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U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2004
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ______ TO ______
COMMISSION FILE NUMBER 1-14896
NETWORK-1 SECURITY SOLUTIONS, INC.
----------------------------------
(EXACT NAME OF SMALL BUSINESS ISSUER AS
SPECIFIED IN ITS CHARTER)
DELAWARE 11-3027591
(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
445 Park Avenue, Suite 1028, New York, New York 10022
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
212-829-5770
(ISSUER'S TELEPHONE NUMBER)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 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 [_]
The number of shares of Common Stock, $.01 par value per share, outstanding as
of November 12, 2004 was 15,012,572.
Transitional Small Business Disclosure Format (check one): Yes [_] No [X]
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NETWORK-1 SECURITY SOLUTIONS, INC.
INDEX
Page No.
PART I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
Condensed Balance Sheets as of September 30, 2004
(unaudited) and December 31, 2003 3
Condensed Statements of Operations for the three and
nine months ended September 30, 2004 and 2003
(unaudited) 4
Condensed Statements of Cash Flows for the nine
months ended September 30, 2004 and 2003 (unaudited) 5
Notes to Condensed Financial Statements 6
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION 10
Item 3. CONTROLS AND PROCEDURES 16
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 17
Item 2. Changes in Securities and Small Business Issuer Purchases
of Equity Securities 17
Item 3. Defaults Upon Senior Securities 17
Item 4. Submission of Matters to a Vote of Security Holders 17
Item 5. Other Information 17
Item 6. Exhibits and Reports on Form 8-K 17
SIGNATURES 18
2
NETWORK-1 SECURITY SOLUTIONS, INC.
CONDENSED BALANCE SHEETS
SEPTEMBER 30, DECEMBER 31,
2004 2003
------------ ------------
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents $ 333,000 $ 984,000
Prepaid expenses and other current assets 12,000 86,000
------------ ------------
Total current assets 345,000 1,070,000
Patents 94,000 99,000
------------ ------------
$ 439,000 $ 1,169,000
============ ============
LIABILITIES
Current liabilities:
Accounts payable $ 45,000 $ 78,000
Accrued expenses and other current liabilities 570,000 520,000
------------ ------------
Total current liabilities 615,000 598,000
------------ ------------
Liability to be settled with equity instrument 117,000 54,000
------------ ------------
Commitments and contingencies
STOCKHOLDERS' EQUITY (Deficit)
Preferred stock - $0.01 par value, 10,000,000 shares
authorized, Series D - convertible, voting, authorized
1,250,000 shares; 231,054 shares issued and outstanding
at December 31, 2003, liquidation preference of
$705,000 at December 31, 2003 -- 2,000
Series E - convertible, authorized 3,500,000 shares;
2,483,508 shares issued and outstanding at December 31, 2003,
liquidation preference of $ 5,265,000 at December 31, 2003
-- 25,000
Common stock - $0.01 par value; authorized 40,000,000 shares;
15,012,572 shares and 8,314,458 shares issued and
outstanding at September 30, 2004 and December 31,
2003, respectively 150,000 83,000
Additional paid-in capital 41,454,000 41,443,000
Accumulated deficit (41,897,000) (41,036,000)
------------ ------------
Total stockholders' equity (deficit) (293,000) 517,000
------------ ------------
$ 439,000 $ 1,169,000
============ ============
See notes to condensed financial statements
3
NETWORK-1 SECURITY SOLUTIONS, INC.
CONDENSED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2004 2003 2004 2003
------------ ------------ ------------ ------------
Revenue:
Licenses $ -- $ -- $ -- $ 130,000
Services -- 12,000 -- 88,000
------------ ------------ ------------ ------------
Total revenue -- 12,000 -- 218,000
Cost of revenue:
Cost of services -- 17,000 -- 51,000
------------ ------------ ------------ ------------
Total cost of revenue -- 17,000 -- 51,000
------------ ------------ ------------ ------------
Gross Profit -- (5,000) -- 167,000
------------ ------------ ------------ ------------
Operating expenses:
General and administrative 280,000 212,000 862,000 802,000
------------ ------------ ------------ ------------
Total operating expenses 280,000 212,000 862,000 802,000
------------ ------------ ------------ ------------
LOSS BEFORE OTHER INCOME (280,000) (217,000) (862,000) (635,000)
Interest income - net -- 2,000 1,000 9,000
Gain on sale of assets -- -- -- 415,000
------------ ------------ ------------ ------------
Net (loss) $ (280,000) $ (215,000) $ (861,000) $ (211,000)
============ ============ ============ ============
(LOSS) PER COMMON SHARE:
BASIC $ (0.02) $ (0.03) $ (0.06) $ (0.03)
============ ============ ============ ============
DILUTED $ (0.02) $ (0.03) $ (0.06) $ (0.03)
============ ============ ============ ============
WEIGHTED AVERAGE SHARES:
BASIC 15,012,572 8,314,458 14,108,917 8,314,458
============ ============ ============ ------------
DILUTED 15,012,572 8,314,458 14,108,917 8,314,458
============ ============ ============ ============
See notes to condensed financial statements
4
NETWORK-1 SECURITY SOLUTIONS, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30,
2004 2003
----------- -----------
Cash flows from operating activities:
Net loss $ (861,000) $ (211,000)
Adjustments to reconcile net loss to net cash used in operating
activities:
Valuation adjustment for non-employee stock options 114,000 (49,000)
Gain on sale of assets -- (415,000)
Depreciation and amortization 5,000 22,000
Security deposits written off -- 8,000
Changes in:
Accounts receivable -- 6,000
Prepaid expenses and other current assets 74,000 86,000
Accounts payable, accrued expenses and other current liabilities 17,000 (329,000)
Deferred revenue -- (218,000)
----------- -----------
