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U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2008
[_] 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.
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(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 11-3027591
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(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
445 Park Avenue, Suite 1028, New York, New York 10022
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(Address of principal executive offices)
212-829-5770
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(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 [_]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of "Large accelerated filer," "accelerated filer" and "smaller
reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer |_| Accelerated filer |_|
Non-accelerated filer |_| Smaller reporting company |X|
(Do not check if a smaller
reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
The number of shares of Common Stock, $.01 par value per share, outstanding as
of May 8, 2008 was 24,135,557
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NETWORK-1 SECURITY SOLUTIONS, INC.
Form 10-Q INDEX
Page No.
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PART I. Financial Information
Item 1. Financial Statements
Condensed Balance Sheets as of March 31, 2008 (unaudited)
and December 31, 2007............................................. 3
Condensed Statements of Operations for the three months
ended March 31, 2008 and 2007 (unaudited)......................... 4
Condensed Statements of Cash Flows for the three months
ended March 31, 2008 and 2007 (unaudited)......................... 5
Notes to Interim Unaudited Condensed Financial Statements......... 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations......................................... 13
Item 3. Controls and Procedures........................................... 17
PART II. Other Information
Item 1. Legal Proceedings................................................. 17
Item 1A. Risk Factors...................................................... 19
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds....... 19
Item 3. Defaults Upon Senior Securities................................... 19
Item 4. Submission of Matters to a Vote of Security Holders............... 19
Item 5. Other Information................................................. 19
Item 6. Exhibits.......................................................... 19
Signatures................................................................. 20
2
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
NETWORK-1 SECURITY SOLUTIONS, INC.
CONDENSED BALANCE SHEETS
UNAUDITED
MARCH 31, DECEMBER 31,
2008 2007
------------ ------------
(UNAUDITED)
ASSETS:
Current assets:
Cash and cash equivalents $ 5,511,000 $ 5,928,000
Royalty and Interest Receivable 35,000 23,000
Other current assets 61,000 71,000
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Total current assets 5,637,000 6,022,000
Security Deposits 6,000 6,000
Patents 71,000 72,000
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$ 5,684,000 $ 6,100,000
============ ============
LIABILITIES:
Current liabilities:
Accounts payable $ 113,000 $ 103,000
Accrued expenses and other current liabilities 84,000 264,000
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Total current liabilities 198,000 367,000
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Commitments and contingencies
STOCKHOLDERS' EQUITY
Common stock - $0.01 par value ; authorized 50,000,000 shares;
24,135,557 shares issued and outstanding at March 31, 2008 and
December 31, 2007 241,000 241,000
Additional paid-in capital 54,842,000 54,769,000
Accumulated deficit (49,596,000) (49,277,000)
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5,486,000 5,733,000
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$ 5,684,000 $ 6,100,000
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See notes to condensed financial statements
3
NETWORK-1 SECURITY SOLUTIONS, INC.
CONDENSED STATEMENTS OF OPERATIONS
UNAUDITED
Three Months Ended
March 31,
------------------------------
2008 2007
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Royalty Revenue $ 69,000 --
Cost of Revenue 3,000 --
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Gross Profit 66,000 --
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Operating Expenses:
General and administrative 352,000 $ 614,000
Non-cash compensation 73,000 461,000
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Total Operating Expenses 425,000 1,075,000
OPERATING LOSS (359,000) (1,075,000)
Other Income (Expenses): 40,000 15,000
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Interest income, net
Loss Before Income Taxes (319,000) (1,060,000)
INCOME TAXES -- --
------------ ------------
Net Loss $ (319,000) $ (1,060,000)
Net loss per share - Basic and Diluted $ (0.01) $ (0.05)
============ ============
Weighted average number of common shares outstanding 24,135,557 19,784,724
============ ============
4
NETWORK-1 SECURITY SOLUTIONS, INC.
