================================================================================
U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2004
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ______ TO ______
COMMISSION FILE NUMBER 1-14896
NETWORK-1 SECURITY SOLUTIONS, INC.
--------------------------------------------------------------------------------
(EXACT NAME OF SMALL BUSINESS ISSUER AS
SPECIFIED IN ITS CHARTER)
DELAWARE 11-3027591
--------------------------------------------------------------------------------
(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
445 Park Avenue, Suite 1028, New York, New York 10022
--------------------------------------------------------------------------------
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
212-829-5770
--------------------------------------------------------------------------------
(ISSUER'S TELEPHONE NUMBER)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes [X] No [_]
The number of shares of Common Stock, $.01 par value per share, outstanding as
of May 10, 2004 was 15,012,576.
Transitional Small Business Disclosure Format (check one): Yes [_] No [X]
================================================================================
NETWORK-1 SECURITY SOLUTIONS, INC.
INDEX
Page No.
PART I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
Condensed Balance Sheets as of March 31, 2004 (unaudited)
and December 31, 2003............................................... 3
Condensed Statements of Operations for the three months
ended March 31, 2004 and 2003 (unaudited)........................... 4
Condensed Statements of Cash Flows for the three months
ended March 31, 2004 and 2003 (unaudited)........................... 5
Notes to Condensed Financial Statements............................. 6
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION........... 10
Item 3. CONTROLS AND PROCEDURES............................................. 16
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................................... 16
Item 2. Changes in Securities and Small Business Issuer Purchases
of Equity Securities................................................ 17
Item 3. Defaults Upon Senior Securities..................................... 17
Item 4. Submission of Matters to a Vote of Security Holders................. 17
Item 5. Other Information................................................... 17
Item 6. Exhibits and Reports on Form 8-K.................................... 17
SIGNATURES................................................................... 18
2
NETWORK-1 SECURITY SOLUTIONS, INC.
CONDENSED BALANCE SHEETS
MARCH 31, DECEMBER 31,
2004 2003
============ ============
(UNAUDITED)
ASSETS
------
Current assets:
Cash and cash equivalents $ 660,000 $ 984,000
Prepaid expenses and other current assets 62,000 86,000
------------ ------------
Total current assets 722,000 1,070,000
Patents 97,000 99,000
------------ ------------
$ 819,000 $ 1,169,000
============ ============
LIABILITIES
-----------
Current liabilities:
Accounts payable $ 33,000 $ 78,000
Accrued expenses and other current liabilities 521,000 520,000
------------ ------------
Total current liabilities 554,000 598,000
------------ ------------
Liability to be settled with equity instrument 111,000 54,000
------------ ------------
Commitments and contingencies
STOCKHOLDERS' EQUITY
--------------------
Preferred stock - $0.01 par value, 10,000,000 shares authorized,
Series D - convertible, voting, authorized 1,250,000 shares;
231,054 shares issued and outstanding at March 31, 2004 and
December 31, 2003, liquidation preference of $705,000 at
March 31,2004 and December 31, 2003 2,000 2,000
Series E - convertible, authorized 3,500,000 shares; 2,483,508
shares issued and outstanding at March 31, 2004 and December
31, 2003, liquidation preference of $5,265,000 at March 31,
2004 and December 31, 2003
25,000 25,000
Common stock - $0.01 par value ; authorized 40,000,000 shares;
8,314,458 shares issued and outstanding at March 31, 2004 and
December 31, 2003 83,000 83,000
Additional paid-in capital 41,443,000 41,443,000
Accumulated deficit (41,399,000) (41,036,000)
------------ ------------
154,000 517,000
------------ ------------
$ 819,000 $ 1,169,000
============ ============
3
NETWORK-1 SECURITY SOLUTIONS, INC.