Net cash used in operating activities (651,000) (1,100,000)
----------- -----------
Cash flows provided by investing activities:
Proceeds from the sale of assets -- 415,000
----------- -----------
NET DECREASE IN CASH AND CASH EQUIVALENTS (651,000) (685,000)
Cash and cash equivalents, beginning of period 984,000 2,029,000
----------- -----------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 333,000 $ 1,344,000
=========== ===========
NON-CASH TRANSACTIONS:
Non-employee compensation paid with equity stock options $ 51,000 $ 5,000
=========== ===========
Par value of Common stock issued on conversion of Series D and E Preferred stock
(See Note B)
$ 67,000 $ --
=========== ===========
See notes to condensed financial statements
5
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
[1] BASIS OF PRESENTATION:
The accompanying condensed financial statements as of September 30, 2004 and for
the three and nine month periods ended September 30, 2004 and September 30,
2003, are unaudited, but, in the opinion of the management of Network-1 Security
Solutions, Inc. (the "Company") contain all adjustments which the Company
considers necessary for the fair presentation of the Company's financial
position as of September 30, 2004, the results of its operations and its cash
flows for the three and nine month periods ended September 30, 2004 and
September 30, 2003. The condensed financial statements included herein have been
prepared in accordance with the accounting principles generally accepted in the
United States of America for interim financial information and the instructions
to Form 10-QSB. Accordingly, certain information and footnote disclosures
normally included in the financial statements prepared in accordance with
accounting principles generally accepted in the United States of America have
been omitted pursuant to such rules and regulations, although management
believes that the disclosures are adequate to make the information presented not
misleading. These financial statements should be read in conjunction with the
audited financial statements for the year ended December 31, 2003 included in
the Company's Annual Report on Form 10-KSB filed with the Securities and
Exchange Commission. The results of operations for the nine months ended
September 30, 2004 and 2003 are not necessarily indicative of the results of
operations to be expected for the full year.
[2] BUSINESS:
The principal business of the Company is the acquisition, development, licensing
and protection of its intellectual property. The Company presently owns six
patents covering various telecommunications and data networking technologies
(the "Patent Portfolio"). The Company is pursuing licensing and strategic
business alliances with companies in the industries that manufacture and sell
products that make use of the technologies underlying the Patent Portfolio as
well as with other users of the technology who benefit directly from the
technology including corporate, educational and governmental entities.
On November 18, 2003, the Patent Portfolio was acquired from Merlot
Communications, Inc., a broadband communications solutions provider and a
related party through common ownership. In February 2004, following the
acquisition of the Patent Portfolio and its review of applicable markets, the
Company commenced initial efforts to license one of its patents (U.S. Patent No.
6,218,930) covering the remote delivery of power over Ethernet cables (the
"Remote Power Patent").
As of the date of this Report, the Company has not entered into any license
arrangements with respect to its Remote Power Patent, although it is pursuing
such arrangements with third parties. The Company does not currently have any
revenue from operations. The success of the Company and its ability to achieve
revenue is largely dependent on its ability to consummate such licensing
arrangements with third parties.
From June 1995 until December 2002, the Company developed, marketed, licensed
and supported a suite of security software products designed to prevent
unauthorized access to critical information residing on networked servers,
desktops and laptops. In December 2002, the Company discontinued its security
software product line and associated operations, ceased its product development
and eliminated its sales and marketing efforts. In May 2003, the Company
completed the sale of its security software technology and related intellectual
property to an unaffiliated foreign corporation for an aggregate consideration
of $415,000.
[3] GOING CONCERN:
The Company has incurred substantial net losses from operations during 2003 and
for the nine months ended September 30, 2004, has a stockholder's deficit and
has a negative working capital position at September 30, 2004. The Company as of
September 30, 2004 has cash and cash equivalents of $333,000 and currently is
not generating revenues to support its operations. The Company has been
dependent upon capital raised through both public and private placements of
equity to finance its business operations. This raises substantial doubt about
the Company's ability to continue as a going concern.
6
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
GOING CONCERN: (Continued)
In November 2003, the Company acquired a Patent Portfolio and is pursuing
licensing opportunities for these patents. However, the Company has not entered
into any license arrangements as of September 30, 2004. Until the Company
generates positive cash flow from operations, of which there can be no
assurance, the Company plans to seek additional financing through the issuance
of debt and/or equity securities.
The accompanying condensed financial statements have been prepared assuming that
the Company will continue as a going concern and do not include any adjustments
that may result from the outcome of this uncertainty.
