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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, 2009
[_] 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 1018, NEW YORK, NEW YORK 10022
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(Address of principal executive offices)
212-829-5770
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(Registrant's Telephone Number)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark whether the registrant has submitted electronically and
posted on its corporate web site every Interactive Date required to be submitted
and posted pursuant to Rule 405 of Regulation S-T(ss.223.405) of this chapter)
during the preceding 12 months (or such shorter period that the registrant was
required to submit and post such files). Yes [_] No [X]
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 14, 2009 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 Statements
Item 1. Financial Statements
Condensed Balance Sheets as of March 31, 2009 (unaudited)
and December 31, 2008........................................... 3
Condensed Statements of Operations for the three months
ended March 31, 2009 and 2008 (unaudited)....................... 4
Condensed Statements of Cash Flows for the three months
ended March 31, 2009 and 2008 (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 4. 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,
2009 2008
------------ ------------
(UNAUDITED)
ASSETS:
Current assets:
Cash and cash equivalents $ 4,013,000 $ 4,484,000
Royalty and Interest Receivable 15,000 78,000
Other current assets 51,000 71,000
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Total current assets 4,079,000 4,633,000
Security Deposits 6,000 6,000
Patents 98,000 100,000
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$ 4,183,000 $ 4,739,000
============ ============
LIABILITIES:
Current liabilities:
Accounts payable $ 106,000 $ 86,000
Accrued expenses and other current liabilities 85,000 251,000
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Total current liabilities 191,000 337,000
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Commitments and contingencies
STOCKHOLDERS' EQUITY
--------------------
Common stock - $0.01 par value ; authorized 50,000,000 shares;
24,135,557 shares issued and outstanding at March 31, 2009 and
December 31, 2008 241,000 241,000
Additional paid-in capital 55,611,000 55,056,000
Accumulated deficit (51,849,000) (50,895,000)
------------ ------------
3,993,000 4,402,000
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$ 4,183,000 $ 4,739,000
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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,
--------------------------------
2009 2008
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Royalty Revenue $ 27,000 $ 69,000
Cost of Revenue 1,000 3,000
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Gross Profit 26,000 66,000
Operating Expenses:
General and administrative 436,000 $ 352,000
Non-cash compensation 555,000 73,000
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Total Operating Expenses 991,000 425,000
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OPERATING LOSS (965,000) (359,000)
Other Income (Expenses): 1,000 40,000
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Interest income, net
Loss Before Income Taxes (964,000) (319,000)
INCOME TAXES -- --
------------ ------------
Net Loss $ (964,000) $ (319,000)
Net loss per share - Basic and Diluted $ (0.04) $ (0.01)
============ ============
Weighted average number of common shares outstanding 24,135,557 24,135,557
============ ============
See notes to condensed financial statements
4
NETWORK-1 SECURITY SOLUTIONS, INC.
CONDENSED STATEMENTS OF CASH FLOW
UNAUDITED
Three Months Ended March 31,
--------------------------------
2009 2008
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Cash flows from operating activities:
Net loss $ (964,000) $ (319,000)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 2,000 1,000
Non Cash Compensation 555,000 73,000
Changes in:
Prepaid expenses and other current assets 83,000 2,000
Accounts payable, accrued expenses and other
current liabilities (147,000) (170,000)
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Net cash used in operating activities (471,000) (417,000)
Cash Flows from Investing Activities __ __
Cash Flows from Financing Activities
Issuance of Common Stock __ __
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NET INCREASES [DECREASE] IN CASH AND CASH EQUIVALENTS (471,000) (417,000)
Cash and cash equivalents, beginning of period 4,484,000 5,928,000
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CASH AND CASH EQUIVALENTS, END OF PERIOD $ 4,013,000 $ 5,511,000
============ ============
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, 2009 and for the
three month periods ended March 31, 2009 and March 31, 2008, 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, 2009, and the results of its operations and
its cash flows for the three month periods ended March 31, 2009 and March 31,
2008. 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, 2008 included in the Company's Annual
Report on Form 10-K filed with the Securities and Exchange Commission. The
results of operations for the three months ended March 31, 2009 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 patent (U.S. Patent No. 6,218,930) covering
the control of power delivery over Ethernet cables (the "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 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 (See Note D[1]). On August
13, 2008, as part of an agreement entered into in June 2008 with Microsemi
Corp-Analog Mixed Signal Group Ltd. ("Microsemi-Analog"), previously PowerDsine
Ltd., Microsemi Corporation, the parent company of Microsemi-Analog, entered
into a license agreement with us for our Remote Power Patent with respect to
certain of its
6
NOTE A - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
(CONTINUED)
Midspan PoE products as part of our new Special Licensing Program. As of March
31, 2009, we had entered into a total of 5 license agreements with respect to
our Remote Power Patent (See Note D[4]).
