-employee directors will be at a per share exercise
price equal to the fair market value of the Common Stock at the time of grant.
See "Management -- Stock Option Plan."
Advisory Board
In March 1996, the Board of Directors established an advisory board (the
"Advisory Board"). The following persons serve on the Advisory Board:
Irwin Lieber has served as President and Chief Executive Officer of
GeoCapital LLC, a registered investment adviser since 1979. He is also a general
partner of Applewood Associates, L.P., a principal stockholder of the Company,
and 21st Century Communications Partners, L.P., each of which is an investment
partnership. Mr. Lieber is also a member of Wheatley Partners, LLC, the general
partner of Wheatley Partners, L.P. and a general partner of Wheatley Foreign
Partners, both of which are investment partnerships. From June 1985 to February
1994, Mr. Lieber served as a director of Cheyenne Software, Inc. Mr. Lieber
currently serves as a director of Learonal, Inc., a public company, and serves
as a director of several private technology corporations.
Barry Rubenstein, a principal stockholder of the Company, is a general
partner of Applewood Associates, L.P., Seneca Ventures and Woodland Venture
Fund, all of which are investment partnerships and stockholders of the Company.
Mr. Rubenstein is a member of Wheatley Partners LLC, the general partner of
Wheatley Partners, L.P. and a general partner of Wheatley Foreign Partners,
L.P., both of which are investment partnerships. In addition, he is a principal
of a general partner of the 21st Century Communications Partners, L.P., which is
also an investment partnership. Prior to his experience as an investor, Mr.
Rubenstein also served as a co-founder of several technology companies,
including Applied Digital Data Systems, Inc., Cheyenne Software, Inc. and
Novell, Inc. Mr. Rubenstein is a director of Infonautics, Inc., The Milbrook
Press, Inc., Source Media Inc., and USWeb Corporation as well as several private
technology companies.
Eli Oxenhorn was Chairman of the Board of Cheyenne Software, Inc. from
October 1986 to May 1994. He was also President and Chief Executive Officer of
Cheyenne Software, Inc. from October 1986 to October 1993. He is currently a
private investor and consultant.
53
In consideration of their serving on the Advisory Board, in March 1996, the
Company issued to each of Messrs. Lieber, Oxenhorn and Rubenstein warrants to
purchase 31,040 shares of the Company's Common Stock at an exercise price of
$6.44 per share and 31,040 shares of the Company's Common Stock at an exercise
price of $9.66 per share.
Executive Compensation
The following table sets forth the compensation paid by the Company in all
capacities during the year ended December 31, 1997 to its then President and
Chief Operating Officer and to each of its executive officers whose compensation
for such year exceeded $100,000 (the "Named Executive Officers").
Summary Compensation Table
Long Term
Compensation
Annual Compensation Awards
--------------------------- -----------------
Shares
Year Ended Underlying All Other
Name and Principal Position(4) December 31, Salary ($) Bonus ($) Options (#) Compensation
- ------------------------------ ---------------- -------------- ------------ ----------------- -----------------
Robert Russo,
President and Chief Operating
Officer............................. 1997 $145,000(1) -- -- --
William Hancock,
Executive Vice President............ 1997 160,000(2) -- -- --
Peter Mearsheimer,
Vice President of Sales............. 1997 155,000(3) -- 21,728 --
- ------------------------------------------
(1) Includes $51,692 of deferred salary.
(2) Includes $6,154 of deferred salary.
(3) Includes $5,962 of deferred salary.
(4) Does not include the following executive officers who were employed by the
Company beginning in 1998 and are receiving annual compensation in excess
of $100,000: Avi A. Fogel, President and Chief Executive Officer, Robert P.
Olsen, Vice President of Product Management, Murray P. Fish, Chief
Financial Officer and Joseph A. Donohue, Vice President of Engineering. See
"Management-- Employment Agreements."
54
The following table provides information relating to stock options awarded
to each of the Named Executive Officers during the year ended December 31, 1997.
All such options were awarded under the Stock Option Plan.
Option Grants in 1997
---------------------------------------------------------------------------------------
% of Total Option
Number of Shares Granted to
Underlying Options Employees Exercise Price Expiration
Name Granted in 1997(1) Per Share (2) Date
------- ----------- --------- -----
Peter Mearsheimer 3,104 2% $6.44 5/12/2006
18,624 15% $4.83 9/15/2007
(1) The number of options granted to employees during 1997 used to compute
this percentage excludes options to purchase 79,152 shares of Common Stock
due to the termination of such options pursuant to their terms.
(2) Options were granted at an exercise price equal to the fair market value
of the Company's Common Stock on the date of grant, as determined by the
Board of Directors.
Employment Agreements
On May 18, 1998, the Company entered into an employment agreement with Avi
A. Fogel, pursuant to which Mr. Fogel serves as the Company's Chief Executive
Officer and President for a four year term at an annual base salary of $150,000
per year subject to annual increases in base salary of up to 20% at the
discretion of the Compensation Committee of the Board of Directors. Mr. Fogel is
eligible to receive an additional cash bonus of up to $50,000 as determined by
the Board of Directors in its discretion. In addition, upon execution of his
employment agreement, Mr. Fogel received five year options to purchase 294,879
shares of the Company's common stock at an exercise price of $2.42 per share.
The options granted to Mr. Fogel vested as to 34% of the shares covered thereby
at the time of execution of his employment agreement and vest as 22% of the
shares covered thereby on each of the first three anniversaries thereafter,
subject to acceleration upon a change of control of the Company. In the event
Mr. Fogel's employment agreement is terminated "other than for cause" (as
defined in the agreement), he shall be entitled to (i) the vesting of all
options in the year of termination and 50% of the options that would have vested
in the year following termination and (ii) the lesser of one year's base salary
or the base salary for the balance of the term of the agreement. Mr. Fogel has
agreed not to disclose any confidential information of the Company during the
term of his employment or at any time thereafter or to compete with the Company
during the term of his agreement and for a period of two years thereafter in the
event of termination for cause.
On June 30, 1998, the Company entered into an employment agreement with Mr.
William Hancock pursuant to which Mr. Hancock agreed to continue to serve as the
Company's Chief Technology Officer for a three year term at an annual salary of
$160,000 per annum, subject to additional bonus compensation as determined by
the Compensation Committee of the Board of Directors in its discretion. In the
event Mr. Hancock's employment is terminated for cause (as defined in the
agreement), the Company will have the right to repurchase 50% of the securities
owned by him at the time at a purchase price of $1.00 per share. In the event
Mr. Hancock's employment agreement is terminated "other than for cause" (as
defined in the agreement), he shall
55
be entitled to receive the lesser of six months base salary or the base salary
for the balance of the term of the term of the agreement. Mr. Hancock has agreed
not to disclose any confidential information of the Company during the term of
his employment or at anytime thereafter or to compete with the Company during
the term of his agreement and for a period of two years thereafter in the event
of termination for cause.
On May 18, 1998, the Company entered into an employment agreement with
Robert P. Olsen pursuant to which Mr. Olsen agreed to serve as the Company's
Vice President of Product Management for a three year term at an annual salary
of $120,000 per annum, subject to an additional cash bonus of $30,000 as
determined by the Compensation Committee of the Board of Directors in its
discretion. Upon execution of his employment agreement, Mr. Olsen received an
incentive stock option to purchase 58,976 shares of the Company's common stock
at an exercise price of $5.60 per share. The options granted to Mr. Olsen vested
as to 34% of the shares covered thereby upon execution of the agreement and 22%
of the shares covered thereby on each of the first three anniversaries
thereafter, subject to acceleration upon a change of control of the Company. In
the event Mr. Olsen's employment agreement is terminated "other than for cause"
(as defined in the agreement), he shall be entitled to (i) the vesting of all
options in the year of termination and 50% of the options that would have vested
in the year following termination and (ii) the lesser of one year base salary or
the base salary for the balance of the term of the agreement. Mr. Olsen has
agreed not to disclose any confidential information of the Company during the
term of his employment or at anytime thereafter or to compete with the Company
during the term of his agreement and for a period of two years thereafter in the
event of termination for cause.
On May 19, 1998, the Company entered into an employment agreement with
Murray P. Fish pursuant to which Mr. Fish agreed to serve as the Company's Chief
Financial Officer for a three year term at an annual salary of $120,000 per
annum, subject to an additional cash bonus of $30,000 as determined by
Compensation Committee of the Board of Directors in its discretion. Upon
execution of his employment agreement, Mr. Fish received an incentive stock
option to purchase 58,500 shares of the Company's common stock at an exercise
price of $5.60 per share. The options granted to Mr. Fish vested as to 34% of
the shares covered thereby upon execution of the agreement and vest as to 22% on
each of the first three anniversaries thereafter, subject to acceleration upon a
change of control of the Company. In the event Mr. Fish's employment agreement
is terminated "other than for cause" (as defined in the agreement), he shall be
entitled to (i) the vesting of all options in the year of termination and 50% of
the options that would have vested in the year following termination and (ii)
the lesser of six months base salary or the base salary for the balance of the
term of the agreement. Mr. Fish has agreed not to disclose any confidential
information of the Company during the term of his employment or at anytime
thereafter or to compete with the Company during the term of his agreement and
for a period of two years thereafter in the event of termination for cause.
On April 4, 1994, the Company entered into an employment agreement with
Robert M. Russo pursuant to which Mr. Russo agreed to then serve as the
Company's President and Chief Operating Officer for a three year term at a base
salary of $145,000 per annum, subject to an additional cash bonus as determined
by the Compensation Committee of the Board of Directors in its discretion. In
February 1996, the Company and Mr. Russo agreed to extend the term of his
employment agreement, upon the same terms and conditions, for an additional two
year period expiring April 1999. In accordance with his agreement, Mr. Russo has
agreed not to disclose any confidential information of the Company during the
term of his employment or at anytime thereafter or to
56
compete with the Company during the term of his agreement and for a period of
two years thereafter in the event of termination for cause. In May 1998, Mr.
Russo agreed to serve the Company as its Vice President of Business Development
in accordance with the terms and conditions of his employment agreement.
Stock Option Plan
On March 7, 1996, the Board of Directors and stockholders of the Company
approved the adoption of the Stock Option Plan. The Stock Option Plan, as
amended, is intended to assist the Company in securing and retaining key
employees, directors and consultants by allowing them to participate in the
ownership and growth of the Company through the grant of incentive and
non-qualified options (collectively, the "Options"). Under the Stock Option
Plan, key employees (including officers and employee directors) are eligible to
receive grants of incentive stock options. Employees (including officers),
directors of the Company or any affiliates and consultants are eligible to
receive grants of non-qualified options. Incentive stock options granted under
the Stock Option Plan are intended to be "Incentive Stock Options" as defined by
Section 422 of the Internal Revenue Code of 1986, as amended.
The Stock Option Plan has been administered by the Board of Directors and
following the consummation of this offering will be administered by the
Compensation Committee of the Board of Directors of the Company. The
Compensation Committee of the Board of Directors will consist of members who
have been determined by the Board of Directors to be "disinterested persons"
within the meaning of Rule 16b-3(c)(2)(i) promulgated under the Exchange Act or
any future corresponding rule.
The Compensation Committee will determine who shall receive Options, the
number of shares of Common Stock that may be purchased under the Options, the
time and manner of exercise of Options and exercise prices. The term of Options
granted under the Stock Option Plan may not exceed 10 years (five years in the
case of an incentive stock option granted to an optionee owning more than 10% of
the voting stock of the Company) (a "10% Holder"). The exercise price for
incentive stock options shall not be less than 100% of the "fair market value"
of the shares of Common Stock at the time the Option is granted; provided,
however, that with respect to an incentive stock option, in the case of a 10%
Holder, the purchase price per share shall be at least 110% of such fair market
value. The exercise price for non-qualified options is set by the Compensation
Committee in its discretion. The aggregate fair market value of the shares of
Common Stock as to which an optionee may exercise incentive stock options may
not exceed $100,000 in any calendar year. Payment for shares purchased upon
exercise of Options is to be made in cash, check or other instrument, and at the
discretion of the Committee, may be made by delivery of other shares of Common
Stock of the Company. If any Option granted under the Plan expires or terminates
for any reason without having been exercised in full, then the unpurchased
shares subject to the Option will once again be available for additional Option
grants.
Under certain circumstances involving a change in the number of
outstanding shares of Common Stock including a stock split, consolidation,
merger or payment of stock dividend, the class and aggregate number of shares of
Common Stock in respect of which Options may be granted under the Stock Option
Plan, the class and number of shares subject to each outstanding Option and the
exercise price per share will be proportionately adjusted.
57
An aggregate of 750,000 shares of Common Stock has been reserved for
issuance upon exercise of the Options to be granted under the Stock Option Plan.
As of the date of this Prospectus, the Company has granted Options to purchase
423,908 shares of Common Stock under the Plan, of which Options to purchase
58,976, 58,500, 62,080, 62,500 and 20,000 shares of Common Stock have been
granted to Messrs. Olsen, Fish, Mearsheimer, Donohue, and Ranum, respectively.
The Options granted to Messrs. Olsen and Fish are exercisable at a price of
$5.60 per share, the Options granted to Mr. Mearsheimer are exercisable at
prices ranging from $4.83 to $6.44 per share, and the Options granted to Messrs.
Donohue and Ranum are exercisable at a price of $7.20 per share.
401(k) Plan
The Company maintains the Network-1 Savings and Investment Plan, a defined
contribution pension plan with a cash or deferred arrangement as described in
Section 401(k) of the Internal Revenue Code of 1986, as amended (the "401(k)
Plan"). The 401(k) Plan is intended to qualify under Section 401(a) of the Code,
so that contributions, and income earned thereon, are not taxable to employees
until withdrawn. All regular full-time Company employees over the age of 21 are
eligible to participate in the 401(k) Plan. The 401(k) Plan provides that each
participant may make elective pre-tax salary deferrals up to 15% of his or her
annual compensation, subject to statutory limits. The Company also may make
discretionary annual matching contributions in amounts determined by the
Compensation Committee of the Board of Directors, subject to statutory limits.
The Company's policy is to base its contributions on Company profitability. The
Trustee of the 401(k) Plan invests each employee's account at the direction of
the employee, who may choose among several investment alternatives, which do not
include shares of the Company's Common Stock. The Company did not make any
contributions to the 401(k) Plan during 1997.
Limitation on Liability and Indemnification Matters
The Company's Certificate of Incorporation limits the liability of
directors to the maximum extent permitted by Delaware law. Delaware law provides
that directors of a corporation will not be personally liable for monetary
damages for breach of their fiduciary duties as directors, except for liability
(i) for any breach of their duty of loyalty to the corporation or its
stockholders, (ii) for acts or omissions not in good faith or that involve
intentional misconduct or a knowing violation of law, (iii) for unlawful
payments of dividends or unlawful stock repurchases or redemptions as provided
in Section 174 of the Delaware General Corporation Law or (iv) for any
transaction from which the director derived an improper personal benefit.