CONDENSED STATEMENTS OF CASH FLOW
UNAUDITED
Three Months Ended March 31,
------------------------------
2008 2007
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Cash flows from operating activities:
Net loss $ (319,000) $ (1,060,000)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 1,000 3,000
Non Cash Compensation 73,000 461,000
Changes in:
Prepaid expenses and other current assets 2,000 22,000
Accounts payable, accrued expenses and other
current liabilities (170,000) (148,000
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Net cash used in operating activities (417,000) (722,000)
Cash Flows from Investing Activities __ __
Cash Flows from Financing Activities
Issuance of Common Stock __ 11,000
NET INCREASES [DECREASE] IN CASH AND CASH EQUIVALENTS (417,000) 711,000
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Cash and cash equivalents, beginning of period 5,928,000 1,797,000
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CASH AND CASH EQUIVALENTS, END OF PERIOD $ 5,511,000 $ 1,086,000
============ ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the periods for:
Interest $ 1,000 $ 1,000
Taxes $ -- $ --
See notes to condensed financial statements
5
NOTE A - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
[1] BASIS OF PRESENTATION:
The accompanying condensed financial statements as of March 31, 2008 and for the
three month periods ended March 31, 2008 and March 31, 2007, are unaudited, but,
in the opinion of the management of Network-1 Security Solutions, Inc. (the
"Company"), contain all adjustments consisting only of normal recurring items
which the Company considers necessary for the fair presentation of the Company's
financial position as of March 31, 2008, and the results of its operations and
its cash flows for the three month periods ended March 31, 2008 and March 31,
2007. 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-Q. 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, 2007 included in the Company's Annual
Report on Form 10-KSB filed with the Securities and Exchange Commission. The
results of operations for the three months ended March 31, 2008 are not
necessarily indicative of the results of operations to be expected for the full
year.
[2] BUSINESS:
(a) The principal business of the Company is the acquisition, development,
licensing and protection of its intellectual property. The Company presently
owns six patents (the "Patent Portfolio") covering various telecommunications
and data networking technologies including, among others, patents covering the
delivery of power over Ethernet cable for the purpose of remotely powering
network devices, and the transmission of audio, video and data over computer and
telephony networks. The Company's strategy is to pursue 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. At least for the
next twelve months, the Company does not currently anticipate licensing efforts
for its other patents besides its Remote Power Patent. The Company may seek to
acquire additional patents in the future.
To date, the Company's efforts with respect to its Patent Portfolio have focused
on licensing our patent (U.S. Patent No. 6,218,930) covering the control of
power delivery over Ethernet cables (the "Remote Power Patent"). In August,
2007, as part of a settlement agreement relating to the Company's litigation
with D-Link, the Company entered into a license agreement with D-Link pertaining
to its Remote Power Patent (See Note D[2]). In February 2008, the Company
commenced patent infringement litigation against several major data networking
equipment manufacturers including Cisco Systems, Inc. and 7 other defendants.
6
NOTE A - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
(CONTINUED)
(b) As reflected in the accompanying financial statements, the Company has
incurred substantial losses and has experienced net cash outflows from
operations for 2007 and the three month period ended March 31, 2008. For the
year ended December 31, 2007 and the three month period ended March 31, 2008,
the Company had revenue of $232,000 and $69,000, respectively. The Company will
continue to have operating losses for the foreseeable future until it is
successful in licensing its patented technologies. The Company has been
dependent upon equity financing to fund its operations. The Company had cash and
cash equivalents of $5,511,000 as of March 31, 2008. The Company believes its
current cash position will more likely than not be sufficient to satisfy the
Company's operations and capital requirements until at least December 31, 2009,
although there can be no assurance that such funds will not be expended prior
thereto.
[3] STOCK-BASED COMPENSATION:
Effective January 1, 2006, the Company adopted SFAS No. 123 (revised 2004),
SHARE BASED PAYMENT, or SFAS 123(R), which is a revision of Statement No. 123
("SFAS 123") ACCOUNTING FOR STOCK BASED COMPENSATION. SFAS 123(R) supersedes
Accounting Principles Board ("APB") No. 25, ACCOUNTING FOR STOCK ISSUED TO
EMPLOYEES ("APB 25"), and amends Financial Accounting Standards Board ("FASB")
Statement No. 95 STATEMENT OF CASH FLOWS. SFAS 123(R) requires all share-based
payments to employees, including grants of employee stock options, to be
recognized in the income statement based on their fair values.
7
[3] STOCK-BASED COMPENSATION: (CONTINUED)
On February 28, 2007, the Company granted a 5 year option to its Chairman and
CEO to purchase 375,000 shares at an exercise price of $1.46 per share in
accordance with a new employment agreement (See Note C - Employment Arrangements
and Other Agreements). Such options vested in equal quarterly amounts of 93,750
shares beginning March 31, 2007 through December 31, 2007. The Company recorded
non-cash compensation expenses of $63,000 for this option during the quarter
ended March 31, 2007 based on the Black-Scholes option-pricing model. In
addition, during the quarter ended March 31, 2007, the Company recorded non-cash
compensation expense of $17,000 for the vested portion of options granted to
directors and consultants prior to January 1, 2007.
On January 2, 2008, the Company granted the following options: (i) 5 year
options to purchase an aggregate of 150,000 shares, at an exercise price of
$1.45 per share, to each of its 3 outside directors, 75,000 shares of which
vested on grant and 75,000 shares vest over one year in equal monthly
installments, and (ii) a 5 year option to purchase 100,000 shares, at an
exercise price of $1.45 per share, granted to a consultant, which vests over a 5
year period in equal monthly installments. The Company recorded non-cash
compensation expense of $12,000 for these options based on the Black-Scholes
option-pricing model.