(b) As reflected in the accompanying financial statements, the Company has
incurred substantial losses and has experienced net cash outflows from
operations for the year ended December 31, 2008 and the three month period ended
March 31, 2009. For the year ended December 31, 2008 and the three month period
ended March 31, 2009, the Company had revenue of $349,000 and $27,000,
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 $4,013,000 as of March
31, 2009. 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, 2010, 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 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. During the three month period ended
March 31, 2008 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 purchase 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 vested on a quarterly basis
over a one year period. During the three month period ended March 31, 2008 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 vested 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.
During the three month period ended March 31, 2009, the Company recorded
non-cash compensation expense of $14,000 for the vested portion of options
granted to its Chief Financial Officer, directors and consultants prior to
January 1, 2009.
On March 11, 2009 the Board of Directors of the Company approved adjustments to
the exercise prices and terms of certain of its outstanding options and warrants
as described below and as a result the Company recorded non-cash compensation
expense of $541,000 for the three month period ended March 31, 2009:
(i) the exercise prices of certain outstanding compensatory options and
warrants issued to officers, directors, consultants and others to
purchase an aggregate of 5,029,945 shares of common stock were
adjusted to an exercise price of $0.68 per share (closing price of
the Company's common stock on March 11, 2009) including options and
warrants to purchase an aggregate of 4,031,195 shares held by the
Company's Chairman and Chief Executive Officer, and an affiliated
entity, options to purchase an aggregate of 150,000 shares held by
the Company's Chief Financial Officer, and options and warrants to
purchase an aggregate of 300,000 shares held by two directors of the
Company;
8
(ii) the exercise price of outstanding warrants to purchase an aggregate
of 473,750 shares of common stock (including warrants to purchase
187,500 shares owned by a principal stockholder of the Company),
issued as part of the Company's private placement completed in
December 2004/January 2005, which exercise price was scheduled to
increase to $2.00 per share on March 31, 2009 (from $1.75 per share)
adjusted to an exercise price of $1.75 for the remaining exercise
period of such warrants (May 21, 2010), subject to the adjustment
set forth in item (iv) below;
(iii) the exercise price of warrants to purchase an aggregate of 1,666,667
shares of common stock, (including warrants to purchase an aggregate
of 1,150,001 shares owned by three principal stockholders of the
Company), at an exercise price of $2.00 per share, which warrants
were issued as part of the Company's private placement completed in
April 2007, were adjusted to an exercise price of $1.75 per share
for the remaining exercise period of such warrants (April 16, 2012),
subject to the adjustments set forth in item (iv) below; and
(iv) in the event that any holders of the above referenced outstanding
warrants, issued as part of the Company's December 2004/January 2005
or the April 2007 private placements, exercise such warrants at
anytime up to and including December 31, 2009, the exercise price of
all such warrants shall adjust to $1.25 per share.
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:
THREE MONTHS ENDED MARCH 31,
----------------------------
2009 2008
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Risk-free interest rates 0.44% - 1.87% 2.73% - 3.28%
Expected option life in years 1-7 yrs. 5 yrs.
Expected stock price volatility 68.25% 37.32% - 37.35%
Expected dividend yield -0- -0-
9
[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 12,159,382 and 12,070,856 at March 31, 2009 and
2008, 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,
2009, the Company maintained no cash balances 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
ranging from 5% to 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 then 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.
10
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 provide 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 (which expired on February 28,
2009) 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 vested, 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 was to 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 receives 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, 2009, Mr. Horowitz received $1,000 of Royalty Bonus
Compensation. Mr. Horowitz also receives 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
11
NOTE C - EMPLOYMENT ARRANGEMENTS AND OTHER AGREEMENTS: (CONTINUED)
Mr. Horowitz's term of employment or at 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 accordance with his employment agreement, Mr. Horowitz also had certain
anti-dilution rights which provided 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 were afforded to Mr. Horowitz up to maximum future
financings of $2.5 million. In April 2007, in accordance with the aforementioned
anti-dilution provision of his employment agreement, 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 (subsequently adjusted to $0.68 per share -
See Note A[3].).
