UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended June 30, 2002
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period _______________ to _______________
Commission File No. 0-25831
NetWolves Corporation
(Exact name of registrant as specified in its charter)
New York 11-2208052
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
4002 Eisenhower Blvd, Tampa, Florida 33634-7511
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (813) 286-8644
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.0033 par value
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No _____
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K [X ].
The aggregate market value of the voting stock held by non-affiliates of the
registrant, based upon the closing sale price of the Common Stock on October 8,
2002 as reported on the NASDAQ, was approximately $8,845,000. Shares of Common
Stock held by each executive officer and director and by each person who owns 5%
or more of the outstanding Common Stock have been excluded in that such persons
may be deemed to be affiliates. This determination of affiliates status is not
necessarily a conclusive determination for other purposes.
As of October 8, 2002, the Registrant had outstanding 12,607,571 shares of
Common Stock.
Documents incorporated by reference: None
NETWOLVES CORPORATION AND SUBSIDIARIES
FORM 10-K
AS OF JUNE 30, 2002 , 2001 AND 2000
TABLE OF CONTENTS
PART I
ITEM 1 Business 1
ITEM 2 Properties 13
ITEM 3 Legal Proceedings 14
ITEM 4 Submission of Matters to a Vote of Security Holders 15
PART II
ITEM 5 Market for Registrant's Common Equity and Related
Stockholder Matters 16
ITEM 6 Selected Financial Data 16
ITEM 7 Management's Discussion and Analysis of Financial Condition
and Results of Operations 18
ITEM 7a Quantitative and Qualitative Disclosure About Market Risk 27
ITEM 8 Financial Statements and Supplementary Data 27
ITEM 9 Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 27
PART III
ITEM 10 Directors and Executive Officers of the Registrant 28
ITEM 11 Executive Compensation 28
ITEM 12 Security Ownership of Certain Beneficial Owners and Management 32
ITEM 13 Certain Relationships and Related Transactions 32
PART IV
ITEM 14 Exhibits, Financial Statements Schedules, and Reports on
Form 8-K 33
SIGNATURES 34
PART I
ITEM 1. BUSINESS
This Annual Report on Form 10-K, the exhibits hereto and the information
incorporated by reference herein contain "forward looking statements" within the
meaning of Section 27A of the Securities Act of 1933, as amended (the
"Securities Act") and Section 21E of the Securities Exchange Act of 1934, as
amended (the "Exchange Act"), and such forward looking statements involve risks
and uncertainties. When used in this report, the words "expects", "anticipates",
"estimates" and similar expressions are intended to identify forward looking
statements. Such statements are subject to risks and uncertainties that could
cause actual results to differ materially from those projected. These risks and
uncertainties include those discussed below and those discussed in "Management's
Discussion and Analysis of Financial Condition and Results of Operations" or
incorporated by reference herein. NetWolves Corporation undertakes no obligation
to publicly release any revisions to these forward looking statements to reflect
events or circumstances after the date this Report is filed with the Securities
and Exchange Commission or to reflect the occurrence of unanticipated events.
Overview
NetWolves Corporation ("NetWolves" or the "Company") designs, develops,
assembles and sells Internet infrastructure security platforms, coupled with
network based management services, designed to significantly reduce the up-front
and ongoing costs associated with small, medium and remote offices' global
Internet access. The Company was founded in order to leverage the rapid
progression of technology, removing barriers of entry for organizations desiring
to attain the benefits and flexibility a public network enterprise offers.
NetWolves' patent pending system technology enables organizations to obtain
their short, middle and long term IT and e-business initiatives through the
deployment of our plug 'n' play perimeter office security platform, coupled with
our secure remote monitoring and management ("SRM2 TM") system. Additionally,
NetWolves' advanced, centralized, reporting module offers the ability for
corporate executives to view, via the Internet, both statistical and performance
based metrics for their global network.
NetWolves products and services offer complete system solutions to
organizations needing cost effective network security (firewall, routing,
intrusion detection, content filtering, email, intranet, FTP, etc.) complete
with advanced integrated hardware, a user-friendly interface, and Internet-based
expansion capabilities. As companies migrate from the traditional private leased
lines to public network connectivity to reduce costs, NetWolves provides
cost-effective, value-added expansion technologies such as virtual private
networking ("VPN"), a process used to allow secure data transmissions on a local
area network, a wide area network, or to secure wireless network connections.
This feature affords the user virtually all the benefits of lease-line service
without the attendant recurring costs.
NetWolves differentiates itself from its competitors primarily through its
proprietary patent pending technology, which provides centralized remote
monitoring and management facilities. While other, more labor-intensive
management systems currently exist, such systems require an inbound
administrative port to provide remote monitoring and management. Most Fortune
1000 companies are unwilling to take the risk of opening up an inbound
administrative port while having their entire enterprise on a public broadband
medium. "Hackers", using simple port scanning tools, can easily locate these
administrative inbound ports. SRM2 TM has the ability to monitor thousands of
locations concurrently without opening an administrative inbound port and allows
the secure, remote management and monitoring of multiple all-in-one gateway
servers located worldwide. This monitoring can be performed in real-time from
one or numerous central sites. This technology also allows a network
administrator to create a configuration template with all necessary information
changes required to manage all-in-one units. This template can be applied to
each unit via a secure configuration mechanism from the central monitoring
location, without compromising network security. It is this SRM2 TM system that
forms the basis of the Company's agreement with the General Electric Company.
NetWolves "edge of the network" security platforms and centralized
management and monitoring systems are designed for our customers' present and
future needs. The Company's initial target markets are the end users in small
and mid-size businesses and large organizations with satellite offices. Larger
end users, to whom the product is marketed, are companies with multi-state or
country locations, government agencies, retail outlets and kiosks. NetWolves
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products are designed to service numerous markets, including financial, medical,
legal, travel, entertainment, hotel, education, government, auto and petroleum
industries. The Company's strategy is to establish SRM2 TM technology as the
standard for enterprise-wide secure network connectivity and management
worldwide. To achieve its objectives, NetWolves seeks to form relationships with
leading companies to deliver a secure connectivity solution which is
interoperable with their existing network infrastructure, thereby lessening
their need for material capital improvements while migrating to public network
connectivity.
Acquisition of Norstan Network Services, Inc.
On July 9, 2002, the Company, through its wholly owned subsidiary,
NetWolves Acquisitions, Inc., acquired all of the outstanding capital stock of
Norstan Network Services, Inc. ("NNSI") pursuant to a Stock Purchase Agreement
dated as of January 30, 2002, as amended, among Norstan, Inc. (the "Seller") and
NNSI, both Minnesota corporations, the Company and NetWolves Acquisitions, Inc.,
a Delaware corporation. The Company paid to the Seller $7,500,000, $3,750,000 of
which was paid in cash on or prior to closing and $3,750,000 is payable under
the term of a non-interest bearing promissory note due July 9, 2003. The
purchase price was determined through arms' length negotiations. The $3,750,000
in cash paid by the Company to the Seller was primarily obtained through equity
and debt financing and to a lesser extent from working capital.
NNSI provides multiple source data and voice services and related
consulting and professional services throughout the United States. For the nine
months ended March 31, 2002, NNSI's net sales were $16,279,000, its gross profit
from sales was $5,964,000, its operating expenses (including a management fee to
its parent, Norstan, Inc. of $1,481,000) was $4,177,000 and its income before
income taxes was $1,787,000. As a result of the acquisition, we expect to
increase our security solution revenues by leveraging NNSI's existing customer
base. In addition, we expect the acquisition will enable us to expand the range
of services we can offer our major customer as well as future customers. The
results of NNSI's operations will be included in our consolidated financial
statements commencing July 9, 2002.
Agreements with General Electric
On June 29, 2000, NetWolves and General Electric Company ("GE") entered
into a six year agreement for the master purchase, license and support services
of NetWolves' security, remote monitoring and configuration management system.
GE, after extensive due diligence in looking for the all-in-one small office
solution for network management, interconnectivity and security, chose the
Company's products for deployment throughout their enterprise.
The contract is for a term of six years and can be extended for four
additional one-year periods unless prior notice of non-renewal is given by
either party as defined in the agreement. The contract provides for the Company
to receive a fee upon shipment of each unit, and an additional one-time
configuration fee. Additionally, upon shipment of each unit, GE has the right to
purchase from the Company support service and annual monitoring and management
service on an annual basis ("Annual Services"). The Annual Services shall
continue at the same rate per annum, at GE's discretion, provided that GE
requests such services at any time during a subsequent year. GE is required to
pay fees for Annual Services in full from the expiration date of the prior year
period and revenue generated from the Annual Services is recognized over the
service period.
GE has commenced the process of using the Company's products for
interconnectivity of its worldwide offices. The Company's products enable GE's
offices to interact with each other, utilizing NetWolves advanced firewall
security. NetWolves believes that this agreement further validates the Company's
technology and innovations within the firewall and network security markets.
Network security is one of the most formidable challenges facing Fortune 1000
companies, and with its new SRM2 TM system, NetWolves can offer the appropriate
solutions.
On September 26, 2002, the Company entered into a three year agreement with
General Electric Consumer Finance, the consumer financing arm of the General
Electric Company. The agreement covers the use of the Company's technology by
General Electric Consumer Finance in all of its offices worldwide, encompassing
36 countries. The first rollouts of NetWolves' products are scheduled for Japan
and Germany.
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Industry Background
International Data Corporation (IDC), a market research organization,
expects worldwide Internet infrastructure spending to increase from about $124
billion in 1999 to $370 billion in 2003, with a Compounded Annual Growth Rate of
32%. In order for the Internet to achieve its potential, the market for
corporate users require that a comprehensive security infrastructure must exist
in order to establish the requisite level of trust and confidence for conducting
medium-to-large scale business communications. The realization that the Internet
remains unsecured is not unknown to the investment community. Based on
information gathered from various industry sources, the Internet security
appliance market will reach as much as $13.3 billion by 2004. Infonetics
Research, Inc. sees the VPN products segment within the Internet security
marketplace growing to $32 billion by 2003. NetWolves is positioning to leverage
this emerging and growing market.
While security awareness is apparent among the Fortune 100, the issue is
only now becoming a high priority within the Fortune 1000. NetWolves products
and services allow companies from the Fortune 1000 to the medium and small
office markets to take full advantage of the emerging global market for public
connectivity. The medium and small office markets include business enterprises,
remote and branch offices of large corporations, government offices,
telecommuter home offices, and education markets for businesses and consumers.
NetWolves' products can be deployed pre-configured, which minimizes the
integration, installation and maintenance costs typical of traditional Internet
security and access solutions. With retail prices ranging from $1,000 to $5,000,
compared to competitive products that range in price from approximately $5,000
to in excess of $20,000, the Company's products are designed to enable customers
to reduce purchase, service and personnel hiring costs. NetWolves' products are
designed to maximize reliability and uptime, and can be used in networks ranging
in size from one to thousands of users in multiple locations. In effect,
NetWolves is fast becoming a beneficiary of growing awareness among corporations
looking to acquire security.
Historically, to establish Internet connectivity, an organization needed
access to complex network technologies and one or more costly general-purpose
servers, which often require technically skilled staff to maintain. The expense
and technical complexity of these network technologies and general purpose
servers often discourage their adoption by small-to-medium-size organizations,
due to their limited budgets and technology skills. The reliability of these
complex networks are often called to question, due, if for no other reason, for
their complexity alone. NetWolves SRM2 TM system represents an innovative
approach to cost effective network managed security, working with other network
devices, to provide services to perimeter network users. Today, building upon
NetWolves core foundation, our technology has evolved to become centrally
managed networks and security services, designed to facilitate authorized users
within the network while, at the same time providing an aggressive rejection of
unauthorized users who have the capabilities to gain access to private networks.
The security of the perimeter or remote office is a critical component for
virtually every local area network (LAN) and wide area network (WAN) connected
to the Internet. Applications such as firewall, VPN, web server and web access
control have become absolute necessities for virtually every business. The
ongoing threat of security breaches is driving corporation globally to focus
their priorities on identifying and correcting network vulnerabilities. The
NetWolves security-software hardened platform, integral to our SRM2 TM system
configurations, is an important step forward toward meeting the challenge of
today's increasingly sophisticated network assaults.
Products and Services
The NetWolves Security Suite ("NSS") and WolfPac Security Platforms offer
sophisticated, yet easy-to-administer devices for securely connecting people and
offices to the Internet by combining a wide range of functionality and
communications choices. This functionality includes Internet access, firewall
security, web access control, e-mail, IP routing, web server, web caching
server, DNS caching server, DHCP server, and file sharing in an
easy-to-configure integrated software and hardware gateway solution. NetWolves'
WolfPac Security Platforms work with a variety of access methods including North
American T1/56K, European E1 standards, ISDN lines, DSL, cable or satellite
modems.
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When NetWolves' WolfPac Security Platform resides between a company's
local-area network and an Internet service, it provides shared Internet access
for a few or up to hundreds of users behind the device. The Internet provides
one of today's most cost-effective means of communication, and through use of
the WolfPac Security Platforms, an organization with many locations can create
online communities leveraging the power of the Internet and SRM2.
The WolfPac Security Platforms are advanced firewall security systems that
enable businesses to implement company-wide network security policies. The
WolfPac Security Platforms protect a company's valuable data assets from
unauthorized users. The WolfPac Security Platforms cost substantially less than
the purchase of its functionality found via the traditional, integrated or
patchwork approach in separate products. Further, its "all-in-one" solution
significantly reduces costly network administration, since there are less
disparate components to administer within the WolfPac Security Platforms. Each
application within the server is designed to work together using integrated
hardware and software with a common interface. This facilitates expansion and
support of the converging voice and data industries.
NetWolves' WolfPac Security Platforms are configured using a web-based
graphical user interface (GUI) and are designed for public network connectivity,
can be configured to handle large-scale network deployments. NetWolves develops
custom software applications that are fully integrated with commodity off-
the-shelf server components. NetWolves maximizes its focus in core technology
research and development, and out-sources the assembly functions required to
meet production requirements.
Keeping data secure is one of the main functions of the WolfPac Security
Platform. Companies significantly reduce leased line/private communication costs
by installing the VPN applications and utilizing the Public Network (Internet)
to maintain data privacy, which is maintained through the use of a tunneling
protocol and security procedures, sending encrypted data over the Internet. The
primary benefit of the VPN is providing the client communication services at
significantly reduced costs by utilizing the shared public networks rather than
private networks. Businesses are implementing a similar process called client or
remote VPN, allowing employees to communicate with their company's network at
any time from outside the workplace, using a laptop or desktop computer and
client VPN software. This cost-effective solution makes businesses more
productive by giving remote users secure access to corporate resources.
With NetWolves' Connectivity Failover solution in place, the WolfPac
Security Platform continuously monitors Internet (circuit level) connectivity,
utilizing hardware level verifications. Simultaneously, the WolfPac Security
Platform monitors performance levels of the VPN tunnel that pass through the
primary interface by conducting scheduled interval tests. If the primary
interface fails or the VPN tunnel does not meet established performance
criteria, the WolfPac Security Platform will automatically fail over to a
secondary interface and permit the data to reach its intended destination,
securely and reliably using RIP, OSPF or BGP protocols.
If the High Availability (Hardware) Connectivity Failover solution with
Virtual Routing Redundancy Protocol ("VRRP") is used, a WolfPac Security
Platform designated as the "master" will automatically fail over to a second
WolfPac Security Platform designated as the "slave" using VRRP. The slave
WolfPac Security Platform behaves much like the master WolfPac Security
Platform, offering both primary and secondary WAN connections. When a WAN
connection is again established on the master WolfPac Security Platform,
responsibility is shifted back to it from the slave.
The World Wide Web is a broad universe of network-accessible information.
To enable employers to keep employees focused on business issues, most WolfPac
Security Platforms include Web Access Control as an optional feature. Using Web
Access Control, a client's system administrator can block or permit access to
the Internet and specific web sites. If a business owner or teacher needs to
enforce or implement an acceptable usage policy to keep employees productive or
students from inappropriate sites, this is accommodated through Web Access
Control.
E-mail allows electronic messages to be delivered over the Internet to
specific individuals and groups. It is one of the fastest, most cost-effective
ways to deliver messages, documents, web pages, and secured information. Many
WolfPac Security Platform models include as a standard or an optional feature an
integrated mail server that supports a virtually unlimited number of accounts.
4
WolfPac Security Platforms incorporate an Internet Protocol (IP) router.
The Internet Protocol is the language the Internet "speaks" in order to
communicate. A router is a device, or in some cases, software that determines
the next network point to which a packet of data should be forwarded toward its
destination. The router is connected to at least two networks and decides which
way to send each information packet based on its current understanding of the
state of the networks to which it is connected.
The WolfPac Security Platform web server is a program that, using the
client/server model and the World Wide Web's Hypertext Transfer Protocol (HTTP),
serves the files that form web pages to web users (whose computers contain web
browsers such as Netscape that forward their requests). Every computer on the
Internet that contains a web site must have a web server. The most widely used
web servers are Apache, which is the server used by NetWolves to host an
Internet web site or an intranet. An intranet is similar to an Internet site
except that it is accessible by internal users and not by the general public.
When businesses need to make an area of the Intranet available to a business
partner or supplier it is done through authentication (usually a username and
password) - this is referred to as an extranet.
Clients using a NetWolves web server can quickly bring new products to
market, use it as a portal for customer service, and build web sites to sell
products and services online. Utilized with the web server, additional programs
can be used with it to collect valuable customer data, such as personal
preferences, product interest, and time spent browsing specific web pages.
More advanced WolfPac Security Platforms incorporate a web caching server,
which stores web pages visited by users. Caching web pages speeds up browsing
and optimizes Internet services. Pages stored remain available locally for
subsequent requests. This feature enhances the efficiency of the WolfPac
Security Platform as an Internet access solution.
Typically, using a web browser, a user attempting to access information on
the Internet performs a Domain Name System (DNS) lookup. DNS is the Internet
service that converts understandable web site names (for example
www.netwolves.com) into computer readable web site numbers or IP addresses (IP
numbers are meaningful only to those who need to know them and not to the
average web user). By integrating a DNS caching server directly into the WolfPac
Security Platform, Internet traffic is reduced and web site address look-up time
is faster, therefore increasing the overall performance of the system.
A Dynamic Host Configuration Protocol (DHCP) server integrated into the
WolfPac Security Platform allows for easy management when adding computers to
the company network. It saves time and allows network administrators to work
more efficiently, eliminating the need for a person to travel to a remote
location to configure a computer with an IP address.
File sharing allows employees or departments to use the WolfPac Security
Platform to share data files with co-workers, specifying varying levels of
access privileges. Individuals and groups can be organized in any way a company
chooses. Access is restricted to those connected to the company network and
permitted to have access. Benefits include centrally located files, backup of
local computer files, password protection, and the ability to preset privileges
for files so only certain users can open, read and modify them.
A web based Administrative Interface (AI) allows the network administrator
to configure the various subsystems of the NSS. The NSS becomes completely
transparent to the Internet user. Likewise, because the NSS is easy to set-up,
it will feel transparent to the administrator. This is especially true should
changes be required following initial installation. Since all administration of
the NSS is performed through a web browser, the administrator can work from any
workstation on the LAN.
Features of NetWolves Security Suite
The NetWolves Security Suite offers the following standard features:
-- Securely connects any number of users in a small geographic area (LAN)
simultaneous to the Internet through a dedicated connection.
-- Hierarchical caching, which are rules that tell a computer to look for
the data stored locally before accessing the Internet for data, gives
the WolfPac Security Platform more efficient web viewing and greater
ability to transfer data from one file to another.
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-- Any number of users can send and receive e-mail individually, while
sharing one Internet service provider account.
-- A firewall protects the LAN from Internet-borne attacks.
-- An advanced network address translation module allows the creation of
powerful address translation rules for greater firewall flexibility.
-- Files that store events for review at a later date ensure appropriate
use of Internet resources.
-- Scalability allows Internet usage to grow as a company expands.
-- A network file server centrally stores programs and data for
accessibility to multiple users simultaneously, and shares data and
programs from a central location.
-- Can be used as a stand-alone firewall to protect the resources of a
private network from users outside on a public network.
-- Allows a company to publish and host a web site.
-- Easily manage internal and external proxy services.
Optional Features of NetWolves Security Suite
The NetWolves Security Suite also offers the following optional features:
-- Web access control allows the network administrator to effectively
block or deny access to the Internet and specific web sites.
-- The Virtual Private Networking (VPN) module provides a process for
encrypting data for secure transmission over public networks and
supports Internet Key Exchange (IKE) and IPSec (a security protocol).
-- Intrusion Detection System (IDS) is a real time, network-based system
designed to detect, report, and terminate unauthorized activity
throughout the network.
-- Connectivity Failover with VRRP establishes a WAN connection on a
WolfPac Security Platform slave if WAN connection on WolfPac Security
Platform master is lost or fails to meet minimum VPN performance
criteria.
-- NetMetrics provides a means for measuring two performance parameters:
the time required to load a single web page from the Internet, and the
time it takes to send an email to a specified account and receive a
reply from that same account. Net Metrics also provides the monitoring
mechanism within Connectivity Failover.
Firewall and Security Functions
NetWolves believes that security is an essential element of any Internet
connectivity solution. For this reason, the WolfPac Security Platform includes
high-end firewall security protection, without requiring the purchase of
additional components.
The WolfPac Security Platforms are designed to protect a company's private
data and systems from outside intruders with its firewall security system,
incorporating three separate firewall technologies:
-- Stateful packet filters verify that all incoming data packets coming
from the Internet have been requested by an authorized user on the
LAN.
-- Proxy applications prevent unauthorized Internet applications from
accessing the LAN.
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-- Network Address Translation ("NAT"), which is a conversion of public
addresses to and from private addresses, makes the network invisible
to outside Internet users by hiding the internal network's addresses
of each sender or receiver of information.
-- All packets of data entering the WolfPac Security Platform from the
Internet are first checked for validity against a series of stateful
packet filters. Data is then forwarded to proxy applications that
further inspect the contents of the packets for potential security
violations. If the data is determined to be valid by both the stateful
packet filters and proxy applications, it is allowed to enter the
secure LAN.
-- WolfPac Security Platforms are designed with fully configurable
firewalls and network address translation rules that give the network
administrator greater flexibility in allowing or denying incoming and
outgoing data.
E-Mail Services
A key feature of the WolfPac Security Platform is the advanced and powerful
management of electronic mail. With only one Internet account, an unlimited
number of users can send and receive e- mail. In addition, the WolfPac Security
Platform supports Internet e-mail standards. For e-mail between the WolfPac
Security Platform and the Internet, NetWolves uses the standard simple mail
transfer protocol (SMTP), which is the standard for e-mail transmission on the
Internet. For LAN users, the WolfPac Security Platform supports a number of
different protocols. If the WolfPac Security Platform is used as the LAN's
e-mail server, two common client-server e-mail protocol standards are supported:
-- POP3 is a process for retrieving e-mail from its stored location to
the viewer.