CONDENSED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED MARCH 31,
==============================
2004 2003
============ ============
Revenue:
Services $ -- $ 42,000
------------ ------------
Cost of revenue:
Cost of services -- 17,000
------------ ------------
Gross Profit -- 25,000
------------ ------------
Operating expenses:
General and administrative 364,000 305,000
------------ ------------
LOSS BEFORE INTEREST INCOME (364,000) (280,000)
Interest income - net 1,000 4,000
------------ ------------
Net loss $ (363,000) $ (276,000)
============ ============
LOSS PER COMMON SHARE - BASIC AND DILUTED $ (0.04) $ (0.03)
============ ============
WEIGHTED AVERAGE COMMON SHARES - BASIC AND DILUTED 8,314,458 8,314,458
============ ============
4
NETWORK-1 SECURITY SOLUTIONS, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(UNAUDITED)
THREE MONTHS ENDED MARCH 31,
==============================
2004 2003
============ ============
Cash flows from operating activities:
Net loss $ (363,000) $ (276,000)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 2,000 22,000
Security Deposits written off -- 8,000
Issuance of options and warrants for services rendered 57,000 (41,000)
Changes in:
Accounts receivable -- 6,000
Prepaid expenses and other current assets 24,000 29,000
Accounts payable, accrued expenses and other
current liabilities (44,000) (159,000)
Deferred revenue -- (42,000)
------------ ------------
Net cash used in operating activities (324,000) (453,000)
------------ ------------
NET DECREASE IN CASH AND CASH EQUIVALENTS (324,000) (453,000)
Cash and cash equivalents, beginning of period 984,000 2,029,000
------------ ------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 660,000 $ 1,576,000
============ ============
5
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
[1] BASIS OF PRESENTATION:
The accompanying condensed financial statements as of March 31, 2004 and
for the three month periods ended March 31, 2004 and March 31, 2003, 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,
2004, the results of its operations and its cash flows for the three
month periods ended March 31, 2004 and March 31, 2003. The condensed
financial statements included herein have been prepared in accordance
with the accounting principles generally accepted in the United States of
America for interim financial information and the instructions to Form
10-QSB. Accordingly, certain information and footnote disclosures
normally included in the financial statements prepared in accordance with
accounting principles generally accepted in the United States of America
have been omitted pursuant to such rules and regulations, although
management believes that the disclosures are adequate to make the
information presented not misleading. These financial statements should
be read in conjunction with the audited financial statements for the year
ended December 31, 2003 included in the Company's Annual Report on Form
10-KSB filed with the Securities and Exchange Commission. The results of
operations for the three months ended March 31, 2004 and 2003 are not
necessarily indicative of the results of operations to be expected for
the full year.
[2] BUSINESS:
The principal business of the Company is the acquisition, development,
licensing and protection of its intellectual property. The Company
presently owns six patents covering various telecommunications and data
networking technologies. The Company is pursuing licensing and strategic
business alliances with companies in the industries that manufacture and
sell products that make use of the technologies underlying its patents as
well as with other users of the technology who benefit directly from the
technology including corporate, educational and governmental entities.
On November 18, 2003, the Company acquired a portfolio of
telecommunications and data networking patents (the "Patent Portfolio")
from Merlot Communications, Inc., a broadband communications solutions
provider and a related party through common ownership. In February 2004,
following the acquisition of the Patent Portfolio and its review of
applicable markets, the Company commenced initial efforts to license its
patent (U.S. Patent No. 6,218,930) covering the remote delivery of power
over Ethernet cables (the "Remote Power Patent"). As of March 31, 2004,
the Company transmitted letters to approximately 80 companies offering
licenses to the Remote Power Patent. To date the Company has not entered
into any license agreements with third parties with respect to its Remote
Power Patent.
From June 1995 until December 2002, the Company developed, marketed,
licensed and supported a suite of security software products designed to
prevent unauthorized access to critical information residing on networked
servers, desktops and laptops. In May 2003, the
6
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
[2] BUSINESS (CONTINUED)
Company completed the sale of its security software technology and
related intellectual property to an unaffiliated foreign corporation for
an aggregate consideration of $415,000.
[3] GOING CONCERN:
The Company has incurred substantial net losses from operations during
2003. The Company as of March 31, 2004 has cash and cash equivalents of
$660,000 and currently is not generating revenues to support its
operations. The Company has been dependent upon capital raised through
private offerings of equity and debt to finance its business operations.
This raises substantial doubt about the Company's ability to continue as
a going concern.
The Company has not entered into any license arrangements as of March 31,
2004 with respect to its Patent Portfolio. Until the Company generates
positive cash flows from operations, of which there can be no assurance,
the Company plans to seek additional financing through the issuance of
debt and/or equity securities. The accompanying condensed financial
statements have been prepared assuming the Company will continue as a
going concern and do not include any adjustments that may result from the
outcome of this uncertainty.
[4] STOCK-BASED COMPENSATION:
The Company accounts for stock-based employee compensation under
Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock
Issued to Employees", and related interpretations. The Company has
adopted the disclosure-only provisions of Statement of Financial
Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based
Compensation" and SFAS No. 148, "Accounting for Stock-Based Compensation
- Transition and Disclosure", which was released in December 2002 as an
amendment of SFAS No. 123. The following table illustrates the effect on
net loss and loss per share if the fair value-based method had been
applied to all awards.