In February 2008, the Company also granted to another consultant a 5 year option
to pursue 50,000 shares, at an exercise price of $1.42 per share, and also
granted to a new advisory board member an option to purchase 17,500 shares, at
an exercise price of $1.32 per share, which option vests on a quarterly basis.
The Company recorded non-cash compensation expense of $9,000 for these options
based on the Black-Scholes option-pricing model.
On February 28, 2008 the Company granted an additional 5 year option to its
Chairman and CEO to purchase 375,000 shares at an exercise price of $1.32 per
share pursuant to his employment agreement. These options vest in equal
quarterly amounts of 93,750 shares beginning March 31, 2008 through December 31,
2008. The Company recognized non-cash compensation expense of $48,000 for these
options during the quarter ended March 31, 2008. In addition, during the three
month period ended March 31, 2008 the Company recorded non-cash compensation
expense of $4,000 for the vested portion of options granted to a consultant
prior to January 1, 2008.
The fair value of each option grant on the date of grant is estimated using the
Black-Scholes option-pricing utilizing the fo assumptions:
THREE MONTHS ENDED MARCH 31,
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2008 2007
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Risk-free interest rates 2.73% - 3.28% 4.52%
Expected option life in years 5 yrs. 5 yrs.
Expected stock price volatility 37.32 - 37.35% 45.92%
Expected dividend yield -0- -0-
8
[4] REVENUE RECOGNITION:
The Company recognizes revenue received from the licensing of its intellectual
property portfolio in accordance with Staff Accounting Bulletin No. 104,
"Revenue Recognition" ("SAB No. 104") and related authoritative pronouncements.
Revenue is recognized when (i) persuasive evidence of an arrangement exists,
(ii) all obligations have been performed pursuant to the terms of the license
agreement, (iii) amounts are fixed or determinable and (iv) collectibility of
amounts is reasonably assured.
[5] LOSS PER SHARE:
Basic net loss per share is calculated by dividing the net loss by the weighted
average number of outstanding common shares during the period. Diluted per share
data includes the dilutive effects of options, warrants and convertible
securities. Potential shares of 12,070,856 and 9,581,481 at March 31, 2008 and
2007, respectively, are anti-dilutive, and are not included in the calculation
of diluted loss per share. Such potential common shares reflect outstanding
options and warrants.
[6] CASH EQUIVALENTS:
The Company places cash investments in high quality financial institutions
insured by the Federal Deposit Insurance Corporation ("FDIC"). At March 31,
2008, the Company maintained cash balance of approximately $5,411,000 in excess
of FDIC limits.
NOTE B - COMMITMENTS AND CONTINGENCIES
SERVICES AGREEMENT:
On November 30, 2004, the Company entered into a master services agreement (the
"Agreement") with ThinkFire Services USA, Ltd. ("ThinkFire") pursuant to which
ThinkFire has been granted the exclusive worldwide rights (except for direct
efforts by the Company and related companies) to negotiate license agreements
for the Remote Power Patent with respect to certain potential licensees agreed
to between the parties. Either the Company or ThinkFire can terminate the
Agreement upon 60 days' notice for any reason or upon 30 days' notice in the
event of a material breach. The Company has agreed to pay ThinkFire a fee not to
exceed 20% of the royalty payments received from license agreements consummated
by ThinkFire on its behalf.
AMENDED PATENT PURCHASE AGREEMENT:
On January 18, 2005, the Company and Merlot Communications, Inc. ("Merlot")
amended the Patent Purchase Agreement originally entered into in November 2003
(the "Amendment") pursuant to which the Company paid additional purchase price
of $500,000 to Merlot in consideration for the restructuring of future
contingent payments to Merlot from the licensing or sale of the Patents. The
Amendment provides for future contingent payments by the Company to Merlot of
$1.0 million upon achievement of $25 million of Net Royalties (as defined), an
additional $1.0 million upon achievement of $50 million of Net Royalties and an
additional $500,000 upon achievement of $62.5 million of Net Royalties from
licensing or sale of the patents acquired from Merlot. Certain principal
stockholders of the Company and related parties were also principal stockholders
and directors of Merlot at the time of the original agreement in November 2003
and the Amendment.
9
NOTE B - COMMITMENTS AND CONTINGENCIES: (CONTINUED)
LEGAL FEES:
Dovel & Luner, LLP provides legal services to the Company with respect to the
litigation commenced in February 2008 against several major data networking
equipment manufacturers (See Note D[1]). The terms of the Company's agreement
with Dovel & Luner, LLP provides for legal fees of a maximum aggregate cash
payment of $1.5 million plus a contingency fee of up to 24% depending upon when
an outcome is achieved.