-- IMAP is a method for viewing electronic mail at its stored location.
-- The WolfPac Security Platform supports several e-mail clients,
including:
-- Microsoft Exchange TM
-- Microsoft Internet Mail TM
-- Netscape Navigator Mail TM
-- Eudora TM
-- Pegasus TM
-- The WolfPac Security Platform also supports several e-mail gateways,
including:
-- Microsoft Exchange Server TM
-- Lotus cc:Mail TM
-- GroupWise Mail TM
-- Others with SMTP gateways TM
Secure Remote Management and Monitoring Services ("SRM2 TM")
Under the SRM2 TM umbrella, product architecture planners believe that
Managed Security Services (MSS) will play an even more important role in future
security plans. Since a customer base already exists within WolfPac Security
Platforms, the security-monitoring infrastructure will significantly reduce
costs and provide effective and economical network managed security services to
NetWolves clients.
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SRM2 TM is comprised of the following product subsystems:
-- SRM2 TM Monitoring & Notification provides monitoring, notification,
paging and alarming capabilities of remote WolfPac Security Platforms.
In addition, the firewall status, VPN tunnel status and Administrative
Interface configuration status of all remote end points are monitored
and logged.
-- SRM2 TM Management and Configuration manages and configures remote end
points individually or by groups, including complete operating system
upgrades. Remote end points are capable of failover to an alternate
SRM2 TM server in the event that the primary server is inaccessible.
This service also allows user access to specific information about
remote WolfPac Security Platforms (individually or by groups) via a
Monitoring Console. Specific information includes firewall status, the
number of active VPN connections, traffic statistics, intrusion
detection data, activity logs, and Administrative Interface
configuration data.
-- SRM2 TM Intrusion Detection provides host and network based intrusion
detection capabilities for remote WolfPac Security Platforms. The IDS
information is then transferred from each remote end point to a
database, where it can be accessed by the SRM2 TM Monitoring Console.
-- SRM2 TM Anti-Virus stipulates both protection (security) of remote
WolfPac Security Platforms from hardware glitches, software bugs and
any attempts to sabotage client data, and damage control through
immediate detection. Activity logs are transferred from each remote
end point to a database, where it can be accessed by the SRM2 TM
Monitoring Console.
-- SRM2 TM VPN provides the network manager with the ability to connect
separate business locations, using the IP infrastructure rather than
the private medium such as leased lines.
-- Security Policy Management is the process by which the client's
security policy is created, defined, or redefined to reflect security
management processes enabled by advent of NetWolves product and
services. This policy reflects particularly the rules governing remote
end point security and the processes guiding how security platforms
are managed and configured to ensure specified protections.
-- Firewall Policy Management is the process by which the client's
firewall security policy is created to reflect the methods by which
NetWolves firewall platforms are to be utilized to ensure network
protections. This policy reflects particularly the rules governing
remote end point security and the processes guiding how the firewall
platform is utilized to manage and configure the client network.
SRM2 TM technology, combined with the Company's core suite of security
applications and a centralized monitoring office, makes available to network
administrators and organizations what the Company believes to be the complete
solution to managing, monitoring and securing their networks.
Engineering and development
The Internet and the computer hardware and software industry are
characterized by rapid technological change, which requires ongoing development
and maintenance of products. It is customary for modifications to be made to
products as experience with their use grows or changes in manufacturer's
hardware and software are required.
NetWolves' engineering and development group is comprised of a core team of
engineers who specialize in different areas of security and product development.
NetWolves' team has experience in a variety of industries, including information
security, designing networking protocols, building interfaces, designing
databases, and computer telephony. Their expertise is used in the design of our
core products and seeking enhanced functionality to meet future customer needs.
As of September 13, 2002, the Company's engineering and development group
consists of 19 employees. The Company seeks to recruit highly qualified
employees and its ability to attract and retain such employees will be a
principal factor in its success in achieving and maintaining a leading
technological position.
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Engineering and development expenses were approximately $1,856,000,
$1,893,000 and $1,329,000, exclusive of capitalized software development costs
of approximately $73,000, $116,000 and $170,000 for the years ended June 30,
2002, 2001 and 2000, respectively. The Company intends to increase its
investment in product development and believes that its future product offerings
will depend, in part, on its ability to develop, manufacture and market new
products and enhancements to existing products on a cost-effective and timely
basis.
Manufacturing
The Company currently uses a hybrid manufacturing and assembly model to
produce its products. The enclosures for the Company's WolfPac Security
Platforms are manufactured by Florida Metal Stamping, Inc. ("FMS") of Largo,
Florida. FMS is an ISO 9002 certified manufacturer, fabricator and assembler of
enclosures for major electronic systems manufacturers. SED Corp. ("SED") of
Tucker, Georgia supplies the motherboards and most other electronic components
for the Company's WolfPac Security Platforms. Electronic components and custom
enclosure components for significant future builds will be outsourced to one or
numerous manufacturers.
While the Company has no long-term agreement with FMS or SED, it believes
that alternative manufacturers and suppliers are available in the event the
Company seeks to change or expand upon manufacturers of its products.
Production Process
The process used to produce NetWolves products begins with hardware
configuration, installing the appropriate version of the Company's software,
configuring client-specific software components, followed by a unit testing
process. Raw/prefabricated materials, components, and subassemblies required for
production include motherboards, CPU's, cases, Ethernet cards, network
communication cards, hard drives, memory, CPU fans and power supplies. The
Company believes that these materials are available from several companies and
that alternative sources of supply are currently available.
Testing
A majority of testing is performed as part of the manufacturing process. In
addition, NetWolves performs quality testing via the Internet on a periodic
basis to verify that the assembled products meet all production quality
criteria. Also, randomly chosen units are shipped from the production assembly
facility back to NetWolves for additional testing.
In addition to testing the product on a regular basis, NetWolves researches
the status of existing components used in its products to determine if they are
being phased out or prices have changed. If it concludes that a certain
component must be substituted, trial testing is performed on a new component to
determine if it meets product component criteria. If it meets this criterion,
which includes cost effectiveness, longer life expectancy and product
efficiency, a plan to develop and use the component is implemented.
Customer Service and Technical Support
The Company maintains an experienced staff of customer service personnel to
provide technical support to its customers. Each member of the customer service
staff is certified through an ongoing in-house training and testing program to
provide support for each individual product. The Company's customer service
staff provides product support via telephone and e-mail 24 hours per day, seven
days per week. The Company generally provides software and documentation
updates, including maintenance releases, operating system upgrades and major
functional upgrades (for an additional fee), as part of its customer support
services.
Sales and Marketing
The Company's marketing and sales strategy is to position NetWolves as a
premier total IP network solutions provider. NetWolves is an IP security systems
developer that provides network circuits and software/hardware end point
security solutions to it customers. We intend to enter into multi-national
reseller agreements with value added resellers (VARs), Internet Service
Providers (ISP's), Competitive Local Exchange Carriers (CLEC's), Incumbent Local
Exchange Carriers (ILEC's), and systems integrators of Internet access security
devices.
9
In addition, NetWolves' direct sales force is focused on opening large
scale multi-national opportunities for firewalls, caching servers, hosting
servers, email servers, web access filtering systems, Intrusion Detection and
anti-virus with Fortune 1000 enterprises. The channel and direct sales approach
allows NetWolves to take advantage of the personal business contacts of its
senior stockholders and executive management while building channel sales
potential in the medium and low end of the market.
The Company is also entering into agreements and partnerships with
providers of services, software and hardware products that enhance the
functionality of its product lines. This functionality is geared to enhance our
security system's functionality and advance NetWolves' entry into markets that
include education, finance, medical, legal, petroleum, government, travel,
hotel, entertainment and auto industries. Agreements and partnerships currently
under consideration include applications for Intrusion Detection, web access
content filtering and anti-virus detection and deletion.
NetWolves intends to recruit sales representatives and sales engineering
consultants in two North American regional areas; Eastern and Western United
States, managed initially by our Director of Sales and Marketing and by two
Regional Managers in the future. Field Sales Representatives are currently in
place in London, New York, Tampa, Cincinnati and Chicago. They are supported by
an in- house telemarketing organization based in Tampa, Florida. Our sales
engineers work closely with field sales representatives and perform important
pre and post-sales functions, including systems analysis, product
demonstrations, pilot evaluation program configuration and implementation, and
customizing solutions for various end user and value added reseller clients.
The Company has implemented marketing initiatives to support sales and
distribution of its products and services and to communicate and promote
corporate initiatives and direction. The Company's sales and marketing
management employees are responsible for NetWolves' award winning web site,
product white papers and collateral development, lead generation programs,
customer support, systems analysis, systems evaluation and pilot programs, and
market awareness of the Company and its products. Marketing programs include
public relations, product seminars, industry conferences and trade shows, coop
advertising, telemarketing and direct mail. The Company's marketing employees
also contribute to both the product development direction and strategic planning
processes by providing product/market research and conducting focused
competitive product surveys.
The Company has devoted its marketing and sales resources to attract
competent and professional marketing and sales management personnel, define
current and long range market needs, develop security products that exceed the
defined market needs, generate leads with multi-national business enterprises,
establish pilot security product evaluations with Fortune 1000 organizations,
and close sales after successful pilot evaluation programs. To date, our
marketing and sales programs have established a business relationship with one
of the world's largest corporations, defined a management and monitoring
solution that lead to the development of a patent pending technology (SRM2 TM),
and provided NetWolves with a total solutions approach to IP networking security
and reliability.
Licensing and Intellectual Property
The Company considers certain features of its products, including its
methodology and technology, to be proprietary. The Company relies on a
combination of trade secret, copyright and trademark laws, contractual
provisions and certain technology and security measures to protect its
proprietary intellectual property. We generally enter into confidentiality
agreements with our employees, consultants, business partners and major
customers. NetWolves owns numerous copyrighted works of authorship in computer
programs, including, but not limited, to portions of the FoxOS (operating
system), ESCN (distance learning), products related to FoxOS and ESCN, and
various proprietary enhancements to publicly available open source system
software; as well as traditional media, including, but not limited to, marketing
materials, documentation and white papers. Applications for registration of
those copyrights have been filed with respect to some of these works, and
further applications are expected to be filed in the near future.
On June 21, 2000, the Company filed a patent application with the U.S.
Patent and Trademark Office for technology that provides secure, centralized
remote management and monitoring of networks using the Internet. This SRM2 TM
system has enabled the Company to expand the use of its technology to Fortune
1000 organizations with multiple worldwide locations such as General Electric.
10
Notwithstanding the efforts the Company takes to protect its proprietary
rights, existing trade secret, copyright, and trademark laws afford only limited
protection. Despite our efforts to protect our proprietary rights and other
intellectual property, unauthorized parties may attempt to copy aspects of our
products, obtain and use information that we regard as proprietary or
misappropriate our copyrights, trademarks, trade dress and similar proprietary
rights. In addition, the laws of some foreign countries do not protect
proprietary rights to as great an extent as do the laws of the United States.
Our means of protecting our proprietary rights may not be adequate. In addition,
our competitors might independently develop similar technology or duplicate our
products or circumvent any patents or our other intellectual property rights.
The Company does not intend to sell or transfer title of its products to
its clients, though this structure may change as the Company expands its
operations. The Company intends to license products pursuant to licensing and
maintenance agreements for which extended payment terms may be offered. In the
case of extended payment term agreements, the customer is contractually bound to
equal monthly fixed payments. In the case of extended payment term agreements,
maintenance may be bundled for the length of the payment term. Thereafter, in
both instances, the customer may purchase maintenance annually.
In connection with the acquisition of NNSI, the Company obtained
Certificates of Public Convenience and Necessity, which enables NNSI to resell
long distance services within the state obtained. NNS is subject to regulation
from the Public Utility Commissions in each specific state.
Competition
Current and potential competitors in our markets include, but are not
limited to, the following, all of whom sell world-wide or have a presence in
most of the major markets for such products: security appliance suppliers such
as Watchguard Technologies, Inc., NetScreen Technologies, Inc., SonicWALL, Inc.,
enterprise firewall software vendors such as Check Point Software and Axent
Technologies; network equipment manufacturers such as IBM, Cisco Systems, Lucent
Technologies, Nortel Networks, 3COM and Nokia; computer or network component
manufacturers such as Intel Corporation; and operating system software vendors
such as Microsoft Corporation, Novell, Inc. and Sun Microsystems, Inc. The
Company expects competition to intensify as more companies enter the market and
compete for market share. In addition, companies currently in the server market
may continue to change product offerings in order to capture further market
share. Many of these companies have substantially greater financial and
marketing resources, research and development staffs, manufacturing and
distribution facilities than the Company. There can be no assurance that the
Company's current and potential competitors will not develop products that may
or may not be perceived to be more effective or responsive to technological
change than that of the Company, or that current or future products will not be
rendered obsolete by such developments. Furthermore, increased competition could
result in price reductions, reduced margins or loss of market share, any of
which could have a material adverse effect on the Company's business operating
results and financial condition.
The Company believes that an important competitive factor in its market is
the cost effective integration of many services in a single unit. In this
regard, the Company believes that it compares favorably to its competitors in
the markets it serves in price and overall cost of ownership, including
administrative and maintenance costs. However, equally important are other
factors, including but not limited to, product quality and scope of performance,
product reliability, availability, upgradability, and technical service and
support. The Company's ability to compete will depend upon, among other factors,
its ability to anticipate industry trends, invest in product research and
development, and effectively manage the introduction of new or upgraded products
into targeted markets.
Employees
As of September 13, 2002, the Company (including NNSI) employed
approximately 74 full-time employees (7 of which are covered by employment
agreements). Approximately 19 of these employees are involved in engineering and
11
development, 17 in sales and marketing, 9 in finance and 29 in general
administration and operations. In addition, the Company has retained independent
contractors on a consulting basis who support engineering and marketing
functions. To date, the Company believes it has been successful in attracting
and retaining skilled and motivated individuals. The Company's success will
depend in large part upon its continued ability to attract and retain qualified
employees. The Company has never experienced a work stoppage and its employees
are not covered by a collective bargaining agreement. The Company believes that
it has good relations with its employees.
About Norstan Network Services, Inc.
On July 9, 2002, the Company, through its wholly owned subsidiary,
NetWolves Acquisitions, Inc., acquired all of the outstanding capital stock of
Norstan Network Services, Inc. pursuant to a Stock Purchase Agreement dated as
of January 30, 2002, as amended, among Norstan, Inc. (the "Seller") and NNSI,
both Minnesota corporations, the Company and NetWolves Acquisitions, Inc., a
Delaware corporation. The Company paid to the Seller $7,500,000, $3,750,000 of
which was paid in cash on or prior to closing and $3,750,000 is payable under
the term of a non-interest bearing promissory note due July 9, 2003. The
purchase price was determined through arms' length negotiations. The $3,750,000
in cash paid by the Company to the Seller was primarily obtained through equity
and debt financing and to a lesser extent from working capital.
NNSI provides multiple source long distance services and related consulting
and professional services throughout the United States. For the nine months
ended March 31, 2002, NNSI's net sales were $16,279,000, its gross profit from
sales was $5,964,000, its operating expenses (including a management fee to its
parent, Norstan, Inc. of $1,481,000) was $4,177,000 and its income before income
taxes was $1,787,000. As a result of the acquisition, we expect to increase our
security solution revenues by leveraging NNSI's existing customer base. In
addition, we expect the acquisition will enable us to expand the range of
services we can offer our major customer as well as future customers. The
results of NNSI's operations will be included in our consolidated financial
statements commencing July 9, 2002.
NNSI's Mission/Methodology
NNSI's mission is to understand its business partners' complex needs and
translate them into solutions utilizing the largest carriers in the country.
With its flexibility NNSI provides a multi-carrier solution under one contract
and support structure to meet customers requirements.
NNSI's methodology includes completing a thorough needs assessment to
understand the current infrastructure and future requirements of the prospective
customer. Upon completion of the assessment, NNSI designs a custom, unique and
flexible solution utilizing multi-carrier alternatives under one contract, one
invoice and support structure. Its account teams, strategic industry
relationships and state of the art information and billing system allow NNSI to
deliver a single source solution utilizing the best of what is available to
solve the customer's communication and network needs.
NNSI's Business Partners
In addition to NNSI's own internal business units, its business partners
include:
-- Sprint
-- MCI WorldCom
-- Broadwing Communications
-- Bell South
-- SBC Communications
-- Qwest (subagent to Global Communications)
-- Ameritech
-- TelePlus Consulting
NNSI's Primary Products and Services
Voice services
-- Switched and dedicated inbound/outbound long distance
-- Travel cards
-- Conference Calling
-- Local services
12
Data services
-- IP Dedicated and Dial-up Services
-- Broadband Services (including DSL, Cable and Satellite)
-- Frame Relay
-- Private Line
Integrated Information and Billing Systems
NNSI's consolidated billing platform offers maximum flexibility in managing
networks by providing the information needed in a format most useful to a
customer's organization. This results in immediate and long-term cost savings
for the customer. The end result is one easy-to-read invoice that streamlines
your telecommunication expenses.
Customers
NNSI currently works with more than 400 customers, ranging from start-up
organizations to large well-established corporations, both domestic and global.
ITEM 2. PROPERTIES
The Company currently maintains leased facilities in the locations listed
below.
Square Term of Current annual
Function Location Feet Lease lease costs
-------- -------- ------- ------- --------------
NetWolves Corporation - 4002 Eisenhower Blvd. 20,520 12/20/05 $ 467,000
Corporate Headquarters Tampa, FL 33634
ComputerCOP Corp. - One Corporate Drive 4,318 06/30/05 $ 102,000
Corporate Headquarters* Bohemia, NY 11716
Norstan Network Services, 5101 Shady Oak Road 6,700 07/03/03 $ 92,000
Inc. - Corporate Minnetonka, MN 55343
Headquarters
* Effective September 1, 2002 and in connection with the disposal of the
ComputerCOP business segment, a majority of this facility was subleased for
a period of six months at a monthly rental amount of $5,000, the effect of
which is not included above.
On February 27, 2001, the Company entered into an agreement with GATX
Capital Corporation ("GATX"), whereby the Company assigned one of its leases to
GATX through the term of the lease. In accordance with the terms of the
agreement, the Company was required to make monthly payments approximating
$2,500 through June 2002.
Effective July 3, 2002, NNSI entered into a one year lease agreement with
Norstan, Inc. to occupy the facilities it had previously utilized prior to the
purchase of NNSI by NetWolves.
The Company believes that its present facilities are adequate to meet its
current business requirements and that suitable facilities for expansion will be
available, if necessary, to accommodate further physical expansion of corporate
operations and for additional sales and support offices.
13
ITEM 3. LEGAL PROCEEDINGS
The Sullivan Group
On or about November 22, 2000 the Company commenced a lawsuit ("Action 1")
in the United States District Court for the Southern District of New York
against certain defendants who were officers and/or directors of TSG (the
"Sullivan Group") and against an Ohio Corporation, ProCare, Inc. ("ProCare"). In
response to Action 1, on or about December 19, 2000, the Sullivan Group
commenced a lawsuit ("Action 2") in the United States District Court for the
Southern District of New York against the Company and other defendants. The
Company claimed that it was induced to enter into the merger agreement and
consummate the merger transaction based upon fraudulent misrepresentations and
the purposeful concealment of material information by the Sullivan Group. The
Sullivan Group were contending, correspondingly, that it was the Company and
certain of the current and former officers and directors who induced the
Sullivan Group to enter into the merger agreement by making false or negligent
misrepresentations regarding the Company's principal product. Service revenue
from the TSG subsidiary has been, and will continue to be substantially reduced
as a result of the reduction in its operations.
The Sullivan Group and ProCare moved to dismiss Action 1 based upon their
contention that the Court lacked subject matter jurisdiction to adjudicate the
controversy. Correspondingly, NetWolves and TSG moved in Action 2 to dismiss the
claims of the Sullivan Group against them therein on the ground that the Federal
Rules of Civil Procedure compel the Sullivan Group to interpose such claims, if
at all, as counterclaims in Action 1.
Subsequently, the Sullivan Group (as the Plaintiffs in Action 2) sought an
Order compelling the Company to issue an opinion that the shares originally
issued to the Sullivan Group (the "Shares") are freely saleable without any
restrictions or limitations under Rule 144. The Company opposed this application
on the ground that independent of the aggregation or "acting in concert"
limitation under Rule 144 which the Company contends was applicable, the return
of the Shares was an element of the relief sought by the Company in Action 1.
In a decision dated May 8, 2001, which addressed all three motions, the
Court granted the Sullivan Group's motion to dismiss Action No. 1 on the ground
that full diversity of citizenship between the plaintiffs and the defendants did
not exist, and, therefore, as a procedural matter, the Court lacked subject
matter jurisdiction. As a consequence, in addition to denying the material
allegations of the Sullivan Group's complaint and setting forth several
affirmative defenses to the 10b-5 claim and the claims for fraud, negligent
misrepresentation and breach of the Employment Agreements, the Company and TSG
had then reasserted as counterclaims in their answer in Action No. 2, all of the
claims which they had asserted against the Sullivan Group and ProCare (as an
additional defendant on the counterclaims) in their complaint in Action No. 1
plus an additional claim against the Sullivan Group for breach of certain of the
express representations and warranties in the Merger Agreement. Based on the
foregoing, the Company and TSG were seeking compensatory damages in excess of $5
million, punitive damages in the amount of $5 million and injunctive and other
ancillary relief. Based upon the allegations in their complaint, the Sullivan
Group were seeking $8 million in compensatory damages and $8 million in punitive
damages. Although the Court did enjoin the Company to have its counsel issue an
opinion letter under Rule 144, the Sullivan Group nevertheless were restricted
to selling as a group during the prescribed temporal periods only that limited
number of shares permitted under the aggregation proscriptions of Rule 144(e).
The Court further mandated that as a condition of granting such preliminary
injunctive relief, the Sullivan Group were compelled to deposit all of the
proceeds of such sales into an escrow.
In July 2002, this action including all of the counterclaims was settled in
all respects pursuant to a settlement agreement which provided essentially for
the exchange of releases among the parties and the reimbursement to David
Sullivan of $50,000 in respect of prior unpaid expenses incurred by him on
behalf of the Sullivan Group.
14
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company held its Annual Meeting of Stockholders on June 28, 2002. Four
directors were elected at the Annual Meeting. James A. Cannavino was elected at
the Annual Meeting to serve in Class III until the Annual Meeting of
Stockholders in 2002 or until his successor is duly elected and qualified.