[4] STOCK-BASED COMPENSATION:
The Company accounts for stock-based employee compensation under Accounting
Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to
Employees", and related interpretations. The Company has adopted the
disclosure-only provisions of Statement of Financial Accounting Standards
("SFAS") No. 123, "Accounting for Stock-Based Compensation" and SFAS No. 148,
"Accounting for Stock-Based Compensation - Transition and Disclosure", which was
released in December 2002 as an amendment of SFAS No. 123. The following table
illustrates the effect on net loss and loss per share if the fair value-based
method had been applied to all awards.
NINE MONTHS ENDED
SEPTEMBER 30,
----------------------------
2004 2003
------------ ------------
Reported net loss attributable to common stockholders $ (861,000) $ (211,000)
Stock-based employee compensation expense included in
reported net loss, net of related tax effects -- --
Stock-based employee compensation determined under the
fair value-based method, net of related tax effects (3,000) (7,000)
------------ ------------
Pro forma net loss $ (864,000) $ (218,000)
============ ============
Loss per common share (basic and diluted):
As reported $ (0.06) $ (0.03)
============ ============
Pro forma $ (0.06) $ (0.03)
============ ============
The fair value of each option grant on the date of grant is estimated
using the Black-Scholes option-pricing utilizing the following weighted
average assumptions :
NINE MONTHS ENDED
SEPTEMBER 30,
----------------------------
2004 2003
------------ ------------
Risk-free interest rates 3.93% 2.36%
Expected option life in years 3.00 5.00
Expected stock price volatility 229.49% 112.00%
Expected dividend yield 0.00% 0.00%
7
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
[5] REVENUE RECOGNITION
License revenue was recognized upon delivery of software or delivery of a
required software key. License revenue from distributors or resellers was
recognized as the distributor or reseller delivers software or the required
software key to end users or original equipment manufacturers. Service revenues
consisted of maintenance and training services. Annual maintenance fees were a
separate component of each contract, and are recognized ratably over the
contract term. Training revenues were recognized as such services were
performed. Revenue from advance license fees were deferred until they are earned
pursuant to the agreements.
[6] (LOSS) EARNINGS PER SHARE:
Basic (loss) per share is calculated by dividing the net (loss) by the weighted
average number of outstanding common shares during the period. Diluted income
per share data includes the dilutive effects of options, warrants and
convertible securities. Potential shares of 6,053,104 for the three and nine
months ended September 30, 2004 are anti-dilutive and are not included in the
calculation of diluted loss per share. Such potential common shares reflect
options and warrants. Potential shares of 16,394,453 and 18,853,335 were
outstanding for the three and nine month periods ended September 30, 2003,
respectively. However, these shares were not included in the calculation of
diluted earnings per share because the options and warrants exercise prices and
the preferred shares conversion prices were greater than the average market
price of the Company's common stock during the three and nine month periods
ending September 30, 2003.
[7] CASH EQUIVALENTS:
The Company places cash investments in high quality financial institutions
insured by the Federal Deposit Insurance Corporation ("FDIC"). At September 30,
2004, the Company maintained cash balances of $198,000 in excess of FDIC limits.
NOTE B - CONVERSION OF "SERIES D" AND "SERIES E" PREFERRED STOCK TO COMMON STOCK
In April 2004, the Company entered into an exchange agreement with the holders
of the Company's Series E convertible preferred stock ("Series E") and Series D
convertible preferred stock ("Series D") to exchange 2,483,508 shares of Series
E into 6,208,769 shares of common stock and 231,054 shares of Series D into
489,347 shares of common stock. As an inducement for agreeing to such
conversion, the holders of the Series E and Series D received 1.25 times the
number of shares of common stock that each preferred stockholder would have
otherwise received upon conversion. The holders of preferred stock participating
in the exchange included, among others, CMH Capital Management Corp. ("CMH"),
the sole stockholder, officer and director of which is Corey M Horowitz,
Chairman and CEO of the Company (1,084,935 of Series E shares), the wife of
Corey M. Horowitz (35,377 of Series E shares) and other principal stockholders
of the Company (990,552 of Series E shares and 209,125 of Series D shares).
NOTE C - LIABILITY TO BE SETTLED WITH EQUITY INSTRUMENTS
On April 18, 2002, in consideration of additional consulting and financial
advisory services, the Company issued to CMH an option to purchase 750,000
shares of the common stock at an exercise price of $1.20 per share, which was
the market price of the Company's common stock on the date of issuance. Corey
M.Horowitz, Chairman and CEO of the Company, is the sole stockholder, officer
and director of CMH. The shares underlying the option vest over a three-year
period in equal amounts of 250,000 shares per year beginning April 18, 2003. In
addition, the shares underlying the option shall vest in full in the event of a
"change of control" or in the event that the closing price of the Company's
common stock reaches a minimum of $3.50 per share for 20 consecutive trading
days. These options are treated as contingent options and valued utilizing the
Black-Scholes option pricing model at each balance sheet date. These options
were originally priced in the quarter ended June 30, 2002 at $416,000 and have
been subsequently revalued at end of each quarter or when a portion of these
options vested. On April 18, 2003, 250,000 of these options, having a fair value
of $5,000 as of that date, vested. Accordingly, $5,000 was reallocated to
additional paid-in capital by correspondingly reducing the liability.
