Pre-Effective Amendment to Registration of Securities — Form S-2
Filing Table of Contents
Document/Exhibit Description Pages Size
1: S-2/A Network-1 Security Solutions, Inc. Form 2-S/A 82 359K
3: COVER ¶ Comment-Response or Cover Letter to the SEC 3 5K
2: EX-23.1 Consent of Public Accounting Firm 1 5K
‘S-2/A’ — Network-1 Security Solutions, Inc. Form 2-S/A
Document Table of Contents
As filed with the Securities and Exchange Commission on November 23, 2005
REGISTRATION NO. 333-126013
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
AMENDMENT NO. 2
ON
FORM S-2
TO
FORM S-3
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
NETWORK-1 SECURITY SOLUTIONS, INC.
(Exact Name of Registrant as Specified in its Charter)
DELAWARE 11-3027591
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification number)
445 PARK AVENUE, SUITE 1028
NEW YORK, NEW YORK 10022
(212) 829-5700
(Address, including zip code, and telephone number, including area code,
of Registrant's principal executive offices)
COREY M. HOROWITZ
CHAIRMAN AND CHIEF EXECUTIVE OFFICER
445 PARK AVENUE, SUITE 1028
NEW YORK, NEW YORK 10022
(212) 829-5700
(Name, address, including zip code, and telephone number,
including area code, of agent for service)
COPIES TO:
SAM SCHWARTZ, ESQ.
EISEMAN LEVINE LEHRHAUPT & KAKOYIANNIS, P.C.
845 THIRD AVENUE
NEW YORK, NEW YORK 10022
(212) 752-1000
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO PUBLIC: From time to
time after the effective date of this Registration Statement.
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1993, check the following box: |X|
If the registrant elects to deliver its latest annual report to security
holders, or a complete or legible facsimile thereof, pursuant to Item 11(a)(1)
of this Form, check the following box |_|
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering: |_|
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering: |_|
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering |_|
If the delivery of the prospectus is expected to be made pursuant to Rule
434, check the following box: |_|
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CALCULATION OF REGISTRATION FEE
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PROPOSED MAXIMUM PROPOSED MAXIMUM AMOUNT OF
AMOUNT TO BE PER SHARE OFFERING AGGREGATE OFFERING REGISTRATION
TITLE OF EACH CLASS OF REGISTERED (2) PRICE (3) PRICE (3) FEE
SECURITIES TO BE REGISTERED
---------------------------------------------- -------------------- ---------------------- ------------------------ ----------------
Common Stock, par value $.01 per share 16,886,267(1) $.73 $12,326,975 $1,450.89
---------------------------------------------- -------------------- ---------------------- ------------------------ ----------------
Previously Paid $1,450.89
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Total Due $ 0
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(1) Includes the registration for resale of the following: (i) 2,685,000 shares
of common stock and 2,063,750 shares of common stock issuable upon exercise of
warrants issued in a private offering in December 2004 and January 2005, (ii)
8,471,679 shares of common stock, (iii) 1,352,152 shares of common stock
issuable upon exercise of warrants issued as part of a private offering in
December 1999 and (iv) 2,313,686 shares of common stock issuable upon exercise
of certain other outstanding warrants and options.
(2) Pursuant to Rule 416 promulgated under the Securities Act of 1933, as
amended, this Registration Statement includes an indeterminate number of
additional shares of common stock as from time to time become issuable upon the
exercise of certain warrants by reason of stock splits, stock dividends and
other similar transactions.
(3) Estimated solely for the purpose of calculating the registration fee
pursuant to Rule 457(c) under the Securities Act of 1933, as amended, and based
on the average of the bid and asked prices of the common stock on the OTC
Bulletin Board on June 15, 2005 in accordance with Rule 457(c) under the
Securities Act of 1933, as amended.
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE SECURITIES AND EXCHANGE COMMISSION, ACTING
PURSUANT TO SAID SECTION 8(A), MAY DETERMINE.
NETWORK-1 SECURITY SOLUTIONS, INC.
16,886,267 SHARES OF COMMON STOCK
o The selling stockholders listed on pages 16 to 20 of this Prospectus are
offering and selling up to 16,886,267 shares of our common stock.
o We will not receive any proceeds from the sale of these shares of common
stock. We will receive proceeds if warrants and options to purchase common
stock are exercised by payment of cash and those proceeds will be used for
our general corporate purposes.
o Our common stock is traded on the OTC Bulletin Board under the symbol
"NSSI.OB".
o On November 21, 2005, the closing price of our common stock, as reported on
the Over-the-Counter Bulletin Board, was $1.38 per share.
o This prospectus relates to the resale from time to time of:
o 2,685,000 shares of common stock and 2,063,750 shares of common stock
issuable upon exercise of warrants issued in our private offering in
December 2004 and January 2005;
o 8,471,679 shares of common stock owned by certain of our stockholders;
o 1,352,152 shares of common stock issuable upon the exercise of
outstanding warrants issued as part of our private offering in
December 1999; and
o 2,313,686 shares of common stock issuable upon exercise of certain
other warrants and options.
THE SECURITIES OFFERED IN THIS PROSPECTUS INVOLVE A HIGH DEGREE OF
RISK. YOU SHOULD CAREFULLY CONSIDER THE FACTORS DESCRIBED UNDER THE
HEADING "RISK FACTORS" BEGINNING ON PAGE 7 OF THIS PROSPECTUS.
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE
SECURITIES COMMISSION HAS APPROVED OR DISAPPROVED OF THESE
SECURITIES OR PASSED UPON THE ADEQUACY OR ACCURACY OF THIS
PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL
OFFENSE.
THE DATE OF THIS PROSPECTUS IS NOVEMBER _____, 2005
TABLE OF CONTENTS
PAGE
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PROSPECTUS SUMMARY.............................................................3
RISK FACTORS...................................................................7
WHERE YOU CAN FIND MORE INFORMATION...........................................12
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE...............................13
NOTE REGARDING FORWARD-LOOKING STATEMENTS.....................................14
USE OF PROCEEDS...............................................................15
SELLING STOCKHOLDERS..........................................................15
PLAN OF DISTRIBUTION..........................................................27
MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS......................30
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.....................32
BUSINESS......................................................................34
DIVIDEND POLICY...............................................................39
LEGAL MATTERS.................................................................39
EXPERTS.......................................................................39
DISCLOSURE OF COMMISSION POSITION.............................................40
INDEX TO FINANCIAL STATEMENTS................................................F-1
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PROSPECTUS SUMMARY
This summary represents a summary of all material terms of the offering and
only highlights the more detailed information that appears elsewhere, or is
incorporated by reference, in this prospectus. This prospectus may not contain
all the information important to you as an investor. Accordingly, you should
carefully read this entire prospectus together with all other information
incorporated by reference in this prospectus before deciding whether to invest
in our common stock, especially the risks of investing in our common stock
discussed under the caption "Risk Factors".
Unless the context otherwise requires, all references to "we," "us," "our,"
or the "Company" in this prospectus refer to Network-1 Security Solutions, Inc.,
a Delaware corporation.
THE COMPANY
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. Our strategy is to
pursue licensing and strategic business alliances with companies in industries
that manufacture and sell products that make use of the technologies underlying
our patents as well as with other users of the technologies who benefit directly
from the technologies including corporate, educational and governmental
entities.
On November 18, 2003, we acquired a portfolio of telecommunications and
data networking patents (the "Patent Portfolio") from Merlot Communications,
Inc., a broadband communications solutions provider. 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 (i) the control of power delivery over Ethernet
networks for the purpose of remotely powering network devices and (ii) systems
and methods for the transmission of audio, video and data over local area
networks ("LANs") in order to achieve higher quality of service.
Our future success is largely dependent upon our proprietary technologies,
our ability to protect our intellectual property rights and to enter into
license agreements for our technology. The complexity of patent and common law,
combined with our limited resources, create risk that our efforts to protect our
proprietary technologies may not be successful. We cannot be assured that our
patents will be upheld, or that third parties will not invalidate our patents.
In August 2005, we commenced litigation against D-Link Corporation and D-Link
Systems, Incorporated for infringement of our patent (U.S. Patent No. 6,218,930)
covering the control of power delivered over Ethernet cables (the "Remote Power
Patent") (See "Risk Factors - We face uncertainty as to the outcome of
litigation with D-Link").
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In February 2004, we initiated licensing efforts relating to our Remote
Power Patent. The Remote Power Patent application was filed on March 11, 1999
and the patent was granted by the U.S. Office of Patent and Trademark on April
17, 2001. The Remote Power Patent expires on March 7, 2020. The Remote Power
Patent relates to, among other things, several key technologies underlying the
IEEE 803.3af Power Over Ethernet standard that was approved on June 13, 2003 by
the Institute of Electrical and Electronic Engineers. This standard governs the
delivery of power over Ethernet cables in order to remotely power network
connected devices, including wireless switches, wireless access points, RFID
card readers, VOIP telephones, enterprise LAN switches and network cameras.
On November 30, 2004, we entered into a Master Services Agreement (the
"Agreement") with ThinkFire Services USA, Ltd. ("ThinkFire") pursuant to which
we granted ThinkFire the exclusive (except for our direct efforts) worldwide
rights to negotiate license agreements for our Remote Power Patent with respect
to certain potential licensees agreed to between the parties. We or ThinkFire
may terminate the Agreement upon 60 days notice for any reason, or upon 30 days
notice in the event of a material breach. We have agreed to pay ThinkFire a fee
not to exceed 20% of the royalty payments received from license agreements
consummated by ThinkFire on our behalf.
As of November 15, 2005, we transmitted letters to approximately 85
companies offering licenses to the Remote Power Patent. To date we have not
entered into any license agreements with third parties with respect to our
Remote Power Patent or any of our other patents.
We also own five (5) additional patents covering various methodologies that
provide for allocating bandwidth and establishing Quality of Service for delay
sensitive data, such as voice, on packet data networks. Quality of Service
issues become important when data networks carry packets that contain audio and
video which may require priority over data packets traveling over the same
network. Covered within these patents are also technologies that establish bi-
directional communications control channels between network-connected devices in
order to support advanced applications on traditional data networks. We believe
that potential licensees of the technologies contained in these patents would be
vendors deploying applications that require the low latency transport of delay
sensitive data such as video over data networks.
We were incorporated under the laws of the State of Delaware in July 1990.
Our executive offices are located at 445 Park Avenue, Suite 1028, New York, New
York 10022 and our telephone number at that address is (212) 829-5700. Our web
site can be found at http://www.network-1.com.
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RECENT DEVELOPMENTS
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 have agreed that we will
not initiate litigation against PowerDsine for its sale of Power over Ethernet
(PoE) integrated circuits. In addition, we have 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 action or litigation against us relating to the validity or
infringement, if any, by PowerDsine or its customers of the Remote Power Patent.
We also agreed that we will not initiate litigation against PowerDsine or its
customers for infringement of the Remote Power Patent arising from the
manufacture and sale of PowerDsine Midspan products for three years following
the dismissal date. Following such three year period, we may seek damages for
infringement of the Remote Power Patent from PowerDsine or its customers with
respect to the purchase and sale of Midspan products beginning 90 days following
the dismissal date of the litigation. The benefits afforded to PowerDsine and
its customers under the Settlement Agreement will cease in the event PowerDsine
institutes, assists or cooperates in any legal proceeding related to our Remote
Power Patent adverse to us (unless otherwise required by law to do so) and
PowerDsine customers will also forfeit benefits under the Settlement Agreement
if they engage in similar action.
No licenses to use the technologies covered by the 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 the Remote Power Patent has been provided to
PowerDsine's customers and that in order to combine, modify or integrate any
PowerDsine product with or into any other device or software, PowerDsine's
customers may need to receive patent license(s) for such third party patents
which is the customer's responsibility. (For the full text of our Settlement
Agreement with PowerDsine, see Exhibit 10.1 of our Current Report on Form 8-K
filed with the Securities and Exchange Commission on November 17, 2005).
D-LINK LITIGATION
On August 10, 2005, we commenced patent litigation against D-Link
Corporation and D-Link Systems, Incorporated in the United States District Court
for the Eastern District of Texas, Tyler division (Civil Action No. 6:05W291),
for infringement of our Remote Power Patent. Our complaint seeks, among other
things, a judgment that our Remote Power Patent is enforceable and has been
infringed by the defendants. We also seek a permanent injunction restraining the
defendants from continued infringement, or active inducement of infringement by
others, of our Remote Power Patent. In the event the Court determines that our
Remote Power Patent was not valid or enforceable, and/or that the defendants did
not infringe any such determination would have a material adverse effect on us.
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POWER UP LICENSING PROGRAM
On September 8, 2005, we commenced our Power Up licensing program for our
Remote Power Patent. Beginning September 8, 2005, and continuing through
December 31, 2005 subject to extension, vendors of Power over Ethernet power
sourcing equipment (PSE) and powered devices (PD) may license the Remote Power
Patent at a substantial discount from our standard reasonable and
non-discriminatory royalty rates and a discount from standard license
origination fees. Upon completion of the Power Up program, we will only offer
licenses on our standard terms and conditions, which will include higher royalty
rates and full license origination fees.
BLANK ROME AGREEMENT
In August 2005, we entered into an agreement with Blank Rome, LLP ("Blank
Rome"), a national law firm, pursuant to which Blank Rome has been engaged to
represent us in connection with all litigation involving our Remote Power
Patent. Blank Rome has agreed to represent us with respect to each litigation
pertaining to the Remote Power Patent on a full contingency basis (except for
any proceeding before the International Trade Commission). As compensation for
its services on a full contingency basis, Blank Rome will receive from us
percentages of Net Consideration (as defined in the Agreement) ranging from
12.5% to 35% of the amount received by us by way of settlement or judgment in
connection with each litigation matter. We have also agreed to compensate Blank
Rome in an amount equal to 10% of the Net Consideration received by us from
certain designated parties mutually agreed upon by us and Blank Rome in the
event such designated parties enter into license agreements or similar
agreements with us. (For the full text of our agreement with Blank Rome, see
Exhibit 10.1 to our Current Report on Form 8-K filed with the Securities and
Exchange Commission on August 11, 2005).
SHARES BEING OFFERED
This prospectus relates to the offering by the selling shareholders of an
aggregate of 16,886,267 shares of our common stock, consisting of (i) 2,685,000
shares of our common stock and 2,063,750 shares of our common stock issuable
upon exercise of warrants issued in our private offering in December 2004 and
January 2005, (ii) 8,471,679 shares of common stock owned by certain of our
stockholders, (iii) 1,352,152 shares of our common stock issuable upon exercise
of warrants issued to such selling stockholders as part of our private offering
in December 1999 and (iv) 2,313,686 shares of our common stock issuable upon
exercise of certain other outstanding warrants and options.
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RISK FACTORS
AN INVESTMENT IN OUR COMMON STOCK INVOLVES A HIGH DEGREE OF RISK. THE RISK
FACTORS LISTED BELOW ARE THOSE THAT WE CONSIDER TO BE MATERIAL TO AN INVESTMENT
IN OUR COMMON STOCK AND THOSE WHICH, IF REALIZED, COULD HAVE MATERIAL ADVERSE
EFFECTS ON OUR BUSINESS, FINANCIAL CONDITION OR RESULTS OF OPERATIONS AS
SPECIFICALLY DISCUSSED BELOW. IN SUCH AN EVENT, THE TRADING PRICE OF OUR COMMON
STOCK COULD DECLINE, AND YOU COULD LOSE ALL OR PART OF YOUR INVESTMENT. BEFORE
YOU INVEST IN OUR COMMON STOCK, YOU SHOULD BE AWARE OF VARIOUS RISKS, INCLUDING
THOSE DESCRIBED BELOW. YOU SHOULD CAREFULLY CONSIDER THESE RISK FACTORS,
TOGETHER WITH ALL OF THE OTHER INFORMATION INCLUDED OR INCORPORATED BY REFERENCE
IN THIS PROSPECTUS, BEFORE YOU DECIDE WHETHER TO PURCHASE OUR COMMON STOCK. THIS
SECTION INCLUDES OR REFERS TO CERTAIN FORWARD-LOOKING STATEMENTS. YOU SHOULD
REFER TO THE EXPLANATION OF THE QUALIFICATIONS AND LIMITATIONS ON SUCH
FORWARD-LOOKING STATEMENTS DISCUSSED ON PAGE 14.
WE HAVE A HISTORY OF LOSSES AND NO REVENUE FROM CURRENT OPERATIONS.
We have incurred substantial operating losses since our inception, which
has resulted in an accumulated deficit of $(44,269,000) as of September 30,
2005. For the years ended December 31, 2004 and 2003, we incurred net losses of
$(1,953,000) and $(614,000), respectively. For the nine months ended September
30, 2005, we incurred a net loss of $(1,280,000). We have financed our
operations primarily by sales of equity securities. Since December 2002, when we
discontinued our security software products and following the commencement of
our new technology licensing business in November 2003, we have had no revenue
from operations and for the year ended December 31, 2004 and for the nine months
ended September 30, 2005 we had no revenue from operations. Our ability to
achieve revenue and generate positive cash flow from operations is dependent
upon consummating licensing agreements with respect to our patented technology.
We may not be successful in achieving licensing agreements with third parties
and our failure to do so would have a material adverse effect on our business,
financial condition and results of operations. We may not be able to achieve
revenue or generate positive cash flow from operations from our new licensing
business.
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 cash position of
approximately 1,257,000 at September 30, 2005 will more likely than not be
sufficient to satisfy our operations and capital requirements until September
2006. However, we may expend our funds 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 2006. Our
inability to obtain additional financing when needed, absent generating
sufficient cash from licensing arrangements, would have a material adverse
effect on the Company, requiring us to curtail or possibly cease our operations.
In addition, any
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additional equity financing may involve substantial dilution to the interests of
our then existing stockholders.
OUR NEW LICENSING BUSINESS MAY NOT BE SUCCESSFUL.
In November 2003, we entered the technology licensing business following
our acquisition of six patents relating to various telecommunications and data
networking technologies including, among others, patents covering the delivery
of remote power over Ethernet and the transmission of audio, video and data over
computer and telephony networks. 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 patented technologies in a
highly specialized and competitive market. We may not be able to achieve revenue
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. 6,218,930) (the "Remote
Power Patent"). To date, we have not entered into any licensing agreements with
third parties with respect to our Remote Power Patent or our other 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 not likely to produce a stable or predictable stream of revenue in the
foreseeable future. Furthermore, the success of our licensing efforts depends
upon the strength of our intellectual property rights.
WE ARE CURRENTLY RELYING UPON THE EFFORTS OF THINKFIRE TO CONSUMMATE LICENSING
AGREEMENTS FOR OUR REMOTE POWER PATENT WITH CERTAIN SELECT POTENTIAL LICENSEES.
On November 30, 2004, we entered into a Master Services Agreement (the
"Agreement") with ThinkFire Services USA, Ltd. ("ThinkFire") pursuant to which
we granted ThinkFire the exclusive (except for us and related companies)
worldwide rights to negotiate license agreements for the Remote Power Patent
with respect to certain potential licensees agreed to between the parties.
Either we 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. We have agreed
to pay ThinkFire a fee not to exceed 20% of the royalty payments received from
license agreements consummated by ThinkFire on our behalf. ThinkFire may not be
successful in consummating license agreements on our behalf and even if such
agreements are consummated they may not result in significant royalty payments
to us.
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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 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 us.
WE ARE CURRENTLY RELYING UPON OUR CONTINGENCY FEE AGREEMENT WITH BLANK ROME.
In August 2005, we entered into an agreement with Blank Rome, LLP ("Blank
Rome"), a national law firm, pursuant to which Blank Rome has been engaged to
represent us in connection with all litigation involving our Remote Power
Patent. Blank Rome has agreed to represent us with respect to each litigation
pertaining to the Remote Power Patent on a full contingency basis (except for
any proceeding before the International Trade Commission). As compensation for
its services on a full contingency basis, Blank Rome will receive from us
percentages of Net Consideration (as defined in the Agreement) ranging from
12.5% to 35% received by us by way of settlement or judgment in connection with
each litigation matter. We have also agreed to compensate Blank Rome in an
amount equal to 10% of the Net Consideration received by us from certain
designated parties mutually agreed upon by us and Blank Rome in the event such
designated parties enter into license agreements or similar agreements with us.
The Agreement may be terminated by either Blank Rome or us upon 30 days notice.
If we elect to terminate the Agreement, we will compensate Blank Rome in an
amount equal to 5% of the Net Consideration received by us from the Designated
Parties with whom Blank Rome has not commenced litigation on our behalf,
provided that such parties had substantive licensing or settlement discussions
related to our Remote Power Patent during the term of the Agreement and entered
into a license agreement or similar agreement with us providing for Net
Consideration within the 12 month period following termination. In addition, in
the event of termination, Blank Rome will receive its pro-rata share of Net
Consideration based upon its hourly time charges with respect to parties against
whom Blank Rome commenced litigation (or defended) on our behalf. In the event
our agreement with Blank Rome is terminated, depending upon our financial
resources at the time, we may need to enter into a contingent fee agreement with
a new law firm in order to enforce and/or defend our Remote Power Patent and our
inability to secure such an arrangement on satisfactory terms and on a timely
basis may have a material adverse effect on us.