Walter R. Groteke was elected at the Annual Meeting to serve in Class I until
the Annual Meeting of Stockholders in 2003 or until his successor is duly
elected and qualified. Myron Levy and Walter M. Groteke were elected to serve in
Class II until the Annual Meeting of Stockholders in 2004 or until their
successors are duly elected and qualified. The votes cast in favor of their
election and shares withheld are as follows:
Name Votes For Votes Withheld
---- --------- --------------
James A. Cannavino 6,688,167 20,114
Walter R. Groteke 6,678,167 30,114
Myron Levy 6,688,167 20,114
Walter M. Groteke 6,678,167 30,114
15
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
On April 20, 2000, NetWolves' common stock commenced trading on the
NASDAQ SmallCap market under the trading symbol "WOLV". From December 1998 to
April 20, 2000, NetWolves' common stock was traded on the OTC Bulletin Board
under the same symbol. Prior to the December 1998 name and symbol change, the
Company's stock traded under the symbol "WDGT", Watchdog Patrols, Inc. The
following table sets forth the high and low closing prices for the common stock
for the fiscal quarters indicated:
Fiscal 2002 Fiscal 2001
----------- -----------
Quarter High Low High Low
------- ---- --- ---- ---
First $ 3.800 $ 1.890 $ 11.000 $ 4.625
Second 4.050 2.190 7.500 2.625
Third 4.150 2.000 6.000 2.969
Fourth 2.450 1.120 5.420 2.594
As of October 8, 2002, there were approximately 154 holders of record of
the common stock. On October 8, 2002, the closing sales price of NetWolves
common stock was $1.00 per share.
NetWolves has not paid any cash dividends on its Common Stock and does not
presently intend to do so. Future dividend policy will be determined by its
Board of Directors on the basis of NetWolves' earnings, capital requirements,
financial condition and other factors deemed relevant.
The transfer agent and registrar of NetWolves' Common Stock is American
Stock Transfer and Trust Co., 40 Wall Street, New York, New York 10005.
ITEM 6. SELECTED FINANCIAL DATA
The following consolidated financial data set forth below should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and our consolidated financial statements and notes
thereto. The selected consolidated statement of operations data for the years
ended June 30, 2002, 2001 and 2000 and the selected consolidated balance sheet
data as of June 30, 2002 and 2001 are derived from, and are qualified by
reference to, the audited consolidated financial statements included elsewhere
in this annual report on Form 10-K. The selected consolidated statement of
operations data for the year ended June 30, 1999 and the period from February
13, 1998 (inception) to June 30, 1998 and the selected consolidated balance
sheet data as of June 30, 1999 and 1998 are derived from our audited
consolidated financial statements that are not included in this annual report on
Form 10-K. The historical results presented below are not necessarily indicative
of future results.
16
Period from
February 13,
Year ended June 30, 1998
---------------------------------------------------- (inception) to
2002 2001 2000 1999 June 30, 1998
---- ---- ---- ---- --------------
Consolidated Statements of Operations
Data:
Revenue $ 738,748 $ 1,425,138 $ 1,423,690 $ 1,789,144 $ 29,621
Cost of revenue 700,398 1,345,120 959,039 582,724 5,681
------------- ------------- ------------- ------------- ------------
Gross profit 38,350 80,018 464,651 1,206,420 23,940
Operating expenses 10,704,422 15,982,067 24,281,166 8,666,381 149,510
------------- ------------- ------------- ------------- ------------
Loss before other income (expense)
and income taxes (10,666,072) (15,902,049) (23,816,515) (7,459,961) (125,570)
Investment income (expense), net 79,576 650,003 611,746 58,884 6,501
Other (expense) income 9,160 (3,545) 68,012 478,063 (345)
------------- ------------- ------------- ------------- ------------
Loss before income taxes (10,577,336) (15,255,591) (23,136,757) (6,923,014) (119,414)
(Provision for) benefit from income
taxes - - (25,000) - 20,000
------------- ------------- ------------- ------------- ------------
Net loss from continuing operations (10,577,336) (15,255,591) (23,161,757) (6,923,014) (99,414)
Discontinued business
Loss from discontinued operations - (4,725,901) (1,165,191) - -
Loss on disposal of discontinued
operations (1,053,274) (650,000) - - -
------------- ------------- ------------- ------------- ------------
Net loss $(11,630,610) $(20,631,492) $(24,326,948) $(6,923,014) $ (99,414)
============= ============= ============= ============= ============
Basic and diluted net loss per share
Loss from continuing operations $ (0.90) $ (1.74) $ (3.29) $ (1.48) $ (0.04)
Loss from discontinued operations (0.09) (.61) (.17) - -
------------- ------------- ------------- ------------- ------------
$ (0.99) $ (2.35) $ (3.46) $ (1.48) $ (0.04)
============= ============= ============= ============= ============
Weighted average common shares
Outstanding, basic and diluted 11,756,220 8,776,928 7,034,994 4,691,651 2,810,102
============= ============= ============= ============= ============
June 30,
---------------------------------------------------------------------------
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
Consolidated Balance Sheet Data:
Cash and cash equivalents $ 656,880 $ 4,087,767 $ 20,204,309 $ 5,585,981 $ 1,118,416
Marketable securities, available for
sale 82,250 71,000 99,500 606,000 1,063,828
Working capital 1,110,257 3,794,438 19,459,099 5,799,246 2,918,327
Total assets 3,224,454 6,860,444 25,543,130 12,811,934 2,959,451
Long-term debt, net of current
maturities - 80,000 418,102 266,537 -
Minority interest 272,533 281,693 305,761 704,500 -
Total shareholders' equity 1,493,868 4,662,230 22,807,629 11,099,802 2,928,003
17
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Forward-looking Statements
Certain statements in this "Management's Discussion and Analysis of
Financial Condition and Results of Operations" are forward looking statements.
These statements relate to future events or our future financial performance and
involve known and unknown risks, uncertainties and other factors that may cause
our or our industry's actual results, levels of activity, performance or
achievements to be materially different from any future results, levels of
activity, performance or achievements expressed or implied by the
forward-looking statements. In some cases, you can identify forward-looking
statements by terminology such as "may", "will", "should", "expects", "plans",
"anticipates", "believes", "estimates", "predicts", "potential", "continue" or
the negative of these terms or other comparable terminology. These statements
are only predictions. Actual events or results may differ materially. In
evaluating these statements, you should specifically consider various factors,
including the risks included in this annual report on Form 10-K. These factors
may cause our actual results to differ materially from any forward- looking
statement.
Overview
The Company is a corporation with a limited operating history, formed in
February 1998, when it commenced field trial and limited sales of its original
product, the "FoxBox". Additionally, efforts were made to obtain operating
capital and convert the Company to a public entity. This was successfully
accomplished through a reverse merger with Watchdog Patrols, Inc., a publicly
traded (OTCBB), non-reporting corporation. Operating expenses have increased
significantly since the Company's inception. This reflects the cost associated
with the formation of the Company as well as increased efforts to promote market
awareness for the Company's security products and services, solicit new
customers, recruit personnel, build operating infrastructure and continued
product development.
NetWolves products and services offer complete system solutions to
organizations needing cost effective network security (firewall, routing,
intrusion detection, content filtering, email, intranet, FTP, etc.) complete
with advanced integrated hardware, a user-friendly interface, and net-based
expansion capabilities. As companies combine data and communications to reduce
costs, NetWolves' provides cost-effective, value-added expansion technologies
such as VPN, a process used to allow secure data transmissions on a local area
network, a wide area network, or to secure wireless network connections. This
feature affords the user virtually all the benefits of lease-line service
without the attendant recurring costs.
NetWolves differentiates itself from its competitors primarily through its
proprietary patent pending technology, which provides centralized remote
monitoring and management ("SRM2 TM"). While other, more labor intensive
management systems currently exist, such systems require an inbound
administrative port to provide remote monitoring and management. Most Fortune
1000 companies are unwilling to take the risk of opening up an administrative
inbound port while having their entire enterprise on a public broadband format.
"Hackers", using simple port scanning tools, can easily locate these
administrative inbound ports. SRM2 TM has the ability to monitor thousands of
locations concurrently without opening an administrative inbound port and allows
the secure, remote management and monitoring of multiple all-in-one gateway
servers located worldwide. This monitoring can be performed in real-time, and
from one or numerous central sites. This technology also allows a network
administrator to create a configuration template with all the configuration
information and changes required for all-in-one units. This template can be
applied to each unit, all via a secure configuration mechanism from the central
monitoring location, without compromising network security. It is this SRM2 TM
system that forms the basis of the Company's agreement with the General Electric
Company.
The Company's initial target markets are perimeter offices of Fortune 1000
companies and small to medium size business requiring secure managed Internet
access.
On July 9, 2002, the Company, through its wholly owned subsidiary,
NetWolves Acquisitions, Inc., acquired all of the outstanding capital stock of
Norstan Network Services, Inc. ("NNSI") pursuant to a Stock Purchase Agreement
dated as of January 30, 2002, as amended, among Norstan, Inc. (the "Seller") and
18
NNSI, both Minnesota corporations, the Company and NetWolves Acquisitions, Inc.,
a Delaware corporation. The Company paid to the Seller $7,500,000, $3,750,000 of
which was paid in cash on or prior to closing and $3,750,000 is payable under
the term of a non-interest bearing promissory note due July 9, 2003. The
purchase price was determined through arms' length negotiations. The $3,750,000
in cash paid by the Company to the Seller was primarily obtained through equity
and debt financing and to a lesser extent from working capital.
NNSI provides multiple source long distance services and related consulting
and professional services throughout the United States. As a result of the
acquisition, we expect to increase our security solution revenues by leveraging
NNSI's existing customer base. In addition, we expect the acquisition will
enable us to expand the range of services we can offer our major customer as
well as future customers. The results of NNSI's operations will be included in
our consolidated financial statements commencing July 9, 2002.
In January 1999, the Company entered into an agreement with Sales &
Management Consulting, Inc. (d/b/a The Sullivan Group), a consulting
organization serving the needs of the automobile aftermarket, convenience stores
and oil industry. In July 1999, the Company acquired The Sullivan Group and the
five principal officers and employees of The Sullivan Group were retained under
long-term employment contracts. On or about November 22, 2000 the Company
commenced a lawsuit in the United States District Court for the Southern
District of New York against certain defendants who were officers and/or
directors of TSG. This lawsuit was settled during July 2002 (see Item 3 - Legal
Proceedings).
In February 2000, NetWolves acquired ComputerCOP Corporation, whose assets
included ComputerCOP technology, inventory and $20.5 million in cash intended to
fund future growth. The shares issued by the Company in connection with the
acquisition were subject to a Voting Trust Agreement, wherein the Company's
chief executive officer had been granted the right to vote all Trust Shares for
two years, subject to earlier termination on the sale of the shares based on
certain parameters. During June 2001, the Company formally adopted a plan to
discontinue its ComputerCOP software operations. At that time, this consisted
primarily of ComputerCOP software technology, inventory and property and
equipment. The Company has accrued a provision for estimated losses during the
phase out period operations of approximately $497,000 at June 30, 2001 and has
restated the consolidated financial statements for the years prior to fiscal
2001 to separately report results of discontinued operations from the results of
continuing operations. Effective August 31, 2002, the Company terminated all
remaining employees of ComputerCOP and subleased a majority of the space
previously occupied by ComputerCOP for $5,000 per month for a period of six
months. The sublease also provides the lessee use of certain furniture and
equipment during the period of the lease.
On June 29, 2000, NetWolves and General Electric Company ("GE") signed a
contract for the master purchase, license and support services of NetWolves'
security, remote monitoring and configuration management system. GE is in the
process of using the Company's products for interconnectivity of its worldwide
offices.
The contract is for a term of six years and can be extended for four
additional one-year periods unless prior notice of non-renewal is given by
either party as defined in the agreement. The contract provides for the Company
to receive a fee upon shipment of each unit, and an additional one-time
configuration and installation fee. Additionally, upon shipment of each unit, GE
has the right to purchase from the Company support service and annual monitoring
and management service on an annual basis ("Annual Services"). The Annual
Services shall continue at the same rate per annum, at GE's discretion, provided
that GE requests such services at any time during a subsequent year. GE is
required to pay fees for Annual Services in full from the expiration date of the
prior year period and revenue generated from the Annual Services is recognized
over the service period.
In connection with the Company entering into the agreement, the Company
issued GE a warrant to purchase 500,000 shares of common stock that may be
exercised ratably at a price equivalent to the market price at the time of
vesting and which vest upon the Company receiving orders (as defined in the
agreement) of an amount equal to or in excess of, in the aggregate, $2, $3, $4
and $5 million.
The Company issued 200,000 shares of common stock to GE in June 2000.
19
On September 26, 2002, the Company entered into a three year agreement with
General Electric Consumer Finance, the consumer financing arm of the General
Electric Company. The agreement covers the use of the Company's technology by
General Electric Consumer Finance in all of its offices worldwide, encompassing
36 countries. The first rollouts of NetWolves' products are in Japan and
Germany.
Results of Operations
The Company had operated in three business segments, the technology
segment, the training and consulting segment and the computer software segment.
During June 2001, the Company formally adopted a plan to discontinue its
ComputerCOP software operations, eliminating the computer software segment, and
has restated the consolidated financial statements for the years prior to fiscal
2001 to separately report results of discontinued operations from the results of
continuing operations.
The year ended June 30, 2002 ("Fiscal 2002") compared to the year ended
June 30, 2001 ("Fiscal 2001") is as follows:
Revenue
Revenue from continuing operations decreased to $738,748 in Fiscal 2002
from $1,425,138 in Fiscal 2001. The decrease was primarily the result of a
decrease in revenue from the Training and Consulting segment due to the
termination of a contract with BP Amoco in December 2000. Service revenue from
the TSG subsidiary has been substantially reduced as a result of the reduction
in its operations and the recently settled dispute between the parties. The
decrease in sales of the Company's Internet products and services (Technology
segment) was primarily the result of reduced shipments to the Company's major
customer. Sales to this major customer were delayed largely as a result of
requests by this customer that the Company develop and add new Failover
technology to be utilized in future large- scale deployments. The Company
believes this additional feature will result in substantial additional benefits,
since the feature added to its core products should assist the Company in
facilitating sales to other Fortune 1000 companies. The Company intends to
generate continuing revenue from the sale of its Internet products and services
in the coming year, including continuing revenue from this customer, including
sales under its September 2002 agreement with General Electric Consumer Finance.
Revenue from discontinued operations increased to $220,267 compared to
$102,525 in the prior year. The increase was due to an increased effort to sell
as much product as possible preceding the discontinuance of operations.
Cost of revenue and gross profit
Cost of revenue for sale of the Company's Internet products and services
include manufacturing costs, which to date have been outsourced, packaging and
shipping costs and warranty expenses. Cost of revenue in connection with
management and consulting services include direct expenses of employees and
consultants utilized in the generation of management and consulting revenue.
Cost of revenue from continuing operations decreased to $700,398 for Fiscal 2002
as compared to $1,345,120 for Fiscal 2001.
Overall gross profit percentage from continuing operations was at 5% for
Fiscal 2002 as compared to 6% for Fiscal 2001. Negative gross profit in the
technology segment resulted from a writedown of inventory approximating
$193,000, caused by the substantial upgrades and improvements made by the
Company to its core products by discontinuing its FoxBox line of 4U products
with the introduction of its WolfPac Security Platform 2U product line as
compared to a writedown of $243,000 in the prior period. The gross profit
percentage in the training and consulting segment remained constant and the
Company does not anticipate a significant change in such percentage in the near
future.
Cost of revenue from discontinued operations increased to $37,970 compared
to $8,356 in Fiscal 2001. The increase is consistent with an increase in sales
of ComputerCOP software during the year end June 30, 2002.
Engineering and development
Engineering and development expenses, which are expensed as incurred,
consist primarily of salaries and related expenses for personnel utilized in
designing, maintaining and enhancing our products as well as material costs for
test units and prototypes. Costs associated with the development of software
products are generally capitalized once technological feasibility is reached.
Engineering and development expenses from continuing operations decreased to
$1,856,223 in Fiscal 2002 from $1,893,372 in Fiscal 2001. The decrease in
engineering and development costs was primarily the result of a limited
reduction of engineering and development personnel. Additionally, the Company
capitalized approximately $73,000 in software development costs during Fiscal
20
2002 as compared to approximately $116,000 in Fiscal 2001. We expect to incur
engineering and development costs in the future as we continue to maintain our
existing product line as well as develop new products and features, as evidenced
by the development of our intelligent Failover and continued development of our
SRM2 TM technology.
Engineering and development expenses from discontinued operations decreased
to $83,007 in Fiscal 2002 compared to $478,068 in Fiscal 2001. The decrease was
primarily due a reduction of engineering personnel in accordance with the
cessation of operations.
Sales and marketing
Sales and marketing expenses consist primarily of salaries, commissions and
related expenses for personnel engaged in marketing, sales and customer support
functions, as well as costs associated with trade shows, promotional activities,
advertising and public relations. Sales and marketing expenses from continuing
operations decreased to $2,500,793 in Fiscal 2002 from $4,958,719 in Fiscal
2001. The decrease in sales and marketing expenses was primarily the result of a
reduction in the number of sales personnel and a decrease in marketing efforts
to focus primarily on direct sales to Fortune 1000 customers. The Company
intends to continue to aggressively promote its current and future products and,
therefore, expects sales and marketing costs to increase in absolute dollars in
the future.
Sales and marketing expenses from discontinued operations decreased to
$381,024 in Fiscal 2002 compared to $681,636 in Fiscal 2001. The decrease was
primarily due a reduction in the number of sales and marketing personnel in
accordance with the cessation of operations.
General and administrative
General and administrative expenses consist primarily of salaries and
related expenses for executive, finance, facilities and human resources
personnel, recruiting expenses and professional fees. General and administrative
expenses from continuing operations decreased to $6,347,406 in Fiscal 2002
compared to $7,714,047 in Fiscal 2001. The decrease was primarily due to a
reduction in equity compensation given to various financial consultants and
staff reductions. We expect general and administrative costs to increase in
absolute dollars in the future.
General and administrative expenses from discontinued operations decreased
to $671,540 in Fiscal 2002 compared to $1,551,384 in Fiscal 2001. The decrease
was primarily due to no amortization expense on the acquired ComputerCOP
software technology in the current year and a reduction of administrative
personnel in accordance with the cessation of operations.
Impairment charges
There were no impairment charges from continuing operations in Fiscal 2002
compared to $1,415,929 in Fiscal 2001. In June 2001, the Company determined that
the remaining unamortized value of a warrant previously issued to Comdisco,
Inc., was impaired and, accordingly, recorded a charge to operations of
approximately $1,245,000 during fiscal 2001.
Impairment charges from discontinued operations decreased to $100,000 in
Fiscal 2002 compared to $2,108,982 in Fiscal 2001. On December 31, 2000, the
Company recorded a writedown of its ComputerCOP technology in the amount of
$2,000,000, reducing the carrying value of the asset to $202,395 at December 31,
2000. Additionally, in June 2001 the Company recorded an impairment of the
remaining carrying value of the ComputerCOP technology totaling $108,982. The
asset was determined to be impaired because of the inability of the software
technology to generate future operating income without substantial sales volume
increases, which are uncertain. Fair value was based on discounted future cash
flows.
21
Other income (expenses)
Other income (expenses) from continuing operations consists primarily of
investment portfolio income which decreased to $88,736 in Fiscal 2002 from
$646,458 in Fiscal 2001. The decrease was primarily due to a reduction in
interest income due to a decrease in the average cash balances during the
current year.
The year ended June 30, 2001 ("Fiscal 2001") compared to the year ended June 30,
2000 ("Fiscal 2000") is as follows:
Revenue
Revenue from continuing operations increased to $1,425,138 in Fiscal 2001
from $1,423,690 in Fiscal 2000. The increase in revenue was primarily the result
of an increase in sales of the Company's Internet products and services
(technology segment), partially offset by a decrease in management and
consulting service revenue as a result of the continuing disputes between TSG
and certain former employees (See "Item 3 - Legal Proceedings"). The increase in
revenue in the technology segment is from shipments to its major customer within
that segment. Additional sales to this major customer were delayed largely as a
result of requests by this customer to add additional features in the products
prior to delivery, including the embedding of third party software applications.
The Company believes that the delay in delivery caused by adding these
additional features will result in substantial additional benefits, since the
features added to its core products should assist the Company in facilitating
sales to other Fortune 1000 companies. The Company intends to generate
continuing revenue from the sale of its Internet products and services in the
coming year, including continuing revenue from this customer, as the requested
additional features, including new third party software applications, have now
been added to its products so that the focus will be on the production and sale
of its core technology. The decrease in consulting revenue is primarily
attributable to the termination of a contract with BP Amoco in December 2000.
Service revenue from the TSG subsidiary will be substantially reduced as a
result of the reduction in its operations and the continuing disputes between
the parties.
Revenue from discontinued operations increased to $102,525 compared to none
in the prior year. The increase was due to the commencement of sales of the
ComputerCOP software during the year ended June 30, 2001.
Cost of revenue and gross profit
Cost of revenue from continuing operations increased to $1,345,120 for
fiscal 2001 as compared to $959,039 for Fiscal 2000.
Overall gross profit from continuing operations was at 6% for Fiscal 2001
as compared to 33% for Fiscal 2000. Negative gross profit in the technology
segment resulted from a writedown of inventory approximating $243,000, of which,
approximately $97,000 occurred during the quarter ended June 30, 2001, caused by
the substantial upgrades and improvements made by the Company to its core
products. A decrease in gross profit in the training and consulting segment is
primarily due to the use of higher cost vendors due to limited availability of
comparable alternatives, coupled with a reduced pricing model for the equivalent
levels of service.
Cost of revenue from discontinued operations increased to $8,356 compared
to none in Fiscal 2000. The increase was due to the commencement of sales of the
ComputerCOP software during the year end June 30, 2001.
Engineering and development
Engineering and development expenses from continuing operations increased
to $1,893,372 in Fiscal 2001 from $1,329,341 in Fiscal 2000. The increase in
engineering and development costs was primarily the result of the employment of
additional engineering and development personnel. This was partially offset by
the Company capitalizing approximately $116,000 in software development costs
during Fiscal 2001 as compared to approximately $170,000 in Fiscal 2000. We
expect to incur significant engineering and development costs in the future to
assist in additional development of our core products being sold to our major
customer. We expect to incur engineering and development costs in the future as
we continue to maintain our existing product line as well as develop new
products and features, as evidenced by the development of our "SRM2 TM"
technology.
22
Engineering and development expenses from discontinued operations increased
to $478,068 in Fiscal 2001 compared to $5,000 in Fiscal 2000. The increase was
primarily due to the hiring of engineering personnel and a full year of
operations at ComputerCOP Corporation.
Sales and marketing
Sales and marketing expenses from continuing operations increased to
$4,958,719 in Fiscal 2001 from $4,868,686 in Fiscal 2000. The increase in sales
and marketing expenses was primarily the result of the employment of additional
sales personnel and an increase in marketing efforts to effectuate brand
awareness designed for future growth. The Company intends to continue to
aggressively promote its current and future products and, therefore, expects
sales and marketing costs to increase in absolute dollars in the future.
Sales and marketing expenses from discontinued operations increased to
$681,636 in Fiscal 2001 compared to $48,032 in Fiscal 2000. The increase was
primarily due to a full year of operations at ComputerCOP Corporation.
