Back to GetFilings.com
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
For Fiscal Year Ended: December 31, 1997
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______________ to ______________
Commission File Number 0-21511
V-ONE CORPORATION
---------------------------------------------------------
(Exact name of registrant as specified in its charter)
DELAWARE 52-1953278
------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) identification No.)
20250 Century Blvd., Suite 300, Germantown, Maryland 20874
----------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(301) 515-5200
--------------
(Registrant's telephone number, including area code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
Common Stock, $0.001 par value per share
(Title of Class)
Traded on the Nasdaq National Market
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X ] No [ ].
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of the voting and non-voting equity held by
non-affiliates computed by reference to the price at which the common equity was
sold, or the average bid and asked price of such common equity, as of on
February 27, 1998 was approximately $35,840,000. This calculation does not
reflect a determination that persons are affiliates for any other purposes.
Registrant had 13,033,043 shares of Common Stock outstanding as of February 27,
1998.
DOCUMENTS INCORPORATED BY REFERENCE
Part III -- Portions of the registrant's definitive proxy statement to be issued
in conjunction with registrant's 1998 annual stockholder's meeting to be held on
May 14, 1998.
Forward-Looking Statements
In addition to historical information, this Annual Report contains
forward-looking statements that involve risks and uncertainties. These
statements may differ in a material way from actual future events. For instance,
factors that could cause results to differ from future events include rapid
rates of technological change and intense competition, among others. Readers are
cautioned not to place undue reliance on these forward-looking statements. V-ONE
Corporation undertakes no obligation to publicly revise these forward-looking
statements or to reflect events or circumstances that arise after the date
hereof.
PART I
ITEM 1. BUSINESS
V-ONE Corporation ("V-ONE" or the "Company") develops markets and licenses a
comprehensive suite of network security products that enable organizations to
conduct secured electronic transactions and information exchange using public
switched networks, such as the Internet. The Company's suite of products address
network user authentication, perimeter security, access control and data
integrity through the use of smart cards, tokens, digital certificates,
firewalls and encryption technology. The Company's products interoperate
seamlessly and can be combined to form a complete, integrated network security
solution or can be used as independent components in customized security
solutions. The Company's products have been designed with an open and flexible
architecture to enhance application functionality and to support emerging
network security standards. In addition, the Company's products enable
organizations to deploy and scale their solutions from small single-site
networks to large multi-site environments, and can accommodate both wireline and
wireless media.
The Company offered 3,000,000 shares of its Common Stock, par value $0.001
("Common Stock"), in an initial public offering (the "IPO") on October 24, 1996
at $5.00 per share. On November 22, 1996, the Company's underwriters exercised
their option to purchase an additional 200,000 shares of Common Stock from the
Company and certain shareholders for $5.00 per share.
On December 8, 1997, the Company issued 4,000 shares of Series A Convertible
Preferred Stock ("Series A Stock") to Advantage Fund II Ltd. ("Advantage") for
$4 million in the aggregate. Each share of Series A Stock is convertible into
shares of Common Stock and Series A Warrants. For additional information, please
refer to Item 5. "Market for Registrant's Common Equity and Related Stockholder
Matters - Series A Convertible Preferred Stock" in the Company's Form 10-K.
The Company was incorporated in Maryland in February 1993 and reincorporated in
Delaware in February 1996. Effective July 2, 1996, the Company changed its name
from "Virtual Open Network Environment Corporation" to "V-ONE Corporation." The
Company's principal executive offices are located at 20250 Century Boulevard,
Suite 300, and Germantown, Maryland 20874. The Company's telephone number is
(301) 515-5200.
BACKGROUND
OVERVIEW. Over the last decade, decentralized computing has emerged as a result
of the widespread adoption of personal computers, local area networks and wide
area networks. This emergence has enabled users to communicate with each other
and share data throughout an entire organization. With the recent popularization
2
of the Internet and increased performance capabilities offered by high-speed
modems, ISDN services and frame relay technology, the volume of data transferred
over networks has increased dramatically. Further fueling this expansion,
carriers and Internet Service Providers have dramatically reduced their tariffs
for their high speed aggregation services running over T-1 and T-3 transits
which have data transfer rates that approximate local area network performance.
In addition, leading hardware and software vendors have adopted and support
TCP/IP, the Internet's non-proprietary communications protocol, for computer
communications and information exchange. This open platform, along with the
emergence of the Internet, allows increasing numbers of businesses and consumers
to engage in electronic commerce, such as home banking, credit verification,
securities trading and home shopping. The problem is that TCP/IP networks are
unsecure. Using the Company's technology, users can create "virtual" private
networks at a fraction of the cost of actual private WANs.
Organizations, recognizing the potential cost savings using public networks,
such as the Internet, as an extension of their enterprise networks, have begun
connecting branch offices and remote and mobile users to mission critical
applications and corporate resources such as groupware, customer databases and
inventory control systems. Also, the Internet can be used as a lower cost
alternative to value-added networks as a means to link companies with customers,
suppliers and trading partners. This instantiation is known in the industry as
Extranet architecture. The need for internal security continues to grow as
businesses deploy intranets, internal networks using TCP/IP protocols, and
browser-based applications to facilitate geographically dispersed communications
and the transmission of information throughout an enterprise in a cost-effective
manner.
With the increased use of the Internet and intranets, many organizations are
discovering that network security is a key element in successfully implementing
distributed applications and services, including electronic mail, electronic
data interchange, electronic commerce and information exchange services.
Information becomes more vulnerable as organizations rely heavily on computer
networks for the electronic transmission of data. In the absence of
comprehensive network security, individuals and organizations are able to
exploit system weaknesses to gain unauthorized access to networks, network
transmissions and individual network computers. These individuals and
organizations use such access to alter or steal data or, in some cases, to
launch destructive attacks on data and computers within a network.
NETWORK SECURITY ELEMENTS. Each of the following elements is critical in
creating a complete network security solution to protect an organization's data,
network and computer systems:
- - - Data Privacy through Encryption -- Preventing unauthorized users from
viewing private data through the process of "scrambling" data before it is
transmitted or placed into electronic storage.
- - - User Identification and Authentication -- Verifying the user's identity to
prevent unauthorized access to computer and network resources.
- - - Authorization -- Controlling which systems, data and applications a user can
access.
- - - Data Integrity -- Ensuring that network data, whether in storage or
transmission, has not been changed or compromised by any unauthorized
manipulation.
- - - Non-repudiation -- Verifying that data transmissions have been executed
between specific parties so that neither party may legitimately claim that the
transaction did not occur.
3
NETWORK SECURITY PRODUCTS. Over the years, a number of network security products
have been developed, including passwords, token-based access devices, firewalls,
encryption products, biometric devices, smart cards and digital certificates.
Each of these products was designed with a specific function or objective;
however, few were designed to meet all of the needs of enterprise-wide network
security. Single function or "point" products that have been developed to
address one or a limited number of network security requirements include the
following:
Passwords and Tokens -- Until recently, passwords were the most common method of
authentication. Static (non-changing) passwords were developed as the first
attempt to address the need for authentication. Static passwords, however, are
inadequate as they are susceptible to "sniffing" (unauthorized viewing) and to
attacks using software designed to randomly generate and enter thousands of
passwords. As a result, dynamic passwords, including single-use passwords, were
created to provide a greater level of authentication. Dynamic password
implementations include the use of time-varying and challenge-response
passwords. Generally, dynamic passwords require the use of a hand-held,
electronic device called a hardware token.
Dynamic passwords were subsequently strengthened by incorporating two-factor
identification, which provides a higher level of authentication in that two
independent components are combined to identify a user (for example, a bank ATM
card and a PIN code). However, dynamic passwords and two-factor identification
provide only a limited level of security because the sessions they authenticate
are still vulnerable to interception.
Biometric Systems - Biometric systems are used to measure fingerprint images,
voice analysis, or facial/retinal characteristics. They provide strong user
authentication while eliminating the need for cards or passwords.
Firewalls -- Firewalls are network access control devices that regulate the
passage of information based on a set of user-defined rules. Generally,
firewalls are based upon one of two technical architectures: packet filters
(customarily used in routers) or proxy-based application-level gateways. Packet
filters screen network traffic and allow or prevent network access based upon
source and destination Internet protocol addresses. Proxy-based
application-level gateways provide access to applications on the network only
after the user has identified the desired application and submitted a valid
password.
Encryption -- Encryption products provide privacy for transmitted data.
Encryption algorithms scramble data so that only users with the appropriate
decoding key are able to view transmitted or stored data. Public-key encryption
has recently gained additional credibility for managing the keys (codes) used to
encrypt and subsequently decrypt user designated data.
Smart Cards -- Smart cards are similar in size to credit cards, but contain a
small, tamper-proof microprocessor chip and are capable of storing data and
processing complex encryption algorithms. Smart cards are advanced
authentication tokens that are also capable of storing information, such as
credit card or bank account numbers, medical records, photographic images or
digital certificates.
Digital Certificates -- A digital certificate serves as an individual's
electronic identification card. The certificates are digitally certified by a
third party, called a certificate authority, who vouches for the identity of the
certificate holder. Digital certificates are being standardized as a means of
authenticating on-line users and are perceived to be a key technology for the
expansion of secure transactions and electronic commerce.
As organizations increase their dependence on the Internet and deploy intranets,
the Company believes that there will be an increasing need for a comprehensive
enterprise-wide network security solution. Many network security vendors,
4
however, have focused on developing products that address only one or a limited
number of specific security requirements. In addition, products developed by
different vendors are often difficult to integrate with each other and pose
interoperability problems. Consequently, the Company believes that organizations
will increasingly demand comprehensive network security solutions that are easy
to implement and transparent to the user. These solutions must have the ability
to integrate with existing applications, networks and/or mainframe applications,
while being flexible and powerful enough to address the needs created by newly
developed technologies.
THE V-ONE SOLUTION
The Company offers a comprehensive suite of network security products that
address the need for identification and authentication, integrity,
non-repudiation, authorization and encryption. This combination of network
security products enables organizations to identify and authenticate network
users while controlling access to specific network services. The Company's
technology is designed to prevent unauthorized access to an organization's
mission critical applications and internal data without impeding permitted uses
of the organization's resources and information. The Company's products are
compatible with many leading hardware platforms and operating systems, as well
as many third-party security products. The Company's customers are able to
integrate V-ONE's security products into their networks with minimal impact on
existing systems and applications.
The Company's current suite of products can be combined and configured to
provide network perimeter security, secure remote access and
intra/inter-enterprise security to facilitate secured electronic commerce and
information exchange. The Company's principal products are SmartGate, a
client/server product that offers identification and authentication, integrity,
non-repudiation, authorization and encryption; and SmartWall, and an
application-level firewall that incorporates SmartGate's functionality. The
Company provides customers with two-factor identification, mutual
authentication, fine-grained access control and encryption by combining smart
card emulation technology with the SmartGate server. In addition, SmartGate
users can access enterprise networks from remote locations using SmartCAT
technology incorporated in SmartGate.
The Company's technology provides customers with the ability to create network
security solutions designed to meet their specific network security
requirements. V-ONE's customers can securely deploy a broad range of services
and applications to engage in secured electronic transactions, information
exchange and remote access to mission critical applications and corporate
resources. The Company's technology is designed to be (i) modular, allowing
organizations to utilize the security product or products best suited to address
their immediate needs, with a seamless migration path to additional products as
required, (ii) scaleable, ranging from a single system supporting several users
to multiple systems potentially supporting hundreds of thousands of users, and
(iii) portable, securing access independent of any particular user's machine or
network entry point through the use of smart card technology.
STRATEGY
The Company's goal is to become the leading provider of comprehensive, open and
interoperable network security products that are easy to install, convenient to
use, and highly scalable. The Company's strategy to realize its goal contains
the following elements:
- - - Provide an Interoperable, Scaleable and Open Solution. The Company intends
to continue to provide network security products that operate on leading
platforms and that are interoperable and compatible with other network security
products. The flexible and open architecture of the Company's products enable
the Company to deliver component technologies for a seamless and interoperable
system. In addition, the Company's technology is scaleable,
application-independent and designed both to integrate with existing
technologies as well as to support emerging standards and applications.
5
- - - Augment and Integrate with Existing Security Products. The Company will
continue to offer products that interoperate with a wide variety of third-party
security products, including multiple firewalls and tokens, allowing a customer
to augment existing network security systems. The Company believes that its
technology protects a customer's existing network security investments because
the Company's products are designed to integrate easily with point products
currently employed by its customers. The Company believes that this strategy
will enable it to gain access to potential customers who have previously made
network security investments but whose network security needs are continuing to
evolve.
- - - Leverage Key Reference Accounts in Selected Vertical Markets. The Company
has identified strategic vertical markets that require sophisticated network
security solutions and has targeted its marketing and direct sales efforts on
key participants within these selected vertical markets. By successfully
installing its products at key accounts, the Company intends to leverage
positive references from its installed customer base to expand its market
penetration within those information critical industries. The Company intends to
increase its marketing and sales efforts to expand its customer base in
additional vertical markets.
- - - Develop and Leverage Strategic Alliances. The Company has established
strategic alliances to increase the distribution and market acceptance of its
network security products including an alliance with GTE Internetworking, a unit
of GTE Corp. ("GTE") and MCI Telecommunications Corporation ("MCI"). The Company
intends to continue to strengthen its existing strategic alliances while forging
new relationships with key industry participants. In addition, the Company is
exploring opportunities to develop new products and expand the functionality of
its existing products through alliances with key vendors of complementary
technologies.
PRODUCTS AND SERVICES
The Company's network security products are designed to protect an
organization's information and networks from unauthorized access while allowing
users of the network to conduct business securely over the Internet and
intranets. These products have been designed to interoperate seamlessly and
enhance application functionality. The Company designs its products so that they
can be combined in different configurations to provide customized solutions for
its customers. The following table lists the Company's current products:
- --------------------------------------------------------------------------------------------------------------
PRODUCT CATEGORY DESCRIPTION DATE OF
INTRODUCTION
DMSGate(TradeMark) X.400 Mail Guard A multi-platform security gateway meeting the Q4 1996
National Security Agency's DMS Firewall Plus
requirements
SmartGate(Registered) Client/server End-to-end, application level network data Q4 1995
security security system providing two-factor
identification, mutual authentication, encryption
and access control
SmartWall(Registered) Network perimeter An application level, dual-homed firewall that Q4 1994
security protects internal networks while enabling remote
(firewall) access to internal resources
SmartCAT(Registered) Smart card Smart card client software that is interoperable Q2 1994
technology with third-party smart cards and smart card
readers incorporated in SmartGate(R) technology
6
- ------------------------------------------------------------------------------------------------------------
PRODUCT CATEGORY DESCRIPTION DATE OF
INTRODUCTION
Online Registration Client/server A system that allows remote creation and Q2 1996
Service(TradeMark) token management of secure tokens and workstation
distribution configuration files incorporated in SmartGate(R)
technology
Wallet Electronic Electronic technology that enables secure payment Q3 1995
Technology(TradeMark) commerce transactions containing credit card information
incorporated in SmartGate(R) technology
- ------------------------------------------------------------------------------------------------------------
DMSGate -- DMSGate is a platform independent security gateway for flexible
deployment of defense messaging system (DMS) security services. DMSGate meets
the National Security Agency's DMS Firewall Plus requirements and is available
as a software module hosted on leading vendor firewalls.
SmartGate -- SmartGate is designed to interoperate easily with most TCP/IP-based
applications and to allow the end user to securely use existing and future
software applications over the Internet and intranets. SmartGate employs
two-factor identification (two independent components are combined to
authenticate a user) and mutual authentication (both the server and client,
SmartPass(TM), determine that the other party to the transaction is authorized
to participate in the transaction) through the use of virtual or physical smart
cards or other authentication devices.
SmartGate establishes a secured, encrypted link over an unsecured network once
both parties to a communication over the unsecured network have been identified
and authenticated. The authorized user is then granted access to only those
services and data for which the user has been approved. SmartGate supports
secure remote administration, which can be accessed using a Web browser or
telnet. SmartGate also supports the data encryption standard ("DES") (which, in
most forms, cannot be exported from the United States without the approval of
the Department of Commerce) and the RC4 encryption algorithm of RSA Data
Security, Inc. ("RSA") (which is exportable).
SmartGate server software versions are available on a variety of leading
operating systems, including Berkeley Software Development, Inc.'s BSD/OS, Sun
Microsystems, Inc.'s SunOS and Solaris, and Hewlett-Packard Company's HP-UX.
SmartGate client supports Microsoft Corporation's Windows versions 3.0 and 3.1,
Windows 95 and Windows NT. A turnkey version of SmartGate server is available
for BSD/OS on an Intel Pentium hardware platform.
SmartWall -- SmartWall, the Company's firewall product, provides a high level of
protection against unauthorized access to a secured network from an unsecured
network. SmartWall also allows transparent access from the secured network to
services and applications on the unsecured network. SmartWall includes a secured
graphical user interface for firewall administration, strong mutual
authentication to identify users and complete transparency for authorized
traffic. In addition, SmartWall allows multiple sites to be administered from
any location using a Web browser or telnet. SmartWall supports multiple types of
existing encryption products, authentication tokens, proxy services and secure
transmission channels. SmartGate is bundled into every SmartWall.
SmartWall software-only versions are currently available on a variety of leading
operating systems, including Windows NT, BSD/OS, Solaris and HP-UX. A SmartWall
turnkey system is currently available for BSD/OS.
7
SmartCAT -- The SmartCAT product, when used with the SmartGate server, provides
two-factor identification and mutual authentication using physical smart card
technology. There are three key parts to the SmartCAT product: (i) a standard
smart card (ISO/IEC 7816-3, T=0 compliant), (ii) a smart card reader designed by
the Company, and (iii) the Company's proprietary SmartPass client software.
Together these elements provide smart card-based encryption and authentication
services.
Online Registration Service -- A user must be registered to access an
authentication-based system. The Online Registration Service product is a system
for efficient on-line enrollment of large user communities. The Online
Registration Service completely automates the creation and exchange of the
user's keys and initializes the user's default access privileges. The Online
Registration Service either creates a virtual smart card or formats a physical
smart card that contains a shared secret key that is PIN code protected. Online
registration service is now incorporated in SmartGate server version 2.4 and
SmartPass client version 3.0.
Wallet Technology -- Wallet Technology enables secured electronic credit card
payment transactions over unsecured networks. Wallet Technology encrypts the
credit card information supplied by the purchaser and forwards that information
to the vendor. The vendor adds the purchase value to the encrypted credit card
information and sends all of this information to the credit card
issuer/processor. The issuer/processor decodes this information and either
authorizes or rejects the purchaser's request. The Company's design does not
allow the vendor to view the unencrypted credit card information supplied by the
purchaser. Elements of the Wallet Technology are incorporated in SmartGate.
Network Security Support -- The Company's support staff provides pre-and
post-sales support, vulnerability analysis, performance analysis, systems
integration and system security architecture support. The Company's support
staff also provides fee-based engineering services.
TECHNOLOGY
The cornerstone of the Company's network security solution is its patented
SmartGate client/server security technology. SmartGate enables two-factor
identification, mutual authentication and fine-grained access control for most
TCP/IP-based client/server applications. Using SmartGate technology,
organizations can employ two-factor identification and mutual authentication to
identify and authenticate a network user while fine-grained access control
restricts each user's access to only those services to which the user is
entitled.
Two-Factor Identification -- Two-factor identification employs two independent
components to identify a user using an identity token contained in a physical or
virtual smart card. The information in the physical or virtual smart card is
secured by a PIN code that is set by the user and is not known by anyone else.
SmartCAT provides the means for accessing and using smart cards via smart card
readers. SmartGate client provides the means for using virtual smart cards. Both
physical and virtual smart cards store information about the user including the
user's keys, which are used for authentication. The keys also contain
information that allows the SmartGate client to authenticate the SmartGate
server with which it communicates.
Mutual Authentication -- Mutual authentication employs a dual set of challenges
and encrypted responses that interact to enable both the client and the server
to determine that the other party to the transaction is authorized to
participate in the transaction. SmartGate's mutual authentication employs dual
challenges coupled with encrypted responses to ensure non-repudiation between
the two parties to an electronic transaction. When a client application attempts
to make a connection with an application service protected by a SmartGate
server, the SmartGate client performs a mutual authentication process with the
SmartGate server protecting the application service. During the authentication
process, the SmartGate server sends a challenge to the SmartGate client, and the
SmartGate client uses the secret keys on the physical or virtual smart card to
correctly respond to the challenge. In addition, the SmartGate client sends a
8
challenge to the SmartGate server, and the SmartGate server must prove to the
SmartGate client that the server is the issuer of the client's secret key.
Fine-Grained Access Control -- Fine-grained access control employs access
control lists to compare an identified user's request for services against a
list of entitlements to determine whether to grant the user access to the
requested service. SmartGate employs an access control list to define the
specific Web content page, file or host application that identified users are
permitted to use. If SmartGate determines that the user is permitted to access
the requested service, the connection is passed through the SmartGate server to
the requested service; otherwise the connection is dropped.
In addition to providing identification, authentication and access control, the
SmartGate client and server independently compute a session key for encrypting
the current TCP/IP data stream. The encryption key is computed based on
information exchanged during the authentication process and is never transmitted
over the network.
SALES AND MARKETING
The Company markets its network security products through its "direct touch"
sales force through systems integrators, value-added resellers ("VARs") and
international distributors. The sales organization is equally incented to work
with resellers and channel partners. This agnostic approach anticipates the need
to grow sales via opening new channels. "Direct touch" gives V-ONE the option to
work directly in support of a sales opportunity without requiring the Company to
assume the burden of credit collection or high inventory levels but still ship
direct if required by the end customer. The Company is currently seeking to
expand its sales and marketing staff and intends to devote additional resources
to marketing and business development activities in order to expand its
third-party distribution channels.
Direct Marketing Effort -- The Company has developed its initial marketing and
direct touch sales efforts on key industry participants within certain industry
and market segments, including financial services, telecommunications and
information services companies and government agencies. The Company employs a
direct touch sales force to market its products to these key industry
participants. The Company's direct touch sales force solicits prospective
customers and provides technical advice and support with respect to the
Company's products. The Company anticipates hiring additional sales
representatives and opening regional sales offices in select cities. In 1996,
the Company opened regional sales offices in New York, New York and San
Francisco, California and added a Chicago, Illinois regional sales office in
1997.