The Company's Bylaws provide that the Company'shall indemnify its
directors, officers, employees and agents to the fullest extent permitted by
law. The Company's Bylaws also permit the Company to secure insurance on behalf
of any officer, director, employee or other agent for any liability arising out
of his or her actions in such capacity, regardless of whether the Bylaws would
permit indemnification. The Company currently maintains liability insurance for
its officers and directors.
At present, there is no pending material litigation or proceeding involving
any director, officer, employee or agent of the Company where indemnification
will be required or permitted. The Company is not aware of any threatened
litigation or proceeding that might result in a material claim for such
indemnification.
58
PRINCIPAL STOCKHOLDERS
The following table sets forth certain information, as of the date of this
Prospectus (after giving effect to the Pro Forma Adjustments and the CommHome
Acquisition) and as adjusted to reflect the sale by the Company of 1,875,000
shares of Common Stock offered hereby, relating to the beneficial ownership of
shares of Common Stock by: (i) each person or entity who is known by the Company
to own beneficially five percent or more of the outstanding shares of Common
Stock; (ii) each director or person who has agreed to become a director of the
Company; (iii) by the Named Executive Officers; and (iv) by all directors and
executive officers of the Company as a group.
Number of
Shares of Percent of Shares Beneficially Owned (1)
Name and Address Beneficially
of Beneficial Owner Owned
- --------------------------------------------- ---------------- -------------------------------------------------
Before Offering After Offering
------------------------ ------------------------
Corey M. Horowitz (2)........................ 897,982 32.6% 19.4%
CMH Capital Management Corp.
Pisces Investors, L.P.
Security Partners, L.P.
Applewood Associates, L.P. (3)............... 571,963 21.7 12.7
Robert Russo................................. 298,319 11.3 6.6
William Hancock ............................. 235,057 8.9 5.2
Barry Rubenstein (4)......................... 145,112 5.4 3.2
Avi A. Fogel (5)............................. 125,054 4.6 2.7
Peter Mearsheimer (6)........................ 62,080 2.3 1.4
Robert P. Olsen (7).......................... 26,252 1.0 *
Joseph A. Donohue (8) ....................... 21,250 * *
Murray P. Fish (9)........................... 19,890 * *
Marcus Ranum (10)............................ 5,000 * *
All directors and executive 1,690,884 56.6 34.8%
officers as group (9 persons)..............
- -------------------
* Less than 1%.
(1) Unless otherwise indicated, the Company believes that all persons named in
the table have sole voting and investment power with respect to all shares
of Common Stock beneficially owned by them. A person is deemed to be the
beneficial owner of securities that can be acquired by such person within
60 days from the date of this Prospectus upon the exercise of options,
warrants or convertible securities. Each beneficial owner's percentage
ownership is determined by assuming that options, warrants or convertible
securities that are held by such person (but not those held by any other
person) and which are exercisable within 60 days of the date of this
Prospectus have been exercised and converted. Assumes a base of 2,633,369
shares of Common Stock outstanding prior to this offering and a base of
4,508,369 shares of Common Stock outstanding immediately after this
offering, before any consideration is given to outstanding options,
warrants or convertible securities.
59
(2) Includes (i) 374,906 shares of Common Stock held by Mr. Horowitz, (ii)
206,933 shares of Common Stock issuable upon conversion of Series
Convertible B Preferred Stock held by Pisces Investors, L.P., a limited
partnership whose general partner is CMH Capital Management Corp. ("CMH"),
a corporation whose sole stockholder and officer is Mr. Horowitz, (iii)
145,887 shares of Common Stock (including 62,080 shares of Common Stock
issuable upon conversion of Series B Convertible Preferred Stock) owned by
Security Partners, L.P. CMH is a general and a limited partner of Security
Partners, L.P., (iv) 45,320 shares of Common Stock held by CMH; and (v)
124,936 shares of Common Stock subject to currently exercisable warrants
held by CMH. Mr. Horowitz disclaims beneficial ownership of the shares held
by Pisces Investors, L.P. and Security Partners, L.P. except to the extent
of his equity interest therein. The address of CMH Capital Management Corp.
is 909 Third Avenue, New York, New York 10022 and the address of Pisces
Investors, L.P. and Security Partners, L.P. is c/o CMH Capital Management
Corp., 909 Third Avenue, New York, New York 10022.
(3) Does not include (i) 31,040, 23,280, 31,040, 4,656 and 3,104 shares of
Common Stock held by Barry Rubenstein, Irwin Lieber, Barry Fingerhut, Seth
Lieber and Jonathan Lieber, respectively, each of which is a general
partner of Applewood Associates L.P., (ii) an aggregate of 99,328 shares of
Common Stock subject to currently exercisable warrants held by Barry
Rubenstein (49,664 shares) and Irwin Lieber (49,664 shares). Each of
Messrs. Rubenstein, I. Lieber, Fingerhut, S. Lieber and J. Lieber disclaim
beneficial ownership of the shares held by Applewood Associates, L.P.,
except to the extent of their equity interest therein. Applewood
Associates, L.P.'s business address is 80 Cuttermill Road, Great Neck, New
York 11021.
(4) Includes (i) 49,664 shares of Common Stock subject to currently exercisable
warrants owned by Mr. Rubenstein, (ii) 41,128 and 23,280 shares of Common
Stock held by Woodland Venture Fund and Seneca Ventures, respectively.
Barry Rubenstein and Woodland Services Corp. are the general partners of
Woodland Venture Fund and Seneca Ventures. Barry Rubenstein is also
President and sole director of Woodland Services Corp. Does not include
571,963 shares held by Applewood Associates, L.P., of which Mr. Rubenstein
is a general partner. Mr. Rubenstein disclaims beneficial ownership of the
shares of Common Stock held by Applewood Associates, L.P., except the
extent of his equity interest therein. The address of Woodland Venture Fund
and Seneca Ventures is c/o Barry Rubenstein, 68 Wheatley Road, Brookville,
New York 11545.
(5) Includes (i) 100,259 shares of Common Stock subject to currently
exercisable stock options, (ii) 17,920 shares of Common Stock to be issued
to Mr. Fogel in connection with the CommHome Acquisition and (iii) 6,875
shares of Common Stock to be issued to Mr. Fogel in satisfaction of
indebtedness owed to Mr. Fogel by CommHome. Does not include 194,620 shares
subject to stock options which are not currently exercisable.
(6) Includes an aggregate of 62,080 shares of Common Stock subject to currently
exercisable stock options issued to Mr. Mearsheimer pursuant to the Stock
Option Plan.
(7) Includes (i) 20,052 shares of Common Stock subject to currently exercisable
stock options issued to Mr. Olsen pursuant to the Stock Option Plan, (ii)
6,200 shares of Common Stock to be issued to Mr. Olsen in satisfaction of
indebtedness owed to Mr. Olsen by CommHome. Does not include 38,924 shares
of Common Stock subject to stock options which are not currently
exercisable.
60
(8) Includes 21,250 shares of Common Stock subject to stock options issued to
Mr. Donohue pursuant to the Stock Option Plan. Does not include 41,250
shares of Common Stock subject to stock options which are not currently
exercisable.
(9) Includes 19,890 shares of Common Stock subject to stock options issued to
Mr. Fish pursuant to the Stock Option Plan. Does not include 38,610 shares
of Common Stock subject to stock options which are not currently
exercisable.
(10) Includes 5,000 shares of Common Stock subject to stock options issued to
Mr. Ranum pursuant to the Stock Option Plan. Does not include 15,000 shares
of Common Stock subject to stock options which are not currently
exercisable.
61
CERTAIN TRANSACTIONS
In February and April 1997, the Company issued an aggregate principal
amount of $1,000,000 of notes bearing interest at the rate of 6% per annum, and
warrants to purchase an aggregate of 139,679 shares of the Company's Common
Stock at an exercise price of $6.44 per share in private financings (the
"February and April 1997 Private Financings"). The principal amount of the notes
issued in connection with the February and April 1997 Private Financings, plus
accrued interest thereon, will be repaid from the proceeds of this offering. In
connection with the February and April 1997 Private Financings, the Company
issued a note in the principal amount of $250,000 and warrants to purchase
34,920 shares of Common Stock to Applewood Associates, L.P. ("Applewood"), a
principal stockholder of the Company, and a note in the principal amount of
$50,000 and warrants to purchase 6,984 shares of Common Stock to Herb Karlitz.
Barry Rubenstein, a principal stockholder of the Company, is a general partner
of Applewood. Herb Karlitz is the brother-in-law of Corey M. Horowitz, Chairman
of the Board of Directors and a principal stockholder of the Company. In
connection with the February and April 1997 Private Financings, Robert Russo,
Vice President of Business Development and Secretary of the Company, delivered
to the Company for cancellation 39,110 shares of Common Stock in consideration
of $630, and William H. Hancock, Chief Technology Officer and a director of the
Company, delivered to the Company for cancellation 54,009 shares of Common Stock
in consideration of $870.
On August 30, 1996 the Company entered into an agreement (the "CMH Advisory
Agreement"), as amended, with CMH Capital Management Corp. ("CMH"), a
corporation wholly-owned by Corey M. Horowitz, Chairman of the Board of
Directors and a principal stockholder of the Company, pursuant to which CMH
agreed to render advisory services to the Company in consideration of fees of
$12,500 per month for a period of two years and the issuance of warrants to
purchase 31,040 shares of the Company's Common Stock at an exercise price of
$8.05 per share and 31,040 shares of the Company's Common Stock at an exercise
price of $6.44 per share (collectively, the "CMH Advisory Warrants"). In
addition, the Company agreed that in the event it completes a merger or sale of
substantially all of its assets prior to January 15, 1999, CMH would be entitled
to a cash fee equal to 2% of the value of the total consideration received in
connection with such transaction. CMH agreed that the monthly fee of $12,500
would accrue until the Company completed a financing of a minimum of $5,000,000.
On May 14, 1998, CMH agreed with the Company to convert accrued fees of $200,000
into 31,250 shares of Common Stock of the Company in full satisfaction of
Company's fee obligation to CMH under the CMH Advisory Agreement.
On August 8, 1997, CMH loaned the Company $100,000 at an interest rate of
8% per annum. As further consideration for such loan, the Company agreed to
reduce the exercise price of all of the CMH Advisory Warrants to $3.22 per
share. In addition, the Company agreed to reduce the exercise price of warrants
to purchase 124,159 shares of Common Stock at an exercise price of $3.22 per
share previously issued to Corey M. Horowitz on November 29, 1995 to $1.61 per
share.
On September 26, 1997, the Company issued to Applewood and CMH, principal
stockholders of the Company, notes in the principal amounts of $350,000 and
$50,000, respectively, bearing interest at the rate of 8% per annum, which,
together with accrued and unpaid interest thereon, will be repaid from the
proceeds of this offering and warrants to purchase 62,080 and 8,869 shares of
Common Stock, respectively (the "September 1997 Private Financing"). In
connection with the September 1997 Private Financing, Robert Russo, Vice
President of Business Development and Secretary of the Company, William Hancock,
Chief Technology Officer and a director of the
62
Company, and Kenneth Conquest, then Vice President of Engineering of the
Company, delivered to the Company for cancellation 112,373, 86,112 and 10,103
shares of Common Stock, respectively, for an aggregate consideration of $3,360.
On November 21, 1997, CMH loaned the Company $50,000 at an interest rate of
8% per annum pending the Company's receipt of a certain accounts receivable. As
additional consideration for the loan, the Company agreed to further reduce the
exercise price of the CMH Advisory Warrants to $1.61 per share from $3.22 per
share. The aforementioned loan was repaid in full by the Company on December 12,
1997.
From March 2, 1998 through May 14, 1998, the Company issued an aggregate
principal amount of $1,750,000 of notes, bearing interest at the rate of 8% per
annum, and warrants to purchase up to 325,919 shares of Common Stock at an
exercise price of $4.83 per share (the "1998 Private Financing"). In connection
with the 1998 Private Financing, Applewood purchased a $1,300,000 principal
amount note and warrants to purchase 242,111 shares of Common Stock, CMH
purchased a $50,000 note and warrants to purchase 9,312 shares of Common Stock,
Mr. Horowitz purchased a $50,000 principal amount note and warrants to purchase
9,312 shares of Common Stock and Herb Karlitz purchased a $25,000 principal
amount note and warrants to purchase 4,656 shares of Common Stock, at purchase
prices of $1,900,000, $50,000, $50,000, and $25,000, respectively. In
connection with the 1998 Private Financing, Messrs. Russo and Hancock delivered
to the Company for cancellation 38,800 and 23,280 shares of Common Stock,
respectively, for an aggregate consideration of $1,000.
As part of the 1998 Private Financing, in consideration of Applewood's
investment of $1,000,000 in May 1998, the Company, CMH and Applewood entered
into an advisory agreement, which amended the CMH Advisory Agreement, pursuant
to which the Company agreed to increase the cash fee payable to CMH, if the
Company completes a merger or sale of all or substantially all its assets at any
time up to January 15, 2001, from 2% to 3% of the value of the total
consideration received by the Company, and CMH agreed to share such
consideration with Applewood. As further consideration for Applewood's
$1,000,000 investment in May 1998, each of CMH, Mr. Horowitz, Security Partners,
L.P., Messrs. Russo, Hancock and Conquest agreed that for a period of 24 months
from the consummation of this offering, they would not sell in the public market
any securities of the Company owned by them without the consent of Applewood,
unless 60% of the securities owned by Applewood and affiliated parties have been
sold.
On July 8, 1998, the Company entered into an exchange agreement with
certain holders of outstanding warrants and options to which the Company issued
an aggregate of 596,741 shares of its Common Stock in exchange for cancellation
of outstanding warrants and options to purchase 789,521 shares of the Company's
Common Stock. Pursuant to such agreement, Applewood exchanged warrants to
purchase 339,111 shares of Common Stock, at exercise prices of $4.83 and $6.44
per share, for 261,565 shares of Common Stock, Mr. Horowitz and CMH, exchanged
warrants to purchase an aggregate of 151,652 shares of Common Stock, at exercise
prices ranging from $1.61 to $4.83, for 131,267 shares of Common Stock and Herb
Karlitz exchanged warrants to purchase 11,640 shares of Common Stock, at
exercise prices of $4.83 and $6.44 per share, for 8,572 shares of Common Stock.