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ANY LITIGATION TO PROTECT OUR INTELLECTUAL PROPERTY OR ANY THIRD PARTY CLAIMS TO
INVALIDATE OUR PATENTS COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS.
Our success depends on our ability to protect our intellectual property
rights. In August 2005, we commenced patent litigation against D-Link
Corporation and D-Link Systems, Incorporated for infringement of our Remote
Power Patent (See "Risk Factors - Uncertainty of outcome of D-Link Litigation").
In the future, it may be necessary for us to commence patent litigation against
additional third parties whom we believe require a license to our patents. In
addition, we may be subject to claims seeking to invalidate our patents, which
will likely be asserted by D-Link as a defense in the pending litigation (see
Risk Factors - "We face uncertainty as to the outcome of litigation with
D-Link"). These types of claims, with or without merit, may subject us to costly
litigation and diversion of management's focus. If we are unsuccessful in
enforcing and validating our patents and/or if third parties making claims
against us seeking to invalidate our patents 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 us.
WE FACE UNCERTAINTY AS TO THE OUTCOME OF LITIGATION WITH D-LINK.
On August 10, 2005, we commenced litigation against D-Link Corporation and
D-Link Systems, Incorporated in the United States District Court for the Eastern
District of Texas, Tyler division (Civil Action No. 6:05W291), for infringement
of our Remote Power Patent. Our complaint seeks, among other things, a judgment
that our Remote Power Patent is duly enforceable and has been infringed by the
defendants. We also seek a permanent injunction restraining defendants from
continued infringement, or active inducement of infringement by others, of our
Remote Power Patent. In the event that the Court determines that our Remote
Power Patent was not valid or enforceable, and/or that the defendants did not
infringe, any such determination would have a material adverse effect on us.
MATERIAL LICENSING REVENUES FROM OUR REMOTE POWER PATENT MAY BE DEPENDENT UPON
THE APPLICABILITY OF THE IEEE STANDARD.
The Institute of Electrical and Electronic Engineers ("IEEE") is a
non-profit, technical professional association of more than 360,000 individual
members in approximately 175 countries. The Standards Association of the IEEE is
responsible for the creation of global industry standards for a broad range of
technology industries. In 1999, the IEEE formed a task force to facilitate the
adoption of a standardized methodology for the delivery of remote power over
Ethernet networks which would insure interoperability among vendors of switches
and terminal devices. In June 2003, the IEEE Standards Association approved the
802.3af Power Over Ethernet standard (the "Standard"), which covers technologies
deployed in delivering power over Ethernet cables including whether deployed in
switches or as standalone midspan hubs, both of which provide power to remote
devices including wireless access points, IP phones and network based cameras.
The technology is commonly referred to as Power Over Ethernet ("PoE"). We
believe our Remote Power Patent covers several of the key
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technologies covered by the Standard. However, there is a risk that as a result
of litigation a court may determine otherwise and such a determination would
have a material adverse effect on our ability to enter into license agreements
and achieve revenue and profits from our Remote Power Patent.
WE FACE INTENSE COMPETITION AND WE MAY NOT BE ABLE TO SUCCESSFULLY COMPETE.
The telecommunications and data networking 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, the
telecommunications and data networking industries may develop technologies that
may be more effective than our proprietary technologies or that render our
technologies less marketable or obsolete.
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.
DEPENDENCE UPON CEO AND CHAIRMAN.
Our success is largely dependent upon the personal efforts of Corey M.
Horowitz, our Chairman and Chief Executive Officer and Chairman of the Board of
Directors. On November 26, 2004, we entered into a two (2) year employment
agreement with Mr. Horowitz pursuant to which he continues to serve as our
Chairman and Chief Executive Officer. We do not maintain key man life insurance
on the life of Mr. Horowitz. The loss of the services of Mr. Horowitz would have
a material adverse effect on our business and prospects.
RISKS RELATED TO LOW PRICED STOCKS.
Our common stock currently trades on the OTC Bulletin Board under the
symbol NSSI.OB. Since the trading price of our common stock is below $5.00 per
share, our common stock is considered a penny stock. SEC regulations generally
define a penny stock to be an equity security that is not listed on Nasdaq or a
national securities exchange and that has a market value of less than $5.00 per
share,
11
subject to certain exceptions. SEC regulations 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.
THE SIGNIFICANT NUMBER OF OPTIONS AND WARRANTS OUTSTANDING MAY ADVERSELY AFFECT
THE MARKET PRICE FOR OUR COMMON STOCK.
As of September 30, 2005, there are outstanding (i) options and warrants to
purchase an aggregate of 11,267,244 shares of our common stock at exercise
prices ranging from $.12 to $10.13, and (ii) 7,630 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, stockholder
percentage ownership will be diluted and any sales in the public market of the
common stock underlying such options may adversely affect prevailing market
prices for our common stock.
WE HAVE A SIGNIFICANT AMOUNT OF AUTHORIZED BUT UNISSUED PREFERRED STOCK, WHICH
MAY AFFECT THE LIKELIHOOD OF A CHANGE OF CONTROL IN OUR COMPANY.
Our Board of Directors has the authority, without further action by the
stockholders, to issue 10,000,000 shares of preferred stock on such terms and
with such rights, preferences and designations as our Board of Directors may
determine. Such terms may include restricting dividends on our common stock,
dilution of the voting power of our common stock or impairing the liquidation
rights of the holders of our common stock. Issuance of such preferred stock,
depending on the rights, preferences and designations thereof, may have the
effect of delaying, deterring or preventing a change in control. In addition,
certain "anti-takeover" provisions in Delaware law may restrict the ability of
our stockholders to authorize a merger, business combination or change of
control.
WHERE YOU CAN FIND MORE INFORMATION
We file annual, quarterly and current reports, proxy statements and other
information with the SEC. You may read and copy any document we file at the
SEC's Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549.
The SEC has prescribed rates for copying. You may obtain information on the
operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. Our
SEC filings are also available to you on the SEC's Internet site at
http://www.sec.gov.
This prospectus is part of a Registration Statement on Form S-2 filed by us
with the SEC under the Securities Act and therefore omits certain information in
the Registration Statement. We have also filed exhibits with the Registration
Statement that are not included in this prospectus, and you should refer to the
applicable exhibit for a complete description of any statement referring to
12
any document. You can inspect a copy of the Registration Statement and its
exhibits, without charge, at the SEC's Public Reference Room, and can copy such
material upon paying the SEC's prescribed rates.
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE
The SEC allows us to incorporate by reference the information we file with
them, which means that we can disclose important information to you by referring
you to those documents. The information we incorporate by reference is
considered to be part of this prospectus. You must look at each of the filings
with the Securities and Exchange Commission that have been incorporated by
reference to determine if any of the statements in another document incorporated
by reference have been modified or superseded. Accordingly, we incorporate by
reference the documents listed below:
1. our Annual Report on Form 10-KSB/A (Amendment No. 2) for the year
ended December 31, 2004 (filed November 23, 2005);
2. our Current Report on Form 8-K (filed January 20, 2005);
3. our Current Report on Form 8-K/A (filed January 24, 2005);
4. our Quarterly Report on Form 10-QSB for the three months ended March
31, 2005 (filed May 16, 2005);
5. our Quarterly Report on Form 10-QSB/A for the three months ended March
31, 2005 (filed June 14, 2005);
6. our Quarterly Report on Form 10-QSB/A for the three months ended June
30, 2005 (filed November 18, 2005);
7. our Current Report on Form 8-K (filed August 9, 2005);
8. our Current Report on Form 8-K (filed August 11, 2005);
9. our Current Report on Form 8-K (filed August 11, 2005);
10. our Quarterly Report on Form 10-QSB/A for the three months ended March
31, 2005 (filed August 17, 2005);
11. our Current Report on Form 8-K (filed September 22, 2005);
12. our Quarterly Report on Form 10-QSB for the three months ended
September 30, 2005 (filed November 15, 2005);
13. our Current Report on Form 8-K (filed November 15, 2005);
13
14. our Current Report on Form 8-K (filed November 17, 2005);
15. the description of our common stock incorporated by reference in our
Registration Statement on Form 8-A (filed October 9, 1998), as amended
on November 3, 1998.
We will provide at no cost to each person, including any beneficial owner,
to whom this prospectus is delivered, upon written or oral request, a copy of
any of these filings including any and all information that has been
incorporated by reference in this Prospectus. You should direct such requests to
us at 445 Park Avenue, Suite 1028, New York, New York 10022, attention: Corey M.
Horowitz, Chairman and Chief Executive Officer, telephone number (212) 829-5700.
You should rely only on the information and representations provided in
this prospectus or on the information incorporated by reference in this
prospectus. Neither we nor the selling stockholders have authorized anyone to
provide you with different information. Neither we nor the selling stockholders
are making an offer of these securities in any state where the offer is not
permitted. You should not assume that the information in this prospectus is
accurate as of any date other than the date on the front of this document.
NOTE REGARDING FORWARD-LOOKING STATEMENTS
This prospectus contains certain forward-looking statements that are
statements that include information based upon beliefs of our management, as
well as assumptions made by and information available to our management.
Statements containing terms such as "believes," "expects," "anticipates,"
"intends" or similar words are intended to identify forward-looking statements.
Our management, based upon assumptions they consider reasonable, has
compiled these forward-looking statements. Such statements reflect our current
views with respect to future events. These statements involve known and unknown
risks and uncertainties that may cause our actual results in future periods to
differ materially from what is currently anticipated. We make cautionary
statements in certain sections of this prospectus, including under "Risk
Factors." You should read these cautionary statements as being applicable to all
related forward-looking statements wherever they appear in this prospectus, the
materials referred to in this prospectus or the materials incorporated by
reference into this prospectus.
You are cautioned that no forward-looking statement is a guarantee of
future performance and you should not place undue reliance on any
forward-looking statement. Such statements speak only as of the date of this
prospectus and we are not undertaking any obligation to publicly release any
revisions to these forward-looking statements to reflect events or circumstances
after the date of this prospectus or to reflect the occurrence of unanticipated
events.
14
USE OF PROCEEDS
We will not receive any proceeds from the sale of the shares of our common
stock by the selling stockholders. All proceeds from the sale of such shares
will be for the accounts of the selling stockholders. We will receive
approximately $8,119,119 in proceeds, equal to the aggregate exercise price of
all warrants and options to purchase an aggregate of 5,729,588 shares of our
common stock, if the holders of all of the warrants and options referenced in
this prospectus exercise such securities into shares of our common stock for
cash. Warrants to purchase 550,000 shares of our common stock at an aggregate
exercise price of $580,000 may be exercised on a cashless basis (by payment of
the exercise price in shares rather than a cash payment). Any cash proceeds that
we may receive upon exercise of the warrants and options will be used for
working capital purposes.
SELLING STOCKHOLDERS
The following table sets forth information, as of November 15, 2005, with
respect to the common stock beneficially owned by each selling stockholder. The
selling stockholders are not obligated to sell any of the shares offered by this
prospectus. The number of shares sold by each selling stockholder may depend on
a number of factors, such as the market price of our common stock.
We are registering 16,886,267 shares of our common stock for resale by the
selling stockholders. We agreed to file a registration statement under the
Securities Act of 1933, as amended (the "Securities Act") with the Securities
and Exchange Commission, of which this prospectus is a part, with respect to the
resale of:
o 2,685,000 shares of our common stock and 2,063,750 shares of our
common stock issuable upon exercise of warrants issued in our private
offering completed in December 2004 and January 2005;
o 8,471,679 additional shares of our common stock issued to certain of
our stockholders;
o 1,352,152 shares of our common stock issuable upon the exercise of
warrants issued as part of our private offering completed in December
1999; and
o 2,313,686 shares of our common stock issuable upon exercise of certain
other outstanding warrants and options, all as disclosed in the table
below.
The number of shares of our common stock shown in the following table as
being offered by the selling stockholders do not include such presently
indeterminate number of additional shares of our common stock that may be
issuable as a result of stock splits, stock dividends and similar transactions.
Pursuant to Rule 416 under the Securities Act, however, such shares are included
in the Registration Statement of which this prospectus is a part.
15
The selling stockholders may sell any or all of their shares listed below
from time to time. Accordingly, we cannot estimate how many shares the selling
stockholders will own upon consummation of any such sales. Also, the selling
stockholders may have sold, transferred or otherwise disposed of all or a
portion of their shares since the date on which the information was provided in
transactions exempt from the registration requirements of the Securities Act.
Of the selling stockholders listed in the table below, Singer Opportunity
Fund, L.P., Singer Fund, L.P., Hilary Bergman, Steven Goldfarb, William Walters,
Jack Erlanger, Patrick McBrien, Scott Zelnick and Steven Heineman are believed
by us to be affiliates of broker-dealers, who purchased the shares in the
ordinary course of business and at the time of the purchase of the securities to
be resold, such selling stockholders did not have any agreements or
understandings, directly or indirectly, with any person to distribute the
securities.
None of the selling stockholders has had a material relationship
with us within the past three years other than as a result of the ownership of
our securities except: (i) Corey M. Horowitz is our Chairman and Chief Executive
Officer, (ii) Mr. Horowitz, Robert Graifman and Laurent Ohana serve as our
directors, (iii) Sam Schwartz, as a partner in the law firms of Eiseman Levine
Lehrhaupt & Kakoyiannis, P.C. and Olshan Grundman Frome Rosenzweig & Wolosky
LLP, has rendered legal services to us, and (iv) CHM Capital Management Corp.,
the sole shareholder, director and officer of which is Mr. Horowitz, performed
consulting services for us prior to Mr. Horowitz becoming our Chairman and Chief
Executive Officer in December 2003.
[Enlarge/Download Table]
NUMBER OF
SHARES NUMBER OF PERCENTAGE OF
BENEFICIALLY NUMBER OF SHARES OUTSTANDING
OWNED PRIOR SHARES BENEFICIALLY COMMON
TO BEING OWNED AFTER STOCK AFTER
NAME OFFERING(1) OFFERED OFFERING(1)(2) OFFERING(1)
----- ----------- ------- -------------- -----------
Barry Rubenstein 3,792,915(3) 3,745,415 47,500 *
Irwin Lieber 2,098,002(4) 2,050,502 47,500 *
Barry Fingerhut 2,008,598(5) 2,008,598 0 0%
Seth Lieber 1,632,300(6) 1,632,300 0 0%
Jonathan Lieber 1,630,748(7) 1,630,748 0 0%
Wheatley Partners II, L.P. 1,280,207(8) 1,280,207 0 0%
Wheatley Partners, L.P. 194,280(9) 194,280 0 0%
Wheatley Foreign Partners, L.P. 16,868(9) 16,868 0 0%
Woodland Venture Fund 829,226(10) 829,226 0 0%
Seneca Ventures 619,983(10) 619,983 0 0%
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[Enlarge/Download Table]
NUMBER OF
SHARES NUMBER OF PERCENTAGE OF
BENEFICIALLY NUMBER OF SHARES OUTSTANDING
OWNED PRIOR SHARES BENEFICIALLY COMMON
TO BEING OWNED AFTER STOCK AFTER
NAME OFFERING(1) OFFERED OFFERING(1)(2) OFFERING(1)
----- ----------- ------- -------------- -----------
Woodland Partners 309,316(10) 309,316 0 0%
Brookwood Partners, L.P. 294,810(10) 294,810 0 0%
Marilyn Rubenstein 1,049 1,049 0 0%
Corey M. Horowitz 8,969,446(11) 4,746,365 4,223,081 19.3%
CMH Capital Management Corp. 4,167,800(12) 4,167,800 0 0%
Donna Slavitt 67,471 67,471 0 0%
Logan Zev Horowitz 1999 Trust 15,000(13) 15,000 0 0%
Dylan Max Horowitz 1999 Trust 15,000(13) 15,000 0 0%
Corey M. Horowitz Custodian for
Zachary Jordon Horowitz 15,000(13) 15,000 0 0%
Horowitz Partners 2,291(14) 2,291 0 0%
FalconStor Software, Inc. 650,000(15) 650,000 0 0%
Emigrant Capital Corporation 1,312,500(16) 1,312,500 0 0%
Singer Opportunity Fund, L.P. 784,125(17) 625,625 158,500 *
Singer Fund, L.P. 282,355(18) 249,375 32,980 *
David M. Seldin 474,000(19) 455,000 19,000 *
Robert Graifman 279,777(20) 175,000 104,777 *
Gilbert S. Stein 175,000(21) 175,000 0 0%
John R. Hart 175,000(22) 175,000 0 0%
Granite Bridge Fund, L.P. 131,250(23) 131,250 0 0%
CGA Resources, LLC 87,500(24) 87,500 0 0%
Barry S. Friedberg 87,500(25) 87,500 0 0%
Dasa Sada, LLC 87,500(26) 87,500 0 0%
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[Enlarge/Download Table]
NUMBER OF
SHARES NUMBER OF PERCENTAGE OF
BENEFICIALLY NUMBER OF SHARES OUTSTANDING
OWNED PRIOR SHARES BENEFICIALLY COMMON
TO BEING OWNED AFTER STOCK AFTER
NAME OFFERING(1) OFFERED OFFERING(1)(2) OFFERING(1)
----- ----------- ------- -------------- -----------
Steven Ackerman 87,500(27) 87,500 0 0%
Francis May 43,750(28) 43,750 0 0%
Matthew Balk 17,500(29) 17,500 0 0%
Kenneth L. Walters 17,500(30) 17,500 0 0%
Jeb Investment Ltd. 175,450(31) 166,250 9,200 *
Jeb Partners, L.P. 175,050(32) 166,250 8,800 *
Manchester Explorer Limited Partnership 115,200(33) 105,000 10,200 *
Steven Heineman 175,000(34) 175,000 0 0%
Brian Eng 112,500(35) 87,500 25,000 *
Brad Reifler 13,125(36) 13,125 0 0%
Steven Goldfarb 8,750(37) 8,750 0 0%
Hilary Bergman 13,125(38) 13,125 0 0%
Samuel Solomon 17,500(39) 17,500 0 0%
Jeffrey Finkle 105,000(40) 105,000 0 0%
Edward Sussi 35,000(41) 35,000 0 0%
Alan Friedman 35,000(42) 35,000 0 0%
Alan Weiner 43,750(43) 43,750 0 0%
Laurent Ohana 50,000(44) 100,000 0 0%
Philip Bloom 486,526(45) 486,526 0 0%
New Dimensions Trading, LTD 114,554(46) 114,554 0 0%
Eli Oxenhorn 95,073(47) 95,073 0 0%
Aaron Wolfson 76,472(48) 76,472 0 0%
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[Enlarge/Download Table]
NUMBER OF
SHARES NUMBER OF PERCENTAGE OF
BENEFICIALLY NUMBER OF SHARES OUTSTANDING
OWNED PRIOR SHARES BENEFICIALLY COMMON
TO BEING OWNED AFTER STOCK AFTER
NAME OFFERING(1) OFFERED OFFERING(1)(2) OFFERING(1)
----- ----------- ------- -------------- -----------
Avi Fogel 44,857(49) 44,857 0 0%
Jack Erlanger 44,855(50) 44,855 0 0%
Abraham Wolfson 38,186(51) 38,186 0 0%
William Walters 38,186(52) 38,186 0 0%
Gerald Josephson 36,355(53) 36,355 0 0%
MW Partnership 34,066(54) 34,066 0 0%
Gyenes and Co. 31,139(55) 22,707 8,432 *
Jeffrey Rubinstein 29,518(56) 29,518 0 0%
Sandler Co-Investment Partners, L.P. 35,792(57) 24,665 11,127 *
Maurice Shamah 22,707(58) 22,707 0 0%
Larry Altman 22,707(59) 22,707 0 0%
G.E.R. Family Partnership 16,862(60) 16,862 0 0%
Patrick McBrien 12,267(61) 12,267 0 0%
Scott Zelnick 12,267(62) 12,267 0 0%
Levitan Family Charitable Trust 12,154(63) 12,153 0 0%
Abbey Oxenhorn 11,351(64) 11,351 0 0%
Seth Oxenhorn 11,351(65) 11,351 0 0%
MLPF&S as custodian FBO
Emanuel R. Pearlman, IRA 8,677(66) 4,098 4,579 *
Brad Zelnick 4,812(67) 4,812 0 0%
Sage Alliances Inc. 135,462(68) 135,462 0 0%
Jim McNeil 37,248(69) 37,248 0 0%
Sam Schwartz 38,412(70) 2,328 36,084 *
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[Download Table]
NUMBER OF
SHARES NUMBER OF PERCENTAGE OF
BENEFICIALLY NUMBER OF SHARES OUTSTANDING
OWNED PRIOR SHARES BENEFICIALLY COMMON
TO BEING OWNED AFTER STOCK AFTER
NAME OFFERING(1) OFFERED OFFERING(1)(2) OFFERING(1)
----- ----------- ------- -------------- -----------
Roy Martin 2,328(71) 2,328 0 0%
Malcolm Taub 2,328(72) 2,328 0 0%
Miriam Gibofsky 100,000(73) 100,000 0 0%
------------------
* Less than 1%
(1) Except as otherwise indicated, the address for each beneficial owner is c/o
Network-1 Security Solutions, Inc., 445 Park Avenue, Suite 1028, New York,
New York 10022.