Indirect Marketing Effort -- An important component of the Company's sales
strategy is the development of indirect sales channels such as Internet Service
Providers ("ISPs"), systems integrators and value-added network service
providers. The Company utilizes indirect sales channels to leverage the efforts
of its direct sales force. The Company has initiated sales and marketing
programs to sign up integrators, value-added resellers ("VARs") and original
equipment manufacturers within the United States. The Company has signed VAR
agreements with GTE, MCI and GE Information Services, Inc. ("GEIS"). The Company
has established relationships with international distributors in the United
Kingdom, Sweden, Germany, Belgium, Canada, Chile, Japan, Singapore, Korea and
Australia, including relationships with Internet Solutions, Ltd. in the United
Kingdom and ASCII Network Technology, Inc. in Japan.
Strategic Alliance Development -- The Company plans to increase market
penetration by developing and capitalizing upon strategic alliances. These
alliances are intended to increase the distribution and market acceptance of
V-ONE's network security products in markets where direct sales and traditional
indirect sales efforts are not cost-effective. The Company intends to continue
efforts to strengthen its existing relationships while also forging new
relationships with key industry participants.
9
CUSTOMER SERVICE AND SUPPORT
The Company believes that customer support and product maintenance is critical
to retaining existing customers and attracting prospective customers. The
Company provides on-site installation support and basic administrator training
with each turnkey hardware product sale. Each turnkey product comes with 24
hours a day, seven days per week hardware and software support for 90 days. Upon
expiration of the 90-day period, customers may purchase an annual maintenance
plan. Purchasers of the Company's software products may also purchase annual
maintenance plans. The annual maintenance plan provides customers access to the
Company's customer service line, technical support personnel and software
upgrades.
The Company provides additional user or administrator training, on-site support,
vulnerability analysis, performance analysis, systems integration and system
security architecture support as an optional service through its support staff.
Additionally, the Company provides customer support services for those customers
who have entered into an evaluation agreement with the Company.
PRODUCT DEVELOPMENT
The market for the Company's products is dynamic and rapidly changing. The
Company believes that its future success will depend upon its ability to: (i)
enhance its existing products, (ii) identify new opportunities to leverage
existing technologies, and (iii) develop new technologies resulting in new
products, markets and services. Accordingly, the Company expects to continue to
make a significant investment in research and development, product market
analysis and systems integration. The Company believes that its customer-driven
development strategy will enable it to continue to broaden its product
offerings.
COMPETITION
The market for network security products and services is intensely competitive.
The Company expects competition to intensify in the future.
Currently, the Company competes in several different markets, including hardware
assisted encryption devices, token authentication, smart card-based security
applications and electronic commerce applications. The Company's competitors for
Internet and intranet perimeter security and access control include Advanced
Network and Services (a subsidiary of America Online, Inc.), Ascend
Communications, Inc., AXENT Technologies, Inc., Bay Networks, Inc., Check Point
Software Technology Ltd., Cisco Systems, Inc., Digital Equipment Corporation,
Harris Computer Systems Corporation, International Business Machines
Corporation, Milkyway Networks Corporation, Network Systems Corporation, Secure
Computing Corporation, Sun Microsystems, Inc. and Trusted Information Systems,
Inc. ("TIS").
The Company competes to a lesser degree with token vendors because the Company's
SmartGate product supports many vendor tokens. Token vendors include CRYPTOCard
Inc., AXENT Technologies, Inc., Leemah DataCom Security Corporation, National
Semiconductor Inc., Racal-Guardata, Inc. and Security Dynamics Technologies,
Inc. ("Security Dynamics"). Security Dynamics has acquired RSA. RSA's data
encryption and authentication technology is licensed to and incorporated within
certain products of the Company. As a result, Security Dynamics may become a
more substantial competitor of the Company.
For smart card-based security applications, the Company principally competes
with those token vendors listed above who offer smart card technology.
The Company's principal competitors in electronic commerce applications are
Netscape Communication's Secure Socket Layer, Open Market Inc.'s Secure HTTP and
Cylink Corporation's transaction software.
10
Because of the rapid expansion of the network security market, the Company will
face competition from existing and new entrants, possibly including the
Company's customers, suppliers and/or resellers. There can be no assurance that
the Company's competitors will not develop network security products that may be
more effective than the Company's current or future products or that the
Company's technologies and products would not be rendered obsolete by such
developments.
Many of the Company's current and potential competitors have longer operating
histories, greater name recognition, larger installed customer bases and
significantly greater financial, technical and marketing resources than the
Company. As a result, they 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. There
can be no assurance that the Company's customers will not perceive the products
of such other companies as substitutes for the Company's products.
The Company believes that the principal competitive factors affecting the market
for network security products include effectiveness, scope of product offerings,
technical features, ease of use, reliability, customer service and support, name
recognition, distribution resources and price. Current and potential competitors
have established, or may establish in the future, strategic alliances to
increase their ability to compete for the Company's prospective customers.
Accordingly, it is possible that new competitors or alliances may emerge and
rapidly acquire significant market share. Increased competition may result in
price reductions, reduced gross margins and loss of market share, which would
materially adversely affect the Company's business, financial condition and
results of operations.
BACKLOG
The Company's customers order on an as-needed basis. The Company has typically
been able to ship products within 30 days after the customer submits a firm
purchase order. The Company does not generally maintain long-term contracts with
its customers that require customers to purchase its products. Accordingly, the
Company has not maintained and does not anticipate maintaining a backlog.
In 1997, product revenues from Internet Solutions Ltd. and Government Technology
Services, Inc. ("GTSI") accounted for approximately 23% and 11%, respectively,
of total revenues. In 1996, product revenues from MCI and the National Security
Agency ("NSA") accounted for approximately 12% and 12%, respectively, of total
revenues. In 1995, product revenues from GEIS, NCTS Washington, a division of
the Department of the Navy, and the U.S. Defense Information Systems Agency
accounted for approximately 19%, 10%, and 10%, respectively, of total revenues.
SUPPLY SOURCES
Components used in the Company's network security products consist primarily of
computer diskettes and computer magnetic tapes purchased from commercial
vendors. Components used in the Company's turnkey SmartWall and SmartGate server
products consist primarily of off-the-shelf computers, memory, displays, power
supplies and third-party peripherals (such as hard drives and network interface
cards).
The Company has agreements with at least two vendors for each of its parts and
components. However, the Company orders most of each of its parts and components
from a single vendor to maintain quality control and enhance working
relationships. The Company uses smart card readers manufactured by two contract
manufacturers based on the Company's design specifications. The Company has
outsourced to hardware fulfillment companies its hardware and hardware
integration requirements.
While the Company believes that alternative sources of supply could be obtained,
the Company's inability to develop alternative sources if and as required in the
11
future could result in delays or reductions in product shipments that could have
a material adverse effect on the Company's business, financial condition and
results of operations.
REGULATION AND GOVERNMENT CONTRACTS
The Company's information security products are subject to the export
restrictions administered by the U.S. Department of Commerce, which permit the
export of encryption products only with the required level of export license or
through a license exception KMI (Key Management Infrastructure). U.S. export
laws prohibit the export of encryption products to a number of hostile
countries. Although to date the Company has been able to secure all required
U.S. Export licenses, including the license exception KMI, there can be no
assurance that the Company will continue to be able to secure such licenses in a
timely manner in the future, or at all.
In certain foreign countries, the Company's distributors are required to secure
licenses or formal permission before encryption products can be imported. To
date, except for certain limited cases, the Company's distributors have not been
denied permission to import the Company's products.
LICENSE AGREEMENTS
RSA Data Security, Inc. Agreement. The Company's SmartCAT and Wallet Technology
software incorporate data encryption and authentication technology owned by RSA.
The Company has a perpetual license agreement with RSA, which became effective
as of December 30, 1994. On May 23, 1996, RSA exercised an option granted under
the agreement to convert its right to receive future royalties into 2% of the
Company's outstanding voting securities, after giving effect to the issuance to
RSA, until the date of the Company's IPO. Pursuant to a separate agreement
between RSA and Massachusetts Institute of Technology ("MIT"), MIT is entitled
to receive a portion of any royalties that RSA receives. As a result, the
Company issued directly to MIT a portion of the shares of Common Stock to which
RSA was entitled under the RSA Agreement. The Company issued 188,705 shares of
Common Stock to RSA and MIT immediately prior to consummation of the IPO. RSA
was acquired by Security Dynamics in 1996.
There can be no assurance that the Company will be able to maintain its license
rights for the RSA data encryption and authentication technology, and the loss
of such rights could have a material adverse effect on the Company's business,
financial condition and results of operations. If either RSA terminates or fails
to renew the respective license agreement or take any other action that results
in the loss of, or inability to maintain, such licensed technology, the Company
may incur lost sales, delays in delivery of the Company's current products and
services or delays in the introduction of new products and services, which could
have a material adverse effect on the Company's business, financial condition
and results of operations.
PATENTS, PROPRIETARY TECHNOLOGY, TRADEMARKS AND LICENSES
The Company relies on trademark, copyright, patent and trade secret laws,
employee and third-party non-disclosure agreements and other methods to protect
its proprietary rights. The Company has received three patents, which expire in
2013 and 2014, and has pending four patent applications with the United States
Patent and Trademark Office that cover certain aspects of its technology.
Prosecution of these patent applications and any other patent applications that
the Company may subsequently determine to file may require the expenditure of
substantial resources. The issuance of a patent from a patent application may
require 24 months or longer. There can be no assurance that the Company's
technology will not become obsolete while the Company's applications for patents
are pending. There also can be no assurance that any pending or future patent
application will be granted, that any future patents will not be challenged,
invalidated or circumvented or that the rights granted thereunder will provide
competitive advantages to the Company. The Company has pursued patent protection
outside of the United States for the technology covered by the most recently
filed patent applications although there can be no assurance that any such
12
protection will be granted or, if granted, that it will adequately protect the
technology covered thereby.
The Company's success is also dependent in part upon its proprietary software
technology. There can be no assurance that the Company's trade secrets or
non-disclosure agreements will provide meaningful protection for its proprietary
technology and other proprietary information. In addition, the Company relies on
"shrink wrap" license agreements that are not signed by the end user to license
the Company's products and, therefore, may be unenforceable under the laws of
certain jurisdictions. Further, there can be no assurance that others will not
independently develop similar technologies or duplicate any technology developed
by the Company or that its technology will not infringe upon patents, copyrights
or other intellectual property rights owned by others.
Further, 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 protections of the Company's rights may
be ineffective in foreign markets, and technology manufactured or sold abroad
may not be protectable in jurisdictions in circumstances where protection is
ordinarily available in the United States.
The Company believes that, due to the rapid pace of technological innovation for
network security products, the Company's ability to establish and, if
established, maintain a position of technology leadership in the industry is
dependent more upon the skills of its development personnel than upon legal
protections afforded its existing or future technology.
As the number of security products in the industry increases and the
functionality of these products further overlaps, software developers may become
subject to infringement claims. There can be no assurance that third parties
will not assert infringement claims against the Company in the future with
respect to current or future products. The Company also may desire or be
required to obtain licenses from others to effectively develop, produce and
market commercially viable products. Failure to obtain those licenses could have
a material adverse effect on the Company's ability to market its software
security products. There can be no assurance that such licenses will be
obtainable on commercially reasonable terms, if at all, that the patents
underlying such licenses will be valid and enforceable or that the proprietary
nature of the unpatented technology underlying such licenses will remain
proprietary.
There has been, and the Company believes that there may be in the future,
significant litigation in the industry regarding patent and other intellectual
property rights. Although the Company is not currently the subject of any
material intellectual property litigation, litigation involving other software
developers, including companies from which the Company licenses certain
technology, could have a material adverse affect on the Company's business,
financial condition and results of operations.
IMPACT OF THE YEAR 2000 ISSUE ON THE COMPANY
The Year 2000 Issue is the result of computer programs being written using two
digits rather than four digits to define the applicable year. Based on a recent
assessment, the Company has determined that its principle management information
system software, Dynamics and Dynamics C/S+, provided by Great Plains Software,
Inc., Fargo, ND, is year 2000 qualified.
V-ONE's products are year 2000 qualified.
EMPLOYEES
As of February 27, 1998, the Company had 71 full-time employees and 3
consultants. Of these employees and consultants, 37 were in sales and marketing,
13
25 were in development and 12 were in finance and administration. None of the
Company's employees are represented by a labor union or are subject to a
collective bargaining agreement. The Company has never experienced a work
stoppage and believes that its employee relations are good.
RISK FACTORS THAT MAY AFFECT FUTURE RESULTS AND MARKET PRICE OF COMMON STOCK
The Company operates in a rapidly changing environment that involves numerous
risks, some of which are beyond the Company's control. The following discussion
highlights some of the risks the Company faces.
LIMITED OPERATING HISTORY; ACCUMULATED DEFICIT. The Company was founded in
February 1993 and introduced its first product in December 1994. Accordingly,
the Company did not generate any significant revenues until 1995 when it
commenced sales of its SmartWall firewall product and introduced its SmartGate
client/server system. Revenues for 1995, 1996 and 1997 are approximately
$1,104,000, $6,266,000, and $9,403,000. The Company's growth in recent periods
may not be an accurate indication of future results of operations in light of
the Company's short operating history, the evolving nature of the network
security market and the uncertainty of the demand for Internet and intranet
products in general and the Company's products in particular. As of December 31,
1997, the Company had accumulated a deficit of approximately $18,339,000. The
Company currently expects to incur additional net losses over the next several
quarters as a result of operating expenses incurred to fund research and
development and to increase its sales and marketing efforts.
Because of the Company's limited operating history, there can be no assurance
that the Company will achieve or sustain profitability or significant revenues.
To address these risks, the Company must, among other things, continue its
emphasis on research and development, successfully execute and implement its
marketing strategy, respond to competitive developments and seek to attract and
retain talented personnel. There can be no assurance that the Company will
successfully address these risks and the failure to do so could have a material
adverse effect on the Company's business, financial condition and results of
operations.
DEPENDENCE ON KEY PERSONNEL. The Company's success will depend, to a large
extent, upon the performance of its senior management and its technical, sales
and marketing personnel, many of who have only recently joined the Company.
There is keen competition in the software security industry to hire and retain
qualified personnel and the Company is actively searching for additional
qualified personnel. The Company's success will depend upon its ability to
retain and hire additional key personnel. The loss of the services of key
personnel or the inability to attract additional qualified personnel could have
a material adverse effect upon the Company's results of operations and product
development efforts. The Company currently has $1.0 million "key man" life
insurance policies on the lives of each of James F. Chen, its Chairman and
founder, Jieh-Shan Wang, its Senior Vice President of Engineering, and Marcus J.
Ranum, its Chief Scientist (Mr. Ranum is no longer an employee of the Company,
but is serving in this capacity as a consultant). This coverage, however, may
not be sufficient to mitigate the impact that the loss of the services of Mr.
Chen, Mr. Wang or Mr. Ranum would have on the Company. Although the Company has
entered into employment agreements with Mr. Chen and Mr. Wang, as well as with
David D. Dawson, its President and Chief Executive Officer, that provide for
fixed terms of employment, the Company has not historically provided such types
of employment agreements to its other employees, including its executive
officers. This may adversely impact the Company's ability to attract and retain
the necessary technical, management and other key personnel, which could have a
material adverse effect upon the Company's results of operations and product
development efforts.
MANAGEMENT OF GROWTH. The Company has experienced and may continue to experience
substantial growth and turnover in the number of its employees and the scope of
its operations, resulting in increased responsibilities for management and added
pressure on the Company's operating and financial systems. As of February 27,
14
1998, the Company had 71 employees, as compared to 75 employees on January 1,
1997 and 34 employees on January 1, 1996. To manage growth effectively, the
Company will need to continue to improve its operational, financial and
management information systems and will need to hire, train, motivate and manage
a growing number of employees. Competition is intense for qualified technical,
marketing and management personnel. There can be no assurance that the Company
will be able to achieve or manage any future growth, and its failure to do so
could delay product development cycles and marketing efforts or otherwise have a
material adverse effect on the Company's business, financial condition and
results of operations. Although the Company is not currently involved in
negotiations for any acquisitions, the Company may undertake acquisitions in the
future. Any such transaction would place additional strains upon the Company's
management resources.
ANTICIPATED FLUCTUATIONS IN QUARTERLY RESULTS. As a result of the Company's
limited operating history, the Company does not have historical financial data
for a significant number of periods on which to base planned operating expenses.
Accordingly, the Company's expense levels are based in part on its expectations
as to future revenues. The Company's quarterly sales and operating results
generally depend on the volume and timing of, and ability to fill, orders
received within the quarter, which are difficult to forecast. The Company may be
unable to adjust spending in a timely manner to compensate for any unexpected
revenue shortfall. Accordingly, any significant shortfall of demand for the
Company's products in relation to the Company's expectations could have an
immediate adverse impact on the Company's business, financial condition and
results of operations. In addition, the Company plans to increase its operating
expenses to fund the rapid growth of its sales and marketing operations,
distribution channels, customer support capabilities and research and
development activities. To the extent that such expenses precede or are not
subsequently followed by increased revenues, the Company's business, financial
condition and results of operations may be materially adversely affected.
The Company expects to experience significant fluctuations in future quarterly
operating results, which may be caused by a number of factors, such as the
pricing and mix of products and services sold, the introduction of new products
by the Company and its competitors, the timing of orders and the shipment of
products, market acceptance of the Company's products, the ability of the
Company's direct sales force and resellers to market its products successfully,
the mix of distribution channels used and other factors that may be beyond the
Company's control. Thus, the Company believes that comparisons of quarterly
operating results are not 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 Company's Common Stock would likely
be materially adversely affected.
DEPENDENCE ON THE INTERNET AND INTRANETS. The Company's success depends
substantially upon the market acceptance of the Internet and Intranets as
mediums for commerce and communication. Although the Company believes that its
software security products will facilitate and fortify commerce and
communication over the Internet and Intranets, there can be no assurance that
commerce and communication over the Internet and Intranets will expand or that
the Company's products will be adopted for security purposes. In addition, the
Internet may not prove to be a viable commercial marketplace because of
inadequate development of the necessary infrastructure, such as a reliable
network backbone or timely development of complementary products and services.
If the Internet and intranets do not develop as mediums of commerce and
communication or the Internet does not develop as a viable commercial
marketplace due to inadequate development of infrastructure or complementary
products and services, or for other reasons beyond the Company's control, the
Company's business, financial condition and results of operations may be
materially adversely affected.
RISKS ASSOCIATED WITH THE EMERGING NETWORK SECURITY MARKET. The market for the
Company's products is in an early stage of development. The rapid development of
Internet and Intranet computing has increased the ability of users to access
15
proprietary information and resources and has recently increased demand for
network security products. Because the market for network security products is
only beginning to develop, it is difficult to assess the size of the market, the
product features desired by the market, the optimal price structure for the
Company's products, the optimal distribution strategy and the competitive
environment that will develop in this market. Declines in demand for the
Company's products, whether as a result of competition, technological change,
the public's perception of the need for security products, developments in the
hardware and software environments in which these products operate, general
economic conditions or other factors beyond the Company's control, could have a
material adverse effect on the Company's business, financial condition or
results of operations.
DEPENDENCE ON PRINCIPAL PRODUCTS; UNCERTAINTY PRODUCT ACCEPTANCE. The Company
currently generates most of its revenues from its SmartWall and SmartGate
products. Accordingly, any factor that adversely affects sales of these products
could have a material adverse effect on the Company. While SmartWall and
SmartGate have met with a favorable degree of market acceptance since sales of
SmartWall commenced in the first quarter of 1995 and since SmartGate was
introduced in the fourth quarter of 1995, respectively, there can be no
assurance that SmartWall or SmartGate will continue to be accepted in the
future. In addition, there can be no assurance that there will be market
acceptance of any of the Company's products that may be introduced in the
future. The Company's success will, in part, depend upon the Company's ability
to design, develop and introduce new products, services and enhancements on a
timely basis to meet changing customer needs, technological developments and
evolving industry standards.
INTELLECTUAL PROPERTY RIGHTS; INFRINGEMENT CLAIMS. The Company relies on
trademark, copyright, patent and trade secret laws, employee and third-party
non-disclosure agreements and other methods to protect the proprietary rights of
the Company and the companies from which the Company licenses technology.
Prosecution of patent applications and any other patent applications that the
Company may subsequently determine to file may require the expenditure of
substantial resources. The issuance of a patent from a patent application may
require 24 months or longer. There can be no assurance that the Company's
technology will not become obsolete while the Company's applications for patents
are pending. There also can be no assurance that any pending or future patent
application will be granted, that any future patents will not be challenged,
invalidated or circumvented or that the rights granted thereunder will provide
competitive advantages to the Company. The Company currently intends to pursue
patent protection outside of the United States for the technology covered by the
most recently filed patent application although there can be no assurance that
any such protection will be granted or, if granted, that it will adequately
protect the technology covered thereby. The Company currently holds patents on
its Wallet Technology, its SmartGate Technology, and its Smartcard Technology.
The Company's success is also dependent in part upon its proprietary software
technology and technology licensed from others. There can be no assurance that
the Company's trade secrets or license or non-disclosure agreements will provide
meaningful or contractually required protection for the proprietary technology
and other proprietary information of the Company and the companies from which
the Company licenses technology. Further, the Company relies on "shrink wrap"
license agreements that are not signed by the end user to license the Company's
products and, therefore, may be unenforceable under the laws of certain
jurisdictions. In addition, there can be no assurance that others will not
independently develop similar technologies or duplicate any technology developed
by the Company or that its technology will not infringe upon patents, copyrights
or other intellectual property rights owned by others.
Further, the Company may be subject to additional risk as the Company enters
into transactions in countries where intellectual property laws are not well
developed or are poorly enforced. Legal protections of the Company's rights may
be ineffective in foreign markets and technology developed by the Company may
not be protectable in such foreign jurisdictions in circumstances where
protection is ordinarily available in the United States.
16
The Company believes that, due to the rapid pace of technological innovation for
network security products, the Company's ability to establish and, if
established, maintain a position of technology leadership in the industry is
dependent more upon the skills of its development personnel than upon legal
protections afforded its existing or future technology.