63
Prior to the consummation of this offering, the Company will enter into a
merger agreement with CommHome Systems Corp. ("CommHome"), effective upon
consummation of this offering, pursuant to which the CommHome stockholders have
agreed to exchange all of the outstanding common stock of CommHome for 35,000
shares of Common Stock of the Company. The Company will assume liabilities of
CommHome on the effective date of the merger not in excess of $200,000, which
include $55,000 and $50,000 owed to Avi A. Fogel and Robert P. Olsen,
respectively. Messrs. Fogel and Olsen have agreed to accept 6,875 and 6,200
shares, respectively, of the Company's Common Stock in full satisfaction of such
indebtedness. Avi A. Fogel, President, Chief Executive Officer and a director of
the Company, is also President and Chief Executive Officer of CommHome and owns
51% of the outstanding shares of CommHome.
DESCRIPTION OF SECURITIES
The authorized capital stock of the Company consists of 25,000,000 shares
of Common Stock, par value $0.01 per share, and 5,000,000 shares of Preferred
Stock, par value $.01 per share. As of the date of this Prospectus (after giving
effect to the Pro Forma Adjustments and the Additional Adjustments), Company has
outstanding 2,633,369 shares of Common Stock, held of record by 79 stockholders.
Upon consummation of this offering, there will be 4,508,369 shares of Common
Stock and no shares of Preferred Stock outstanding.
Common Stock
Holders of Common Stock are entitled to one vote per share on all matters
submitted to a vote of stockholders. There are no cumulative voting rights for
the election of directors, which means that the holders of more than 50% of such
outstanding shares voting for the election of directors can elect all of the
directors of the Company'standing for election. Subject to the rights of any
outstanding class or series of Preferred Stock created by the authority of the
Board of Directors, holders of Common Stock are entitled to received dividends
as and when declared by the Board of Directors out of funds legally available
therefor. Subject to the rights of any outstanding class or series of Preferred
Stock created by the authority of the Board of Directors, in the event of the
liquidation, dissolution or winding up of the Company, the holder of each share
of Common Stock is entitled to share equally in the balance of any of the
Company's assets available for distribution to stockholders. Outstanding shares
of Common Stock do not have subscription or conversion rights and there are no
redemption or sinking fund provisions applicable thereto. Holders of Common
Stock have no preemptive rights to purchase pro-rata portions of new issues of
Common Stock or Preferred Stock of the Company. The outstanding shares of Common
Stock are, and the shares of Common Stock offered by the Company hereby will be,
when issued and sold hereunder, fully paid and non-assessable.
Preferred Stock
Upon the consummation of this Offering, all 500,000 shares of Series B
Preferred Stock outstanding will be converted into 310,399 shares of Common
Stock (See Note F(1) to Notes to Financial Statements for a description of the
Series B Convertible Preferred Stock). The Board is authorized, subject to any
limitations prescribed by Delaware law, to provide for the issuance of
additional shares of Preferred Stock in one or more series, to establish from
time to time the number
64
of shares to be included in each such series, to fix the rights, preferences and
privileges of the shares of each wholly unissued series and any qualifications,
limitations or restrictions thereon, and to increase or decrease the number of
shares of any such series (but not below the number of shares of such series
then outstanding), without any further vote or action by the stockholders. The
Board may authorize the issuance of Preferred Stock with voting or conversion
rights that could adversely affect the voting power or other rights of the
holders of Common Stock. Thus, the issuance of Preferred Stock may have the
effect of delaying, deferring or preventing a change in control of the Company.
The Company has no current plan to issue any shares of Preferred Stock.
Warrants and Options
As of the date of this Prospectus, the Company has outstanding warrants
to purchase 336,007 shares of Common Stock (excluding the Underwriter's Warrants
to purchase 187,500 shares of Common Stock) and options to purchase 294,879
shares of Common Stock (excluding options to purchase 423,908 shares of Common
Stock issued pursuant to the Company's Stock Option Plan). All outstanding
warrants are currently exercisable and outstanding options are currently
exercisable to purchase 100,259 shares of Common Stock. The outstanding warrants
are exercisable at prices ranging from $1.61 to $9.66 and expire between
February 2002, and May 2008. The outstanding options are exercisable at $2.42
per share and expire May 2003.
The warrants also entitle the holder to certain registration rights
with respect to the shares of Common Stock issuable upon exercise of such
warrants. No warrantholder has any stockholder rights with respect to the shares
issuable upon exercise of warrants held by such holder until such warrants are
exercised and the purchase price is paid for the shares. Each of the warrants
and options also provides, among other things, for the adjustment of the price
per share and number of shares issuable upon exercise of such warrants and
options upon a merger or consolidation of the Company, reclassification of the
Company's securities, a stock split, subdivision or combination of the Company's
securities, the payment of a dividend in Common Stock of the Company or of
certain other dividends or distributions with respect to the Common Stock of the
Company.
Registration Rights of Certain Holders
The holders of 1,040,612 shares of Common Stock (including warrants
exercisable to purchase 62,856 shares of Common Stock) have been granted certain
demand registration rights, including the right to request on up to two
occasions that the Company file a registration statement with respect to such
shares under the Securities Act and use its best efforts to effect any such
registration. In addition, the holders of 1,453,442 shares of Common Stock
(including warrants exercisable to purchase 336,007 shares) are entitled to
piggyback registration rights with respect to such shares. If the Company
proposes to register any of its securities, either for its own account or for
the account of other stockholders, the Company is required to notify these
holders and, subject to certain conditions and limitations, to include in such
registration all of the shares of Common Stock requested to be included by such
holders. All holders of registration rights have agreed to waive such rights in
connection with this offering and not to exercise any such rights for one year
from the date of this Prospectus, without the Underwriter's prior written
consent.
65
In connection with this offering, the Company has agreed to grant the
Underwriter certain demand and piggyback registration rights with respect to the
shares of Common Stock issuable upon exercise of the Underwriter's Warrants. See
"Underwriting."
Delaware Anti-Takeover Law
The Company is subject to the provisions of Section 203 of the Delaware
General Corporation Law (the "Anti-Takeover Law") regulating corporate
takeovers. The Anti-Takeover Law prevents certain Delaware corporations,
including those whose securities are listed on the Nasdaq SmallCap Market from
engaging, under certain circumstances, in a "business combination" (which
includes a merger or sale of more than 10% of the corporation's assets) with any
"interested stockholder" (a stockholder who owns 15% or more of the
corporation's outstanding voting stock) for three years following the date that
such stockholder became an "interested stockholder" unless the business
combination is approved in a prescribed manner. A Delaware corporation may "opt
out" of the Anti-Takeover Law with an express provision in its original or
amended certificate of incorporation or an express provision in its Bylaws
resulting from a stockholders' amendment approved by at least a majority of the
outstanding voting shares. The Company has not "opted out" of the provisions of
the Anti-Takeover Law.
Transfer Agent
The Transfer Agent for the Company's Common Stock is American Stock
Transfer and Trust Company, 40 Wall Street, New York, New York 10005.
SHARES ELIGIBLE FOR FUTURE SALE
Upon the consummation of this offering, the Company will have 4,508,369
shares of Common Stock outstanding, of which the 1,875,000 shares being offered
hereby will be freely tradeable without restriction or further registration
under the Securities Act, except for any shares purchased by an "affiliate of
the Company" (in general, a person who has a controlling position with regard to
the Company), which will be subject to the resale limitations of Rule 144
promulgated under the Securities Act.
All of the remaining 2,633,369 shares of Common Stock currently outstanding
are "restricted securities" or owned by "affiliates" (as those terms are defined
in Rule 144) and thus may not be sold publicly unless they are registered under
the Securities Act or are sold pursuant to Rule 144 or another exemption from
registration. Of the 2,633,369 restricted shares, an aggregate of 1,977,124
shares will be eligible for sale, without registration, under Rule 144 (subject
to certain volume limitations prescribed by such rule and to the contractual
restrictions described below), commencing 90 days following the date of this
Prospectus and the balance of such shares will become eligible for sale at
various times commencing February 1999. Holders of all of the 2,633,369
outstanding shares of Common Stock have agreed not to (i) sell or otherwise
dispose of any shares of Common Stock or (ii) exercise any rights held by such
holders to cause the Company to register any shares of Common Stock for sale
pursuant to the Securities Act, in each case, for a period of 12 months
following the date of this Prospectus, without the Underwriter's prior written
consent.
66
In general, under Rule 144 as currently in effect, beginning 90 days after
the date of this Prospectus, a person (or persons whose shares are aggregated)
who has beneficially owned restricted securities for at least one year
(including the holding period of any prior owner except an affiliate of the
Company) would be entitled to sell within any three-month period a number of
shares that does not exceed the greater of: (i) 1% of the number of shares of
Common Stock then outstanding (which will equal approximately 45,083 shares
immediately following the consummation of this offering); or (ii) the average
weekly trading volume of the Common Stock during the four calendar weeks
preceding the filing of a Form 144 with respect to such sale. Sales under Rule
144 are also subject to certain manner of sale provisions, notice requirements
and the availability of current public information about the Company. Under Rule
144(k), a person who is not deemed to have been an affiliate of the Company at
any time during the 90 days preceding a sale, and who has beneficially owned the
shares proposed to be sold for at least two years (including the holding period
of any prior owner except an affiliate of the Company), is entitled to sell such
shares without complying with the manner of sale, public information, volume
limitation or notice provisions of Rule 144. Unless otherwise restricted,
"144(k) shares" may therefore be sold immediately upon the consummation of this
offering.
Rule 701 permits resales of shares in reliance upon Rule 144 but without
compliance with certain restrictions, including the holding period requirement,
of Rule 144. Any employee, officer or director of or consultant to the Company
who purchased his or her shares pursuant to a written compensatory plan or
contract may be entitled to rely on the resale provisions of Rule 701. Rule 701
permits affiliates to sell their Rule 701 shares under Rule 144 without
complying with the holding period requirements of Rule 144. Rule 701 further
provides that non-affiliates may sell such shares in reliance on Rule 144
without having to comply with the holding period, public information, volume
limitation or notice provisions of Rule 144. In both cases, a holder of Rule 701
shares is required to wait until 90 days after the date of this Prospectus
before selling such shares.
Prior to this offering, there has been no market for the Common Stock and
no prediction can be made as to the effect, if any, that market sales of shares
of Common Stock or the availability of such shares for sale will have on the
market prices of the Common Stock prevailing from time to time. Nevertheless,
the possibility that substantial amounts of Common Stock may be sold in the
public market may adversely affect prevailing market prices for the Common Stock
and could impair the Company's ability to raise capital through the sale of its
equity securities.
UNDERWRITING
Whale Securities Co., L.P. (the "Underwriter") has agreed, subject to the
terms and conditions contained in the Underwriting Agreement, to purchase the
1,875,000 shares of Common Stock offered hereby from the Company. The
Underwriter is committed to purchase and pay for all of the shares of Common
Stock offered hereby if any of such securities are purchased. The shares of
Common Stock are being offered by the Underwriter, subject to prior sale, when,
as and if delivered to and accepted by the Underwriter and subject to certain
legal matters by counsel and to certain other conditions.
67
The Underwriter has advised the Company that it proposes to offer the
shares of Common Stock to the public at the public offering price set forth on
the cover page of this Prospectus. The Underwriter may allow certain dealers who
are member of the National Association of Securities Dealers, Inc. (the "NASD")
concessions, not in excess of $ per share, of which not in excess of $ per share
may be reallowed to other dealers who are members of the NASD.
The Company has granted to Underwriter an option, exercisable for 45 days
following the date of this Prospectus, to purchase up to 281,250 shares at the
public offering price set forth on the cover page of this Prospectus, less
underwriting discounts and commissions. The Underwriter may exercise this option
in whole or, from time to time, in part, solely for the purpose of covering
over-allotments, if any, made in connection with the sale of the shares offered
hereby.
The Company has agreed to pay to the Underwriter a non-accountable expense
allowance equal to 3% of the gross proceeds derived from the sale of the shares
offered hereby, including any securities sold prior to the Underwriter's
over-allotment option, $50,000 of which has been paid as of the date of this
Prospectus. The Company has also agreed to pay all expenses in connection with
qualifying the shares offered under the laws of such states as the Underwriter
may designate, including expenses of counsel retained for such purpose by the
Underwriter.
The Company has agreed to sell to the Underwriter and its designees, for an
aggregate of $100 (the "Underwriter's Warrants") to purchase up to 187,500
shares of Common stock at an exercise price of $13.20 per share (165% of the
public offering price per share). The Underwriter's Warrants may not be assigned
or hypothecated for one year following the date of this Prospectus, except to
the officers and partners of the Underwriter and members of the selling group,
and are exercisable at any time, in whole or in part, during the four-year
period commencing one year from the date of this Prospectus (the "Warrant
Exercise Term"). During the Warrant Exercise Term, the holders of the
Underwriter's Warrants are given, at nominal cost, the opportunity to profit
from a rise in the market price of the Common Stock. To the extent that the
Warrants are exercised, dilution to the interests of the Company's stockholders
will occur. Further, the terms upon which the Company will be able to obtain
additional equity capital may be adversely affected, since the holders of the
Underwriter's Warrants can be expected to exercise them at a time when the
Company would, in all likelihood, be able to obtain any needed capital on terms
more favorable to the Company than in the Underwriter's Warrants. Any profit
realized by the Underwriter on the sale of the Underwriter's Warrants, the
underlying shares of Common Stock or the underlying warrants may be deemed
additional underwriting compensation. The Underwriter's Warrants contain a
cashless exercise provision. Subject to certain limitations and exclusions, the
Company has agreed that, upon the request of the holders of the majority of the
Underwriter's Warrants, the Company will (at its own expense), on one occasion
during the Warrant Exercise term, register the Underwriter's Warrants and the
securities underlying the Underwriter's Warrants under the Securities Act and
that it will include the Underwriter's Warrants and all such underlying
securities in any appropriate registration statement which is filed by the
Company under the Securities Act during the seven years following the date of
this Prospectus.
The Company has agreed, for a period of five years from the date of
this Prospectus, if so requested by the Underwriter, to recommend and use its
best efforts to elect a designee of the Underwriter as a director of the
Company. The Company's officers, directors and principal
68
stockholders have agreed to vote their shares of Common Stock in favor of such
designee. The Underwriter has not yet exercised its right to designate such a
person.
All of the Company's officers, directors and securityholders have agreed
not to sell or otherwise dispose any of their securities in the public markets
for a period of twelve months from the date of this Prospectus without the
Underwriter's prior written consent.
The Underwriter has informed the Company that it does not expect sales of
the securities offered discretionary accounts to exceed 1% of the shares offered
hereby.
The Company has agreed to indemnify the Underwriter against certain civil
liabilities, including liabilities under the Securities Act.
Prior to this offering there has been no public market for the Common
Stock. Accordingly, the initial public offering price of the Common Stock will
be determined by negotiation between the Company and the Underwriter and may not
necessarily be related to the Company's asset value, net worth or other
established criteria of value. Factors to be considered in determining such
price include the Company's financial condition and prospects, an assessment of
the Company's management, market prices of similar securities of comparable
publicly-traded companies, certain financial and operating information of
companies engaged in activities similar to those of the Company and the general
condition of the securities market.