General and administrative
General and administrative expenses from continuing operations decreased to
$7,714,047 in Fiscal 2001 compared to $14,067,059 in Fiscal 2000. The decrease
was primarily due to a reduction in equity compensation given to various
financial consultants, and staff reductions and reduced operations of the
Company's training and consulting segment. We expect general and administrative
costs to increase in absolute dollars in the future.
General and administrative expenses from discontinued operations increased
to $1,551,384 in Fiscal 2001 compared to $1,112,159 in Fiscal 2000. The increase
was primarily due to a full year of amortization expense on the acquired
ComputerCOP software technology and a full year of operations at ComputerCOP
Corporation.
Impairment charges
Impairment charges from continuing operations decreased to $1,415,929 in
Fiscal 2001 compared to $4,016,080 in Fiscal 2000. In June 2001, the Company
determined that the remaining unamortized value of a warrant previously issued
to Comdisco, Inc., was impaired and, accordingly, recorded a charge to
operations of approximately $1,245,000 during fiscal 2001. On June 30, 2000, the
Company recorded a writedown of its training content and goodwill (training and
consulting segment) relating to the acquisition of Sales and Management
Consulting, Inc. ("SMCI") in the amount of $4,016,080. This writedown eliminated
all remaining intangible assets relating to the SMCI acquisition. The intangible
assets were determined to be impaired because of the current financial condition
of TSG and TSG's inability to generate future operating income without
substantial sales volume increases which are uncertain. Moreover, anticipated
future cash flows of TSG indicate that the recoverability of the asset is not
reasonably assured.
Impairment charges from discontinued operations increased to $2,108,982 in
Fiscal 2001 compared to none in Fiscal 2000. On December 31, 2000, the Company
recorded a writedown of its ComputerCOP technology in the amount of $2,000,000,
reducing the carrying value of the asset to $202,395 at December 31, 2000.
Additionally, in June 2001 the Company recorded an impairment of the remaining
carrying value of the ComputerCOP technology totaling $108,982. The asset was
determined to be impaired because of the inability of the software technology to
generate future operating income without substantial sales volume increases,
which are uncertain. Fair value was based on discounted future cash flows.
Other income (expenses)
Other income (expenses) from continuing operations consists primarily of
investment portfolio income and decreased to $646,458 in Fiscal 2001 from
$679,758 in Fiscal 2000. The decrease was primarily due to a decrease in gains
from the minority interest in TSG due to a reduced loss from the subsidiary in
Fiscal 2001, partially offset by an increase in interest income due to the
increased average cash balance from the ComputerCOP Corporation acquisition.
23
Quarterly Results
The following table presents certain unaudited quarterly results for the
last eight quarters:
Three months ended
Sep 30, Dec 31, Mar 31, Jun 30, Sept 30 Dec 31, Mar 31, Jun 30,
2000 2000 2001 2001 2001 2001 2002 2002
------- ------- ------- ------- ------- ------- ------- -------
Revenue $ 453,531 $ 534,911 $ 233,949 $ 202,747 $ 187,425 $ 188,234 $ 183,556 $ 179,533
Cost of revenue 312,693 330,779 396,667 304,981 158,018 137,481 125,260 279,639
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Gross profit (1) 140,838 204,132 (162,718) (102,234) 29,407 50,753 58,296 (100,106)
Operating expenses(2) 4,511,822 3,780,837 3,064,945 4,624,463 3,155,942 2,430,376 2,689,172 2,428,932
Other income, net 272,720 200,344 106,995 66,399 44,896 19,289 12,741 11,810
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Loss from continuing
operations (4,098,264) (3,376,361) (3,120,668) (4,660,298) (3,081,639) (2,360,334) (2,618,135) (2,517,228)
Loss from
discontinued
operations (3) (853,898) (2,970,854) (452,281) (448,868) - - - -
Loss on disposal of
discontinued
operations - - - (650,000) - (470,000) (265,534) (317,740)
------------ ----------- ----------- ----------- ----------- ----------- ----------- -----------
Net loss $(4,952,162) $(6,347,215) $(3,572,949) $(5,759,166) $(3,081,639) $(2,830,334) $(2,883,669) $(2,834,968)
============ =========== =========== =========== =========== =========== =========== ============
Basic and diluted
loss per share:
Loss from continuing
operations $ (.47) $ (.39) $ (.36) $ (.53) $ (.30) $ (.20) $ (.21) $ (.20)
========== =========== ========== ========== ========== ========== ========== ==========
Loss from
discontinued
operations $ (.10) $ (.34) $ (.05) $ (.13) $ - $ (.04) $ (.02) $ (.03)
========== =========== ========== ========== ========== ========== ========== ==========
Weighted average
common shares
outstanding, basic
and diluted 8,667,613 8,742,613 8,742,613 8,742,613 10,439,135 11,520,765 12,490,132 12,599,976
(1) Negative gross profit for the quarters ended March 31, 2001, June 30, 2001
and June 30, 2002 is primarily due to writedowns of inventory due to
obsolescence in such quarters.
(2) The increase in operating expenses during the quarter ended June 30, 2000
is primarily due to an impairment recorded on the training and consulting
segment.
(3) The increase in loss from discontinued operations during the quarter ended
December 31, 2000 is primarily due to an impairment recorded on the
ComputerCOP software technology.
Liquidity and Capital Resources
The year ended June 30, 2002 ("Fiscal 2002") compared to the year ended
June 30, 2001 ("Fiscal 2001") is as follows:
Our operating activities used cash of $8.5 million during the year ended
June 30, 2002, as compared to $13.7 million during the prior year. Cash used for
the year ended June 30, 2002 was primarily attributable to a net loss of $11.6
million, partially offset by non-cash expenses including equity compensation of
$2.3 million. Cash used for the year ended June 30, 2001 was primarily
attributable to a net loss of $20.6 million and a decrease in accounts payable
and accrued expenses of $.9 million, partially offset by non-cash expenses
including amortization, equity compensation and an impairment provision totaling
$1.2 million, $2.0 million and $3.5 million, respectively. Cash used in
operating activities included above relating to discontinued operations totaled
$1.0 and $1.5 million for the years ended June 30, 2002 and 2001, respectively.
Our investing activities used cash of $.9 million during the year ended
June 30, 2002, as compared to using cash of $1.1 million during the prior year.
Cash used in investing activities for the year ended June 30, 2002 was primarily
attributable to a finders fee and purchase deposit of $.35 million and $.4
million, respectively, related to the purchase of NNSI. Cash used in investing
activities for the year ended June 30, 2001 was primarily attributable to the
Company's purchases of property and equipment totaling $.7 million. There were
no cash flows from investing activities related to discontinued operations for
the year ended June 30, 2002. Cash used in investing activities included above
relating to discontinued operations totaled $.1 million for the year ended June
30, 2001.
24
Our financing activities provided cash of $6.0 million during the year
ended June 30, 2002, as compared to using cash of $1.0 million during the prior
year. Cash provided by financing activities for the year ended June 30, 2002 was
primarily attributable to the private sale of the Company's common stock for
$6.3 million, exclusive of financing costs paid of $.3 million. Cash used in
financing activities for the year ended June 30, 2001 was primarily attributable
to the Company's repurchases of warrants relating to the Anicom settlement
totaling $.7 million. There were no cash flows from financing activities related
to discontinued operations for the years ended June 30, 2002 and 2001.
The year ended June 30, 2001 ("Fiscal 2001") compared to the year ended June 30,
2000 ("Fiscal 2000") is as follows:
Our operating activities used cash of $13.7 million during the year ended
June 30, 2001, as compared to $8.4 million during the prior year. Cash used for
the year ended June 30, 2001 was primarily attributable to a net loss of $20.6
million and a decrease in accounts payable and accrued expenses of $.9 million,
partially offset by non-cash expenses including amortization, equity
compensation and an impairment provision totaling $1.2 million, $2.0 million and
$3.5 million, respectively. Cash used in operating activities for the year ended
June 30, 2000 was primarily attributable to a net loss of $24.3 million,
partially offset by non-cash expenses including amortization, equity
compensation and an impairment provision totaling $3.0 million, $8.7 million and
$4.0 million, respectively and an increase in accounts payable and accrued
expenses of $1.0 million. Cash used in operating activities included above
relating to discontinued operations totaled $1.5 million for the year ended June
30, 2001.
Our investing activities used cash of $1.1 million during the year ended
June 30, 2001, as compared to providing cash of $19.2 million during the prior
year. Cash used in investing activities for the year ended June 30, 2001 was
primarily attributable to the Company's purchases of property and equipment
totaling $.7 million. Cash provided by investing activities for the year ended
June 30, 2000 was primarily attributable to $20.5 million of cash acquired in
the ComputerCOP Corporation acquisition, partially offset by finders fees paid
related to the transaction of $.6 million. Cash used in investing activities
included above relating to discontinued operations totaled $.1 million for the
year ended June 30, 2001.
Our financing activities used cash of $1.0 million during the year ended
June 30, 2001, as compared to providing cash of $3.8 million during the prior
year. Cash used for the year ended June 30, 2001 was primarily attributable to
the Company's repurchases of warrants relating to the Anicom settlement totaling
$.7 million. Cash provided by financing activities for the year ended June 30,
2000 was primarily attributable to cash proceeds from the issuance of common
stock totaling $4.3 million, partially offset by financing costs paid. There
were no cash flows from financing activities related to discontinued operations
for the year ended June 30, 2001.
Post June 30, 2002 transactions
On July 16, 2002 the Company amended its Certificate of Incorporation, as
authorized by its Board of Directors, by designating 1,000,000 shares of its
2,000,000 shares of preferred stock as Series A Convertible Preferred Stock, par
value $.0033 per share ("Series A Preferred Stock").
Cumulative dividends on the Series A Preferred Stock will accrue at a rate
of 8% per annum from the date of issuance and will be payable annually in
additional shares of the Series A Preferred Stock. Each share of the Series A
Preferred Stock will be convertible at the time of the holders' option into 10
shares of the common stock (an exercise price of $1.50 per share). Holders of
Series A Preferred Stock will have voting rights on an as if converted basis and
will vote as a single class with holders of the Company's common stock.
Through August 15, 2002, the Company has issued 219,833 shares of its
Series A Preferred Stock for a total cash consideration of $3,297,500. The
shares were issued in connection with a private offering of the Company's
securities pursuant to which shareholders also received warrants to purchase
shares of the Company's common stock at an initial exercise price equal to $1.65
25
per share. Five warrants were issued for each share of Series A Preferred Stock
(one-half warrant for each share of common stock issuable upon conversion of the
Series A Preferred Stock). The warrants are exercisable for five years from the
issuance date and are callable by the Company if the closing price of the
Company's common stock is at or above three times the exercise price for 30
consecutive trading days.
Approximately $3,000,000 of the proceeds from the sale of the Series A
Preferred Stock was utilized to purchase the outstanding capital stock of
Norstan Network Services, Inc. The Company is seeking to sell additional shares
of its Series A Preferred Stock, the proceeds of which are intended to be used
for working capital
On July 10, 2002, the Company received advances from certain individuals,
some of whom are officers and directors of the Company, aggregating $600,000, of
which, $100,000 was subsequently repaid. The advances are non-interest bearing,
due on demand and have no scheduled repayment terms.
Summary
Historically, the Company's source of liquidity has been equity financing
which is used to fund losses from operating activities. NetWolves had cash and
cash equivalents of approximately $657,000 at June 30, 2002 and an additional $4
million was received subsequent to June 30, 2002 (as noted above). In order for
the Company to execute its business plan, additional cash outflows are necessary
for, among other things, continued development of technology, conducting
customer pilot programs and increased sales efforts. To the extent necessary,
the Company intends to utilize the expected operating profits of the recently
acquired Norstan Network Services, Inc. and raise additional monies from the
sale of its capital stock to meet its funding needs over the next 12 to 24
months, however, there can be no assurance that the Company will have sufficient
capital to finance its operations. If the Company is unable to raise additional
monies from the sale of its capital stock, or there is a reduction in the
expected operating profits of Norstan Network Services, Inc., management will
institute cost saving measures intended to significantly reduce its overhead
expenses and curtail the operations of certain business segments. However, even
if the Company does raise sufficient operating capital and Norstan Network
Services, Inc. continues to generate operating profits, there can be no
assurances that the net proceeds will be sufficient to enable it to develop its
business to a level where it will generate profits and cash flows from
operations. These matters raise substantial doubt about the Company's ability to
continue as a going concern.
Critical accounting policies
The Company's discussion and analysis of its financial condition and
results of operations is based upon the consolidated financial statements, which
have been prepared in accordance with U.S. generally accepted accounting
principles. The preparation of financial statements in conformity with U.S.
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities, the
disclosure of contingent assets and liabilities as of the date of the financial
statements, and the reported amounts of revenue and expenses during the periods.
Estimates have been made by management in several areas, including, but not
limited to, revenue recognition, allowance for doubtful accounts, inventory
reserves and the realizability of deferred tax assets. We base our estimates on
historical experience and on various other assumptions that we believe to be
reasonable under the circumstances. Actual results may differ materially from
these estimates under different assumptions or conditions.
We believe the following critical accounting policies affect our more
significant judgments and estimates used in the preparation of our consolidated
financial statements.
Revenue recognition
The Company records revenue in accordance with Statement of Position 97-2
"Software Revenue Recognition" ("SOP 97-2"), issued by the American Institute of
Certified Public Accountants (as modified by Statement of Position 98-9) and SEC
Staff Accounting Bulletin No. 101 ("SAB 101") regarding revenue recognition in
the financial statements. SOP 97-2 provides additional guidance with respect to
multiple element arrangements; returns, exchanges, and platform transfer rights;
resellers; services; funded software development arrangements; and contract
accounting. Accordingly, revenue from the sale of hardware and perpetual and
term software licenses are recognized, net of provisions for returns, at the
26
time of delivery and acceptance of hardware and software products by the
customer, when the fee is fixed and determinable and collectibility is probable.
Maintenance or monitoring revenue that is bundled with an initial license fee is
deferred and recognized ratably over the maintenance or monitoring period.
Amounts deferred for maintenance or monitoring are based on the fair value of
equivalent maintenance or monitoring services sold separately. The Company
recognizes revenue from consulting and training fees when the services are
provided. Shipping and handling costs are included in cost of revenue in the
accompanying consolidated statements of operations.
Allowance for doubtful accounts
We maintain allowances for doubtful accounts for estimated losses resulting
from the inability of our customers to make required payments. If the financial
condition of our customers were to deteriorate, resulting in an impairment of
their ability to make payments, additional allowances may be required.
Income taxes
As part of the process of preparing our consolidated financial statements
we are required to prepare our income taxes in each of the jurisdictions in
which we operate. This process involves estimating our actual current tax
exposure together with assessing temporary differences resulting from differing
treatment of items for tax and accounting purposes. These differences result in
deferred tax assets and liabilities, which are included within our consolidated
balance sheet. We must then assess the likelihood that our deferred tax assets
will be recovered from future taxable income and to the extent we believe that
recovery is not likely, we must establish a valuation allowance. We have fully
reserved our deferred tax assets at June 30, 2002 and 2001.
Obsolete inventory
Significant management judgment is required to determine the reserve for
obsolete or excess inventory. Inventory on hand may exceed future demand either
because the product is outdated, or obsolete, or because the amount on hand is
more than can be used to meet future need, or excess. During the year ended June
30, 2002, the Company recorded a writedown of inventory approximating $193,000,
caused by the substantial upgrades and improvements made by the Company to its
core products by discontinuing its FoxBox line of 4U products with the
introduction of its WolfPac Security Platform 2U product line
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Management does not believe that there is any material market risk exposure
with respect to derivative or other financial instruments that would require
disclosure under this item.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements of the Company and its subsidiaries are included
herein:
-- Reports of Independent Certified Public Accountants
-- Consolidated Balance Sheets at June 30, 2002 and 2001
-- Consolidated Statements of Operations, Cash Flows and Shareholders'
Equity for the years ended June 30, 2002, 2001 and 2000
-- Notes to Consolidated Financial Statements
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Previously disclosed in Report on Form 8-K dated July 9, 2002.
27
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The directors and executive officers of the Company and their ages are as
follows:
Name Age Position
---- --- --------
Walter M. Groteke 32 Chairman of the Board, President and
Chief Executive Officer
Walter R. Groteke 55 Vice President - Sales and Marketing
and Director
Peter C. Castle 34 Treasurer, Secretary, Vice President -
Finance
Myron Levy 61 Director
Principal Occupations of Officers and Directors
Walter M. Groteke, a co-founder of the Company, has been Chairman of the
Board, Chief Executive Officer and a director of the Company since June 1998.
Mr. Groteke is responsible for planning, developing and establishing policies
and business objectives for the Company. From June 1995 until 1997, Mr. Groteke
was regional business development manager for Techmatics, Inc., an information
systems Department of Defense contractor. From May 1993 to June 1995, Mr.
Groteke was senior account manager for NYNEX's strategic account management
program.
Walter R. Groteke has been a director of the Company since February 1999
and Vice President - Sales and Marketing since August 1998. From 1995 through
July 1998, Mr. Groteke was a regional and district sales manager for GTE Florida
and GTE Communications Corporation. Mr. Groteke founded Hawk Telecom in 1975 and
was President until its sale in 1994. Mr. Groteke is the father of Walter M.
Groteke.
Peter C. Castle has been Vice President - Finance since January 2000,
Controller from August 1998 until December 1999 and Treasurer and Secretary
since August 1999. From 1996 through July 1998 Mr. Castle was the Southeast
Regional Finance Manager for Magellan Health Service, Inc. a $1.6 billion
managed behavioral care company based in Georgia. Prior to that Mr. Castle was
the Controller for Physician's Care Network of NY, Inc.
Mr. Levy is a certified public accountant and has been President of Herley
Industries, Inc., a NASDAQ National Market Company, since June 1993 and Chief
Executive Officer since July 2001. He has been employed by Herley since October
1988 having held various executive positions. For the ten years prior to joining
Herley, Mr. Levy was employed in various executive capacities, including Vice
President, of Griffon Corporation, a New York Stock Exchange company. For
approximately ten years prior thereto, Mr. Levy was an accountant with Arthur
Andersen LLP.
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth the annual and long-term compensation with
regard to the Chairman/Chief Executive Officer and each of the other executive
officers of the Company who received more than $100,000 for services rendered
during fiscal 2002. No bonuses or options were issued to any executive officer
in fiscal 2002.
28
Summary Compensation Table
Annual Compensation Long Term Compensation
---------------------------------------- ------------------------
Securities
Other Restricted underlying
Fiscal annual stock options/
Name and principal position year Salary Bonus Compensation(1) awards warrants
--------------------------- ------ ------ ----- ---------------- ----------- ----------
Walter M. Groteke 2002 $ 275,000 $ - $ - $ - $ -
Chairman and Chief Executive 2001 238,750 - - - 850,000
Officer 2000 130,000 - - - -
Walter R. Groteke 2002 $ 175,000 $ - $ - $ - $ -
Senior Vice President 2001 161,250 - - - 300,000
2000 154,740 - - - -
Peter C. Castle 2002 $ 150,000 $ - $ - $ - $ -
Treasurer, Secretary and 2001 138,750 - - - 275,000
Vice President Finance 2000 97,620 - - - 65,000
(1) Other annual compensation excludes certain perquisites and other non-cash
benefits provided by the Company since such amounts do not exceed the
lesser of $50,000 or 10% of the total annual base salary disclosed in the
table for the respective officer.
Aggregate Option Exercises in Last Fiscal Year and Fiscal Year-End Option Values
The following table provides information regarding value realized from
options exercised during fiscal 2002 and unexercised options held as of June 30,
2002 by our Chief Executive Officer and the other executive officers whose
compensation exceeded $100,000 in fiscal 2002. The value of unexercised
in-the-money options is calculated at June 30, 2002.
Number of securities Value of unexercised
underlying unexercised in-the-money
Shares options at fiscal options at fiscal
acquired on Value year end (#) year end ($) (1)
Name exercise (#) realized ($) Exercisable Unexercisable Exercisable Unexercisable
- ---- ------------ ------------ ----------- ------------- ----------- -------------
Walter M. Groteke - - 1,050,000 - $ - $ -
Walter R. Groteke - - 500,000 - - -
Peter C. Castle - - 380,000 - - -
(1) Based upon the closing price of common stock of $1.50 on June 30, 2002.
Employment Agreements
Effective October 2000, the Company has entered into employment agreements
with certain members of its executive management team. All of the employment
agreements provide for certain payments following death or disability, for
certain fringe benefits such as reimbursement for reasonable expenses and
participation in medical plans, and for accelerated payments in the event of
change of control of the Company. The specific terms are as follows:
-- The agreement with the Walter M. Groteke, Chairman and Chief Executive
Officer, is for a term of five years at an annual salary of $275,000
subject to cost of living increments.
-- The agreement with the Walter R. Groteke, Senior Vice President, is
for a term of three years, subject to two additional one-year
extensions, at an annual salary of $175,000.
-- The agreement with the Peter C. Castle, Treasurer, Secretary and Vice
President of Finance, is for a term of three years, subject to two
additional one-year extensions, at an annual salary of $150,000.
29
Stock Option Plans
The Company's Stock Option Plans (the "Plans"), authorize the Board of
Directors to grant nonstatutory stock options to employees, directors and
consultants to purchase up to a total of 3,532,500 shares of the Company's
common stock. Generally, options granted under the Plans vest ratably over three
years. If any award under the Plans terminates, expires unexercised, or is
canceled, the shares of common stock that would otherwise have been issuable
pursuant thereto will be available for issuance pursuant to the grant of new
awards.
Date Maximum Approximate net
Date Allowance issuances Maximum
Plan name plan adopted Issuances June 30, 2002 term in years
------------------- ------------------- ------------------- ----------------- -------------
1998 Plan June 1998 282,500 121,000 10
2000 Plan July 2000 1,500,000 1,394,000 10
2001 Plan February 2001 1,750,000 850,000 10
--------- ---------
3,532,500 2,365,000
========= =========
In June 2002, the Company's Board of Directors authorized its 2002 stock
option plan (the "2002 Plan") to grant non-qualified stock options to employees,
directors and consultants to purchase up to a total of 3,000,000 shares of the
Company's common stock. If any award under the Plans terminates, expires
unexercised, or is canceled, the shares of common stock that would otherwise
have been issuable pursuant thereto will be available for issuance pursuant to
the grant of new awards. As of September 30, 2002, no options had been issued
under this plan.
Director's Compensation
Directors who are not employees of the Company receive an annual fee of
$1,500 and a fee of $1,000 for each board of directors or committee meeting
attended. In addition, we reimburse out-of-state directors for their cost of
travel and lodging to attend such meetings.
Limitation on Liability of Officers and Directors
We have entered into indemnification agreements with each of our current
officers and directors pursuant to which we have agreed, among other things, to
indemnify these officers and directors to the fullest extent permitted by New
York law.
Compensation Committee Interlocks and Insider Participation
During fiscal 2002, our Compensation Committee consisted of Messrs.