With respect to the Company's litigation against D-Link, which was settled in
May 2007 (See Note D[2]), the Company utilized the services of Blank Rome, LLP
on a full contingency basis. In accordance with the Company's contingency fee
agreement with Blank Rome LLP, the Company will pay legal fees to Blank Rome LLP
equal to 25% of the royalty revenue received by the Company from its license
agreement with D-Link after the Company recovers its expenses related to the
litigation.
NOTE C - EMPLOYMENT ARRANGEMENTS AND OTHER AGREEMENTS
On February 28, 2007, the Company entered into a new Employment Agreement with
Corey M. Horowitz pursuant to which Mr. Horowitz continued to serve as Chairman
and Chief Executive Officer for a two year term at an annual base salary of
$288,750 for the first year, increasing by 5% for the second year. In connection
with his employment agreement, Mr. Horowitz was issued a five (5) year option to
purchase 375,000 shares of common stock at an exercise price of $1.46 per share
which vests, on a quarterly basis over a one year period subject to acceleration
upon a change of control. The Company also agreed to issue to Mr. Horowitz on
the one year anniversary date an additional five (5) year option to purchase a
minimum of 375,000 shares of our common stock at an exercise price equal to the
closing price of our common stock on the date of grant, which option will vest
on a quarterly basis over a one year period. On February 28, 2008, the Company
issued such option to Mr. Horowitz to purchase 375,000 shares at an exercise
price of $1.32 per share. In addition to the aforementioned option grants, the
Company agreed to extend for an addition three (3) years the expiration dates of
all options and warrants (an aggregate of 2,620,000 shares) expiring in calendar
year 2007 and 2008 owned by Mr. Horowitz and CMH Capital Management Corp.
("CMH"), an affiliate. In connection with the extension of the expiration dates
of such options and warrants, the Company recorded compensation expense of
$371,000 during the quarter ended March 31, 2007 based on the Black-Scholes
option pricing model. Under the terms of his Employment Agreement, Mr. Horowitz
shall receive bonus compensation in a amount equal to 5% of Company royalties or
other payments (before deduction of payments to third parties including, but not
limited to, legal fees and expenses and third party license fees) received from
licensing its patents (including patents currently owned and acquired or
licensed on an exclusive basis during the period in which Mr. Horowitz continues
to serve as an executive officer of the Company) (the "Royalty Bonus
Compensation"). For the three months ended March 31, 2008, Mr. Horowitz received
$3,000, of Royalty Bonus Compensation. Mr. Horowitz shall also receive bonus
compensation equal 5% of the gross proceeds from (i) the sale of any of the
Company's patents or (ii) the Company's merger with or into another corporation
or entity. The Royalty Bonus Compensation shall continue to be paid to Mr.
Horowitz for the life of each of the Company's patents with respect to licenses
entered into by us with third parties during Mr. Horowitz's term of employment
or at
10
NOTE C - EMPLOYMENT ARRANGEMENTS AND OTHER AGREEMENTS: (CONTINUED)
anytime thereafter, whether Mr. Horowitz is employed by the Company or not,
provided, that, Mr. Horowitz's employment has not been terminated by the Company
"For Cause" (as defined) or terminated by Mr. Horowitz without "Good Reason" (as
defined). In the event that Mr. Horowitz's employment is terminated by the
Company "Other Than For Cause" (as defined) or by Mr. Horowitz for "Good Reason"
(as defined), Mr. Horowitz shall be entitled to a severance of 12 months base
salary.
In accordance with his employment agreement, Mr. Horowitz also has certain
anti-dilution rights which provide that if at any time during the period ended
December 31, 2008, in the event that the Company completes an offering of its
common stock or any securities convertible or exercisable into common stock
(exclusive of securities issued upon exercise of outstanding options, warrants
or other convertible securities), Mr. Horowitz shall receive from the Company,
at the same price as the securities issued in the financing, such number of
additional options to purchase common stock so that he maintains the same
derivative ownership percentage (21.47%) of the Company based upon options and
warrants owned by Mr. Horowitz and CMH (an affiliated entity) and exclusive of
his ownership of shares of common stock as he and CMH owned as of the time of
execution of his employment agreement; provided, that, the aforementioned
anti-dilution protection shall be afforded to Mr. Horowitz up to maximum future
financings of $2.5 million. In April 2007, with respect to the Company's
completion of a $5.0 million private placement, Mr. Horowitz was issued a five
(5) year option to purchase 732,709 shares of common stock, at an exercise price
of $1.67 per share, in accordance with the aforementioned anti-dilution
provision of his employment agreement.