THREE MONTHS ENDED MARCH 31,
==============================
2004 2003
============ ============
Reported net loss attributable to common stockholders $ (363,000) $ (276,000)
Stock-based employee compensation expense included in
reported net loss, net of related tax effects -- --
Stock-based employee compensation determined under the
fair value-based method, net of related tax effects (11,000) (1,000)
------------ ------------
Pro forma net loss $ (374,000) $ (277,000)
============ ============
Loss per common share (basic and diluted):
As reported $ (0.04) $ (0.03)
============ ============
Pro forma $ (0.05) $ (0.03)
============ ============
7
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
[4] STOCK-BASED COMPENSATION (CONTINUED)
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,
---------------------------
2004 2003
---------- ----------
Risk-free interest rates 2.79% 2.98%
Expected option life in years 3.00 6.60
Expected stock price volatility 220.90% 112.00%
Expected dividend yield 0.00% 0.00%
[5] REVENUE RECOGNITION:
Service revenues consist of maintenance and training services. Annual
renewable maintenance fees are a separate component of each contract, and
are recognized ratably over the contract term. Revenue from advance
license fees are deferred until they are earned pursuant to the
agreements.
[6] LOSS PER SHARE:
Basic loss per share is calculated by dividing the net loss by the
weighted average number of outstanding common shares during the period.
Diluted per share data includes the dilutive effects of options, warrants
and convertible securities. Potential shares of 12,814,078 and 17,627,953
at March 31, 2004 and 2003 respectively, are anti-dilutive, and are not
included in the calculation of diluted loss per share. Such potential
common shares reflect options, warrants and convertible preferred stock.
[7] CASH EQUIVALENTS:
The Company places cash investments in high quality financial
institutions insured by the Federal Deposit Insurance Corporation
("FDIC"). At March 31, 2004, the Company maintained cash balance of
approximately $560,000 in excess of FDIC limits.
[8] 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.
NOTE B - LIABILITY TO BE SETTLED WITH EQUITY INSTRUMENTS
On April 18, 2002, in consideration of additional consulting and
financial advisory services, the Company issued to CMH Capital Management
Corp. ("CMH") an option to purchase 750,000 shares of the common stock at
an exercise price of $1.20 per share, which was the market price of the
Company's common stock on the date of issuance. Corey M.Horowitz,
Chairman and CEO of the Company, is the sole owner and officer of CMH.
The shares underlying the option shall vest over a three-year period in
equal amounts of 250,000 shares per year beginning April
8
18, 2003. In addition, the shares underlying the option shall vest in
full in the event of a "change of control" or in the event that the
closing price of the Company's common stock reaches a minimum of $3.50
per share for 20 consecutive trading days. These options are treated as
contingent options and valued utilizing the Black-Scholes option pricing
model at each balance sheet date. These options were originally priced in
the quarter ended June 30, 2002 at $416,000. Subsequently, these were
revalued to $55,000 at December 31,2002 and $14,000 at March 31,2003. On
April 18, 2003, 250,000 of these options, having a fair value of $5,000
as of that date, vested. Accordingly, $5,000 was reallocated to
additional paid-in capital by correspondingly reducing the liability. The
options to purchase the remaining 500,000 shares continue to be treated
as contingent options and valued utilizing the Black-Scholes option
pricing model at each balance sheet date. Subsequently, these unvested
options were revalued to $ 54,000 at December 31, 2003 and $111,000 at
March 31, 2004. Any increase/decrease in the valuation has been reflected
in general and administrative expenses at each balance sheet date.
NOTE C - LITIGATION
In March 2004, PowerDsine Inc. ("PowerDsine") commenced an action against
the Company in the United District Court, Southern District of New York,
seeking a declaratory judgment that the Company's patent (U.S. Patent No.
6,218,930) covering the remote delivery of power over Ethernet (the
"Remote Power Patent") is not infringed by PowerDsine and/or its
customers. PowerDsine further seeks an order permanently enjoining the
Company (i) from making any claims to any person or entity that
PowerDsine's products infringe the Remote Power Patent or contribute to
infringement of the patent, (ii) from interfering with or threatening to
interfere with the importation, sale, license or use of PowerDsine's
power over Ethernet components or products, and (iii) from instituting or
prosecuting any lawsuit or proceeding, placing at issue the right of
PowerDsine, its customers, licensees, successors, or assigns to import,
use or sell PowerDsine's power over Ethernet components or products. The
Company believes its Remote Power Patent is valid and has meritorious
defenses to the action. The Company intends to vigorously defend the
action and take whatever actions are necessary to protect its
intellectual property.
In January 2003, Murray P. Fish, former Chief Financial Officer and a
director of the Company, commenced a lawsuit against the Company in the
Commonwealth of Massachusetts, County of Essex, Superior Court, seeking
severance and bonus compensation and other benefits allegedly due him in
the aggregate amount of $190,000. In April 2004, the Company entered into
a settlement agreement with Mr. Fish pursuant to which the Company paid
Mr. Fish the sum of $55,000 in full settlement of all claims asserted by
him in the litigation. This settlement was reflected in the December 31,
2003 financial statements.