(2) Unless otherwise indicated, the Company believes that all persons named in
the above table have sole voting and investment power with respect to all
shares of common stock beneficially owned by them. A person is deemed to be
the beneficial owner of securities that can be acquired by such person
within 60 days from the date hereof upon the exercise of options, warrants
or convertible securities. Each beneficial owner's percentage ownership is
determined by assuming that options, warrants and convertible securities
held by such person (but not those held by any other person) and which are
exercisable or convertible within 60 days have been exercised and
converted. Assumes a base of 17,697,572 shares of common stock outstanding.
(3) Includes (i) 1,280,207 shares of common stock held by Wheatley Partners II,
L.P., (ii) 194,280 shares of common stock held by Wheatley Partners, L.P.,
(iii) 16,868 shares of common stock held by Wheatley Foreign Partners,
L.P., (iv) 150,012 shares of common stock held by Mr. Rubenstein, (v)
47,500 shares of common stock subject to currently exercisable stock
options held by Mr. Rubenstein, (vi) 49,664 shares of common stock subject
to currently exercisable warrants held by Mr. Rubenstein, (vii) 829,226,
619,983, 309,316, 294,810 and 1,049 shares of common stock held by Woodland
Venture Fund, Seneca Ventures, Woodland Partners, Brookwood Partners, L.P.
and Marilyn Rubenstein, respectively. Does not include options to purchase
11,875 shares of common stock held by Mr. Rubenstein which are not
currently exercisable. The aforementioned beneficial ownership by Mr.
Rubenstein is based upon Amendment No. 6 to Schedule 13D jointly filed by
Mr. Rubenstein and related parties with the Securities and Exchange
Commission on January 3, 2005 and Form 4s filed by Mr. Rubenstein with the
Securities and Exchange Commission on December 21, 2004 and February 17,
2005. Barry Rubenstein is a general partner of Wheatley Partners II, L.P.
and a member of the general partner of each of Wheatley Partners, L.P. and
Wheatley Foreign Partners, L.P. Barry Rubenstein
20
and Woodland Services Corp. are the general partners of Woodland Venture
Fund and Seneca Ventures. Barry Rubenstein is the President and sole
director of Woodland Services Corp. Marilyn Rubenstein is the wife of Barry
Rubenstein. Mr. Rubenstein disclaims beneficial ownership of the shares of
common stock held by Wheatley Partners II, L.P., Wheatley Partners, L.P.
and Wheatley Foreign Partners, L.P., except to the extent of his equity
interest therein. The address of Barry Rubenstein is 68 Wheatley Road,
Brookville, New York 11545. The address of Wheatley Partners II, L.P. and
Wheatley Partners, L.P. is 60 Cuttermill Road, Great Neck, New York 11021.
The address of Wheatley Foreign Partners, L.P. is c/o Fiduciary Trust, One
Capital Place, Snedden Road, P.O. Box 162, Grand Cayman, British West
Indies. The address for Woodland Venture Fund, Seneca Ventures, Brookwood
Partners, L.P. and Woodland Partners is c/o Barry Rubenstein, 68 Wheatley
Road, Brookville, New York 11545.
(4) Includes (i) 1,280,207 shares of common stock held by Wheatley Partners II,
L.P., (ii) 194,280 shares of common stock held by Wheatley Partners, L.P.,
(iii) 16,868 shares of common stock held by Wheatley Foreign Partners,
L.P., (iv) 509,483 shares of common stock owned by Mr. Lieber, (v) 47,500
shares of common stock subject to currently exercisable stock options owned
by Mr. Lieber, and (vi) 49,664 shares of common stock subject to currently
exercisable warrants owned by Mr. Lieber. Does not include options to
purchase 11,875 shares of common stock owned by Mr. Lieber which are not
currently exercisable. The aforementioned beneficial ownership by Mr.
Lieber is based upon Amendment No. 6 to Schedule 13D jointly filed by Mr.
Lieber and related parties with Securities and Exchange Commission on
January 3, 2005 and Form 4s filed with the Securities and Exchange
Commission on December 21, 2004 and February 17, 2005. Mr. Lieber disclaims
beneficial ownership of the shares of common stock held by Wheatley
Partners II, L.P., Wheatley Partners, L.P. and Wheatley Foreign Partners,
L.P., except to the extent of his equity interest therein. The address of
Irwin Lieber is c/o Wheatley Partners, II, L.P., 80 Cuttermill Road, Great
Neck, New York 11021.
(5) Includes (i) 1,280,207 shares of common stock held by Wheatley Partners,
II, L.P., (ii) 194,280 shares of common stock held by Wheatley Partners,
L.P., (iii) 16,868 shares of common stock held by Wheatley Foreign
Partners, L.P., and (iv) 517,243 shares of common stock owned by Mr.
Fingerhut. Mr. Fingerhut disclaims beneficial ownership of the shares of
common stock held by Wheatley Partners II, L.P., Wheatley Partners, L.P.
and Wheatley Foreign Partners, L.P., except to the extent of his equity
interest therein. The address of Barry Fingerhut is c/o Wheatley Partners,
II, L.P., 80 Cuttermill Road, Great Neck, New York 11021.
(6) Includes (i) 1,280,207 shares of common stock held by Wheatley Partners,
II, L.P., (ii) 194,280 shares of common stock held by Wheatley Partners,
L.P., (iii) 16,868 shares of common stock held by Wheatley Foreign
Partners, L.P., and (iv)140,945 shares of common stock owned by Mr. Lieber.
Mr. Lieber disclaims beneficial ownership of the shares of common stock
held by Wheatley Partners II, L.P., Wheatley Partners, L.P. and Wheatley
Foreign Partners, L.P., except to the extent of his equity interest
therein. The
21
address of Seth Lieber is c/o Wheatley Partners, II, L.P., 80 Cuttermill
Road, Great Neck, New York 11021.
(7) Includes (i) 1,280,207 shares of common stock held by Wheatley Partners,
II, L.P., (ii) 194,280 shares of common stock held by Wheatley Partners,
L.P., (iii) 16,868 shares of common stock held by Wheatley Foreign
Partners, L.P., and (iv)139,393 shares of common stock owned by Mr. Lieber.
Mr. Lieber disclaims beneficial ownership of the shares of common stock
held by Wheatley Partners II, L.P., Wheatley Partners, L.P. and Wheatley
Foreign Partners, L.P., except to the extent of his equity interest
therein. The address of Jonathan Lieber is c/o Wheatley Partners, II, L.P.,
80 Cuttermill Road, Great Neck, New York 11021.
(8) Barry Rubenstein, Irwin Lieber, Barry Fingerhut, Seth Lieber and Jonathan
Lieber, by virtue of each being a general partner of Wheatley Partners II,
L.P., may be deemed to have shared power to vote and dispose of the shares
of common stock owned by Wheatley Partners II, L.P. Wheatley Partners II,
L.P.'s business address is 80 Cuttermill Road, Great Neck, New York 11021.
(9) Barry Rubenstein, Irwin Lieber, Barry Fingerhut, Seth Lieber and Jonathan
Lieber by virtue of being a member and officer of Wheatley Partners, LLC,
the general partner of Wheatley Partners, L.P. and Wheatley Foreign
Partners, L.P., may be deemed to have shared power to vote and to dispose
of the shares of common stock owned by Wheatley Partners, L.P. and Wheatley
Foreign Partners, L.P.
(10) Barry Rubenstein, by virtue of being a General Partner of Woodland Venture
Fund, Seneca Ventures, Woodland Partners and Brookwood Partners L.P., and
Marilyn Rubenstein, by virtue of being an officer of Woodland Services
Corp. (a general partner of Woodland Venture Fund and Seneca Ventures) and
a general partner of Woodland Partners and Brookwood Partners L.P., may be
deemed to have shared power to vote and dispose of the shares of common
stock owned by Woodland Venture Fund, Seneca Ventures, Woodland Partners
and Brookwood Partners L.P.
(11) Includes (i) 463,803 shares of common stock held by Mr. Horowitz, (ii)
4,137,861 shares of common stock subject to currently exercisable stock
options held by Mr. Horowitz, (iii) 2,867,800 shares of common stock held
by CMH Capital Management Corp. ("CMH"), (iv) 550,000 shares of common
stock subject to currently exercisable warrants held by CMH, (v) 750,000
shares of common stock subject to currently exercisable options held by
CMH, (vi) 85,220 shares of common stock subject to currently exercisable
warrants held by Mr. Horowitz, (vii) 67,471 shares of common stock owned by
Donna Slavitt, the wife of Mr. Horowitz, (viii) 45,000 shares of common
stock held by two trusts and a custodian account for the benefit of Mr.
Horowitz's three children and (ix) 2,291 shares of common stock held by
Horowitz Partners, a general partnership of which Mr. Horowitz is a
partner. Does not include options to purchase 210,625 shares of
22
common stock which are not currently exercisable. The address of CMH
Capital Management Corp. is 445 Park Avenue, New York, New York 10022.
(12) Includes (i) 2,867,800 shares of common stock, (ii) 550,000 shares of
common stock subject to currently exercisable warrants and (iii) 750,000
shares of common stock subject to currently exercisable options. Corey M.
Horowitz, by virtue of being the sole officer and shareholder of CMH
Capital Management Corp., has sole power to vote and dispose of the shares
of common stock owned by CMH.
(13) Gary Horowitz, by virtue of being the trustee of the Logan Zev Horowitz
1999 Trust and the Dylan Max Horowitz 1999 Trust, has sole power to vote
and dispose of the shares of common stock owned by each of the trusts.
Corey M. Horowitz, by virtue of being custodian for Zachary Jordan
Horowitz, has the sole power to vote and dispose of such shares.
(14) Corey M. Horowitz, Gary Horowitz, Cindy Horowitz and Syd Horowitz, by
virtue of being a general partner of Horowitz Partners, may each be deemed
to have shared power to vote and dispose of the shares owned by Horowitz
Partners.
(15) Includes 650,000 shares of common stock subject to currently exercisable
warrants. Reijane Huai, Lawrence S. Dolin, Steven Fischer, Steven L. Block,
Patrick Carney and Alan W. Kaufman, by virtue of being members of the Board
of Directors of FalconStor Software, Inc., may be deemed to have shared
power to vote and dispose of the securities. The address of FalconStor
Software, Inc. is 2 Huntington Quadrangle, Suite 2501, Mellvile, New York
11747.
(16) Includes (i) 750,000 shares of common stock and (ii) 562,500 shares of
common stock subject to currently exercisable warrants. Howard Millstein,
by virtue of being an officer of New York Private Bank and Trust
Corporation and trustee of the Paul Milstein Revocable 1998 Trust, both
indirect owners of Emigrant Capital Corporation, may be deemed to have sole
power to vote and dispose of the securities owned by Emigrant Capital
Corporation. The address of Emigrant Capital Corporation is 6 East 43rd
Street, New York, New York 10017.
(17) Includes (i) 516,000 shares of Common Stock and (ii) 268,125 shares of
Common Stock subject to currently exercisable warrants owned by Singer
Opportunity Fund, L.P. Eric Singer, by virtue of being managing member of
Singer Opportunity Fund, L.P. and Singer Fund Management, LLC, has sole
power to vote and dispose of the shares owned by Singer Opportunity Fund,
L.P. The address of Singer Opportunity Fund, L.P. is 650 Fifth Avenue, New
York, New York 10019.
(18) Includes (i) 175,480 shares of Common Stock and (ii) 106,875 shares of
Common Stock subject to currently exercisable warrants owned by Singer
Fund, L.P. Eric Singer, by virtue of being managing member of Singer Fund,
L.P. and Singer Fund Management,
23
LLC, has sole power to vote and dispose of the securities owned by Singer
Fund, L.P. The address of Singer Fund, L.P. is 650 Fifth Avenue, New York,
New York 10019.
(19) Includes (i) 279,000 shares of common stock and (ii) 195,000 shares of
common stock subject to currently exercisable warrants.
(20) Includes (i) 154,777 shares of common stock and (ii) 75,000 shares of
common stock subject to currently exercisable warrants and (iii) 50,000
shares subject to currently exercisable stock options.
(21) Includes (i) 100,000 shares of common stock and (ii) 75,000 shares of
common stock subject to currently exercisable warrants.
(22) Includes (i) 100,000 shares of common stock and (ii) 75,000 shares of
common stock subject to currently exercisable warrants.
(23) Includes (i) 75,000 shares of common stock and (ii) 56,250 shares of common
stock subject to currently exercisable warrants. Clarke Adams, by virtue of
being managing partner of Granite Bridge Fund, L.P., may be deemed to have
sole power to vote and dispose of the securities owned by Granite Bridge
Fund, L.P.
(24) Includes (i) 50,000 shares of common stock and (ii) 37,500 shares of common
stock subject to currently exercisable warrants. Cass Gunther Adelman, by
virtue of being the sole member of CGA Resources, LLC, may be deemed to
have sole power to vote and dispose of the securities.
(25) Includes (i) 50,000 shares of common stock and (ii) 37,500 shares of common
stock subject to currently exercisable warrants.
(26) Includes (i) 50,000 shares of common stock and (ii) 37,500 shares of common
stock subject to currently exercisable warrants. Allysa Ackerman, by virtue
of being the sole member of Dasa Sada, LLC, may be deemed to have sole
power to vote and dispose of the securities.
(27) Includes (i) 50,000 shares of common stock and (ii) 37,500 shares of common
stock subject to currently exercisable warrants.
(28) Includes (i) 25,000 shares of common stock and (ii) 18,750 shares of common
stock subject to currently exercisable warrants.
(29) Includes (i) 10,000 shares of common stock and (ii) 7,500 shares of common
stock subject to currently exercisable warrants.
(30) Includes (i) 10,000 shares of common stock and (ii) 7,500 shares of common
stock subject to currently exercisable warrants.
24
(31) Includes (i) 104,200 shares of common stock and (ii) 71,250 shares of
common stock subject to currently exercisable warrants. James Bresser, by
virtue of being a partner of the investment advisor of Jeb Investment Ltd.,
may be deemed to have sole power to vote and dispose of the securities.
(32) Includes (i) 103,800 shares of common stock and (ii) 71,250 shares of
common stock subject to currently exercisable warrants. James Bresser, by
virtue of being an officer of the general partner of Jeb Partners, L.P.,
may be deemed to have sole power to vote and dispose of the securities.
(33) Includes (i) 70,200 shares of common stock and (ii) 45,000 shares of common
stock subject to currently exercisable warrants. James Bresser, by virtue
of being an officer of Manchester Explorer Limited Partnership, may be
deemed to have sole power to vote and dispose of the securities.
(34) Includes (i) 100,000 shares of common stock and (ii) 75,000 shares of
common stock subject to currently exercisable warrants.
(35) Includes (i) 75,000 shares of common stock and (ii) 37,500 shares of common
stock subject to currently exercisable warrants.
(36) Includes (i) 7,500 shares of common stock and (ii) 5,625 shares of common
stock subject to currently exercisable warrants.
(37) Includes (i) 5,000 shares of common stock and (ii) 3,750 shares of common
stock subject to currently exercisable warrants.
(38) Includes (i) 7,500 shares of common stock and (ii) 5,625 shares of common
stock subject to currently exercisable warrants.
(39) Includes (i) 10,000 shares of common stock and (ii) 7,500 shares of common
stock subject to currently exercisable warrants.
(40) Includes (i) 60,000 shares of common stock and (ii) 45,000 shares of common
stock subject to currently exercisable warrants.
(41) Includes (i) 20,000 shares of common stock and (ii) 15,000 shares of common
stock subject to currently exercisable warrants.
(42) Includes (i) 20,000 shares of common stock and (ii) 15,000 shares of common
stock subject to currently exercisable warrants.
(43) Includes (i) 25,000 shares of common stock and (ii) 18,750 shares of common
stock subject to currently exercisable warrants.
25
(44) Includes 50,000 shares of common stock subject to currently exercisable
warrants and does not include 50,000 shares of common stock subject to
options which are not currently exercisable but which shares are being
registered for resale herein.
(45) Includes 486,526 shares of common stock subject to currently exercisable
warrants.
(46) Includes 114,554 shares of common stock subject to currently exercisable
warrants. Chana Edelstein and Isaac Hebroni, by virtue of being directors
of New Dimensions Trading LTD, have shared power to vote and dispose of the
securities.
(47) Includes 95,073 shares of common stock subject to currently exercisable
warrants.
(48) Includes 76,472 shares of common stock subject to currently exercisable
warrants.
(49) Includes 44,857 shares of common stock subject to currently exercisable
warrants.
(50) Includes 44,857 shares of common stock subject to currently exercisable
warrants.
(51) Includes 38,186 shares of common stock subject to currently exercisable
warrants.
(52) Includes 38,186 shares of common stock subject to currently exercisable
warrants.
(53) Includes 36,355 shares of common stock subject to currently exercisable
warrants.
(54) Includes 34,066 shares of common stock subject to currently exercisable
warrants. Morris Wolfson, by virtue of being managing partner of MW
Partnership, may be deemed to have sole power to vote and dispose of the
securities. (55) Includes (i) 8,432 shares of common stock and (ii) 22,707
shares of common stock subject to currently exercisable warrants. Andrew
Geynes, by virtue of being general partner of Geynes & Co., may be deemed
to have sole power to vote and dispose of the securities.
(56) Includes 29,518 shares of common stock subject to currently exercisable
warrants.
(57) Includes 35,792 shares of common stock subject to currently exercisable
warrants. Michael Marocco, by virtue of being Managing Director of Sandler
Capital Management, the general partner of Sandler Co-Investment Partners,
L.P., may be deemed to have sole power to vote and dispose of the
securities.
(58) Includes 22,707 shares of common stock subject to currently exercisable
warrants.
(59) Includes 22,707 shares of common stock subject to currently exercisable
warrants.
26
(60) Includes 16,862 shares of common stock subject to currently exercisable
warrants. Gerald Reich, by virtue of being General Partner of GER Family
Partnership, may be deemed to have sole power to vote and dispose of the
securities.
(61) Includes 12,267 shares of common stock subject to currently exercisable
warrants.
(62) Includes 12,267 shares of common stock subject to currently exercisable
warrants.
(63) Includes 12,154 shares of common stock subject to currently exercisable
warrants. Eli Levitin, by virtue of being trustee of the Levitin Family
Charitable Trust, may be deemed to have sole power to vote and dispose of
the securities.
(64) Includes 11,351 shares of common stock subject to currently exercisable
warrants.
(65) Includes 11,351 shares of common stock subject to currently exercisable
warrants.
(66) Includes (i) 4,579 shares of common stock and (ii) 4,098 shares of common
stock subject to currently exercisable warrants.
(67) Includes 4,812 shares of common stock subject to currently exercisable
warrants.
(68) Includes 135,462 shares of common stock subject to currently exercisable
warrants. John Redding, by virtue of being the principal of Sage Alliances,
Inc., may be deemed to have sole power to vote and dispose of the
securities.
(69) Includes 37,248 shares of common stock subject to currently exercisable
warrants.
(70) Includes (i) 23,584 shares of common stock and (ii) 14,828 shares subject
to currently exercisable options and warrants.
(71) Includes 2,328 shares of common stock subject to currently exercisable
warrants.
(72) Includes 2,328 shares of common stock subject to currently exercisable
warrants.
(73) Includes 100,000 shares of common stock subject to currently exercisable
warrants.
PLAN OF DISTRIBUTION
This offering is self-underwritten; neither we nor the selling stockholders
have employed an underwriter for the sale of common stock by the selling
stockholders. We will bear all expenses in connection with the preparation of
this prospectus. The selling stockholders will bear all expenses associated with
the sale of their common stock.
27
The selling stockholders may offer their shares of common stock directly or
through pledgees, donees, transferees or other successors in interest in one or
more of the following transactions:
o ordinary brokerage transactions in which the broker-dealer solicits
purchasers;
o block trades in which the broker-dealer will attempt to sell the
shares as agent but may position and resell a portion of the block as
principal to facilitate the transaction;
o purchases by a broker-dealer as principal and resale by the
broker-dealer for its account;
o an exchange distribution in accordance with the rules of the
applicable exchange;
o privately negotiated transactions;
o broker-dealers may agree with the selling stockholders to sell a
specified number of such shares at a stipulated price per share;
o a combination of any such methods of sale; and
o any other method permitted pursuant to applicable law.