NOTE D - LITIGATION
[1] In February 2008, the Company commenced litigation against several major
data networking equipment manufacturers in the United States District Court for
the Eastern District of Texas, Tyler Division, for infringement of the Company's
Remote Power Patent. The defendants in the lawsuit include Cisco Systems, Inc.,
Cisco Linksys, LLC, Enterasys Networks, Inc., 3COM Corporation, Inc., Extreme
Networks, Inc., Foundry Networks, Inc., Netgear, Inc. and Adtran, Inc. The
Company seeks injunctive relief and monetary damages for infringement based upon
reasonable royalties as well as treble damages for the defendants continued
willful infringement of the Remote Power Patent. To date all of the defendants
have answered the complaint and asserted that they do not infringe any valid
claim of the Remote Power Patent, and further asserted that, based on several
different theories, the patent claims are invalid or unenforceable. In addition
to these defenses, the defendants also asserted counterclaims for, among other
things, non-infringement, invalidity, and unenforceability of the Remote Power
Patent. In the event that the courts determine that the Remote Power Patent is
not valid or enforceable, and/or that the defendants do not infringe, any such
determination would have a material adverse effect on the Company.
[2] In August 2005, the Company commenced patent litigation against D-Link
Corporation and D-Link Systems, Incorporated (collectively "D-Link") in the
United States District Court for the Eastern District of Texas, Tyler division
(Civil Action No. 6:05W291), for infringement of the Company's Remote Power
Patent. The complaint sought, among other things, a judgment that the Company's
Remote Power Patent is enforceable and has been infringed by the defendants.
11
NOTE D - LITIGATION: (CONTINUED)
The Company also sought a permanent injunction restraining the defendants from
continued infringement, or active inducement of infringement by others, of the
Remote Power Patent.
In August 2007, the Company finalized the settlement of its patent infringement
litigation against D-Link. Under the terms of the settlement, D-Link entered
into a license agreement for the Company's Remote Power Patent the terms of
which include monthly royalty payments of 3.25% of the net sales of D-Link Power
over Ethernet products, including those products which comply with the IEEE
802.3af and 802.3at Standards, for the full term of our Remote Power Patent,
which expires in March 2020. The royalty rate is subject to adjustment beginning
after the first quarter of 2008 to a rate consistent with other similarly
situated licensees of the Remote Power Patent based on units of shipments of
licensed products. In addition, D-Link paid the Company $100,000 upon signing of
the Settlement Agreement.
[3] On November 17, 2005 the Company entered into a Settlement Agreement with
PowerDsine, Inc and PowerDsine Ltd. which dismisses, with prejudice, a civil
action brought by PowerDsine in the United States District Court for the
Southern District of New York that sought a declaratory judgment that U.S.
Patent No. 6,218,930 (the "Remote Power Patent") owned by the Company was
invalid and not infringed by PowerDsine and/or its customers. Under the terms of
the Settlement Agreement, the Company has agreed that it will not initiate
litigation against PowerDsine for its sale of Power over Ethernet (PoE)
integrated circuits. In addition, the Company has agreed that it will not seek
damages for infringement from customers that incorporate PowerDsine integrated
circuit products in PoE capable Ethernet switches manufactured on or before
April 30, 2006. PowerDsine has agreed that it will not initiate, assist or
cooperate in any legal action relating to the Remote Power Patent. The Company
also agreed that it will not initiate litigation against PowerDsine or its
customers for infringement of the Remote Power Patent arising from the
manufacture and sale of PowerDsine Midspan products for three years following
the dismissal date. Following such three year period, the Company may seek
damages for infringement of the Remote Power Patent from PowerDsine or its
customers with respect to the purchase and sale of Midspan products beginning 90
days following the dismissal date.
12
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION
THIS QUARTERLY REPORT ON FORM 10-Q CONTAINS FORWARD-LOOKING STATEMENTS WHICH ARE
STATEMENTS THAT INCLUDE INFORMATION BASED UPON BELIEF OF OUR MANAGEMENT, AS WELL
AS ASSUMPTIONS MADE BY AND INFORMATION AVAILABLE TO MANAGEMENT. STATEMENTS
CONTAINING TERMS SUCH AS "BELIEVES", "EXPECTS", "ANTICIPATES", "INTENDS" OR
SIMILAR WORDS ARE INTENDED TO IDENTIFY FORWARD LOOKING STATEMENTS. 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 8-14 OF OUR ANNUAL REPORT ON FORM 10-KSB FOR THE YEAR 2007.
OVERVIEW
Our principal business is the acquisition, development, licensing and
protection of our intellectual property. We presently own six patents covering
various telecommunications and data networking technologies (the "Patent
Portfolio") including, among others, patents covering the delivery of power over
Ethernet for the purpose of remotely powering network devices, and the
transmission of audio, video and data over computer and telephony networks. Our
strategy is to pursue licensing and strategic business alliances with companies
in the industries that manufacture and sell products that make use of the
technologies underlying our patents as well as with other users of the
technology who benefit directly from the technology including corporate,
educational and governmental entities.