NOTE D - SUBSEQUENT EVENT
In April 2004, the Company entered into an exchange agreement with the
holders of the Company's Series E ("Series E") and Series D ("Series D")
convertible preferred stock to exchange 2,483,508 shares of Series E into
6,208,770 shares of common stock and 231,054 shares of Series D into
489,348 shares of common stock. As an inducement for agreeing to such
conversion, the holders of the Series E and Series D received 1.25 times
the number of shares of common stock that each preferred stockholder
would have otherwise received upon conversion. The holders of preferred
stock participating in the exchange included, among others, CMH
(1,084,935 of Series E shares), the wife of Corey M. Horowitz, Chairman
and CEO of the Company (35,377 of Series E shares) and other principal
stockholders of the Company (990,552 of Series E shares and 209,125 of
Series D shares).
9
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
THIS QUARTERLY REPORT ON FORM 10-QSB CONTAINS FORWARD-LOOKING STATEMENTS WITHIN
THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED (THE
"SECURITIES ACT"), AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS
AMENDED (THE "EXCHANGE ACT"). ACTUAL RESULTS, EVENTS AND CIRCUMSTANCES
(INCLUDING FUTURE PERFORMANCE, RESULTS AND TRENDS) COULD DIFFER MATERIALLY FROM
THOSE SET FORTH IN SUCH STATEMENTS DUE TO VARIOUS RISKS AND UNCERTAINTIES,
INCLUDING, BUT NOT LIMITED TO, THOSE DISCUSSED BEGINNING ON PAGES 12-15 OF THIS
QUARTERLY REPORT ON 10-QSB FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2004.
OVERVIEW
The principal business of the Company is the acquisition, development,
licensing and protection of its intellectual property. The Company presently
owns six patents covering various telecommunications and data networking
technologies. The Company is pursuing licensing and strategic business alliances
with companies in the industries that manufacture and sell products that make
use of the technologies underlying its patents as well as with other users of
the technology who benefit directly from the technology including corporate,
educational and governmental entities.
On November 18, 2003, the Company acquired a portfolio of
telecommunications and data networking patents (the "Patent Portfolio") from
Merlot Communications, Inc., a broadband communications solutions provider. In
February 2004, following the acquisition of the Patent Portfolio and its review
of applicable markets, the Company commenced initial efforts to license its
Patent Portfolio.
The Patent Portfolio consists of six patents issued by the U.S. Patent
Office that relate to various telecommunications and data networking
technologies and includes, among other things, patents covering the transmission
of audio, video and data over computer and telephony networks and the delivery
of power over Ethernet networks for the purpose of remotely powering network
devices. The consideration paid by the Company to Merlot Communications, Inc.
("Merlot") for the acquisition of the Patent Portfolio consisted of a cash
payment of $100,000 and contingent future payments equal to 20% of the net
income (as defined in the acquisition agreement) of the Company from the sale or
licensing of the Patent Portfolio after the Company achieves $4.0 million of net
income from each patent comprising the Patent Portfolio ("Net Profit Payments").
The Company has an option to terminate the Net Profit Payments, at any time
between January 1, 2007 through March 31, 2007, and from January 1 through March
31 of each year thereafter, by making payments to Merlot in an amount equal to
the greater of (i) two times the payment due for the twelve month period
following the notice of termination or (ii) $3.0 million plus 10% for each
additional year starting January 1, 2008. The Company has granted Merlot a
non-exclusive royalty free license for the term of each patent to use the patent
for the development, manufacture or sale of its own branded products to end
users. Wheatley Partners II, L.P. and its affiliates and related parties (the
"Wheatley Parties"), who are principal stockholders of the Company, owned a
majority of the outstanding voting stock of Merlot at the time of the Company's
acquisition of the Patent Portfolio. The Wheatley Parties did not participate in
the negotiation or the approval of the patent acquisition transaction by Merlot
or the Company.
As of the date of this Report, the Company has not entered into any
license arrangements with respect to the Patent Portfolio, although it is
pursuing such arrangements with third parties. The Company does not currently
have any revenue from operations. The success of the Company and its ability to
achieve revenue is largely dependent on its ability to consummate such licensing
arrangements with third parties.
10
To date the Company has incurred significant losses and at March 31,
2004, had an accumulated deficit of $(41,399,000). At March 31, 2004, the
Company had $660,000 of cash and cash equivalents. Management believes that
based on its current cash position, the Company has sufficient capital to fund
its operations until September 2004, although there is no assurance that the
Company will not have sufficient capital prior to such date. (See "Liquidity and
Capital Resources" at page 11 hereof).