The selling stockholders may offer their shares of common stock at any of
the following prices:
o fixed prices that may be changed;
o market prices prevailing at the time of sale;
o prices related to such prevailing market prices; and
o at negotiated prices.
The selling stockholders may effect transactions by selling shares to or
through broker-dealers, and all such broker-dealers may receive compensation in
the form of discounts, concessions, or commissions from the selling stockholders
and/or the purchasers of shares of common stock for whom such broker-dealers may
act as agents or to whom they sell as principals, or both (which compensation as
to a particular broker-dealer might be in excess of customary commissions).
Any broker-dealer acquiring common stock from the selling stockholders may
sell the shares either directly, in its normal market-making activities, through
or to other brokers on a
28
principal or agency basis or to its customers. Any such sales may be at prices
then prevailing on the OTC Bulletin Board or at prices related to such
prevailing market prices or at negotiated prices to its customers or a
combination of such methods. The selling stockholders and any broker-dealers
that act in connection with the sale of the common stock hereunder might be
deemed to be "underwriters" within the meaning of Section 2(11) of the
Securities Act; any commission received by them and any profit on the resale of
shares as principal might be deemed to be underwriting discounts and commissions
under the Securities Act. Any such commissions, as well as other expenses
incurred by the selling stockholders and applicable transfer taxes, are payable
by the selling stockholders.
The selling stockholders reserve the right to accept, and together with any
agent of the selling stockholder, to reject in whole or in part any proposed
purchase of the shares of common stock. The selling stockholders will pay any
sales commissions or other seller's compensation applicable to such
transactions.
We have not registered or qualified offers and sales of shares of the
common stock under the laws of any country other than the United States. To
comply with certain states' securities laws, if applicable, the selling
stockholders will offer and sell their shares of common stock in such
jurisdictions only through registered or licensed brokers or dealers. In
addition, in certain states the selling stockholders may not offer or sell
shares of common stock unless we have registered or qualified such shares for
sale in such states or we have complied with an available exemption from
registration or qualification.
The selling stockholders with respect to any purchase or sale of shares of
common stock are required to comply with Regulation M promulgated under the
Securities Exchange Act of 1934, as amended. In general, Rule 102 under
Regulation M prohibits any person connected with a distribution of securities
(the "Distribution") from directly or indirectly bidding for, or purchasing for
any account in which he or she has a beneficial interest, any of such securities
or any right to purchase such securities, for a period of one business day
before and after completion of his or her participation in the Distribution (we
refer to that time period as the "Distribution Period").
During the Distribution Period, Rule 104 under Regulation M prohibits the
selling stockholders and any other persons engaged in the Distribution from
engaging in any stabilizing bid or purchasing of our common stock except for the
purpose of preventing or retarding a decline in the open market price of our
common stock. No such person may effect any stabilizing transaction to
facilitate any offering at the market. Inasmuch as the selling shareholders will
be reoffering and reselling our common stock at the market, Rule 104 prohibits
them from effecting any stabilizing transaction in contravention of Rule 104
with respect of our common stock.
There can be no assurance that the selling stockholders will sell any or
all of the shares offered by them hereunder or otherwise.
29
MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
MARKET INFORMATION. Our Common Stock currently trades on OTC Bulletin Board
under the symbol NSSI.OB. The following table sets forth, for the periods
indicated, the range of the high and low closing bid prices for the Common Stock
as reported. Such prices reflect inter-dealer quotations, without retail
mark-up, mark-down or commission and may not necessarily represent actual
transactions.
NINE MONTHS ENDED SEPTEMBER 30, 2005 HIGH LOW
---- ---
Third Quarter $1.55 $0.66
Second Quarter $1.12 $0.66
First Quarter $1.45 $0.92
YEAR ENDED DECEMBER 31, 2004 HIGH LOW
---- ---
Fourth Quarter $1.25 $0.33
Third Quarter $0.53 $0.05
Second Quarter $0.25 $0.05
First Quarter $0.39 $0.05
YEAR ENDED DECEMBER 31, 2003 HIGH LOW
---- ---
Fourth Quarter $0.22 $0.01
Third Quarter $0.04 $0.01
Second Quarter $1.06 $0.01
First Quarter $0.16 $0.05
On November 21, 2005, the closing price for the Common Stock as reported on
the OTC Bulletin Board was $1.38 per share. The number of record holders of our
Common Stock was 105 as of November 17, 2005.
30
EQUITY COMPENSATION PLAN INFORMATION
The following table summarizes share and exercise price information about
our equity compensation plans as of December 31, 2004.
[Enlarge/Download Table]
---------------------------------------------------------------------------------------------------------------------------
Number of securities remaining
Number of securities to be available for future issuance
issued upon exercise of Weighted-average exercise under equity compensation
outstanding options, price of outstanding plans (excluding securities
warrants and rights options, warrants and reflected in column
(a) rights (a))
---------------------------------------------------------------------------------------------------------------------------
Equity compensation plans approved
by security holders 3,792,370 $.94 207,630
---------------------------------------------------------------------------------------------------------------------------
Equity compensation plans not
approved by security holders 0 -- 0
---------------------------------------------------------------------------------------------------------------------------
Total 3,792,370 $.94 207,630
---------------------------------------------------------------------------------------------------------------------------
31
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
PLAN OF OPERATION
Our principal business is the acquisition, development, licensing and
protection of our intellectual property. We presently owns 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 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, we acquired the Patent Portfolio from Merlot
Communications, Inc., a broadband communications solutions provider. In February
2004, following our review of applicable markets, we initiated licensing efforts
relating to one of its patents (U.S. Patent No. 6,218,930) covering the remote
delivery of power over Ethernet cable (the "Remote Power Patent"). We have
focused, and will continue to focus, our efforts on licensing our Remote Power
Patent. As of the date of this report, we have not entered into any license
arrangement with respect to the Remote Power Patent, although we are pursing
such arrangements with third parties. During the next 12 months, we do not
presently anticipate licensing efforts for our other patents besides the Remote
Power Patent.
To date we have incurred significant losses and at September 30, 2005 had
an accumulated deficit of $(44,269,000). For the year ended December 31, 2004,
we incurred a net loss of $(1,953,000) and incurred a net loss of $(1,280,000)
for the nine months ended September 30, 2005. We anticipate that we will
continue to incur losses until we enter into material license agreements with
respect to our patented technologies. We have not achieved any revenue from our
technology licensing business. To date we have not entered any licensing
agreements with third parties with respect to our Remote Power Patent or our
other patented technologies. Our inability to consummate license agreements and
achieve revenue from its patented technologies would have a material adverse
effect on our operations and our ability to continue our business.
We do not currently have any revenue from operations. Our success and our
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 the Remote Power Patent with certain agreed-upon potential
licensees. We have agreed to pay ThinkFire a fee not to exceed 20% of the
royalty payments received from license agreements consummated by ThinkFire on
our behalf.
32
Our success depends on our ability to protect our intellectual property
rights. In the future, it may be necessary for us to commence patent litigation
against third parties whom we believe require a license to our patents. In
addition, we may be subject to third-party claims seeking to invalidate our
patents, as is anticipated to be asserted by D-Link in the pending action
related to our Remote Power Patent (See Risk Factors - "We face uncertainty as
to the outcome of litigation with D-Link"). These types of claims, with or
without merit, may subject us to costly litigation and diversion of our focus.
In August 2005, we engaged Blank Rome LLP as litigation counsel with respect to
the Remote Power Patent on a contingency basis pursuant to which Blank Rome is
entitled to share in the proceeds of any successful enforcement of the Remote
Power Patent (See Risk Factors - "We are currently relying upon our contingency
fee agreement with Blank Rome"). 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 us.
On December 21, 2004 and January 13, 2005, we completed a private offering
of our equity securities resulting in gross proceeds of $2,685,000. At September
30, 2005, we had $1,257,000 of cash and cash equivalents and working capital of
$688,000. We anticipate, based on currently proposed plans and assumptions,
relating to our operations, that our cash and cash equivalents of approximately
$1,257,000 as of September 30, 2005 will more likely than not be sufficient to
satisfy our operations and capital requirements until September 2006. 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 support our operations prior to September 2006. 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 us, requiring us
to curtail or cease operations. In addition, any equity financing may involve
substantial dilution to our current stockholders.
33
BUSINESS
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. Our strategy is to
pursue licensing and strategic business alliances with companies in 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.
On November 18, 2003, we 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 a review of applicable markets, we
commenced initial efforts to license our 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 systems and methods for the transmission of audio,
video and data over local area networks (LANS) in order to achieve higher
quality of service (QoS) and the control of power delivery over LANs for the
purpose of remotely powering network devices.
Historical Business
From June 1995 until December 2002, we developed, marketed, licensed and
supported a suite of security software products designed to prevent unauthorized
access to information residing on networked servers, desktops and laptops. In
May 2003, we completed the sale of our security software technology and related
intellectual property to an unaffiliated foreign corporation for an aggregate
consideration of $415,000.
THE PATENTS
Our Patent Portfolio consist of the following patents:
U.S. PATENT NO. 6,218,930: APPARATUS AND METHOD FOR REMOTELY POWERING
ACCESS EQUIPMENT OVER A 10/100 SWITCHED ETHERNET NETWORK;
U.S. PATENT NO. 6,577,631: COMMUNICATION SWITCHING MODULE FOR THE
TRANSMISSION AND CONTROL OF AUDIO, VIDEO, AND COMPUTER DATA OVER A SINGLE
NETWORK FABRIC;
U.S. PATENT NO. 6,574,242: METHOD FOR THE TRANSMISSION AND CONTROL OF
AUDIO, VIDEO, AND COMPUTER DATA OVER A SINGLE NETWORK FABRIC;
34
U.S. PATENT NO. 6,570,890: METHOD FOR THE TRANSMISSION AND CONTROL OF
AUDIO, VIDEO, AND COMPUTER DATA OVER A SINGLE NETWORK FABRIC USING ETHERNET
PACKETS;
U.S. PATENT NO. 6,539,011: METHOD FOR INITIALIZING AND ALLOCATING BANDWIDTH
IN A PERMANENT VIRTUAL CONNECTION FOR THE TRANSMISSION AND CONTROL OF AUDIO,
VIDEO, AND COMPUTER DATA OVER A SINGLE NETWORK FABRIC; AND
U.S. PATENT NO. 6,215,789: LOCAL AREA NETWORK FOR THE TRANSMISSION AND
CONTROL OF AUDIO, VIDEO, AND COMPUTER DATA.
Our future success is largely dependent upon our proprietary technologies,
our ability to protect our intellectual property rights and consummate license
agreements with respect to our Patent Portfolio. The complexity of patent and
common law, combined with our limited resources, create risk that our efforts to
protect our proprietary technologies may not be successful. We cannot be assured
that our patents will be upheld, or that third parties will not invalidate our
patents. In August 2005, we commenced litigation against D-Link Corporation and
D-Link Systems, Incorporated for infringement of our patent (U.S. Patent No.
6,218,930) covering the control of power delivered over Ethernet Cables (the
"Remote Power Patent (see Risk Factors - "We face uncertainty as to the outcome
of litigation with D-Link).
In February 2004, we initiated our licensing efforts relating to our patent
(U.S. Patent No. 6,218,930) covering the control of power delivery over Ethernet
cables (the "Remote Power Patent"). The Remote Power Patent application was
filed on March 11, 1999 and the patent was granted by the U.S. Office of Patent
and Trademark on April 17, 2001. The Remote Power Patent expires on March 7,
2020.
As of November 1, 2005, we transmitted letters to approximately 85
companies offering licenses to the Remote Power Patent. To date we have not
entered into any license agreements with third parties.
We were incorporated under the laws of the State of Delaware in July 1990.
Our offices are located at 445 Park Avenue, Suite 1028, New York, New York 10022
and our telephone number is (212) 829-5770.
MARKET OVERVIEW
We have determined that our initial licensing efforts will be focused on
our Remote Power Patent. U.S. Patent No. 6,218,930 relates to several
technologies that describe a methodology for controlling the delivery of power
to certain devices over an Ethernet network.
The Institute of Electrical and Electronic Engineers (IEEE) is a
non-profit, technical professional association of more than 360,000 individual
members in approximately 175 countries. The Standards Association of the IEEE is
responsible for the creation of global industry standards
35
for a broad range of technology industries. In 1999, at the urging of several
industry vendors, the IEEE formed a task force to facilitate the adoption of a
standardized methodology for the delivery of remote power over Ethernet networks
that would insure interoperability among vendors of switches and terminal
devices. On June 13, 2003 the IEEE Standards Association approved the 802.3af
Power Over Ethernet standard (the "Standard"), which covers technologies
deployed in delivering power over Ethernet cables. The Standard provides for the
Power Sourcing Equipment (PSE) to be deployed in switches or as standalone
midspan hubs to provide power to remote devices such as wireless access points,
IP phones and network based cameras. The technology is commonly referred to as
Power Over Ethernet ("PoE"). We believe our Remote Power Patent covers several
of the key technologies covered by the Standard.
Ethernet is the leading local area networking technology in use today. PoE
technology allows for the delivery of power over Ethernet cables rather than by
separate power cords. As a result, a variety of network devices, including IP
telephones, wireless LAN Access Points, web-based network security cameras, data
collection terminals and other network devices, will be able to receive power
over existing data cables without the need to modify the existing infrastructure
to facilitate the provision of power for such devices through traditional AC
outlets. Advantages such as lower installation costs, remote management
capabilities, lower maintenance costs, centralized power backup, and flexibility
of device location as well as the advent of worldwide power compatibility create
the possibility of PoE becoming widely adopted in networks throughout the world.
PoE provides numerous benefits including quantifiable returns on
investment. The cost of hiring electricians to pull power cable to remote
locations used for access points or security cameras can rival or exceed the
cost of the devices. Another key benefit is the need for Voice over IP power
reliability in the face of power failures. Using PoE enables data center power
supply systems to ensure on-going power - a function that would be difficult and
expensive to implement if each phone required AC outlets.
These and other advantages such as remote management capabilities, lower
maintenance costs, and flexibility of device location have led to forecasts that
PoE will be widely adopted in networks throughout the world. International Data
Corporation (IDC) forecasts that the annual PoE sales will reach 134 million PSE
switch ports (does not include midspan ports) by 2008 which equates to a 5 year
compound annual growth rate of 63%. A recent Gartner report estimates that PoE
port shipments more than tripled in 2004 and that price premiums for such ports
ranged from $45 to $65 per port and that 18% of all wiring closet switch ports
shipped in 2004 were PoE-enabled.
The benefits of PoE are compelling as evidenced by the introduction of
products by such leading vendors as 3Com, Seimens, Nortel Networks and Avaya, as
well as many others. In February 2004, Cisco Systems, Inc., the world's largest
network switch manufacturer, announced that all of its switches will ultimately
be PoE enabled. PowerDsine, Inc., the world's leader in PoE technology and a
founding member of the IEEE Task Force that developed the Standard, and
36
Motorola, Inc., has announced a partnership to develop chip-based PoE solutions
thereby reducing cost and the number of components necessary to deliver
manufactured Standard compliant products.
We believe the cost savings as well as the other benefits that can be
realized by utilizing the technology contained in the Remote Power Patent may be
of significant importance to the growth of the Wireless Local Area Networking
(WLAN) industry and Voice Over IP Telephony (VOIP) industry. According to
In-Stat/MDRs, a market research firm, purchases of wireless hardware, including
Access Points for IEEE 802.11b/g (Wi-Fi) networks, reached $2.2 billion in 2002
and are expected to exceed $3.9 billion by 2006. A January 2004 market study by
The Dell'Oro Group, a research firm, projects that annual shipments of
enterprise wireless LAN access points will grow from 882,000 units in 2003 to
5.9 million units in 2008, representing a compound annual growth rate of 46.2%.
The VOIP market is currently one of the fastest growing segments in the
telecommunications industry. VOIP traffic has steadily increased over the last
several years and is being deployed by service providers and carriers worldwide.
IDC, a market research firm, estimates that worldwide IP telephone unit sales
are set to grow from 1.5 million units in 2003 to nearly 5 million units in 2007
and overall voice-over IP equipment, which in 2003 represented a market of $3.3
billion, is expected to grow at a compound annual growth rate of 45.0% to $15.1
billion by 2007.
The ability to supply power to end-devices through Ethernet cables can be
applied to other end-devices, such as advanced security cameras, RFID card
readers, laptop computers, personal digital assistants and portable digital
music players. As the desire to connect more end-devices to the Ethernet network
grows, we believe that PoE technology will become more widely used as a method
to power these end-devices.
We also own five (5) additional patents covering various methodologies that
provide for allocating bandwidth and establishing Quality of Service for delay
sensitive data, such as voice, on packet data networks. Quality of Service
issues become important when data networks carry packets that contain audio and
video which may require priority over data packets traveling over the same
network. Covered within these patents are also technologies that establish
bi-directional communications control channels between network-connected devices
in order to support advanced applications on traditional data networks. We
believe that potential licensees of the technologies contained in these patents
would be vendors deploying applications that require the low latency transport
of delay sensitive data such as video over data networks.
NETWORK-1 STRATEGY
Our strategy is to capitalize on our Patent Portfolio through entering into
licensing arrangements with third parties including manufacturers and users that
utilize the Patent Portfolio's proprietary technologies as well as any
additional proprietary technologies covered by patents
37
which may be acquired by us in the future. We will also seek to enter into
licensing arrangements with users of the proprietary technologies, including
corporate, educational and governmental entities in those cases where the patent
rights extend to the users of the technologies contained in manufactured
products.
We do not anticipate manufacturing products utilizing the Patent Portfolio
or any of the proprietary technologies contained in the Patent Portfolio.
Accordingly, we do not anticipate establishing a manufacturing, sales or
marketing infrastructure. Consequently, we believe that our capital requirements
will be less than the capital requirements for companies with such
infrastructure requirements.
In connection with our activities relating to the protection of our Patent
Portfolio, it may be necessary to assert patent infringement claims against
third parties that we believe are infringing our Patent Portfolio. Such
litigation may be costly and based on our current limited financial resources,
we may not be able to pursue litigation as aggressively as companies with
substantially greater financial resources.
MARKETING AND DISTRIBUTION
In February 2004, we commenced licensing efforts for our Remote Power
Patent. We believe that potential licensees include, among others, Wireless
Local Area Networking (WLAN) equipment manufacturers, Local Area Networking
(LAN) equipment manufacturers, Voice Over IP Telephony (VOIP) equipment
manufacturers, and Network Camera manufacturers. In addition, we believe that
additional potential licensees include users of the equipment embodying the PoE
technology covered by our Remote Power Patent, including corporate, educational
and federal, state and local government users, as they are significant
beneficiaries of the technologies covered by the Remote Power Patent.
ThinkFire Agreement
On November 30, 2004, we entered into a Master Services Agreement (the
"Agreement") with ThinkFire Services USA, Ltd. ("ThinkFire") pursuant to which
ThinkFire has been granted the exclusive (except for direct efforts by us)
worldwide rights to negotiate license agreements for our Remote Power Patent
with respect to certain potential licensees agreed to between the parties.
Either we or ThinkFire may terminate the Agreement upon 60 days notice for any
reason or upon 30 days notice in the event of a material breach. We has agreed
to pay ThinkFire a fee not to exceed 20% of the royalty payments received from
license agreements consummated by ThinkFire on our behalf.
COMPETITION
The telecommunications and data networking licensing market is
characterized by intense competition and rapidly changing business conditions,
customer requirements and technologies.
38
Our current and potential competitors have longer operating histories, greater
name recognition and possess substantially greater financial, technical,
marketing and other competitive resources than do we. Although we believe that
we have enforceable patents relating to telecommunications and data networking,
there can be no assurance that the Patent Portfolio will be upheld or that third
parties will not invalidate any or all of the patents in the Patent Portfolio.
In addition, our current and potential competitors may develop technologies that
may be more effective than our proprietary technologies or that would render our
technologies less marketable or obsolete. We may not be able to compete
successfully.
In addition, other companies may develop competing technologies that offer
better or less expensive alternatives to PoE and the other technologies covered
by the Patent Portfolio. Several companies have notified the IEEE that they may
have patents and proprietary technologies that are covered by the Standard. In
the event any of those companies assert claims relating to our patents, the
licensing royalties available to us may be limited. Moreover, technological
advances or entirely different approaches developed by one or more of our
competitors or adopted by various standards groups could render our Remote Power
Patent obsolete, less marketable or unenforceable.
EMPLOYEES AND CONSULTANTS
As of November 1, 2005, we had one full time employee, no part time
employees and three consultants.