As the number of security products in the industry increases and the
functionality of these products further overlap, software developers may become
subject to infringement claims. There can be no assurance that third parties
will not assert infringement claims against the Company in the future with
respect to current or future products. The Company also may desire or be
required to obtain licenses from others in order to develop, produce and market
commercially viable products effectively. Failure to obtain those licenses could
have a material adverse effect on the Company's ability to market its software
security products. There can be no assurance that such licenses will be
obtainable on commercially reasonable terms, if at all, that the patents
underlying such licenses will be valid and enforceable or that the proprietary
nature of the unpatented technology underlying such licenses will remain
proprietary.
Any claims or litigation, with or without merit, could be costly and could
result in a diversion of management's attention, which could have a material
adverse effect on the Company's business, financial condition and results of
operations. Adverse determinations in such claims or litigation could also have
a material adverse effect on the Company's business, financial condition and
results of operations.
RISK OF ERRORS OR FAILURES; PRODUCT LIABILITY RISKS. The complex nature of the
Company's products can make the detection of errors or failures in certain of
its software products difficult when such products are introduced, which may
result in delays and lost revenues during the correction process. In addition,
there can be no assurance that any technology licensed by the Company for use in
its products does not contain errors that would adversely affect such products.
Despite testing by the Company and current and prospective customers, there can
be no assurance that errors will not be discovered in new products or releases
after commencement of commercial shipments, possibly resulting in delay, adverse
publicity, loss of market acceptance and claims against the Company.
A malfunction or the inadequate design of the Company's products could result in
tort or warranty claims. The Company generally attempts to reduce the risk of
such losses to itself and to the companies from which the Company licenses
technology through warranty disclaimers and liability limitation clauses in its
license agreements. There can be no assurance that the Company has obtained
adequate contractual protection in all instances or where otherwise required
under agreements the Company has entered into with others or that such measures
will be effective in limiting the Company's liability to end users and to the
companies from which the Company licenses technology. The Company also relies on
"shrink wrap" license agreements that are not signed by the end user and,
therefore, may be unenforceable under the laws of certain jurisdictions. The
Company currently has product liability insurance. However, there can be no
assurance that adequate insurance coverage was obtained by the Company, and any
product liability claim against the Company for damages resulting from security
breaches could be substantial and could have a material adverse effect on the
Company's business, financial condition and results of operations. In addition,
a well-publicized actual or perceived security breach could adversely affect the
market's perception of security products in general, or the Company's products
in particular, regardless of whether such breach is attributable to the
Company's products. This could result in a decline in demand for the Company's
products, which could have a material adverse effect on the Company's business,
financial condition and results of operations.
CHANGES IN TECHNOLOGY AND INDUSTRY STANDARDS; RISK OF NEW PRODUCT INTRODUCTION.
The network security industry is characterized by rapid changes, including
evolving industry standards, frequent new product introductions, continuing
advances in technology and changes in customer requirements and preferences.
Advances in techniques by individuals and entities seeking to gain unauthorized
access to networks could expose the Company's existing products to new and
unexpected attacks and require accelerated development of new products or
17
enhancements to existing products. There can be no assurance that the Company
will be able to counter challenges to its current products, that the Company's
future product offerings will keep pace with technological changes implemented
by competitors or persons seeking to breach network security, that its products
will satisfy evolving consumer preferences or that the Company will be
successful in developing and marketing products for any future technology.
Failure to develop and introduce new products and product enhancements in a
timely fashion could have a material adverse effect on the Company's business,
financial condition and results of operations.
RISK OF DEFECTS AND DEVELOPMENT COSTS. The Company may experience schedule
overruns in software development triggered by factors such as insufficient
staffing or the unavailability of development-related software, hardware or
technologies. Further, when developing new software products, the Company's
development schedules may be altered as a result of the discovery of software
bugs, performance problems or changes to the product specification in response
to customer requirements, market developments or Company initiated changes.
Changes in product specifications may delay completion of documentation,
packaging or testing, which may, in turn, affect the release schedule of the
product. When developing complex software products, the technology market may
shift during the development cycle, requiring the Company either to enhance or
change a product's specifications to meet a customer's changing needs. These
factors may cause a product to enter the market behind schedule, which may
adversely affect market acceptance of the product or place it at a disadvantage
to a competitor's product that has already gained market share or market
acceptance during the delay.
EVOLVING DISTRIBUTION CHANNELS. The Company has previously relied primarily on
its direct sales force for the sale and marketing of its products, but is now
focusing on a channel distribution strategy. The Company has added to its
internal sales and marketing staff in orders to increase this sales effort.
There can be no assurance the cost of such expansion will not exceed the
revenues generated or that the Company's sales and marketing organization will
successfully compete against the more extensive and well-funded sales and
marketing operations of certain of its current and future competitors.
The Company has developed a distribution strategy that involves the development
of strategic alliances with resellers and international distributors to enable
the Company to achieve broad market penetration. Although the Company has begun
to establish its reseller distribution channel, there can be no assurance that
the Company will be able to continue to attract integrators and resellers that
will be able to market the Company's products effectively and will be qualified
to provide timely and cost-effective customer support and service. The Company
generally ships products to distributors, integrators and resellers on a
purchase-order basis, and its distributors, integrators and resellers generally
carry competing product lines. Therefore, there can be no assurance that any
distributor, integrator or reseller will continue to represent the Company's
products. The inability to recruit, or the loss of, important sales personnel,
distributors, integrators or resellers could materially adversely affect the
Company's business, financial condition and results of operations in the future.
In addition, the Company has experienced difficulty in collecting, on a timely
basis, receivables from these distributors. Although the Company has begun to
make efforts to collect these receivables on a timely basis, there can be no
assurance that the Company will be able to do so and the failure to collect such
receivables could have a material adverse effect on the Company's financial
condition and results of operations.
INTERNATIONAL SALES. The Company has increased its presence in overseas markets
by expanding international distribution relationships for its suite of network
security products, including SmartWall and SmartGate. There can be no assurance,
however, that the Company will be successful in expanding its relationships with
international distributors or in gaining commercial acceptance of its products
abroad. To the extent that the Company expands international sales, currency
fluctuations could make its products less competitive in foreign markets and
contribute to fluctuations in the Company's operating results. Political
18
instability, difficulties in staffing and managing international operations,
potential insolvency of international resellers, longer receivable collection
periods and difficulty in collecting accounts receivable also pose risks to the
development of international marketing efforts. Moreover, the laws of certain
countries, or the enforcement thereof, may not protect the Company's products
and intellectual property rights to the same extent as the laws of the United
States. There can be no assurance that these factors will not have a material
adverse effect on the Company's business, financial condition and results of
operations.
LONG SALES CYCLE; SEASONALITY. Sales of the Company's products generally involve
a significant commitment of capital by customers, with the attendant delays
frequently associated with large capital expenditures. Prior to such sales, the
Company often permits customers to evaluate products being considered for
license, generally for a period of up to 30 days. For these and other reasons,
the sales cycle associated with the Company's products is likely to be lengthy
and subject to a number of significant risks over which the Company has little
or no control and, as a result, the Company believes that its quarterly results
are likely to vary significantly in the future. The Company may be required to
ship products shortly after it receives orders and, consequently, order backlog,
if any, at the beginning of any period may represent only a small portion of
that period's expected revenues. As a result, product revenues in any period
will be substantially dependent on orders booked and shipped in that period. The
Company plans its production and inventory levels based on internal forecasts of
customer demand, which is highly unpredictable and can fluctuate substantially.
If revenues fall significantly below anticipated levels, the Company's financial
condition and results of operations could be materially and adversely affected.
In addition, the Company may experience significant seasonality in its business,
and the Company's financial condition and results of operations may be affected
by such trends in the future. Such trends may include higher revenues in the
third and fourth quarters of the year and lower revenues in the first and second
quarters. The Company believes that revenues may tend to be higher in the third
quarter due to the fiscal year end of the U.S. Government and higher in the
fourth quarter due to year-end budgetary pressures on the Company's commercial
customers and the tendency of certain of its existing and prospective customers
to implement changes in computer or network security prior to the end of the
calendar year.
LIQUIDITY AND CAPITAL REQUIREMENTS; DEPENDENCE ON THE PUBLIC OFFERING. The
Company anticipates that its existing capital resources will be adequate to
satisfy its capital requirements at least through March 31, 1999. The Company's
future capital requirements, however, will depend on many factors, including its
ability to successfully market and sell its products. To the extent that the
funds generated by the Company's initial public offering in 1996, the recent
sale of 4,000 shares of Series A Stock (see "Market for Registrant's Common
Equity and Related Stockholder Matters"), and from the Company's on-going
operations are insufficient to fund the Company's future operating requirements,
it may be necessary to raise additional funds through public or private
financings. Any equity or debt financings, if available at all, may be on terms
that are not favorable to the Company and, in the case of equity financings,
could result in dilution to the Company's shareholders. If adequate capital is
not available, the Company may be required to curtail its operations
significantly.
RISK OF SALES TO U.S. GOVERNMENT. In 1995, the Company derived a substantial
portion of its revenue from the sale of SmartWall to departments and agencies of
the U.S. Government and government contractors. In 1996, the Company's revenues
were attributable, in part, to a contract with the National Security Agency. In
1997, approximately one-third of the Company's total sales were attributable to
contracts with various agencies and departments of the United States government
and of state and local governments. Because no government agency or department
has an obligation to award contracts to, or to purchase products from, the
Company in the future, the Company believes that future government contracts and
orders for its network security products will in part be dependent upon the
continued favorable reaction of government agencies and departments to the
development capabilities of the Company and the reliability and perception of
its products. There can be no assurance that the Company will be able to sell
its products to government departments and agencies and government contractors
or that such sales, if any, will result in commercial acceptance of the
Company's products. In addition, reductions or delays in funds available for
19
projects the Company is performing or to purchase its products could have an
adverse impact on the Company's government contracts business.
Contracts involving the U.S. government are also subject to the risks of
disallowance of costs upon audit, changes in government procurement policies,
the necessity to participate in competitive bidding and, with respect to
contracts involving prime contractors or government-designated subcontractors,
the inability of such parties to perform under their contracts. The Company is
also exposed to the risk of increased or unexpected costs, causing losses or
reduced profits, under government and certain third-party contracts. Any of the
foregoing events could have a material adverse effect on the Company's business,
financial condition and results of operations.
EFFECT OF GOVERNMENT REGULATIONS OF TECHNOLOGY EXPORTS. The Company currently
sells its products abroad and intends to continue to expand its relationships
with international distributors for the sale of its products overseas. The
Company's international sales and operations could be subject to risks such as
the imposition of governmental controls, export license requirements,
restrictions on the export of critical technology, trade restrictions and
changes in tariffs. In particular, the Company's information security products
are subject to the export restrictions administered by the U.S. Department of
Commerce, which, in the case of some products, permit the export of encryption
products only with a specific export license. These export laws also prohibit
the export of encryption products to a number of countries, individuals and
entities and may restrict exports of some products to a narrow range of
end-users. In certain foreign countries, the Company's distributors are required
to secure licenses or formal permission before encryption products can be
imported. While the Company has obtained a license exception to export strong
encryption from the U. S. Department of Commerce, there is no assurance that the
Company or its distributors will be able to secure required licenses in a timely
manner, if at all. As a result, foreign competitors that face less stringent
controls on their products may be able to compete more effectively than the
Company in the global network security market. There can be no assurance that
these factors will not have a material adverse effect on the Company's business,
financial condition and results of operations.
MARKET VOLATILITY. The market price of the Company's Common Stock could be
subject to significant fluctuations in response to variations in quarterly
operating results and other factors, such as announcements of new products by
the Company or its competitors and changes in financial estimates by securities
analysts or other events. Moreover, the stock market has experienced extreme
volatility that has particularly affected the market prices of equity securities
of many technology companies and that has often been unrelated and
disproportionate to the operating performance of such companies. Broad market
fluctuations as well as economic conditions generally and in the software
industry specifically, may adversely affect the market price of the Company's
Common Stock.
EXECUTIVE OFFICERS AND DIRECTORS OF THE REGISTRANT
The executive officers and directors of the Company, and their respective ages
at December 31, 1997, are as follows:
NAME AGE POSITION
James F. Chen 47 Chairman of the Board and Director
David D. Dawson 50 President, Chief Executive Officer and Director
Jieh-Shan Wang 43 Senior Vice President and Chief Technical Officer
Charles B. Griffis 53 Senior Vice President, Chief Financial Officer and Treasurer
Christopher T. Brook 58 Vice President of Product Development
20
Charles C. Chen 43 Director
Harry S. Gruner 38 Director
William E. Odom 65 Director
JAMES F. CHEN founded the Company in February 1993 and has since served as a
director. From inception until November 21, 1997, Mr. Chen served as the
Company's President and Chief Executive Officer. On November 21, 1997, Mr. Chen
was elected Chairman of the Board. From 1980 to 1990, Mr. Chen managed
INTELSAT's worldwide ground network engineering projects. From 1990 to January
1993, he managed the INTELSAT Ground Network Engineering Department and, from
March 1992 to January 1993, he also directed its Management Information Systems
Division. Mr. Chen holds an M.S. in Computer Science from George Washington
University and a B.S. in Electrical Engineering from Georgia Institute of
Technology. He is Charles C. Chen's brother.
DAVID D. DAWSON has served as the President and Chief Executive Officer of the
Company since November 21, 1997 and as a director since December 12, 1997. From
March 1996 until November 1997, he served as General Manager of Ascend
Communications, Inc., a data communications hardware company. From April 1994
until March 1996, he served as Chief Operating Officer, and from November 1995
until March 1996, he served as Chief Executive Officer of Morning Star
Technologies, a firewall and communications company. From October 1992 until
April 1994, he was Vice President of Development for Net Express Systems, a data
communications hardware company. Mr. Dawson holds an M.S. in Computer Science
from Fairleigh Dickinson University, an M.S. in Operations Research from Air
Force Institute of Technology, and a B.S. in Electrical Engineering from the
United States Military Academy at West Point.
JIEH-SHAN WANG, Ph.D. has been with the Company since its inception and has
served as the Company's Senior Vice President and Chief Technical Officer since
January 1997. From April 1996 to December 1996, Dr. Wang served as the Company's
Senior Vice President and Chief Technical Officer, from August 1995 to April
1996, Dr. Wang served as the Company's Vice President of Engineering and, from
April 1994 to August 1995, he served as Chief Engineer. Dr. Wang was with
INTELSAT from June 1991 to April 1994, as Senior Systems Engineer, where he led
a team of engineers in the development of network applications. Dr. Wang holds a
Ph.D. in Physics from the University of Maryland and a B.S. in Physics from
National Taiwan University.
CHARLES B. GRIFFIS has served as the Company's Senior Vice President and Chief
Financial Officer since September 1996 and began serving as the Company's
Treasurer as of January 1, 1997. Prior to joining the Company, Mr. Griffis
served as Senior Vice President and Chief Financial Officer of Masstor Systems
Corporation, a company that filed a petition for reorganization under Chapter 11
of the United States Bankruptcy Code on September 8, 1994, from April 1990 to
September 1996. From November 1983 to April 1990, Mr. Griffis served as a
General Partner of Griffis, Sandler & Co., a private venture capital firm, and
as President of Charles Griffis & Co., Inc., a business consulting firm. Mr.
Griffis holds an M.B.A. in Finance from Columbia University and a B.A. in
History from Yale University.
CHRISTOPHER T. BROOK has served as the Company's Vice President of Product
Development since February 1997. From September 1996 to February 1997, Mr. Brook
served as the Company's Director of Product Development. Mr. Brook was with GE
Information Services, Inc. for approximately 27 years prior to joining the
Company, holding a number of technology-related positions including Manager of
Directory Services and Network Architecture, Manager of Network Architecture and
most recently, Manager of Emerging Technology, where Mr. Brook was responsible
for investigating new information technologies. Mr. Brook graduated from Clifton
College (Bristol, England) with an emphasis in the Classics.
21
CHARLES C. CHEN, D.D.S has served as a director of the Company since February
1993 and as the Company's Secretary from December 12, 1995 until February 2,
1998. Since July 1982, Dr. Chen has practiced periodontics with Zupnik, Winson &
Chen, D.D.S.P.A. Dr. Chen holds a D.D.S. from the Baltimore College of Dental
Surgery, University of Maryland, and a B.S. in Chemistry from the University of
Maryland. He is James F. Chen's brother.
HARRY S. GRUNER has served as a director of the Company since June 1996. Since
November 1992, he has been a general partner of JMI Equity Fund, a private
equity investment partnership. From August 1986 to October 1992, Mr. Gruner was
with Alex. Brown & Sons Incorporated, most recently as a principal. Mr. Gruner
is also a director of the META Group, Inc., a syndicated information technology
research company, and Hyperion Software, Inc., a financial software company, and
numerous other privately held companies. Mr. Gruner holds an M.B.A. from Harvard
Business School and a B.A. in History from Yale University.
(RETIRED) LT. GEN. WILLIAM E. ODOM has served as a director of the Company since
June 1996. Since October 1988, General Odom has served as Director of National
Security Studies at the Hudson Institute. He has also served as an adjunct
professor at Yale University since January 1989. Prior to his retirement from
the military in 1988, General Odom held several military posts including,
Director of the National Security Agency, Assistant Chief of Staff for
Intelligence and Military Assistant to the National Security Advisor during the
Carter Administration. He is also a director of Nichols Research Corporation,
American Technologies Group and American Science & Engineering. General Odom
holds an M.A. and Ph.D. from Columbia University and a B.S. from the United
States Military Academy at West Point.
ITEM 2. PROPERTIES
The Company leases approximately 28,312 square feet of office space in
Germantown, Maryland under a lease agreement that will expire on July 1, 2003.
The Company expects that this space will be sufficient for its needs through
March 31, 1999. The Company also leases approximately 10,699 square feet, which
is sublet in Rockville, Maryland under leases that will expire on April 17,
2001.
The Company also leases office space in Rochelle Park, New Jersey, Chicago,
Illinois and Walnut Creek, California under leases that can be extended on a
month to month basis.
ITEM 3. LEGAL PROCEEDINGS
The Company is not a party to any material legal proceedings.
22
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's security holders during the
quarter ended December 31, 1997.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock has been traded in the Nasdaq National Market since
the Company's IPO on October 24, 1996. According to records of the Company's
transfer agent, the Company had approximately 73 stockholders of record on March
23, 1998. Because brokers and other institutions hold many of such shares on
behalf of stockholders, the Company is unable to estimate the total number of
stockholders represented by these record holders. The following table sets forth
the low and high sale prices as of the close of market of the Company's Common
Stock from the time of the Company's IPO for each quarter through the quarter
ending December 31, 1997 and through the period ended March 23, 1998.
1996
----
High Sale Price Low Sale Price
--------------- --------------
Fourth Quarter $7.750 $4.750
1997
----
High Sale Price Low Sale Price
--------------- --------------
First Quarter $9.250 $5.375
Second Quarter $6.375 $4.000
Third Quarter $6.250 $3.000
Fourth Quarter $5.063 $2.750
1998
----
High Sale Price Low Sale Price
--------------- --------------
First Quarter through
March 23, 1998 $4.125 $2.250
The Company has never declared or paid cash dividends on its Common Stock or
other securities. The Company anticipates that all of its net earnings, if any,
will be retained for use in its operations and does not anticipate paying cash
dividends on its Common Stock in the foreseeable future. Payments of future cash
dividends, if any, will be at the discretion of the Company's Board of Directors
after taking into account various factors, including the Company's financial
condition, operating results and current and anticipated cash needs. No
dividends may be paid on the Common Stock until all accrued and unpaid
dividends, if any, are paid on the Series A Stock.
23
SERIES A CONVERTIBLE PREFERRED STOCK
On December 8, 1997, the Company issued 4,000 shares of Series A Stock to
Advantage for $4 million in the aggregate. Each share of Series A Stock is
convertible into shares of Common Stock and warrants to purchase shares of
Common Stock ("Series A Warrants").
As a result of the issuance of the 4,000 shares of Series A Stock, the Company
issued to Wharton Capital Partners, Ltd. ("Wharton") for its services as the
Company's exclusive financial consultant, warrants ("Consultant Warrants") to
purchase 60,000 shares of Common Stock at an exercise price of $4.725 per share.
As of January 5, 1998, Wharton assigned Consultant Warrants to purchase 12,000
shares of Common Stock to Dennis Rush. The number of shares issuable on exercise
of the Consultant Warrants and the exercise price per share is subject to
adjustment in certain circumstances. The Company also paid Wharton a fee of
$200,000. The Consultant Warrants expire on December 8, 2002. The terms of the
Series A Stock and the Consultant Warrants were determined by the Company's
Board of Directors.
The shares of Series A Stock, Series A Warrants and Consultant Warrants were
issued in reliance on Rule 506 of Regulation D.
On December 8, 1997, the Company and Advantage entered into a commitment letter
("Commitment Letter") pursuant to which Advantage agreed to purchase shares of a
new series of preferred stock for $4 million on the same terms and conditions as
the Series A Stock, subject to certain conditions, some of which are that (1)
the Company obtain shareholder approval with respect to the issuance of the
Series A Stock and any new series of preferred stock pursuant to certain rules
of the Nasdaq National Market, (2) the Company's stockholders' equity, including
the Series A Stock, is at least $13.5 million, and (3) the ratio of the
Company's total liabilities to stockholders' equity, including the Series A
Stock, is not less than 1:4. The commitment becomes effective April 21, 1998 and
expires on December 8, 1998. The Company may terminate the Commitment Letter at
any time, on ten days' prior notice. Advantage also has the right to terminate
the Commitment Letter in certain circumstances. The Company is obligated to pay
Advantage a non-refundable commitment fee of $3,333 per month during the stated
commitment period.
Under the Subscription Agreement dated as of December 3, 1997 between the
Company and Advantage, (1) the Company agreed not to sell any equity securities
or securities convertible into equity securities entitling the holder to
purchase shares of the Company's Common Stock at a price below the market price
of the Common Stock on the date of such issuance or acquisition ("Discounted
Securities") until April 21, 1998 and (2) the Company granted Advantage a right
of first refusal on sales of Discounted Securities until December 8, 1998. Under
a letter dated October 22, 1997 between the Company and Wharton ("Wharton
Letter"), the Company retained Wharton as its exclusive financial consultant and
granted Wharton an exclusive on certain offshore or discounted financings for a
period that ended on March 22, 1998 and a right of first refusal on any offshore
or discounted financings until June 8, 1998. Wharton has agreed that its rights
as described in the preceding sentence are subject and secondary to the rights
of Advantage and do not apply to any sale of preferred stock pursuant to the
Commitment Letter.