8
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
LIABILITY TO BE SETTLED WITH EQUITY INSTRUMENTS (Continued)
On April 18, 2004, 250,000 options of the remaining 500,000 options, having a
fair value of $51,000 as of that date, vested. Accordingly, $51,000 was
reallocated to additional paid-in capital by correspondingly reducing the
liability. The options to purchase the remaining 250,000 shares continue to be
treated as contingent options and valued utilizing the Black-Scholes option
pricing model at each balance sheet date. These unvested options were valued at
$117,000 at September 30, 2004. Any increase/decrease in the valuation has been
reflected as addition/reduction of general and administrative expenses at each
balance sheet date.
NOTE D - LITIGATION
In March 2004, PowerDsine Inc. ("PowerDsine") commenced an action against the
Company in the United District Court, Southern District of New York, seeking a
declaratory judgment that the Company's patent (U.S. Patent No. 6,218,930)
covering the remote delivery of power over Ethernet (the "Remote Power Patent")
is not infringed by PowerDsine and/or its customers. PowerDsine further seeks an
order permanently enjoining the Company (i) from making any claims to any person
or entity that PowerDsine's products infringe the Remote Power Patent or
contribute to infringement of the patent, (ii) from interfering with or
threatening to interfere with the importation, sale, license or use of
PowerDsine's power over Ethernet components or products, and (iii) from
instituting or prosecuting any lawsuit or proceeding, placing at issue the right
of PowerDsine, its customers, licensees, successors, or assigns to import, use
or sell PowerDsine's power over Ethernet components or products. The Company
believes its Remote Power Patent is valid and has meritorious defenses to the
action. The Company and PowerDsine have been engaged in settlement discussions
in an effort to resolve the litigation. In the event that the settlement
discussions are not successful, the Company intends to vigorously defend the
lawsuit and take whatever actions are necessary to protect it's intellectual
property. In the event, however, that the Court granted the declaratory judgment
and the patent was determined to be invalid, such a determination would have a
material adverse effect on the Company.
9
Item 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THIS QUARTERLY REPORT ON FORM 10-QSB CONTAINS 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"). ACTUAL RESULTS, EVENTS AND CIRCUMSTANCES
(INCLUDING FUTURE PERFORMANCE, RESULTS AND TRENDS) COULD DIFFER MATERIALLY FROM
THOSE SET FORTH IN SUCH STATEMENTS DUE TO VARIOUS RISKS AND UNCERTAINTIES,
INCLUDING, BUT NOT LIMITED TO, THOSE DISCUSSED BEGINNING ON PAGES 12-15 OF THIS
QUARTERLY REPORT ON 10-QSB FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2004.
Overview
The principal business of the Company is the acquisition, development,
licensing and protection of its intellectual property. The Company presently
owns six patents covering various telecommunications and data networking
technologies. The Company is pursuing licensing and strategic business alliances
with companies in the industries that manufacture and sell products that make
use of the technologies underlying its patents as well as with other users of
the technology who benefit directly from the technology including corporate,
educational and governmental entities.
On November 18, 2003, the Company acquired a portfolio of
telecommunications and data networking patents (the "Patent Portfolio") from
Merlot Communications, Inc., a broadband communications solutions provider. In
February 2004, following the acquisition of the Patent Portfolio and its review
of applicable markets, the Company commenced initial efforts to license its
Patent Portfolio.
The Patent Portfolio consists of six patents issued by the U.S. Patent
Office that relate to various telecommunications and data networking
technologies and includes, among other things, patents covering the transmission
of audio, video and data over computer and telephony networks and the delivery
of power over Ethernet networks for the purpose of remotely powering network
devices.
In February 2004, the Company initiated licensing efforts relating to one
of its patents (U.S. Patent No. 6,218,930) covering the remote delivery of power
over Ethernet cable (the "Remote Power Patent"). As of the date of this Report,
the Company has not entered into any license arrangements with respect to the
Remote Power Patent, although it is pursuing such arrangements with third
parties. The Company does not currently have any revenue from operations. The
success of the Company and its ability to achieve revenue is largely dependent
on its ability to consummate such licensing arrangements with third parties.
To date the Company has incurred significant losses and at September 30,
2004, had an accumulated deficit of $(41,897,000). At September 30, 2004, the
Company had $333,000 of cash and cash equivalents. Management believes that
based on its current cash position, the Company has sufficient capital to fund
its operations until January 2005, although there is no assurance that the
Company will not have sufficient capital prior to such date. The Company is
currently seeking financing from third parties necessary to support its
continued operations. The Company's failure to obtain such financing, absent
generating sufficient cash from licensing arrangements in the short term, would
have a material adverse effect on the Company, requiring it to curtail or cease
operations. (See "Liquidity and Capital Resources" at page 12 hereof).