DIVIDEND POLICY
We have never declared or paid any cash dividends on our common stock and
do not currently intend to do so. We intend to retain any future earnings to
support the development and growth of our business. Any further determination to
pay cash dividends will be at the discretion of our board of directors and will
be dependent upon our financial condition, results of operations, cash
requirements, plans for expansion, contractual restrictions, if any, and other
factors deemed relevant by the by the board of directors.
LEGAL MATTERS
The validity of the securities offered hereby will be passed upon for us by
the law firm of Eiseman Levine Lehrhaupt & Kakoyiannis, P.C., 845 Third Avenue,
New York, New York. Sam Schwartz, a member of such firm, owns 23,584 shares of
our common stock and owns warrants and options to purchase 14,828 shares of our
common stock as of the date of this prospectus.
EXPERTS
The financial statements of the Company as of December 31, 2004 and 2003
and for each of the years then ended appearing in this Prospectus and
Registration Statement have been audited by Eisner LLP, independent registered
public accounting firm, as set forth in their report
39
thereon appearing elsewhere herein, and are included in reliance upon such
report given upon authority of said firm as experts in accounting and auditing.
DISCLOSURE OF COMMISSION POSITION ON
INDEMNIFICATION FOR SECURITIES ACT LIABILITIES
Our Certificate of Incorporation and Bylaws provide our directors with
protection for breaches of their fiduciary duties to us and our shareholders.
Insofar as indemnification for liabilities arising under the Securities Act may
be permitted to our directors, officers or persons controlling us, we have been
advised that it is the SEC's opinion that such indemnification is against public
policy as expressed in the Securities Act and is, therefore, unenforceable.
In the event that a claim for indemnification against such liabilities
(other than the payment by us of expenses incurred or paid by a director,
officer or controlling person in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, we will, unless in the opinion
of our counsel the matter has been settled by controlling precedent, submit to a
court of appropriate jurisdiction the question whether such indemnification by
it is against public policy as expressed in the Securities Act and will be
governed by the final adjudication of such issue.
40
NETWORK-1 SECURITY SOLUTIONS, INC.
INDEX TO FINANCIAL STATEMENTS
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Page
Number
------
Condensed Balance Sheets as of September 30, 2005 (unaudited) and December 31, 2004...............................F-2
Condensed Statements of Operations for the Three and Nine Months ended June 30, 2005 and 2004 (unaudited).........F-3
Condensed Statements of Cash Flows for the Nine Months ended September 30, 2005 and 2004 (unaudited)..............F-4
Notes to Condensed Financial Statements for the Nine Months ended September 30, 2005 and 2004 (unaudited).........F-5
Report of independent registered public accounting firm...........................................................F-14
Balance Sheets as of December 31, 2004 and 2003...................................................................F-15
Statements of operations for the years ended December 31, 2004 and 2003...........................................F-16
Statements of stockholders' equity for the years ended December 31, 2004 and 2003.................................F-17
Statements of cash flows for the years ended December 31, 2004 and 2003...........................................F-18
Notes to Financial Statements for the years ended December 31, 2004 and 2003......................................F-19
F-1
NETWORK-1 SECURITY SOLUTIONS, INC.
CONDENSED BALANCE SHEETS
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SEPTEMBER 30, DECEMBER 31,
2005 2004
============ ============
(UNAUDITED)
ASSETS
------
Current assets:
Cash and cash equivalents $ 1,257,000 $ 2,177,000
Prepaid expenses and other current assets 30,000 100,000
------------ ------------
Total current assets 1,287,000 2,177,000
Patents 87,000 92,000
Security Deposit 6,000 --
------------ ------------
$ 1,380,000 $ 2,369,000
============ ============
LIABILITIES
-----------
Current liabilities:
Accounts payable $ 83,000 $ 437,000
Accrued expenses and other current liabilities 516,000 505,000
------------ ------------
Total current liabilities 599,000 942,000
------------ ------------
Liability to be settled with equity instrument -- 294,000
------------ ------------
Commitments and contingencies
STOCKHOLDERS' EQUITY
--------------------
Common stock - $0.01 par value ; authorized 50,000,000 shares;
17,697,572 shares issued and outstanding at September 30, 2005
and 17,097,572 at December 31, 2004 177,000 171,000
Additional paid-in capital 44,873,000 43,951,000
Accumulated deficit (44,269,000) (42,989,000)
------------ ------------
781,000 1,133,000
------------ ------------
$ 1,380,000 $ 2,369,000
============ ============
See notes to unaudited condensed financial statements.
F-2
NETWORK-1 SECURITY SOLUTIONS, INC.
CONDENSED STATEMENTS OF OPERATIONS
(Unaudited)
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THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
============================== ==============================
2005 2004 2005 2004
============ ============ ============ ============
(as restated -
see Note 3)
Operating expenses:
General and administrative $ 329,000 $ 280,000 $ 809,000 $ 862,000
Patent Costs 500,000
LOSS BEFORE INTEREST INCOME (329,000) (280,000) (1,309,000) (862,000)
Interest income - net 9,000 29,000 1,000
------------ ------------ ------------ ------------
Net Loss (320,000) (280,000) (1,280,000) (861,000)
============ ============ ============ ============
Deemed dividend on additional warrant
antidilutution adjustment
Deemed dividend on Preferred Stock conversion (6,000)
(273,000)
Net loss attributable to common stockholders $ (320,000) $ (280,000) $ (1,286,000) $ (1,134,000)
------------ ------------ ------------ ------------
LOSS PER COMMON SHARE: BASIC AND DILUTED $ (0.02) $ (0.02) $ (0.07) $ (0.08)
============ ============ ============ ============
WEIGHTED AVERAGE SHARES: BASIC AND DILUTED 17,697,572 15,012,572 17,671,198 14,108,917
============ ============ ============ ============
See notes to unaudited condensed financial statements.
F-3
NETWORK-1 SECURITY SOLUTIONS , INC.
CONDENSED STATEMENTS OF CASH FLOWS (UNAUDITED)
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NINE MONTHS ENDED SEPTEMBER 30,
==============================
2005 2004
============ ============
Cash flows from operating activities:
Net loss $ (1,280,000) $ (861,000)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 5,000 5,000
Valuation adjustment for outstanding stock options (32,000) 114,000
Issuance of options and warrants for services rendered 68,000 --
Changes in:
Prepaid expenses and other current assets 70,000 74,000
Security Deposits (6,000) --
Accounts payable, accrued expenses and other
current liabilities (343,000) 17,000
------------ ------------
Net cash used in operating activities (1,520,000) (651,000)
------------ ------------
Cash Flows from Investing Activities -- --
------------ ------------
Cash Flows from Financing Activities
Issuance of Common Stock 600,000 --
------------ ------------
NET DECREASE IN CASH AND CASH EQUIVALENTS (920,000) (651,000)
Cash and cash equivalents, beginning of period 2,177,000 984,000
------------ ------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 1,257,000 $ 333,000
============ ============
NON-CASH TRANSACTIONS:
Non-employee compensation paid with equity stock options $ 262,000 $ 51,000
============ ============
Par value of Common stock issued on conversion of
Series D and E Preferred stock -- $ 67,000
============ ============
See notes to unaudited condensed financial statements
F-4
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 September 30, 2005 and for
the three and nine month periods ended September 30, 2005 and September 30,
2004, 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 September 30, 2005, the
results of its operations and its cash flows for the three and nine month
periods ended September 30, 2005 and 2004. 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, 2004 included in the Company's Annual Report on Form 10-KSB filed
with the Securities and Exchange Commission. The results of operations for the
nine months ended September 30, 2005 and 2004 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.
On November 18, 2003, the Company acquired the Patent Portfolio from Merlot
Communications, Inc., a broadband communications solutions provider. In February
2004, the Company initiated licensing efforts relating to one of its patents
(U.S. Patent No. 6,218,930) covering the remote delivery of power over Ethernet
cables (the "Remote Power Patent"). As of September 30, 2005, the Company
transmitted letters to approximately 85 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.
F-5
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
[2] BUSINESS: (CONTINUED)
(b) As reflected in the accompanying financial statements, the Company has
incurred substantial losses and has experienced net cash outflows from
operations for 2004 and the nine month period ended September 30, 2005. For the
year ended December 31, 2004 and the nine month period ended September 30, 2005,
the Company had no revenue from operations. The Company will continue to have
operating losses for the foreseeable future until it is successful in licensing
its patented technologies. The Company is dependent upon debt and equity
financing until it generates cash flows from operations. In December 2004 and
January 2005, the Company completed a private placement of its equity
securities. As a result of such private placement, the Company has cash and cash
equivalents of $2,177,000 as of December 31, 2004 and $1,257,000 as of September
30, 2005. The Company believes its current cash position will more likely than
not be sufficient to satisfy the Company's operations and capital requirements
until September 2006, although there can be no assurance that such funds will
not be expended prior thereto. If necessary, the Company will take further
action which it believes is required to sustain its operations for the next
twelve months.
[3] - RESTATEMENT:
The Company has restated its condensed statements of operations for the nine
months ended September 30, 2004 presented in this Quarterly Report on Form
10-QSB for the nine months ended September 30, 2005, following comments received
from the staff of the Division of Corporation Finance of the Securities and
Exchange Commission and the resulting discussions with the staff pertaining to
the Company's Annual Report on 10-KSB for the year ended December 31, 2004
("2004 10-KSB").
The Company's 2004 10-KSB included disclosure in Note D [1] pertaining to its
April 2004 exchange transaction pursuant to which all holders the Company's
outstanding Series E convertible preferred stock ("Series E") and Series D
convertible preferred stock ("Series D") (collectively, the Series E and Series
D, the "Preferred Stock") exchanged their preferred shares for shares of common
stock of the Company (the "2004 Exchange Transaction"). The Staff commented on
the Company's accounting of the 2004 Exchange Transaction which included
discussions concerning whether or not the Preferred Stock contained a
"beneficial conversion feature" which should be accounted for under Emerging
Issues Task Force Issue No. (EITF) 00-27 as a deemed dividend and included in
the net loss attributable to common stockholders and the per share amounts.
In the 2004 Exchange Transaction, the Company entered into an exchange agreement
with the holders of all of the Company's outstanding shares of Series E (Series
E") and Series D ("Series D") convertible preferred stock to exchange 2,483,508
shares of Series E for 6,208,770 shares of common stock and 231,054 shares of
Series D for 489,348 shares of common stock. The holders of the Series E and
Series D received 1.25 times the number of shares of common stock that each
preferred stockholder would have otherwise received upon conversion. The holders
of preferred stock participating in the exchange included, among others, CMH
Capital Management Corp. (1,084,935 Series E shares), the sole owner and officer
of which is Corey M. Horowitz, Chairman and Chief Executive Officer of the
F-6
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
[3] - RESTATEMENT: (CONTINUED)
Company, the wife of Corey M. Horowitz, (35,377 Series E shares) and other
principal stockholders of the Company (990,552 of Series E shares and 209,125 of
Series D shares). Upon closing of the 2004 Exchange Transaction, there were no
shares of preferred stock outstanding. In its original accounting for the 2004
Exchange Transaction, the Company did not reflect a deemed dividend.
The Company has concluded that it should have recognized a deemed dividend as a
result of the beneficial conversion feature in accordance with ETIF 00-27. The
change in the accounting treatment for the Exchange Transaction and the
restatement of the Company's condensed statement of operations for nine months
ended September 30, 2004 resulted in the following changes:
o the inclusion of a "Deemed Dividend on Preferred Stock Conversion" in
the amount of $273,000 for the nine months ended September 30, 2004;
o increase the net loss attributable to common stockholders by $273,000,
to $1,134,000 from $861,000 for the nine months ended September 30,
2004; and
o increase the loss per common share to $(.08) per share from $(.06) per
share basis, and diluted, for the nine months ended September 30,
2004.
The effect of the restatement on the amounts previously reported in the
Company's condensed statements of operations included in the Company's Form
10-QSB for the nine months ended September 30, 2004 are as follows:
Nine Months Ended
September 30, 2004
-----------------------------
As Previously
Reported As Restated
------------ ------------
STATEMENTS OF OPERATIONS:
Deemed Dividend on Preferred Stock Conversion -- $ 273,000
Net Loss attributable to common stockholders $ (861,000) $ (1,134,000)
Loss per common share: basic and diluted $ (0.06) $ (0.08)
F-7
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
[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 net loss per share attributable to common
stockholders as if the fair value-based method of SFAS No. 123 had been applied
to all awards.
[Enlarge/Download Table]
NINE MONTHS ENDED SEPTEMBER 30,
===============================
2005 2004
============ ============
(Restated)
Reported net loss attributable to common stockholders $ (1,286,000) $ (1,134,000)
Stock-based employee compensation expense included in
the reported net loss, net of related tax effects -- --
Stock-based employee compensation determined under the
fair value-based method, net of related tax effects (433,000) (3,000)
------------ ------------
Pro forma net loss $ (1,719,000) $ (1,137,000)
============ ============
Loss per common share (basic and diluted):
As reported $ (0.07) $ (0.08)
============ ============
Pro forma $ (0.10) $ (0.08)
============ ============
The fair value of each option grant on the date of grant is estimated using the
Black-Scholes option-pricing utilizing the following weighted average
assumptions:
NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------
2005 2004
------------ ------------
Risk-free interest rates 3.95% 3.93%
Expected option life in years 3.00-7.00 3.00
Expected stock price volatility 220.65% 229.49%
Expected dividend yield 0.00% 0.00%
F-8
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
[5] REVENUE RECOGNITION:
The Company intends on recognizing 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. Under this guidance, 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.
[6] 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. Potential shares
of 11,267,244 for the three and nine month periods ending September 30, 2005 are
antidilutive and are not included in the calculation of diluted loss per share.
Potential shares of 6,053,104 for the three and nine month periods ending
September 30, 2004 are antidilutive and are not included in the calculation of
diluted loss per share. Such potential common shares reflect options and
warrants.
[7] CASH EQUIVALENTS:
The Company places cash investments in high quality financial institutions
insured by the Federal Deposit Insurance Corporation ("FDIC"). At September 30,
2005, the Company maintained cash balance of approximately $1,243,000 in one
financial institution.
NOTE B - AMENDED PATENT PURCHASE AGREEMENT
In November 2003, the Company acquired a portfolio of telecommunications and
data networking patents (six patents) from Merlot Communications, Inc.
("Merlot"). The purchase price for the Patent Portfolio was $100,000, paid in
cash. The cash price paid has been capitalized and is being amortized over the
remaining useful life of each patent. In addition, the Company has granted
Merlot a nonexclusive, royalty free, perpetual license for the term of each
patent to use the patents for the development, manufacture or sale of its own
branded products to end users. The Company had agreed to pay Merlot 20% of the
net income, as defined, after the first $4,000,000 of net income realized by the
Company on a per patent basis from the sale or licensing of the patents. On
January 18, 2005, the Company and Merlot amended the Patent Purchase Agreement
(the "Amendment") pursuant to which the Company paid additional purchase price
of $500,000 to Merlot in consideration for the restructuring of future
contingent payments to Merlot from the licensing or sale of the Patents. The
Amendment provides for future contingent payments by the Company to Merlot of
$1.0 million upon achievement of $25 million of Net Royalties (as defined), an
additional $1.0 million upon achievement of $50 million of Net Royalties and an
additional $500,000 upon achievement of $62.5 million of Net Royalties from
licensing or sale of the patents acquired from Merlot. Certain principal
stockholders of the Company and related parties are also principal stockholders
of Merlot and were also directors of Merlot at the time of the original
agreement in November 2003 and the Amendment. The Company has treated this
expenditure as an expense called Patent Costs for the nine months ended
September 30, 2005.
F-9
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE C - PRIVATE PLACEMENT
[1] On December 21, 2004, the Company completed the first closing of a private
placement of 2,085,000 shares of common stock and three-year warrants to
purchase 1,563,750 shares of common stock (warrants to purchase 1,042,500 shares
of common stock at an exercise price of $1.25 and warrants to purchase 521,250
shares of common stock at an exercise price of $1.75) for an aggregate purchase
price of $2,035,000, net of $50,000 issuance costs. On January 13, 2005, the
Company completed a second closing with respect to the private placement of
securities, which consisted of an additional 600,000 shares of common stock and
warrants to purchase an additional 450,000 shares of common stock for an
aggregate purchase price of $600,000. In connection with the private placement,
the Company paid to a finder $50,000 and issued to such finder warrants to
purchase 50,000 shares of common stock at an exercise price of $1.00 expiring in
December 2009. As part of the private placement, the Company filed a
registration statement on June 21, 2005, to register the common stock and the
shares issuable upon exercise of the warrants.
[2] In connection with the private placement and anti-dilutive provisions for
the warrants previously issued to Falconstor Software, Inc., the Company issued
warrants to purchase an aggregate of 135,000 additional shares of common stock
at an exercise price of $1.00 per share expiring in October 2006. The associated
expense, which is treated as an imputed dividend, is based on the fair value of
these warrants using the Black-Scholes model utilizing the risk-free interest
rate of 3.01%, life of 2 years, volatility of 270% and dividend yield of 0%.
Such expense was $6,000 and is included in the accompanying statement of
operations for the nine month period ended September 30, 2005.
NOTE D - 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., an entity
solely owned by Corey M. Horowitz, Chairman and Chief Executive Officer of the
Company, 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. The options vest over a three-year period in
equal amounts of 250,000 per year beginning April 18, 2003. In addition, the
options 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 were originally priced in the quarter ended June 30, 2002
at $416,000. Subsequently, they are revalued at each balance sheet date. On
April 18, 2003, 250,000 of these options vested, having a fair value of $5,000.
Accordingly, $5,000 was reallocated to additional paid-in capital with a
corresponding reduction to the liability. On April 18, 2004, 250,000 of these
options vested having a fair value of $51,000. Accordingly, $51,000 was
reallocated to additional paid-in-capital with a corresponding reduction to the
liability. On April 18, 2005 the remaining 250,000 options vested and were
revalued from $294,000 at December 31, 2004 to $262,000 which was then
reallocated to additional paid in capital. Any increase or decrease in the
valuation has been reflected as an addition or reduction of general and
administrative expenses at each balance sheet date.
F-10
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE E - EQUITY TRANSACTIONS
In August 2005, the Company renewed its arrangement with David C Kahn, CPA to
continue as its Chief Financial Officer on a consulting basis through December
31, 2006 and issued options to Mr. Kahn to purchase an aggregate of 75,000
shares of common stock, at an exercise price of $.80 per share, which vested
30,000 shares on the date of grant and the balance of 45,000 shares shall vest
in equal amounts of 7,500 shares on a quarterly basis beginning September 30,
2005 through December 31, 2006.
In September 2005, Laurent Ohana was elected to the Board of Directors and was
granted an option to purchase 50,000 shares, at an exercise price of $.80 per
share, which vest at the rate of 12,500 shares per quarter beginning December
16, 2005.
NOTE F - COMMITMENTS AND CONTINGENCIES
On November 30, 2004, the Company entered into a master services agreement (the
"Agreement") with ThinkFire Services USA, Ltd. ("ThinkFire") pursuant to which
ThinkFire has been granted the exclusive worldwide rights (except for direct
efforts by the Company and related companies) to negotiate license agreements
for the Remote Power Patent with respect to certain potential licensees agreed
to between the parties. Either the Company or ThinkFire can terminate the
Agreement upon 60 days' notice for any reason or upon 30 days' notice in the
event of a material breach. The Company has agreed to pay ThinkFire a fee not to
exceed 20% of the royalty payments received from license agreements consummated
by ThinkFire on its behalf.
NOTE G - EMPLOYMENT ARRANGEMENTS AND OTHER AGREEMENTS
On November 26, 2004, the Company entered into an employment agreement with
Corey M. Horowitz pursuant to which he agreed to continue to serve as Chairman
and Chief Executive Officer of the Company for a two-year term at an annual base
salary of $250,000 for the first year and $275,000 for the second year. Mr.
Horowitz was also issued options to purchase an aggregate of 1,500,000 shares of
the Company's common stock consisting of (i) a ten (10) year fully vested option
to purchase 1,100,000 shares at an exercise price of $0.25 per share, and (ii) a
five-year option to purchase 400,000 shares at an exercise price of $0.68 per
share which vested 50% on the date of grant and 50% one year thereafter, subject
to acceleration upon a change of control. In addition, Mr. Horowitz will receive
a bonus of 5% of the Company's royalties or other payments received from
licensing its patents. This bonus will continue to be paid to Mr. Horowitz for a
period of five (5) years following the term of the employment agreement with
respect to licenses entered into by the Company during the term of the
employment agreement, provided that he has not been terminated by the Company
"for cause" or by Mr. Horowitz himself without "good reason".