Under the Wharton Letter, the Company is obligated to issue additional warrants
to Wharton to purchase 15,000 shares of Common Stock for each $1 million of
additional financing provided by persons introduced by Wharton (including the
transaction contemplated by the Commitment Letter) at an exercise price of
$4.725 per share and to pay Wharton a consulting fee equal to 5% of the amount
raised.
The net proceeds of the offering ($3.8 million) have been, and the net proceeds
of any additional issuance pursuant to the Commitment Letter will be, used for
general working capital purposes.
On December 3, 1997, the Company entered into a registration rights agreement
with Advantage ("Advantage Registration Rights Agreement") and, on December 8,
24
1997, the Company entered into a registration rights agreement with Wharton
("Wharton Registration Rights Agreement" and, collectively with the Advantage
Registration Rights Agreement, the "Registration Rights Agreements"). As of
January 5, 1998, Dennis Rush became a beneficiary of the Wharton Registration
Rights Agreement. Under the Registration Rights Agreements, the Company was
obligated to file a registration statement with the Securities and Exchange
Commission ("SEC") by January 7, 1998 registering the shares of Common Stock
issuable upon conversion of the Series A Stock and the shares of Common Stock
issuable on exercise of the Series A Warrants and the Consultant Warrants. This
registration statement was timely filed and has been declared effective by the
SEC. Advantage, Wharton and Rush have also been granted certain piggyback
registration rights.
The following is a summary of the terms and features of the Series A Stock:
DIVIDENDS. Each share of Series A Stock is entitled to receive dividends at a
rate of $50.00 per annum, which are cumulative and accrue without interest
(other than with respect to dividends in arrears). Dividends are payable on
March 1, June 1, September 1 and December 1 of each year. Dividends not paid
when due bear interest at 12% per annum. The Company may pay dividends on the
Series A Stock in shares of Common Stock valued at the "Computed Price" of the
Common Stock. The "Computed Price" of a share of Common Stock is the product of
the applicable "Conversion Percentage" (which term is described below) and the
"Average Market Price." The "Average Market Price" is the average of the lowest
sale price on the Nasdaq National Market on each of the five trading days having
the lowest sale price during the 25 consecutive trading days prior to the
measurement date, which in the case of a dividend paid in shares of Common Stock
is the dividend payment date.
No dividends may be paid on any parity dividend stock or junior dividend stock
(such as the Common Stock) until all accrued and unpaid dividends are paid on
the Series A Stock.
CONVERSION RIGHTS. Each share of Series A Stock is convertible at the option of
the holder into shares of Common Stock and Series A Warrants. The number of
Series A Warrants issuable on conversion of a share of Series A Stock is the
number of shares of Common Stock issued on conversion per share of Series A
Stock divided by 5. The exercise price per share of each Series A Warrant is
$4.77 per share. Each Series A Warrant is exercisable for 5 years from the date
of conversion. The number of shares of Common Stock issuable on exercise of the
Series A Warrants and the exercise price per share is subject to adjustment in
certain circumstances.
The number of shares of Common Stock issuable per share of Series A Stock is
determined by dividing the sum of (a) $1,000, (b) accrued and unpaid dividends,
and (c) interest on dividends in arrears ("Conversion Amount") by the lesser of
(1) $4.77 ("Ceiling Price") and (2) the product of the applicable Conversion
Percentage and the Average Market Price on the conversion date. The "Conversion
Percentage" is generally 85%; however, if (1) the registration statement ceases
to be available for use by any holder of Series Stock that is named therein as a
selling stockholder for any reason, or (2) a holder of Series A Stock becomes
unable to convert any shares of Series A Stock in accordance with the
Certificate of Designations of Series A Convertible Preferred Stock ("Series A
Certificate") (other than by reason of the 4.9% limitation described below),
then (A) the applicable Conversion Percentage is permanently reduced by 2% per
month up to a maximum aggregate reduction in the Conversion Percentage of 10%
and (B) the Ceiling Price is permanently reduced by $.0954 per month up to a
maximum aggregate reduction in the Ceiling Price of $.477. However, in lieu of
each such reduction, the Company can make cash payments equal to 2% of the
aggregate subscription price per share ($1,000 per share) of Series A Stock
(which amount is limited to 10% of the aggregate subscription price). The
Conversion Amount is adjusted in the event the Company issues certain rights or
warrants or distributes to the holders of securities junior to the Series A
Stock evidences of indebtedness or assets.
25
No holder of Series A Stock is entitled to receive shares of Common Stock on
conversion of its Series A Stock or on exercise of its Series A Warrants to the
extent that the sum of (1) the shares of Common Stock owned by such holder and
its affiliates and (2) the shares of Common Stock issuable on conversion of the
Series A Stock and on exercise of its Series A Warrants would result in
beneficial ownership by such holder and its affiliates of more than 4.9% of the
outstanding shares of Common Stock. Beneficial ownership for this purpose is
determined in accordance with Section 13(d) of the Securities Exchange Act of
1934, excluding shares of Common Stock so owned through ownership of unconverted
shares of Series A Stock and unexercised Series A Warrants.
If a holder tenders his or her shares of Series A Stock for conversion and does
not receive certificates for all of the shares of Common Stock and Series A
Warrants to which such holder is entitled when required, then, among other
things, the Ceiling Price otherwise applicable to such conversion is reduced by
$.0954 and the Conversion Percentage otherwise applicable to such conversion is
reduced by 2%.
RANKING. The Series A Stock ranks (1) senior to the Common Stock, (2) on a
parity with any additional series of the class of preferred stock, which series
the Board of Directors may from time to time authorize, (3) on a parity with the
shares of any additional class of preferred stock (or series of preferred stock
of such class) that the Board of Directors or the stockholders may from time to
time authorize, which class (or series thereof) by its terms ranks on a parity
with the shares of Series A Stock and (4) senior to any other class or series of
preferred stock (other than as stated in the immediately preceding clauses (2)
and (3)) of the Company.
STATED CAPITAL. Under the Series A Certificate, the amount to be represented in
stated capital at all times for each share of Series A Stock is required to be
the greater of (i) the quotient obtained by dividing (a) the sum of (1) $1,000,
(2) to the extent legally available, the accrued but unpaid dividends on such
share of Series A Stock, and (3) an amount equal to the accrued and unpaid
interest on dividends in arrears through the date of determination by (b) the
applicable Conversion Percentage and (ii) an amount equal to the product
obtained by multiplying (x) the number of shares of Common Stock that would, at
the time of such determination, be issuable on conversion of one share of Series
A Stock and any accrued and unpaid dividends thereon and any accrued and unpaid
interest on dividends thereon in arrears (determined without regard to the 4.9%
limitation) times (y) the arithmetic average of the closing bid price of the
Common Stock for the five consecutive trading days ending one trading day prior
to the date of such determination. The Company is required to take such action
as may be required to maintain the required amount of stated capital not less
frequently than monthly.
VOTING RIGHTS. The Series A Stock generally has no voting rights except as
otherwise provided by the Delaware General Corporation Law. However, the
affirmative vote or consent of the holders of a majority of the outstanding
shares of the Series A Stock, voting separately as a class, will be required for
(1) any amendment, alteration or repeal, whether by merger or consolidation or
otherwise, of the Company's Certificate of Incorporation if the amendment,
alteration or repeal materially and adversely affects the powers, preferences or
special rights of the Series A Stock, or (2) the creation and issuance of any
security of the Company that is senior to the Series A Stock as to dividend
rights or liquidation preference; provided, however, that any increase in the
authorized preferred stock of the Company or the creation and issuance of any
stock that is both junior as to dividend rights and liquidation preference is
not deemed to affect materially and adversely such powers, preferences or
special rights and any such increase or creation and issuance may be made
without any such vote by the holders of Series A Stock except as otherwise
required by law.
MANDATORY REDEMPTION. The Series A Certificate provides that the Company is not
obligated to issue, upon conversion of the Series A Stock, more than the number
of shares of Common Stock that the Company may issue pursuant to the rules of
Nasdaq ("Maximum Share Amount"), less the aggregate number of shares of Common
Stock issued by the Company as dividends on the Series A Stock. The Company is
26
seeking approval from the holders of Common Stock to issue shares of Common
Stock in connection with the Series A Stock in excess of the amounts permitted
by Nasdaq Rule 4460(i)(1)(D).
If the Company would not be obligated to convert shares of Series A Stock
because of the Maximum Share Amount limitation, the Company is required to give
a notice to that effect to each holder of Series A Stock. In such event, a
holder may require the Company to redeem such portion of its Series A Stock that
cannot be converted as a result of this limitation at the "Share Limitation
Redemption Price" per share. The "Share Limitation Redemption Price" is the
greater of (i) the quotient obtained by dividing (a) the sum of (1) $1,000, (2)
an amount equal to the accrued but unpaid dividends on the share of Series A
Stock to be redeemed, and (3) an amount equal to the accrued and unpaid interest
on dividends in arrears on such share through the applicable redemption date by
(b) the applicable Conversion Percentage and (ii) an amount equal to the product
obtained by multiplying (x) the number of shares of Common Stock that would, but
for the redemption pursuant to this provision of the Series A Certificate, be
issuable on conversion of one share of Series A Stock and any accrued and unpaid
dividends thereon and any accrued and unpaid interest on dividends thereon in
arrears (determined without regard to the 4.9% limitation) times (y) the
arithmetic average of the closing bid price of the Common Stock for the five
consecutive trading days ending one trading day prior to the redemption date.
In addition, the Company is obligated to redeem all outstanding shares of Series
A Stock on December 8, 2000 at the "Redemption Price" per share. The "Redemption
Price" is the greater of (i) the quotient obtained by dividing (a) the sum of
(1) $1,000, (2) an amount equal to the accrued but unpaid dividends on the share
of Series A Stock to be redeemed, and (3) an amount equal to the accrued and
unpaid interest on dividends in arrears on such share through the applicable
redemption date by (b) the applicable Conversion Percentage and (ii) an amount
equal to the product obtained by multiplying (x) the number of shares of Common
Stock that would, but for the redemption pursuant to this provision of the
Series A Certificate, be issuable on conversion of one share of Series A Stock
and any accrued and unpaid dividends thereon and any accrued and unpaid interest
on dividends thereon in arrears (determined without regard to the 4.9%
limitation) times (y) the arithmetic average of the closing bid price of the
Common Stock for the five consecutive trading days ending one trading day prior
to the redemption date.
OPTIONAL REDEMPTION BY THE COMPANY. As long as the Company is in compliance in
all material respects with its obligations to the holders of Series A Stock
under the Series A Certificate and the Advantage Registration Rights Agreement,
the Company may redeem all or, from time to time, part of the outstanding shares
of Series A Stock at the Redemption Price per share.
OPTIONAL REDEMPTION BY THE HOLDERS OF SERIES A STOCK. In the event an "Optional
Redemption Event" occurs, each holder of Series A Stock has the right to require
the Company to redeem all or a portion its shares of Series A Stock at the
"Optional Redemption Price" per share. "Optional Redemption Event" means any one
of the following: (1) for any period of five consecutive trading days there is
no closing bid price of the Common Stock on any national securities exchange or
the Nasdaq National Market; (2) the Common Stock ceases to be listed for trading
on the Nasdaq National Market, the New York Stock Exchange ("NYSE"), the
American Stock Exchange ("AMEX") or the Nasdaq SmallCap Market; (3) the
inability for 30 or more days (whether or not consecutive) of any holder of
shares of Series A Stock who is entitled to optional redemption rights to sell
such shares of Common Stock issued or issuable on conversion of shares of Series
A Stock pursuant to the registration statement for any reason on each of such 30
days; (4) the Company fails or defaults in the timely performance of any
material obligation to a holder of shares of Series A Stock under the terms of
the Series A Certificate or under the Advantage Registration Rights Agreement or
any other agreements or documents entered into in connection with the issuance
of shares of Series A Stock; (5) any consolidation or merger of the Company with
or into another entity (other than a merger or consolidation of a subsidiary of
the Company into the Company or a wholly owned subsidiary of the Company) where
the shareholders of the Company immediately prior to such transaction do not
collectively own at least 51% of the outstanding voting securities of the
27
surviving corporation of such consolidation or merger immediately following such
transaction or the common stock of such surviving corporation is not listed for
trading on the Nasdaq National Market, the NYSE, the AMEX or the Nasdaq SmallCap
Market; or (6) the taking of any action, including any amendment to the
Company's Certificate of Incorporation, that materially and adversely affects
the rights of any holder of shares of Series A Stock.
The "Optional Redemption Price" is the greater of (i) the quotient obtained by
dividing (a) the sum of (1) $1,000, (2) an amount equal to the accrued but
unpaid dividends on the share of Series A Stock to be redeemed, and (3) an
amount equal to the accrued and unpaid interest on dividends in arrears on such
share through the applicable redemption date by (b) the applicable Conversion
Percentage and (ii) an amount equal to the product obtained by multiplying (x)
the number of shares of Common Stock that would, but for the redemption pursuant
to this provision of the Series A Certificate, be issuable on conversion of one
share of Series A Stock and any accrued and unpaid dividends thereon and any
accrued and unpaid interest on dividends thereon in arrears (determined without
regard to the 4.9% limitation) times (y) the arithmetic average of the closing
bid price of the Common Stock for the five consecutive trading days ending one
trading day prior to the redemption date.
LIMITATIONS ON REDEMPTIONS AND TENDER OFFERS. Neither the Company nor any
subsidiary of the Company may redeem, repurchase or otherwise acquire any shares
of Common Stock or other securities of the Company junior to the Series A Stock
in dividend rights or liquidation preference ("Junior Stock") if the number of
shares so repurchased, redeemed or otherwise acquired in such transaction or
series of related transactions (excluding any shares surrendered to the Company
in accordance with one of its stock option plans) is more than either (x) 5% of
the number of shares of Common Stock or such Junior Stock, as the case may be,
outstanding immediately prior to such transaction or series of related
transactions or (y) 1% of the number of shares of Common Stock or Junior Stock,
as the case may be, outstanding immediately prior to such transaction or series
of related transactions if such transaction or series of related transactions is
with any one person or group of affiliated persons, unless the Company or such
subsidiary offers to purchase for cash from each holder of shares of Series A
Stock at the time of such redemption, repurchase or acquisition the same
percentage of such holder's shares of Series A Stock as the percentage of the
number of outstanding shares of Common Stock or Junior Stock, as the case may
be, to be so redeemed, repurchased or acquired at a purchase price per share of
Series A Stock equal to the greater of (i) the quotient obtained by dividing (a)
the sum of (1) $1,000, (2) an amount equal to the accrued but unpaid dividends
on such share of Series A Stock, plus (3) an amount equal to the accrued and
unpaid interest on dividends in arrears through the date of purchase by (b) the
applicable Conversion Percentage and (ii) an amount equal to the product
obtained by multiplying (x) the number of shares of Common Stock that would, but
for this purchase, be issuable on conversion of one share of Series A Stock and
any accrued and unpaid dividends thereon and any accrued and unpaid interest on
dividends thereon in arrears (determined without regard to the 4.9% limitation)
times (y) the arithmetic average of the closing bid price of the Common Stock
for the five consecutive trading days ending one trading day prior to the date
of purchase.
Neither the Company nor any subsidiary of the Company may (1) make any tender
offer or exchange offer ("Tender Offer") for outstanding shares of Common Stock,
unless the Company contemporaneously therewith makes an offer, or (2) enter into
an agreement regarding a Tender Offer for outstanding shares of Common Stock by
any person other than the Company or any subsidiary of the Company, unless such
person agrees with the Company to make an offer, in either such case to each
holder of outstanding shares of Series A Stock to purchase for cash at the time
of purchase in such Tender Offer the same percentage of shares of Series A Stock
held by such holder as the percentage of outstanding shares of Common Stock
offered to be purchased in such Tender Offer at a price per share of Series A
Stock equal to the greater of (i) the quotient obtained by dividing (a) the sum
of (1) $1,000, (2) an amount equal to the accrued but unpaid dividends on such
share of Series A Stock, and (3) an amount equal to the accrued and unpaid
interest on dividends in arrears through the date of purchase by (b) the
applicable Conversion Percentage and (ii) an amount equal to the product
obtained by multiplying (x) the number of shares of Common Stock that would, but
28
for this purchase, be issuable on conversion of one share of Series A Stock and
any accrued and unpaid dividends thereon and any accrued and unpaid interest on
dividends thereon in arrears (determined without regard to the 4.9% limitation)
times (y) the highest price per share of Common Stock offered in such Tender
Offer.
SINKING FUND. The shares of Series A Stock are not subject to the operation of a
purchase, retirement or sinking fund.
LIQUIDATION PREFERENCE. The holders of the Series A Stock are entitled to a
liquidation preference of $1,000 per share plus accrued and unpaid dividends
plus interest on accrued and unpaid dividends in arrears.
WARRANT GRANTED TO DAVID D. DAWSON
On November 21, 1997, the Company issued warrants to purchase 300,000 shares of
Common Stock at an exercise price of $3.125 per share to its President and Chief
Executive Officer, David D. Dawson, in connection with his employment by the
Company. These warrants were issued in reliance on Rule 506 of Regulation D.
WARRANT GRANTED TO SVG
On November 4, 1997, the Company issued warrants to purchase 25,000 shares of
Common Stock at an exercise price of $3.875 per share to SVG in connection with
the execution of a consulting agreement between SVG and the Company. These
warrants were issued in reliance on Section 4(2) of the Securities Act of 1933.
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data set forth below with respect to the
Company's Statements of Operations from February 16, 1993 (date of inception) to
December 31, 1993 and for the years ended December 31, 1994, 1995, 1996 and 1997
and balance sheets as of December 31, 1993, 1994, 1995, 1996 and 1997 are
derived from the financial statements of the Company included elsewhere in this
Annual Report. The financial data set forth below should be read in conjunction
with the Company's financial statements and the notes thereto included elsewhere
in this Annual Report and "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
For the Period
February 16, Year ended December 31,
1993 (date of
inception) to
December 31,
------------------------------------------------------------
1993 1994 1995 1996 1997
---- ---- ---- ---- ----
Statement of Operations Data:
Revenues:
Products $ --- $ --- $1,101,418 $ 5,955,592 $ 8,899,973
Consulting and services 76,183 59,716 2,083 310,557 502,771
--------- --------- ---------- ----------- -----------
Total revenues 76,183 59,716 1,103,501 6,266,149 9,402,744
--------- --------- ---------- ----------- -----------
29
Cost of revenues:
Products --- --- 376,359 1,969,117 2,064,645
Consulting and services 38,090 35,114 800 56,502 96,949
---------- --------- --------- ---------- ----------
Total cost of revenues 38,090 35,114 377,159 2,025,619 2,161,594
---------- --------- --------- ---------- ----------
Gross profit 38,093 24,602 726,342 4,240,530 7,241,150
---------- --------- --------- ---------- ----------
Operating expenses:
Sales and marketing 6,652 36,212 130,917 3,744,630 9,341,208
General and administrative 74,212 315,192 1,350,361 4,879,940 3,801,828
Research and development 21,000 127,926 304,973 1,960,727 3,012,051
Restructuring costs --- --- --- --- 800,000
---------- ---------- ---------- ---------- ----------
Total operating expenses 101,864 479,330 1,786,251 10,585,297 16,955,087
---------- ---------- ---------- ---------- ----------
Operating loss (63,771) (454,728) (1,059,909) (6,344,767) (9,713,937)
---------- ---------- ---------- ----------- ----------
Other (expense) income:
Interest expense (1,913) (2,360) (66,615) (518,965) (13,130)
Interest income
--- --- 4,513 168,176 341,469
---------- ---------- ----------- ----------- ----------
Total other expenses (1,913) (2,360) (62,102) (350,789) 328,339
---------- ---------- ----------- ----------- ----------
Net loss (65,684) (457,088) (1,122,011) (6,695,556) (9,385,598)
Dividend on preferred stock --- --- --- --- 12,600
Deemed dividend on preferred stock --- --- --- --- 600,000
---------- ---------- ----------- ----------- -----------
Loss attributable to holder of
common stock $ (65,684) $ (457,088) $(1,122,011) $(6,695,556) $(9,998,198)
========== ========== =========== =========== ===========
Basic loss per share attributable
to holder of common stock $ (.01) $ (.06) (0.14) $ (0.72) $ (0.78)
========== ========== =========== =========== ===========
Weighted average shares outstanding
6,186,978 8,046.766 8,099,223 9,245,305 12,868,859
========== ========== =========== =========== ===========
December 31,
----------------------------------------------------------------------------
1993 1994 1995 1996 1997
---- ---- ----- ----- ----
Balance Sheet Data:
Working capital (deficit) $ (19,436) $ 245,598 $ (168,311) $12,643,160 $ 7,858,856
Total assets 28,182 394,906 2,050,602 15,697,415 11,860,086
Long-term debt, less current --- --- 126,908 134,704 300,861
portion
Series A Convertible Preferred --- --- --- --- 3,766,297
Stock
Total shareholder's equity (11,523) 318,028 (139,938) 13,993,745 6,158,020
(deficit)
Cash dividends per common share --- --- --- --- ---
30
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION
OVERVIEW
The Company offered 3,000,000 shares of Common Stock, par value $0.001 ("Common
Stock"), in its initial public offering ("IPO") on October 24, 1996 at $5.00 per
share. On November 22, 1996, the Company's underwriters exercised their option
to purchase an additional 200,000 shares of Common Stock from the Company
(117,791 shares) and certain shareholders (82,209 shares) for $5.00 per share.
Net of the underwriting discount and related expenses, the Company raised
approximately $13,195,000 from the IPO and the underwriter's exercise of the
overallotment.
On December 8, 1997, the Company issued 4,000 shares of Series A Stock to
Advantage for $4 million in the aggregate. Each share of Series A Stock is
convertible into shares of Common Stock and Series A Warrants to purchase Common
Stock. Net of fees and related expenses, the Company raised approximately
$3,766,000.
The Company generates revenues primarily from software licenses and sale of
hardware products and, to a lesser extent, consulting and related services. The
Company anticipates that revenues from products will continue to be the
principal source of the Company's total revenues.