In order to facilitate the offering, the Underwriter may engage in
transactions that stabilize, maintain, otherwise affect the price of the Common
Stock. Specifically, the Underwriter may over-allotment in connection with the
offering, creating a short position in the Common Stock for its own account. In
addition, to cover over-allotments or to stabilize the price of the Common
Stock, the Underwriter may bid for, and purchase, shares of Common Stock in the
open market. The Underwriter may also reclaim selling concessions allowed to a
dealer for distributing the Common Stock in the offering, if the Underwriter
repurchases previously distributed Common Stock in transactions to cover short
positions, in stabilization transactions or otherwise. Any of these activities
may stabilize or maintain the market price of the Common Stock above independent
market levels. The Underwriter is not required to engage in these activities,
and may end any of these activities at any time.
LEGAL MATTERS
The validity of the Common Stock offered hereby will be passed upon for the
Company by Bizar Martin & Taub, LLP. Certain legal matters in connection with
this offering will be passed upon for the Underwriter by Tenzer Greenblatt LLP.
Bizar Martin & Taub, LLP owns currently exercisable warrants to purchase 9,312
shares of the Company's Common Stock at an exercise price of $6.44 per share.
69
EXPERTS
The financial statements of the Company as of December 31, 1997 and 1996
and for each of the years then ended appearing in this Prospectus and
Registration Statement have been audited by Richard A. Eisner & Company, LLP,
independent auditors, as set forth in their report thereon (which contains an
explanatory paragraph with respect to the Company's ability to continue as a
going concern) appearing elsewhere herein, and are included in reliance upon
such report given upon the authority of said firm as experts in accounting and
auditing.
ADDITIONAL INFORMATION
The Company has filed with the Securities and Exchange Commission (the
"Commission") a Registration Statement on Form SB-2 under the Securities Act
with respect to the Common Stock offered hereby. This Prospectus, which
constitutes a part of the Registration Statement, does not contain all of the
information set forth in the Registration Statement and the exhibits and
schedules thereto. For further information with respect to the Company and the
Common Stock offered hereby, reference is hereby made to the Registration
Statement and the exhibits and schedules filed as a part thereof. Statements
contained in this Prospectus as to the contents of any contract or any other
document referred to are not necessarily complete. In each instance, reference
is made to the copy of such contract or document filed as an exhibit to the
Registration Statement, and each such statement is qualified in all respects by
such reference. The Registration Statement, including exhibits and schedules
thereto, may be inspected and copied at the principal office of the Commission
at Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549 and at the
Commission's regional offices located at Seven World Trade Center, Suite 1300,
New York, New York 10048 and Citicorp Center, 500 West Madison Street, Suite
1400, Chicago, Illinois 60661. Copies of such materials may also be obtained at
prescribed rates from the Public Reference Section of the Commission, at 450
Fifth Street, N.W., Washington, D.C. 20549. In addition, registration statements
and certain other filings made with the Commission through its Electronic Data
Gathering, Analysis and Retrieval ("EDGAR") systems are publicly available
through the Commission's site on the Internet's World Wide Web, located at
http://www.sec.gov. The Registration Statement, including all exhibits thereto
and amendments thereof, has been filed with the Commission through EDGAR.
Upon consummation of this offering, the Company will become subject to the
reporting requirements of the Securities Exchange Act of 1934 and in accordance
therewith will file reports, proxy statements and other information with the
Commission. The Company intends to furnish its stockholders with annual reports
containing audited financial statements and such other reports as the Company
deems appropriate or as may be required by law.
70
NETWORK-1 SECURITY SOLUTIONS, INC.
Page
Index to Financial Statements
Independent auditors' report F-2
Balance sheets as of December 31, 1996 and 1997 and March 31, 1998 (unaudited) F-3
Statements of operations for the years ended December 31, 1996 and 1997 and
for the three months ended March 31, 1997 and 1998 (unaudited) F-4
Statements of stockholders' equity for the years ended December 31, 1996 and 1997 and
for the three months ended March 31, 1998 (unaudited) F-5
Statements of cash flows for the years ended December 31, 1996 and 1997 and
for the three months ended March 31, 1997 and 1998 (unaudited) F-6
Notes to financial statements F-7
F-1
INDEPENDENT AUDITORS' REPORT
Board of Directors and Stockholders
Network-1 Security Solutions, Inc.
Wellesley, Massachusetts
We have audited the accompanying balance sheets of Network-1 Security Solutions,
Inc. (the "Company") as of December 31, 1996 and 1997 and the related statements
of operations, stockholders' equity and cash flows for each of the years then
ended. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements enumerated above present fairly, in all
material respects, the financial position of Network-1 Security Solutions, Inc.
as of December 31, 1996 and 1997 and the results of its operations and its cash
flows for each of the years then ended in conformity with generally accepted
accounting principles.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note A to the
financial statements, the Company has incurred substantial losses from
operations, and as of December 31, 1997 has a working capital deficiency of
$661,000 and a stockholders' deficiency of $75,000. These factors raise
substantial doubt about the Company's ability to continue as a going concern.
Management's plans in regard to these matters are also described in Note A. The
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.
Richard A. Eisner & Company, LLP
New York, New York
June 17, 1998
With respect to Note J[1]
July 8, 1998
With respect to the third paragraph of Note A
July 17, 1998
F-2
NETWORK-1 SECURITY SOLUTIONS, INC.
Balance Sheets
December 31, March 31,
1996 1997 1998
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 217,000 $ 60,000 $ 67,000
Accounts receivable - net of allowance for doubtful accounts
of $5,000, $70,000 and $60,000, respectively 191,000 435,000 286,000
Prepaid expenses and other current assets 30,000 30,000 30,000
--------------- --------------- ---------------
Total current assets 438,000 525,000 383,000
Equipment and fixtures 518,000 400,000 364,000
Capitalized software costs - net 729,000 1,258,000 1,125,000
Security deposits 193,000 131,000 132,000
Deferred offering costs 90,000 90,000
--------------- --------------- ---------------
$ 1,878,000 $ 2,404,000 $ 2,094,000
--------------- --------------- ---------------
--------------- --------------- ---------------
LIABILITIES
Current liabilities:
Accounts payable $ 275,000 $ 776,000 $ 519,000
Accrued fee - related party 138,000 175,000
Accrued expenses and other current liabilities 155,000 201,000 186,000
Notes payable - related parties, net of discount 856,000
Notes payable - others, net of discount 765,000
Interest payable - related parties 40,000
Interest payable - other 47,000
Current portion of capital lease obligations 24,000 8,000 2,000
Deferred revenue 25,000 63,000 76,000
--------------- --------------- ---------------
Total current liabilities 479,000 1,186,000 2,666,000
Capital lease obligations - less current portion 8,000
Notes payable - related parties, net of discount 564,000
Notes payable - others, net of discount 670,000
Interest payable - related parties 24,000
Interest payable - others 35,000
--------------- --------------- ---------------
487,000 2,479,000 2,666,000
--------------- --------------- ---------------
Commitments and contingencies
STOCKHOLDERS' EQUITY (DEFICIENCY)
Preferred stock - $.01 par value; authorized 5,000,000 shares;
Series A -10% cumulative, none issued and outstanding
Series B - 500,000 shares issued and outstanding 5,000 5,000 5,000
Common stock - $.01 par value; authorized 25,000,000 shares;
2,004,951, 1,706,037 and 1,706,037 shares issued and
outstanding 20,000 17,000 17,000
Additional paid-in capital 6,446,000 7,373,000 7,573,000
Accumulated deficit (5,080,000) (7,470,000) (8,167,000)
--------------- --------------- ---------------
1,391,000 (75,000) (572,000)
--------------- --------------- ---------------
$ 1,878,000 $ 2,404,000 $ 2,094,000
--------------- --------------- ---------------
--------------- --------------- ---------------
See notes to financial statements
F-3
NETWORK-1 SECURITY SOLUTIONS, INC.
Statements of Operations
Year Ended Three Months Ended
December 31, March 31,
1996 1997 1997 1998
(Unaudited)
Revenues:
Licenses $ 624,000 $ 1,632,000 $ 346,000 $ 195,000
Services 403,000 737,000 133,000 144,000
------------- ------------- ------------- -------------
Total revenues 1,027,000 2,369,000 479,000 339,000
------------- ------------- ------------- -------------
Cost of revenues:
Cost of licenses 439,000 497,000 105,000 177,000
Cost of services 298,000 293,000 76,000 75,000
------------- ------------- ------------- -------------
Total cost of revenues 737,000 790,000 181,000 252,000
------------- ------------- ------------- -------------
Gross profit 290,000 1,579,000 298,000 87,000
------------- ------------- ------------- -------------
Operating expenses:
Product development costs 984,000 917,000 97,000 208,000
Selling and marketing 1,614,000 926,000 326,000 140,000
General and administrative 1,931,000 1,573,000 434,000 212,000
------------- ------------- ------------- -------------
Total operating expenses 4,529,000 3,416,000 857,000 560,000
------------- ------------- ------------- -------------
Loss from operations (4,239,000) (1,837,000) (559,000) (473,000)
Interest expense - net (260,000) (553,000) (31,000) (224,000)
------------- ------------- ------------- -------------
Net loss $ (4,499,000) $ (2,390,000) $ (590,000) $ (697,000)
------------- ------------- ------------- -------------
------------- ------------- ------------- -------------
Loss per share - basic and diluted $(2.46) $(1.29) $(.30) $(.41)
------------- ------------- ------------- -------------
------------- ------------- ------------- -------------
Weighted average number of shares
outstanding - basic and diluted 1,825,163 1,855,244 1,942,872 1,706,037
------------- ------------- ------------- -------------
------------- ------------- ------------- -------------
See notes to financial statements
F-4
NETWORK-1 SECURITY SOLUTIONS, INC.
Statements of Stockholders' Equity
Common Stock Preferred Stock
Shares Amount Shares Amount
Balance - December 31, 1995 1,164,133 $ 12,000 750,000 $ 7,000
Issuance of common stock for cash - net 698,397 7,000
Issuance of common stock and warrants for
services rendered 18,262
Conversion of notes payable into common stock 108,639 1,000
Redemption of preferred stock (250,000) (2,000)
Exercise of warrants 15,520
Net loss
------------- ---------- ----------- ---------
Balance - December 31, 1996 2,004,951 20,000 500,000 5,000
Issuance of common stock and warrants for
services rendered 2,794
Warrants issued in connection with debt financing
Repurchase and retirement of common shares (301,708) (3,000)
Net loss
------------- ---------- ----------- ---------
Balance - December 31, 1997 1,706,037 17,000 500,000 5,000
Issuance of warrants for services rendered
Warrants issued in connection with debt financing
Net loss
------------- ---------- ----------- ---------
Balance - March 31, 1998 (Unaudited) 1,706,037 $ 17,000 500,000 $ 5,000
------------- ---------- ----------- ---------
------------- ---------- ----------- ---------
Additional
Paid-in Accumulated
Capital Deficit Total
Balance - December 31, 1995 $ 1,146,000 (581,000) $ 584,000
Issuance of common stock for cash - net 4,141,000 4,148,000
Issuance of common stock and warrants for
services rendered 683,000 683,000
Conversion of notes payable into common stock 699,000 700,000
Redemption of preferred stock (248,000) (250,000)
Exercise of warrants 25,000 25,000
Net loss (4,499,000) (4,499,000)
------------- -------------- -------------
Balance - December 31, 1996 6,446,000 (5,080,000) 1,391,000
Issuance of common stock and warrants for
services rendered 163,000 163,000
Warrants issued in connection with debt financing 766,000 766,000
Repurchase and retirement of common shares (2,000) (5,000)
Net loss (2,390,000) (2,390,000)
------------- -------------- -------------
Balance - December 31, 1997 7,373,000 (7,470,000) (75,000)
Issuance of warrants for services rendered 25,000 25,000
Warrants issued in connection with debt financing 175,000 175,000
Net loss (697,000) (697,000)
------------- -------------- -------------
Balance - March 31, 1998 (Unaudited) $ 7,573,000 $ (8,167,000) $ (572,000)
------------- -------------- -------------
------------- -------------- -------------
See notes to financial statement
F-5
NETWORK-1 SECURITY SOLUTIONS, INC.
Statements of Cash Flows
Three Months Ended
December 31, March 31,
1996 1997 1997 1998
(Unaudited)
Cash flows from operating activities:
Net loss $ (4,499,000) $ (2,390,000) $ (590,000) $ (697,000)
Adjustments to reconcile net loss to net cash used in
operating activities:
Amortization of debt discount 306,000 500,000 28,000 164,000
Issuance of common stock and warrants for
services rendered 683,000 163,000 61,000 25,000
Provision for doubtful accounts (15,000) 65,000 55,000 (10,000)
Depreciation and amortization 368,000 481,000 112,000 171,000
Changes in:
Accounts receivable 131,000 (309,000) (129,000) 159,000
Prepaid expenses and other current assets (15,000)
Accounts payable, accrued expenses and
other current liabilities 196,000 744,000 65,000 (208,000)
Deferred revenue 25,000 38,000 (21,000) 13,000
------------- ------------- ------------- -------------
Net cash used in operating activities (2,820,000) (708,000) (419,000) (383,000)
------------- ------------- ------------- -------------
Cash flows from investing activities:
Acquisitions of equipment and fixtures (235,000) (42,000) (30,000) (3,000)
Capitalized software costs (750,000) (850,000) (283,000)
Security deposit (164,000) 62,000 (1,000) (1,000)
------------- ------------- ------------- -------------
Net cash used in investing activities (1,149,000) (830,000) (314,000) (4,000)
------------- ------------- ------------- -------------
Cash flows from financing activities:
Proceeds from issuance of notes payable and
warrants 700,000 1,550,000 650,000 400,000
Repayment of notes payable (400,000) (50,000)
Proceeds from exercise of options and warrants 25,000
Net proceeds from sale of common stock 4,148,000
Repayment of capital lease obligations (23,000) (24,000) (6,000)
Purchase of treasury shares (5,000)
Repayment of line of credit (62,000)
Repayment of stockholder's loan (48,000)
Redemption of preferred stock (250,000)
Deferred offering costs (90,000)
------------- ------------- ------------- -------------
Net cash provided by financing activities 4,090,000 1,381,000 650,000 394,000
------------- ------------- ------------- -------------
Net increase (decrease) in cash and cash equivalents 121,000 (157,000) (83,000) 7,000
Cash and cash equivalents - beginning of period 96,000 217,000 217,000 60,000
------------- ------------- ------------- -------------
Cash and cash equivalents - end of period $ 217,000 $ 60,000 $ 134,000 $ 67,000
------------- ------------- ------------- -------------
------------- ------------- ------------- -------------
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest $ 32,000 $ 1,000
Noncash transaction:
Issuance of stock in connection with repayment of
debt $ 700,000
F-6
NETWORK-1 SECURITY SOLUTIONS, INC.
