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