Cannavino, Levy and Walter R. Groteke. Except for Walter R. Groteke, who is an
officer of the Company, none of these persons were officers or employees during
fiscal 2002.
In accordance with rules promulgated by the Securities and Exchange
Commission, the information included under the caption "Compensation Committee
Report on Executive Compensation" will not be deemed to be filed or to be
proxy-soliciting material or incorporated by reference in any prior or future
filings by the Company under the Securities Act of 1933 or the Securities
Exchange Act.
COMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION
The compensation of our executive officers is generally determined by the
Compensation Committee of our Board of Directors, subject to applicable
employment agreements. The following report with respect to certain compensation
paid or awarded to our executive officers during fiscal 2002 is furnished by the
directors who comprised the Compensation Committee during fiscal 2002.
30
General Policies
Our compensation programs are intended to enable us to attract, motivate,
reward and retain the management talent required to achieve corporate objectives
and thereby increase shareholder value. It is our policy to provide incentives
to its senior management to achieve both short-term and long-term objectives and
to reward exceptional performance and contributions to the development of our
business. To attain these objectives, our executive compensation program
includes a competitive base salary, cash incentive bonuses and stock-based
compensation.
Stock options are granted to employees, including our executive officers,
by the Compensation Committee under Stock Option Plans. The Committee believes
that stock options provide an incentive that focuses the executive's attention
on managing us from the perspective of an owner with an equity stake in the
business. Options are awarded with an exercise price equal to the market value
of common stock on the date of grant, have a maximum term of ten years and
generally become exercisable, in whole or in part, starting one year from the
date of grant. Among our executive officers, the number of shares subject to
options granted to each individual generally depends upon the level of that
officer's responsibility. The largest grants are awarded to the most senior
officers who, in the view of the Compensation Committee, have the greatest
potential impact on our profitability and growth. Previous grants of stock
options are reviewed but are not considered the most important factor in
determining the size of any executive's stock option award in a particular year.
From time to time, the Compensation Committee intends to utilize the
services of independent consultants to perform analyses and to make
recommendations to the Committee relative to executive compensation matters. No
compensation consultant has so far been retained.
Relationship of Compensation to Performance and Compensation of Chief Executive
Officer
The Compensation Committee annually establishes, subject to the approval of
the Board of Directors and any applicable employment agreements, the salaries
that will be paid to our executive officers during the coming year. In setting
salaries, the Compensation Committee takes into account several factors,
including competitive compensation data, the extent to which an individual may
participate in the stock plans maintained by us, and qualitative factors bearing
on an individual's experience, responsibilities, management and leadership
abilities, and job performance.
The Compensation Committee did not make any determinations on executive
compensation during fiscal 2002 since the executive officers are covered by
prior employment agreements and no bonuses nor stock options were awarded to
executive officers during fiscal 2002.
Our Compensation Committee:
Myron Levy, Chairman
James A. Cannavino
Walter R. Groteke
31
Performance Chart
The following graph sets forth the cumulative total return to the Company's
shareholders during the period indicated as well as an overall stock market
index (S & P SmallCap 600 Index) and the Company's peer group index (S & P
SmallCap 600 Systems Software Index):
COMPARISON OF 40 MONTH CUMULATIVE TOTAL RETURN*
AMONG NETWOLVES CORPORATION, THE S & P SMALLCAP 600 INDEX
AND THE S & P SMALLCAP 600 SYSTEMS SOFTWARE INDEX
NETWOLVES CORPORATION
Cumulative Total Return ($)
--------------------------------------------------
3/1/99 6/99 6/00 6/01 6/02
NETWOLVES CORPORATION 100.00 182.00 80.50 26.24 11.92
S & P SMALLCAP 600 100.00 101.29 132.38 130.69 159.40
S & P SMALLCAP 600 SYSTEMS SOFTWARE 100.00 137.77 199.67 150.65 88.47
*$100 invested on 3/1/99 in stock or on 2/28/99 in index-including
reinvestment of dividends. Fiscal year ending June 30.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth the beneficial ownership of shares of voting
stock of the Company, as of September 3, 2002, of (i) each person known by the
Company to beneficially own 5% or more of the shares of outstanding common
stock, based solely on filings with the Securities and Exchange Commission, (ii)
each of the Company's executive officers and directors and (iii) all of the
Company's executive officers and directors as a group. Except as otherwise
indicated, all shares are beneficially owned, and investment and voting power is
held by the persons named as owners.
Name and Address Amount and Nature
Of Beneficial Owner of Shares Ownership Percentage
- ------------------- ------------------- ----------
Pequot Capital Management, Inc. 1,200,000 8.2%
Credit Suisse Warburg Pincus 1,000,000 6.8%
Westbury (Bermuda) Ltd. 1,000,000 6.8%
Walter M. Groteke 1,478,064(1) 10.1%
Walter R. Groteke 625,000(2) 4.3%
Peter C. Castle 385,000(3) 2.6%
Myron Levy 70,000(4) * %
Executive officers and
directors as a group (5 persons) 2,558,064 17.5%
* less than one percent (1%) unless otherwise indicated.
(1) Includes an option to purchase 450,000 shares of common stock at $5.00 per
share, options to purchase 400,000 shares of common stock at $4.00 per
share and a warrant to purchase 200,000 shares of common stock at $1.63 per
share.
(2) Includes an option to purchase 100,000 shares at $5.00 per share, an option
to purchase 200,000 shares of common stock at $4.00 per share and a warrant
to purchase 200,000 shares at $1.63 per share.
(3) Includes an option to purchase 40,000 shares of common stock at $5.00 per
share, a warrant to purchase 65,000 shares of common stock at $12.00 per
share, an option to purchase 75,000 shares of common stock at $5.00 per
share and an option to purchase 200,000 shares at $4.00 per share.
(4) Includes a warrant issued to Mr. Levy to purchase 50,000 shares of common
stock at $5.00 per share and an option issued to purchase 15,000 shares of
common stock at $4.82 per share.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None
32
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) See Index to Financial Statements at beginning of attached financial
statements.
(b) Reports on Form 8-K
None.
(c) Exhibits
3.1 Certificate of Incorporation, as amended.
3.2 By-Laws. *
4.1 Specimen common stock certificate.*
4.2 Form of warrant to investment banking firm. *
4.3 Form of warrant to employees.*
10.1 Agreement between The Sullivan Group and NetWolves Corporation dated
January 5, 1999.*
10.2 Warrant Agreement between NetWolves Corporation and Walter M. Groteke dated
June 17, 1998.*
10.3 1998 Stock Option Plan*
10.4 2000 Stock Option Plan **
10.5 2001 Stock Option Plan ***
10.6 2002 Stock Option Plan
10.7 Form of Indemnification Agreement*
10.8 Employment Agreement between NetWolves Corporation and Walter M. Groteke
dated October 1, 2000. ***
10.9 Employment Agreement between NetWolves Corporation and Walter R. Groteke
dated October 1, 2000. ****
10.10Employment Agreement between NetWolves Corporation and Peter C. Castle
dated October 1, 2000. ****
22 Subsidiaries of the Registrant
State of Incorporation Percentage
Name of Incorporation owned by Company
---- ---------------------- -----------------
ComputerCOP Corp. New York 100%
NetWolves Technologies Corporation New York 100%
NNS, Inc. Delaware 100%
Norstan Network Services, Inc. Minnesota 100%
TSG Global Education, Inc. Delaware 97%
99 CEO and CFO Certifications Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
-----------------------------------------------------------------------------
* Previously filed as exhibits to Report on Form 10, as amended.
** Previously filed as an exhibit to Report on Form 10-K for the fiscal year
ended June 30, 2000.
*** Previously filed as an exhibit to Report on Form 10-K for the fiscal year
ended June 30, 2001.
**** Previously filed as an exhibit to Report on Form 10-Q for the quarter ended
March 31, 2001.
33
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Company has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized on the 10th day of
October 2002.
NetWolves Corporation
By: /s/ Walter M. Groteke
Walter M. Groteke
Chairman of the Board, President
and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below on October 10, 2002 by the following persons in the
capacities indicated:
/s/ Walter M. Groteke Chairman of the Board and President
Walter M. Groteke Chief Executive Officer
/s/ Walter R. Groteke Vice President - Sales and Marketing
Walter R. Groteke and Director
/s/ Peter C. Castle Secretary and Treasurer
Peter C. Castle Principal Financial Officer and
Principal Accounting Officer
/s/ Myron Levy Director
Myron Levy
34
CONTENTS
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS F-1
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS F-2
INDEPENDENT AUDITORS' REPORT F-3
CONSOLIDATED BALANCE SHEETS
June 30, 2002 and 2001 F-4
CONSOLIDATED STATEMENTS OF OPERATIONS
For the years ended June 30, 2002, 2001 and 2000 F-5
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
For the years ended June 30, 2000, 2001 and 2002 F-6 - F-7
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended June 30, 2002, 2001 and 2000 F-8 - F-9
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS F-10 - F-37
INDEPENDENT AUDITORS' REPORT ON SCHEDULE II F-38
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES F-39
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Board of Directors and Shareholders of
NetWolves Corporation:
We have audited the accompanying consolidated balance sheet of NetWolves
Corporation (a New York corporation) and subsidiaries as of June 30, 2002, and
the related consolidated statements of operations, shareholders' equity and cash
flows for the year then ended. Our audit also included the financial statement
schedule for the year ended June 30, 2002 listed in the index at Item 14. These
financial statements and schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and schedule based on our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of NetWolves
Corporation and subsidiaries at June 30, 2002, and the consolidated results of
their operations and their cash flows for the year then ended in conformity with
accounting principles generally accepted in the United States. Also, in our
opinion, the related financial statement schedule for the year ended June 30,
2002, when considered in relation to the basic financial statements taken as a
whole, presents fairly in all material respects the information set forth
therein.
The accompanying financial statements have been prepared assuming that NetWolves
Corporation will continue as a going concern. As more fully described in Note
16, NetWolves Corporation has incurred recurring operating losses, declining
revenues, negative cash flows from operations, and has limited cash and other
resources to fund future operations. These conditions raise substantial doubt
about the Company's ability to continue as a going concern. Management's plans
in regard to these matters are also described in Note 16. The financial
statements do not include any adjustments to reflect the possible future effects
of the recoverability and classification of assets or the amounts and
classification of liabilities that may result from the outcome of this
uncertainty.
/s/ Ernst & Young LLP
Tampa, Florida
October 9, 2002
F-1
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Board of Directors and Shareholders of
NetWolves Corporation:
We have audited the accompanying consolidated balance sheet of NetWolves
Corporation (a New York corporation) and subsidiaries as of June 30, 2001, and
the related consolidated statements of operations, shareholders' equity and cash
flows for the year then ended. These financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audit provides 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 NetWolves Corporation and
subsidiaries as of June 30, 2001, and the results of their operations and their
cash flows for the year then ended in conformity with accounting principles
generally accepted in the United States.
Our audit was made for the purpose of forming an opinion on the basic financial
statements taken as a whole. Schedule II listed in the index of financial
statements is presented for purposes of complying with the Securities and
Exchange Commission's rules and is not part of the basic financial statements.
Schedule II has been subjected to the auditing procedures applied in the audit
of the basic financial statements and, in our opinion, fairly states in all
material respects the financial data required to be set forth therein in
relation to the basic financial statements taken as a whole.
/s/ Arthur Andersen LLP
Tampa, Florida
August 17, 2001 (except with respect to
the matters discussed in Note 17, as to
which the date is October 11, 2001)
The report is a copy of the previously issued Arthur Andersen accountants'
report and such report has not been reissued by Arthur Andersen.
F-2
Board of Directors and Shareholders
NetWolves Corporation
Bohemia, New York
INDEPENDENT AUDITORS' REPORT
We have audited the accompanying consolidated statements of operations,
shareholders' equity and cash flows of NetWolves Corporation and subsidiaries
(the "Company") for the year ended June 30, 2000. 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 audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated results of operations and consolidated
cash flows of NetWolves Corporation and subsidiaries for the year ended June 30,
2000 in conformity with accounting principles generally accepted in the United
States of America.
/s/ Eisner LLP
Eisner LLP
(formerly Richard A. Eisner & Company, LLP)
New York, New York
August 24, 2000
F-3
NETWOLVES CORPORATION AND SUBSIDARIES
CONSOLIDATED BALANCE SHEETS
June 30,
-------------------------------
2002 2001
---- ----
ASSETS
Current assets
Cash and cash equivalents $ 656,880 $ 4,087,767
Restricted cash 366,276 323,890
Marketable securities, available for sale 82,250 71,000
Accounts receivable, net of allowance for doubtful accounts of
$191,164 and $152,259 at June 30, 2002 and 2001, respectively 107,178 366,868
Inventories 136,930 361,656
Prepaid expenses 129,293 234,648
Purchase deposits 841,000 -
Other current assets 13,491 185,130
------------- -------------
Total current assets 2,333,298 5,630,959
Property and equipment, net 682,395 982,748
Software, net 104,874 73,414
Other assets 103,887 173,323
------------- -------------
$ 3,224,454 $ 6,860,444
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Accounts payable and accrued expenses $ 675,321 $ 926,634
Accrued losses of discontinued operations 137,958 496,927
Deferred revenue 46,780 129,978
Current maturities of long-term debt 362,982 282,982
------------- -------------
Total current liabilities 1,223,041 1,836,521
Accrued losses of discontinued operations 235,012 -
Long-term debt, net of current maturities - 80,000
------------- -------------
Total liabilities 1,458,053 1,916,521
------------- -------------
Minority interest 272,533 281,693
------------- -------------
Commitments and contingencies
Shareholders' equity
Preferred stock, $.0033 par value; 2,000,000 and no shares
authorized on June 30, 2002 and 2001, respectively; no
shares issued and outstanding on June 30, 2002 and 2001 - -
Common stock, $.0033 par value; 50,000,000 shares authorized
on June 30, 2002 and 2001; 12,607,119 and 9,167,613 shares
issued and outstanding on June 30, 2002 and 2001, respectively 41,604 30,254
Additional paid-in capital 65,176,647 57,748,499
Unamortized value of equity compensation - (1,011,500)
Accumulated deficit (63,611,478) (51,980,868)
Accumulated other comprehensive loss (112,905) (124,155)
------------- -------------
Total shareholders' equity 1,493,868 4,662,230
------------- -------------
$ 3,224,454 $ 6,860,444
============= =============
The accompanying notes to the financial statements
are an integral part of these consolidated
balance sheets.
F-4
NETWOLVES CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
For the year ended June 30,
---------------------------
2002 2001 2000
---- ---- ----
Revenue
Products $ 246,016 $ 341,203 $ 132,825
Services 492,732 1,083,935 1,290,865
------------ ------------ ------------
738,748 1,425,138 1,423,690
------------ ------------ ------------
Cost of revenue
Products 304,809 439,799 56,739
Services 395,589 905,321 902,300
------------ ------------ ------------
700,398 1,345,120 959,039
------------ ------------ ------------
Gross profit 38,350 80,018 464,651
------------ ------------ ------------
Operating expenses
General and administrative 6,347,406 7,714,047 14,067,059
Engineering and development 1,856,223 1,893,372 1,329,341
Sales and marketing 2,500,793 4,958,719 4,868,686
Impairment charges - 1,415,929 4,016,080
------------ ------------ ------------
10,704,422 15,982,067 24,281,166
------------ ------------ ------------
Loss before other income (expense)
and income taxes (10,666,072) (15,902,049) (23,816,515)
Other income (expense)
Investment income 117,147 650,003 611,746
(Loss) gain on sale of marketable securities - - (35,000)
Minority interest 9,160 24,068 148,739
Interest expense (37,571) (27,613) (45,727)
------------ ------------ ------------
Loss before income taxes (10,577,336) (15,255,591) (23,136,757)
Provision for income taxes - - (25,000)
------------ ------------ ------------
Net loss from continuing operations (10,577,336) (15,255,591) (23,161,757)
Discontinued business
Loss from discontinued operations - (4,725,901) (1,165,191)
Loss on disposal of discontinued operations,
including $525,204 and none for
operating losses at June 30, 2002 and
2001, respectively. (1,053,274) (650,000) -
------------ ------------ ------------
Net loss $(11,630,610) $(20,631,492) $(24,326,948)
============ ============ ============
Basic and diluted net loss per share
Loss from continuing operations $ (0.90) $ (1.74) $ (3.29)
Loss from discontinued operations (0.09) (.61) (.17)
------------ ------------ ------------
$ (0.99) $ (2.35) $ (3.46)
============ ============ ============
Weighted average common shares
outstanding, basic and diluted 11,756,220 8,776,928 7,034,994
============ ============ ============
The accompanying notes to the financial statements
are an integral part of these consolidated
statements.
F-5
NETWOLVES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED JUNE 30, 2000, 2001 AND 2002
Accumulated
Additional other Unamortized Total
Common stock paid-in Accumulated comprehensive value of equity shareholders' Comprehensive
Shares Amount Capital deficit income(loss) compensation equity income (loss)
------ ------ ---------- ----------- -------------- ---------------- ------------ --------------
Balance, June 30, 1999 6,063,870 $ 20,011 $17,726,374 $(7,022,428) $ 375,845 $ - $ 11,099,802
Common stock, options
and warrants issued
for services 212,500 701 10,543,272 - - (1,851,893) 8,692,08
Common stock issued
in private placement,
net of expenses 287,500 949 3,980,726 - - - 3,981,675
Common stock issued upon
exercise of warrants
(cashless) 114,855 379 (379) - - - -
Common stock and warrants
issued in purchase
business combination
(Note 3) 1,900,000 6,270 23,576,250 - - - 23,582,520
Common stock issued in
conversion of TSG
preferred stock 13,888 46 249,954 - - - 250,000
Marketable securities
valuation adjustment - - - - (471,500) - (471,500) $ (471,500)
Net loss, year ended
June 30, 2000 - - - (24,326,948) - - (24,326,948) (24,326,948)
---------- -------- ---------- ----------- ----------- ----------- ------------ ------------
Total comprehensive
loss $(24,798,448)
============
Balance, June 30, 2000 8,592,613 28,356 56,076,197 (31,349,376) (95,655) (1,851,893) 22,807,629
Common stock, options
and warrants issued
for services 575,000 1,898 2,377,302 - - 840,393 3,219,593
Marketable securities
valuation adjustment - - - - (28,500) - (28,500) $ (28,500)
Repurchase of warrant - - (705,000) - - - (705,000)
Net loss, year ended
June 30, 2001 - - - (20,631,492) - - (20,631,492) (20,631,492)
---------- -------- ---------- ----------- ----------- ----------- ------------ ------------
Total comprehensive
loss $(20,659,992)
============
Balance, June 30, 2001 9,167,613 $ 30,254 $57,748,499 $(51,980,868) $ (124,155) $(1,011,500) $ 4,662,230
F-6
NETWOLVES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED JUNE 30, 2000, 2001 AND 2002
(continued)
Accumulated
Additional other Unamortized Total
Common stock paid-in Accumulated comprehensive value of equity shareholders' Comprehensive
Shares Amount Capital deficit income(loss) compensation equity income (loss)
------ ------ ---------- ----------- -------------- ---------------- ------------ --------------
Balance, June 30, 2001 9,167,613 $ 30,254 $57,748,499 $(51,980,868) $ (124,155) $(1,011,500) $ 4,662,230
Common stock, options
and warrants issued
for services 130,000 429 466,569 - - - 466,998
Amortization of warrants - - - - - 1,011,500 1,011,500
Common stock issued in
settlement of
employment agreements 350,000 1,155 956,345 - - - 957,500
Common stock issued in
private placement,
net of expenses of
$310,000 2,830,000 9,339 6,005,661 - - - 6,015,000
Common stock issued
upon exercise of
warrants 129,506 427 (427) - - - -
Marketable securities
valuation adjustment - - - - 11,250 - 11,250 $ 11,250
Net loss, year ended
June 30, 2002 - - - (11,630,610) - - (11,630,610) (11,630,610)
---------- -------- ---------- ----------- ----------- ----------- ------------ ------------
Total comprehensive
loss $(11,619,360)
=============
Balance, June 30, 2002 12,607,119 $ 41,604 $65,176,647 $(63,611,478) $(112,905) $ - $ 1,493,868
========== ========= =========== ============ =========== =========== ============
The accompanying notes to the financial statements
are an integral part of these consolidated statements.
F-7
NETWOLVES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the year ended June 30,
-------------------------------------------------------
2002 2001 2000
---- ---- ----
Cash flows from operating activities
Net loss $ (11,630,610) $ (20,631,492) $ (24,326,948)
Adjustments to reconcile net loss to net cash used
in operating activities
Depreciation 243,715 231,029 93,763
Amortization 42,390 1,190,223 2,968,786
Realized loss on sale of marketable securities - - 35,000
Provision for impairment 100,000 3,524,911 4,016,080
Provision for inventory obsolescence 193,086 243,222 -
Loss on disposal of property and equipment 91,723 64,435 -
Provision for doubtful accounts 38,905 141,101 4,747
Provision for other assets 56,000 - -
Non-cash charge to operations with respect to
common stock, options and warrants issued for
services 2,344,998 1,974,799 8,692,080
Minority interest (9,160) (24,068) (148,739)
Changes in operating assets and liabilities
Restricted cash (42,386) (323,890) -
Accounts receivable 220,785 (225,519) (176,701)
Inventories 15,021 86,484 (340,099)
Prepaid expenses
105,355 (83,304) (83,443)
Other current assets 165,639 14,551 7,928
Accounts payable and accrued expenses (251,313) (865,396) 978,694
Accrued loss on disposal of discontinued operations (123,957) 496,927 -
Deferred compensation - - (100,000)
Deferred revenue (83,198) 118,805 11,173
------------ ------------ ------------
Net cash used in operating activities (8,523,007) (14,067,182) (8,367,679)
------------ ------------ ------------
Cash flows from investing activities
Finders fee paid in connection with acquisition of
Norstan Network Services, Inc. (350,000) - -
Deposit paid to Norstan, Inc. in connection with
acquisition of Norstan Network Services, Inc. (400,000) - -
Issuance of notes receivable - - (56,000)
License fees paid - (150,000) -
Patent costs paid (13,293) (32,101) -
Finders fees paid in connection with acquisition of
ComputerCOP Corp. - - (550,000)
Appraisal fee paid in connection with acquisition of - -
ComputerCOP Corp. (40,000)
Cash acquired - ComputerCOP Corp. - - 20,500,000
Purchases of property and equipment (104,456) (745,215) (459,978)
Capitalized software costs, net of funding (72,852) (116,066) (170,913)
Return of (payments for) security deposits 17,721 (37,423) (31,018)
------------ ------------ ------------
Net cash (used in) provided by investing
activities (922,880) (1,080,805) 19,192,091
------------ ------------ ------------
F-8
NETWOLVES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the year ended June 30,
-------------------------------------------------------
2002 2001 2000
---- ---- ----
Cash flows from financing activities
Repayment of long-term debt - (263,555) (43,411)
Repayment of advances from TSG officer - - (144,348)
Repurchase of warrant - (705,000) -
Cash proceeds from issuance of common stock 6,325,000 - 4,312,500
Financing costs paid in connection with sale of
common stock (310,000) - (330,825)
------------ ------------ -------------
Net cash provided by (used in) financing
activities 6,015,000 (968,555) 3,793,916
------------ ------------ -------------
Net (decrease) increase in cash and cash equivalents (3,430,887) (16,116,542) 14,618,328
Cash and cash equivalents, beginning of year 4,087,767 20,204,309 5,585,981
------------ ------------ -------------
Cash and cash equivalents, end of year $ 658,880 $ 4,087,767 $ 20,204,309
============ ============ =============
Cash paid for interest $ 16,250 $ 27,613 $ 45,727
============ ============ =============
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND
FINANCING ACTIVITIES
Noncash conversion of preferred stock to common stock
(Note 3) $ - $ - $ 250,000
============ ============ =============
Common stock issued for services related to purchase
of Norstan Network Services, Inc. (Note 17) $ 91,000 $ - $ -
============ ============ =============
Software ($2,907,520) and inventory ($175,000)
acquired through issuance of equity instruments $ - $ - $ 3,082,520
============ ============ =============
The accompanying notes to the financial statements
are an integral part of these consolidated
statements. F-9
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1 The Company
The consolidated financial statements include the accounts of NetWolves
Corporation and its three subsidiaries, NetWolves Technologies Corporation,
ComputerCOP Corporation and its majority owned TSG Global Education Web,
Inc. ("TSG") (collectively "NetWolves" or the Company").