Notes to Financial Statements
(unaudited with respect to data as of March 31, 1998 and for
the three-month periods ended March 31, 1997 and 1998)
NOTE A - THE COMPANY AND BASIS OF PRESENTATION
Network-1 Security Solutions, Inc. (the "Company"), formerly known as Network-1
Software & Technology, Inc., develops, markets, licenses and supports its
proprietary network security software products designed to provide comprehensive
security to computer networks. The Company also provides maintenance and network
consulting and training services.
The accompanying financial statements have been prepared on a going concern
basis. As reflected in the accompanying financial statements, the Company has
incurred substantial losses from operations and as of December 31, 1997 has a
working capital deficiency of $661,000 and a stockholders' deficiency of
$75,000. Subsequent to December 31, 1997 through May 14, 1998, the Company
received $1,750,000 in short-term debt financing, a significant portion of which
was from principal stockholders of the Company. However, the Company will
require additional financing to satisfy its obligations and fund its operations
through December 31, 1998. Also, in May 1998, the Company'signed a letter of
intent with an underwriter for the sale of its securities in an initial public
offering (the "Offering"). There is no assurance, however, that the Offering
will be consummated or that the Company will be able to obtain alternative
financing. The above factors give rise to substantial doubt as to the ability of
the Company to continue as a going concern. The financial statements do not
include any adjustments that might result from the outcome of this uncertainty.
On July 17, 1998, the stockholders approved a 1 for 1.610831 reverse split of
the outstanding shares of the Company's common stock. The accompanying financial
statements have been retroactively adjusted to reflect the split and all
references to numbers of common shares, options, warrants and per share amounts
have been restated to give effect to the split.
NOTE B - SIGNIFICANT ACCOUNTING POLICIES
[1] Cash equivalents:
The Company considers all highly liquid short-term investments purchased
with a maturity of three months or less to be cash equivalents.
[2] Revenue recognition:
In October 1997, the AICPA issued Statement of Position ("SOP") No. 97-2,
"Software Revenue Recognition," which the Company adopted, effective
January 1, 1997. Such adoption had no effect on the Company's methods of
recognizing revenue from its license and service activities. Prior to 1997,
the Company's revenue recognition policy was in accordance with SOP No.
91-1, "Software Revenue Recognition."
License revenue is recognized upon delivery of software or delivery of a
required software key. Service revenues consist of maintenance, consulting
and training services. Annual renewable maintenance fees are a separate
component of each contract, and are recognized ratably over the contract
term. Consulting and training revenues are recognized as such services are
performed.
[3] Equipment and fixtures:
Equipment and fixtures are stated at cost and are depreciated using the
straight-line method over their estimated useful lives of five years.
F-7
NETWORK-1 SECURITY SOLUTIONS, INC.
Notes to Financial Statements
(unaudited with respect to data as of March 31, 1998 and for
the three-month periods ended March 31, 1997 and 1998)
NOTE B - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
[4] Software development costs:
Costs to maintain developed programs and development costs incurred to
establish the technological feasibility of computer software are expensed
as incurred. The Company capitalizes costs incurred in producing computer
software after technological feasibility of the software has been
established. Such costs are amortized based on current and estimated future
revenue of each product with an annual minimum equal to the straight-line
amortization over the remaining estimated economic life of the product. The
Company estimates the economic life of its software to be three years. At
each balance sheet date, the unamortized capitalized software costs of each
product are compared with the net realizable value of that product and any
excess capitalized costs are written off.
[5] Income taxes:
The Company utilizes the liability method of accounting for income taxes.
Under such method, deferred tax assets and liabilities are recognized for
the future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and liabilities and
their respective tax bases. Deferred tax assets and liabilities are
measured using enacted tax rates in effect at the balance sheet date. The
resulting asset or liability is adjusted to reflect enacted changes in tax
law.
[6] Loss per share:
During 1997, the Company adopted Statement of Financial Accounting
Standards No. 128, "Earnings Per Share" ("SFAS No. 128"). SFAS No. 128
requires the reporting of basic and diluted earnings/loss per share. Basic
loss per share is calculated by dividing net loss by the weighted average
number of outstanding common shares during the year. Diluted per share data
includes the dilutive effects of options, warrants and convertible
securities. As all potential common shares are anti-dilutive, they are not
included in the calculation of diluted loss per share. Loss per share for
1996 has been presented to conform to SFAS No. 128.
[7] Use of estimates:
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
[8] Financial instruments:
The carrying amounts of accounts receivable, accounts payable, accrued
expenses, capitalized lease obligations and notes payable approximate their
fair value as the interest rates on the Company's indebtedness approximate
current market rates and due to the short period to maturity of these
instruments.
F-8
NETWORK-1 SECURITY SOLUTIONS, INC.
Notes to Financial Statements
(unaudited with respect to data as of March 31, 1998 and for the three-month
periods ended March 31, 1997 and 1998)
NOTE B - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
[9] Stock-based compensation:
In October 1995, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 123 ("SFAS No. 123"), "Accounting for
Stock-Based Compensation". SFAS No. 123 encourages, but does not require,
companies to record compensation cost for stock-based employee compensation
plans at fair value. The Company has elected to continue to account for its
employee stock-based compensation plans using the intrinsic value method
prescribed by Accounting Principles Board Opinion No. 25 ("APB No. 25"),
Accounting for Stock Issued to Employees" and to disclose the pro forma
effect on net loss per share had the fair value of options been expensed.
Under the provisions of APB No. 25, compensation cost for stock options is
measured as the excess, if any, of the estimated market value of the
Company's common stock at the date of the grant over the amount an employee
must pay to acquire the stock.
[10] Interim financial statements:
The accompanying balance sheet as of March 31, 1998, the statement of
changes in stockholders' equity for the three-month period then ended and
the statements of operations and cash flows for the three-month periods
ended March 31, 1997 and 1998 are unaudited. In the opinion of management,
all adjustments (consisting only of normal recurring accruals) considered
necessary for a fair presentation have been included. The results of
operations for the three-month period ended March 31, 1998 are not
necessarily indicative of the results to be expected for the year ended
December 31, 1998.
NOTE C - EQUIPMENT AND FIXTURES
Equipment and fixtures are summarized as follows:
December 31, March 31,
1996 1997 1998
(Unaudited)
Office and computer equipment $ 669,000 $ 661,000 $ 663,000
Furniture and fixtures 59,000 59,000 59,000
Leasehold improvements 46,000 46,000 46,000
------------- ------------- -------------
774,000 766,000 768,000
Less accumulated depreciation (256,000) (366,000) (404,000)
------------- ------------- -------------
$ 518,000 $ 400,000 $ 364,000
------------- ------------- -------------
------------- ------------- -------------
F-9
NETWORK-1 SECURITY SOLUTIONS, INC.
Notes to Financial Statements
(unaudited with respect to data as of March 31, 1998 and for
the three-month periods ended March 31, 1997 and 1998)
NOTE D - CAPITALIZED SOFTWARE COSTS
Three
Months
Year Ended Ended
December 31, March 31,
1996 1997 1998
(Unaudited)
Balance, beginning of period (net of accumulated
amortization) $ 225,000 $ 729,000 $ 1,258,000
Additions 750,000 850,000
Amortization (246,000) (321,000) (133,000)
------------- ------------- -------------
Balance, end of period (net of accumulated
amortization) $ 729,000 $ 1,258,000 $ 1,125,000
------------- ------------- -------------
------------- ------------- -------------
Amortization of capitalized software costs is included in cost of licenses in
the accompanying statements of operations.
NOTE E - NOTES PAYABLE
Notes payable is summarized as follows:
December 31, March 31,
1997 1998
Notes payable on the earlier of a) January 1, 1999 b) the date
upon which the Company receives $6,000,000 net proceeds
of equity or debt financing from one or a series of transactions
c) a sale of all of the Company's assets or d) a merger or
consolidation of the Company:
Notes bearing interest at 6%, including $250,000 payable
to a related party (1) $ 650,000 $ 650,000
Notes bearing interest at 6% (2) 350,000 350,000
Note bearing interest at 8%, payable to a related party (3) 100,000 100,000
Notes bearing interest at 8%, payable to related parties (4) 400,000 400,000
Notes payable to related parties on the earlier of a) March 2, 1999
b) the date upon which the Company receives $6,000,000 net
proceeds of equity or debt financing from one or a series of
transactions c) a sale of all of the Company's assets or
d) a merger or consolidation of the Company; bearing
interest at 8% (5) 400,000
---------------- -------------
1,500,000 1,900,000
Less unamortized debt discount (266,000) (279,000)
---------------- -------------
$ 1,234,000 $ 1,621,000
---------------- -------------
---------------- -------------
F-10
NETWORK-1 SECURITY SOLUTIONS, INC.
Notes to Financial Statements
(unaudited with respect to data as of March 31, 1998 and for
the three-month periods ended March 31, 1997 and 1998)
NOTE E - NOTES PAYABLE (CONTINUED)
(1) In connection with the issuance of the notes, including $250,000 issued to
an entity which is a principal stockholder of the Company, the Company
issued ten-year warrants valued at $290,000 to purchase 90,791 shares of
the Company's common stock at an exercise price of $6.44 per share,
increasing the effective interest rate on the notes to 91%.
(2) In connection with the issuance of the notes, the Company issued ten-year
warrants valued at $159,000 to purchase 48,888 shares of the Company's
common stock at an exercise price of $6.44 per share, increasing the
effective interest rate to 94%.
(3) In connection with the issuance of the note to a corporation wholly owned
by the Chairman of the Board and a principal stockholder of the Company,
the Company agreed to reduce the exercise price of previously issued
warrants to the noteholder from $6.44 per share (31,040 shares) and $8.05
per share (31,040 shares) to $3.22 per share (see Note G[5]). In addition,
the Company agreed to reduce the exercise price of warrants to purchase
124,159 shares of common stock at an exercise price of $3.22 per share
previously issued to the noteholder to $1.61 per share. The Company valued
the modified warrants at $45,000 in excess of the value ascribed to the
original warrants, increasing the effective interest rate to 96%. The
warrants exercisable at $3.22 per share were further reduced to $1.61 per
share in connection with the issuance in November 1997 of a note for
$50,000 to the same corporation referred to above which was repaid in
December 1997. This modification was valued at $22,000 in excess of the
value ascribed to the warrants as previously modified.
(4) In connection with the issuance of the notes to an entity which is a
principal stockholder of the Company and to the corporation referred to in
(3) above, the Company issued ten-year warrants valued at $168,000 to
purchase 70,949 shares of the Company's common stock at an exercise price
of $4.83 per share, increasing the effective interest rate to 86%.
(5) In connection with the issuance of the notes, $350,000 of which are payable
to the entities referred to in (4) above, the Company issued ten-year
warrants valued at $175,000 to purchase 74,496 shares of the Company's
common stock at an exercise price of $4.83 per share, increasing the
effective interest rate to 92%.
The proceeds from the issuance of the notes were allocated to the debt and the
warrants based on their estimated fair values. The Company estimated the fair
value of these warrants using the Black-Scholes pricing model and has accounted
for this amount as a debt discount to be amortized over the life of the debt.
Interest expense for the years ended December 31, 1996, 1997 and for the three
months ended March 31, 1997 and 1998 includes $325,000, $268,000, $10,000 and
$117,000, respectively, of interest and amortization of debt discount on notes
to related parties.
In April and May 1998, the Company borrowed an additional $1,350,000. The notes
bear interest at 8% per annum and are payable on the earlier of a) one year b)
the date upon which the Company receives $6,000,000 net proceeds of equity or
debt financing from one or a series of transactions c) a sale of all of the
Company's assets or d) a merger or consolidation of the Company. In connection
therewith, the Company issued ten-year warrants valued at $591,000 to purchase
251,423 shares of the Company's common stock at an exercise price of $4.83 per
share increasing the effective interest rate to 92%.
F-11
NETWORK-1 SECURITY SOLUTIONS, INC.
Notes to Financial Statements
(unaudited with respect to data as of March 31, 1998 and for
the three-month periods ended March 31, 1997 and 1998)
NOTE F - STOCKHOLDERS' EQUITY
[1] Preferred stock:
The Company has outstanding 500,000 shares of Series B convertible
preferred stock. Such stock is convertible on a 1.610831-to-1 basis into
common shares and automatically converts into common shares upon the
completion of an initial public offering of the Company's securities which
results in gross proceeds to the Company of a minimum of $4,000,000. The
preferred stock has identical voting rights as the Company's common stock
and has a liquidation preference of $1.00 per share.
[2] Stock options and warrants:
During 1996, the Board of Directors and stockholders approved the adoption
of the 1996 Stock Option Plan (the "1996 Plan"). The 1996 Plan, as amended,
provides for the granting of both incentive and non-qualified options to
purchase up to 750,000 shares of common stock of the Company.
The term of options granted under the 1996 Plan may not exceed ten years
(five years in the case of an incentive stock option granted to an optionee
owning more than 10% of the voting stock of the Company). The option price
for incentive stock options can not be less than 100% of the fair market
value of the shares of common stock at the time the option is granted (110%
for a 10% stockholder). The exercise price for non-qualified options is set
by the Compensation Committee in its discretion.
The following table summarizes the activity under the 1996 Plan:
Year Ended December 31, Three Months Ended
1996 1997 March 31, 1998
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
Options outstanding at
beginning of period 104,139 $6.44 184,687 $5.72
Granted 107,398 $6.44 159,700 $5.54 103,984 $4.83
Cancelled (3,259) $6.44 (79,152) $6.30 (62,080) $5.51
----------- ----------- -----------
Options outstanding at end of
period 104,139 $6.44 184,687 $5.72 226,591 $5.38
----------- ----------- -----------
----------- ----------- -----------
Options exercisable at end of
period 84,118 $6.44 184,687 $5.72 226,591 $5.38
----------- ----------- -----------
----------- ----------- -----------
F-12
NETWORK-1 SECURITY SOLUTIONS, INC.