Under the Company's revenue recognition policy, revenues are generally
recognized from the license of software upon the signing of a contract and the
product shipment. The Company often permits customers to evaluate products being
considered for purchase, generally for a period of up to 30 days, in which event
the Company does not recognize revenues until the customer has accepted the
product. Accordingly, the Company's revenue recognition policy does not
necessarily correlate with the signing of a contract or the shipment of a
product.
As of December 31, 1997, the Company had an accumulated deficit of approximately
$18,339,000. The Company currently expects to incur net losses over the next
several quarters as a result of greater operating expenses incurred to fund
research and development and to increase its sales and marketing efforts. To
date, the Company has expensed all development costs as incurred in compliance
with Statement of Financial Accounting Standards No. 86, "Accounting for the
Costs of Computer Software to Be Sold, Leased or Otherwise Marketed." The
Company believes that with its current development cycle, it will be able to
continue to expense all development costs as incurred.
The Company recently has hired and intends to continue to hire additional senior
level personnel. In addition, general and administrative costs have increased
significantly since the Company's date of inception and the Company expects such
costs to continue to increase in the future.
In 1997, product revenues from Internet Solutions Ltd. and Government Technology
Services, Inc. ("GTSI") accounted for approximately 23% and 11%, respectively,
of total revenues. In 1996, product revenues from MCI Telecommunications
Corporation ("MCI") and the National Security Agency ("NSA") accounted for
approximately 12% and 12%, respectively, of total revenues. In 1995, product
revenues from GEIS, NCTS Washington, a division of the Department of the Navy,
and the U.S. Defense Information Systems Agency accounted for approximately 19%,
10%, and 10%, respectively, of total revenues.
RESULTS OF OPERATIONS
The following table sets forth-certain statement of operations data as a
percentage of revenues for the periods indicated:
31
For the Period Ended
Dec. 31, Dec. 31, Dec. 31,
1995 1996 1997
--------- -------- --------
Revenues:
Products 99.8 % 95.0 % 94.7 %
Consulting and services 0.2 5.0 5.3
------ ------ ------
Total revenues 100.0 100.0 100.0
------ ------ ------
Cost of revenues:
Products 34.1 31.4 22.0
Consulting and services 0.1 0.9 1.0
------ ------ ------
Total cost of revenues 34.2 32.3 23.0
------ ------ ------
Gross profit 65.8 67.7 77.0
------ ------ ------
Operating expenses:
Sales and marketing 11.9 59.8 99.3
General and administrative 122.4 77.9 40.4
Research and development 27.6 31.3 32.0
Restructuring costs - - 8.5
------ ------ ------
Total operating expenses 161.9 169.0 180.3
------ ------ ------
Operating loss (96.1) (101.3) (103.3)
------ ------ ------
Other (expense) income:
Interest expense (6.0) (8.3) (0.1)
Interest income 0.4 2.7 3.6
------ ------ ------
Total other expenses (5.6) (5.6) 3.5
------ ------ ------
Net loss (101.7) (106.9) (99.8)
Dividend on preferred stock - - (0.1)
Deemed dividend on - - (6.4)
preferred stock
------ ------ ------
Loss attributable to holders of (101.7)% (106.9)% (106.3)%
common stock ====== ====== ======
32
COMPARISON OF YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
REVENUES
Total revenues increased from approximately $1,104,000 in 1995, to approximately
$6,266,000 in 1996 and to approximately $9,403,000 in 1997. Product revenues are
derived principally from software licenses and the sale of hardware products.
Product revenues increased significantly from approximately $1,101,000 in 1995,
to approximately $5,956,000 in 1996 and to approximately $8,900,000 in 1997. The
increase from 1995 to 1996 was due principally to increased sales of the
Company's SmartWall product and the introduction of its SmartGate product in
December 1995, along with increased sales and marketing efforts. The increase
from 1996 to 1997 was due principally to increased sales of the Company's
SmartGate product.
Consulting and services revenues are derived principally from fees for services
complementary to the Company's products, including consulting, maintenance and
training. Consulting and services revenues increased substantially from
approximately $2,000 in 1995, to approximately $311,000 in 1996 and to
approximately $503,000 in 1997. Consulting and services revenues increased from
1995 to 1996 and from 1996 to 1997 as the Company increased staffing to support
consulting and services and product sale installations.
COST OF REVENUES
Total cost of revenues as a percentage of total revenues were 34.2%, 32.3% and
23% in 1995, 1996 and 1997, respectively.
Cost of product revenues consists principally of the costs of computer hardware,
licensed technology, manuals and labor associated with the distribution and
support of the Company's products and shipping costs. Cost of product revenues
increased from approximately $376,000 in 1995, to approximately $1,969,000 in
1996 and to approximately $2,065,000 in 1997. Cost of product revenues as a
percentage of product revenues was 34.2%, 33.0% and 23.2% for 1995, 1996 and
1997, respectively. The dollar increase and percentage decrease in 1996 were
primarily attributable to an increase in revenues from increased sales and
marketing efforts and from the introduction of SmartGate, combined with a higher
product mix of software licenses to turnkey hardware sales. The dollar increase
and substantial percentage decrease in 1997 were primarily attributable to an
increase in revenues combined with a higher mix of SmartGate software licenses
to SmartWall turnkey hardware sales.
Cost of consulting and services revenues consists principally of personnel and
related costs incurred in providing consulting, support and training services to
customers. Cost of consulting and services revenues increased significantly from
approximately $800 in 1995, to approximately $57,000 in 1996 and to $97,000 in
1997. Cost of consulting and services revenues as a percentage of consulting and
services revenues was 38.4%, 18.2%, and 19.3% for 1995, 1996 and 1997,
respectively. The dollar increases in 1996 over 1995 and in 1997 over 1996 were
attributable to increased staffing to support consulting and services. The
percentage decrease from 1995 to 1996 was principally due to allocation over a
larger revenue base. The percentage increase from 1996 to 1997 was principally
due to a reduced emphasis on consulting and a greater concentration on training
and support.
OPERATING EXPENSES
Sales and Marketing -- Sales and marketing expenses consist principally of the
costs of sales and marketing personnel, advertising, promotions and trade shows.
Sales and marketing expenses increased from approximately $131,000 in 1995, to
approximately $3,745,000 in 1996 and to approximately $9,341,000 in 1997. Sales
and marketing expenses as a percentage of total revenues were 11.9%, 59.8% and
99.3% in 1995, 1996 and 1997, respectively. The dollar increase in 1996 was
principally due to increased personnel, higher levels of sales and marketing
efforts and sales associated with the sales of SmartWall and SmartGate. The
percentage increase was due to significantly higher expenses. The dollar
increase in 1997 was principally due to increased personnel, higher levels of
sales and marketing efforts, the recognition of approximately $1,332,000 for bad
33
debt expenses and an increase of approximately $1,248,000 in allowances for
accounts receivable. The percentage increase was due to significantly higher
expenses. Sales and marketing expenses are expected to decrease both in the
aggregate and as a percentage of total revenues in the near term as a result of
the Company's efforts to reduce expense. This statement is based on current
expectations. It is forward-looking, and the actual results could differ
materially. For information about factors that could cause the actual results to
differ materially, please refer to Item 1. "Business - Risk Factors that May
Affect Future Results and Market Price of Common Stock" in the Company's Form
10-K.
General and Administrative -- General and administrative expenses consist
principally of the costs of finance, management and administrative personnel and
facilities expenses. General and administrative expenses increased substantially
from approximately $1,350,000 in 1995 to approximately $4,880,000 in 1996 and
decreased significantly to approximately $3,802,000 in 1997. General and
administrative expenses as a percentage of total revenues were 122.4%, 77.9% and
40.4% in 1995, 1996 and 1997, respectively. In 1996, the Company recorded
non-cash compensation expense of approximately $2,515,000 in conjunction with
the grant of options to purchase 590,394 shares of Common Stock at an exercise
price of $3.75 per share and options to purchase 10,000 shares of Common Stock
at an exercise price of $4.50 per share, each granted pursuant to the Company's
1996 Incentive Stock Plan, and the grant of options to purchase 383,965 shares
of Common Stock at an exercise price of $0.75 per share pursuant to the
Company's 1996 Non-Statutory Stock Option Plan, the underlying shares of which
were funded by a contribution of 383,965 shares of Common Stock by James F.
Chen, the Company's founder and Chairman of the Board. The non-cash compensation
expense was recognized in the second quarter of 1996. In the fourth quarter of
1996, the Company recognized a non-cash compensation expense of approximately
$264,000 in conjunction with a contribution to the Company of 52,885 shares of
Common Stock by James F. Chen. The remainder of the dollar increase in 1996 was
principally attributable to additional hiring of management and administrative
personnel and professional and legal fees. The percentage decrease was primarily
due to allocation over a larger revenue base. The dollar decrease in 1997 was
due to the absence of non-cash compensation expenses, partially offset by higher
costs for the recruitment of senior management, professional and legal fees, and
a $200,000 non-cash charge attributable to the resetting of the exercise price
on certain warrants in the fourth quarter of 1997 (see "4. Related Party
Transactions" in the Notes to Financial Statements). The percentage decrease was
primarily due to the reduced level of expenditure and the allocation over a
larger revenue base. The Company anticipates that general and administrative
expenses will increase in future periods. This statement is based on current
expectations. It is forward-looking, and the actual results could differ
materially. For information about factors that could cause the actual results to
differ materially, please refer to Item 1. "Business - Risk Factors that May
Affect Future Results and Market Price of Common Stock" in the Company's Form
10-K.
Research and Development -- Research and development expenses consist
principally of the costs of research and development personnel and other
expenses associated with the development of new products and enhancement of
existing products. Research and development expenses increased from
approximately $305,000 in 1995, to approximately $1,961,000 in 1996 and to
approximately $3,012,000 in 1997. Research and development expenses as a
percentage of total revenues were 27.6%, 31.3% and 32.0% in 1995, 1996 and 1997,
respectively. The dollar and percentage increases in 1996 and 1997 were
primarily due to increases in the number of personnel associated with the
Company's product development efforts. The Company believes that a continuing
commitment to research and development is required to remain competitive.
Accordingly, the Company intends to allocate substantial resources to research
and development, but research and development expenses may vary as a percentage
of total revenues. This statement is based on current expectations. It is
forward-looking, and the actual results could differ materially. For information
about factors that could cause the actual results to differ materially, please
refer to Item 1. "Business - Risk Factors that May Affect Future Results and
Market Price of Common Stock" in the Company's Form 10-K.
34
Restructuring Charge -- Restructuring charge expense consist of the costs
associated with the Company's shift in its sales and marketing efforts toward a
channel distribution strategy. Accordingly, the Company recognized in the second
quarter of 1997 a restructuring charge of $800,000, comprised of $400,000
relating to certain marketing expenses and $400,000 relating to reductions in
the Company's workforce. The restructuring and its associated expenses were
completed by the end of 1997.
Interest Income and Expense -- Interest income represents interest earned on
cash, cash equivalents and marketable securities. Interest income in 1995 was
approximately $5,000 from interest earned on the net proceeds from the Company's
private financings, approximately $168,000 in 1996 from interest earned on the
net proceeds from the Company's IPO and private financings and approximately
$341,000 in 1997 from interest earned on the net proceeds from the Company's IPO
and the private placement. Interest expense represents interest payable or
accreted on promissory notes and capitalized lease obligations. Interest expense
was approximately $67,000 in 1995. Interest expense increased substantially to
approximately $519,000 in 1996. The increase was primarily due to the Company's
issuance of $1,250,000 in promissory notes in 1995, the issuance of
approximately $1,250,000 promissory notes in 1996 and the issuance of a
promissory note in the amount of $1,500,000 in 1996. Interest expense was
approximately $13,000 in 1997 was attributable to interest accreted on
promissory notes and capitalized lease obligations.
Income Taxes -- The Company did not incur income tax expenses in December 31,
1995, 1996 and 1997 as a result of the net loss incurred during these periods.
As of December 31, 1997, the Company had net operating loss carry forwards of
approximately $15,395,000 as a result of net losses incurred since inception.
Dividend on Preferred Stock -- The Company provided approximately $13,000 for a
dividend on preferred stock.
Deemed Dividend on Preferred Stock - In December 1997, the Company recorded a
deemed dividend on the Series A Stock of $600,000, or $150 per share of Series A
Stock, in accordance with the Securities and Exchange Commission's position on
accounting for preferred stock which is convertible at a discount to the market
price for common stock.
LIQUIDITY AND CAPITAL RESOURCES
On October 24, 1996, the Company commenced an IPO of its Common Stock, which
ultimately provided the Company with net proceeds, inclusive of the
underwriter's exercise of the overallotment, of approximately $13,195,000. On
December 8, 1997, the Company issued 4,000 shares of Series A Stock to Advantage
for $4 million in the aggregate. Each share of Series A Stock is convertible
into shares of Common Stock and Series A Warrants. Net of fees and related
expenses, the Company raised approximately $3,766,000. As of December 31, 1997,
the Company had nominal debt and had cash and cash equivalents of approximately
$6,203,000 and working capital of approximately $7,858,000.
The Company's operating activities used cash of approximately $1,121,000,
$5,119,000, and $8,823,000 in 1995, 1996 and 1997, respectively. Cash used in
operating activities was principally a result of net losses and increases in
accounts receivable, prepaid expenses and inventory, which were partially offset
by increases in accounts payable, the establishment of allowances for
potentially uncollectible accounts receivable and non-saleable inventory,
non-cash expenses related to the issuance of certain stock options and non-cash
charges for preferred stock dividends.
Capital expenditures for property and equipment were approximately $20,000,
$562,000 and $669,000 in 1995, 1996 and 1997, respectively. These expenditures
35
have generally been for computer workstations and personal computers, office
furniture and equipment, and leasehold additions and improvements. The Company
expects capital expenditures to be less in 1998, as it has completed its
relocation to Germantown, Maryland and intends primarily to lease computer
equipment and office furniture in the future. In 1997, the Company paid a
security deposit of $370,000 as part of the six year operating lease agreement
for its principle office in Germantown, Maryland and made an investment of
$250,000 in Network Flight Recorder, Inc. Network Flight Recorder, Inc. develops
software to provide network administrators with network audit capabilities and
is headed by Marcus J. Ranum, the Company's Chief Scientist.
Prior to its IPO, the Company had financed its operations through the private
sale of equity securities, notes to shareholders and short-term borrowings. In
1995, the Company raised approximately $400,000 through the sale of Common
Stock. In addition, in December 1995 and January 1996, the Company raised
$2,500,000 from the sale of 7% unsecured promissory notes scheduled to mature on
June 30, 1996. In addition, in April 1996, the Company raised approximately
$1,000,000 by selling an additional 222,222 shares of its former Series A
Convertible Preferred Stock ("Old Series A Stock) at $4.50 per share. In April
and May of 1996, the Company exchanged all of the 7% unsecured promissory notes
for Old Series A Stock. Upon consummation of the IPO, each share of Old Series A
Stock automatically converted into 1.20 shares of Common Stock and the Old
Series A Stock was retired.
In June 1996, the Company raised an additional $1,500,000 by issuing to JMI
Equity Fund II, L.P. ("JMI") an 8% unsecured senior subordinated note with
detachable warrants to purchase 333,332 shares of Common Stock of which 266,666
were exercisable at $4.50 per share ("$4.50 Warrants") and 66,666 were
exercisable at $0.015 per share ("$0.015 Warrants"). The note was redeemed upon
consummation of the IPO and the $0.015 Warrants were exercised on June 28, 1996.
Pursuant to the terms of the $4.50 Warrants, upon consummation of the IPO at a
price per share of $5.00, the $4.50 Warrants were adjusted to entitle JMI to
purchase 319,999 shares of Common Stock at $3.75 per share. The $4.50 Warrants
were further adjusted on November 21, 1997 to entitle JMI to purchase 383,999
shares of Common Stock at $3.125 per share as a result of the issuance of
warrants to David D. Dawson to purchase 300,000 shares of Common Stock at an
exercise price of $3.125 per share. As of March 18, 1998, 276 shares of Series A
Stock had been converted at an exercise price of $2.1144, which will result in a
further adjustment of the $4.50 Warrants and a further non-cash expense during
the first quarter of 1998. The $4.50 Warrants may be further adjusted as a
result of subsequent conversions of the Series A Stock and/or the issuance of
options under the Company's proposed 1998 Incentive Stock Plan.
Financing activities include cash received of approximately $1,261,000 from the
exercise of stock options during 1997. Also in the second quarter of 1997, the
Company received 6,020 shares of Common Stock as payment for stock options
issued under the 1996 Non-Statutory Stock Option Plan. The Company retired the
6,020 shares of Common Stock.
The Company believes that its current cash and cash equivalents and funds that
may be generated from on-going operations will be sufficient to finance the
Company's operations at least through March 31, 1999.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Not Applicable
36
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
V-ONE CORPORATION
FINANCIAL STATEMENTS
--------
As of December 31, 1996 and
1997 and for the years ended December
31, 1995, 1996, and 1997
AND
REPORT THEREON
--------
37
Coopers Coopers & Lybrand L.L.P.
& Lybrand a professional services firm
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors of V-ONE Corporation
We have audited the accompanying balance sheets of V-ONE Corporation (the
Company) as of December 31, 1996 and 1997 and the related statements of
operations, shareholders' equity and cash flows for the years ended December 31,
1995, 1996, and 1997. 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 have conducted our audits in accordance with generally accepted auditing
standards. These standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of the Company as of December 31,
1996 and 1997 and the results of its operations and its cash flows for the years
ended December 31, 1995, 1996, and 1997, in conformity with generally accepted
accounting principles.
/s/ Coopers & Lybrand L.L.P.
McLean, Virginia
March 13, 1998
38
V-ONE CORPORATION
BALANCE SHEETS
--------
ASSETS
December 31,
1996 1997
---- ----
Current assets:
Cash and cash equivalents $10,894,375 $ 6,203,525
Accounts receivable, less allowances of $252,395 and
$1,500,405 as of December 31, 1996 and 1997, respectively 2,647,195 2,556,979
Finished goods inventory, less allowances of $50,000 and $212,700
as of December 31, 1996 and 1997, respectively 418,870 368,120
Prepaid expenses and other current assets 173,411 328,261
----------- ------------
Total current assets 14,133,851 9,456,885
Property and equipment:
Office and computer equipment 790,373 1,251,922
Furniture and fixtures 98,579 165,316
----------- ------------
888,952 1,417,238
Less accumulated depreciation (132,365) (415,657)
----------- -------------
756,587 1,001,581
Licensing fee, net of accumulated amortization of $70,764 and $353,820
as ofDecember 31, 1996 and 1997, respectively 778,409 538,434
Other assets 28,568 863,186
----------- ------------
Total assets $15,697,415 $11,860,086
=========== ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 1,311,044 $ 1,151,589
Deferred revenue 97,748 412,647
Notes payable - current 16,667 16,667
Capital lease obligations - current 65,232 17,126
----------- ------------
Total current liabilities 1,490,691 1,598,029
Notes payable - noncurrent 22,222 5,555
Deferred rent 78,275 36,879
Capital lease obligations - noncurrent 112,482 295,306
----------- ------------
Total liabilities 1,703,670 1,935,769
Commitments and contingencies
39
Mandatorily redeemable series A convertible preferred stock, $0.001 par value;
13,333,333 shares authorized; -0- and 4,000 shares issued and outstanding as
of December 31, 1996 and 1997, respectively (liquidation preference of
$4,012,600) - 3,766,297
Shareholders' equity:
Common stock, $0.001 par value; 33,333,333 shares authorized; 12,658,347 and
13,070,235 shares issued and outstanding; -0- and 1,476,000 reserved for
conversion, as of December 31, 1996 and 1997,
respectively 12,658 13,070
Additional paid-in capital 22,608,866 24,649,538
Notes receivable from sales of common stock (287,400) (166,011)
Accumulated deficit (8,340,379) (18,338,577)
----------- -----------
Total shareholders' equity 13,993,745 6,158,020
----------- -----------
Total liabilities and shareholders' equity $15,697,415 $11,860,086
=========== ===========
The accompanying notes are an integral part of these financial statements.
40
V-ONE CORPORATION
STATEMENTS OF OPERATIONS
--------
1995 1996 1997
---- ---- ----
Revenues:
Products $ 1,101,418 $ 5,955,592 $ 8,899,973
Consulting and services 2,083 310,557 502,771
------------ ----------- -----------
Total revenues 1,103,501 6,266,149 9,402,744
------------ ----------- -----------
Cost of revenues:
Revenues:
Products 376,359 1,969,117 2,064,645
Consulting and services 800 56,502 96,949
------------ ----------- -----------
Total cost of revenues 377,159 2,025,619 2,161,594
------------ ----------- -----------
Gross profit 726,342 4,240,530 7,241,150
------------ ----------- -----------
Operating expenses:
Sales and marketing 130,917 3,744,630 9,341,208
General and administrative 1,350,361 4,879,940 3,801,828
Research and development 304,973 1,960,727 3,012,051
Restructuring costs - - 800,000
------------ ----------- -----------
Total operating expenses 1,786,251 10,585,297 16,955,087
Operating loss (1,059,909) (6,344,767) (9,713,937)
------------ ----------- -----------
Other (expense) income:
Interest expense (66,615) (518,965) (13,130)
Interest income 4,513 168,176 341,469
------------ ----------- -----------
Total other (expense) income (62,102) (350,789) 328,339
------------ ----------- -----------
Net loss (1,122,011) (6,695,556) (9,385,598)
Dividend on preferred stock - - 12,600
Deemed dividend on
preferred stock - - 600,000
------------ ----------- -----------
Loss attributable to holders of
common stock $ (1,122,011) $(6,695,556) $(9,998,198)
============ =========== ===========
Basic loss per share attributable
To holder of common stock $ (0.14) (0.72) $ (0.78)
============ =========== ===========
Weighted average number of
common shares outstanding 8,099,223 9,245,305 12,868,859
============ =========== ===========
The accompanying notes are an integral part of these financial statements.