To date, our efforts with respect to our Patent Portfolio have focused on
licensing our patent (U.S. Patent No. 6,218,930) covering the control of power
delivery over Ethernet cables (the "Remote Power Patent"). In August, 2007, as
part of a settlement agreement relating to our litigation with D-Link, we
entered into a license agreement with D-Link pertaining to our Remote Power
Patent (See Note D[2] to our financial statements). In February 2008, we
commenced patent infringement litigation against several major data networking
equipment manufacturers including Cisco Systems, Inc. and seven (7) other
defendants (See Note D[1] to our financial statements). During the next 12
months we do not presently anticipate licensing efforts for our other patents
besides our Remote Power Patent.
To date we have incurred significant losses and at March 31, 2008 had an
accumulated deficit of $(49,596,000). For the year ended December 31, 2007 and
for the three months ended March 31, 2008, we incurred net losses of
$(2,998,000) and $(319,000), respectively. We anticipate that we will continue
to incur losses until we enter into additional license agreements with respect
to our patented technologies. We achieved revenue of $232,000 from our
technology licensing business for the year ended December 31, 2007 and $69,000
for the three months ended March 31, 2008 with respect to royalties pertaining
to our Remote Power Patent. Our inability to consummate additional material
license agreements and achieve revenue from our patented technologies would have
a material adverse effect on our operations and our ability to continue
business.
13
Our success and ability to generate revenue is largely dependent on our
ability to consummate licensing arrangements with third parties. In November
2004, we entered into an agreement with ThinkFire Services USA, Ltd.
("ThinkFire") pursuant to which ThinkFire has been granted the exclusive
worldwide rights to negotiate license agreements for our Remote Power Patent
with certain agreed-upon potential licensees. We have agreed to pay ThinkFire a
fee of up to 20% of the royalty payments received from license agreements
consummated by ThinkFire on our behalf after we recover our expenses.
In August 2007 we finalized the settlement of our patent litigation against
D-Link in the United States District Court for the Eastern District of Texas,
Tyler Division, for infringement of our Remote Power Patent (U.S. Patent No.
6,218,930). Under the terms of the settlement, D-Link has agreed to license our
the Remote Power Patent the terms of which include monthly royalty payments of
3.25% of the net sales of D-Link branded Power over Ethernet products, including
those products which comply with the IEEE 802.3af and 802.3at Standards, for the
full life of our Remote Power Patent, which expires in March 2020. The royalty
rate is subject to adjustment beginning after the first quarter of 2008 to a
rate consistent with other similarly situated licensees of our Remote Power
Patent based on units of shipments of licensed products. In addition, D-Link
paid us $100,000 upon signing the settlement agreement. Notwithstanding the
settlement and our license agreement with D-Link, there is no assurance that we
will achieve significant royalty revenue from D-Link, that we will be able to
achieve additional license agreements with third parties relating to our Remote
Power Patent or our other patents, or that such license arrangements will result
in material revenue to us.
In February 2008, we commenced litigation against several major data
networking equipment manufacturers in the United States District Court for the
Eastern District of Texas, Tyler Division, for infringement of our Remote Power
Patent. The defendants in the lawsuit include Cisco Systems, Inc., Cisco
Linksys, LLC, Enterasys Networks, Inc., 3COM Corporation, Inc., Extreme
Networks, Inc., Foundry Networks, Inc., Netgear, Inc. and Adtran, Inc. We seek
injunctive relief and monetary damages for infringement based upon reasonable
royalties as well as treble damages for the defendant's continued willful
infringement of our Remote Power Patent. To date all of the defendants have
answered the complaint and asserted that they do not infringe any valid claim of
our Remote Power Patent, and further asserted that, based on several different
theories, the patent claims are invalid or unenforceable. In addition to these
defenses, the defendants also asserted counterclaims for, among other things,
non-infringement, invalidity, and unenforceability of our Remote Power Patent.
In the event that the Court determines that our Remote Power Patent is not valid
or enforceable, and/or that the defendants do not infringe, any such
determination would have a material adverse effect on us.
14
RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 2008 COMPARED TO THREE MONTHS ENDED MARCH 31, 2008
We had revenues of $69,000 for the three months ended March 31, 2008 which
were related to the receipt of royalties from D-Link for the three months ended
March 31, 2008 pursuant to our license agreement with D-Link. We had no revenues
for the three months ended March 31, 2007.
