Risk Factor Disclosure

1
Risk Factor Disclosure

• Mark Shuman
• Special Counsel
• SEC, Division of Corporation Finance

2
Risk Factor Disclosure

• Item 503(c) of Regulation S-K generally
  requires disclosure of the most significant
  factors that make the offering risky
• Concise and organized logically
• Explain how the risk affects the issuer or
• the securities

3
Risk Factor Disclosure (contd)

• Presented under a sub-caption that
• adequately describes the risk
• Immediately follow the summary section
• Location referenced by page number on
• the cover.

4
Risk Factors Should Avoid

• Legalistic or overly complex presentations
• Vague "boilerplate" explanations that are
  imprecise

5
Risk Factors Should Avoid (contd)

• Complex information copied directly from legal
  documents
• Repetitive disclosure that does not inform.

6
Risk Factors Fall into Three Categories

• Industry Risk
• Will acquire properties with significant
• environmental issues
• Seasonal demand, uncertain supply of
• raw materials.

7
Risk Factors --Three Categories (contd)

• Company Risk
• Specific owned properties require
• environmental clean-up
• Issuer has decided not to obtain insurance
• coverage.

8
Risk Factors --Three Categories (contd)

• Investment Risk
• No prior market
• Debt being offered is subordinate to
• current and future debt.

9
Example of Industry Risk

• All of our key customers are
• telecommunications companies. If the
• telecommunications industry continues to
• experience significant economic downturn,
• our sales could be adversely impacted.

10
Example of Industry Risk (contd)

• A significant portion of our revenues is
  generated from sales of our products and services
  to various telecommunications companies. During
  the last twelve to eighteen months, the
  telecommunications industry has endured a
  significant economic downturn. Telecommunications
  service providers have typically reduced planned
  capital spending, have reduced staff, and sought
  bankruptcy proceedings and/or ceased operations.

11
Example of Industry Risk (contd)

• Consequently, the spending cutback of these
  organizations has affected the Company through
  reduced product orders. The decline in product
  orders negatively impacted our revenues,resulting
  in significant operating losses and negative cash
  flows. If the telecommunications industry
  experiences further economic downturns, this
  could negatively impact our sales and revenue
  generation, and consequently have a material
  adverse effect on our business, financial
  condition and results of operations.

12
Example of Company Risk

• We may be unable to protect our proprietary
• rights, permitting competitors to duplicate our
• products and services, which could negatively
• impact our business and operations.

13
Example of Company Risk (contd)

• We hold no patents on any of our technology.
  If we are unable to license any technology or
  products that we may need in the future, our
  business and operations may be materially and
  adversely impacted. However, we do not consider
  any of these licenses to be critical to our
  operations. We have made a consistent effort to
  minimize the ability of competitors to duplicate
  our software technology utilized in our products.

14
Example of Company Risk (contd)

• However, there remains the possibility of
  duplication of our products, and competing
  products have already been introduced. Any such
  duplication by our competitors could negatively
  impact on our business and operations. 
• We may be unable to protect our proprietary
  rights, permitting competitors to duplicate our
  products and services, which could negatively
  impact our business and operations. 

15
Example of Securities Risk

• Our common stock may be delisted from Nasdaq
  and if this occurs you may have difficulty
  converting your investment into cash efficiently.

16
Example of Securities Risk (contd)

• The National Association of Securities
  Dealers, Inc. has established certain standards
  for the continued listing of a security on the
  Nasdaq National Market and the Nasdaq SmallCap
  Market. The standards for continued listing on
  either market require, among other things, that
  the minimum bid price for the listed securities
  be at least 1.00 per share.

17
Example of Securities Risk (contd)

• Our Common Stock has traded below 1.00 since
  January 29, 2002, and on March 13, 2002, we
  received notice from Nasdaq stating that our
  Common Stock has not met the 1.00 continuing
  listing standard for a period of 30 consecutive
  trading days. There can be no assurance that we
  will continue to satisfy the requirements for
  maintaining a Nasdaq National Market or SmallCap
  listing.

18
Example of Securities Risk (contd)

• If our common stock were to be excluded from
  Nasdaq, the prices of our common stock and the
  ability of holders to sell such stock would be
  adversely affected, and we would be required to
  comply with the initial listing requirements to
  be relisted on Nasdaq.