NetWolves, LLC was an Ohio limited liability company formed on February 13,
1998, which was merged into Watchdog Patrols, Inc. ("Watchdog") on June 17,
1998. Watchdog, the legal surviving entity of the merger was incorporated
under the laws of the State of New York on January 5, 1970. As a result of
the merger and subsequent sale of Watchdog's business, Watchdog changed its
name to NetWolves.
NetWolves is an Internet systems developer that has designed and developed
multi-functional products that are secure, integrated, modular Internet
gateways. Its products support secure access to the Internet for multiple
users through a single connection and, among other things, provides
electronic mail, firewall security and web site hosting and also contains a
network file server. Since inception, the Company has been developing its
business plan and building its infrastructure in order to effectively
market its products.
In conjunction with TSG's acquisition of Sales and Management Consulting,
Inc. (d/b/a The Sullivan Group, see Note 3), the Company provided
consulting, educational and training services primarily to the oil and gas
and automotive industries throughout the United States.
Pursuant to an agreement dated February 10, 2000, the Company acquired all
of the outstanding capital stock of ComputerCOP Corporation
("ComputerCOP"), a New York corporation and a subsidiary of Computer
Concepts Corp. ("Computer Concepts"), in exchange for 1,775,000 restricted
shares of the Company's common stock valued at $23,962,500 (Note 3).
ComputerCOP's assets included ComputerCOP technology, inventory and $20.5
million in cash. In June 2001, management approved a formal plan of
disposal of its computer software business segment and such segment was
disposed of in August 2002 (Note 4).
On July 9, 2002, the Company acquired all of the outstanding common stock
of Norstan Network Services, Inc., a provider of multiple source long
distance services to customers located throughout the United States (Note
17).
2 Significant accounting policies
Use of estimates
In preparing consolidated financial statements in conformity with
accounting principles generally accepted in the United States, management
makes estimates and assumptions that affect the reported amounts of assets
and liabilities and disclosures of contingent assets and liabilities at the
date of the consolidated financial statements, as well as the reported
amounts of revenue and expenses during the reporting period. Actual results
could differ from those estimates.
Principles of consolidation
The consolidated financial statements include the accounts of the Company
and its subsidiaries. All significant intercompany transactions and
balances have been eliminated in consolidation. The separate ownership of
one of the Company's subsidiaries is reflected in the Company's
consolidated financial statements as minority interest (Note 3). The
minority interest includes common stock representing 1.7% of the
outstanding shares of the subsidiary and preferred stock, until January 24,
2000, at which time the preferred stockholder elected to convert the
preferred stock into shares of NetWolves common stock (Note 3).
F-10
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2 Significant accounting policies (continued)
Prepaid expenses Prepaid expenses consist primarily of prepaid rent and
insurance and are being amortized over their respective lives using the
straight-line method.
Discontinued operations
The consolidated financial statements for the years prior to fiscal 2001
have been restated to separately report results of discontinued operations
from the results of continuing operations. Disclosures included herein
pertain to the Company's continuing operations unless otherwise noted.
Revenue recognition
The Company records revenue in accordance with Statement of Position 97-2
"Software Revenue Recognition" ("SOP 97-2"), issued by the American
Institute of Certified Public Accountants (as modified by Statement of
Position 98-9) and SEC Staff Accounting Bulletin No. 101 ("SAB 101")
regarding revenue recognition in financial statements. SOP 97-2 provides
additional guidance with respect to multiple element arrangements; returns,
exchanges, and platform transfer rights; resellers; services; funded
software development arrangements; and contract accounting. Accordingly,
revenue from the sale of hardware and perpetual and term software licenses
are recognized, net of provisions for returns, at the time of delivery and
acceptance of hardware and software products by the customer, when the fee
is fixed and determinable and collectibility is probable. Maintenance or
monitoring revenue that is bundled with an initial license fee is deferred
and recognized ratably over the maintenance or monitoring period. Amounts
deferred for maintenance or monitoring are based on the fair value of
equivalent maintenance or monitoring services sold separately. The Company
recognizes revenue from consulting and training fees when the services are
provided. Shipping and handling costs are included in cost of revenue in
the accompanying consolidated statements of operations.
Marketable securities
Marketable securities, which are all classified as "available for sale",
are valued at fair value. Unrealized gains or losses are recorded net of
income taxes as "accumulated other comprehensive income" in shareholders'
equity, whereas realized gains and losses are recognized in the Company's
consolidated statements of operations using the first-in, first-out method.
Inventories
Inventories consist of raw materials and finished goods. Inventories are
valued at the lower of cost or net realizable value using the first-in,
first-out method. During the year ended June 30, 2001, the Company recorded
a writedown of inventory approximating $243,000. Additionally, raw material
and finished goods amounted to $108,079 and $28,851, respectively, at June
30, 2002 and $154,331 and $207,325, respectively, at June 30, 2001.
Included in inventory at June 30, 2001 is $25,000, of finished goods and
raw materials inventory relating to discontinued operations (Note 4).
F-11
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2 Significant accounting policies (continued)
Property and equipment
Property and equipment are stated at cost. Costs assigned to property and
equipment of the acquired businesses (Note 3) were based on estimated fair
value at acquisition. Depreciation is provided on furniture and fixtures
and machinery and equipment over their estimated lives, ranging from 5 to 7
years, using the straight-line method. Leasehold improvements are amortized
over the lesser of the term of the respective lease or the useful lives of
the related assets. Expenditures for maintenance and repairs are charged
directly to the appropriate operating accounts at the time the expense is
incurred. Expenditures determined to represent additions and betterments
are capitalized and amortized over the lesser of their useful lives or the
useful lives of the related assets. Depreciation and amortization is
included in general and administrative expenses in the accompanying
consolidated statements of operations.
Software costs
Costs associated with the development of software products are generally
capitalized once technological feasibility is established in accordance
with Statement of Financial Accounting Standards ("SFAS") No. 86,
"Accounting for the Costs of Computer Software to be Sold, Leased or
Otherwise Marketed". Purchased software technologies are recorded at cost.
Software costs associated with technology development and purchased
software technologies are amortized using the greater of the ratio of
current revenue to total projected revenue for a product or the
straight-line method over its estimated useful life. Amortization of
software costs begins when products become available for general customer
release. The Company recorded approximately $41,000, $1,190,000 and
$960,000 in amortization expense for the years ended June 30, 2002, 2001
and 2000, respectively, relating to software costs. Costs incurred prior to
establishment of technological feasibility are expensed as incurred and
reflected as engineering and development costs in the accompanying
consolidated statements of operations. The Company capitalized software
development costs of approximately $73,000, $116,000 and $170,000 and
incurred approximately $1,856,000, $1,893,000 and $802,000 in research and
development costs for the years ended June 30, 2002, 2001 and 2000,
respectively. Accumulated amortization at June 30, 2002 was approximately
$2,192,000.
Impairment of long-lived assets
In accordance with Statement of Financial Accounting Standard No. 121,
"Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets
to Be Disposed Of", the Company reviews its long-lived assets, including
software development costs, intangible assets and property and equipment,
for impairment whenever events or changes in circumstances indicate that
the carrying amount of the assets may not be fully recoverable. To
determine recoverability of its long-lived assets, the Company evaluates
the probability that future undiscounted net cash flows, without interest
charges, will be less than the carrying amount of the assets.
Income taxes
In accordance with Statement of Financial Accounting Standard No. 109
"Accounting for Income Taxes", the Company accounts for income taxes using
the liability method which requires the determination of deferred tax
assets and liabilities based on the differences between the financial and
tax bases of assets and liabilities using enacted tax rates in effect for
the year in which differences are expected to reverse. The net deferred tax
asset is adjusted by a valuation allowance, if, based on the weight of
available evidence, it is more likely than not that some portion or all of
the net deferred tax asset will not be realized. The Company and its
subsidiaries file a consolidated Federal income tax return.
F-12
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2 Significant accounting policies (continued)
Stock options
SFAS No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123")
establishes a fair value-based method of accounting for stock based
compensation plans. The Company has chosen to adopt the disclosure
requirements of SFAS 123 and continue to record stock compensation for its
employees and outside directors in accordance with Accounting Principles
Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB
25"). Under APB 25, charges are made to operations in accounting for stock
options granted to employees and outside directors when the option exercise
prices are below the fair market value of the common stock at the
measurement date. Options and other stock based compensation granted to
non-employees are recorded in accordance with SFAS 123.
Basic and diluted net loss per share
The Company displays loss per share in accordance with SFAS No.128,
"Earnings Per Share" ("SFAS 128"). SFAS 128 requires dual presentation of
basic and diluted earnings per share. Basic earnings per share includes no
dilution and is computed by dividing net income (loss) available to common
shareholders by the weighted average number of common shares outstanding
for the period. The diluted loss per share does not include the impact of
potential shares to be issued upon exercise of options and warrants
aggregating approximately 7,474,200, 7,135,000 and 3,057,000, for the years
ended June 30, 2002, 2001 and 2000, respectively, which would be
antidilutive.
Cash and cash equivalents
Generally, the Company considers highly liquid investments in debt
securities with original maturities of three months or less to be cash
equivalents. At June 30, 2002, approximately $366,000 of the Company's cash
is being utilized to secure various letters of credit.
Concentrations and fair value of financial instruments
Financial instruments that potentially subject the Company to
concentrations of credit risk consist principally of cash investments and
marketable securities. At June 30, 2002, the Company's cash investments are
held at primarily one financial institution. The fair value of financial
instruments approximates their recorded values.
Comprehensive income (loss)
The Company presents comprehensive income (loss) in accordance with
Statement of Financial Accounting Standards No. 130, "Reporting
Comprehensive Income" ("SFAS 130"). SFAS 130 establishes standards for
reporting and display of comprehensive income (loss) and its components. As
this statement pertains to disclosure information requirements, it has no
impact on the Company's operating results or financial position. The
Company's adjustment to arrive at comprehensive income (loss) consists of
the marketable securities valuation adjustment and is presented in the
accompanying consolidated statements of shareholders' equity and
comprehensive income (loss).
F-13
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2 Significant accounting policies (continued)
Summary of recent accounting pronouncements
In June 2001, the FASB issued SFAS No. 141, Business Combinations ("SFAS
No. 141") and SFAS No. 142, Goodwill and Other Intangible Assets ("SFAS No.
142"). SFAS No. 141 addresses financial accounting and reporting for
business combinations while SFAS No. 142 addresses financial accounting and
reporting for acquired goodwill and other intangible assets. SFAS No. 141
applies to all business combinations initiated after June 30, 2001, while
SFAS No. 142 is required to be applied in fiscal years beginning after
December 15, 2001. The adoption of SFAS No. 141 had a material impact on
our financial statements due to the segregation of identifiable intangibles
separate from goodwill. Identifiable intangible assets with other than
indefinite lives will continue to be amortized in the financial statements,
however, goodwill and identifiable intangible assets with indefinite lives
will no longer be amortized. In connection with the acquisition discussed
in Note 17 to the financial statements, the adoption of SFAS No. 141 will
have a material impact on our financial statements. Other than the impact
on amortization, the adoption of SFAS No. 142 is not expect to have a
material impact on our financial statements although we will be required to
review our intangibles and goodwill annually for indicators of impairment
and this review could result in recognition of impairment losses.
During August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets" ("SFAS No. 144"). SFAS No. 144
addresses financial accounting and reporting for the impairment or disposal
of long-lived assets. SFAS No. 144 supersedes SFAS No. 121, "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to Be
Disposed Of" ("SFAS No. 121"), and the accounting and reporting provisions
of Accounting Principles Board Opinion No. 30, "Reporting the Results of
Operations - Reporting the Effects of Disposal of a Segment of a Business,
and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions" ("APB No. 30"). SFAS No. 144 was issued because SFAS No. 121
did not address the accounting for a segment of a business accounted for as
a discontinued operation under APB No. 30, and two accounting models
existed for long-lived assets to be disposed of. SFAS No. 144 establishes a
single accounting model for long-lived assets to be disposed of by sale.
SFAS No. 144 retains the requirements of SFAS No. 121 to (a) recognize an
impairment loss only if the carrying amount of a long-lived asset is not
recoverable from its undiscounted cash flows and (b) measure an impairment
loss as the difference between the carrying amount and fair value of the
asset. SFAS No. 144 also requires that a long-lived asset to be abandoned,
exchanged for a similar productive asset, or distributed to owners in a
spinoff be considered held and used until it is disposed of. Lastly, SFAS
No. 144 retains the requirement of SFAS No. 121 to measure a long-lived
asset classified as held for sale at the lower of its carrying amount or
fair value less cost to sell and to cease depreciation (amortization).
Therefore, discontinued operations are no longer measured on a net
realizable value basis, and future operating losses are no longer
recognized before they occur. SFAS No. 144 retains the basic provisions of
APB No. 30 for the presentation of discontinued operations in the income
statement but broadens that presentation to include a component of an
entity. The provisions of SFAS No. 144 are effective for financial
statements issued for fiscal years beginning after December 15, 2001, and
interim periods within those fiscal years, with early application
encouraged. The provisions of SFAS No. 144 generally are to be applied
prospectively. The Company plans to adopt SFAS No. 144 effective July 1,
2002, and has not yet determined the impact of adoption.
F-14
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2 Significant accounting policies (continued)
Summary of recent accounting pronouncements (continued)
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections" ("SFAS No. 145"). This standard concludes that debt
extinguishments used as part of a company's risk management strategy should
not be classified as an extraordinary item. SFAS No. 145 also requires
sale- leaseback accounting for certain lease modifications that have
economic effects that are similar to sale-leaseback transactions. SFAS No.
145 is effective for fiscal years beginning after May 15, 2002.
In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated
With Exit or Disposal Activities ("SFAS No. 146"). SFAS No. 146 requires
that a liability for a cost associated with an exit or disposal activity is
recognized at fair value when the liability is incurred and is effective
for exit or disposal activities that are initiated after December 31, 2002.
The Company does not expect its adoption of this standard in fiscal 2003 to
have a significant impact on its financial statements.
Shipping and handling costs
Shipping and handling costs are included in cost of revenue - products in
the consolidated statements of operations.
Product warranties
The Company offers warranties on the sales of certain of its products and
records an accrual for estimated future claims. Such accruals are based
upon historical experience and management's estimate of the level of future
claims.
Reclassifications
Certain reclassifications have been made to the consolidated financial
statements shown for the prior periods in order to have them conform to the
current period's classifications.
3 Purchase acquisitions
ComputerCOP Corporation
Pursuant to an agreement dated February 10, 2000, the Company acquired all
of the outstanding capital stock of ComputerCOP, a New York corporation and
a subsidiary of Computer Concepts, in exchange for 1,775,000 restricted
shares of the Company's common stock valued at $23,962,500. ComputerCOP's
assets included ComputerCOP technology, inventory and $20.5 million in
cash. In connection with the transaction, the Company incurred finders fees
of approximately of $960,000 and issued 125,000 restricted shares of the
Company's common stock valued at $2,405,000 and a five year warrant to
purchase 300,000 shares of the Company's common stock valued at $2,928,000.
In addition, a warrant to purchase 600,000 shares of the Company's common
stock did not vest in accordance with its term and were canceled on March
31, 2000 (Note 9). In addition, the Company incurred professional fees
relating to the acquisition aggregating $350,000. The fair value of the
shares issued (approximately $24.0 million) and finders fees and other
acquisition costs (approximately $6.6 million) have been allocated as
follows: cash of $20,500,000, ComputerCOP software technology of $4,217,520
and inventory of $175,000, with a portion of the finders fees and other
acquisition costs charged as a cost of raising capital.
F-15
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3 Purchase acquisitions (continued)
ComputerCOP Corporation (continued)
Additionally, Computer Concepts purchased 225,000 shares of the Company's
common stock from three other officers of the Company for $4.5 million.
All of the shares issued by the Company in connection with the ComputerCOP
acquisition as well as all the shares sold by the three officers (the
"Trust Shares") were subject to a Voting Trust Agreement, wherein the
Company's chief executive officer had been granted the right to vote all
Trust Shares for two years, subject to earlier termination on the sale of
those shares based on certain parameters.
On December 31, 2000, the Company recorded a writedown of its ComputerCOP
technology (computer software segment) in the amount of $2,000,000,
reducing the carrying value of the asset to $202,395 at December 31, 2000.
Additionally, in June 2001 the Company recorded an impairment of the
remaining carrying value of the ComputerCOP technology totaling $108,982.
These impairments are included in loss from discontinued operations in the
consolidated statements of operations (Note 4). The asset was determined to
be impaired because of the inability of the software technology to generate
future operating income without substantial sales volume increases, which
are uncertain. Fair value was based on discounted future cash flows.
Accordingly, actual results could vary significantly from such estimates.
In June 2001, management approved a formal plan of disposal of its computer
software business segment and on August 31, 2002 the operations of
ComputerCOP ceased (Note 4).
Sales and Management Consulting, Inc.
On July 7, 1999 (effective June 30, 1999), NetWolves and Sales and
Management Consulting, Inc. (d/b/a The Sullivan Group) ("SMCI") executed a
merger agreement (the "Merger") pursuant to which NetWolves acquired the
outstanding capital stock of SMCI. Under the terms of the Merger, TSG
Global Education Web, Inc. ("TSG") (a subsidiary of NetWolves), with
4,150,000 shares of common stock outstanding prior to the Merger, purchased
all of the outstanding shares of SMCI's common stock in exchange for
180,000 shares of NetWolves' restricted common stock. The shareholders were
restricted from selling, transferring or pledging such shares for an
eighteen- month period. Upon consummation of the Merger SMCI merged into
TSG and TSG was the surviving entity.
Concurrent with the Merger, the shareholders of SMCI purchased 70,000
shares of TSG common stock at $.35 per share for aggregate cash proceeds of
$24,500. This represents 1.7% of the outstanding common stock of TSG.
Additionally, TSG issued 250,000 shares of TSG Series A Non-Voting
Cumulative (8%) Convertible Preferred Stock to one of the SMCI
shareholders, which was issued in partial settlement of outstanding
liabilities owed to the former shareholder. The preferred stockholder was
entitled to preferential liquidation rights and was also entitled to
cumulative dividends to be included in minority interest expense that
accrued at the rate of 8% per annum commencing on June 30, 1999. On January
24, 2000, the preferred stockholder elected to convert the preferred stock
into 13,888 shares of NetWolves common stock (the fair market value at the
time of conversion). The TSG common and preferred stock (until conversion
on January 24, 2000) have been reflected as minority interest in the
accompanying consolidated financial statements.
F-16
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3 Purchase acquisitions (continued)
Sales and Management Consulting, Inc. (continued)
On June 30, 2000, the Company recorded a writedown of its training content
and goodwill (training and consulting segment) relating to the acquisition
of SMCI in the amount of $4,016,080. This writedown eliminates all
remaining intangible assets relating to the acquisition. The intangible
assets were determined to be impaired because of the current financial
condition of TSG and TSG's inability to generate future operating income
without substantial sales volume increases which were uncertain. Moreover,
anticipated future cash flows of TSG indicated that the recoverability of
the asset was not reasonably assured. In November 2000, the Company
commenced a lawsuit against certain defendants who were officers and/or
directors of TSG (the "Sullivan Group") and against an Ohio Corporation,
ProCare, Inc. ("ProCare"). This lawsuit was settled in July 2002 (Note 15).
4 Disposal of business segment
During June 2001, the Company formally adopted a plan to discontinue its
ComputerCOP software operations. At that time, this operation consisted
primarily of ComputerCOP software technology, inventory and property and
equipment. At June 30, 2001, the Company accrued a provision for estimated
losses during the phase out period of approximately $497,000. During the
year ended June 30, 2002, the Company recorded additional charges
aggregating $1,053,275, which primarily represented the cost of salaries
through an extended disposal date of August 31, 2002, coupled with an
equity settlement of an employment contract (Note 14) and a revised
estimate of the total leased facility costs, net of a sublease. At the time
of the decision to discontinue this operation, the Company restated its
consolidated financial statements for the years prior to fiscal 2001 to
separately report results of discontinued operations from the results of
continuing operations. A summary of the operating results of the
discontinued operations follows:
For the year ended June 30,
-------------------------------------------
2002 2001 2000
---- ---- ----
Revenue $ 220,267 $ 102,525 $ -
Cost of revenue 37,970 8,356 -
Selling, general and administrative 1,135,571 2,213,295 204,446
Amortization - 1,147,793 960,745
Impairment 100,000 2,108,982 -
----------- ----------- -----------
1,053,274 5,375,901 1,165,191
Loss on disposal of discontinued
operations (1,053,274) (650,000) -
----------- ----------- -----------
Loss from discontinued operations $ - $(4,725,901) $(1,165,191)
=========== =========== ===========
Effective August 31, 2002, the Company ceased all operations of
ComputerCOP, terminated all remaining employees of ComputerCOP and
subleased a majority of the space previously occupied by ComputerCOP for
$5,000 per month for a period of six months. The sublease also provides the
lessee use of certain furniture and equipment during the period of the
lease.
F-17
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5 Marketable securities, available for sale
The following is a summary of marketable securities, available for sale:
Gross
Amortized unrealized
cost loss Fair value
---------- ----------- -----------
June 30, 2002
Bonds $ 195,155 $(112,905) $ 82,250
========== ========= =========
June 30, 2001
Bonds $ 195,155 $(124,155) $ 71,000
========== ========= =========
There were no sales of marketable securities during the years ended June
30, 2002, 2001 and 2000 and the Company recognized a realized loss of
$35,000 on the expiration of a warrant to purchase restricted common stock
of an unrelated publicly traded company during the year ended June 30,
2000.