We had a cost of royalties of $3,000 for the three months ended March 31,
2008 which was related to the payment of bonus compensation on the royalties
pursuant to an employment agreement with our Chief Executive Officer. The gross
profit for the three months ended March 31, 2008 was $66,000 as compared to no
gross profit for the three months ended March 31, 2007.
General and administrative expenses include overhead expenses, and finance,
accounting, legal and other professional services incurred by us. General and
administrative expenses decreased by $262,000, from $614,000 for the three
months ended March 31, 2008 to $352,000 for the three months ended March 31,
2007 due primarily to decreased legal fees and expenses attributable to the
settlement of the D-Link litigation.
We incurred an operating loss of ($359,000) for the three months ended
March 31, 2008 compared with an operating loss of ($1,075,000) for the three
months ended March 31, 2007. Included in the operating loss for the three months
ended March 31, 2008 was $73,000 in charges relating to non-cash compensation
expenses as compared to $461,000 or such non-cash expenses for the three months
ended March 31, 2007. These losses were offset by interest earned of $40,000 and
$15,000 for the three months ended March 31, 2008 and 2007, respectively.
No provision for or benefit from federal, state or foreign income taxes was
recorded for three months ended March 31, 2008 and March 31, 2007 because we
incurred net operating losses and fully reserved our deferred tax assets as
their future realization could not be determined.
As a result of the foregoing, we incurred a net loss of $(319,000) for the
three months ended March 31, 2008 compared with a net loss of $(1,060,000) for
the three months ended March 31. 2007.
LIQUIDITY AND CAPITAL RESOURCES
We have financed our operations primarily from the sale of equity securities. In
April 2007, we completed a private offering of equity securities resulting in
gross proceeds of $5,000,000. In addition, during the fourth quarter of 2007 we
received $1,184,375 of cash proceeds from the exercise of warrants issued in
December 2004 and January 2005. We anticipate, based on currently proposed plans
and assumptions, relating to our operations, that our cash and cash equivalents
of approximately $5,511,000 as of March 31, 2008 will more likely than not be
sufficient to satisfy our operations and capital requirements until at least
December 31, 2009. 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 may have insufficient funds to
15
support our operations prior to December 31, 2009. Our inability to consummate
licensing arrangements with respect to our Remote Power Patent and generate
revenues therefrom on a timely basis or obtain additional financing when needed
would have a material adverse effect on our company, requiring us to curtail or
cease operations. In addition, any equity financing may involve substantial
dilution to our current stockholders.
CRITICAL ACCOUNTING POLICIES:
Patents:
The Company owns a patent portfolio that relates to various telecommunications
and data networking technologies. The Company capitalizes the costs associated
with acquisition, registration and maintenance of the patents and amortizes
these assets over their remaining useful lives on a straight-line basis. Any
further payments made to maintain or develop the patents would be capitalized
and amortized over the balance of the useful life for the patents.
Impairment of long-lived assets:
In accordance with Statement of Financial Accounting Standards ("SFAS") No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets", the Company
records impairment losses on long-lived assets used in operations or expected to
be disposed of when indicators of impairment exist and the cash flows expected
to be derived from those assets are less than carrying amounts of those assets.
Use of estimates:
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
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ITEM 4. CONTROLS AND PROCEDURES.
(a) Evaluation of Disclosure Controls and Procedures.
Our Chief Executive Officer and Chief Financial Officer have reviewed our
disclosure controls and procedures of the Company as of the end of the period
covered by this Quarterly Report on Form 10-Q. Based upon this review, these
officers concluded that, as of the end of the period covered by this Quarterly
Report on Form 10-Q, our disclosure controls and procedures are effective to
ensure that information required to be disclosed by us in the reports we file or
submit under Securities Exchange Act of 1934 is recorded, processed, summarized
and reported, within the time periods specified in applicable rules and forms
and is accumulated and communicated to management, including our Chief Executive
Officer and Chief Financial Officer, to allow timely decisions regarding
required disclosure.
(b) Changes in Internal Controls
There was no change in our internal control over financial reporting that
occurred during the fiscal quarter ended March 31, 2008 that has materially
affected, or is reasonably likely to materially affect, our internal control
over financial reporting.
PART II. OTHER INFORMATION
ITEM 1: LEGAL PROCEEDINGS
Pending Litigation Against Major Data Networking Equipment Manufacturers
In February 2008, we commenced litigation against several major data networking
equipment manufacturers in the United States District Court for the Eastern
District of Texas, Tyler Division, for infringement of our Remote Power Patent.