10
Results of Operations:
THREE MONTHS ENDED SEPTEMBER 30, 2004 COMPARED TO THREE MONTHS ENDED SEPTEMBER
30, 2003
The Company had no revenues for the quarter ended September 30, 2004 compared to
revenues of $12,000 for the quarter ended September 30, 2003, which were related
to the amortization of deferred maintenance revenues from customers who, in
earlier periods, had elected to purchase maintenance and support contracts for
the Company's software product line which was discontinued in December 2002.
The Company did not incur any cost of revenue for the three months ended
September 30, 2004 as compared to $17,000 for the three months ended September
30, 2003, which was related to the cost of one employee who provided the support
services for former customers of the Company's software business. There was no
gross profit for the three months ended September 30, 2004 compared to a gross
loss of $5,000 for the three months ended September 30, 2003.
General and administrative expenses include management expenses, finance and
accounting and legal and other professional services provided to the Company.
General and administrative expenses increased by $68,000, from $212,000 for the
three months ended September 30, 2003 to $280,000 for the three months ended
September 30, 2004. Expenses during the quarter ended September 30, 2004 include
expenses associated with the Company's business of developing, licensing and
protection of its intellectual property.
The Company had an operating loss of $280,000 for the three months ended
September 30, 2004 compared with an operating loss of $212,000 for the three
months ended September 30, 2003. No provision for or benefit from federal, state
or foreign income taxes was recorded for three months ended September 30, 2004
and 2003 because the Company incurred net operating losses and fully reserved
its deferred tax assets as their future realization could not be determined.
As a result of the foregoing, the Company incurred a net loss of $280,000 for
the three months ended September 30, 2004 compared with a net loss of $215,000
for the three months ended September 30, 2003.
NINE MONTHS ENDED SEPTEMBER 30, 2004 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
2003
The Company had no revenues for the nine months ended September 30, 2004
compared to revenues of $218,000 for the nine months ended September 30, 2003.
Revenues during the nine months ended September 30, 2003 of $130,000 were
related to the recognition of deferred revenue arising out of an agreement with
Falconstor Software, Inc., a former strategic partner of the Company. Revenues
during the nine months ended September 30, 2003 of $88,000 were related to the
amortization of deferred maintenance revenues from customers who had elected to
purchase maintenance and support contracts in earlier periods.
The Company incurred no cost of revenue for the nine months ended September 30,
2004. Cost of services were $51,000 for the nine months ended September 30, 2003
which was related to the cost of one employee who provided the support services
for former customers of the Company's software business. There was no gross
profit for the nine months ended September 30, 2004 compared to a gross profit
of $167,000 for the nine months ended September 30, 2003.
General and administrative expenses include employee costs, including salary,
benefits, travel and other related expenses associated with management, finance
and accounting operations, and legal and other professional services provided to
the Company. General and administrative expenses increased by $60,000, from
$802,000 for the nine months ended September 30, 2003 to $862,000 for the nine
months ended September 30, 2004. Expenses during the nine months ended September
30, 2003 included expenses associated with the
11
discontinuation of the Company's product line and associated headcount reduction
and general downsizing associated with the termination of the Company's software
product business.
The Company had an operating loss of $862,000 for the nine months ended
September 30, 2004 compared with a operating loss of 635,000 for the nine months
ended September 30, 2003. No provision for or benefit from federal, state or
foreign income taxes was recorded for nine months ended September 30, 2003 and
2004 because the Company incurred net operating losses and fully reserved its
deferred tax assets as their future realization could not be determined.
On May 30, 2003, the Company completed the sale of its CyberwallPlus technology
and related intellectual property (the "Assets") and assignment of its rights
under the Falconstar Agreement for aggregate proceeds of $415,000. The carrying
value of these Assets was written down to zero in the third quarter of 2002. The
$415,000 was included as "Gain on Sale of Assets" in the condensed statements of
operations for the nine months ended September 30, 2003.
The Company incurred a net loss of $861,000 for the nine months ended September
30, 2004, compared to net loss of $211,000 for the nine months ended September
30, 2003.
Liquidity and Capital Resources
At September 30, 2004, the Company had $333,000 of cash and cash equivalents and
a working capital deficit of $270,000. Net cash used in operating activities was
$651,000 during the nine months ended September 30, 2004 and net cash used in
operating activities was $1,100,000 during the nine months ended September 30,
2003. Net cash used in operating activities for the nine months ended September
30, 2004 was primarily attributable to the net loss of $861,000 partially offset
by an increase in accounts payable, accrued expenses and other current
liabilities of $17,000, a non-cash expense of $114,000 related to the valuation
of warrants and a decrease in prepaid expenses and other current assets of
$74,000.
The Company's operating activities during the nine months ended September 30,
2004 were financed primarily with the remaining funds raised in the 2001
financing of $6,765,000 and $415,000 received from the sale of CyberwallPLUS
software and related intellectual property in May 2003. The Company does not
currently have a line of credit from a commercial bank or other institution.