41
V-ONE CORPORATION
STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
----------
Notes
Additional Receivable
Common Stock Paid-in from Accumulated
Shares Amount Capital Stock Sales Deficit Total
------ ------ ------- ----------- ------- -----
Balance, January 1, 1995 7,863,139 $ 7,863 $ 832,937 $ - $ (522,772) $ 318,028
Sale of common stock 107,954 108 399,892 - - 400,000
Contribution capital in lieu of
cash compensation (132,666) (133) 133 - - -
Issuance of common stock in
accordance with anti-dilution
agreement 56,000 56 (56) - - -
Issuance of common stock as
payment for accrued interest 76,666 77 32,468 - - 32,545
Issuance of common stock as
payment for services 333,333 333 141,167 - - 141,500
Contributed capital in lieu of
cash compensation - - 90,000 - - 90,000
Net loss - - - - (1,122,011) (1,122,011)
---------- ------- ---------- --------- ---------- -----------
Balance, December 31, 1995 8,304,426 8,304 1,496,541 - (1,644,783) (139,938)
Contribution of common stock
from related party (383,965) (384) 288,360 - - 287,976
Issuance of common stock
related to 1996 Non-Statutory
Stock Option Plan 383,965 384 1,727,459 287,400) - 1,440,443
Issuance of common stock
as payment for services 11,111 11 49,989 - - 50,000
Issuance of non-qualified stock
options below fair market
value - - 487,796 - - 487,796
Issuance of warrants to purchase
common stock - - 299,000 - - 299,000
Exercise of warrants to purchase
common stock 66,666 67 933 - - 1,000
Issuance of common stock as
payment of a note 73,333 74 329,926 - - 330,000
Contribution of common stock
from related party (153,333) (153) 153 - - -
Issuance of common stock as
payment on accrued interest 153,333 153 64,937 - - 65,090
Repurchase of fractional shares
of common stock related to
the reverse stock split (9) - (41) - (40) (81)
Issuance of common stock as
payment of licensing fees 188,705 188 848,985 - - 849,173
42
Public sale of common stock
at $5.00 per share, net of
issuance costs 3,000,000 3,000 12,641,755 - - 12,644,755
Contribution of common stock
from related party (52,885) (53) 264,531 - - 264,478
Conversion of preferred stock to
common stock at 1-to-1.2
ratio 949,209 949 3,558,605 - - 3,559,554
Issuance of common stock due
to exercise of overallotment
option 117,791 118 549,937 - - 550,055
Net loss - - - - (6,695,556) (6,695,556)
---------- ------ ---------- --------- ---------- ----------
Balance, December 31, 1996 12,658,347 12,658 22,608,866 (287,400) (8,340,379) 13,993,745
Issuance of common stock
related to 1995 and 1996 Stock
Option Plans 417,908 418 1,260,975 - - 1,261,393
Payments received in connection
with notes receivable for stock - - - 88,480 - 88,480
Retirement of common stock (6,020) (6) (32,903) 32,909 - -
Issuance of warrants to purchase
common stock - - 200,000 - - 200,000
Dividend and deemed dividend
on preferred stock - - 612,600 - - 612,600
Net loss - - - - (9,998,198) (9,998,198)
---------- -------- ----------- --------- ------------ ----------
Balance, December 31, 1997 13,070,235 $ 13,070 $24,649,538 $(166,011) $(18,338,577) $6,158,020
========== ======== =========== ========= =========== ==========
The accompanying notes are an integral part of these financial statements.
43
V-ONE CORPORATION
STATEMENTS OF CASH FLOWS
--------
For the years ended
December 31,
1995 1996 1997
---- ---- ----
Cash flows from operating activities:
Net loss attributable to common stock $(1,122,011) $(6,695,556) $(9,998,198)
Adjustments to reconcile net loss to net cash from
used in operating activities:
Provision for doubtful accounts receivable 23,620 228,775 1,248,010
Provision for obsolete inventory 50,000 - 162,700
Depreciation and amortization 24,623 172,582 591,965
Loss on disposal of assets - - 101,354
Interest expense on accretion of note payable - 299,000 -
Consulting expense satisfied by issuance of
common stock - 45,833 -
Compensation expense satisfied by issuance of
common stock 141,500 - -
Compensation expense for issuance of
non-qualified stock options - 487,796 -
Compensation expense recognized for receipt
of contributed capital 90,000 - -
Compensation expense for common stock
contributed to stock option plan - 287,976 -
Compensation expense for issuance of common
stock related to 1996 non-statutory stock
option plan - 1,440,443 -
Compensation expense recognized for conversion
of preferred stock to common - 264,425 -
Noncash charges for preferred stock dividends
and accretion of preferred stock to common - - 612,600
Noncash charge related to issuance of warrants
of preferred stock to common - - 200,000
Accrued interest satisfied with common stock 32,545 65,090 -
Accrued interest satisfied with preferred stock - 59,554 -
Changes in assets and liabilities:
Accounts receivable (265,172) (2,633,578) (1,157,794)
Inventory (307,630) (161,240) (111,950)
Prepaid expenses and other (24,145) (173,667) (782,549)
Accounts payable and accrued expenses 235,919 1,194,035 114,048
------------- ----------- -----------
Net cash used in operating activities (1,120,751) (5,118,532) (9,019,814)
------------- ----------- -----------
Cash flows from investing activities:
Purchase of property and equipment (19,840) (562,190) (353,110)
Investment in affiliate - - (250,000)
Collection of note receivable - - 88,480
------------- ------------- ------------
Net cash used in investing activities (19,840) (562,190) (514,630)
------------- ------------ ------------
44
Cash flows from financing activities:
Issuance of common stock 400,000 - -
Issuance of common stock in public sale - 15,000,000 -
Payment of stock issuance costs - (2,355,245) (233,703)
Issuance of common stock due to exercise
of overallotment option - 550,055 -
Issuance of preferred stock - 1,000,000 4,000,000
Issuance of debt with detachable warrants - 1,500,000 -
Exercise of options and warrants - 1,000 1,261,393
Issuance of notes payable 1,300,000 1,250,000 -
Issuance of notes payable to related parties 454,351 - -
Principal payments on capitalized lease obligations (7,011) (43,843) (167,429)
Repayment of notes payable - (11,111) (16,667)
Repayment of notes payable to related parties - (1,644,144) -
---------- ----------- -----------
Net cash provided by financing activities 2,147,340 15,246,712 4,843,594
---------- ----------- -----------
Net increase (decrease) in cash and cash equivalents 1,006,749 9,565,990 (4,690,850)
Cash and cash equivalents at beginning of period 321,636 1,328,385 10,894,375
---------- ----------- -----------
Cash and cash equivalents at end of period $1,328,385 $10,894,375 $ 6,203,525
========== =========== ===========
The accompanying notes are an integral part of these financial statements.
45
V-ONE CORPORATION
STATEMENTS OF CASH FLOWS - (Continued)
--------
For the years ended
December 31,
1995 1996 1997
---- ---- ----
Noncash investing and financing activities:
Property and equipment acquired through
capital leases $ 123,392 $ 98,165 $ 302,147
========== ========== ===========
Retirement of fully depreciated property and
equipment $ - $ 5,405 $ -
========== ========== $==========
Retirement of common stock $ - $ - $ 32,909
========== ========== ===========
Deemed dividend and dividend on preferred stock $ - $ - $ 612,600
========== ========== ===========
Issuance of common stock as compensation $ 141,500 $ - $ -
========== ========== ===========
Issuance of stock purchase warrants $ - $ - $ 200,000
========== ========== ===========
Accrued interest satisfied with common stock $ 32,545 $ 65,090 $ -
========== ========== ===========
Notes received for stock options exercised $ - $ 287,400 $ -
========== ========== ===========
Consulting expense recognized by issuance of
common stock $ - $ 50,000 $ -
========== ========== ===========
Notes payable plus accrued interest satisfied with
preferred stock $ - $2,559,554 $ -
========== ========== ===========
Issuance of common stock to satisfy note payable
to related party $ - $ 330,000 $ -
========== ========== ===========
Issuance of common stock payment of licensing fee $ - $ 849,173 $ -
========== ========== ===========
Conversion of preferred stock to common stock $ - $3,559,554 $ -
========== ========== ===========
Repurchase of fractional shares of common
stock related to the reverse stock split $ - $ 81 $ -
========== ========== ===========
Supplemental cash flow disclosure:
Cash paid for interest $ 182 $ 133,042 $ 13,130
========== ========== ===========
The accompanying notes are an integral part of these financial statements.
46
V-ONE CORPORATION
NOTES TO FINANCIAL STATEMENTS
------------------
1. NATURE OF BUSINESS
V-ONE Corporation ("V-ONE" or the "Company") develops, markets and
licenses a comprehensive suite of network security products that enable
organizations to conduct secured electronic transactions and
information exchange using private enterprise networks and public
networks, such as the Internet. The Company's principal market is the
United States, with headquarters in Maryland, and regional offices in
New York and California; and secondary markets located in Europe and
Japan.
The Company was originally incorporated in the State of Maryland on
February 16, 1993 with the authorization to issue 5,666,666 shares of
Common Stock. The Board of Directors authorized and the shareholders
approved a stock split of the Company's Common Stock as of November 11,
1995 increasing authorized Common Stock to 13,333,333 shares. Effective
February 7, 1996, the Company merged with a pre-existing corporation
formed in Delaware. The Delaware corporation became the surviving
corporation.
In connection with its reincorporation, the Company increased the
number of authorized shares of Common Stock from 13.3 million to 33.3
million and authorized 13.3 million shares of Preferred Stock. On June
12 and June 28, 1996, respectively, the Board of Directors authorized
and the shareholders approved a two-for-three reverse stock split of
the outstanding shares of the Company's Preferred and Common Stock,
which was effective July 2, 1996. All references to Common Stock,
Preferred Stock, options and per share data have been restated to give
effect to both stock splits.
2. SIGNIFICANT ACCOUNTING POLICIES
REVENUE RECOGNITION
Revenues are generally recognized from the license of software
upon the signing of a contract and shipment of the product. The
Company often permits customers to evaluate products being
considered for purchase, generally for a period up to 30 days, in
which event the Company does not recognize revenues until the
customer has accepted the product. Accordingly, the Company's
revenue recognition policy does not necessarily correlate with the
signing of a contract or the shipment of a product. Allowances for
estimated future returns, credits and doubtful accounts are netted
against accounts receivable. Service and training revenues are
recognized as the services are performed.
Maintenance and support revenues are recognized ratably over the
contract term, typically one year. Payments received in advance of
revenue recognition are included in deferred revenue.
In certain instances, the Company recognizes revenues from the
sale of systems using the percentage of completion method as the
work is performed, measured primarily by the ratio of labor hours
incurred to total estimated labor hours for each specific
contract. When the total estimated cost of a contract is expected
to exceed the contract price, the total estimated loss is charged
to expense in the period when the information becomes known.
In October 1997, the American Institute of Certified Public
Accountants issued Statement of Position 97-2 (SOP 97-2) SOFTWARE
REVENUE RECOGNITION, which requires specific criteria be met prior
47
V-ONE CORPORATION
NOTES TO FINANCIAL STATEMENTS
------------------
to the recognition of revenue from software arrangements
consisting of multiple elements. This statement becomes effective
for fiscal years beginning after December 15, 1997. The Company
believes that future adoption of this statement will not have a
significant impact on its results of operations or financial
position.
RESEARCH AND DEVELOPMENT AND SOFTWARE DEVELOPMENT COSTS
Software development costs are included in research and
development and are expensed as incurred. Statement of Financial
Accounting Standards ("SFAS") No. 86, "Accounting for the Cost of
Computer Software to be Sold, Leased or Otherwise Marketed"
requires the capitalization of certain software development costs
once technological feasibility is established, which the Company
generally defines as completion of a working model. Capitalization
ceases when the products are available for general release to
customers, at which time amortization of the capitalized costs
begins on a straight-line basis over the estimated product life,
or on the ratio of current revenues to total projected product
revenues, whichever is greater. To date, the period between
achieving technological feasibility and the general availability
of such software has been short, and software development costs
qualifying for capitalization have been insignificant.
Accordingly, the Company has not capitalized any software
development costs.
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 disclosures of contingent assets and
liabilities at the date of the financial statements and the
reported amounts of revenues and expenses during the reported
period. Actual results could differ from these estimates and could
impact future results of operations and cash flows.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments with original
maturities of three months or less to be cash equivalents. Cash
and cash equivalents include time deposits with commercial banks
used for temporary cash management purposes.
INVENTORIES
Inventories are valued at the lower of cost or market and consist
primarily of computer equipment for sale on orders received from
customers, items held for stock and training kits. Cost is
determined based on specific identification.
PROPERTY AND EQUIPMENT
Office and computer equipment and furniture and fixtures are
recorded at cost. Depreciation and amortization of property and
equipment is calculated using the straight-line method over a
useful life of the assets, generally three to seven years.
Depreciation expense was $24,623, $101,818 and $285,213 for the
years ended December 31, 1995, 1996 and 1997, respectively.
48
V-ONE CORPORATION
NOTES TO FINANCIAL STATEMENTS
------------------
Repairs and maintenance costs are charged to expense as incurred.
Upon sale or retirement of property and equipment, the costs and
related accumulated depreciation are eliminated from the accounts
and any resulting gain or loss on such disposition is included in
the determination of net income.
49
V-ONE CORPORATION
NOTES TO FINANCIAL STATEMENTS
------------------
INCOME TAXES
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 by applying presently enacted statutory tax rates,
which are applicable to the future years in which deferred tax
assets or liabilities are expected to be settled or realized, to
the differences between the financial statement carrying amounts
and the tax bases of existing assets and liabilities. The effect
of a change in tax rates on deferred tax assets and liabilities is
recognized in net income in the period that the tax rate is
enacted.
The Company provides a valuation allowance against net deferred
tax assets if, based upon available evidence, it is more likely
that some or all of the deferred tax assets may not be realized.
COMPUTATION OF NET LOSS PER COMMON SHARE
The Company adopted Statement of Financial Accounting Standards
No. 128, EARNINGS PER SHARE ("SFAS 128") effective December 31,
1997. All prior period net loss per share amounts have been
restated to comply with the provisions of SFAS 128. Basic earnings
(or loss) per share is computed by dividing net income or (loss)
by the weighted average number of shares of common stock
outstanding. Diluted earnings per share is computed by dividing
net income by the weighted average common and potentially dilutive
common equivalent shares outstanding, determined in the following
table. However, the computation of diluted loss per share was
antidilutive in each of the years presented; therefore, basic and
diluted loss per share are the same.
1995 1996 1997
---- ---- ----
Weighted average shares outstanding
used to compute basic earnings per
share 8,099,223 9,245,305 12,868,859
Incremental shares issuable upon the
assumed conversion of convertible
preferred stock - - -
Incremental shares issuable upon the
assumed exercise of stock options and
warrants - - -
---------- ---------- ----------
Shares used to compute diluted
earnings per share 8,099,223 9,245,305 12,868,859
========== ========== ==========
RISKS, UNCERTAINTIES AND CONCENTRATIONS
Financial instruments that potentially subject the Company to
significant concentration of credit risk consist primarily of cash
equivalents and accounts receivable. The Company's cash balances
50
V-ONE CORPORATION
NOTES TO FINANCIAL STATEMENTS
------------------
exceed federally insured amounts. The Company invests its cash
primarily in money market funds with an international commercial
bank. The Company had cash invested in these funds of $1,175,279,
$10,875,652, and $5,981,688 as of December 31, 1995, 1996 and
1997, respectively. The Company has not experienced any losses to
date on its invested cash.
The Company sells its products to a wide variety of customers in a
variety of industries. The Company performs ongoing credit
evaluations of its customers but does not require collateral or
other security to support customer accounts receivable. In
management's opinion, the Company has provided sufficient
provisions to prevent a significant impact of credit losses to the
financial statements.
In 1995, three customers accounted for approximately 39% of total
revenues. In 1996, two customers accounted for approximately 24%
of total revenues and, when combined with a third customer,
aggregated 41% of total accounts receivable at December 31, 1996.
As of December 31, 1997 and for the year then ended, two customers
comprised 34% and 56% of total revenues and accounts receivable,
respectively.
The Company had significant purchases of product from one major
supplier in the amount of approximately $307,000 during fiscal
1996 and approximately $1,201,000 from the same supplier and
another major supplier during fiscal year 1997, representing 16%
and 58% of total product cost of revenues for those periods,
respectively. No supplier accounted for more than 10% of total
product cost of revenues in 1995.
3. NOTES PAYABLE
In October 1995, the Company entered into a $50,000 loan agreement with
an international financial institution. The loan requires monthly
payments of interest at a rate equal to the institution's prime lending
rate for the first twelve months or 8.25% as of December 31, 1996. In
October 1996, the interest rate increased to 1.5% over prime or 10% as
of December 31, 1997. The Company is required to repay the loan through
36 monthly payments commencing May 1996. The loan is collateralized by
the assets of the Company.
In both December 1995 and January 1996, the Company issued $1,250,000
in 7% uncollateralized promissory notes to fourteen individual
investors. During April 1996, the principal and accrued interest was
converted into shares of the Company's former Series A Convertible
Preferred Stock ("Old Series A Stock") which was, concurrent with the
Company's initial public offering ("IPO"), converted to Common Stock
(See Note 7.)
Maturities of notes payable as of December 31, 1997 are as follows:
1998 $ 16,667
1999 5,555
------------
$ 22,222
============
51
V-ONE CORPORATION
NOTES TO FINANCIAL STATEMENTS
------------------
4. RELATED PARTY TRANSACTIONS
On June 1, 1995, the Company borrowed $330,000 from Scientek
Corporation and issued a promissory note, bearing no interest, due June
1, 1996. The note was assigned to Hai Hua Cheng (a former board member
of the Company), by Scientek Corporation. The terms of the note
provided that, as further consideration for the loan, the Company would
issue 153,333 shares of Common Stock to Mr. Cheng immediately after
repayment of the loan. On June 12, 1996, in consideration for Mr.
Cheng's agreement not to demand payment of the note until May 31, 1997,
the Board of Directors authorized the Company to offer Mr. Cheng the
option to receive Common Stock based on a $4.50 per share conversion
price in lieu of cash in payment of the note. The Board reserved and
authorized the issuance of 73,333 shares of Common Stock for this
purpose. On June 28, 1996, the Company repaid the loan by issuing
226,666 shares of Common Stock to Mr. Cheng, inclusive of the 153,333
shares of Common Stock described above. In connection with this loan,
the Company recognized interest expense of $56,954 and $40,681 during
the years ended December 31, 1995 and 1996, respectively.
The Company's founder, Chairman of the Board, and majority shareholder,
advanced the Company operating funds under three separate promissory
notes. The notes bore interest at 8% and were due on demand. Following
the consummation of the IPO, the Company repaid the outstanding balance
of the notes and all accrued interest.
During June 1996, the Company borrowed $1,500,000 and issued an 8%
uncollateralized senior subordinated note due June 18, 2000, with
333,332 detachable warrants to purchase Common Stock. Of the original
333,332 detachable warrants, 266,666 were exercisable at $4.50 per
share, and 66,666 were exercisable at $0.015 per share. Because the
initial offering price per share of Common Stock in the IPO was less
than $7.00, each share of Old Series A Stock was automatically
converted into 1.20 shares of Common Stock and the 266,666 warrants
were converted into 319,999 warrants exercisable at $3.75 per share.
James F. Chen, the Company's founder and Chairman of the Board,
contributed 13,333 shares of Common Stock due to the increase in the
Old Series A Stock's conversion ratio. The Company allocated $1,201,000
and $299,000 to notes payable and additional paid-in capital,
respectively, based upon the pro-rata fair market value of the
instruments. As of December 31, 1996, the $299,000 allocated to
additional paid-in capital was fully amortized. Following the
consummation of the IPO, the Company repaid the outstanding balance of
the note and all accrued interest. The 66,666 detachable warrants with
an exercise price of $0.015 were exercised on June 28, 1996. The
remaining 319,999 detachable warrants with an exercise price of $3.75
outstanding at December 31, 1996, increased to 383,999 exercisable at
$3.125, as a result of the anti-dilution clause arising from the
issuance of 300,000 warrants with an exercise price of $3.125 to David
D. Dawson, President and Chief Executive Officer, on November 21, 1997.
The Company recognized expense of $200,000 due to the increase and
decrease in the number of the detachable warrants and exercise price,
respectively. These warrants may be further adjusted as a result of
subsequent conversions of the Company's new Series A Convertible
Preferred Stock (see Note 7) and/or the issuance of options under the
Company's 1998 Incentive Stock Plan.
In January 1997, the Company made an investment of $250,000 in Network
Flight Recorder, Inc. ("NFR") in exchange for ten percent of NFR common
stock. NFR develops software to provide network administrators with
network audit capabilities. NFR is headed by the Company's former Chief
Scientist, who continues to work as a consultant for the Company.
5. SELECTED BALANCE SHEET INFORMATION
Other assets consist of the following at December 31:
52
V-ONE CORPORATION
NOTES TO FINANCIAL STATEMENTS
------------------
1996 1997
----------- ------------
Deposits $ 28,568 $ 613,186
Investment in NFR - 250,000
----------- ------------
$ 28,568 $ 863,186
=========== ============
Accounts payable and accrued expenses consist of the following at
December 31:
1996 1997
----------- ------------
Accounts payable $ 645,602 $ 601,046
Accrued compensation 172,299 473,507
Accrued IPO costs 139,679 -
Accrued contract costs 155,000 -
Accrued marketing costs 55,000 48,193
Sales tax payable 118,464 28,843
Other accrued expenses 25,000 -
----------- ------------
$ 1,311,044 $ 1,151,589
=========== ============
6. INCOME TAXES
The tax effect of temporary differences that give rise to significant
portions of the deferred income taxes are as follows at December 31:
1996 1997
------------ ------------
Deferred tax assets (liabilities):
Deferred revenue $ 37,750 $ -
Inventory allowance 19,310 82,145
Allowance for bad debts 97,475 579,456
Deferred rent 30,230 14,243
Non-deductible accruals 93,993 59,071
Stock-based employee compensation 188,388 188,388
Licensing fee (300,622) (123,980)
Net operating loss carryforward 2,894,848 5,698,817
------------ ------------
Total gross deferred tax asset 3,061,372 6,416,243
Valuation allowance (3,061,372) (6,416,243)
------------ ------------
Net deferred tax asset $ - $ -
============ ============
The net change in the valuation allowance from 1996 to 1997 is due
principally to the increase in net operating losses. Valuation
allowances have been recognized due to the uncertainty of realizing the
benefit of net operating loss carryforwards. At December 31, 1997, the
Company had net operating loss carryforwards of approximately
$15,395,000 for Federal and state income tax purposes available to
offset future taxable income. The net operating loss carryforwards
begin to expire in 2008.