Notes to Financial Statements
(unaudited with respect to data as of March 31, 1998 and for
the three-month periods ended March 31, 1997 and 1998)
NOTE F - STOCKHOLDERS' EQUITY (CONTINUED)
[2] Stock options and warrants: (continued)
The following table presents information relating to stock options
outstanding at December 31, 1997:
Options Outstanding and Exercisable
Weighted
Weighted Average
Average Remaining
Exercise Life in
Shares Price Years
82,876 $4.83 9.75
101,811 $6.44 9.03
-------
184,687 $5.72 9.35
-------
-------
The following table presents information relating to stock options
outstanding at March 31, 1998 (unaudited):
Options Outstanding and Exercisable
Weighted
Weighted Average
Average Remaining
Exercise Life in
Shares Price Years
150,543 $4.83 9.79
76,048 $6.44 8.79
-------
226,591 $5.38 9.45
-------
-------
The weighted average fair value at date of grant for options granted during
the year ended December 31, 1996 and 1997 and the three months ended March
31, 1998 were $3.19, $2.77 and $2.32 per option, respectively. There were
no options granted during the three months ended March 31, 1997. The fair
value of options at date of grant was estimated using the Black-Scholes
option pricing model utilizing the following weighted average assumptions:
December 31, March 31,
1996 1997 1998
(Unaudited)
Risk-free interest rates 6.43% 6.50% 5.50%
Expected option life in years 6 6 6
Expected stock price volatility 40% 40% 40%
Expected dividend yield 0% 0% 0%
F-13
NETWORK-1 SECURITY SOLUTIONS, INC.
Notes to Financial Statements
(unaudited with respect to data as of March 31, 1998 and for
the three-month periods ended March 31, 1997 and 1998)
NOTE F - STOCKHOLDERS' EQUITY (CONTINUED)
[2] Stock options and warrants: (continued)
Had the Company elected to recognize compensation cost based on the fair
value of the options at the date of grant as prescribed by SFAS 123, net
loss for the years ended December 31, 1996 and 1997 and for the three-month
period ended March 31, 1998 would have been $(4,842,000), $(2,832,000) and
$(938,000) or $(2.65) per share, $(1.53) per share and $(.55) per share,
respectively.
[3] The Company has the following warrants; and options referred to in [4]
below to purchase common stock outstanding as of December 31, 1997:
Number
of Exercise
Shares Price
186,239 $1.61
62,856 2.42
62,080 3.22
70,949 4.83
318,159 6.44
93,120 9.66
-----------
793,403
-------------
-------------
Subsequent to December 31, 1997 in connection with the issuance of notes,
the Company issued warrants to purchase 325,919 shares of the Company's
common stock at an exercise price of $4.83. The Company also issued a
warrant to purchase 6,208 shares of the Company's common stock at an
exercise price of $6.04 for services rendered.
[4] Private placement:
During March 1996, the Company completed a private placement of its
securities. The Company issued 667,357 shares of its common stock for $6.44
a share, yielding gross proceeds of $4,300,000. In connection with the
private placement the Company incurred costs aggregating $352,000 including
$279,000 in commissions and expense allowance paid to the placement agent.
The Company also issued options to purchase 66,736 shares of common stock
at an exercise price of $6.44 per share expiring in March 2001 to the
placement agents in connection with the private placement. The investors in
the private placement were granted certain demand and piggyback
registration rights. The Company also sold 31,040 shares of stock in 1996
receiving proceeds of $200,000.
F-14
NETWORK-1 SECURITY SOLUTIONS, INC.
Notes to Financial Statements
(unaudited with respect to data as of March 31, 1998 and for
the three-month periods ended March 31, 1997 and 1998)
NOTE G - COMMITMENTS AND CONTINGENCIES
[1] Operating leases:
The Company leases office facilities in Florida, New York and Texas under
operating leases expiring through 1999. Rental commitments for the
remaining term of the Company's noncancellable leases relating to office
space expiring at various dates through 1999 are as follows:
Year Ending
December 31,
1998 $ 120,000
1999 31,000
-----------
$ 151,000
-----------
-----------
Rental expense for the years December 31, 1996 and 1997 and for the
three-month periods ended March 31, 1997 and 1998 aggregated $142,000,
$146,000, $37,000 and $36,000, respectively.
[2] Software distribution agreements:
[a] In June 1997, the Company entered into a software distribution
agreement pursuant to which the Company licensed, on a nonexclusive
basis, the right to incorporate and/or bundle certain technology of the
Company, with the customer's products. In connection therewith, the
Company, which is entitled to royalties based on the customer's sales,
received a $500,000, nonrefundable prepaid royalty, which is included
in license revenue for the year ended December 31, 1997.
[b] In September 1997, the Company entered into a software distribution
agreement, pursuant to which the Company has the right to incorporate
certain technology into its software. The Company is required to make
certain royalty payments based on unit sales as defined. The Company is
obligated to pay a minimum of $100,000 in royalties pursuant to the
agreement for the period September 1997 to March 30, 1999. As of
December 31, 1997 and March 31, 1998, accrued royalty payable was
approximately $29,000 and $37,000, respectively.
[c] In July 1996, the Company entered into an agreement pursuant to which
certain technology was developed for the Company. The Company is
required to make certain royalty payments based on unit sales as
defined, up to a maximum royalty payment of $100,000. For the year
ended December 31, 1997 and the three months ended March 31, 1998,
royalties owed pursuant to such agreement were de minimus.
[3] Employment agreements:
In May 1998, the Company entered into an employment agreement with its
President and Chief Executive Officer which provides for a base salary of
$150,000, subject to annual increases of up to 20% by the Board of
Directors at their discretion. The agreement also provides for an annual
bonus of up to $50,000 as determined by the Board of Directors in its
discretion. The agreement expires in May 2002. In connection therewith, the
Company granted the President a five-year option to purchase 294,879 shares
of the Company's common stock at an exercise price of $2.42 per share. The
option vests 34% immediately and then 22% per year thereafter. As the
estimated fair value of the Company's common stock at the date of grant of
the option ($5.60 per share) was in excess of the exercise price the
Company will incur aggregate compensation expense of approximately $900,000
over the four-year service period.
F-15
NETWORK-1 SECURITY SOLUTIONS, INC.
Notes to Financial Statements
(unaudited with respect to data as of March 31, 1998 and for
the three-month periods ended March 31, 1997 and 1998)
NOTE G - COMMITMENTS AND CONTINGENCIES
[3] Employment agreements: (continued)
The Company has employment agreements with five other officers providing
for aggregate annual salaries of $218,000 through April 1999 with respect
to two officers and aggregate annual salaries of $400,000 through May and
June 2001 with respect to three officers. Certain of the agreements provide
for the granting of bonuses at the discretion of the Board of Directors, as
well as options to purchase shares of common stock.
Aggregate salary commitments pursuant to employment agreements are
$526,000, $622,000, $550,000, $330,000 and $62,000 for 1998, 1999, 2000,
2001 and 2002, respectively.
[4] Savings and investment plan:
The Company has a Savings and Investment Plan which allows participants to
make contributions by salary reduction pursuant to Section 401(k) of the
Internal Revenue Code of 1986. The Company also may make discretionary
annual matching contributions in amounts determined by the Board of
Directors, subject to statutory limits. The Company did not make any
contributions to the 401(k) Plan during the years ended December 31, 1996,
1997 and the three months ended March 31, 1998.
[5] Financial advisory agreement:
In September 1996, as amended in January 1997, the Company entered into a
financial advisory agreement with a corporation owned by the Chairman of
the Board and a principal stockholder, which expires in January 1999.
Pursuant to such agreement, monthly fees of $12,500 were to be paid to such
corporation, and the Company issued two 7-year warrants, each to purchase
up to 31,040 shares of common stock at an exercise price of $6.44 and
$8.05, respectively. Such exercise prices were subsequently reduced to an
exercise price of $1.61 per share (see Note E[3]). The Company also agreed
to pay such corporation and another corporation which is a principal
stockholder of the Company, a cash fee equal to 3% of the total proceeds or
other consideration received in connection with a merger or sale of
substantially all of the Company's assets completed by January 2001.
Expenses under the agreement, including amortization of the value ascribed
to the warrants, included in general and administrative expenses, for the
year ended December 31, 1997 and the three-month periods ended March 31,
1997 and 1998 amounted to $253,000, $58,000 and $50,000, respectively.
On May 14, 1998, the Company issued 31,250 shares of common stock to this
entity in satisfaction of amounts owed pursuant the financial advisory
agreement.
F-16
NETWORK-1 SECURITY SOLUTIONS, INC.
Notes to Financial Statements
(unaudited with respect to data as of March 31, 1998 and for
the three-month periods ended March 31, 1997 and 1998)
NOTE H - INCOME TAXES
The principal components of deferred tax assets and valuation allowance are as
follows:
Three Months
Year Ended Ended
December 31, March 31,
1996 1997 1998
Deferred tax assets:
Net operating loss carryforwards $ 1,464,000 $ 2,122,000 $ 2,780,000
Common stock and warrants issued for
compensation and debt discount, not yet
deductible 266,000 525,000 599,000
Other 240,000 261,000 275,000
--------------- --------------- ---------------
1,970,000 2,908,000 3,654,000
Valuation allowance (1,970,000) (2,908,000) (3,654,000)
--------------- --------------- ---------------
Net deferred tax asset $ 0 $ 0 $ 0
--------------- --------------- ---------------
--------------- --------------- ---------------
The Company has recorded a valuation allowance for the full amount of its
deferred tax assets as the likelihood of its future realization cannot be
presently determined.
The difference between the tax benefit and the amount that would be computed by
applying the statutory federal income tax rate to loss before taxes is
attributable to the following:
Year Ended Three Months Ended
December 31, March 31,
1996 1997 1997 1998
Income tax benefit - statutory rate (34.0)% (34.0)% (34.0)% (34.0)%
Increase in valuation allowance on deferred
tax assets 34.0% 34.0% 34.0% 34.0%
---------- ---------- ---------- -----------
0% 0% 0% 0%
---------- ---------- ---------- -----------
---------- ---------- ---------- -----------
At December 31, 1997, the Company has available net operating loss carryforwards
to reduce future federal taxable income of approximately $5,500,000 for tax
reporting purposes which expire from 2009 through 2012. Pursuant to the
provisions of the Internal Revenue Code, future utilization of these past losses
is subject to certain limitations based on changes in the ownership of the
Company's stock that have occurred or may occur.
NOTE I - OTHER MATTERS
[1] For the year ended December 31, 1997, approximately $500,000 (21%) and
$331,000 (14%) of the Company's revenues were from two customers. For the
three months ended March 31, 1998, approximately $80,000 (24%) and $45,000
(13%) of the Company's revenues were from two different customers. No
customer accounted for 10% or more of the Company's revenue for the year
ended December 31, 1996 or for the three months ended March 31, 1997.
[2] For the years ended December 31, 1996 and 1997 and for the three months
ended March 31, 1997 and 1998, export sales of the Company's products
amounted to approximately $69,000, $370,000, $144,000 and $9,000,
respectively.
F-17
NETWORK-1 SECURITY SOLUTIONS, INC.
Notes to Financial Statements
(unaudited with respect to data as of March 31, 1998 and for
the three-month periods ended March 31, 1997 and 1998)
NOTE J - SUBSEQUENT EVENTS
[1] On July 8, 1998, the Company entered into an agreement with certain of its
option and warrant holders pursuant to which the Company issued 596,741
shares of its common stock in exchange for cancellation of outstanding
warrants to purchase 789,521 shares of the Company's common stock.
[2] The Company has agreed in principle to acquire for 35,000 shares of its
common stock and the assumption of liabilities of up to $200,000 all of the
outstanding common stock of CommHome Systems Corp. ("CommHome") effective
upon the consummation of the offering. The Company's President is also the
President of CommHome and owns 51% of its outstanding common stock. Of the
assumed liabilities, $105,000 is owed to two officers of the Company and
will be satisfied by the issuance of 13,125 shares of common stock. The
Company will incur a charge of approximately $465,000 for purchased
research and development upon the acquisition. CommHome is a development
stage company and has had no revenues. The principal activity has been the
design of residential networking solutions. The Company intends to
incorporate CommHome's designs into its future security products.
F-18
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
No dealer, salesperson or other person has been
authorized to give any information or to make any
representations other than those contained in this
Prospectus in connection with this offering and, if given
or made, such information or representations must not
be relied upon as having been authorized by the
Company or the Underwriter. This Prospectus does not
constitute an offer to sell or a solicitation of an offer
to buy any security other than the securities offered by this
Prospectus, or an offer to sell or a solicitation of an offer
to buy any securities by anyone in any jurisdiction in
which such offer or solicitation is not authorized or is
unlawful. Neither the delivery of this Prospectus nor
any sale made hereunder shall, under any circumstances,
create any implication that the information contained
herein is correct as of any time subsequent to the date
hereof.
TABLE OF CONTENTS
Page
----
Prospectus Summary.............................. 3
Risk Factors ................................... 7
Use of Proceeds................................. 20
Dilution ....................................... 22
Dividend Policy ................................ 23
Capitalization.................................. 23
Selected Financial Data......................... 24
Management's Discussion and Analysis of
Financial Condition and Results of
Operations................................. 25
Business........................................ 33
Management...................................... 50
Principal Stockholders.......................... 59
Certain Transactions............................ 62
Description of Securities....................... 64
Shares Eligible for Future Sale................. 66
Underwriting.................................... 67
Legal Matters................................... 69
Experts......................................... 70
Additional Information.......................... 70
Index to Financial Statements...................F-1
Until _______________, 1998 (25 days after the date of this Prospectus), all
dealers effecting transactions in the registered securities, whether or not
participating in this distribution, may be required to deliver a Prospectus.
This delivery requirement is in addition to the obligation of dealers to deliver
a Prospectus when acting as an underwriter and with respect to their unsold
allotments or subscriptions.
[NETWORK-1 LOGO]
1,875,000 Shares
NETWORK-1 SECURITY
SOLUTIONS, INC.
Common Stock
---------------------
Prospectus
---------------------
Whale Securities Co., L.P.
, 1998
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
Item 24. Indemnification of Directors and Officers
As permitted by Section 102(b)(7) of the Delaware General Corporation Law
(the "GCL"), Article VI of the Company's Amended and Restated Certificate of
Incorporation, filed as Exhibit 3.1 hereto, includes a provision that eliminates
any director's personal liability to the Company or its stockholders for
monetary damages for breach of fiduciary duty as a director. Such elimination of
personal liability does not apply to the following: (i) breach of the duty of
loyalty to the Company or its stockholders; (ii) acts or omissions not in good
faith or which involve intentional misconduct or a knowing violation of the law;
(iii) payment of an illegal dividend or an illegal redemption or purchase of the
Company's stock, pursuant to Section 174 of the GCL; or (iv) any transaction
from which the director derived an improper benefit. If the GCL is amended to
authorize corporate action further eliminating or limiting the personal
liability of directors, then the liability of a director of the Company'shall be
eliminated or limited to the fullest extent permitted by the GCL, as so amended.
Any repeal or modification of this Article by the stockholders of the Company
shall not adversely affect any right or protection of a director of the Company
with respect to events occurring prior to the time of such repeal or
modification.