Results of Operations:
THREE MONTHS ENDED MARCH 31, 2004 COMPARED TO THREE MONTHS ENDED MARCH 31, 2003
The Company had no revenues for the quarter ended March 31, 2004 compared to
revenues of $42,000 for the quarter ended March 31, 2003, which were related to
the amortization of deferred maintenance revenues from customers who, in earlier
periods, had elected to purchase maintenance and support contracts for the
Company's software product line which was discontinued in December 2002.
The Company did not incur any cost of revenues for the three months ended March
31, 2004 as compared to $17,000 for the three months ended March 31, 2003,
which was related to the cost of one employee who provided the support services
for former customers of the Company's software business. There was no gross
profit for the three months ended March 31, 2004 compared to a gross profit of
$25,000 for the three months ended March 31, 2003.
General and administrative expenses include management expenses, finance and
accounting and legal and other professional services provided to the Company.
General and administrative expenses increased by $59,000, from $305,000 for the
three months ended March 31, 2003 to $364,000 for the three months ended March
31, 2004. Expenses during the quarter ended March 31, 2004 include expenses
associated with the Company's business of developing, licensing and protection
of its intellectual property.
No provision for or benefit from federal, state or foreign income taxes was
recorded for three months ended March 31, 2004 and 2003 because the Company
incurred net operating losses and fully reserved its deferred tax assets as
their future realization could not be determined.
As a result of the foregoing, the Company had net loss of $363,000 for the three
months ended March 31, 2004 compared with a net loss of $276,000 for the three
months ended March 31, 2003.
Liquidity and Capital Resources
At March 31, 2004, the Company had $660,000 of cash and cash equivalents and
working capital of $168,000. Net cash used in operating activities was $324,000
during the three months March 31, 2004 compared to $453,000 during the three
months ended March 31, 2003. Net cash used in operating activities for the three
months ended March 31, 2004 was primarily attributable to the net loss of
$363,000, partially offset by a non-cash expense of $57,000 related to the
valuation of options and a decrease in accounts payable, accrued expenses and
other current liabilities of $44,000.
The Company's operating activities during the three months ended March 31, 2004
were financed primarily with the remaining funds raised in the 2001 financing of
$6,765,000 and $415,000 received from the sale of CyberwallPLUS software and
related intellectual property in May 2003. The Company does not currently have a
line of credit from a commercial bank or other institution.
11
The Company anticipates, based on currently proposed plans and assumptions,
relating to its operations that its cash balance of $660,000 as of March 31,
2004 will more likely than not be sufficient to satisfy the Company's operations
and capital requirements until September 2004. There can be no assurance,
however, that such funds will not be expended prior thereto. In the event the
Company's plans change, or its assumptions change, or prove to be inaccurate
(due to unanticipated expenses, difficulties, delays or otherwise), the Company
may have insufficient funds to support its operations prior to September 2004.
The Company is currently pursuing licensing opportunities for its patent,
however, to date the Company has not entered into any such licensing
arrangements. Since the Company does not anticipate material revenues from its
licensing business in the near term, the Company currently intends to make
efforts to raise capital during the second or third quarter of 2004. The Company
has no current arrangements with respect to any additional financing.
Consequently, there can be no assurance that any additional financing will be
available to the Company when needed, on commercially reasonable terms or at
all. The Company's inability to consummate licensing arrangements and derive
revenues therefrom on a timely basis or obtain additional financing when needed
would have a material adverse effect on the Company, requiring it to curtail or
cease operations. In addition, any equity financing may involve substantial
dilution to the then current stockholders of the Company.
RISK FACTORS THAT MAY AFFECT FUTURE RESULTS
The Company operates in a highly competitive environment that involves a
number of risks, some of which are beyond the Company's control. The following
discussion highlights the most material of the risks.
WE HAVE A HISTORY OF LOSSES, NO REVENUE FROM CURRENT OPERATIONS AND WE
MAY NOT BE ABLE TO CONTINUE OUR OPERATIONS IN THE FUTURE.
We have incurred substantial operating losses since our inception, which
has resulted in an accumulated deficit of $(41,399,000) as of March 31, 2004.
For the years ended December 31, 2003 and 2002, we incurred net losses of
$(614,000) and $(5,905,000), respectively. For the quarter ended March 31, 2004,
we incurred a net loss of ($363,000). We have financed our operations primarily
from the balance of funds from sales of equity and convertible debt securities
as well as the sale of our CyberWall PLUS security software technology in May
2003. Since December 2002, when we discontinued our offering of security
software products, we have not had material revenue from operations and for the
quarter ended March 31, 2004 we had no revenues from operations. We may not have
sufficient funds to continue our operations if we are unable to secure
additional financing or generate sufficient revenue from our new business of
licensing our telecommunications and data networking patents.