53
V-ONE CORPORATION
NOTES TO FINANCIAL STATEMENTS
------------------
7. SHAREHOLDERS' EQUITY
OLD SERIES A STOCK
During April and May, 1996, the Board of Directors authorized the
issuance of 791,011 shares of Old Series A Stock with a par value
of $0.001. On April 15, 1996, the Company repaid the full amount
of the 7% uncollateralized promissory notes outstanding, including
accrued interest, to seven of the investors who participated in
the December 1995 and January 1996 note offering, by issuing
shares of the Company's Old Series A Stock, at a price of $4.50
per share. The Company paid cash to each of these investors in an
amount equal to the value of any fractional shares of Old Series A
Stock that would otherwise have been transferred to such
investors. In addition, the Company permitted the seven investors
to purchase an additional 222,222 shares of Old Series A Stock at
a price of $4.50 per share. Of the remaining seven investors, two
transferred their notes to one of the other remaining investors.
The remaining five investors exchanged their notes, including the
transferred notes, for shares of the Company's Old Series A Stock
on May 24, 1996, also at a price of $4.50 per share. A total of
791,011 shares of Old Series A Stock were issued on May 24, 1996.
In connection with the IPO, each share of Old Series A Stock
automatically converted into 1.20 shares of Common Stock. The
791,011 shares of Old Series A Stock were converted into 949,209
shares of Common Stock. James F. Chen, the Company's founder and
Chairman of the Board, contributed 39,552 shares of Common Stock,
to the Company due to the increase in the Old Series A Stock's
conversion ratio, because the initial offering price per share of
Common Stock in the IPO was less that $7.00.
MANDATORILY REDEEMABLE PREFERRED STOCK
On December 8, 1997, the Company issued 4,000 shares of Series A
Stock to Advantage Fund II Ltd. ("Advantage") for $4 million, less
issuance costs of approximately $234,000. Each share of Series A
Stock is convertible into shares of Common Stock and warrants to
purchase shares of Common Stock ("Series A Warrants").
The holders of Series A Stock are entitled to receive, at the
discretion of the Board of Directors, dividends at the rate of
$50.00 per annum per share, which are fully cumulative, accrue
without interest from the date of original issuance and are
payable quarterly commencing March 1, 1998. The amount of the
dividends payable per share of Series A Stock for each quarterly
dividend is computed by dividing the annual dividend amount by
four. Dividends not paid on a payment date, whether or not such
dividends have been declared, will bear interest at the rate of
twelve percent per annum until paid. The Company can elect to
issue shares of the Company's Common Stock in payment of dividends
on the Series A Stock.
In the event of any liquidation, dissolution or winding up of the
Company, whether voluntary or involuntary, the holders of Series A
Stock are entitled to receive out of the assets of the Company, an
amount per share of Series A Stock equal to the liquidation
preference before any payment shall be made to holders of any
class of Common Stock or any stock ranking on liquidation junior
to the Series A Stock, an amount equal to the sum of (1) all
dividends accrued and unpaid thereon to the date of final
distribution to such holders, (2) accrued and unpaid interest on
dividends in arrears and (3) $1,000. The liquidation preference of
54
V-ONE CORPORATION
NOTES TO FINANCIAL STATEMENTS
------------------
the Series A Stock is $4,012,600 as of December 31, 1997. In the
event, the assets of the Company are insufficient to pay
liquidation preference amounts, then all of the assets available
for distribution shall be distributed ratably among the holders of
Series A Stock.
CONVERSION RIGHTS. Each share of Series A Stock is convertible at
the option of the holder into shares of Common Stock and warrants
to purchase Common Stock ("Series A Warrants"). The number of
Series A Warrants issuable on conversion of a share of Series A
Stock is the number of shares of Common Stock issued on conversion
per share of Series A Stock divided by 5. The exercise price per
share of each Series A Warrant is $4.77 per share. Each Series A
Warrant is exercisable for 5 years from the date of conversion.
The number of shares of Common Stock issuable on exercise of the
Series A Warrants and the exercise price per share is subject to
adjustment in certain circumstances.
The number of shares of Common Stock issuable per share of Series
A Stock is determined by dividing the sum of (a) $1,000, (b)
accrued and unpaid dividends, and (c) interest on dividends in
arrears ("Conversion Amount") by the lesser of (1) $4.77 ("Ceiling
Price") and (2) the product of the applicable Conversion
Percentage and the Average Market Price on the conversion date.
The "Conversion Percentage" is generally 85%; however, if (1) the
registration statement ceases to be available for use by any
holder of Series Stock that is named therein as a selling
stockholder for any reason, or (2) a holder of Series A Stock
becomes unable to convert any shares of Series A Stock in
accordance with the Certificate of Designations of Series A
Convertible Preferred Stock ("Series A Certificate") (other than
by reason of the 4.9% limitation described below), then (A) the
applicable Conversion Percentage is permanently reduced by 2% per
month up to a maximum aggregate reduction in the Conversion
Percentage of 10% and (B) the Ceiling Price is permanently reduced
by $.0954 per month up to a maximum aggregate reduction in the
Ceiling Price of $.477. However, in lieu of each such reduction,
the Company can make cash payments equal to 2% of the aggregate
subscription price per share ($1,000 per share) of Series A Stock
(which amount is limited to 10% of the aggregate subscription
price). The Conversion Amount is adjusted in the event the Company
issues certain rights or warrants or distributes to the holders of
securities junior to the Series A Stock evidences of indebtedness
or assets. The "Average Market Price" is the average of the lowest
sale price on the Nasdaq National Market on each of the five
trading days having the lowest sale price during the 25
consecutive trading days prior to the measurement date, which in
the case of a dividend paid in shares of Common Stock is the
dividend payment date.
No holder of Series A Stock is entitled to receive shares of
Common Stock on conversion of its Series A Stock or on exercise of
its Series A Warrants to the extent that the sum of (1) the shares
of Common Stock owned by such holder and its affiliates and (2)
the shares of Common Stock issuable on conversion of the Series A
Stock and on exercise of its Series A Warrants would result in
beneficial ownership by such holder and its affiliates of more
than 4.9% of the outstanding shares of Common Stock. Beneficial
ownership for this purpose is determined in accordance with
Section 13(d) of the Securities Exchange Act of 1934, excluding
shares of Common Stock so owned through ownership of unconverted
shares of Series A Stock and unexercised Series A Warrants.
If a holder tenders his or her shares of Series A Stock for
conversion and does not receive certificates for all of the shares
of Common Stock and Series A Warrants to which such holder is
55
V-ONE CORPORATION
NOTES TO FINANCIAL STATEMENTS
------------------
entitled when required, then, among other things, the Ceiling
Price otherwise applicable to such conversion is reduced by $.0954
and the Conversion Percentage otherwise applicable to such
conversion is reduced by 2%.
MANDATORY REDEMPTION. The Series A Certificate provides that the
Company is not obligated to issue, upon conversion of the Series A
Stock, more than the number of shares of Common Stock that the
Company may issue pursuant to the rules of Nasdaq ("Maximum Share
Amount"), less the aggregate number of shares of Common Stock
issued by the Company as dividends on the Series A Stock. The
Company is seeking approval from the holders of Common Stock to
issue shares of Common Stock in connection with the Series A Stock
in excess of the amounts permitted by Nasdaq Rule 4460(i)(1)(D).
If the Company would not be obligated to convert shares of Series
A Stock because of the Maximum Share Amount limitation, the
Company is required to give a notice to that effect to each holder
of Series A Stock. In such event, a holder may require the Company
to redeem such portion of its Series A Stock that cannot be
converted as a result of this limitation at the "Share Limitation
Redemption Price" per share. The "Share Limitation Redemption
Price" is the greater of (i) the quotient obtained by dividing (a)
the sum of (1) $1,000, (2) an amount equal to the accrued but
unpaid dividends on the share of Series A Stock to be redeemed,
and (3) an amount equal to the accrued and unpaid interest on
dividends in arrears on such share through the applicable
redemption date by (b) the applicable Conversion Percentage and
(ii) an amount equal to the product obtained by multiplying (x)
the number of shares of Common Stock that would, but for the
redemption pursuant to this provision of the Series A Certificate,
be issuable on conversion of one share of Series A Stock and any
accrued and unpaid dividends thereon and any accrued and unpaid
interest on dividends thereon in arrears (determined without
regard to the 4.9% limitation) times (y) the arithmetic average of
the closing bid price of the Common Stock for the five consecutive
trading days ending one trading day prior to the redemption date.
In addition, the Company is obligated to redeem all outstanding
shares of Series A Stock on December 8, 2000 at the "Redemption
Price" per share. The "Redemption Price" is the greater of (i) the
quotient obtained by dividing (a) the sum of (1) $1,000, (2) an
amount equal to the accrued but unpaid dividends on the share of
Series A Stock to be redeemed, and (3) an amount equal to the
accrued and unpaid interest on dividends in arrears on such share
through the applicable redemption date by (b) the applicable
Conversion Percentage and (ii) an amount equal to the product
obtained by multiplying (x) the number of shares of Common Stock
that would, but for the redemption pursuant to this provision of
the Series A Certificate, be issuable on conversion of one share
of Series A Stock and any accrued and unpaid dividends thereon and
any accrued and unpaid interest on dividends thereon in arrears
(determined without regard to the 4.9% limitation) times (y) the
arithmetic average of the closing bid price of the Common Stock
for the five consecutive trading days ending one trading day prior
to the redemption date.
OPTIONAL REDEMPTION BY THE COMPANY. As long as the Company is in
compliance in all material respects with its obligations to the
holders of Series A Stock under the Series A Certificate and the
registration rights agreement with Advantage, the Company may
redeem all or, from time to time, part of the outstanding shares
of Series A Stock at the Redemption Price per share.
56
V-ONE CORPORATION
NOTES TO FINANCIAL STATEMENTS
------------------
OPTIONAL REDEMPTION BY THE HOLDERS OF SERIES A STOCK. In the event
an "Optional Redemption Event" occurs, each holder of Series A
Stock has the right to require the Company to redeem all or a
portion its shares of Series A Stock at the "Optional Redemption
Price" per share. "Optional Redemption Event" means any one of the
following: (1) for any period of five consecutive trading days
there is no closing bid price of the Common Stock on any national
securities exchange or the Nasdaq National Market; (2) the Common
Stock ceases to be listed for trading on the Nasdaq National
Market, the New York Stock Exchange ("NYSE"), the American Stock
Exchange ("AMEX") or the Nasdaq SmallCap Market; (3) the inability
for 30 or more days (whether or not consecutive) of any holder of
shares of Series A Stock who is entitled to optional redemption
rights to sell such shares of Common Stock issued or issuable on
conversion of shares of Series A Stock pursuant to the
registration statement for any reason on each of such 30 days; (4)
the Company fails or defaults in the timely performance of any
material obligation to a holder of shares of Series A Stock under
the terms of the Series A Certificate or under the registration
rights agreement with Advantage or any other agreements or
documents entered into in connection with the issuance of shares
of Series A Stock; (5) any consolidation or merger of the Company
with or into another entity (other than a merger or consolidation
of a subsidiary of the Company into the Company or a wholly owned
subsidiary of the Company) where the shareholders of the Company
immediately prior to such transaction do not collectively own at
least 51% of the outstanding voting securities of the surviving
corporation of such consolidation or merger immediately following
such transaction or the common stock of such surviving corporation
is not listed for trading on the Nasdaq National Market, the NYSE,
the AMEX or the Nasdaq SmallCap Market; or (6) the taking of any
action, including any amendment to the Company's Certificate of
Incorporation, that materially and adversely affects the rights of
any holder of shares of Series A Stock.
The "Optional Redemption Price" is the greater of (i) the quotient
obtained by dividing (a) the sum of (1) $1,000, (2) an amount
equal to the accrued but unpaid dividends on the share of Series A
Stock to be redeemed, and (3) an amount equal to the accrued and
unpaid interest on dividends in arrears on such share through the
applicable redemption date by (b) the applicable Conversion
Percentage and (ii) an amount equal to the product obtained by
multiplying (x) the number of shares of Common Stock that would,
but for the redemption pursuant to this provision of the Series A
Certificate, be issuable on conversion of one share of Series A
Stock and any accrued and unpaid dividends thereon and any accrued
and unpaid interest on dividends thereon in arrears (determined
without regard to the 4.9% limitation) times (y) the arithmetic
average of the closing bid price of the Common Stock for the five
consecutive trading days ending one trading day prior to the
redemption date.
STOCK OFFERING
In October 1996, the Company completed an underwritten initial
public offering of 3,000,000 shares of its Common Stock, at a
public offering price of $5.00 per share (the "IPO"). The net
proceeds from the IPO of approximately $12,645,000 were used to
repay indebtedness outstanding under the Company's senior
subordinated note and promissory notes due to the Company's
founder and Chairman of the Board. (See Note 4.) On November 22,
1996, the Company's underwriters exercised their option to
purchase an additional 200,000 shares of Common Stock of which
117,791 shares were issued by the Company at $5.00 per share.
57
V-ONE CORPORATION
NOTES TO FINANCIAL STATEMENTS
------------------
STOCK SPLITS
On November 11, 1995, the Board of Directors authorized and the
shareholders approved a ten-for-one stock split of the outstanding
shares of the Company's Common Stock. On June 12 and June 28,
1996, respectively, the Board of Directors authorized and the
shareholders approved a two-for-three reverse stock split of the
outstanding shares of the Company's Preferred and Common Stock,
which was effective July 2, 1996. All references to Common Stock,
Preferred Stock, options and per share data have been restated to
give effect to both stock splits.
WARRANTS
In addition to the warrants discussed in Note 4, the Company has
issued other warrants during fiscal 1997.
On December 8, 1997, the Company issued warrants to purchase
60,000 shares of Common Stock at an exercise price of $4.725 to
its underwriter in consideration for services rendered in
connection with the private placement of its Series A Stock. Such
warrants are due to expire on December 8, 2002.
In connection with a marketing agreement, the Company issued to a
consultant 25,000 warrants to purchase Common Stock at an exercise
price of $3.875 per share, exercisable as of November 4, 1997.
As of December 31, 1997, warrants aggregating 768,999 remain
outstanding.
STOCK OPTIONS PLANS
The Company has the following three stock options plans: 1995
Non-Statutory Stock Option Plan, the 1996 Non-Statutory Stock
Option Plan and the 1996 Incentive Stock Plan ("Plans"). The Plans
were adopted to attract and retain key employees, directors,
officers and consultants. The Plans are administered by a
committee appointed by the Board of Directors ("Compensation
Committee").
1995 NON-STATUTORY STOCK OPTION PLAN
The Compensation Committee determines the number of options
granted to a key employee, the vesting period and the exercise
price provided it is not below market value on the date of the
grant for the 1995 Non-Statutory Stock Option Plan ("1995 Plan").
In most cases, the options vest over a two year period and
terminate ten years from the date of grant. The 1995 Plan will
terminate during May 2005 unless terminated earlier with the
provisions of the 1995 Plan. On June 12, 1996, the Board of
Directors determined that no further options would be granted
under the 1995 Plan.
Option activity for the period from the 1995 Plan's inception to
December 31, 1996 was as follows:
Shares Price
-------- --------------
Balance as of December 31, 1994 - -
Granted 350,293 $0.4245-$2.505
Exercised - -
Canceled - -
--------
58
V-ONE CORPORATION
NOTES TO FINANCIAL STATEMENTS
------------------
Balance as of December 31, 1995 350,293 $0.4245-$2.505
Granted 2,000 $4.50
Exercised - -
Canceled (2,000) $4.50
--------
Balance as of December 31, 1996 350,293 $0.4245-$2.505
Granted -
Exercised (119,070) $0.4245-$2.505
Canceled -
--------
Balance as of December 31, 1997 231,223
========
The Compensation Committee was authorized by the Board of
Directors to grant options for a total of 352,293 shares of Common
Stock under the 1995 Plan. As of December 31, 1996, the
Compensation Committee had granted a total of 352,293 options with
a ten year term, of which 213,331 are exercisable at $0.4245 per
share, 136,962 are exercisable at $2.505 per share and 2,000 are
exercisable at $4.50 per share. As of December 31, 1995, 1996 and
1997, 44,445, 229,087 and 231,223, respectively, of the options
were vested.
As of December 31, 1996 and 1997, the Company had no shares of
Common Stock available for grant under the 1995 Plan.
1996 NON-STATUTORY STOCK OPTION PLAN
The Compensation Committee, which administers the 1996
Non-Statutory Stock Option Plan ("Non-Statutory Plan"),
established the option price to be the fair market value of the
stock on the date of grant. The options were not transferable,
were subject to various restrictions outlined in the Non-Statutory
Plan and must have been exercised by December 31, 1996. During
April 1996, the Company's founder and Chairman of the Board
contributed 383,965 shares of Common Stock to the Company and the
Company issued those shares to employees in connection with the
exercise of stock options granted under the Non-Statutory Plan.
The Company recognized compensation expense of $287,976 with a
corresponding increase to additional paid-in capital to record
this transaction.
Option activity for the period from the Non-Statutory Plan's
inception to December 31, 1996 was as follows:
Shares Price
---------- ---------
Balance as of December 31, 1995 - -
Granted 383,965 $0.75
Exercised (383,965) $0.75
Canceled - -
----------
Balance as of December 31, 1996 - -
==========
59
V-ONE CORPORATION
NOTES TO FINANCIAL STATEMENTS
------------------
The options were exercised on April 22, 1996 at $0.75 a share in
exchange for notes and par value in cash. No additional options
are available for grant under the Non-Statutory Plan. The Company
recognized $1,439,867 in compensation expense based upon the
difference between the fair market value of $4.50 at the date of
grant and the exercise price of $0.75 per share. The notes are
full recourse promissory notes bearing interest at 6% per annum
and are collateralized by the underlying Common Stock. Principal
and interest are payable in installments. Maturities range from
April 1997 to April 2006. The Company has accounted for these
notes as a reduction to shareholders' equity as of December 31,
1996 and 1997.
1996 INCENTIVE STOCK PLAN
During June 1996, the Company adopted the 1996 Incentive Stock
Plan ("1996 Plan"), under which incentive stock options,
non-qualified stock options and restricted share awards may be
made to the Company's key employees, directors, officers and
consultants. Both incentive stock options and options that are not
qualified under Section 422 of the Internal Revenue Code of 1986,
as amended ("non-qualified options"), are available under the 1996
Plan. The options are not transferable and are subject to various
restrictions outlined in the 1996 Plan. The Compensation Committee
or the Board of Directors determines the number of options granted
to a key employee, officer or consultant, the vesting period and
the exercise price provided that it is not below market value. The
1996 Plan will terminate during June 2006 unless terminated
earlier by the Board of Directors.
The 1996 Plan also provides for the automatic grant of a
non-qualified option to purchase 6,666 shares of Common Stock to
each new non-employee director. All options have a five year term
and are exercisable on the date of grant. As of December 31, 1996,
two of the Company's directors were eligible to participate in the
1996 Plan and each director was granted a non-qualified option to
purchase 6,666 shares of Common Stock.
Option activity for the period from the 1996 Plan's inception to
December 31, 1997 was as follows:
Incentive Non-Qualified
Stock Options Stock Options
Shares Price Share Price
------ ----- ----- -----
Balance as of December 31, 1995 - - - -
Granted 386,310 $4.50-$9.00 837,903 $3.75-$9.00
Exercised - - - -
Canceled (41,476) $4.50-$9.00 (29,066) $3.75
---------- ----------
Balance as of December 31, 1996 344,834 $4.50-$9.00 808,837 $3.75-$9.00
Granted 703,501 $4.50-$5.88 612,000 $3.75-$5.88
Exercised (28,196) $4.50-$5.00 (270,642) $3.75
Canceled (88,202) $4.50-$9.00 (110,097) $3.75-$9.00
---------- ----------
Balance as of December 31, 1997 931,937 $4.50-$9.00 1,040,098 $3.75-$9.00
========== ==========
60
V-ONE CORPORATION
NOTES TO FINANCIAL STATEMENTS
------------------
Awards may be granted under the 1996 Plan with respect to a total
of 2,333,333 shares of Common Stock under the 1996 Plan. As of
December 31, 1997, of the total 1,040,098 non-qualified options,
395,435 are vested and exercisable as of December 31, 1997. As of
December 31, 1997, the Company had 62,460 share of Common Stock
available for grant under the 1996 Plan.
The Company accounts for the fair value of its grants under the
Plans in accordance with the Accounting Principles Board Opinion
25 and related Interpretations. Accordingly, no compensation
expense has been recognized for the Plans. Had compensation
expense been determined based on the fair value at the grant dates
for awards under the Plans consistent with the method of SFAS 123,
the Company's net loss and loss per common share would have been
increased to the pro forma amounts indicated below:
1995 1996 1997
----- ----- ----
Net loss
As reported $1,122,011 $6,695,556 $9,998,198
Pro forma $1,154,939 $9,509,366 $10,312,521
Loss per common share
As reported $0.14 $0.72 $0.78
Pro forma $0.14 $1.03 $0.80
The fair value of each option is estimated on the date of grant
using a type of Black-Scholes option pricing model with the
following weighted-average assumptions used for grants during the
years ended December 31, 1995, 1996 and 1997, respectively:
dividend yield of 0% in all periods; expected volatility of 43%,
43%, and 56%; risk-free interest rate of 6.2%, 6.5%, and 6.0%; and
expected terms of 3.0, 3.4, and 4.0 years, respectively.
A summary of the status of the Plans is presented below:
Year ended December 31,
1995 1996 1997
---- ---- ----
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------ ----- ------ ----- ------ -----
Options outstanding beginning
of period - - 350,293 $1.238 1,503,964 $2.433
Options exercised - - (383,965) $0.750 (417,908) $3.018
Options canceled - - (72,542) $5.480 (198,299) $4.977
Options granted 350,293 $1.238 1,610,178 $2.438 1,315,501 $4.146
------- ------- --------- ---------
Options outstanding end
of period 350,293 $1.238 1,503,964 $2.433 2,203,258 $3.960
Options exercisable at end
of period 44,445 $0.425 786,846 $3.118 746,858 $3.621
Weighted-average fair value
of options granted
during the period - $0.094 - $1.758 - $2.039
61
V-ONE CORPORATION
NOTES TO FINANCIAL STATEMENTS
------------------
As of December 31, 1997, the weighted average remaining
contractual life of the options that range from $3.75 to $9.00 is
9 years.