19
Combination Risk Issuer and Security

• We do not anticipate the payment of dividends. 
• We have never declared or paid cash dividends
  on our common stock. We currently anticipate that
  we will retain all available funds for use in the
  operation of our business. Thus, we do not
  anticipate paying any cash dividends on our
  common stock in the foreseeable future.

20
Sample Comment 

• Currently, it appears you are including more
  than one risk factor under one subheading. For
  example, is the second paragraph under "Recent
  Operating Results" a significant risk factor of
  this offering that needs to stand alone under an
  explanatory subheading? Other examples of
  "bundled" risk factors include . . . In order to
  give the proper prominence to each risk you
  present, we suggest you assign each risk its own
  descriptive subheading.

21
Another Sample Comment 

• Provide the information investors need to assess
  the magnitude of the risk. For example, in the
  second risk factor on page 4, you state that
  increases in short-term interest rates could have
  a material adverse effect on XYZ Bank's
  profitability. Explain why. Are a substantial
  percentage of XYZ's interest-earning assets in
  long-term investments that pay fixed rates while
  the interest you pay to your depositors
  fluctuates? If so, what percentage of your
  interest-earning assets are in long-term
  investments?

22
Risks Associated with Blank Check Offerings.What
Is a Blank Check Offering? 

• A blank check company
• Is a development stage company that has no
  specific business plan or purpose or has
  indicated that its business plan is to engage in
  a merger or acquisition with an unidentified
  company or companies, or other entity or person
  and
• Is issuing penny stock

23
What Risks Are Associated with Blank Check
Offerings?

• Investors dont have a business plan or history
  to evaluate
• Investors dont know the business to be entered
• Investors dont know the terms on which a
  business is acquired or entered

24
What Risks Are Associated with Blank Check
Offerings? (contd)

• Investor reliance upon management is pronounced
• Investors may be mislead about prospects.

25
What is Required in a Blank Check Offering?

• With limited exceptions, all securities issued in
  connection with an offering by a blank check
  company and the gross proceeds from the offering
  shall be deposited promptly into an escrow
  account
• Securities held in the escrow or trust account
  are to be held for the sole benefit of the
  purchasers

26
What is Required in a Blank Check Offering?
(contd)

• Upon acquisition of a business, amended
  disclosure is required and investors have a
  specified period to evaluate the proposed company
  and whether they wish to continue as investors
• If an acquisition has not occurred by a date 18
  months after the effective date of the initial
  registration statement, funds held in the escrow
  or trust account shall be returned.

27
Liquidity and Going Concern Problems

• In the past we have experienced significant
  losses and negative cash flows from operations.
  If these trends continue in the future, it could
  adversely affect our financial condition. 

28
Liquidity and Going Concern Problems (contd)

• We have incurred significant losses and negative
  cash flows from operations in the past. For the
  fiscal years ended March 31, 2001 and 2002, we
  experienced net losses of 16,676,666 and
  6,929,379, respectively, and negative cash flows
  from operations of 7,086,246 and 5,026,038,
  respectively. These results have had a negative
  impact on our financial condition.

29
Liquidity and Going Concern Problems (contd)

• There can be no assurance that our business
  will become profitable in the future and that
  additional losses and negative cash flows from
  operations will not be incurred.If these trends
  continue in the future, it could have a material
  adverse affect on our financial condition.

30
Final Paragraph from Report of Independent Public
Accountant

• The accompanying financial statements have
  been prepared assuming that the Company will
  continue as a going concern. As discussed in Note
  1 to the financial statements, the Company's
  recurring losses from operations and its
  difficulty in generating sufficient cash flow to
  meet its obligations and sustain its operations
  raise substantial doubt about its ability to
  continue as a going concern.

31
Final Paragraph from Report of Independent Public
Accountant

• Management's plans concerning these
• matters are also described in Note 1. The
• financial statements do not include any
• adjustments that might result from the
• outcome of this uncertainty. 

32
MDA Disclosure By Distressed Issuer

• Our consolidated financial statements have
  been prepared on the basis that we will continue
  as a going concern, which contemplates the
  realization and satisfaction of liabilities and
  commitments in the normal course of business. At
  March 31, 2002, we had an accumulated deficit of
  37,094,424 and working capital of 5,040,922. We
  also realized net losses of 6,929,379 for the
  year ended March 31, 2002 and 16,676,666 for the
  year ended March 31, 2001. Our existing working
  capital might not be sufficient to sustain our
  operations.