The Company anticipates, based on currently proposed plans and assumptions,
relating to its operations that its cash balance of $333,000 as of September 30,
2004 will more likely than not be sufficient to satisfy the Company's operations
and capital requirements until January 2005. There can be no assurance, however,
that such funds will not be expended prior thereto. In the event the Company's
plans change, or its assumptions change, or prove to be inaccurate (due to
unanticipated expenses, difficulties, delays or otherwise), the Company may have
insufficient funds to support its operations prior to January 2005. The Company
is currently pursuing licensing opportunities for its patent. However, to date
the Company has not entered into any such licensing arrangements. The Company is
currently seeking financing necessary to continue its operations. The Company
has no current arrangements with respect to any additional financing.
Consequently, there can be no assurance that any additional financing will be
available to the Company when needed, on commercially reasonable terms or at
all. The Company's inability to obtain additional financing when needed, absent
generating sufficient cash from licensing arrangements in the short term, would
have a material adverse effect on the Company, requiring it to curtail or cease
operations. In addition, any equity financing may involve substantial dilution
to the stockholders of the Company.
12
RISK FACTORS THAT MAY AFFECT FUTURE RESULTS
The Company operates in a highly competitive environment that involves a
number of risks, some of which are beyond the Company's control. The following
discussion highlights the most material of the risks.
WE HAVE A HISTORY OF LOSSES, NO REVENUE FROM CURRENT OPERATIONS AND WE MAY
NOT BE ABLE TO CONTINUE OUR OPERATIONS IN THE FUTURE.
We have incurred substantial operating losses since our inception, which
has resulted in an accumulated deficit of $(41,897,000) as of September 30,
2004. For the years ended December 31, 2003 and 2002, we incurred net losses of
$(614,000) and $(5,905,000), respectively. For the quarter ended September 30,
2004, we incurred a net loss of ($280,000). We have financed our operations
primarily from the balance of funds from sales of equity and convertible debt
securities as well as the sale of our CyberWall PLUS security software
technology in May 2003. Since December 2002, when we discontinued our offering
of security software products, we have not had material revenue from operations
and for the quarter ended September 30, 2004 we had no revenues from operations.
We may not have sufficient funds to continue our operations if we are unable to
secure additional financing or generate sufficient revenue from our new business
of licensing our telecommunications and data networking patents.
WE COULD BE REQUIRED TO STOP OPERATIONS IF WE ARE UNABLE TO DEVELOP OUR
TECHNOLOGY LICENSING BUSINESS OR RAISE CAPITAL WHEN NEEDED.
We anticipate, based on our currently proposed plans and assumptions
relating to our operations (including the timetable of, costs and expenses
associated with our continued operations), that our current cash position will
more likely than not be sufficient to satisfy our operations and capital
requirements until January 2005. There can be no assurance, however, that such
funds will not be expended prior thereto. In the event our plans change, or our
assumptions change or prove to be inaccurate (due to unanticipated expenses,
difficulties, delays or otherwise), we could have insufficient funds to support
our operations prior to January 2005. We are currently pursuing licensing
opportunities for our patented technologies. However, to date we have not
entered into any such licensing arrangements. In addition, even if we consummate
licensing arrangements, such agreements may not result in sufficient cash to
support our operations or achieve material revenues or profitability. We are
currently making efforts to raise capital to continue to fund our operations. We
have no current arrangements with respect to any additional financing.
Consequently, there can be no assurance that any additional financing will be
available to the Company when needed, on commercially reasonable terms or at
all. Our inability to obtain additional financing when needed, absent generating
sufficient cash from licensing arrangements in the short term, would have a
material adverse effect on the Company, requiring us to curtail or possibly
cease our operations. In addition, any additional equity financing may involve
substantial dilution to the interests of our then existing stockholders.
OUR NEW LICENSING BUSINESS MAY NOT BE SUCCESSFUL.
In November 2003, we entered the technology licensing business as a result
of our acquisition of six patents relating to various telecommunications and
data networking technologies including, among others, patents covering the
transmission of audio, video and data over computer and telephony networks and
the delivery of remote power over Ethernet. Accordingly we have a very limited
history in the technology licensing business upon which an evaluation of our
prospects and future performance can be made. Our prospects must be considered
in light of the risks, expenses and difficulties frequently encountered in the
development, operation and expansion of a new business based on rapidly changing
technologies in a highly specialized and competitive market. We may not be able
to achieve revenues or profitable operations from our new licensing business.
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OUR FUTURE SOURCE OF LICENSING REVENUE IS UNCERTAIN.
In February 2004, we initiated our first licensing efforts relating to the
technologies in our Remote Power Patent (U.S. Patent No. 6,212,930). To date, we
have not entered into any licensing agreements with third parties with respect
to our patented technologies. Our inability to consummate licensing agreements
and achieve revenue from our patented technologies would have a material adverse
effect on our operations and our ability to continue our business. In addition,
in the event we consummate license arrangements with third parties, such
arrangements are unlikely to produce a stable or predictable stream of revenue
in the foreseeable future. Furthermore, the success of our licensing efforts
depends upon the strength of our intellectual property rights.
WE FACE UNCERTAINTY AS TO THE OUTCOME OF LITIGATION WITH POWERDSINE.