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. The Defendants, in their
answers to the complaint, 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. A
Markman hearing, a hearing on claim construction of our Remote Power Patent, is
currently scheduled for December, 2009 and a trial date has been set for July,
2010. In the event that the court determines 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.
12
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 the Remote Power Patent,
which expires in March 2020. The royalty rate is subject to adjustment 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 16, 2005 the Company entered into a Settlement Agreement with
PowerDsine, Inc and PowerDsine Ltd. which dismissed, 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 agreed that it will not initiate
litigation against PowerDsine for its sale of Power over Ethernet (PoE)
integrated circuits. In addition, the Company 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 agreed that it will not initiate, assist or cooperate
in any legal action relating to the Remote Power Patent.
[4] In June 2008, the Company entered into a new agreement with Microsemi
Corp-Analog Mixed Signal Group Ltd ("Microsemi Analog"), previously PowerDsine
Ltd, a subsidiary of Microsemi Corporation ("Microsemi"), a leading manufacturer
of high performance analog mixed-signal integrated circuits and high reliability
semiconductors, which, among other things, amended the prior Settlement
Agreement entered into between the parties in November 2005. As part of the
Company's Special Licensing Program and its agreement with Microsemi Analog
entered into in June 2008, Microsemi, entered into a license agreement, dated
August 13, 2008, with the Company with respect to the Remote Power Patent. The
license agreement provides that Microsemi is obligated to pay the Company
quarterly royalty payments of 2% of the sales price for certain of Microsemi's
Midspan PoE products for the full term of the Remote Power Patent (March 2020).
NOTE E - SHAREHOLDERS EQUITY:
On March 17, 2009, the Board of Directors of the Company extended the expiration
dates until December 31, 2009 of outstanding warrants to purchase an aggregate
of 395,000 shares of common stock, exercisable at $1.45 per share, and
outstanding warrants to purchase an aggregate of 197,500 shares of common stock,
exercisable at $2.00 per share, which expiration dates were scheduled to expire
on March 17, 2009 and March 31, 2009, respectively.
13
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 9-14 OF OUR ANNUAL REPORT ON FORM 10-K FOR THE YEAR 2008.
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"). As of March 31, 2009,
we had entered into 5 license agreements with respect to our 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 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, 2009 had an
accumulated deficit of $(51,859,000). For the year ended December 31, 2008 and
for the three months ended March 31, 2009, we incurred net losses of
$(1,618,000) and $(964,000), 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 $349,000 from our
technology licensing business for the year ended December 31, 2008 and $27,000
for the three months ended March 31, 2009 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.
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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 agreed to pay ThinkFire a fee
ranging from 5% 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 licenses our 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 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.
In February 2008, we commenced litigation against eight 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. 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. A
Markman hearing, a hearing on claim construction of our Remote Power Patent, is
currently scheduled for December, 2009 and a trial date has been set for July,
2010. 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.
As part of our Special Licensing Program and our agreement with Microsemi
Corp-Analog Mixed Signal Group Ltd. ("Microsemi-Analog") entered into in June
2008, Microsemi Corporation ("Microsemi"), the parent company of
Microsemi-Analog, entered into a license agreement, dated August 13, 2008, with
us with respect to the Remote Power Patent. The license agreement provides that
Microsemi is obligated to pay us quarterly royalty payments of 2% of the sales
price for certain of Microsemi's Midspan PoE products for the full term of the
Remote Power Patent (through March 2020).
Notwithstanding our license agreements with D-Link and Microsemi described
above, there is no assurance that we will achieve significant royalty revenue
from such licenses, that we will be able to achieve additional material 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.
15
RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 2009 COMPARED TO THREE MONTHS ENDED MARCH 31, 2008
We had revenues of $27,000 and $69,000 for the three months ended March 31,
2009 and March 31, 2008, respectively, which were related to the receipt of
royalties pursuant to our license agreements with D-Link, Microsemi and others.
The revenue decline of $42,000 for the three months ended March 31, 2009 as
compared to the three months ended March 31, 2008 was due primarily to the
slowdown in worldwide economic conditions.