WE COULD BE REQUIRED TO STOP OPERATIONS IF WE ARE UNABLE TO DEVELOP OUR
TECHNOLOGY LICENSING BUSINESS OR RAISE CAPITAL WHEN NEEDED.
We anticipate, based on our currently proposed plans and assumptions
relating to our operations (including the timetable of, costs and expenses
associated with our continued operations), that our current cash position will
more likely than not be sufficient to satisfy our operations and capital
requirements until September 2004. There can be no assurance, however, that such
funds will not be expended prior thereto. In the event our plans change, or our
assumptions change or prove to be inaccurate (due to unanticipated expenses,
difficulties, delays or otherwise), we could have insufficient funds to support
our operations prior to September 2004. We are currently pursuing
12
licensing opportunities for our patented technologies. However, to date we have
not entered into any such licensing arrangements. In addition, even if we
consummate licensing arrangements, such agreements may not result in sufficient
cash to support our operations or achieve material revenues or profitability.
Since we do not anticipate material revenues from our licensing business in the
near term, we intend to make efforts to raise capital during the second or third
quarter of 2004 to continue to fund our operations. We have no current
arrangements with respect to any additional financing. Consequently, there can
be no assurance that any additional financing will be available to the Company
when needed, on commercially reasonable terms or at all. Our inability to
consummate licensing arrangements and derive revenues therefrom on a timely
basis or obtain additional financing when needed would have a material adverse
effect on the Company, requiring us to curtail or possibly cease our operations.
In addition, any additional equity financing may involve substantial dilution to
the interests of our then existing stockholders.
WE RECENTLY ENTERED A NEW LICENSING BUSINESS AND MAY NOT BE SUCCESSFUL.
In November 2003, we entered the technology licensing business as a
result of our acquisition of six patents relating to various telecommunications
and data networking technologies including, among others, patents covering the
transmission of audio, video and data over computer and telephony networks and
the delivery of remote power over Ethernet. Accordingly we have a very limited
history in the technology licensing business upon which an evaluation of our
prospects and future performance can be made. Our prospects must be considered
in light of the risks, expenses and difficulties frequently encountered in the
development, operation and expansion of a new business based on rapidly changing
technologies in a highly specialized and competitive market. We may not be able
to achieve revenues or profitable operations from our new licensing business.
OUR FUTURE SOURCE OF LICENSING REVENUE IS UNCERTAIN.
In February 2004, we initiated our first licensing efforts relating to
the technologies in our Remote Power Patent (U.S. Patent No. 6,212,930). To
date, we have not entered into any licensing agreements with third parties with
respect to our patented technologies. Our inability to consummate licensing
agreements and achieve revenue from our patented technologies would have a
material adverse effect on our operations and our ability to continue our
business. In addition, in the event we consummate license arrangements with
third parties, such arrangements are unlikely to produce a stable or predictable
stream of revenue in the foreseeable future. Furthermore, the success of our
licensing efforts may depend upon the strength of our intellectual property
rights.
WE FACE UNCERTAINTY AS TO THE OUTCOME OF LITIGATION WITH POWERDSINE.
On March 31, 2004, PowerDsine Inc. ("PowerDsine") commenced an action
against us in the United District Court, Southern District of New York (Civil
Action No. 04 CV 2502) seeking a declaratory judgment that our Remote Power
Patent (U.S. Patent No. 6,218,930) is invalid and is not infringed by PowerDsine
and/or its customers. PowerDsine further seeks an order permanently enjoining us
(i) from making any claims to any person or entity that PowerDsine's products
infringe the Remote Power Patent or contributes to infringement of the patent,
(ii) from interfering with or threatening to interfere with the importation,
sale, license or use of PowerDsine's PoE components or products, and (iii) from
instituting or prosecuting any lawsuit or proceeding placing at issue the right
of PowerDsine, its customers, licensees, successors, or assigns to import, use
or sell PowerDsine's PoE components or products. We believe our Remote Power
Patent is valid and that we have meritorious defenses to the action. We intend
to vigorously defend the action and take whatever actions are necessary to
protect our intellectual property. In the event, however, that the Court granted
the declaratory judgment and our patent was determined to be invalid, such a
determination would have a material adverse effect on us. Regardless of the
outcome, this litigation may subject us to significant costs and diversion of
management time.
13
WE FACE INTENSE COMPETITION AND WE MAY NOT BE ABLE TO SUCCESSFULLY
COMPETE.
The telecommunications and data networking licensing market is
characterized by intense competition and rapidly changing business conditions,
customer requirements and technologies. Our current and potential competitors
have longer operating histories, greater name recognition and possess
substantially greater financial, technical, marketing and other competitive
resources than us. Although we believe that we have rights to enforceable
patents relating to telecommunications and data networking, there can be no
assurance that third parties will not invalidate any or all of our patents. In
addition, our current and potential competitors may develop technologies that
may be more effective than our proprietary technologies or that render our
technologies less marketable or obsolete. We may not be able to compete
successfully.