As permitted by Section 145 of the GCL, pursuant to Article VII of the
Company's Amended and Restated Certificate of Incorporation, the Company, to the
fullest extent permitted by the provisions of the GCL, as now or hereafter in
effect, indemnifies any director, officer, employee or agent of the Company and
certain other persons serving at the request of the Company in related
capacities against amounts paid and expenses incurred in connection with an
action or proceeding to which that person is or is threatened to be made a party
by reasons of such position, if such person shall have acted in good faith and
in a manner he reasonably believed to be in or not opposed to the best interests
of the Company and, in any criminal proceeding, if such person had no reasonable
cause to believe his conduct was unlawful; provided that, in the case of actions
brought by or in the right of the Company, no indemnification shall be made with
respect to any matter as to which such person shall have been adjudged to be
liable to the Company unless and only to the extent that the adjudicating court
determines that such indemnification is proper under the circumstances. The
indemnification provided by Article VII of the Company's Amended and Restated
Certificate of Incorporation does not limit or exclude any rights, indemnities
or limitations of liability to which any person may be entitled, whether as a
matter of law, under the Bylaws of the Company, by agreement, vote of the
stockholders or vote of disinterested directors of the Company or otherwise.
The Company believes that the indemnification provisions contained in
Article VI and Article VII of the Company's Amended and Restated Certificate of
Incorporation have assisted and will assist the Company in attracting and
retaining qualified individuals to serve as directors and officers.
The Underwriting Agreement, filed as Exhibit 1.1 hereto, provides for
indemnification by the Underwriter of the Company, its directors and officers,
and by the Company of the Underwriter, for certain liabilities, including
liabilities under the Act, and affords certain rights of contribution with
respect thereto.
II-1
Item 25. Other Expenses of Issuance and Distribution
The following table sets forth all expenses, other than underwriting
discounts and commissions, payable by the Company in connection with the sale of
the securities being registered.
The foregoing, except for the SEC Registration Fee and NASD Filing Fee are
estimates.
SEC Registration Fee.......................................................................................$ 5,818.94
NASD Filing Fee............................................................................................$ 2,472.52
NASDAQ SmallCap Listing Fee................................................................................$ 10,000
Boston Stock Exchange Listing Fee..........................................................................$ 7,500
Accounting Fees and Expenses...............................................................................$ 80,000
Legal Fees and Expenses (other than Blue Sky)..............................................................$ 180,000
Blue Sky Fees and Expenses (including legal and filing fees)...............................................$ 50,000
Printing and Engraving Expenses............................................................................$ 100,000
Directors' and Officers' Liability Insurance...............................................................$ 50,000
Transfer Agent Fees and Expenses...........................................................................$ 2,500
Miscellaneous..............................................................................................$ 19,708.54
-----------------
Total......................................................................................................$ 508,000
Item 26. Recent Sales of Unregistered Securities
During the past three years, the Company has issued unregistered securities
to the persons described below. No underwriting discounts or commissions were
paid in connection with such issuance of securities, except in connection with
the Company's issuance of an aggregate 667,357 shares of Common Stock on March
14, 1996 and March 21, 1996 (the "March 1996 Private Offering," as further
described below under paragraph 5). In issuing the securities described below,
the Company relied upon the exemption from the registration requirements of the
Securities Act of 1933, as amended (the "Securities Act"), by reason of Section
4(2) thereof and Regulation D promulgated thereunder, based on the fact that
each investor was either an "accredited investor" as such term is defined in
Rule 501 of Regulation D promulgated under the Securities Act or such investor
had such knowledge and experience in financial and business matters that such
person was capable of evaluating the merits and risks of the investment. The
share amounts below reflect a stock split at the rate of 12,836.97-to-1 on March
2, 1994, and a reverse stock split at the rate of 1-for-1.61083 on July 20,
1998.
(1) On November 29, 1995, the Company issued to Corey M. Horowitz warrants to
purchase 124,160 shares of Common Stock at an exercise price of $3.22 per
share, expiring November 29, 2005, in consideration for a loan of $150,000.
II-2
(2) On November 29, 1995, the Company issued to the CAPCOR Employee Pension
Plan warrants to purchase 62,080 shares of Common Stock at an exercise
price of $3.22 per share, expiring November 29, 2005, in consideration for
a loan of $75,000.
(3) On March 14, 1996, the Company issued to each of Irwin Lieber, Barry
Rubenstein and Eli Oxenhorn warrants to purchase 31,040 shares of Common
Stock at an exercise price of $6.44 per share, expiring March 14, 2006, and
warrants to purchase 31,040 shares of Common Stock at an exercise price of
$9.67 per share, expiring March 14, 2006, in consideration for their
agreement to serve on the Company's advisory board.
(4) On March 14, 1996, the Company issued to Bizar Martin & Taub, LLP warrants
to purchase 9,312 shares of Common Stock at an exercise price of $6.44 per
share, expiring March 14, 2006, in consideration for services rendered.
(5) On March 14, 1996 and March 21, 1996, in connection with the March 1996
Private Offering, the Company issued to 34 investors an aggregate 667,357
shares of Common Stock, in consideration for payment of $6.44 per share,
for an aggregate consideration of $4.3 million. GKN Securities Corp. served
as Placement Agent for the March 1996 Private Offering, and received a 4.5%
sales commission (or $193,500). The Company also issued to GKN Securities
Corp., related parties and Barington Capital Group, L.P. options to
purchase an aggregate 66,736 shares of Common Stock at an exercise price of
$6.44 per share, expiring March 14, 2001, in consideration of $100.
(6) On March 14, 1996, the Company issued to Corey M. Horowitz 24,832 shares of
Common Stock and 83,808 shares of Common Stock to Security Partners, L.P.
in consideration for conversion of outstanding debt in the aggregate
principal amount of $700,000.
(7) On March 21, 1996, the Company issued to J. Robert Scott, Inc. 6,467 shares
of Common Stock in consideration for services rendered.
(8) On April 26, 1996, the Company issued to Michael Stansky and Jill Stansky
as Tenants of the Entirety, w/r/o/s, 3,880 shares of Common Stock, in
consideration for payment of $6.44 per share or aggregate consideration of
$25,000.
(9) On April 28, 1996, the Company issued to James J. Pallotta 7,760 shares of
Common Stock, in consideration for payment of $6.44 per share or aggregate
consideration of $50,000.
(10) On April 29, 1996, the Company issued to Robert Russo 2,483 shares of
Common Stock in consideration for services rendered as the Company's
President.
(11) On June 3, 1996, the Company issued to Navigator Fund, L.P. 17,615 shares
of Common Stock in consideration for payment of $6.44 per share or
aggregate consideration of $113,500.
(12) On June 3, 1996, the Company issued to Navigator Global Fund 1,785 shares
of Common Stock in consideration for payment of $6.44 per share or
aggregate consideration of $11,500.
II-3
(13) On October 3, 1996, the Company issued to each of Craig Bandes and Mona
Geller 7,760 shares of Common Stock, upon the exercise of stock options by
Bandes and Geller at an exercise price of $1.61 per share or aggregate
consideration of $25,000. The stock options had been issued pursuant to
Stock Option Agreements, dated April 4, 1994, in consideration for
financial advisory services rendered to the Company.
(14) On October 11, 1996, the Company issued to CMH Capital Management Corp.
("CMH") warrants to purchase 31,040 shares of Common Stock at an exercise
price of $8.05 per share, expiring October 11, 2003, in consideration for
financial advisory services.
(15) On October 22, 1996, the Company issued to Communica, Inc. and related
parties 9,312 shares of Common Stock in consideration for services
rendered.
(16) The Company's Stock Option Plan provides for the grant of stock options to
key employees, directors, and consultants of the Company (the "Stock Option
Plan"). Under the Stock Option Plan, employees (including officers and
employee directors) are eligible to receive grants of incentive stock
options, which are intended to be "Incentive Stock Options" as defined by
Section 422 of the Internal Revenue Code of 1986, as amended. Employees
(including officers), directors of the Company or any affiliates or
consultants are eligible to receive grants of non-qualified options. An
aggregate of 465,598 shares of Common Stock has been reserved for issuance
upon exercise of outstanding options issued under the Stock Option Plan.
The Company believes that the Employee Stock Option grants described in
this paragraph are exempt from the registration requirements of the
Securities Act by reason of Rule 701 promulgated thereunder, because such
options were granted pursuant to a written compensatory benefit plan of the
Company, copies of which were provided to each participant, and the
aggregate offering price did not exceed the limit prescribed by Rule 701 in
connection with any such grant. As of July 15, 1998, pursuant to the Stock
Option Plan, options to purchase an aggregate of 423,908 shares of Common
Stock were outstanding, including options to purchase 36,316 shares of
Common Stock at an exercise price of $6.44 per share, options to purchase
127,264 shares of Common Stock at an exercise price of $4.83 per share,
options to purchase 177,828 shares of Common Stock at an exercise price of
$5.60 per share, and options to purchase 82,500 shares of Common Stock at
an exercise price of $7.20 per share. No such outstanding options had been
exercised.
(17) On January 15, 1997, the Company issued to CMH warrants to purchase 31,040
shares of Common Stock at an exercise price of $6.44 per share, expiring
January 15, 2004, in consideration for financial advisory services to the
Company.
(18) In February and April of 1997, the Company borrowed $1 million through the
issuance to ten (10) investors of unsecured promissory notes, bearing 6%
interest (the "February and April 1997 Private Financing"), and due at the
earlier of (i) one year from the date of issuance, (ii) the date upon which
the Company receives $4,000,000 net proceeds (after deduction of all
related offering expenses) of equity or debt financing from one transaction
or a series of transactions, (iii) a sale of all or substantially all of
the Company's assets or (iv) a merger or consolidation of the Company. In
addition, as part of the February and April 1997 Private Financing,
investors received receive ten (10) year warrants to purchase an aggregate
of 139,679 shares of Common Stock at an exercise price of $6.44 per share
(the "Warrants"), as follows:
II-4
(a) On February 24, 1997, the Company issued to Charles P.
Stevenson, Jr. warrants to purchase 13,968 shares of Common Stock in
consideration for a loan of $100,000;
(b) On February 24, 1997, the Company issued to Albert Kalimian
warrants to purchase 6,984 shares of Common Stock in consideration for
a loan of $50,000;
(c) On February 24, 1997, the Company issued to Raptur Management
Co. warrants to purchase 13,968 shares of Common Stock in
consideration for a loan of $100,000;
(d) On February 24, 1997, the Company issued to Douglas Lipton
warrants to purchase 6,984 shares of Common Stock in consideration for
a loan of $50,000;
(e) On February 24, 1997, the Company issued to Applewood
Associates, L.P. warrants to purchase 34,920 shares of Common Stock in
consideration for a loan of $250,000;
(f) On February 24, 1997, the Company issued to Lawrence Wein
warrants to purchase 3,492 shares of Common Stock in consideration for
a loan of $25,000;
(g) On February 24, 1997, the Company issued to Steven Heineman
warrants to purchase 3,492 shares of Common Stock in consideration for
a loan of $25,000;
(h) On February 24, 1997, the Company issued to Herb Karlitz
warrants to purchase 6,984 shares of Common Stock in consideration for
a loan of $50,000;
(i) On April 29, 1997, the Company issued to Navigator Fund, L.P.
warrants to purchase 42,882 shares of Common Stock in consideration
for a loan of $307,000; and
(j) On April 29, 1997, the Company issued to Navigator Global
Fund warrants to purchase 6,006 shares of Common Stock in
consideration for a loan of $43,000.
(19) On February 24, 1997, the Company issued to Alan Kaufman warrants to
purchase 9,312 shares of Common Stock at an exercise price of $6.44 per
share, expiring February 24, 2007, in consideration for services rendered.
(20) On August 8, 1997, the Company agreed to reduce the exercise prices of
warrants to purchase 31,040 shares of Common Stock, at an exercise price of
$8.05 per share, issued to CMH on October 11, 1996 and warrants to purchase
31,040 shares of Common Stock, at an exercise price of $6.44 per share,
issued to CMH on January 15, 1997, to an exercise price of $3.22 per share,
in consideration for a loan $100,000 made by CMH. In addition, the
II-5
Company agreed to reduce the exercise price of warrants to purchase 124,160
shares of Common Stock, at an exercise price of $3.22 per share, issued to
Corey M. Horowitz on November 29, 1995, to an exercise price of $1.61 per
share, in consideration for that same loan.
(21) On September 26, 1997, the Company issued to Applewood Associates, L.P.
warrants to purchase 62,080 shares of Common Stock at an exercise price of
$4.83 per share, expiring September 26, 2007, in consideration for a loan
of $350,000.
(22) On September 26, 1997, the Company issued to CMH warrants to purchase 8,869
shares of Common Stock at an exercise price of $4.83 per share, expiring
September 26, 2007, in consideration for a loan of $50,000.
(23) On November 12, 1997, the Company issued to Progressive Strategies, Inc.
2,794 shares of Common Stock in consideration for services rendered.
(24) On November 21, 1997, in consideration of a loan of $50,000, the Company
agreed to reduce the exercise prices to $1.61 of warrants to purchase
31,040 shares of Common Stock, originally issued to CMH at an exercise
price of $8.05 per share on October 11, 1996 and warrants to purchase
31,040 shares of Common Stock, originally issued to CMH at an exercise
price of $6.44 per share on January 15, 1997.
(25) On February 17, 1998, the Company issued to Venture Strategies, Inc.
warrants to purchase 6,208 shares of Common Stock at an exercise price of
$6.04 per share, expiring February 17, 2002, in consideration for services
rendered.
(26) On March 2, 1998, the Company issued an aggregate of $400,000 of promissory
notes and ten year warrants to purchase up to 74,496 shares of Common Stock
at an exercise price of $4.83 per share to four (4) investors including
Applewood Associates, L.P. ($300,000 note and warrants to purchase 55,871
shares of common stock), CMH Capital Management Corp.($50,000 note and
warrants to purchase 9,312 shares of common stock), Robert Graifman
($25,000 note and warrants to purchase 4,656 shares of common stock) and
Herb Karlitz ($25,000 note and warrants to purchase 4,656 shares of common
stock).
(27) On April 24, 1998, the Company issued to each of Corey Horowitz and MBF
Capital Corp. ten (10) year warrants to purchase 9,312 shares of Common
Stock at an exercise price of $4.83 per share in consideration for a loan
of $50,000 by each party.
(28) On May 10, 1998, the Company issued 2,897 shares of Common Stock to High
Tech Ventures in consideration for services rendered.
(29) On May 14, 1998, the Company issued an aggregate of $1,250,000 of
promissory notes and ten (10) year warrants to purchase up to 232,799
shares of Common Stock at an exercise price of $4.83 per share to Applewood
Associates, L.P. ($1,000,000 note and warrants to purchase 186,239 shares)
and Bentley One, Ltd. ($250,000 note and warrants to purchase 46,560
shares).