F-11
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE G - EMPLOYMENT ARRANGEMENTS AND OTHER AGREEMENTS: (CONTINUED)
Mr. Horowitz shall receive severance equal to 12 months base salary in the event
his employment is terminated "without cause" or by Mr. Horowitz for "good
reason".
Mr. Horowitz was also granted certain anti-dilution rights which provide that if
at any time during the period ending December 31, 2005, in the event that the
Company completes an offering of its common stock or any securities convertible
or exercisable into common stock, he will receive, at the same price as the
securities issued in the financing, such number of additional stock options so
that he maintains the derivative ownership percentage (20.11%) of the Company
based upon options and warrants owned by him and CMH (exclusive of his ownership
of shares of common stock) as he owned as of the date of his employment
agreement (November 26, 2004). As a result of the closings of the private
placement on December 31, 2004 and January 13, 2005 and in accordance with the
anti-dilution protection afforded to Mr. Horowitz in his employment agreement,
Mr. Horowitz earned seven year options to purchase an aggregate of 1,195,361
shares at an exercise price of $1.18 per share. The Company did not recognize
any compensation expense as the exercise price for these options exceeded the
market price.
NOTE H - LITIGATION
In March 2004, PowerDsine Inc. ("PowerDsine") commenced an action against the
Company in the United States 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 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. On December 1, 2004, the
Company moved to dismiss the declaratory judgment action asserting, among other
things, that there is no actual case or controversy because PowerDsine did not
have reasonable apprehension of suit at the time the case was filed, and
therefore the court lacks jurisdiction over the matter. On January 21, 2005, the
Company's motion to dismiss was denied. The Company is engaged in settlement
discussion with PowerDsine in an effort to resolve the litigation. In the event
the Company is unable to settle the litigation, the Company intends to
vigorously defend the action and take whatever actions are necessary to protect
its intellectual property. In the event, however, that the Court grants the
declaratory judgment and the Company's patent is determined to be invalid, such
a determination would have a material adverse effect on the Company.
F-12
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE H - LITIGATION (CONTINUED)
On August 10, 2005, the Company commenced 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 Remote Power Patent. The complaint seeks,
among other things, a judgment that the Remote Power Patent is duly enforceable
and has been infringed by the defendants. The Company also seeks a permanent
injunction restraining defendants from continued infringement, or active
inducement of infringement by others, of the Remote Power Patent. In the event
that the Court determines that the Company's Remote Power Patent was not valid
or enforceable, and/or that the defendants did not infringe, any such
determination would have a material adverse effect on the Company.
F-13
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Network-1 Security Solutions, Inc.
We have audited the accompanying balance sheets of Network-1 Security Solutions,
Inc. as of December 31, 2004 and 2003, and the related statements of operations,
stockholders' equity and cash flows for each of the years then ended. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements enumerated above present fairly, in all
material respects, the financial position of Network-1 Security Solutions, Inc.
as of December 31, 2004 and 2003, and the results of its operations and its cash
flows for each of the years then ended in conformity with accounting principles
generally accepted in the United States of America.
Eisner LLP
New York, New York
February 22, 2005
With respect to Notes B and C[9]
November 20, 2005
SEE NOTES TO FINANCIAL STATEMENTS F-14
NETWORK-1 SECURITY SOLUTIONS, INC.
BALANCE SHEETS
[Enlarge/Download Table]
DECEMBER 31,
------------------------------
2004 2003
------------ ------------
ASSETS
Current assets:
Cash and cash equivalents $ 2,177,000 $ 984,000
Prepaid expenses and other current assets 100,000 86,000
------------ ------------
Total current assets 2,277,000 1,070,000
Patents 92,000 99,000
------------ ------------
$ 2,369,000 $ 1,169,000
============ ============
LIABILITIES
Current liabilities:
Accounts payable $ 437,000 $ 78,000
Accrued expenses and other current liabilities 505,000 520,000
------------ ------------
Total current liabilities 942,000 598,000
Liability to be settled with equity instrument 294,000 54,000
Commitments and contingencies (Note E)
STOCKHOLDERS' EQUITY
Preferred stock - $.01 par value; 10,000,000 shares authorized; Series D -
convertible, voting, authorized 1,250,000 shares; 0 and 231,054
shares issued and outstanding at December 31, 2004 and 2003,
respectively; liquidation preference of $705,000 at December 31, 2003 2,000
Series E - convertible, authorized 3,500,000 shares; 0 and 2,483,508
shares issued and outstanding at December 31, 2004 and 2003,
respectively; liquidation preference of $5,265,000 at December 31, 2003 25,000
Common stock - $.01 par value; authorized 50,000,000 shares; 17,097,572
and 8,314,458 shares issued and outstanding at December 31, 2004 and
2003, respectively 171,000 83,000
Additional paid-in capital 43,951,000 41,443,000
Accumulated deficit (42,989,000) (41,036,000)
------------ ------------
1,133,000 517,000
------------ ------------
$ 2,369,000 $ 1,169,000
============ ============
SEE NOTES TO FINANCIAL STATEMENTS F-15
NETWORK-1 SECURITY SOLUTIONS, INC.
STATEMENTS OF OPERATIONS
[Enlarge/Download Table]
YEAR ENDED
DECEMBER 31,
------------------------------
2004 2003
------------ ------------
Operating expenses: AS RESTATED As restated
(See Note B) (See Note B)
General and administrative $ 1,956,000 595,000
------------ ------------
Operating Loss (1,956,000) (595,000)
Interest income 3,000 12,000
------------ ------------
Loss from continuing operations (1,953,000) (583,000)
Loss from discontinued operations (31,000)
------------
NET LOSS (1,953,000) (614,000)
------------
Deemed Dividend on Conversion of common to Preferred (273,000)
Deemed dividend on extension of warrants to preferred stockholders (1,179,000)
------------
Net loss attributable to common stockholders $ (3,405,000) $ (614,000)
============ ============
NET LOSS PER COMMON SHARE - BASIC AND DILUTED FROM CONTINUING OPERATIONS $ (0.26) $ (0.07)
============ ============
NET LOSS PER COMMON SHARE - BASIC AND FULLY DILUTED FROM DISCONTINUED
OPERATIONS $ (0.00)
$ (0.26) $ (0.07)
NET LOSS PER COMMON SHARE-BASIC AND DILUTED
WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING 13,184,551 8,314,458
============ ============
SEE NOTES TO FINANCIAL STATEMENTS F-16
NETWORK-1 SECURITY SOLUTIONS, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
[Enlarge/Download Table]
SERIES D CONVERTIBLE SERIES E CONVERTIBLE
PREFERRED STOCK PREFERRED STOCK COMMON STOCK
------------------------------ ------------------------------ ---------------------------
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
------------ ------------ ------------ ------------ ---------- ------------
BALANCE - DECEMBER 31, 2002 231,054 $ 2,000 2,483,508 $ 25,000 8,314,458 $ 83,000
Issuance of stock options to
consultants 5,000
Issuance of options for
compensation to an employee
director
Net loss
------------ ------------ ------------ ------------ ---------- ------------
BALANCE - DECEMBER 31, 2003 231,054 2,000 2,483,508 25,000 8,314,458 83,000
Conversion of Series D and E
preferred stock into common stock (231,054) (2,000) (2,483,508) (25,000) 6,698,114 67,000
Issuance of stock options to
consultants
Sale of common stock 2,085,000 21,000
Issuance of options for
services
Issuance of options to an
employee director
Extension of warrants issued
to preferred stockholders
Net loss
------------ ------------ ------------ ------------ ---------- ------------
BALANCE - DECEMBER 31, 2004 0 $ 0 0 $ 0 17,097,572 $ 171,000
============ ============ ============ ============ ========== ============
ADDITIONAL
PAID-IN ACCUMULATED
CAPITAL DEFICIT TOTAL
------------ ------------ ------------
BALANCE - DECEMBER 31, 2002 $ 41,397,000 $(40,422,000) $ 1,085,000
Issuance of stock options to
consultants 5,000
Issuance of options for
compensation to an employee
director 41,000 41,000
Net loss (614,000) (614,000)
------------ ------------ ------------
BALANCE - DECEMBER 31, 2003 41,443,000 (41,036,000) 517,000
Conversion of Series D and E
preferred stock into common stock (40,000) 0
Issuance of stock options to
consultants 51,000 51,000
Sale of common stock 2,014,000 2,035,000
Issuance of options for 61,000 61,000
services
Issuance of options to an
employee director 422,000 422,000
Extension of warrants issued
to preferred stockholders
Net loss (1,953,000) (1,953,000)
------------ ------------ ------------
BALANCE - DECEMBER 31, 2004 $ 43,951,000 $(42,989,000) $ 1,133,000
============ ============ ============
SEE NOTES TO FINANCIAL STATEMENTS F-17
NETWORK-1 SECURITY SOLUTIONS, INC.
STATEMENTS OF CASH FLOWS
[Enlarge/Download Table]
DECEMBER 31,
------------------------------
2004 2003
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (1,953,000) $ (614,000)
Adjustments to reconcile net loss to net cash used in operating activities:
Issuance of options to an employee director 422,000 41,000
Valuation adjustment for outstanding stock options 291,000 4,000
Issuance of options for services 61,000
Gain on sale of assets of discontinued operations (415,000)
Depreciation and amortization 7,000 23,000
Changes in:
Accounts receivable 6,000
Prepaid expenses and other current assets (14,000) 10,000
Security deposits 8,000
Accounts payable, accrued expenses and other current liabilities 344,000 (205,000)
Deferred revenue (218,000)
------------ ------------
Net cash used in operating activities (842,000) (1,360,000)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of patents (100,000)
Proceeds from sale of assets of discontinued operations 415,000
------------
Net cash provided by investing activities 315,000
------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from sale of common stock 2,085,000
Expenses in connection with issuance of common stock (50,000)
------------
Net cash provided by financing activities 2,035,000
------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 1,193,000 (1,045,000)
Cash and cash equivalents - beginning of year 984,000 2,029,000
------------ ------------
CASH AND CASH EQUIVALENTS - END OF YEAR $ 2,177,000 $ 984,000
============ ============
NON-CASH TRANSACTIONS:
Non-employee compensation paid with stock options $ 51,000 $ 5,000
SEE NOTES TO FINANCIAL STATEMENTS F-18
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
NOTE A - THE COMPANY
[1] Network-1 Security Solutions, Inc. (the "Company") is engaged in the
acquisition, licensing and protection of its intellectual property and
proprietary technologies. The Company owns six patents covering various
telecommunications and data networking technologies (the "Patent
Portfolio"). As part of its new business strategy following the
acquisition of the Patent Portfolio in November 2003, the Company offers
licenses to third parties for the technologies covered by its patents. In
February 2004, the Company initiated its licensing efforts relating to
its Patent Portfolio. As of December 31, 2004, the Company has not
entered into any licensing arrangements with respect to its Patent
Portfolio.
Prior to the acquisition of the Patent Portfolio, the Company's business
consisted of development, marketing, and licensing of network security
software products designed to provide comprehensive security to computer
networks. The Company also provided support, maintenance and training
services related to its software products. In December 2002, the Company
discontinued its software product line and associated operations, ceased
its product development and eliminated its sales and marketing efforts
and during May 2003, sold substantially all of its intellectual property
related to its security software. This is shown as discontinued
operations in 2003
[2] As reflected in the accompanying financial statements, the Company has
incurred substantial losses and has experienced net cash outflows from
operations. In 2004, the Company had no revenue from operations. The
Company will continue to have operating losses for the foreseeable future
until it is successful in licensing its patented technology. The Company
is dependent upon debt and equity financing until it generates cash flows
from operations. As discussed in Note E[2], the Company completed the
first closing of a private placement of its securities in December 2004.
As a result of such private placement, the Company has cash and cash
equivalents of $2,177,000 as of December 31, 2004.
Also, as discussed in Note M[1], in January 2005 the Company completed a
second closing of the private placement of its equity securities and
received a gross proceeds of $600,000. If necessary, the Company will
take further action which it believes is required to sustain its
operations for the next twelve months.
NOTE B - RESTATEMENT
The Company has restated its statements of operations for the years ended
December 31, 2004 and December 31, 2003, following comments received from the
staff (the "Staff") of the Division of Corporation Finance of the Securities and
Exchange Commission ("SEC") and the resulting discussions with the staff
pertaining to the Company's Annual Report on Form 10-KSB for the year ended
December 31, 2004 initially filed with the SEC on April 14, 2005.
As disclosed in Note E [1] pertaining to the Company's April 2004 exchange
transaction pursuant to which all holders the Company's outstanding Series E
convertible preferred stock ("Series E") and Series D convertible preferred
stock ("Series D") (collectively, the Series E and Series D, the "Preferred
Stock") exchanged their preferred shares for shares of common stock of the
Company (the "2004 Exchange Transaction"). 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 Staff
of the SEC commented on the Company's accounting of the 2004 Exchange
Transaction which included discussions concerning whether or not the Preferred
Stock contained a "beneficial conversion feature" which should be accounted for
under Emerging Issues Task Force Issue No. (EITF) 00-27 as a deemed dividend and
included in the net loss attributable to common stockholders and the per share
amounts.
F-19
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
NOTE B - RESTATEMENT (CONTINUED)
The Company has restated its statement of operations for the year ended December
31, 2004 to recognize a deemed dividend as a result of the beneficial conversion
feature in accordance with EITF 00-27 based upon the fair market value of the
common stock on the date of the closing of the 2004 Exchange Transaction. The
2004 Exchange Transaction resulted in the following changes to the statements of
operations for the year ended December 31, 2004:
o "Deemed Dividend on Preferred Stock Conversion" in the amount of
$273,000;
o an increase in the net loss attributable to common stockholders by
$273,000, to $3,405,000 from $3,132,000; and
o an increase in the net loss per common share to $(0.26) per share from
$(0.24) per share basic and diluted.
The effect of the restatement to recognize the deemed dividend on the amounts
previously reported in the Company's statements of operations included in the
Company's Form 10-KSB for the year ended December 31, 2004 are as follows:
Year Ended
December 31, 2004
------------------------------
As Previously
Reported As Restated
------------ ------------
STATEMENTS OF OPERATIONS:
Deemed Dividend on Preferred Stock Conversion -- $ 273,000
Net Loss attributable to common stockholders $ (3,132,000) $ (3,405,000)
Net Loss per common share: basic and diluted $ (0.24) $ (0.26)
The restatement had no effect on the Company's balance sheet as of December 31,
2004 and the statements of stockholder's equity and cash flows for the year then
ended.
In addition, following discussions with the Staff of the SEC pertaining to
comments relating to the Company's Annual Report on Form 10-KSB for the year
ended December 31, 2004, the Company also concluded that the financial
statements for the year ended December 31, 2003 should be restated to reclassify
the gain on sale of assets associated with the Company's software products in
May 2003 and expenses and revenues related to the software business as
discontinued operations in accordance with Statement of Financial Accounting
Standards (SFAS) No. 144. This reclassification has no effect on the net loss,
net loss attributable to common stockholders or net loss per common share -
basic and diluted.
In May 2003, the Company completed the sale of its software and related
intellectual property for $415,000 (the "2003 Asset Sale"). The carrying value
of these assets was written down to zero in the third quarter of 2002. The
Company previously recorded the $415,000 as "Gain on Sale of Assets" in its
statements of operations.
The change to reflect the 2003 Asset Sale and discontinued operations, resulted
in the following changes to the statement of operations for the year ended
December 31, 2003:
o "Gain on sale of assets" of $415,000 and revenues of $218,000, cost of
services of $51,000 and expenses of $613,000 were reclassified to
"Loss from discontinued operations" of $(31,000);
o General and administrated expenses were reduced from $1,208,000 to
$595,000 to include only such expenses from continuing operations;
o "Net Loss from continuing operations" of $(583,000) and "Loss from
discontinued operations" of $(31,000); and
o "Net Loss per common share - basic and diluted from continuing
operations" of $(0.07) and "Net Loss per common share basic and
diluted from discontinued operations" of $(0.00).
F-20
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
NOTE B - RESTATEMENT (CONTINUED)
The effect of the restatement of the 2003 Asset Sale and discontinued
operations, on the amounts previously included in the Company's statements of
operations for the year ended December 31, 2003 are as follows:
[Enlarge/Download Table]
Year Ended
December 31, 2003
------------------------------
As Previously
Reported As Restated
------------ ------------
STATEMENTS OF OPERATIONS:
Revenues:
Licenses $ 130,000 --
Services $ 88,000 --
Cost of Revenues:
Cost of services $ 51,000 --
Gross profit $ 167,000 --
Operating expenses - General and administrative $ 1,208,000 $ 595,000
Loss before interest income and gain on sale of assets $ (1,041,000) --
Operating Loss -- $ (595,000)
Gain on sale of assets $ 415,000 --
Net Loss from continuing operations -- $ (583,000)
Net Loss from discontinued operations -- $ (31,000)
Net Loss per common share - basic and diluted from continuing
operations -- $ (0.07)
Net Loss per common share - basic and diluted from discontinued
operations -- $ (0.00)
The restatement had no effect on the Company's balance sheet as of December 31,
2003 and the statement of stockholder's equity for the year then ended.
NOTE C - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
[1] CASH EQUIVALENTS:
The Company considers all highly liquid short-term investments purchased
with an original maturity of three months or less to be cash equivalents.
[2] REVENUE RECOGNITION:
License revenue is recognized upon delivery of software or delivery of a
required software key. License revenue from distributors or resellers is
recognized as the distributor or reseller delivers software or the
required software key to end users or original equipment manufacturers.
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 agreements.
F-21
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
NOTE C - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
[3] 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 of the patents.
[4] 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," intangible assets with finite lives are tested for impairment
whenever events or circumstances indicate that the carrying amount may
not be recoverable. Accordingly, 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 undiscounted cash flows expected
to be derived from those assets are less than carrying amounts of those
assets. During the years ended December 31, 2004 and 2003, there was no
impairment to its patents.
[5] INCOME TAXES:
The Company utilizes the liability method of accounting for income taxes.
Under such method, deferred tax assets and liabilities are recognized for
the future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and liabilities
and their respective tax bases. Deferred tax assets and liabilities are
measured using enacted tax rates in effect at the balance sheet date. The
resulting asset or liability is adjusted to reflect enacted changes in
tax law. Deferred tax assets are reduced, if necessary, by a valuation
allowance when the likelihood of realization is not assured.
[6] NET 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 year.
Diluted per share data includes the dilutive effects of options, warrants
and convertible securities. Potential common shares of 10,111,299 and
11,495,493 at December 31, 2004 and 2003, respectively, are not included
in the calculation of diluted loss per share because its effect will be
anti-dilutive. Such potential common shares are options, warrants,
convertible preferred stock and convertible notes.
[7] 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.
[8] FINANCIAL INSTRUMENTS:
The carrying amounts of cash and cash equivalents, accounts payable and
accrued expenses approximate their fair value due to the short period to
maturity of these instruments.
F-22
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
NOTE C - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
[9] 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 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:
[Download Table]
YEAR ENDED
DECEMBER 31,
------------------------------
2004 2003
------------ ------------
AS RESTATED
Reported net loss attributable to common
Stockholders $ (3,405,000) $ (614,000)
Stock-based employee compensation expense
included in reported net loss 422,000 41,000
Stock-based employee compensation
determined under the fair value-based method (1,744,000) (203,000)
------------ ------------
Pro forma net loss $ (4,727,000) $ (776,000)
============ ============
Net loss per common share (basic and diluted):
As reported $ (0.26) $ (0.07)
============ ============
Pro forma $ (0.36) $ (0.09)
============ ============
The fair value of options on the date of grant is estimated using the
Black-Scholes option-pricing model utilizing the following weighted
average assumptions:
[Download Table]
YEAR ENDED
DECEMBER 31,
-------------------------------------
2004 2003
--------------- ---------------
Risk-free interest rates 2.67 - 3.62% 2.74 - 5.07%
Expected option life in years 3.00 3.00
Expected stock price volatility 111.88 - 231.34% 113.75 - 229.03%
Expected dividend yield 0.00% 0.00%
The weighted average fair value on the option grant date during the years
ended December 31, 2004 and 2003 were $0.37 and $0.19 per option,
respectively.
F-23
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
NOTE C - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
[10] RECENTLY ISSUED ACCOUNTING STANDARDS:
In December 2004, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards No. 123R, "Share-Based
Payment" ("SFAS 123R"), which replaces SFAS No. 123, "Accounting for
Stock-Based Compensation," and supersedes APB Opinion No. 25, "Accounting
for Stock Issued to Employees." This statement requires all share-based
payments to employees be recognized in the financial statements based on
their fair values on the date of grant. The Company currently uses the
intrinsic value method to measure compensation expense for stock-based
awards which requires a pro forma net income and earnings per share
presentation as if the Company had used a fair-value based method
provided by SFAS 123 to measure stock-based compensation. The Company is
required to adopt SFAS 123R in the first quarter of 2006. The Company is
evaluating the requirements of SFAS 123R and expects that any future
issuance of options could upon its adoption have a material impact on the
Company's results of operations and earnings (loss) per share.