OUR MARKETS ARE SUBJECT TO RAPID TECHNOLOGICAL CHANGE AND OUR
TECHNOLOGIES FACE POTENTIAL TECHNOLOGY OBSOLESCENCE.
The telecommunications and data networking technology market including,
transmission of audio, video and data over computer and telephony networks and
the delivery of remote power over Ethernet markets, are characterized by rapid
technological changes, changing customer requirements, frequent new product
introductions and enhancements, and evolving industry standards. The
introduction of products embodying new technologies and the emergence of new
industry standards may render our technologies obsolete or less marketable. To
the extent we are able to achieve revenue in the future, such revenue will be
derived from licensing our technologies based on existing and evolving industry
standards.
OUR SUCCESS IS DEPENDENT UPON OUR ABILITY TO PROTECT OUR PROPRIETARY
TECHNOLOGIES.
Our success is substantially dependent upon our proprietary technologies
and our ability to protect our intellectual property rights. We currently hold 6
patents issued by the U.S. Patent Office that relate to various
telecommunications and data networking technologies and include among other
things, patents covering the transmission of audio, voice and data over computer
and telephony networks and the delivery of remote PoE networks. We rely upon our
patents and trade secret laws, non-disclosure agreements with our employees,
consultants and third parties to protect our intellectual property rights. The
complexity of patent and trade secret law, and common law, combined with our
limited resources, create risk that our efforts to protect our proprietary
technologies may not be successful. We cannot assure you that our patents will
be upheld or that third parties will not invalidate our patent rights. In the
event our intellectual property rights are not upheld, such an event would have
a material adverse effect on our company. In addition, there is a risk that
third parties may independently develop substantially equivalent or superior
technologies.
14
ANY LITIGATION TO PROTECT OUR INTELLECTUAL PROPERTY OR ANY THIRD PARTY
CLAIMS OF INFRINGEMENT COULD INVOLVE SUBSTANTIAL TIME AND MONEY AND COULD HAVE A
MATERIAL ADVERSE EFFECT ON OUR BUSINESS.
Our success depends on our ability to protect our intellectual property
rights. Accordingly, we may be subject to third-party claims seeking to
invalidate our patents. These types of claims, with or without merit, may
subject us to costly litigation and diversion of management's focus. In
addition, based on our limited financial resources, we may not be able to pursue
litigation as aggressively as competitors with substantially greater financial
resources. If third parties making claims against us seeking to invalidate our
patent are successful, they may be able to obtain injunctive or other equitable
relief, which effectively could block our ability to license or otherwise
capitalize on our proprietary technologies. Successful litigation against us
resulting in a determination that our patents are invalid, would have a material
adverse effect on our company.
DEPENDENCE UPON CEO AND CHAIRMAN.
Our success will largely be dependent upon the personal efforts of Corey
M. Horowitz, Chairman and Chief Executive Officer and Chairman of the Board of
Directors. Mr. Horowitz does not currently have an employment agreement with the
Company and serves as an employee-at-will. The loss of the services of Mr.
Horowitz could have a material adverse effect on our business and prospects.
DELISTING OF OUR SECURITIES FROM NASDAQ; RISKS RELATING TO LOW-PRICED
STOCKS.
On March 26, 2003 our common stock was delisted from The Nasdaq Stock
Market's SmallCap Market. As a result of the delisting, an investor could find
it more difficult to dispose of or to obtain accurate quotations as to the
market value of our common stock. Our common stock currently trades on the
over-the-counter market in the "pink sheets."
In addition, since our common stock has been delisted from trading on
Nasdaq and the trading price of our common stock is below $5.00 per share, our
common stock is considered a penny stock. SEC regulations generally define a
penny stock to be an equity security that is not listed on Nasdaq or a national
securities exchange and that has a market value of less than $5.00 per share,
subject to certain exceptions. The SEC regulations would require broker-dealers
to deliver to a purchaser of our common stock a disclosure schedule explaining
the penny stock market and the risks associated with it. Various sales practice
requirements are also imposed on broker-dealers who sell penny stocks to persons
other than established customers and accredited investors (generally
institutions). Broker-dealers must also provide the customer with current bid
and offer quotations for the penny stock, the compensation of the broker-dealer
and monthly account statements disclosing recent price information for the penny
stock held in the customer's account. As a result of the delisting of our Common
Stock from Nasdaq, investors may find it more difficult to obtain timely and
accurate quotes and execute trades in our common stock.