On March 31, 2004, PowerDsine Inc. ("PowerDsine") commenced an action
against us in the United District Court, Southern District of New York (Civil
Action No. 04 CV 2502) seeking a declaratory judgment that our Remote Power
Patent (U.S. Patent No. 6,218,930) is invalid and is not infringed by PowerDsine
and/or its customers. PowerDsine further seeks an order permanently enjoining us
(i) from making any claims to any person or entity that PowerDsine's products
infringe the Remote Power Patent or contributes to infringement of the patent,
(ii) from interfering with or threatening to interfere with the importation,
sale, license or use of PowerDsine's PoE components or products, and (iii) from
instituting or prosecuting any lawsuit or proceeding placing at issue the right
of PowerDsine, its customers, licensees, successors, or assigns to import, use
or sell PowerDsine's PoE components or products. We believe our Remote Power
Patent is valid and that we have meritorious defenses to the action. We recently
entered into settlement negotiations with PowerDsine in an effort to resolve the
litigation. In the event the settlement discussions are not successful, we
intend to vigorously defend the lawsuit and take whatever actions are necessary
to protect our intellectual property. In the event, however, that the Court
granted the declaratory judgment and our patent was determined to be invalid,
such a determination would have a material adverse effect on us. Regardless of
the outcome, this litigation may subject us to significant costs and diversion
of management time.
WE FACE INTENSE COMPETITION AND WE MAY NOT BE ABLE TO SUCCESSFULLY COMPETE.
The telecommunications and data networking licensing market is
characterized by intense competition and rapidly changing business conditions,
customer requirements and technologies. Our current and potential competitors
have longer operating histories, greater name recognition and possess
substantially greater financial, technical, marketing and other competitive
resources than us. Although we believe that we have rights to enforceable
patents relating to telecommunications and data networking, there can be no
assurance that third parties will not invalidate any or all of our patents. In
addition, our current and potential competitors may develop technologies that
may be more effective than our proprietary technologies or that render our
technologies less marketable or obsolete. We may not be able to compete
successfully.
OUR MARKETS ARE SUBJECT TO RAPID TECHNOLOGICAL CHANGE AND OUR TECHNOLOGIES
FACE POTENTIAL TECHNOLOGY OBSOLESCENCE.
The telecommunications and data networking technology market including,
transmission of audio, video and data over computer and telephony networks and
the delivery of remote power over Ethernet markets, are characterized by rapid
technological changes, changing customer requirements, frequent new product
introductions and enhancements, and evolving industry standards. The
introduction of products embodying new technologies and the emergence of new
industry standards may render our technologies obsolete or less marketable. To
the extent we are able to achieve revenue in the future, such revenue will be
derived from licensing our technologies based on existing and evolving industry
standards.
14
OUR SUCCESS IS DEPENDENT UPON OUR ABILITY TO PROTECT OUR PROPRIETARY
TECHNOLOGIES.
Our success is substantially dependent upon our proprietary technologies
and our ability to protect our intellectual property rights. We currently hold 6
patents issued by the U.S. Patent Office that relate to various
telecommunications and data networking technologies and include among other
things, patents covering the transmission of audio, voice and data over computer
and telephony networks and the delivery of remote PoE networks. We rely upon our
patents and trade secret laws, non-disclosure agreements with our employees,
consultants and third parties to protect our intellectual property rights. The
complexity of patent and trade secret law, and common law, combined with our
limited resources, create risk that our efforts to protect our proprietary
technologies may not be successful. We cannot assure you that our patents will
be upheld or that third parties will not invalidate our patent rights. In the
event our intellectual property rights are not upheld, such an event would have
a material adverse effect on our company. In addition, there is a risk that
third parties may independently develop substantially equivalent or superior
technologies.
ANY LITIGATION TO PROTECT OUR INTELLECTUAL PROPERTY OR ANY THIRD PARTY
CLAIMS OF INFRINGEMENT COULD INVOLVE SUBSTANTIAL TIME AND MONEY AND COULD HAVE A
MATERIAL ADVERSE EFFECT ON OUR BUSINESS.
Our success depends on our ability to protect our intellectual property
rights. Accordingly, we may be subject to third-party claims seeking to
invalidate our patents. These types of claims, with or without merit, may
subject us to costly litigation and diversion of management's focus. In
addition, based on our limited financial resources, we may not be able to pursue
litigation as aggressively as competitors with substantially greater financial
resources. Based on our limited financial resources, it may be necessary to
engage third party professionals on a contingency basis pursuant to which such
parties would be entitled to share in the proceeds of any successful enforcement
of our intellectual property rights. We are currently in discussions with third
parties relating to such arrangements. If third parties making claims against us
seeking to invalidate our patent are successful, they may be able to obtain
injunctive or other equitable relief, which effectively could block our ability
to license or otherwise capitalize on our proprietary technologies. Successful
litigation against us resulting in a determination that our patents are invalid
would have a material adverse effect on our company.
DEPENDENCE UPON CEO AND CHAIRMAN.
Our success will largely be dependent upon the personal efforts of Corey M.
Horowitz, Chairman and Chief Executive Officer and Chairman of the Board of
Directors. Mr. Horowitz does not currently have an employment agreement with the
Company and serves as an employee-at-will. The loss of the services of Mr.
Horowitz could have a material adverse effect on our business and prospects.