In November of 2004, the FASB issued SFAS No. 151, "Inventory Costs,"
which amends the guidance in ARB No. 43, Chapter 4, "Inventory Pricing,"
to clarify the accounting for abnormal amounts of idle facility expense,
freight, handling costs, and wasted material (spoilage). This statement
requires that those items be recognized as current-period charges
regardless of whether they meet the criterion of "so abnormal" as stated
in ARB No. 43. Additionally, SFAS 151 requires allocation of fixed
production overheads to the costs of conversion be based on the normal
capacity of the production facilities. The Company is required to adopt
the provision of SFAS No. 151 in the third quarter of 2006. The Company
does not expect SFAS 151 to have a material impact on its results of
operations or financial condition.
In December of 2004, the FASB issued SFAS No. 153, "Exchanges of
Nonmonetary Assets - An Amendment of APB Opinion No. 29 ("SFAS 153").
SFAS 153 eliminates the exception for nonmonetary exchanges of similar
productive assets and replaces it with a general exception for exchanges
of nonmonetary assets that do not have commercial substance. SFAS 153 is
effective for the fiscal periods beginning after June 15, 2005 and is
required to be adopted by the Company in the first quarter of 2006. The
Company does not expect that the adoption of SFAS 153 will have a
material impact on the Company's results of operations or financial
condition.
Financial Accounting Standards Board Interpretation No. 46,
"Consolidation of Variable Interest Entities" (FIN No. 46) was originally
issued in January 2003 and was subsequently revised in December 2003. FIN
No. 46 attempts to clarify the application of Accounting Research
Bulletin No. 51, Consolidated Financial Statements, to certain entities
in which equity investors do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk
for the entity to finance its activities without additional subordinated
financial support. The Company does not believe that it has any
involvement with variable interest entities that are required to be
consolidated under FIN No. 46.
NOTE D- PATENTS
In November 2003, the Company acquired a portfolio of telecommunications and
data networking patents (six patents) from Merlot Communications, Inc. (the
"Seller") in which certain principal stockholders of the Company owned a
majority of the Seller's voting stock at the time of the transaction. The
purchase price for the Patent Portfolio was $100,000, paid in cash. The cash
price paid has been capitalized and is being amortized over the remaining useful
life of each patent. In addition, the Company has granted the Seller a
nonexclusive, royalty free, perpetual license for the term of each patent to use
the patents for the development, manufacture or sale of its own branded products
to end users. The Company had agreed to pay the Seller 20% of the net income, as
defined, after the first $4,000,000 of net income realized by the Company on a
per patent basis from the sale or
F-24
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
NOTE D - PATENTS (CONTINUED)
licensing of the patents. The Company also has an option to terminate these
payments for each of the patents, commencing January 1, 2007 through March 31,
2007, and for each January 1 through March 31 period thereafter, by paying the
greater of: (i) two times the payment due for the 12 months immediately
following the notice of termination for each patent; or (ii) $3 million plus an
extra 10% for each additional year starting the fourth year after the closing of
the patent agreement for each patent. In January 2005, this agreement was
amended (see Note M[2]).
For the years ended December 31, 2004 and 2003, the Company has not derived any
income from sale or licensing of these patents.
Balance - January 1, 2003
Additions $ 100,000
Amortization (1,000)
Balance - December 31, 2003 99,000
Amortization (7,000)
Balance - December 31, 2004 $ 92,000
NOTE E - STOCKHOLDERS' EQUITY
[1] PREFERRED STOCK:
In April 2004, the Company entered into an exchange agreement with the
holders of all of the Company's outstanding shares of Series E ("Series
E") and Series D ("Series D") convertible preferred stock to exchange
2,483,508 shares of Series E for 6,208,770 shares of common stock and
231,054 shares of Series D for 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 Capital Management Corp. ("CMH") (1,084,935
of Series E shares), the wife of Corey M. Horowitz, 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). Upon
closing of the exchange agreement, there were no outstanding shares of
preferred stock. Corey M. Horowitz, Chairman and Chief Executive Officer
and a principal stockholder of the Company, is the sole owner and officer
of CMH.
[2] PRIVATE PLACEMENT:
On December 21, 2004, the Company completed a private placement of
2,085,000 shares of common stock and three-year warrants to purchase
1,563,750 shares of common stock (warrants to purchase 1,042,500 shares
of common stock at an exercise price of $1.25 and warrants to purchase
521,250 shares of common stock at an exercise price of $1.75) for an
aggregate purchase price of $2,035,000, net of $50,000 issuance costs.
The Company issued to a finder, warrants to purchase 50,000 shares of
common stock at an exercise price of $1.00 expiring in December 2009. As
part of the private placement, the Company agreed to file a registration
statement on or before June 21, 2005, to register the common stock and
the shares issuable upon exercise of the warrants.
In connection with the private placement and anti-dilutive provisions for
the warrants previously issued to Falconstor, the Company issued warrants
to purchase 128,713 additional shares of common stock at an exercise
price of $1.01 expiring in October 2006 (see Note I[3]). The associated
expense of $147,000, as an imputed dividend, is based on the fair value
of these warrants using the Black-Scholes model utilizing the risk-free
interest rate of 3.01%, life of 2 years, volatility of 270% and dividend
yield of 0% and is included in the accompanying statement of operations
for the year ended December 31, 2004.
F-25
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
NOTE E - STOCKHOLDERS' EQUITY (CONTINUED)
[3] STOCK OPTIONS:
During 1996, the Board of Directors and stockholders approved the
adoption of the 1996 Stock Option Plan (the "1996 Plan"). The 1996 Plan,
as amended, provides for the granting of both incentive and non-qualified
options to purchase common stock of the Company. A total of 4,000,000
shares are provided for under the 1996 Plan.
The term of options granted under the 1996 Plan may not exceed ten years
(five years in the case of an incentive stock option granted to an
employee/director owning more than 10% of the voting stock of the
Company) ("10% stockholder"). The option price for incentive stock
options cannot be less than 100% of the fair market value of the shares
of common stock at the time the option is granted (110% for a 10%
stockholder). Option terms and vesting periods are set by the
Compensation Committee in its discretion.
The following table summarizes stock option activity for the years ended
December 31:
[Enlarge/Download Table]
2004 2003
----------------------------- ---------------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
OPTIONS EXERCISE OPTIONS EXERCISE
OUTSTANDING PRICE OUTSTANDING PRICE
---------- ------- ---------- -------
Options outstanding at beginning
of year 3,272,370 $ 0.99 3,154,498 $ 2.25
Granted 2,365,628(c)(d) 0.62 1,860,000(a) 0.19
Cancelled/expired (1,742,128)(b) 2.42
---------- ----------
Options outstanding at end of year 5,637,998 0.84 3,272,370 0.99
========== ==========
Options exercisable at end of year 4,007,995 0.80 1,964,545 1.30
========== ==========
(a) Includes five-year options to purchase 1,600,000 shares of the
Company's common stock issued to Corey M. Horowitz, Chairman and
Chief Executive Officer, in connection with an agreement in December
2003 (see Note I[1]) as follows: (i) incentive stock options to
purchase 1,084,782 shares of common stock, at an exercise price of
$0.23 per share, of which 434,782 options vested immediately, 250,000
options vested on December 22, 2004 and 200,000 options each vest on
December 22, 2005 and December 22, 2006 and (ii) non-qualified stock
options to purchase 515,218 shares of common stock, at an exercise
price of $0.13 per share, which vested immediately. The Company
recognized $41,000 of expense in 2003 related to the 515,218 options
representing the difference between the exercise price of the options
and the market price on the date of grant.
(b) Includes ten-year options to purchase 1,200,000 shares of the
Company's common stock at an exercise price of $1.65 per share issued
in March 2002, in connection with a two-year employment agreement
with Richard J. Kosinski, as Chief Executive Officer and President.
In July 2003, all of these options issued were forfeited in
connection with the settlement of a lawsuit by Mr. Kosinski against
the Company.
(c) Includes options issued to Mr. Horowitz with respect to his two-year
employment agreement entered into with the Company in November 2004,
to purchase an aggregate of 1,500,000 shares of common stock
consisting of (i) ten-year non-qualified options to purchase
1,100,000 shares at an exercise price of $0.25 per share fully vested
on the date of grant and (ii) five-year incentive stock options to
purchase 400,000 shares at an exercise price of $0.68 per share which
vested 50% on the date of grant and 50% one year thereafter, subject
to acceleration upon a change of control (see Note J[3]). The Company
recognized $407,000 of expense in 2004 related to the 1,100,000
options representing the difference between the exercise price of the
option and the market price on the date of grant. The Company did not
recognize compensation expense for 400,000 options as the exercise
price exceeded the market price on the date of grant.
F-26
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
NOTE E - STOCKHOLDERS' EQUITY (CONTINUED)
[3] STOCK OPTIONS: (CONTINUED)
(d) Includes 745,628 stock options to be issued to Mr. Horowitz (Note
J[3]). The Company recognized $15,000 of expense in 2004 related to
these options representing the difference between the exercise price
and the market price.
(e) The following table presents information relating to all stock
options outstanding and exercisable at December 31, 2004:
[Download Table]
WEIGHTED
WEIGHTED AVERAGE WEIGHTED
RANGE OF AVERAGE REMAINING AVERAGE
EXERCISE OPTIONS EXERCISE LIFE IN OPTIONS EXERCISE
PRICE OUTSTANDING PRICE YEARS EXERCISABLE PRICE
----- ----------- ----- ----- ----------- -----
$0.12 - $2.91 5,322,273 $ 0.60 8.12 3,765,445 $ 0.48
$3.00 - $3.75 146,625 3.44 5.55 112,250 3.56
$4.13 - $5.69 69,600 5.17 5.09 30,800 5.16
$6.00 - $6.88 89,500 6.22 4.49 89,500 6.22
$10.00 - $10.13 10,000 10.00 5.25 10,000 10.00
---------- ----------
5,637,998 0.84 7.95 4,007,995 0.80
========== ==========
On April 18, 2002, in consideration of additional consulting and
financial advisory services, the Company issued to CMH an option to
purchase 750,000 shares of the common stock at an exercise price of $1.20
per share, which was the market price of the Company's common stock on
the date of issuance. The options vest over a three-year period in equal
amounts of 250,000 per year beginning April 18, 2003. In addition, the
options 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 were originally priced in the
quarter ended June 30, 2002 at $416,000. Subsequently, they are revalued
at each balance sheet date. On April 18, 2003, 250,000 of these options
vested, having a fair value of $5,000. Accordingly, $5,000 was
reallocated to additional paid-in capital with a corresponding reduction
to the liability. On April 18, 2004, 250,000 of these options vested
having a fair value of $51,000. Accordingly, $51,000 was reallocated to
additional paid-in-capital with a corresponding reduction to the
liability. The options to purchase the remaining 250,000 shares continue
to be treated as contingent options and are valued utilizing the
Black-Scholes option-pricing model at each balance sheet date. At
December 31, 2004, the 250,000 unvested options were valued at $294,000.
Any increase or decrease in the valuation has been reflected as an
addition or reduction of general and administrative expenses at each
balance sheet date.
F-27
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
NOTE E - STOCKHOLDERS' EQUITY (CONTINUED)
[4] WARRANTS:
As of December 31, 2004, the following are the outstanding warrants to
purchase shares of the Company's common stock:
NUMBER
OF EXERCISE
WARRANTS PRICE EXPIRATION DATE
-------- ----- ---------------
100,104 $ 6.44 March 14, 2006 - February 24, 2007
93,120 9.66 March 14, 2006
300,000 0.70 July 11, 2011 (a)
250,000 1.48 October 8, 2006 (a)
1,245,972 1.11 December 22, 2005 (b)
106,180 1.00 December 22, 2005 (b)
628,713 1.01 October 2, 2006 (c)
66,621 2.03 April 13, 2006 (d)
64,352 2.00 July 2, 2006 (d)
4,489 2.10 October 1, 2006 (d)
1,042,500 1.25 December 21, 2007 (e)
521,250 1.75 December 21, 2007 (e)
50,000 1.00 December 21, 2009 (e)
----------
4,473,301
==========
(a) Issued to CMH in 2001, a company owned by the Chairman and Chief
Executive Officer.
(b) Issued in connection with Series D preferred stock and notes in
December 1999. As a result of private placement in December 2004, the
warrant holders were entitled to additional warrants under
antidilutive provisions. However, in lieu of such additional
warrants, the Company and the warrant holders agreed to extend the
term of the 1,352,152 warrants for an additional year until December
22, 2005. The associated expense in connection with the extension of
these warrants is shown as an imputed dividend in the accompanying
statement of operations for the year ended December 31, 2004.
(c) Issued in 2001 private offering of Series E preferred stock.
(d) Issued to a software development company for services rendered (see
Note F[4]).
(e) Issued in connection with 2004 private offering of common stock (see
Note E[2]).
NOTE F - COMMITMENTS AND CONTINGENCIES
[1] SERVICES AGREEMENT:
On November 30, 2004, the Company entered into a master services
agreement (the "Agreement") with ThinkFire Services USA, Ltd.
("ThinkFire") pursuant to which ThinkFire has been granted the exclusive
worldwide rights (except for direct efforts by the Company and related
companies) to negotiate license agreements for the Remote Power Patent
with respect to certain potential licensees agreed to between the
parties. Either the Company or ThinkFire can terminate the Agreement upon
60 days' notice for any reason or upon 30 days' notice in the event of a
material breach. The Company has agreed to pay ThinkFire a fee not to
exceed 20% of the royalty payments received from license agreements
consummated by ThinkFire on its behalf.
F-28
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
NOTE F - COMMITMENTS AND CONTINGENCIES (CONTINUED)
[2] OPERATING LEASES:
The Company leases its principal office space in New York City at a
monthly rent of $3,000.
Rental expense for the years ended December 31, 2004 and 2003 aggregated
$36,000 and $42,000, respectively (see Note I[1]).
[3] SAVINGS AND INVESTMENT PLAN:
The Company has a Savings and Investment Plan which allows participants
to make contributions by salary reduction pursuant to Section 401(k) of
the Internal Revenue Code of 1986. The Company also may make
discretionary annual matching contributions in amounts determined by the
Board of Directors, subject to statutory limits. The Company did not make
any contributions to the 401(k) Plan during the years ended December 31,
2004 and 2003.
[4] SOFTWARE DEVELOPMENT CONTRACT DISPUTE:
The Company has a dispute with a software development company pertaining
to the number of warrants the Company is required to issue for services
rendered. The software development company has claimed they are entitled
to approximately 325,000 additional warrants than the Company has
included in the warrants outstanding in Note E[4]. The Company has
included in accrued expenses any additional liability it reasonably
expects to incur regarding this matter.
NOTE G - INCOME TAXES
At December 31, 2004, the Company has available net operating loss carryforwards
to reduce future federal taxable income of approximately $32,464,000 for tax
reporting purposes, which expire from 2009 through 2024. Pursuant to the
provisions of the Internal Revenue Code, future utilization of these past losses
is subject to certain limitations based on changes in the ownership of the
Company's stock that have occurred.
The principal components of the net deferred tax assets are as follows:
[Enlarge/Download Table]
YEAR ENDED
DECEMBER 31,
------------------------------
2004 2003
------------ ------------
Deferred tax assets:
Net operating loss carryforwards $ 12,174,000 $ 11,687,000
Options and warrants not yet deducted, for tax purposes 947,000 676,000
Other 126,000 146,000
------------ ------------
13,247,000 12,509,000
Valuation allowance (13,247,000) (12,509,000)
------------ ------------
Net deferred tax assets $ 0 $ 0
============ ============
The Company has recorded a valuation allowance for the full amount of its
deferred tax assets as the likelihood of the future realization cannot be
presently determined. The valuation allowance increased by $738,000 in 2004 and
$230,000 in 2003.
F-29
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
NOTE G - INCOME TAXES (CONTINUED)
The reconciliation between the taxes as shown and the amount that would be
computed by applying the statutory federal income tax rate to the loss before
income taxes is as follows:
YEAR ENDED
DECEMBER 31,
-------------------
2004 2003
------ ------
Income tax benefit - statutory rate (34.0)% (34.0)%
State and local, net (3.5)% (3.5)%
Valuation allowance on deferred tax assets 37.5 % 37.5 %
NOTE H - CONCENTRATIONS
The Company places its cash investments in high quality financial institutions
insured by the Federal Deposit Insurance Corporation ("FDIC"). At December 31,
2004, the Company maintained cash balances of $2,077,000 in excess of FDIC
limits.
NOTE I - RELATED PARTY TRANSACTIONS
[1] In November 2004, the Company entered into a two-year employment
agreement with Corey M. Horowitz to continue to serve as Chairman and
Chief Executive Officer at a base salary of $250,000 for the first year
and $275,000 for the second year (see Note J[3]).
During the year ended December 31, 2003, the Company paid CMH a monthly
fee of $17,500 in consideration for financial advisory and consulting
services rendered. Corey M. Horowitz, Chairman, Chief Executive Officer,
and a principal stockholder of the Company, is the sole officer, director
and stockholder of CMH. In addition, in connection with such financial
advisory and consulting services, CMH was reimbursed for expenses in 2003
in the amount of $41,000, including the allocated portion of rent for
office space in New York City. In December 2003, the Company employed Mr.
Horowitz as Chief Executive Officer at an annual salary of $210,000 at
which time CMH no longer provided financial and advisory services to the
Company. In addition, Mr. Horowitz received options to purchase 1,600,000
shares of common stock (see Note E[3](a)).
[2] In April 2004, the Company entered into an exchange agreement with the
holders of all of the Company's outstanding shares of Series E and Series
D convertible preferred stock to convert 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 (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). Upon closing of the
agreement, there were no outstanding shares of preferred stock. As a
result of this transaction the Company has imputed a dividend in the
amount of $ 273,000.
[3] The Company entered into a ten-year License and Distribution Agreement
with Falconstor (the "Falconstor Agreement"), an investor in the
Company's financing in 2001. This agreement required Falconstor to pay
royalties after utilizing a non-refundable advance paid by them to the
Company as a credit. On May 30, 2003, as part of the Company's sale of a
portion of its assets, the Company assigned its rights under the
Falconstor Agreement to the Purchaser of its software (Note K) and
recognized as income the balance of the deferred revenue of $130,000 in
2003. Two of the Company's principal stockholders were also principal
stockholders of Falconstor.
F-30
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
NOTE I - RELATED PARTY TRANSACTIONS AND RELATIONSHIPS (CONTINUED)
[4] On December 21, 2004, the Company extended the exercise period for the
1999 Warrants by an additional year until December 22, 2005. The 1999
Warrants were originally issued as part of a private offering completed
by the Company in December 1999. In connection with the extension of
those warrants, the change in fair value of $1,032,000 using the
Black-Scholes model utilizing the risk-free interest rate of 2.67%, life
of 1 year, volatility of 174% and dividend yield of 0% was recorded as a
deemed dividend in 2004. Corey M. Horowitz, Chairman and Chief Executive
Officer of the Company, owns 85,220 warrants of the 1999 Warrants.
[5] On December 21, 2004, the Company completed a private placement of
2,085,000 shares of common stock and three year warrants to purchase
1,563,750 shares of common stock for an aggregate purchase price of
$2,035,000, net of $50,000 in issuance costs. An investor in the above
private placement (100,000 shares of common stock and warrants to
purchase 75,000 shares of common stock) is a director of the Company.
NOTE J - EMPLOYMENT ARRANGEMENTS AND OTHER AGREEMENTS
[1] On December 22, 2003, the Company entered into an arrangement with Corey
M. Horowitz to serve as the Chairman and Chief Executive Officer of the
Company. At the time, the Company agreed to pay a salary of $210,000. In
addition, Mr. Horowitz received options to purchase 1,600,000 shares of
common stock (see Note E[3](a)).
[2] In January 2004, the Company entered into an agreement with an individual
to serve as the Company's Chief Financial Officer ("CFO"). The agreement
expired on December 31, 2004 and provided for a base salary of $5,500 per
month for the period January 22, 2004 through April 30, 2004, $4,500 per
month for the period May 1, 2004 through August 31, 2004 and $3,500 per
month from September 1, 2004 through December 31, 2004. In connection
with his agreement, the CFO received options to purchase 50,000 shares of
common stock of the Company at $0.35 per share under the Company's stock
option plan, at the fair market value of the shares on the date of the
grant. 20,000 of these options vested immediately and the balance vested
on a monthly basis through December 31, 2004. The Company is in process
of negotiating a new agreement with the CFO.