We had a cost of revenue of $1,000 and $3,000 for the three months ended
March 31, 2009 and March 31, 2008, respectively, which was for the payment of
bonus compensation based upon royalties pursuant to our employment agreement
with our Chief Executive Officer. The gross profit for the three months ended
March 31, 2009 was $40,000 as compared to $66,000 for the three months ended
March 31, 2008.
General and administrative expenses include overhead expenses, and finance,
accounting, legal and other professional services incurred by us. General and
administrative expenses increased by $84,000, from $352,000 for the three months
ended March 31, 2008 to $436,000 for the three months ended March 31, 2009, due
primarily to increased fees and expenses with respect to litigation involving
our Remote Power Patent.
We incurred an operating loss of ($965,000) for the three months ended
March 31, 2009 compared with an operating loss of ($319,000) for the three
months ended March 31, 2008. Included in the operating loss for the three months
ended March 31, 2009 was $555,000 in charges relating to non-cash compensation
expenses due primarily to the adjustment of the exercise prices of certain
outstanding options and warrants (See Note A[3] to our financial statements
included herein) as compared to $73,000 or such non-cash expenses for the three
months ended March 31, 2008. These losses were offset by interest earned of
$1,000 and $40,000 for the three months ended March 31, 2009 and 2008,
respectively.
No provision for or benefit from federal, state or foreign income taxes was
recorded for three months ended March 31, 2009 and March 31, 2008 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 $(964,000) for the
three months ended March 31, 2009 compared with a net loss of $(319,000) for the
three months ended March 31. 2008.
LIQUIDITY AND CAPITAL RESOURCES
We have financed our operations primarily from the sale of equity securities. We
anticipate, based on currently proposed plans and assumptions, relating to our
operations, that our cash and cash equivalents of approximately $4,013,000 as of
March 31, 2009 will more likely than not be sufficient to satisfy our operations
and capital requirements until at least December 31, 2010. 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
16
support our operations prior to December 31, 2010. 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.
OFF-BALANCE SHEET ARRANGEMENTS
We do not have any off-balance sheet arrangements.
CONTRACTUAL OBLIGATIONS
We do not have any long-term debt, capital lease obligations, operating lease
obligations, purchase obligations or other long-term liabilities.
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.
17
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, 2009 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 eight 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 defendants' continued willful infringement of our Remote
Power Patent. The defendants, in their answers to our complaint, have 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. A Markman hearing, a hearing on
claim construction of our Remote Power Patent, is scheduled for December, 2009
and a trial date has been set for July, 2010. 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, 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 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, under certain
circumstances, 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.
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 our Remote Power Patent
which is the customer's responsibility.
In June 2008 we entered into a new agreement with Microsemi Corp-Analog Mixed
Signal Group Ltd ("Microsemi Analog"), previously PowerDsine Ltd, a subsidiary
of Microsemi Corporation ("Microsemi"), a leading manufacturer of high
performance analog mixed-signal integrated circuits and high reliability
semiconductors, which, among other things, amended the prior Settlement
Agreement entered into between the parties in November 2005. Under the new
agreement, on June 25, 2008 we announced the commencement of an industry-wide
Special Licensing Program for our Remote Power Patent to vendors of PoE
equipment. The Special Licensing Program was of limited duration (through
December 31, 2008) and was implemented on an industry-wide basis to offer
discounted running royalty rates and exceptions to our standard licensing terms
and conditions for the Remote Power Patent to PoE vendors who were "early
adopters" and entered into license agreements without delay to avoid litigation
and higher royalties. We entered into 3 license agreements as part of our
Special Licensing Program. The new agreement enabled Microsemi Analog to assist
in its customers' evaluation of our Remote Power Patent and the terms being made
available to vendors of PoE equipment pursuant to our
19
Special Licensing Program, an activity that was previously prohibited by the
2005 Settlement Agreement with PowerDsine. As part of our Special Licensing
Program and our agreement with Microsemi Analog entered into in June 2008,
Microsemi entered into a license agreement, on August 13, 2008, with us with
respect to our Remote Power Patent. The license agreement provides that
Microsemi is obligated to pay us quarterly royalty payments of 2% of the sales
price for certain of Microsemi's Midspan PoE products for the full term of our
Remote Power Patent (March 2020).
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-K for the year ended December 31, 2008 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 14, 2009
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