The defendants in the lawsuit include Cisco Systems, Inc., Cisco Linksys, LLC,
Enterasys Networks, Inc., 3COM Corporation, Inc., Extreme Networks, Inc.,
Foundry Networks, Inc., Netgear, Inc. and Adtran, Inc. We seek injunctive relief
and monetary damages for infringement based upon reasonable royalties as well as
treble damages for the defendant's continued willful infringement of our Remote
Power Patent. To date all of the defendants have answered the complaint and
asserted that they do not infringe any valid claim of our Remote Power Patent,
and further asserted that, based on several different theories, the patent
claims are invalid or unenforceable. In addition to these defenses, the
defendants also asserted counterclaims for, among other things,
non-infringement, invalidity, and unenforceability of our Remote Power Patent.
In the event that the Court determines that our Remote Power Patent is not valid
or enforceable, and/or that the defendants do not infringe, any such
determination would have a material adverse effect on our company.
D-LINK SETTLEMENT
In August 2005, we commenced patent litigation against D-Link Corporation and
D-Link Systems, Incorporated (collectively "D-Link") in the United States
District Court for the Eastern District of Texas, Tyler division (Civil Action
No. 6:05W291), for infringement of our Remote Power Patent. Our complaint
sought, among other things, a judgment that our Remote Power Patent is
enforceable and has been infringed by the defendants. We also sought a permanent
injunction restraining the defendants from continued infringement, or active
inducement of infringement by others, of our Remote Power Patent.
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In August 2007, we finalized the settlement of our patent infringement
litigation against D-Link. Under the terms of the settlement, D-Link entered
into a license agreement for our Remote Power Patent the terms of which include
monthly royalty payments of 3.25% of the net sales of D-Link Power over Ethernet
products, including those products which comply with the IEEE 802.3af and
802.3at Standards, for the full term of our Remote Power Patent, which expires
in March 2020. The royalty rate is subject to adjustment beginning after the
first quarter of 2008 to a rate consistent with other similarly situated
licensees of our Remote Power Patent based on units of shipments of licensed
products. In addition, D-Link paid us $100,000 upon signing of the Settlement
Agreement.
POWERDSINE SETTLEMENT
On November 16, 2005, we entered into a Settlement Agreement with PowerDsine,
Inc. (NASDAQ: PDSN) and PowerDsine Ltd. (collectively, "PowerDsine") which
dismissed, with prejudice, patent litigation brought by PowerDsine against us in
March 2004 in the United States District Court for the Southern District of New
York that sought a declaratory judgment that our Remote Power Patent (U.S.
Patent No. 6,218,930) was invalid and not infringed by PowerDsine and/or its
customers.
Under the terms of the Settlement Agreement, we agreed that we will not initiate
litigation against PowerDsine for its sale of Power over Ethernet (PoE)
integrated circuits. In addition, we agreed that we will not seek damages for
infringement from customers that incorporate PowerDsine integrated circuit
products in PoE capable Ethernet switches manufactured on or before April 30,
2006. PowerDsine has agreed that it will not initiate, assist or cooperate in
any legal action relating to the Remote Power Patent. We also agreed that we
will not initiate litigation against PowerDsine or its customers for
infringement of our Remote Power Patent arising from the manufacture and sale of
PowerDsine Midspan products for three years following the dismissal date.
Following such three year period, we may seek damages for infringement of our
Remote Power Patent from PowerDsine or its customers with respect to the
purchase and sale of Midspan products beginning 90 days following the dismissal
date of the litigation. The benefits afforded to PowerDsine under the Settlement
Agreement will cease in the event PowerDsine institutes, assists or cooperates
in any legal proceeding related to our Remote Power Patent adverse to us (unless
otherwise required by law to do so).
No licenses to use the technologies covered by our Remote Power Patent were
granted to PowerDsine or its customers under the terms of the settlement. The
Settlement Agreement further provides that PowerDsine is obligated to provide
each of its customers with written notice of the settlement which notice shall
disclose that no license for our Remote Power Patent has been provided to
PowerDsine's customers and that in order to combine, modify or integrate any
PowerDsine product with or into any other device or software, PowerDsine's
customers may need to receive patent license(s) for such third party patents
which is the customer's responsibility. For the full text of our Settlement
Agreement with PowerDsine, see Exhibit 10.1 of our Current Report on Form 8-K
filed with the Securities and Exchange Commission on November 17, 2005.
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ITEM 1A. RISK FACTORS.
Our operations and financial results are subject to various risks and
uncertainties that could adversely affect our business, financial condition,
results of operations and trading price of our common stock.
Our Annual Report on Form 10-KSB for the year ended December 31, 2007 includes a
detailed discussion of our risk factors and should be carefully considered by
investors.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
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
(a) Exhibits
31.1 Controls and Procedure Certification of Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Controls and Procedure Certification of Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
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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
BY: /S/ DAVID C. KAHN
------------------------------------
David C. Kahn
Chief Financial Officer
DATE: May 12, 2008
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