THE SIGNIFICANT NUMBER OF OPTIONS AND WARRANTS OUTSTANDING MAY ADVERSELY
EFFECT THE MARKET PRICE FOR OUR COMMON STOCK.
As of March 31, 2004, there are outstanding (i) options and warrants to
purchase an aggregate of 5,841,860 shares of our common stock at exercise prices
ranging from $.12 to $10.13, and (ii) 727,630 additional shares of our common
stock which may be issued in the future under our stock option plan. To the
extent that outstanding options and warrants are exercised, your percentage
ownership will be diluted and any sales in the public market of the common stock
underlying such options may adversely affect prevailing market prices for our
common stock.
15
WE HAVE A SIGNIFICANT AMOUNT OF AUTHORIZED BUT UNISSUED PREFERRED STOCK,
WHICH MAY AFFECT THE LIKELIHOOD OF A CHANGE OF CONTROL IN OUR COMPANY.
Our Board of Directors has the authority, without further action by the
stockholders, to issue 10,000,000 shares of preferred stock on such terms and
with such rights, preferences and designations as our Board of Directors may
determine. Such terms may include restricting dividends on our common stock,
dilution of the voting power of our common stock or impairing the liquidation
rights of the holders of our common stock. Issuance of such preferred stock,
depending on the rights, preferences and designations thereof, may have the
effect of delaying, deterring or preventing a change in control. In addition,
certain "anti-takeover" provisions in Delaware law may restrict the ability of
our stockholders to authorize a merger, business combination or change of
control.
ITEM 3. CONTROLS AND PROCEDURES.
(a) Evaluation of Disclosure Controls and Procedures.
The Company's Chief Executive Officer and Chief Financial Officer have
reviewed the disclosure controls and procedures of the Company as of the end of
the period covered by this Quarterly Report on Form 10-QSB. Based upon this
review, these officers concluded that, as of the end of the period covered by
this Quarterly Report on Form 10-QSB, the Company's disclosure controls and
procedures are adequately designed to ensure that information required to be
disclosed by the Company in the reports it files or submits under Securities and
Exchange Act of 1934 is recorded, processed, summarized and reported, within the
time periods specified in applicable rules and forms.
(b) Changes in Internal Controls.
There were no significant changes in the Company's internal controls or
in other factors that could significantly affect these controls during the last
fiscal quarter included in this report or from the end of the reporting period
to the date of this Quarterly Report on Form 10-QSB.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
On March 31, 2004, PowerDsine Inc. commenced an action against the
Company in the United District Court, Southern District of New York (Civil
Action No. 04 CV 2502) seeking a declaratory judgment that the Company's Remote
Power Patent (U.S. Patent No. 6,218,930) is not infringed by PowerDsine and/or
its customers. PowerDsine further seeks an order permanently enjoining the
Company (i) from making any claims to any person or entity that PowerDsine's
products infringe the Remote Power Patent or contributes to infringement of the
patent, (ii) from interfering with or threatening to interfere with the
importation, sale, license or use of PowerDsine's PoE components or products,
and (iii) from instituting or prosecuting any lawsuit or proceeding placing at
issue the right of PowerDsine, its customers, licensees, successors, or assigns
to import, use or sell PowerDsine's PoE components or products. The Company
believes its Remote Power Patent is valid and has meritorious defenses to the
action. The Company intends to vigorously defend the action and take whatever
actions are necessary to protect it's intellectual property. In the event,
however, that the
16
Court granted the declaratory judgment and the patent was determined to be
invalid, such a determination would have a material adverse effect on the
Company.
In January 2003, Murray P. Fish, former Chief Financial Officer and a
director of the Company, commenced a lawsuit against the Company in the
Commonwealth of Massachusetts, County of Essex, Superior Court, seeking
severance and bonus compensation and other benefits allegedly due him in the
aggregate amount of $190,000. In April 2004, the Company entered into a
settlement agreement with Mr. Fish pursuant to which the Company paid Mr. Fish
the sum of $55,000 in full settlement of all claims asserted by him in the
litigation.
ITEM 2. CHANGES IN SECURITIES AND SMALL BUSINESS ISSUER PURCHASES OF EQUITY
SECURITIES.
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
ITEM 5. OTHER INFORMATION.
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
31.1 Controls and Procedure Certification of Chief Executive
Officer and Chief Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer and Chief
Financial Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
(b) Reports of Form 8-K
On February 9, 2004, the Company reported under Item 5 of Form 8-K
certain changes to its management team.
17
SIGNATURES
----------
In accordance with the requirements of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
NETWORK-1 SECURITY SOLUTIONS, INC.
By: /s/ Corey M. Horowitz
------------------------------------
Corey M. Horowitz
Chairman and Chief Executive Officer
Date: May 17, 2004
18