The maturities of the Company's investments in debt securities at June 30,
2002 are as follows:
Amortized Fair
cost value
--------- ----------
Due in one year or less $ - $ -
Due after one year through five years 195,155 82,250
--------- ---------
$ 195,155 $ 82,250
========= =========
6 Property and equipment, net
Property and equipment consist of the following:
June 30,
--------------------------
2002 2001
---- ----
Machinery and equipment $ 755,045 $ 867,832
Furniture and fixtures 218,497 281,484
Leasehold improvements 140,875 152,150
1,114,417 1,301,466
Less: accumulated depreciation and amortization (432,022) (318,718)
----------- -----------
Property and equipment, net $ 682,395 $ 982,748
=========== ===========
F-18
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7 Accounts payable and accrued expenses
Accounts payable and accrued expenses consist of the following:
June 30,
-------------------------
2002 2001
---- ----
Trade accounts payable and other accrued operating
expenses $ 490,311 $ 777,226
Compensated absences 182,671 143,206
Commissions payable 1,300 2,000
Payroll/sales taxes payable 1,039 4,202
----------- -----------
$ 675,321 $ 926,634
=========== ===========
8 Long-term debt
Long-term debt consists of the following:
June 30,
-------------------------
2002 2001
---- ----
Notes payable to DVI $ 242,982 $ 242,982
Finders fee payable 120,000 120,000
----------- -----------
362,982 362,982
Less current maturities of long-term debt (362,982) (282,982)
----------- -----------
Long-term debt, net of current maturities $ - $ 80,000
=========== ===========
The notes payable (the "DVI Notes") to the Duffy-Vinet Institute, Inc.
("DVI") were assumed by the Company in connection with the Merger (Note 3).
The DVI Notes are secured by all of the assets SMCI had acquired from DVI
in 1992. These assets consisted of furniture, fixtures and equipment (with
a net book value of $12,000) and a portion of the intangible assets
acquired from SMCI including a library of master tapes and completed
training programs. At the time of the Merger, the fair value of the
liability (totaling $309,948) was determined by calculating the present
value of the future payments to be made using an implied interest rate of
11%. At June 30, 1999, the DVI Notes required 66 monthly payments of
$6,280, including interest.
During fiscal 2001, TSG ceased making payments on the DVI Notes and is
attempting to negotiate a restructuring of such debt. Accordingly, all
amounts due have been included in current liabilities.
In connection with the Company's purchase of ComputerCOP Corporation, the
Company incurred finder fees of $960,000, $360,000 of which are payable at
$10,000 per month over 36 months commencing on March 1, 2000. The Company
has ceased making payments on the debt in the current fiscal year and has
classified all amounts due as current liabilities.
F-19
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9 Shareholders' equity
Common stock issuances
In July 2000, the Certificate of Incorporation of the Company was amended
to increase the authorized shares of common stock from 10,000,000 to
50,000,000 shares and to authorize issuance of 2,000,000 shares of
preferred stock.
Management determined the fair value of all common stock issuances based on
each respective issuance's quoted market price at the time of issuance.
For the year ended June 30, 2000, the Company issued 2,528,743 shares of
its common stock as follows:
-- The Company sold 287,500 shares of unregistered common stock during
the year to accredited investors at $15 per share (totaling
$4,312,500) exclusive of commissions and fees of approximately 7%.
-- On November 20, 1999, 12,500 shares were issued to a financial
consultant for services rendered during the three months ending
December 31, 1999, which resulted in a charge to operations of
$275,000.
-- During January 2000, its preferred stockholder elected to convert the
preferred stock into 13,888 shares of NetWolves common stock (at fair
market value at the time of conversion).
-- Pursuant to an agreement dated February 10, 2000, the Company acquired
all of the outstanding capital stock of ComputerCOP Corporation, a New
York corporation and a subsidiary of Computer Concepts, in exchange
for 1,775,000 restricted shares of the Company's common stock. In
addition, the Company issued 125,000 restricted shares of the
Company's common stock as finders' fees. The fair value of the common
stock issued to Computer Concepts and common stock issued as finders'
fees is included in the value of the ComputerCOP software and
inventory, less the cash acquired of 20.5 million.
-- In June 2000, the Company issued General Electric Company ("GE"),
200,000 shares of common stock valued at $1,926,000, which is included
in Sales and Marketing expenses in the Consolidated Statements of
Operations (Note 13).
-- A total of 114,855 shares of the Company's common stock was issued to
outside consultants upon the exercise of warrants (cashless)
previously issued to these individuals.
F-20
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9 Shareholders' equity (continued)
Common stock issuances (continued)
For the year ended June 30, 2001, the Company issued 575,000 shares of its
common stock as follows:
-- In August 2000, 150,000 unregistered shares were issued to a
consulting firm for services rendered, which resulted in a charge to
operations of $807,000 and is included in sales and marketing in the
consolidated statements of operations. One of the Company's employees,
who is also a shareholder, has an ownership interest in this
consulting firm.
-- On May 14, 2001 and in connection with the Company entering into a one
year agreement with its investment bankers, the Company issued 400,000
unregistered shares. The fair value of the shares, $1,156,000, was
amortized over the life of the agreement and is included in general
and administrative in the consolidated statements of operations. The
investment bankers have demand registration rights on the shares
issued 90 days after the commencement of the agreement.
-- In June 2001, 25,000 unregistered shares were issued to a consulting
firm for services rendered, which resulted in a charge to operations
of $89,250 and is included in general and administrative in the
consolidated statements of operations.
For the year ended June 30, 2002, the Company issued 3,439,506 shares of
its common stock as follows:
-- On July 9, 2001, the Company completed a private placement with Pequot
Partners Fund, L.P. and Pequot International Fund, Inc., two funds
managed by Pequot Capital Management, Inc. The Company sold 1,200,000
shares of unregistered common stock at $2.50 per share (a total of
$3,000,000).
-- In July 2001, the Company completed a private placement to accredited
investors for $325,000 through the sale of 130,000 shares of
unregistered common stock at $2.50 per share.
-- In July 2001, and in consideration for the termination of a three year
employment agreement, the Company issued 150,000 shares of
unregistered common stock to such employee, which resulted in a charge
to fiscal 2002 operations of $487,500.
-- In November 2001, the Company completed private placements with Credit
Suisse Asset Management, LLC, and Whiffletree Partners, LP, which is
managed by Palisade Capital Management, LLC, whereby the Company sold
an aggregate of 1,500,000 shares of unregistered common stock at $2.00
per share (a total of $3,000,000) exclusive of commissions and
professional services aggregating $310,000, $300,000 of which was paid
to a company in which an employee of NetWolves has an ownership
interest.
-- In November 2001, and in consideration for the termination of a three
year employment agreement, the Company issued 200,000 shares of
unregistered common stock and a warrant to purchase 100,000 shares of
unregistered common stock to such employee, which resulted in a charge
to loss from discontinued operations of $320,000 (exclusive of
$150,000 which had been previously accrued).
F-21
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9 Shareholders' equity (continued)
Common stock issuances (continued)
-- In January 2002, the Company issued 100,000 shares of unregistered
common stock for professional and consulting services relating to
potential business acquisitions to a company in which an employee of
NetWolves has an ownership interest. A portion of the cost of such
issuance has been included in other current assets in the condensed
consolidated balance sheets at June 30, 2002.
-- During the year the Company issued a total of 30,000 shares of
unregistered common stock to two consultants for professional services
which resulted in a charge to fiscal 2002 operations of $68,300.
-- A total of 129,506 shares of the Company's common stock were issued to
individuals upon the cashless exercise of warrants previously issued
to these individuals.
Stock option plans
The Company's Stock Option Plans (the "Plans"), authorize the Board of
Directors to grant nonstatutory stock options to employees, directors and
consultants to purchase up to a total of 3,532,500 shares of the Company's
common stock. Generally, options granted under the Plans vest ratably over
three years. If any award under the Plans terminates, expires unexercised,
or is canceled, the shares of common stock that would otherwise have been
issuable pursuant thereto will be available for issuance pursuant to the
grant of new awards.
Approximate
Maximum net cumulative
allowable issuances Maximum
Plans Date adopted issuances June 30, 2002 term in years
----- ------------ --------- ---------------- -------------
1998 Plan June 1998 282,500 121,000 10
2000 Plan July 2000 1,500,000 1,394,000 10
2001 Plan February 2001 1,750,000 850,000 10
--------- ---------
3,532,500 2,365,000
========= =========
Warrants
For the year ended June 30, 2000, the Company granted warrants to purchase
its common stock as follows:
-- On July 26, 1999 and in connection with the Company entering into an
agreement with Comdisco, Inc. ("Comdisco"), Comdisco was granted a
five-year warrant to purchase 125,000 shares of the Company's
unregistered common stock, at an exercise price of $10 per share. The
warrant is immediately exercisable. The value of the warrant of
$2,390,000 was being amortized over the initial term of the agreement
(four years). In June 2001, the Company determined that the remaining
unamortized value of the warrant was impaired and, accordingly,
recorded a charge to operations of approximately $1,245,000 during
fiscal 2001, which is included in impairment expense in the Company's
consolidated statement of operations.
F-22
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9 Shareholders' equity (continued)
Warrants (continued)
-- On July 31, 1999, a financial consultant to the Company was granted a
five-year warrant to purchase 100,000 shares of common stock, at an
exercise price of $12 per share. The warrants are immediately
exercisable and the shares issuable pursuant to the warrants have
piggyback registration rights. The value of the warrants of $1,704,000
was being amortized over a period of three months.
-- On November 1, 1999, the Company granted a five-year warrant to
purchase 24,000 shares of common stock, at an exercise price of $18
per share to a public relations firm. The warrants vest ratably over
twelve months and resulted in a charge to operations of approximately
$205,000 through May 31, 2000, at which time the remaining unvested
warrants were canceled due to termination of the public relations
firm's services.
-- In November 1999, a consultant was granted a five-year warrant to
purchase 60,000 shares of common stock, at an exercise price of $18
per share for services provided in connection with a private placement
of the Company's common stock.
-- During December 1999, the Company granted 65,000 ten-year warrants to
the Company's Vice President of Finance at an exercise price of $12
per share. The warrants vest immediately and accordingly resulted in a
charge to operations of $422,500, based upon the intrinsic value of
the warrants on the date of grant.
-- In December 1999, a consultant was granted a ten-year warrant to
purchase 100,000 shares of common stock, at an exercise price of $12
per share. The warrants are immediately exercisable. The value of the
warrants resulted in a charge to operations of approximately
$1,536,000 during the three months ended December 31, 1999.
-- In connection with the February 10, 2000 acquisition of ComputerCOP
Corporation, the Company issued a warrant to purchase an aggregate of
300,000 shares of the Company's stock that are initially exercisable
at $25 per share if exercised on or before September 30, 2002 and $30
thereafter until they expire on February 10, 2005. The fair value of
this warrant of $2,928,000 has been allocated between the value of the
software and the cost of capital obtained. In addition, the Company
issued another warrant to purchase an aggregate of 600,000 shares of
the Company's common stock. This warrant did not vest in accordance
with its terms and was canceled on March 31, 2000.
-- On May 12, 2000, and in full settlement with a previously terminated
employee, the Company granted a one-year warrant to purchase 10,000
shares of common stock, at an exercise price of $15 per share. The
warrant is immediately exercisable. The value of the warrant resulted
in a charge to operations of approximately $14,000 during the three
months ended June 30, 2000.
-- In June 2000, three consultants were granted three-year warrants to
purchase 100,000, 50,000 and 7,500, respectively, shares of common
stock, at exercise prices ranging from $15 to $17 per share. Two of
the warrants are immediately exercisable and one vests ratably over 18
months. The value of the warrants resulted in a charge to operations
of approximately $395,000 for the three months ended June 30, 2000.
F-23
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9 Shareholders' equity (continued)
Warrants (continued)
-- On June 22, 2000 and in connection with the Company entering into an
agreement with GE, the Company issued a warrant to purchase 500,000
shares of common stock. The warrant may be exercised with respect to
any given shares in whole or, from time to time in part, on or prior
to the two-year anniversary of the date of vesting of such shares. The
warrant vests as follows: GE may exercise the warrant to purchase,
cumulatively, up to 100,000, 200,000, 350,000 and 500,000,
respectively, shares of the Company's common stock upon the Company
receiving orders (as defined in the agreement) of an amount equal to
or in excess of, in the aggregate, $2, $3, $4 and $5 million. The
exercise price of the warrant shall be the average (weighted by daily
trading volume) of the reported closing price of the Company's common
stock over the 20 consecutive trading day period ending two trading
days prior to the date GE gives notice to exercise its conversion
right. GE has demand registration rights (subject to certain
limitations as defined in the agreement) covering at least 20% of the
shares of common stock issuable upon exercise of these warrant.
For the year ended June 30, 2001, the Company granted warrants to purchase
its common stock as follows:
-- In May 2001, seven consultants were granted warrants to purchase a
total of 105,000 shares of common stock, at exercise prices ranging
from $4 to $5 per share. All of the warrants are immediately
exercisable and have terms ranging from 2 to 5 years. The value of the
warrants resulted in a charge to operations of approximately $197,000
for the three months ended June 30, 2001, portions of which have been
included in general and administrative and sales and marketing in the
consolidated statements of operations.
For the year ended June 30, 2002, the Company granted warrants to purchase
its common stock as follows:
-- In February 2002, a consultant was granted a warrant to purchase a
total of 100,000 shares of common stock, at an exercise price of $2.94
per share. The warrant is immediately exercisable and has a term of 3
years. The value of the warrant resulted in a charge to operations of
approximately $128,000 during the year ended June 30, 2002, which has
been included in general and administrative in the consolidated
statements of operations.
The value of the warrants had been calculated using the Black-Scholes
option-pricing model with the following assumptions: no dividend yield,
expected volatility of 75%, 75% and 65% for fiscal 2002, 2001 and 2000,
respectively, risk-free interest rates ranging from 3.55% to 6.69%, and
expected life equaling the term of each respective warrant.
F-24
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9 Shareholders' equity (continued)
Summary of options and warrants
The Company has adopted the disclosure provisions of SFAS 123 and applies
APB 25 in accounting for stock options granted to employees and,
accordingly, recognizes non-cash compensation charges related to the
intrinsic value of employee stock options. If the Company had elected to
recognize compensation expense based upon the fair value at the date of
grant consistent with the methodology prescribed by SFAS 123, the effect on
the Company's net loss and net loss per share would be as follows:
For the year ended June 30,
------------------------------------------------
2002 2001 2000
---- ---- ----
Net loss
As reported $(11,630,610) $(20,631,492) $(24,326,948)
Pro forma $(12,295,088) $(32,903,464) $(24,950,773)
Basic and diluted net loss per share
As reported $ (0.99) $ (2.35) $ (3.46)
Pro forma $ (1.05) $ (3.74) $ (3.55)
The weighted average fair value per share of common stock, options and
warrants granted to employees during the years ended June 30, 2002, 2001
and 2000, approximated $1.38, $2.73 and $10.97, respectively, are estimated
on the date of grant using the Black-Scholes option-pricing model with the
following assumptions: no dividend yield, expected volatility ranging from
65% to 75%, risk-free interest rates ranging from 4.57% to 6.69%, and
expected lives ranging from 2 to 10 years.
The following is a summary of all of the Company's stock options and
warrants that were described in detail above (excluding the TSG stock
options):
Weighted
average
Number options and exercise
warrants price per
share
------------------- ----------
Outstanding at June 30, 1999 2,115,500 $ 3.13
Granted 1,901,500 $ 18.86
Exercised (120,500) $ 1.90
Forfeited (839,667) $ 19.68
Outstanding at June 30, 2000 3,056,833 $ 6.29
Granted 4,830,250 $ 4.63
Exercised - $ -
Forfeited (752,583) $ 8.23
Outstanding at June 30, 2001 7,134,500 $ 4.96
Granted 719,700 $ 3.43
Exercised (129,506) $ 1.63
Forfeited (250,494) $ 5.29
---------
Outstanding at June 30, 2002 7,474,200 $ 4.86
=========
At June 30, 2002, there were approximately 1,167,500 options available for
future issuance.
F-25
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9 Shareholders' equity (continued)
Summary of options and warrants (continued)
The following table summarizes information about all of the Company's
options and warrants outstanding at June 30, 2002:
Options and warrants Options and warrants
outstanding at exercisable at
June 30, 2002 June 30, 2002
-------------------- ---------------------
Weighted
average Weighted Weighted
remaining average average
Range of Number of contractual exercise Number of exercise
exercise prices shares life price Shares price
--------------- --------- ------------- --------- ---------- ---------
$ 1.63-$1.75 1,507,000 3.54 $ 1.67 1,007,000 $ 1.63
$ 2.94-$3.30 557,500 4.30 $ 3.18 102,500 $ 2.94
$ 4.00-$4.82 1,997,000 3.76 $ 4.03 1,961,667 $ 4.03
$ 5.00-$5.25 2,327,200 3.13 $ 5.10 2,277,333 $ 5.10
$ 6.00-$9.50 244,500 2.58 $ 7.14 134,833 $ 8.03
$10.00-$13.00 623,500 4.07 $ 10.94 611,167 $ 10.92
$15.00-$18.00 217,500 1.86 $ 16.42 217,500 $ 16.42
--------- ---------
7,474,200 6,312,000
========= =========
Options exercisable as of June 30, 2001 and June 30, 2000 was 6,345,832 and
2,297,000, respectively.
All employee based stock compensation awards issued for the year ended June
30, 2002 had no intrinsic value and, accordingly, resulted in no charge to
operations in such period.
10 Segment information
The Company reports segments in accordance with Financial Accounting
Standards Board Statement No. 131 "Disclosures about Segments of an
Enterprise and Related Information". As of June 30, 2002, the Company and
its subsidiaries operate in two separate business segments, the Technology
segment and the Training and Consulting segment. These operating segments
are representative of the Company's management approach to its evaluation
of its operations. The accounting policies of the reportable operating
segments are the same as those described in the summary of significant
accounting policies. The Technology segment, which operates worldwide, is
primarily engaged in the design, development, marketing and support of
information delivery hardware products and software. The Training and
Consulting segment, which operates domestically, provides management,
consulting, educational and training services primarily to the oil and gas
and automotive industries throughout the United States.
F-26
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
10 Segment Information (contined)
For the year ended June 30,
-------------------------------------------
2002 2001 2000
---- ---- ----
Revenue
Technology $ 404,498 $ 487,588 $ 132,825
Training and consulting 334,250 937,550 1,290,865
------------ ------------ ------------
Total $ 738,748 $ 1,425,138 $ 1,423,690
============ ============ ============
Operating loss
Technology $(10,127,644) $(14,460,314) $(14,786,837)
Training and consulting (538,428) (1,441,735) (9,029,678)
------------ ------------ ------------
Total $(10,666,072) $(15,902,049) $(23,816,515)
============ ============ ============
June 30,
-----------------------
2002 2001
---- ----
Identifiable assets
Technology $ 3,114,692 $ 6,413,782
Training and consulting 45,143 241,369
----------- -----------
3,159,835 6,655,151
Net assets of discontinued operations 64,619 205,293
------------ -----------
Total $ 3,224,454 $ 6,860,444
============ ===========
Net revenue by geographic area follows:
For the year ended June 30,
-------------------------------------------
2002 2001 2000
---- ---- ----
Revenue
United States $ 686,882 $ 1,115,838 $ 1,423,690
Foreign 51,866 309,300 -
------------ ------------ ------------
Total $ 738,748 $ 1,425,138 $ 1,423,690
============ ============ ============
The Company incurred interest expense of $16,250 and $21,321 in the
Technology and the Training and Consulting segments, respectively for the
year ended June 30, 2002. Additionally, the Company incurred depreciation
expense of $198,971 and $7,319 in the Technology and the Training and
Consulting segments, respectively, for the year ended June 30, 2002.
The Company had one major customer in the Technology segment, which
accounted for 34% of consolidated revenue for the year ended June 30, 2002
and four customers, one in the Technology segment and three in the Training
and Consulting segment that accounted for 29%, 10%, 13% and 21% of
consolidated accounts receivable at June 30, 2002. The Company had two
major customers, one in the Technology segment and one in the Training and
Consulting segment, which accounted for 21% and 35%, respectively, of
consolidated revenue for the year ended June 30, 2001 and two customers
that accounted for 56% and 12% of consolidated accounts receivable at June
30, 2001. The Company had two major customers, both included in the
Training and Consulting segment, which accounted for 46% and 24% of
consolidated revenue for the year ended June 30, 2000.
F-27
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11 Income taxes
The provision for income taxes consists of the following:
For the year ended June 30,
2002 2001 2000
---- ---- ----
Current - Federal and States $ - $ - $ (25,000)
Deferred - Federal - - -
Deferred - States - - -
---------- ---------- ----------
Provision for income taxes $ - $ - $ (25,000)
========== ========== ==========
The following table summarizes the significant differences between the
Federal statutory tax rate and the Company's effective tax rate for
financial reporting purposes:
For the year ended June 30,
2002 2001 2000
---- ---- ----
Federal statutory tax rate (34.0)% (34.0)% (34.0)%
State and local taxes net of Federal
Tax effect (6.0) (6.0) (6.0)
Stock and option compensation .4 .8 9.2
Other items - (.1) -
Loss on disposal - 1.1 -
Depreciation & amortization - .5 -
Effect of graduated tax rates - - -
Impairment - 5.8 5.7
Permanent differences .2 .2 .1
Valuation allowance on deferred tax
Asset 39.4 31.7 25.1
------ ------ ------
Effective tax rate 0.0% 0.0% 0.1%
====== ====== ======
The tax effects of temporary differences and carryforwards that give rise
to deferred tax assets or liabilities are summarized as follows:
June 30,
---------------------------------
2002 2001
---- ----
Non deductible reserves and other $ 216,000 $ 266,000
Loss on disposal of discontinued operations 148,000 260,000
Net operating loss carryforward 16,246,000 11,465,000
Intangible assets 2,407,000 2,758,000
Valuation allowance on net deferred tax asset (19,017,000) (14,749,000)
------------ -------------
Deferred tax asset, net $ - $ -
============ =============
F-28
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11 Income taxes (continued)
Due to the history of net operating losses for income tax purposes, the
Company has provided for full valuation allowances on the net deferred tax
asset due to it being more likely than not that the deferred tax asset will
not be utilized.
At June 30, 2002, the Company has net tax operating loss carryforwards of
approximately $40.6 million. A portion or all of these losses may be
subject to Section 382 of the Internal Revenue Code and therefore not
available to offset future income tax liabilities. The carryforward losses
expire in the years 2012 through 2022 and have not been recognized in the
accompanying consolidated financial statements as a result of a valuation
allowance against the deferred tax asset.