II-6
(30) On May 18, 1998, the Company issued a five (5) year option to Avi A. Fogel
to purchase up to 294,879 shares of the Common Stock at an exercise price
of $2.42 per share, in consideration for Mr. Fogel's execution of his
employment agreement. The shares underlying the option vest as follows: 34%
on the date of issuance of the option and 22% per year for each year
thereafter.
(31) On May 14, 1998, the Company issued 50,399 shares of Common Stock to CMH in
connection with advisory services rendered to the Company.
(32) On July 8, 1998, the Company issued an aggregate of 596,741 shares of its
Common Stock in exchange for the cancellation of outstanding warrants and
options to purchase an aggregate of 789,521 shares of Common Stock, as
follows:
(a) 261,565 shares of its Common Stock to Applewood Associates, L.P.
in exchange for warrants to purchase 339,111 shares of Common
Stock;
(b) 14,070 shares of its Common Stock to CMH Capital Management Corp.
in exchange for warrants to purchase 18,181 shares of Common
Stock;
(c) 117,138 shares of its Common Stock to Corey M. Horowitz in
exchange for warrants to purchase 133,471 shares of Common Stock;
(d) 49,381 shares of its Common Stock to CAPCOR Employee Pension Plan
in exchange for warrants to purchase 62,080 shares of Common
Stock;
(e) 9,824 shares of its Common Stock to Raptur Management Co. in
exchange for warrants to purchase 13,968 shares of Common Stock;
(f) 4,912 shares of its Common Stock to Douglas Lipton in exchange
for warrants to purchase 6,984 shares of Common Stock;
(g) 2,456 shares of its Common Stock to Lawrence Wein in exchange for
warrants to purchase 3,492 shares of Common Stock;
(h) 2,456 shares of its Common Stock to Steven Heineman in exchange
for warrants to purchase 3,492 shares of Common Stock;
(i) 8,572 shares of its Common Stock to Herb Karlitz in exchange for
warrants to purchase 11,640 shares of Common Stock;
(j) 9,824 shares of its Common Stock to Charles P. Stevenson, Jr. in
exchange for warrants to purchase 13,968 shares of Common Stock;
(k) 4,912 shares of its Common Stock to Albert Kalimian in exchange
for warrants to purchase 6,984 shares of Common Stock;
(l) 30,374 shares of its Common Stock to Navigator Fund, L.P. in
exchange for warrants to purchase 42,882 shares of Common Stock;
II-7
(m) 4,254 shares of its Common Stock to Navigator Global Fund in
exchange for warrants to purchase 6,006 shares of Common Stock;
(n) 3,625 shares of its Common Stock to Robert Graifman in exchange
for warrants to purchase 4,656 shares of Common Stock;
(o) 7,278 shares of its Common Stock to MBF Capital Corp. in exchange
for warrants to purchase 9,312 shares of Common Stock;
(p) 36,441 shares of its Common Stock to Bentley One, Ltd. in
exchange for warrants to purchase 46,560 shares of Common Stock;
(q) 6,897 shares of its Common Stock to Barington Capital Group, L.P.
in exchange for options to purchase 15,520 shares of Common
Stock;
(r) 9,560 shares of its Common Stock to GKN Securities Corp. in
exchange for options to purchase 21,510 shares of Common Stock;
(s) 3,869 shares of its Common Stock to David M. Nussbaum in exchange
for options to purchase 8,707 shares of Common Stock;
(t) 3,869 shares of its Common Stock to Robert Gladstone in exchange
for options to purchase 8,707 shares of Common Stock;
(u) 3,869 shares of its Common Stock to Roger Gladstone in exchange
for options to purchase 8,707 shares of Common Stock;
(v) 593 shares of its Common Stock to Deborah L. Schondorf in
exchange for options to purchase 1,335 shares of Common Stock;
(w) 104 shares of its Common Stock to Neil Betoff in exchange for
options to purchase 233 shares of Common Stock;
(x) 455 shares of its Common Stock to Richard Buonocore in exchange
for options to purchase 1,024 shares of Common Stock;
(y) 166 shares of its Common Stock to Brian K. Coventry in exchange
for options to purchase 372 shares of Common Stock;
(z) 276 shares of its Common Stock to Andrew G. Lazarus in exchange
for options to purchase 621 shares of Common Stock;
II-8
Item 27. Exhibits
The following is a list of all Exhibits filed as part of this
Registration Statement.
Exhibit
Number Exhibit
1.1 Form of Underwriting Agreement
1.2 Form of Underwriter's Warrant
2.1 Merger Agreement, dated , 1998, between the Company and CommHome Systems Corp.*
-----
3.1 Certificate of Incorporation of the Company, as amended
3.2 By-laws of the Company, as amended
4.1 Form of Common Stock Certificate*
4.2 Company's Stock Option Plan, as amended
5.1 Opinion of Bizar Martin & Taub, LLP *
10.1 Employment Agreement, dated May 18, 1998, between the Company and Avi A. Fogel, and amendment,
dated May 30, 1998
10.2 Employment Agreement, dated May 18, 1998, between the Company and Robert P. Olsen
10.3 Employment Agreement, dated May 19, 1998, between the Company and Murray P. Fish
10.4 Employment Agreement, dated June 30, 1998, between the Company and William Hancock
10.5 Employment Agreement, dated April 4, 1994, between the Company and Robert Russo, and amendment,
dated February 16, 1996
10.6 Waiver, dated June 30, 1998, of salary increases by William Hancock and Robert Russo
10.7 Lease and Service Agreement, dated June 5, 1998, between the Company and Alliance Wellesley
L.P.*
10.8 Lease, dated June 29, 1994, between the Company and Greenview Limited Partnership
10.9 Agreement, dated August 30, 1996, between the Company and CMH Capital Management Corp. ("CMH"),
with respect to advisory services, and amendments, dated January 15, 1997, and
January 30, 1997
10.10 Agreement, dated May 14, 1998, between the Company, CMH and Applewood Associates, L.P. with
respect to advisory services
II-9
Exhibit
Number Exhibit
10.11 Master Software License Agreement, dated November 10, 1997, between the Company and Electronic
Data System Corporation, and amendment, dated May 29, 1998**
10.12 Software Distribution Agreement, dated June 5, 1997, between the Company and Trusted
Information Systems, Inc.**
10.13 Software Distribution Agreement, dated September 26, 1997, between the Company and Trusted
Information Systems, Inc.**
10.14 Reseller Agreement, dated April 17, 1998, between the Company and Aventail Software Corporation **
10.15 Agreement, dated January 31, 1997, among the Company, Robert Russo and William Hancock, in
which Messrs. Russo and Hancock surrendered shares of Common Stock
10.16 Agreement, dated September 26, 1997, between the Company, Robert Russo, William Hancock, and
Kenneth Conquest, in which Messrs. Russo, Hancock, and Conquest surrendered shares of Common Stock
10.17 Agreement, dated May 14, 1998, among the Company, Robert Russo and William Hancock, in which
Messrs. Russo and Hancock surrendered shares of Common Stock
10.18 Agreement, dated May 14, 1998, between the Company and CMH, in connection with the issuance of
shares for advisory fees
10.19 Exchange Agreement, dated July 8, 1998, between the Company and certain of its holders of
outstanding warrants and options
23.1 Consent of Richard A. Eisner & Company, LLP
23.2 Consent of Bizar Martin & Taub, LLP (included in Exhibit 5.1)*
24.1 Power of Attorney (see signature page)
27.1 Financial Data Schedule
---------------------------------------
* To be filed by amendment.
** Confidential treatment requested for certain provisions.
Item 28. Undertakings
The Registrant will provide to the Underwriter specified in the
Underwriting Agreement certificates in such denominations and registered in such
names as required by the Underwriter to permit prompt delivery to each
purchaser.
II-10
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 (the "Securities Act") may be permitted to directors, officers and
controlling persons of the registrant pursuant to the foregoing provisions, or
otherwise, the registrant has been advised that in the opinion of the Securities
and Exchange Commission such indemnification is against public policy as
expressed in the Securities Act and is, therefore, unenforceable. In the event
that a claim from indemnification against such liabilities (other than the
payment by the registrant of expenses incurred or paid by a director, officer or
controlling person of the registrant in the successful defense of any action,
suit or proceeding) is asserted by such director, officer or controlling person
in connection with the securities being registered, the registrant will, unless
in the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question of whether
such indemnification by it is against public policy as expressed in the
Securities Act and will be governed by the final adjudication of such issue.
For purpose of determining any liability under the Securities of 1933, each
post-effective amendment that contains a Form of Prospectus shall be deemed to
be a new registration statement relating to the securities offered therein, and
the offering of such securities at that time shall be deemed to be the initial
bona fide offering thereof.
For purposes of determining any liability under the Securities Act, the
information omitted from the Form of Prospectus filed as part of this
Registration Statement in reliance upon Rule 430A and contained in the Form of
Prospectus filed by Company pursuant to Rule 424(b)(1) or (4) or 497(h) under
the Securities Act shall be deemed to be part of this Registration Statement as
of the time it was declared effective.
II-11
SIGNATURES
In accordance with the requirements of the Securities Act of 1933, the
registrant certifies that it has reasonable grounds to believe that it meets all
of the requirements of filing on Form SB-2 and authorized this registration
statement to be signed on its behalf by the undersigned, in the Township of
Wellesley, Commonwealth of Massachusetts on the 22nd day of July, 1998
Network-1 Security Solutions, Inc.
By: /s/ Avi A. Fogel
------------------------------------------
Avi A. Fogel, President and
Chief Executive Officer
POWER OF ATTORNEY
Network-1 Security Solutions, Inc., a Delaware corporation, and each person
whose signature appears below constitutes and appoints Avi A. Fogel and Corey M.
Horowitz, and each of them, as his true and lawful attorney-in-fact and agent,
with full power of substitution and resubstitution, for him and in his name,
place and stead, in any and all capacities, to sign any and all amendments
(including post-effective amendments) to this registration statement, and to
file the same, with exhibits and schedules thereto, and other documents in
connection therewith, with the Securities and Exchange Commission, granting unto
said attorney-in-fact, full power and authority to do and perform each and every
act and thing necessary or desirable to be done in and about the premises, as
fully to all intents and purposes as he might or could do in person, thereby
ratifying and confirming all that said attorney-in-fact, or substitute, may
lawfully do or cause to be done by virtue hereof.
In accordance with the requirements of the Securities Act of 1933, this
registration statement was signed by the following persons in the capacities and
on the dates indicated:
Name Title Date
/s/ Avi A. Fogel President, Chief Executive Officer July 22, 1998
- ----------------------- and Director (principal executive
Avi A. Fogel officer) and Director (principal
executive officer)
/s/ William H. Hancock Chief Technology Officer and July 22, 1998
- ----------------------- Director
William H. Hancock
/s/ Murray P. Fish Chief Financial Officer July 22, 1998
- ----------------------- (principal financial officer
Murray P. Fish and principal accounting officer)
/s/ Robert Russo Vice President of Business July 22, 1998
- ----------------------- Development
Robert Russo
/s/ Corey M. Horowitz Chairman of the Board of Directors July 22, 1998
- -----------------------
Corey M. Horowitz
Registration No. 333
_______________________________________________________________________
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
______________________
EXHIBITS
FILED WITH
FORM SB-2
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
_______________
NETWORK-1 SECURITY SOLUTIONS, INC.
(Exact name of Registrant as specified in its charter)
Volume 1
_____________________________________________________________________________
EXHIBIT INDEX
Exhibit Exhibit Page
Number
________________________________________________________________________
1.1 Form of Underwriting Agreement
1.2 Form of Underwriter's Warrant
2.1 Merger Agreement, dated July , 1998, between the Company
and CommHome Systems Corp.*
3.1 Certificate of Incorporation of the Company, as amended
3.2 By-laws of the Company, as amended
4.1 Form of Common Stock Certificate*
4.2 Company's 1996 Stock Option Plan, as amended
5.1 Opinion of Bizar Martin & Taub, LLP*
10.1 Employment Agreement, dated May 18, 1998, between the
Company and Avi A. Fogel, and amendment, dated May 30, 1998
10.2 Employment Agreement, dated May 18, 1998, between the
Company and Robert P. Olsen
10.3 Employment Agreement, dated May 19, 1998, between the
Company and Murray P. Fish
10.4 Employment Agreement, dated June 30, 1998, between the
Company and William Hancock
10.5 Employment Agreement, dated April 4, 1994, between the
Company and Robert Russo, and amendment, dated February 16,
1996
10.6 Waiver, dated June 30, 1998, of salary increases by William
Hancock and Robert Russo
10.7 Lease and Service Agreement, dated June 5, 1998, between the
Company and Alliance Wellesley L.P.*
10.8 Lease, dated June 29, 1994, between the Company and Greenview
Limited Partnership
10.9 Agreement, dated August 30, 1996, between the Company and CMH
Capital Management Corp. ("CMH"), with respect to advisory
services, and amendments, dated January 15, 1997, and January
30, 1997
Exhibit Exhibit Page
Number
_________________________________________________________________________
10.10 Agreement, dated May 14, 1998, between the Company, CMH
and Applewood Associates, L.P. with respect to advisory
services
10.11 Master Software License Agreement, dated November 10, 1997,
between the Company and Electronic Data Systems Corporation,
and amendment, dated May 29, 1998**
10.12 Software Distribution Agreement, dated June 5, 1997, between
the Company and Trusted Information Systems, Inc.**
10.13 Software Distribution Agreement, dated September 26, 1997,
between the Company and Trusted Information Systems, Inc.**
10.14 Reseller Agreement, dated April 17, 1998, between the Company
and Aventail Software Corporation**
10.15 Agreement, dated January 31, 1997, among the Company, Robert
Russo and William Hancock, in which Russo and Hancock
surrendered shares of Common Stock
10.16 Agreement, dated September 26, 1997, between the Company,
Robert Russo, William Hancock, and Kenneth Conquest, in which
Messrs. Russo, Hancock, and Conquest surrendered shares of
Common Stock
10.17 Agreement, dated May 14, 1998, among the Company, Robert
Russo and William Hancock, in which Messrs. Russo and Hancock
surrendered shares of Common Stock
10.18 Agreement, dated May 14, 1998, between the Company and CMH, in
connection with the issuance of shares for advisory fees
10.19 Exchange Agreement, dated July 8, 1998, between the Company
and certain of its holders of outstanding warrants and options
23.1 Consent of Richard A. Eisner & Company, LLP
23.2 Consent of Bizar Martin & Taub, LLP (included in Exhibit 5.1)*
24.1 Power of Attorney (see signature page)
27.1 Financial Data Schedule
_______________________
*To be filed by amendment.
**Confidential treatment requested for certain provisions.