[3] On November 26, 2004, the Company entered into an employment agreement
with Corey M. Horowitz pursuant to which he agreed to continue to serve
as Chairman and Chief Executive Officer of the Company for a two-year
term at an annual base salary of $250,000 for the first year and $275,000
for the second year. Mr. Horowitz was also issued options to purchase an
aggregate of 1,500,000 shares of the Company's common stock consisting of
(i) a ten (10) year fully vested option to purchase 1,100,000 shares at
an exercise price of $0.25 per share, and (ii) a five-year option to
purchase 400,000 shares at an exercise price of $0.68 per share which
vested 50% on the date of grant and 50% one year thereafter, subject to
acceleration upon a change of control (see Note E[3](c)). In addition,
Mr. Horowitz will receive a bonus of 5% of the Company's royalties or
other payments received from licensing its patents. This bonus will
continue to be paid to Mr. Horowitz for a period of five (5) years
following the term of the employment agreement with respect to licenses
entered into by the Company during the term of the employment agreement,
provided that he has not been terminated by the Company "for cause" or by
Mr. Horowitz himself without "good reason". Mr. Horowitz shall receive
severance equal to 12 months base salary in the event his employment is
terminated "without cause" or by Mr. Horowitz for "good reason". Mr.
Horowitz was also granted certain anti-dilution rights which provide that
if at any time during the period ending December 31, 2005, in the event
that the Company completes an offering of its common stock or any
securities convertible or exercisable into common stock, he will receive,
at the same price as the securities issued in the financing, such number
of additional stock options so that he maintains the same ownership
percentage of (20.11%) of the Company based upon options and warrants
owned by him and CMH (exclusive of his ownership of shares of common
stock) as he owned as of November 26, 2004. As a result of the closings
of the private placement on December 31, 2004 and January 13, 2005 and in
accordance with the anti-dilution protection afforded to Mr. Horowitz in
his employment agreement, Mr. Horowitz earned
F-31
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
NOTE J - EMPLOYMENT ARRANGEMENTS AND OTHER AGREEMENTS (CONTINUED)
[3] (continued)
seven year options to purchase an aggregate of 960,197 shares at an
exercise price of $1.18 per share, consisting of an option to purchase
745,628 shares as a result of first closing on December 21, 2004 and an
option to purchase 214,569 shares as a result of second closing of the
private placement on January 13, 2005 (see Notes E[3](e) and M[3]).
NOTE K - DISCONTINUED OPERATIONS
On May 30, 2003, the Company completed the sale of its CyberwallPlus technology
and related intellectual property and assignment of its rights under the
Falconstar Agreement for aggregate proceeds of $415,000. The carrying value of
these assets was written down to zero in the third quarter of 2002. The gain
from the sale of assets have been shown as a reduction of the loss from
discontinued operations
NOTE L - 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. On December 1, 2004, the Company moved to dismiss the declaratory
judgment action asserting, among other things, that there is no actual case or
controversy because PowerDsine did not have reasonable apprehension of suit at
the time the case was filed, and therefore the court lacks jurisdiction over the
matter. On January 21, 2005, the Company's motion to dismiss was denied. The
Company intends to vigorously defend the action and take whatever actions are
necessary to protect its intellectual property. In the event, however, that the
Court grants the declaratory judgment and the Company's patent is determined to
be invalid, such a determination would have a material adverse effect on the
Company.
NOTE M - SUBSEQUENT EVENTS
[1] On January 13, 2005, the Company completed a second closing with respect
to a private placement of securities (see Note E[2]), which consisted of
an additional 600,000 shares of common stock and warrants to purchase an
additional 450,000 shares of common stock for an aggregate purchase price
of $600,000.
[2] On January 18, 2005, the Company and Merlot Communications, Inc.
("Merlot") entered into an amendment to the Patent Purchase Agreement
(the "Amendment") pursuant to which the Company paid $500,000 to Merlot
in consideration for the restructuring of future contingent payments to
Merlot from the licensing or sale of the Patents. The Amendment provides
for future contingent payments by the Company to Merlot of $1.0 million
upon achievement of $25 million of Net Royalties (as defined), an
additional $1.0 million upon achievement of $50 million of Net Royalties
and an additional $500,000 upon achievement of $62.5 million of Net
Royalties from licensing or sale of the patents acquired from Merlot.
Certain principal officers/directors stockholders of the Company owned a
majority of the outstanding voting stock of Merlot and were also
directors of Merlot at the time of the Amendment.
F-32
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003
NOTE M - SUBSEQUENT EVENTS (CONTINUED)
[3] On January 13, 2005, pursuant to the anti-dilution provisions of his
employment agreement (see Note J[3]), Corey M. Horowitz, Chairman and
Chief Executive Officer of the Company, earned an additional seven-year
option to purchase 214,569 shares of common stock, at an exercise price
of $1.18 per share, as a result of the Company's completion of a private
offering of its securities. The Company did not recognize any
compensation expense as the exercise price for these options exceeded the
market price.
F-33
NETWORK-1 SECURITY SOLUTIONS, INC.
16,886,267 SHARES
OF
COMMON STOCK
------------------
PROSPECTUS
-----------------
NOVEMBER __, 2005
YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED IN THIS PROSPECTUS. NO DEALER,
SALESPERSON OR OTHER PERSON IS AUTHORIZED TO GIVE INFORMATION THAT IS NOT
CONTAINED IN THIS PROSPECTUS. THIS PROSPECTUS IS NOT AN OFFER TO SELL NOR IS IT
SEEKING AN OFFER TO BUY THESE SECURITIES IN ANY JURISDICTION WHERE THE OFFER OR
SALE IS NOT PERMITTED. THE INFORMATION CONTAINED IN THIS PROSPECTUS IS CORRECT
ONLY AS OF THE DATE OF THIS PROSPECTUS, REGARDLESS OF THE TIME OF THE DELIVERY
OF THIS PROSPECTUS OR ANY SALE OF THESE SECURITIES.
PART II.
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 14. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
The following table sets forth the expenses in connection with the offering
described in the Registration Statement, all of which will be borne by the
Company.
SEC registration fee....................................... $ 1,450.89
Legal fees and expenses*................................... $ 25,000.00
Accounting fees and expenses*.............................. $ 2,500.00
Miscellaneous expenses*.................................... $ 1,000.00
-----------
TOTAL.................................... $29,950.89
==========
* Estimated.
ITEM 15. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Section 145 of the Delaware General Corporations Law (the "DGCL") contains
provisions entitling the Company's directors and officers to indemnification
from judgments, fines, amounts paid in settlement, and reasonable expenses
(including attorneys' fees) as the result of an action or proceeding in which
they may be involved by reason of having been a director or officer of the
Company. In its Certificate of Incorporation, the Company has included a
provision that limits, to the fullest extent now or hereafter permitted by the
DGCL, the personal liability of its directors to the Company or its stockholders
for monetary damages arising from a breach of their fiduciary duties as
directors. Under the DGCL as currently in effect, this provision limits a
director's liability except where such director (i) breaches his duty of loyalty
to the Company or its stockholders, (ii) fails to act in good faith or engages
in intentional misconduct or a knowing violation of law, (iii) authorizes
payment of an unlawful dividend or stock purchase or redemption as provided in
Section 174 of the DGCL, or (iv) obtains an improper personal benefit. This
provision does not prevent the Company or its stockholders from seeking
equitable remedies, such as injunctive relief or rescission. If equitable
remedies are found not to be available to stockholders in any particular case,
stockholders may not have any effective remedy against actions taken by
directors that constitute negligence or gross negligence.
The Certificate of Incorporation also includes provisions to the effect
that (subject to certain exceptions) the Company shall, to the maximum extent
permitted from time to time under the law of the State of Delaware, indemnify,
and upon request shall advance expenses to, any director or officer to the
extent that such indemnification and advancement of expenses is permitted under
such law, as it may from time to time be in effect. In addition, the Bylaws
require the Company to
II-1
indemnify, to the full extent permitted by law, any director, office, employee
or agent of the Company for acts which such person reasonably believes are not
in violation of the Company's corporate purposes as set forth in the Certificate
of Incorporation. At present, the DGCL provides that, in order to be entitled to
indemnification, an individual must have acted in good faith and in a manner he
or she reasonably believed to be in or not opposed to the Company's best
interests.
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers and controlling persons of the Company
pursuant to any charter, provision, by-law, contract, arrangement, statute or
otherwise, the Company has been advised that in the opinion of the Securities
and Exchange Commission such indemnification is against public policy as
expressed in the Securities Act and is, therefore, unenforceable.
ITEM 16. EXHIBITS
NO. DESCRIPTION
--- -----------
4.1 Form of Warrant, dated December 21, 2004, issued to certain investors
pursuant to the Securities Purchase Agreement, dated December 21, 2004,
between the Company and the investors listed therein. Previously filed as
an exhibit to Exhibit 10.1 to the Current Report on Form 8-K filed on
December 28, 2004.
4.2 Form of Warrant, dated January 13, 2005, issued to certain investors
pursuant to the Securities Purchase Agreement, dated January 13, 2005,
between the Company the investors listed therein. Previously filed as an
exhibit to Exhibit 10.2 to the Current Report on Form 8-K filed January 20,
2005, and incorporated herein by reference.
4.3 Form of Warrant, dated December 22, 1999, issued by the Company to the
holder listed thereon. Previously filed as Exhibit B to Exhibit 10.28 to
the Form 8-K filed January 4, 2000, and incorporated herein by reference.
4.4 Form of Warrant issued by the Company for services rendered. Previously
filed as Exhibit 4.3 to the Form S-3 Registration Statement (Registration
No. 333-96189) declared effective by the SEC on March 21, 2000.
5.1 Opinion of Eiseman Levine Lehrhaupt & Kakoyiannis, P.C. regarding legality
of securities being registered.
23.1 Consent of Eisner LLP, independent registered public accounting firm.*
23.2 Consent of Eiseman Levine Lehrhaupt & Kakoyiannis, P.C. (included within
Exhibit 5.1).
24.1 No person has signed this Registration Statement under a power of attorney.
A power of attorney relating to the signing of amendments hereto is
incorporated in the signature page hereof.
------------------
* amended filing herewith.
II-2
ITEM 17. UNDERTAKINGS
(1) The undersigned Registrant hereby undertakes that it will:
(a) File, during any period in which offers or sales are being made, a
post-effective amendment to this Registration Statement to:
(i) Include any prospectus required by Section 10(a)(3) of the
Securities Act;
(ii) Reflect in the prospectus any facts or events which,
individually or together, represent a fundamental change in the information in
the registration statement. Notwithstanding the foregoing, any increase or
decrease in volume of securities offered (if the total dollar value of
securities offered would not exceed that which was registered) and any deviation
from the low or high end of the estimated maximum offering range may be
reflected in the form of prospectus filed with the Commission pursuant to Rule
424(b) if, in the aggregate, the changes in volume and price represent no more
than a 20 percent change in the maximum aggregate offering price set forth in
the "Calculation of Registration Fee" table in the effective registration
statement;
(iii) Include any additional or changed material information on
the plan of distribution.
(b) For determining liability under the Securities Act, treat each
post-effective amendment as a new Registration Statement of the securities
offered, and the offering of securities at that time to be the initial BONA FIDE
offering.
(c) File a post-effective amendment to remove from registration any of
the securities that remain unsold at the end of this offering.
(2) The undersigned Registrant hereby undertakes that, for purposes of
determining any liability under the Securities Act of 1933, each filing of the
registrant's annual report pursuant to Section 13(a) or 15(d) of the Securities
Exchange Act of 1934(and, where applicable, each filing of an employee benefit
plan's annual report pursuant to Section 15(d) of the Securities Exchange Act of
1934) that is incorporated by reference in the registration statement shall be
deemed to be a new registration statement relating to the securities offered
therein, and the offering of such securities at that time shall be deemed to be
the initial BONA FIDE offering thereof.
(2) Insofar as indemnification for liabilities arising under the Securities
Act may be permitted to directors, officers and controlling persons of the
Registrant, pursuant to the foregoing provisions, or otherwise, the Registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Securities
II-3
Act and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
Registrant of expenses incurred or paid by a director, officer or controlling
person of the registrant in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the registrant will, unless in
the opinion of its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the Securities
Act and will be governed by the final adjudication of such issue.
II-4
SIGNATURES
----------
Pursuant to the requirements of the Securities Act of 1933, the Registrant
certifies that it has reasonable grounds to believe that it meets all of the
requirements for filing on Form S-2 and has duly caused this Registration
Statement to be signed on its behalf by the undersigned, thereunto duly
authorized, in the City of New York, State of New York.
Dated: November 23, 2005
NETWORK-1 SECURITY SOLUTIONS, INC.
By: /s/ Corey M. Horowitz
---------------------------------
Corey M. Horowitz, Chairman and
Chief Executive Officer
KNOW ALL MEN BY THESE PRESENTS, that each director and officer whose
signature appears below constitutes and appoints Corey M. Horowitz his true and
lawful attorney-in-fact and agent, with full power and substitution and
re-substitution, to sign in any and all capacities any and all amendments or
post-effective amendments to this Registration Statement on Form S-2 and to file
the same with all exhibits thereto and other documents in connection therewith
with the Securities and Exchange Commission, granting to such attorney-in-fact
and agent, full power and authority to do all such other acts and execute all
such other documents as he may deem necessary or desirable in connection with
the foregoing, as fully as the undersigned might or could do in person, hereby
ratifying and confirming all that such attorney-in-fact and agent may lawfully
do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed by the following persons in the
capacities and on the dates indicated:
Signature Title Date
/s/ Corey M. Horowitz Chairman and Chief Executive November 23, 2005
----------------------- Officer (principal executive
Corey M. Horowitz officer)
/s/ David C. Kahn Chief Financial Officer November 23, 2005
----------------------- (principal financial and
David C. Kahn accounting officer)
/s/ Robert Graifman Director November 23, 2005
-----------------------
Robert Graifman
/s/ Robert Pons Director November 23, 2005
-----------------------
Robert Pons
/s/ Harry Schessel Director November 23, 2005
-----------------------
Harry Schessel
II-5
INDEX TO EXHIBITS
NO. DESCRIPTION
4.1 Form of Warrant, dated December 21, 2004, issued to certain investors
pursuant to the Securities Purchase Agreement, dated December 21, 2004,
between the Company and the investors listed therein. Previously filed as
an exhibit to Exhibit 10.1 to the Current Report on Form 8-K filed on
December 28, 2004.
4.2 Form of Warrant, dated January 13, 2005, issued to certain investors
pursuant to the Securities Purchase Agreement, dated January 13, 2005,
between the Company the investors listed therein. Previously filed as an
exhibit to Exhibit 10.2 to the Current Report on Form 8-K filed January 20,
2005, and incorporated herein by reference.
4.3 Form of Warrant, dated December 22, 1999, issued by the Company to the
holder listed thereon. Previously filed as Exhibit B to Exhibit 10.28 to
the Form 8-K filed January 4, 2000, and incorporated herein by reference.
4.4 Form of Warrant issued by the Company for services rendered. Previously
filed as Exhibit 4.3 to the Form S-3 Registration Statement (Registration
No. 333-96189) declared effective by the SEC on March 21, 2000.
5.1 Opinion of Eiseman Levine Lehrhaupt & Kakoyiannis, P.C. regarding legality
of securities being registered.
23.1 Consent of Eisner LLP, independent registered public accounting firm.*
23.2 Consent of Eiseman Levine Lehrhaupt & Kakoyiannis, P.C. (included within
Exhibit 5.1).
24.1 No person has signed this Registration Statement under a power of attorney.
A power of attorney relating to the signing of amendments hereto is
incorporated in the signature page hereof.
------------------
* amended filing herewith.
II-6
Dates Referenced Herein and Documents Incorporated by Reference
| Referenced-On Page |
|---|
| This ‘S-2/A’ Filing | | Date | | First | | Last | | | Other Filings |
|---|
| |  |
| | 3/7/20 | | 6 | | 37 |
| | 7/11/11 | | 70 |
| | 12/21/09 | | 70 |
| | 12/21/07 | | 70 | | | | | 5 |
| | 3/31/07 | | 67 | | | | | 10QSB |
| | 2/24/07 | | 70 |
| | 1/1/07 | | 67 |
| | 12/31/06 | | 53 | | | | | 10KSB, NT 10-K |
| | 12/22/06 | | 68 | | | | | 4, 424B3, 8-K |
| | 10/8/06 | | 70 |
| | 10/2/06 | | 70 |
| | 10/1/06 | | 70 |
| | 7/2/06 | | 70 |
| | 4/30/06 | | 7 |
| | 4/13/06 | | 70 |
| | 3/14/06 | | 70 |
| | 12/31/05 | | 8 | | 73 | | | 10KSB, 5, NT 10-K |
| | 12/22/05 | | 68 | | 73 | | | CORRESP, UPLOAD |
| | 12/16/05 | | 53 |
| Filed on: | | 11/23/05 | | 1 | | 81 | | | 10KSB/A |
| | 11/21/05 | | 3 | | 32 |
| | 11/20/05 | | 56 |
| | 11/18/05 | | 15 | | | | | 10QSB/A |
| | 11/17/05 | | 7 | | 32 | | | 8-K |
| | 11/16/05 | | 7 | | | | | 8-K |
| | 11/15/05 | | 6 | | 17 | | | 8-K, NT 10-Q |
| | 11/1/05 | | 37 | | 41 |
| | 9/30/05 | | 9 | | 53 | | | 10QSB, NT 10-Q |
| | 9/22/05 | | 15 | | | | | 8-K |
| | 9/8/05 | | 8 |
| | 8/17/05 | | 15 | | | | | 10KSB/A, 10QSB/A |
| | 8/11/05 | | 8 | | 15 | | | 8-K |
| | 8/10/05 | | 7 | | 55 | | | 8-K |
| | 8/9/05 | | 15 | | | | | 8-K |
| | 6/30/05 | | 15 | | 43 | | | 10QSB, 10QSB/A |
| | 6/21/05 | | 52 | | 67 | | | S-3 |
| | 6/15/05 | | 2 | | 66 |
| | 6/14/05 | | 15 | | | | | 10QSB/A, SC 13D/A |
| | 5/16/05 | | 15 | | | | | 10QSB |
| | 4/18/05 | | 52 |
| | 4/14/05 | | 61 | | | | | 10KSB |
| | 3/31/05 | | 15 | | | | | 10QSB, 10QSB/A, NT 10-K |
| | 2/22/05 | | 56 |
| | 2/17/05 | | 22 | | 23 | | | 4 |
| | 1/24/05 | | 15 | | | | | 8-K/A |
| | 1/21/05 | | 54 | | 74 |
| | 1/20/05 | | 15 | | 82 | | | 8-K |
| | 1/18/05 | | 51 | | 74 | | | 8-K/A |
| | 1/13/05 | | 35 | | 82 | | | 8-K |
| | 1/3/05 | | 22 | | 23 | | | SC 13D/A |
| | 12/31/04 | | 9 | | 75 | | | 10KSB, 10KSB/A, 5, NT 10-K |
| | 12/28/04 | | 78 | | 82 | | | 8-K |
| | 12/22/04 | | 68 |
| | 12/21/04 | | 22 | | 82 | | | 4, 8-K |
| | 12/1/04 | | 54 | | 74 | | | 8-K |
| | 11/30/04 | | 6 | | 70 | | | 4, 8-K |
| | 11/26/04 | | 13 | | 73 | | | 4, 8-K |
| | 9/30/04 | | 43 | | 51 | | | 10QSB |
| | 9/1/04 | | 73 |
| | 8/31/04 | | 73 |
| | 6/30/04 | | 43 | | | | | 10QSB |
| | 5/1/04 | | 73 |
| | 4/30/04 | | 73 |
| | 4/18/04 | | 52 | | 69 |
| | 1/22/04 | | 73 |
| | 12/31/03 | | 9 | | 75 | | | 10KSB, 3, 4, NT 10-K |
| | 12/22/03 | | 73 | | | | | 3, 4 |
| | 11/18/03 | | 5 | | 47 | | | 3, 4, 8-K, 8-K/A |
| | 6/13/03 | | 6 | | 38 |
| | 5/30/03 | | 72 | | 74 | | | 8-K |
| | 4/18/03 | | 52 | | 69 |
| | 1/1/03 | | 67 |
| | 12/31/02 | | 59 | | | | | 10KSB, NT 10-K |
| | 6/30/02 | | 52 | | 69 | | | 10QSB, NT 10-Q |
| | 4/18/02 | | 52 | | 69 |
| | 4/17/01 | | 6 | | 37 | | | 10KSB |
| | 3/21/00 | | 78 | | 82 | | | 10KSB40, DEF 14A, S-3/A |
| | 1/4/00 | | 78 | | 82 |
| | 12/22/99 | | 78 | | 82 | | | 8-K |
| | 3/11/99 | | 6 | | 37 |
| | 11/3/98 | | 16 | | | | | 8-A12B, 8-A12G/A |
| | 10/9/98 | | 16 | | | | | 8-A12G |
| List all Filings |
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