As of December 31, 1995, 1996 and 1997, the pro forma tax effects
under SFAS 109 would include an increase to both the deferred tax
asset and the valuation allowance of $12,700, $1,086,700 and
$121,392, respectively, and no impact to the statement of
operations.
8. COMMITMENTS
LEASES
The Company is obligated under various operating and capital lease
agreements, primarily for office space and equipment through 2003.
Future minimum lease payments under these non-cancelable operating and
capital leases as of December 31, 1997 are as follows:
Operating Capital
--------- -------
1998 $ 915,021 $ 96,188
1999 943,293 93,249
2000 886,197 91,188
2001 575,807 85,428
2002 818,547 69,345
---------- ---------
Total minimum payments $4,138,865 435,398
==========
Interest (122,966)
---------
Present value of capital lease
obligations 312,432
Less: current portion (17,126)
--------
Capital lease obligations non-current $ 295,306
=========
Rent expense was $92,785, $258,607, and $550,693, for the years ended
December 31, 1995, 1996 and 1997, respectively.
At December 31, 1997, the Company's future minimum sublease rental
income payments with respect to certain non-cancelable operating leases
with terms in excess of one year are as follows:
1998 $144,462
1999 204,043
2000 214,489
2001 74,712
---- --------
Total minimum payments $637,706
========
The cost and accumulated depreciation of assets under capital leases
were as follows as of December 31:
62
V-ONE CORPORATION
NOTES TO FINANCIAL STATEMENTS
------------------
1996 1997
----- ----
Furniture $ 8,752 $ 8,752
Computers and equipment 209,725 440,147
--------- ---------
218,477 448,899
Accumulated depreciation (34,192) (86,428)
--------- ---------
$ 184,256 $ 362,471
========= =========
LICENSE AGREEMENTS
In 1994, the Company entered into two licensing agreements whereby
the Company obtained the right to modify and sell certain
technology used in its product line. One of the agreements
requires the Company to pay fees based on product and subscription
sales for any product using the licensed technology. The other
agreement provides for payment of fees based upon gross revenues
of the Company. This latter agreement also gives the other party
("Licensor") the right to forfeit future licensing fees in
exchange for 2% of the Company's outstanding voting stock, after
giving effect to the issuance. The Licensor elected to receive
voting stock in May 1996. In October 1996, the Company issued
188,705 shares of Common Stock to the Licensor. The fair market
value of the stock issued, $944,000, is recorded as an asset by
the Company and is being amortized over the period of its
estimated useful life, 3 years. The Company incurred amortization
expense and fees totaling $110,860, $135,779, and $775,356
relating to these agreements in 1995, 1996 and 1997, respectively.
EMPLOYMENT AGREEMENTS
Effective November 21, 1997, the Company entered into a three year
employment agreement with David D. Dawson, the President and Chief
Executive Officer. This agreement provides for severance payments
if Mr. Dawson is terminated without cause during the term of the
agreement, and includes one year renewal options. The agreement
also provides a relocation cost allowance; and an incentive
compensation package based on performance criteria, for each year
of the contract term. The relocation cost allowance and certain
incentive compensation have been reflected in the financial
statements.
During 1997, the Company amended the Chairman of the Board of
Directors and certain senior executives of the Company's standing
employment agreements. Such agreements provide for minimum salary
levels and incentive bonuses payable if specified management goals
are attained. In the event of termination due to a change in
control of the Company or employment location, the aggregate
commitment under these agreements should all six covered
executives be terminated is approximately $662,000 to be
discounted at a rate of 1% above the prevailing one-year Treasury
Bill rate. Additionally, all outstanding stock options become
fully vested with no change in term, and current year bonuses to
the extent earned will be payable upon termination.
63
V-ONE CORPORATION
NOTES TO FINANCIAL STATEMENTS
------------------
9. EMPLOYEE 401(K) DEFERRED COMPENSATION PLAN
Effective January 1, 1997, the Company adopted the V-ONE 401(k) Plan
(the "401(k) Plan"). The 401(k) Plan is a contributory profit sharing
plan covering all eligible employees of the Company. An employee is
eligible to participate in the 401(k) Plan upon completing three months
of service and upon reaching age 21. The 401(k) Plan is subject to the
regulations issued by the United States Treasury Department and
Department of Labor under the Employee Retirement Income Security Act
of 1974.
Under the provisions of the 401(k) Plan, eligible participants can
contribute in pretax dollars an amount up to 15% of their annual
compensation, not to exceed the maximum legal deferral. Employer
contributions are discretionary and are determined by the management of
the Company. There were no employer contributions for the year ended
December 31, 1997.
Vesting for Company contributions and actual earnings thereon is based
on the participant's number of years of continuous service with the
Company. A participant is fully vested after six years of continuous
service. Regardless of years of service, a participant is fully vested
upon the occurrence of: (a) normal retirement age; (b) death; (c)
termination of the 401(k) Plan; or (d) retirement due to disability.
10. FINANCING
The Company has incurred net losses of $1,122,011, $6,695,556, and
$9,998,198 for the years ended December 31, 1995, 1996 and 1997.
Management considers the Company's current working capital position
sufficient to cover operating losses over the next operating cycle.
Management has historically been successful in obtaining outside
financing to meet obligations and funding working capital requirements
as they come due.
11. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
First Second Third Fourth
Quarter Quarter Quarter Quarter
1995
Net revenues $150,257 $218,961 $356,021 $378,262
Gross profit 97,667 140,401 230,539 257,735
Net loss (154,791) (245,136) (60,536) (661,548)
Net loss per common share (0.02) (0.03) (0.01) (0.08)
1996
Net revenues 1,021,811 1,354,576 1,720,543 2,169,219
Gross profit 699,813 876,023 1,205,105 1,459,589
Net loss (994,660) (3,393,401) (977,514) (1,329,978)
Net loss per common share (0.12) (0.40) (0.11) (0.11)
1997
Net revenues 2,414,015 2,134,581 2,764,352 2,089,807
Gross profit 1,852,711 1,815,739 2,070,376 1,502,334
Net loss (871,219) (3,149,492) (433,643) (5,543,844)
Net loss per common share (0.07) (0.25) (0.03) (0.43)
64
V-ONE CORPORATION
NOTES TO FINANCIAL STATEMENTS
------------------
12. SUBSEQUENT EVENTS
1998 INCENTIVE STOCK OPTION PLAN
On February 2, 1998, the Board of Directors authorized the adoption of
the 1998 Incentive Stock Option Plan (the "1998 Plan"), subject to
approval of the shareholders at the annual shareholders meeting
scheduled for May 14, 1998. The purpose of the 1998 Plan is to advance
the interests of the Company by providing for the acquisition of an
equity interest in the Company by non-employee directors, officers, key
employees and consultants. If approved, the 1998 Plan will become
effective February 2, 1998 and terminate February 2, 2008. The Company
has reserved 2,500,000 shares of Common Stock for awards granted under
the 1998 Plan.
Incentive stock options may be granted to purchase shares of Common
Stock at a price not less than fair market value on the date of grant.
Only employees may receive incentive stock options; all other qualified
participants may receive non-qualified stock options with an exercise
price determined by a Committee or the Board. Options are generally
exercisable after one or more years and expire no later than ten years
from the date of grant. The 1998 Plan also provides for reload options
and restricted share awards to employee and consultant participants
subject to various terms.
On the effective date of the 1998 Plan, each non-employee director of
the Board (excluding Messrs. Charles Chen, Harry Gruner, and William
Odom) shall be granted non-qualified options to purchase 10,000 shares
of Common Stock, with an exercise price of fair market at date of
grant. Such options are fully vested at grant date and shall have a
five year expiration term.
REPRICING OF OUTSTANDING STOCK OPTIONS UNDER THE 1996 INCENTIVE STOCK
OPTION PLAN
On February 17, 1998, the Board authorized the offer to reset the
exercise price of all full-time employees' (exclusive of Vice
Presidents and the President) incentive stock options and non-qualified
stock options granted under the 1996 Incentive Stock Option Plan. If
accepted by the option holder, such options are to be replaced with
non-qualified options at the new exercise price of $2.625 per share. To
be eligible for repricing, a participant must: 1) be a full-time
employee on February 17, 1998, 2) agree to remain in the employ of the
Company until August 17, 1998, and 3) acceptance of this offer must
have been exercised by February 24, 1998. At the close of business on
February 24, 1998, employees holding options to purchase 451,736 shares
of Common Stock in the aggregate had exercised their right to reprice
at the new exercise price of $2.625 per share.
CONVERSION OF SERIES A PREFERRED STOCK
During March 1998, holders of Series A Stock elected to convert 276
shares into 130,774 shares of Common Stock at a conversion price of
$2.1144 per share, and received warrants to purchase 26,155 shares of
Common Stock at an exercise price of $4.77 per share. Had the preferred
stock transaction occurred on January 1, 1997, pro forma basic loss per
share would have been approximately $(0.77) per share for the year
ended December 31, 1997.
The above transaction triggers a change in the 383,999 detachable
warrants with an exercise price of $3.125, outstanding at December 31,
1997 as a result of the anti-dilution clause. Such detachable warrants
65
V-ONE CORPORATION
NOTES TO FINANCIAL STATEMENTS
------------------
are now exercisable for 567,535 shares of Common Stock at an exercise
price of $2.1144 per share and will result in a noncash charge to
income of approximately $388,000 in the first quarter of fiscal 1998.
66
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item concerning directors and executive
officers is incorporated herein by reference to the Company's definitive proxy
statement for its annual stockholders' meeting to be held on May 14, 1998.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item concerning executive compensation is
incorporated herein by reference to the Company's definitive proxy statement for
its annual stockholders' meeting to be held on May 14, 1998.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item concerning security ownership of certain
beneficial owners and management is incorporated herein by reference to the
Company's definitive proxy statement for its annual stockholders' meeting to be
held on May 14, 1998.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item concerning certain relationships and
related transactions is incorporated herein by reference to the Company's
definitive proxy statement for its annual stockholders' meeting to be held on
May 14, 1998.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON
FORM 8-K
(a) Exhibits
Number Description
- ------ -----------
3.1 Amended and Restated Certificate of Incorporation as of
July 2, 1996 (1)
3.2 Amended and Restated Bylaws dated as of February 2, 1998
3.3 Certificate of Amendment to Certificate of Designation,
Preferences, and Rights of Series A
Convertible Preferred Stock dated September 9, 1996 (1)
3.4 Certificate of Elimination of Certificate of Designation,
Preferences and Rights of Series A
Convertible Preferred Stock (2)
3.5 Certificate of Designations of Series A Convertible
Preferred Stock (2)
9.1 Voting Trust Agreement between Hai Hua Cheng and
James F. Chen, Trustee (1)
9.2 Voting Trust Agreement between Robert Zupnik and
James F. Chen, Trustee (1)
9.3 Voting Trust Agreement between Dennis Winson and
James F. Chen, Trustee (1)
67
10.1 Employment Agreement between V-ONE Corporation ("V-ONE") and
James F. Chen dated as of June 12, 1996 (1)
10.2 V-ONE 1995 Non-Statutory Stock Option Plan (1)
10.3 V-ONE 1996 Non-Statutory Stock Option Plan (1)
10.4 V-ONE 1996 Incentive Stock Plan (1)
10.5 Software License Agreement between Trusted Information
Systems, Inc. ("TIS") and V-ONE executed October 6, 1994 (1)
10.6 First Amendment to the Software License Agreement between
TIS and V-ONE (1)
10.7 Second Amendment to the Software License Agreement between
TIS and V-ONE (1)
10.8 Third Amendment to the Software License Agreement between
TIS and V-ONE (1)
10.9 Fourth Amendment to the Software License Agreement between
TIS and V-ONE (1)
10.10 OEM Master License Agreement between RSA Data Security, Inc.
("RSA") and V-ONE dated December 30, 1994 and Amendment
Number One to the OEM Master License Agreement between RSA
and V-ONE (1)
10.11 Amendment Number Two to the OEM Master License Agreement
between RSA and V-ONE and Conversion Agreement dated May 23,
1996(1)
10.12 Promissory Note for Hai Hua Cheng with Allonge and Amendment
dated June 12, 1996 (1)
10.13 Form of Exchange and Purchase Agreement dated April 1996 (1)
10.14 Registration Rights Agreement Between V-ONE and JMI Equity
Fund II, L.P. ("JMI") (1)
10.15 8% Senior Subordinated Note due June 18, 2000 Issued by
V-ONE to JMI (1)
10.16 Warrant to Purchase 100,000 shares of Common Stock Issued by
V-ONE to JMI (1)
10.17 Warrant to Purchase 400,000 shares of Common Stock Issued by
V-ONE to JMI (1)
10.18 Employment Agreement between V-ONE and Jieh-Shan Wang dated
as of July 8, 1996 (1)
10.19 Subscription Agreement dated as of December 3, 1997 between
V-ONE and Advantage Fund II Ltd. (2)
10.20 Registration Rights Agreement dated as of December 3, 1997
between V-ONE and Advantage Fund II Ltd. (2)
10.21 Commitment Letter dated December 8, 1997 between V-ONE and
Advantage Fund II Ltd. (2)
10.22 Registration Rights Agreement dated as of December 8, 1997
between V-ONE and Wharton Capital Partners, Ltd. (2)
10.23 Warrant to Purchase 60,000 shares of Common Stock Issued on
December 8, 1997 by V-ONE to Wharton Capital Partners,
Ltd. (2)
10.24 Letter Agreement between V-ONE and Wharton Capital Partners,
Ltd. dated October 22, 1997 (2)
10.25 V-ONE 1998 Incentive Stock Plan
10.26 Warrants dated November 21, 1997 to Purchase 300,000 shares
of Common Stock granted to David D. Dawson
10.27 Employment Agreement dated November 21, 1997 between V-ONE
and David D. Dawson
10.28 Amendment to Employment Agreement dated November 7, 1997
between V-ONE and Charles B. Griffis
10.29 Amendment to Section 2.08 of 1996 Incentive Stock Plan
10.30 Lease Agreement dated March 24, 1997 between Bellemead
Development Corporation and V-ONE (3)
23.1 Consent of Coopers & Lybrand L.L.P.
27 Financial Data Schedule for the Year Ended December 31, 1997
- --------------------------------------------------------------------------------
(1) The information required by this exhibit is incorporated herein by
reference to V-ONE's Registration Statement and Form S-1
(No. 333-06535).
(2) The information required by this exhibit is incorporated herein by
reference to V-ONE's Form 8-K dated December 8, 1997.
68
(3) The information required by this exhibit is incorporated herein by
reference to V-ONE's Form 10-Q for the three months ended June 30,
1997.
- ------------------------------------------------------------------------------
(b) Financial Statement Schedules
The financial statement schedules filed as part of this report are listed in the
Index to Financial Statements and Schedules on page F-1 immediately following
the signature page to this report.
(c) Reports on Form 8-K
(ii) Form 8-K dated December 3, 1997 reporting, under Item 5, the
retaining of David D. Dawson to serve as President and Chief
Executive Officer replacing James F. Chen, founder of V-ONE,
who will continue in his role as Chairman, and the resignation
of H.H. Cheng as a director of V-ONE.
(ii) Form 8-K dated December 8, 1997 reporting, under Item 5, the
issuance of the Series A Convertible Preferred Stock.
69
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned thereunto duly authorized.
V-ONE Corporation
Date: March 27, 1998 By: /s/ David D. Dawson
--------------------
David D. Dawson
President and Chief Executive Officer
Pursuant to the requirements of Securities Exchange Act of 1934, this report has
been signed below by the following persons on behalf of the registrant and in
the capacities indicated.
Signature Title Date
- --------- ----- ----
/s/ James F. Chen Chairman of the Board March 27, 1998
- --------------------- And Director
James F. Chen
/s/ David D. Dawson President, Chief Executive March 27, 1998
- --------------------- Officer and Director
David D. Dawson
/s/ Charles B. Griffis Senior Vice President, Chief March 27, 1998
- ---------------------- Financial Officer and Treasurer
Charles B. Griffis (Principal Financial Officer)
/s/ Mark R. Fields Controller (Principal March 27, 1998
- --------------------- Accounting Officer)
Mark R. Fields
/s/ Charles C. Chen Director March 27, 1998
- ---------------------
Charles C. Chen
/s/ Harry S. Gruner Director March 27, 1998
- ---------------------
Harry S. Gruner
/s/ William E. Odom Director March 27, 1998
- ---------------------
William E. Odom
70
V-ONE CORPORATION
INDEX TO FINANCIAL STATEMENTS AND SCHEDULES
Page
----
Financial Statement Schedules:
Schedule II Valuation and Qualifying Accounts and Reserves F-2
F-1
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
V-ONE CORPORATION
(For the years ended December 31, 1995, 1996 and 1997)
Additions
Balance at Charged to Balance at
Beginning of Costs and End of
Description Period Expenses Deductions Period
ALLOWANCE FOR DOUBTFUL ACCOUNTS
December 31, 1995 --- 23,620 --- 23,620
December 31, 1996 23,620 228,775 --- 252,395
December 31, 1997 252,395 1,248,010 --- 1,500,405
DEFERRED TAX ASSET VALUATION ALLOWANCE
December 31, 1995 165,804 340,489 --- 506,293
December 31, 1996 506,293 2,555,079 --- 3,061,372
December 31, 1997 3,061,372 3,779,331 --- 6,416,243
ALLOWANCE FOR NON-SALABLE INVENTORY
December 31, 1995 --- 50,000 --- 50,000
December 31, 1996 50,000 --- --- 50,000
December 31, 1997 50,000 162,700 --- 212,700
F-2
EXHIBIT INDEX
Number Description
- ------ -----------
3.1 Amended and Restated Certificate of Incorporation as of
July 2, 1996 (1)
3.2 Amended and Restated Bylaws dated as of February 2, 1998
3.3 Certificate of Amendment to Certificate of Designation,
Preferences, and Rights of Series A
Convertible Preferred Stock dated September 9, 1996 (1)
3.4 Certificate of Elimination of Certificate of Designation,
Preferences and Rights of Series A
Convertible Preferred Stock (2)
3.5 Certificate of Designations of Series A Convertible
Preferred Stock (2)
9.1 Voting Trust Agreement between Hai Hua Cheng and
James F. Chen, Trustee (1)
9.2 Voting Trust Agreement between Robert Zupnik and
James F. Chen, Trustee (1)
9.3 Voting Trust Agreement between Dennis Winson and
James F. Chen, Trustee (1)
10.1 Employment Agreement between V-ONE Corporation ("V-ONE") and
James F. Chen dated as of June 12, 1996 (1)
10.2 V-ONE 1995 Non-Statutory Stock Option Plan (1)
10.3 V-ONE 1996 Non-Statutory Stock Option Plan (1)
10.4 V-ONE 1996 Incentive Stock Plan (1)
10.5 Software License Agreement between Trusted Information
Systems, Inc. ("TIS") and V-ONE executed October 6, 1994 (1)
10.6 First Amendment to the Software License Agreement between
TIS and V-ONE (1)
10.7 Second Amendment to the Software License Agreement between
TIS and V-ONE (1)
10.8 Third Amendment to the Software License Agreement between
TIS and V-ONE (1)
10.9 Fourth Amendment to the Software License Agreement between
TIS and V-ONE (1)
10.10 OEM Master License Agreement between RSA Data Security, Inc.
("RSA") and V-ONE dated December 30, 1994 and Amendment
Number One to the OEM Master License Agreement between RSA
and V-ONE (1)
10.11 Amendment Number Two to the OEM Master License Agreement
between RSA and V-ONE and Conversion Agreement dated May 23,
1996(1)
10.12 Promissory Note for Hai Hua Cheng with Allonge and Amendment
dated June 12, 1996 (1)
10.13 Form of Exchange and Purchase Agreement dated April 1996 (1)
10.14 Registration Rights Agreement Between V-ONE and JMI Equity
Fund II, L.P. ("JMI") (1)
10.15 8% Senior Subordinated Note due June 18, 2000 Issued by
V-ONE to JMI (1)
10.16 Warrant to Purchase 100,000 shares of Common Stock Issued by
V-ONE to JMI (1)
10.17 Warrant to Purchase 400,000 shares of Common Stock Issued by
V-ONE to JMI (1)
10.18 Employment Agreement between V-ONE and Jieh-Shan Wang dated
as of July 8, 1996 (1)
10.19 Subscription Agreement dated as of December 3, 1997 between
V-ONE and Advantage Fund II Ltd. (2)
10.20 Registration Rights Agreement dated as of December 3, 1997
between V-ONE and Advantage Fund II Ltd. (2)
10.21 Commitment Letter dated December 8, 1997 between V-ONE and
Advantage Fund II Ltd. (2)
10.22 Registration Rights Agreement dated as of December 8, 1997
between V-ONE and Wharton Capital Partners, Ltd. (2)
10.23 Warrant to Purchase 60,000 shares of Common Stock Issued on
December 8, 1997 by V-ONE to Wharton Capital Partners,
Ltd. (2)
10.24 Letter Agreement between V-ONE and Wharton Capital Partners,
Ltd. dated October 22, 1997 (2)
10.25 V-ONE 1998 Incentive Stock Plan
10.26 Warrants dated November 21, 1997 to Purchase 300,000 shares
of Common Stock granted to David D. Dawson
10.27 Employment Agreement dated November 21, 1997 between V-ONE
and David D. Dawson
10.28 Amendment to Employment Agreement dated November 7, 1997
between V-ONE and Charles B. Griffis
10.29 Amendment to Section 2.08 of 1996 Incentive Stock Plan
10.30 Lease Agreement dated March 24, 1997 between Bellemead
Development Corporation and V-ONE (3)
23.1 Consent of Coopers & Lybrand L.L.P.
27 Financial Data Schedule for the Year Ended December 31, 1997
- --------------------------------------------------------------------------------
(1) The information required by this exhibit is incorporated herein by
reference to V-ONE's Registration Statement and Form S-1
(No. 333-06535).
(2) The information required by this exhibit is incorporated herein by
reference to V-ONE's Form 8-K dated December 8, 1997.