12 Related party transactions
In connection with the Merger, the Company had assumed obligations and
entered into commitments with one of the Company's shareholders, who was
also a director and treasurer of TSG, as follows:
-- Deferred compensation payable aggregating $100,000 at June 30, 1999,
represented unpaid salary to the TSG officer for services rendered
prior to the Merger. The deferred compensation was payable in six
monthly installments of $16,667 commencing in October 31, 1999.
-- TSG leased its office facilities from the TSG officer for annual lease
payments of approximately $75,000 (exclusive of sales tax) through
December 2004, which approximates fair market value. The Company paid
approximately $53,000 and $79,000 in connection with this lease for
the years ended June 30, 2001 and 2000, respectively.
-- The loans and advances from the TSG officer of $144,348 were payable
in four equal monthly installments of $37,203 (including interest at
8%) commencing on July 1, 1999.
In addition, in July 1999, another shareholder, who was the President and
Chief Executive Officer of TSG, borrowed $50,000 from the Company at an
interest rate of 6% per annum. Interest on the loan was payable quarterly
and the entire principal balance was payable upon the third anniversary
date of issuance. In connection with the settlement of the TSG lawsuit, the
note was forgiven (Note 15).
In August 2000, 150,000 unregistered shares were issued to a consulting
firm for services rendered (Note 9). One of the Company's employees, who is
also a shareholder, has an ownership interest in this consulting firm. In
December 2000, the Company reduced the exercise price of 300,000 warrants
previously issued to this consulting firm to $5 per share and shortened the
remaining term of the warrant to three years, which resulted in a charge to
operations of $468,000 that is included in general and administrative
expenses. The market price of the Company's common stock at the time of
this reduction was $4.188 per share.
In July 2001, the Company paid $300,000 for marketing services to a
consulting firm in which one of the Company's employees has an ownership
interest. This amount is included in sales and marketing in the
consolidated statements of operations for the year ended June 30, 2001.
F-29
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
13 Major customers/significant agreements
General Electric Company
On June 29, 2000, NetWolves and General Electric Company ("GE") signed a
contract for the master purchase, license and support services of
NetWolves' security, remote monitoring and configuration management system.
GE is using the Company's products for interconnectivity of its worldwide
offices.
The contract is for a term of six years and can be extended for four
additional one-year periods unless prior notice of non-renewal is given by
either party as defined in the agreement. The contract provides for the
Company to receive a fee upon shipment of each unit, and an additional
one-time configuration and installation fee. Additionally, upon shipment of
each unit, GE has the right to purchase from the Company support service
and annual monitoring and management service on an annual basis ("Annual
Services"). The Annual Services shall continue at the same rate per annum,
at GE's discretion, provided that GE requests such services at any time
during a subsequent year. GE is required to pay fees for Annual Services in
full from the expiration date of the prior year period and revenue
generated from the Annual Services is recognized over the service period.
On June 22, 2000 and in connection with the Company entering into the
agreement with GE, the Company issued a warrant to purchase 500,000 shares
of common stock (Note 9).
In June 2000, the Company issued 200,000 shares of common stock to GE (Note
9).
Amoco Oil Company
On December 1, 1999, the Company entered into a three-year agreement (the
"Management Agreement") with Amoco Oil Company ("Amoco"), whereby the
Company was granted the exclusive right to service and support certain
franchised automotive maintenance and repair businesses located within
Minnesota. For the years ended June 30, 2001 and 2000, the Company recorded
management fee revenue from the Management Agreement of approximately
$500,000 and $650,000, respectively.
Effective December 31, 2000, Amoco terminated the contract with the
Company.
Anicom, Inc.
In January 1999, the Company entered into a five-year exclusive master
distribution agreement with Anicom, Inc. ("Anicom") to distribute its
internet connectivity devices throughout North America. Additionally,
Anicom was entitled to receive a commission on any sales or leases of the
units made directly by the Company that Anicom was not involved with and a
commission on certain technical support revenue earned by the Company. In
accordance with the terms of the agreement, the Company shipped
approximately $1,700,000 of product to Anicom, which accounted for
approximately 95% of the Company's revenue for the year ended June 30,
1999.
For cash consideration paid to the Company of $300,000, the Company issued
Anicom 300,000 warrants to purchase common stock of the Company at an
exercise price of $5 per share. The warrants issued to Anicom would have
vested in equal installments over three years, commencing on the first
anniversary of the agreement and would have expired in January 2004. Anicom
also obtained piggyback registration rights with respect to the issuable
shares of common stock.
On April 10, 2000, the Company exercised its right to terminate its
exclusive distributorship agreement with Anicom pursuant to its terms.
F-30
14 Commitments and contingencies
Leases
The Company has entered into several leases for office space, office
equipment and vehicles. At June 30, 2002, the approximate future minimum
annual lease payments, are summarized as follows:
Fiscal year ending June 30,
2003 $ 607,000
2004 604,000
2005 608,000
2006 270,000
----------
$2,089,000
==========
The above future minimum annual lease payments include approximately
$307,000 in payments for discontinued operations.
Total rent expense (excluding discontinued operations) for the years ended
June 30, 2002, 2001 and 2000 was $590,508, $576,914, and $394,184,
respectively.
Employment agreements
In connection with the Merger (Note 3), TSG entered into employment
agreements with 5 executives who were the principals of SMCI. Each of the
agreements were substantially identical and provided for the following
significant terms:
-- employment terms of three years with automatic renewals for additional
one-year terms unless terminated by either party through written
notice,
-- annual salaries of $150,000 for two individuals and $100,000 for three
individuals adjusted annually for cost of living increases,
-- two of the executives were to receive 5% of pre-tax profits of TSG (up
to a maximum of 100% of each employee's base salary) and three of the
executives were to receive 1.67% of pre-tax profits of TSG (up to a
maximum of 50% of each employee's base salary),
-- an aggregate of 605,000 incentive TSG stock options issued to the
employees (Note 3),
-- an aggregate of 175,000 contingently issuable incentive TSG stock
options to the employees (Note 3),
-- if within eighteen months of the Merger, TSG had not initiated an
initial public offering or acquired a publicly held shell, two
executives were to receive 10% of pre- tax profits of TSG up to $10
million and 5% of pre-tax profits in excess of $10 million, not to
exceed, in the aggregate, $1.5 million in compensation in any year.
In November 2000, the Company ceased payments under the TSG employment
agreements in connection with litigation with The Sullivan Group and all
agreements were cancelled as part of the settlement of such litigation
(Note 15).
F-31
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
14 Commitments and contingencies (continued)
Employment agreements (continued)
In August 2000 the Company entered into employment agreements with four
employees with the following terms:
-- One of the agreements was for a period of three years and granted the
employee warrants to purchase 250,000 shares of common stock of the
Company at a purchase price of $5.25 per share, subject to a vesting
schedule as specified in such agreement. This agreement was terminated
in July 2001 (Note 9).
-- Another agreement is for a thirty-month period and provides for a
monthly salary of $12,000, plus reimbursement of certain expenses of
$3,000 per month. In addition, the agreement also grants the employee
warrants to purchase 350,000 shares of common stock of the Company at
a purchase price of $5.25 per share, subject to a vesting schedule as
specified in such agreement. In July 2000 and before commencement of
employment, this individual received $250,000 in consulting fees
relating to the Company's agreement with General Electric Company.
-- Another agreement is for a period of three years and grants the
employee/stockholder, who is affiliated with a law firm who provided
legal services to the Company, warrants to purchase 275,000 shares of
common stock of the Company at a purchase price of $5.125 per share,
subject to a vesting schedule as specified in such agreement;
-- The last agreement was for a period of three years and provided for
monthly compensation of $20,000, and the agreement also granted the
employee warrants to purchase 200,000 shares of common stock of the
Company at a purchase price of $5.25 per share, subject to a vesting
schedule as specified in such agreement. This agreement was terminated
in November 2001 (Note 4).
Effective October 2000, the Company has entered into employment agreements
with certain members of its executive management team. All of the
employment agreements provide for certain payments following death or
disability, for certain fringe benefits such as reimbursement for
reasonable expenses and participation in medical plans, and for accelerated
payments in the event of change of control of the Company. The specific
terms are as follows:
-- The agreement with the Chief Executive Officer is for a term of five
years at an annual salary of $275,000 subject to cost of living
increments.
-- The agreement with the Senior Vice President is for a term of three
years, subject to two additional one-year extensions, at an annual
salary of $175,000.
-- The agreement with the Vice President of Finance is for a term of
three years, subject to two additional one-year extensions, at an
annual salary of $150,000.
Benefit plans
The Company has established a 401(k) defined contribution plan. Employees
21 years or older with at least six months of service are eligible to
participate in the plan. Participants may elect to contribute, on a
tax-deferred basis, up to 15% of their compensation, not to exceed $11,000,
in 2002. The Company did not make any contributions to the plan in 2002,
2001 and 2000.
F-32
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
14 Commitments and contingencies (continued)
Benefit plans (continued)
As of a result of the Merger, TSG had assumed the obligations of a 401(k)
defined contribution plan that provided retirement benefits to qualified
TSG employees. Company contributions to the plan were discretionary. In
addition, employees had the option of deferring and contributing a portion
of their annual compensation to the plan in accordance with the provisions
of the plan. Pension expense was approximately $7,000 and $2,000 for the
years ended June 30, 2001 and 2000, respectively. There was no pension
expense for the year ended June 30, 2002.
15 Legal matters
Anicom Inc.
On April 19, 2000, Anicom, Inc. commenced an action against the Company in
the U.S. District Court for the Northern District of Illinois. The action
was based upon NetWolves' alleged failure to deliver approximately 74,842
shares of its common stock to Anicom, upon exercise by Anicom of the
Company's warrants. The action sought specific performance as well as any
damages that may have resulted from a diminution in value of NetWolves
common stock.
On November 16, 2000, and in connection with the litigation, the Company
and Anicom reached a settlement (the "Settlement Agreement"). Under the
Settlement Agreement the allegations for the breach of the warrant
agreement by the Company and unasserted claims for the breach of the
distribution agreement by Anicom and the Company were settled. The Company
paid $1,150,000 to Anicom pursuant to the Settlement Agreement, which
included the repurchase of all unvested warrants. As of September 30, 2000,
the Company reduced additional paid-in capital in the amount of $705,000,
representing the fair value of the warrants, calculated using the Black-
Scholes option pricing model with the following assumptions: dividend yield
of none, expected volatility of 65%, risk free interest rate of 5.85% and
an expected term of 3.17 years - the remaining life to the maturity date.
The remaining portion of the settlement, in the amount of $445,000, has
been charged to operations and included in general and administrative
expenses for the year ended June 30, 2001.
The Sullivan Group
On or about November 22, 2000 the Company commenced a lawsuit ("Action 1")
in the United States District Court for the Southern District of New York
against certain defendants who were officers and/or directors of TSG (the
"Sullivan Group") and against an Ohio Corporation, ProCare, Inc.
("ProCare"). In response to Action 1, on or about December 19, 2000, the
Sullivan Group commenced a lawsuit ("Action 2") in the United States
District Court for the Southern District of New York against the Company
and other defendants. The Company claimed that it was induced to enter into
the merger agreement and consummate the merger transaction based upon
fraudulent misrepresentations and the purposeful concealment of material
information by the Sullivan Group. The Sullivan Group was contending,
correspondingly, that it was the Company and certain of the current and
former officers and directors who induced the Sullivan Group to enter into
the merger agreement by making false or negligent misrepresentations
regarding the Company's principal product. Service revenue from the TSG
subsidiary has been, and will continue to be substantially reduced as a
result of the reduction in its operations.
The Sullivan Group and ProCare moved to dismiss Action 1 based upon their
contention that the Court lacked subject matter jurisdiction to adjudicate
the controversy. Correspondingly, NetWolves and TSG moved in Action 2 to
dismiss the claims of the Sullivan Group against them therein on the ground
that the Federal Rules of Civil Procedure compel the Sullivan Group to
interpose such claims, if at all, as counterclaims in Action 1.
F-33
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
15 Legal matters (continued)
The Sullivan Group (continued)
Subsequently, the Sullivan Group (as the Plaintiffs in Action 2) sought an
Order compelling the Company to issue an opinion that shares previously
issued to the Sullivan Group (the "Shares") are freely saleable without any
restrictions or limitations under Rule 144. The Company opposed this
application on the ground that independent of the aggregation or "acting in
concert" limitation under Rule 144 which the Company contends was
applicable, the return of the Shares was an element of the relief sought by
the Company in Action 1.
In a decision dated May 8, 2001, which addressed all three motions, the
Court granted the Sullivan Group's motion to dismiss Action No. 1 on the
ground that full diversity of citizenship between the plaintiffs and the
defendants did not exist, and, therefore, as a procedural matter, the Court
lacked subject matter jurisdiction. As a consequence, in addition to
denying the material allegations of the Sullivan Group's complaint and
setting forth several affirmative defenses to the 10b-5 claim and the
claims for fraud, negligent misrepresentation and breach of the Employment
Agreements, the Company and TSG had then reasserted as counterclaims in
their answer in Action No. 2, all of the claims which they had asserted
against the Sullivan Group and ProCare (as an additional defendant on the
counterclaims) in their complaint in Action No. 1 plus an additional claim
against the Sullivan Group for breach of certain of the express
representations and warranties in the Merger Agreement. Based on the
foregoing, the Company and TSG were seeking compensatory damages in excess
of $5 million, punitive damages in the amount of $5 million and injunctive
and other ancillary relief. Based upon the allegations in its complaint,
the Sullivan Group was seeking $8 million in compensatory damages and $8
million in punitive damages. Although the Court did enjoin the Company to
have its counsel issue an opinion letter under Rule 144, the Sullivan Group
nevertheless were restricted to selling as a group during the prescribed
temporal periods only that limited number of shares permitted under the
aggregation proscriptions of Rule 144(e). The Court further mandated that
as a condition of granting such preliminary injunctive relief, the Sullivan
Group was compelled to deposit all of the proceeds of such sales into an
escrow.
In July 2002, this action including all of the counterclaims was settled in
all respects pursuant to a settlement agreement which provided essentially
for the exchange of releases among the parties and the reimbursement to
David Sullivan of $50,000 in respect of prior unpaid expenses incurred by
him on behalf of the Sullivan Group.
Security guard business
Certain claims, suits and complaints arising in the normal course with
respect to the Company's former uniformed security guard services
operations have been filed or are pending against the Company. Generally,
these matters are covered by the Company's general liability insurance
policy. In the opinion of management, all such matters are without merit or
are of such kind, or involve such matters, as would not have a significant
effect on the financial position or results of operations of the Company,
if disposed of unfavorably.
F-34
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
16 Management's plan
Historically, the Company's source of liquidity has been equity financing
which is used to fund losses from operating activities. NetWolves had cash
and cash equivalents of approximately $657,000 at June 30, 2002 and an
additional $4 million was received subsequent to June 30, 2002 (Note 17).
In order for the Company to execute its business plan, additional cash
outflows are necessary for, among other things, continued development of
technology, conducting customer pilot programs and increased sales efforts.
To the extent necessary, the Company intends to utilize the expected
operating profits of the recently acquired Norstan Network Services, Inc.
and raise additional monies from the sale of its capital stock to meet its
funding needs over the next 12 to 24 months, however, there can be no
assurance that the Company will have sufficient capital to finance its
operations. If the Company is unable to raise additional monies from the
sale of its capital stock, or there is a reduction in the expected
operating profits of Norstan Network Services, Inc., management will
institute cost saving measures intended to significantly reduce its
overhead expenses and curtail the operations of certain business segments.
However, even if the Company does raise sufficient operating capital and
Norstan Network Services, Inc. continues to generate operating profits,
there can be no assurances that the net proceeds will be sufficient to
enable it to develop its business to a level where it will generate profits
and cash flows from operations. These matters raise substantial doubt about
the Company's ability to continue as a going concern. However, the
accompanying consolidated financial statements have been prepared on a
going concern basis, which contemplates the realization of assets and
satisfaction of liabilities in the normal course of business. The financial
statements do not include any adjustments relating to the recoverability of
the recorded assets or the classification of the liabilities that might be
necessary should the Company be unable to continue as a going concern.
17 Subsequent events
Acquisition of Norstan Network Services, Inc.
On July 9, 2002, the Company, through its wholly owned subsidiary,
NetWolves Acquisitions, Inc., acquired all of the outstanding capital stock
of Norstan Network Services, Inc. ("NNSI") pursuant to a Stock Purchase
Agreement dated as of January 30, 2002, as amended, among Norstan, Inc.
("Seller") and NNSI, both Minnesota corporations, the Company and NetWolves
Acquisitions, Inc., a Delaware corporation. The Company paid to the Seller
$7,500,000, $3,750,000 of which was paid in cash on or prior to closing and
$3,750,000 is payable under the term of a non-interest bearing promissory
note due July 9, 2003. The purchase price was determined through arms'
length negotiations. The $3,750,000 in cash paid by the Company to the
Seller was primarily obtained through equity and debt financing (see below)
and to a lesser extent from working capital. The total purchase price,
including acquisition costs, is summarized as follows:
Cash paid to Norstan, Inc., on or prior to closing $ 3,750,000
Promissory note payable* 3,479,850
Finders fee 350,000
Professional fees 218,500
------------
$ 7,798,350
============
*The non-interest bearing promissory note payable with a face value of
$3,750,000 was discounted using a rate of 7.5% and is due on July 9, 2003.
F-35
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
17 Subsequent events (continued)
Acquisition of Norstan Network Services, Inc. (continued)
NNSI provides multiple source long distance services and related consulting
and professional services throughout the United States. As a result of the
acquisition, the Company expects to increase its security solution revenues
by leveraging NNSI's existing customer base. In addition, the Company
expects the acquisition will enable it to expand the range of services it
can offer its major customer as well as future customers. The results of
NNSI's operations will be included in our consolidated financial statements
commencing July 9, 2002.
The following table summarizes the preliminary estimated fair values of the
assets acquired and liabilities assumed at the July 9, 2002 acquisition
date. The fair value of intangibles was obtained from a third party
appraisal, the cost of which is included in the purchase price. The
determination of the fair value of assets and liabilities at the
acquisition date as well as the identification of other intangible assets
is continuing and may be subject to change.
Current assets $ 2,860,923
Equipment 56,300
Intangible assets not subject to amortization - licenses 203,000
Intangible assets subject to amortization
(estimated 5 year useful life) 3,376,000
Goodwill 3,574,219
------------
Total assets acquired 10,070,442
------------
Current liabilities (2,272,092)
------------
Total liabilities assumed (2,272,092)
------------
Net assets acquired $ 7,798,350
============
As summary of the fair value of acquired intangible assets subject to
amortization, as determined by a third party appraisal, as well as their
respective estimated useful lives, is as follows:
Estimated
Useful Life Fair Value
----------- ----------
Customer base 5 Years $ 2,436,000
Computer billing software 5 Years 940,000
-----------
Total intangible assets $ 3,376,000
===========
All of the goodwill arising from this acquisition is expected to be
deductible for income tax purposes over a period of 15 years.
F-36
NETWOLVES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
17 Subsequent events (continued)
Post year end financing
On July 16, 2002 the Company amended its Certificate of Incorporation, as
authorized by its Board of Directors, by designating 1,000,000 shares of
its 2,000,000 shares of preferred stock as Series A Convertible Preferred
Stock, par value $.0033 per share ("Series A Preferred Stock").
Cumulative dividends on the Series A Preferred Stock will accrue at a rate
of 8% per annum from the date of issuance and will be payable annually in
additional shares of the Series A Preferred Stock. Each share of the Series
A Preferred Stock will be convertible at the time of the holders' option
into 10 shares of the common stock (an exercise price of $1.50 per share).
Holders of Series A Preferred Stock will have voting rights on an as if
converted basis and will vote as a single class with holders of the
Company's common stock.
Through August 15, 2002, the Company has issued 219,833 shares of its
Series A Preferred Stock for a total cash consideration of $3,297,500. The
shares were issued in connection with a private offering of the Company's
securities pursuant to which shareholders also received warrants to
purchase shares of the Company's common stock at an initial exercise price
equal to $1.65 per share. Five warrants were issued for each share of
Series A Preferred Stock (one-half warrant for each share of common stock
issuable upon conversion of the Series A Preferred Stock). The warrants are
exercisable for five years from the issuance date and are callable by the
Company if the closing price of the Company's common stock is at or above
three times the exercise price for 30 consecutive trading days.
Approximately $3,000,000 of the proceeds from the sale of the Series A
Preferred Stock was utilized to purchase the outstanding capital stock of
Norstan Network Services, Inc. in July 2002. The Company is seeking to sell
additional shares of its Series A Preferred Stock, the proceeds of which
are intended to be used for working capital.
On July 10, 2002, the Company received advances from certain individuals,
some of whom are officers and directors of the Company, aggregating
$600,000, of which, $100,000 was subsequently repaid. The advances are
non-interest bearing, due on demand and have no scheduled repayment terms.
Stock option plan
In June 2002, the Company's Board of Directors authorized the creation of
the 2002 stock option plan (the "2002 Plan") to grant non-qualified stock
options to employees, directors and consultants to purchase up to a total
of 3,000,000 shares of the Company's common stock. If any award under the
Plans terminates, expires unexercised, or is canceled, the shares of common
stock that would otherwise have been issuable pursuant thereto will be
available for issuance pursuant to the grant of new awards. As of September
30, 2002, no options had been issued under this plan.
F-37
To the Board of Directors and
Stockholders of
NetWolves Corporation
INDEPENDENT AUDITORS' REPORT
The audit referred to in our report dated August 24, 2000 on the consolidated
financial statements of NetWolves Corporation and subsidiaries, which appear in
Part II, also include Schedule II for the year ended June 30, 2000. This
schedule is the responsibility of the Company's management. Our responsibility
is to express an opinion based on our audit. In our opinion, the financial
statement schedule referred to above, when considered in relation to the basic
financial statements taken as a whole, presents fairly, in all material
respects, the information set forth therein, in compliance with the applicable
accounting regulations of the Securities and Exchange Commission.
/s/ Eisner LLP
Eisner LLP
(formerly Richard A. Eisner & Company, LLP)
New York, New York
August 24, 2000
F-38
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
Additions
Balance at charged to Deductions Balance
beginning costs and from at end
of period expenses allowances of period
--------- ---------- ---------- ----------
Year ended June 30, 2002:
Allowance for doubtful notes and accounts
receivable $ 152,259 $ 38,905 $ - $ 191,164
Allowance for other assets $ 33,589 $ 56,000 $ - $ 89,589
Accrued losses of discontinued operations $ 496,927 $ - $ 123,957 $ 372,970
Year ended June 30, 2001:
Allowance for doubtful accounts receivable $ 44,747 $ 107,512 $ - $ 152,259
Allowance for other assets $ - $ 33,589 $ - $ 33,589
Accrued losses of discontinued operations $ - $ 496,927 $ - $ 496,927
Year ended June 30, 2000:
Allowance for doubtful accounts receivable $ 40,000 $ 30,000 $ 25,253 $ 44,747
Provision for impairment of intangible assets $ - $4,016,080 $ - $4,016,080
F-39