RISKS RELATED TO LOW PRICED STOCKS.
Our common stock currently trades on the OTC Bulletin Board under the
symbol NSSI.OB. Since the trading price of our common stock is below $5.00 per
share, our common stock is considered a penny stock. SEC regulations generally
define a penny stock to be an equity security that is not listed on Nasdaq or a
national securities exchange and that has a market value of less than $5.00 per
share, subject to certain exceptions. The SEC regulations would require
broker-dealers to deliver to a purchaser of our common stock a disclosure
schedule explaining the penny stock market and the risks associated with it.
Various sales practice requirements are also imposed on broker-dealers who sell
penny stocks to persons other than established customers and accredited
investors (generally institutions). Broker-dealers must also provide the
customer with current bid and offer quotations for the penny stock, the
compensation of the broker-dealer and monthly account statements disclosing
recent price information for the penny stock held in the customer's account.
15
THE SIGNIFICANT NUMBER OF OPTIONS AND WARRANTS OUTSTANDING MAY ADVERSELY
EFFECT THE MARKET PRICE FOR OUR COMMON STOCK.
As of September 30, 2004, there are outstanding (i) options and warrants to
purchase an aggregate of 6,053,104 shares of our common stock at exercise prices
ranging from $.12 to $10.13, and (ii) 727,630 additional shares of our common
stock which may be issued in the future under our stock option plan. To the
extent that outstanding options and warrants are exercised, your percentage
ownership will be diluted and any sales in the public market of the common stock
underlying such options may adversely affect prevailing market prices for our
common stock.
WE HAVE A SIGNIFICANT AMOUNT OF AUTHORIZED BUT UNISSUED PREFERRED STOCK,
WHICH MAY AFFECT THE LIKELIHOOD OF A CHANGE OF CONTROL IN OUR COMPANY.
Our Board of Directors has the authority, without further action by the
stockholders, to issue 10,000,000 shares of preferred stock on such terms and
with such rights, preferences and designations as our Board of Directors may
determine. Such terms may include restricting dividends on our common stock,
dilution of the voting power of our common stock or impairing the liquidation
rights of the holders of our common stock. Issuance of such preferred stock,
depending on the rights, preferences and designations thereof, may have the
effect of delaying, deterring or preventing a change in control. In addition,
certain "anti-takeover" provisions in Delaware law may restrict the ability of
our stockholders to authorize a merger, business combination or change of
control.
Item 3. Controls and Procedures.
(a) Evaluation of Disclosure Controls and Procedures.
The Company's Chief Executive Officer and Chief Financial Officer have
reviewed the disclosure controls and procedures of the Company as of the end of
the period covered by this Quarterly Report on Form 10-QSB. Based upon this
review, these officers concluded that, as of the end of the period covered by
this Quarterly Report on Form 10-QSB, the Company's disclosure controls and
procedures are adequately designed to ensure that information required to be
disclosed by the Company in the reports it files or submits under Securities and
Exchange Act of 1934 is recorded, processed, summarized and reported, within the
time periods specified in applicable rules and forms.
(b) Changes in Internal Controls.
There were no significant changes in the Company's internal controls or in
other factors that could significantly affect these controls during the last
fiscal quarter included in this report or from the end of the reporting period
to the date of this Quarterly Report on Form 10-QSB.
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PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS.
On March 31, 2004, PowerDsine Inc. commenced an action against the Company
in the United District Court, Southern District of New York (Civil Action No. 04
CV 2502) seeking a declaratory judgment that the Company's Remote Power Patent
(U.S. Patent No. 6,218,930) is not infringed by PowerDsine and/or its customers.
PowerDsine further seeks an order permanently enjoining the Company (i) from
making any claims to any person or entity that PowerDsine's products infringe
the Remote Power Patent or contributes to infringement of the patent, (ii) from
interfering with or threatening to interfere with the importation, sale, license
or use of PowerDsine's PoE components or products, and (iii) from instituting or
prosecuting any lawsuit or proceeding placing at issue the right of PowerDsine,
its customers, licensees, successors, or assigns to import, use or sell
PowerDsine's PoE components or products. The Company believes its Remote Power
Patent is valid and has meritorious defenses to the action. The Company and
PowerDsine have been engaged in settlement discussions in an effort to resolve
the litigation. In the event that the settlement discussions are not successful,
the Company intends to vigorously defend the lawsuit and take whatever actions
are necessary to protect it's intellectual property. In the event, however, that
the Court granted the declaratory judgment and the patent was determined to be
invalid, such a determination would have a material adverse effect on the
Company.
Item 2. Changes in Securities and Small Business Issuer Purchases of Equity
Securities.
None
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Submission of Matters to a Vote of Security Holders.
None.
Item 5. Other Information.
None.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
31.1 Controls and Procedure Certification of Chief Executive Officer
and Chief Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer and Chief Financial
Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(b) Reports of Form 8-K
None
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SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
NETWORK-1 SECURITY SOLUTIONS, INC.
By: /s/ Corey M. Horowitz
------------------------------
Corey M. Horowitz
Chairman and Chief Executive Officer
Date: November 15, 2004
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