33
MDA Disclosure By Distressed Issuer (contd)

• Our financial statements do not include any
  adjustments relating to the recoverability and
  classification of recorded asset amounts or to
  amounts and classification of liabilities that
  may be necessary should we be unable to continue
  as a going concern.

34
More MDA Disclosure By Distressed Issuer 

• The decline in product orders negatively
  impacted our revenues, resulting insignificant
  operating losses and negative cash flows. As a
  result, it is imperative for us to be successful
  in increasing our revenue, reducing costs,and/or
  securing additional funding in fiscal 2003 in
  order to continue operating as a going concern.

35
MDA Disclosure By Distressed IssuerThe Problem
Quantified 

• We believe that a minimum of 2,000,000 in
  additional capital will be needed in order to
  fund the Company's planned operations through
  June 2003. We plan to seek equity financing to
  provide funding for operations but the current
  market for equity financing is very weak. If we
  are not successful in raising additional equity
  capital to generate sufficient cash flows to meet
  our obligations as they come due, we plan to
  continue to reduce our overhead expenses by the
  reduction of headcount and other available
  measures.

36
MDA Disclosure By Distressed IssuerThe Problem
Quantified (contd)

• We may also explore the possibility of mergers
  and acquisitions. If we are not successful in
  increasing our revenue, reducing our expenses or
  raising additional equity capital to generate
  sufficient cash flows to meet our obligations as
  they come due, we may not be able to continue as
  a going concern.

37
The Plan to Address the Problem

• Our plans to overcome this condition includes
  refocusing our sales efforts to include
  penetrating additional markets with our
  enterprise infrastructure security products,
  reducing expenses and raising additional equity
  capital. On February 14, 2002, we received
  3,480,000 from the issuance of new shares in a
  private placement of 4,000,000 shares of Common
  Stock.

38
The Plan to Address the Problem (contd)

• We have restructured and reorganized to reduce
  our operating expenses by the layoff of 8
  employees in July 2002 which reduced the
  Company's overhead expenses by approximately
  575,000 in annual salaries and employee
  benefits.  

39
The Plan to Address the Problem (contd)

• The Company has refocused its sales effort to
  emphasize the selling of its software products
  and reengineered its hardware products in an
  effort to increase gross margins. The Company has
  begun to establish alternate channels that will
  open opportunities in the future to sell our
  products without the overhead expenses associated
  with headcount.

40
The Plan to Address the Problem (contd)

• We can not assure that our sales efforts or
  expense reduction programs will be successful, or
  that additional financing will be available to
  us, or, if available, that the terms will be
  satisfactory to us.

41
The Plan to Address the Problem (contd)

• If we are not successful in increasing our
• revenue, reducing our expenses or raising
• additional equity capital, to generate
• sufficient cash flows to meet our obligations
• as they come due, we may not be able to
• continue as a going concern.

42
 Dealing With Issuers Under Investigation

• Issuer may or may not know about the
  investigation 
• Inquiry-investigation process typically is not
  disclosed 

43
Dealing With Issuers Under Investigation (contd)

• Disclosure and Enforcement operations are by
  different persons
•  Disclosure concernsissuer has the disclosure
  obligation.

44
When Issuer Is Aware of Enforcement Interest

• All persons who are responsible for the accuracy
  and adequacy of the disclosure in the
  registration statement are urged to be certain
  that all information required for investors to
  make an informed investment decision is provided.
  Since ABC and its management are in possession
  of all facts with respect to the matter under
  investigation they are responsible for the
  accuracy and adequacy of the disclosures made.

45
When Issuer is Aware of Enforcement Interest
(contd)

• In the event that ABC requests acceleration
• of the effective date of the pending
• registration statement, ABC should furnish
• a letter at the time of such request which
• acknowledges the following
•  

46
When Issuer is Aware of Enforcement Interest
(contd)

• The disclosure in the filing is is the
  responsibility of ABC. ABC represents to the
  Commission that should the Commission or the
  staff acting pursuant to delegated authority,
  declare the filing effective, it does not
  foreclose the Commission from taking any action
  with respect to the filing and ABC represents
  that it will not assert this action as a defense
  in any proceeding initiated by the Commission or
  any person under the federal securities laws of
  the United States.

47
When Issuer is Aware of Enforcement Interest
(contd)

• ABC further acknowledges, that the action of the
  Commission or the staff, acting pursuant to
  delegated authority, in declaring the filing
  effective does not relieve ABC from its full
  responsibility for the adequacy and accuracy of
  the disclosures in the filing.