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U. S. Securities and Exchange Commission
WASHINGTON, D.C. 20549
FORM 10-KSB
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2007.
[_] TRANSITION REPORT UNDER SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____________ to ___________.
Commission File Number: 1-14896
NETWORK-1 SECURITY SOLUTIONS, INC.
(Name of Small Business Issuer in its Charter)
DELAWARE 11-3027591
(State or Other Jurisdiction (IRS Employer
of Incorporation) Identification Number)
445 PARK AVENUE, SUITE 1028
NEW YORK, NEW YORK 10022
(Address of Principal Executive Offices)
Issuer's Telephone Number (Including Area Code): (212) 829-5770
Securities registered under Section 12(b) of the Exchange Act:
Title of each class Name of each exchange on which registered
------------------- -----------------------------------------
None None
Securities registered under Section 12(g) of the Exchange Act:
Common Stock, $.01 par value
Check whether the issuer is not required to file reports pursuant to
Section 13 or 15(d) of the Exchange Act. [_]
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days. Yes [X] No
[_]
Check if there is no disclosure of delinquent filers in response to Item
405 of Regulation S-B contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. [X]
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). Yes [_] No [X]
The issuer's revenues for its most recent fiscal year: $232,000.
The aggregate market value of the voting and non-voting common stock of the
registrant held by non-affiliates computed by reference to the price at which
the stock was sold on March 26, 2008 was approximately $15,417,378.
The number of shares of Common Stock outstanding as of March 26, 2008 was
24,135,557.
Transitional Small Business Disclosure Format (Check One): Yes [_] No [X]
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NETWORK-1 SECURITY SOLUTIONS, INC.
2007 FORM 10-KSB ANNUAL REPORT
TABLE OF CONTENTS
PART I.........................................................................2
ITEM 1. DESCRIPTION OF BUSINESS.............................................2
ITEM 2. DESCRIPTION OF PROPERTY............................................14
ITEM 3. LEGAL PROCEEDINGS..................................................15
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS................16
PART II.......................................................................17
ITEM 5. MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND SMALL
BUSINESS ISSUER PURCHASES OF EQUITY SECURITIES.....................17
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS...............................19
ITEM 7. FINANCIAL STATEMENTS...............................................22
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE...............................................22
ITEM 8A. CONTROLS AND PROCEDURES............................................23
ITEM 8B. OTHER INFORMATION..................................................24
PART III......................................................................25
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS; PROMOTERS, CONTROL PERSONS
AND CORPORATE GOVERNANCE; COMPLIANCE WITH SECTION 16(A)
OF THE EXCHANGE ACT................................................25
ITEM 10. EXECUTIVE COMPENSATION.............................................29
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT AND RELATED STOCKHOLDER MATTERS.........................34
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND
DIRECTOR INDEPENDENCE..............................................37
ITEM 13. EXHIBITS LIST......................................................39
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.............................41
SIGNATURES..................................................................42
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PART I
THIS ANNUAL REPORT ON FORM 10-KSB CONTAINS CERTAIN STATEMENTS WHICH ARE
FORWARD-LOOKING STATEMENTS THAT ARE STATEMENTS THAT INCLUDE INFORMATION BASED
UPON BELIEF OF OUR MANAGEMENT, AS WELL AS ASSUMPTIONS MADE BY AND INFORMATION
AVAILABLE TO MANAGEMENT. STATEMENTS CONTAINING TERMS SUCH AS "BELIEVES",
"EXPECTS", "ANTICIPATES", "INTENDS" OR SIMILAR WORDS ARE INTENDED TO IDENTIFY
FORWARD LOOKING STATEMENTS. ACTUAL RESULTS, EVENTS AND CIRCUMSTANCES (INCLUDING
FUTURE PERFORMANCE, RESULTS AND TRENDS) COULD DIFFER MATERIALLY FROM THOSE SET
FORTH IN SUCH STATEMENTS DUE TO VARIOUS RISKS AND UNCERTAINTIES, INCLUDING BUT
NOT LIMITED TO, THOSE DISCUSSED IN THE SECTION ENTITLED "RISK FACTORS THAT MAY
AFFECT FUTURE RESULTS" IN ITEM 1 OF THIS REPORT AS WELL AS THOSE RISKS DISCUSSED
ELSEWHERE IN THIS REPORT.
ITEM 1. DESCRIPTION OF BUSINESS.
OVERVIEW
Our principal business is the acquisition, development, licensing and
protection of our intellectual property. We presently own six patents issued by
the U.S. Patent Office that relate to various telecommunications and data
networking technologies (the "Patent Portfolio") and includes, among other
things, patents covering the control of power delivery over LANs for the purpose
of remotely powering network devices and 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). 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 Patent
Portfolio as well as with other users of the technologies who benefit directly
from the technologies including corporate, educational and governmental
entities.
To date, our efforts with respect to our Patent Portfolio have focused on
licensing our patent (U.S. Patent No. 6,218,930) covering the control of power
delivery over Ethernet cables (the "Remote Power Patent"). In August, 2007, as
part of a settlement agreement relating to our litigation with D-Link, we
entered into a license agreement with D-Link pertaining to our Remote Power
Patent (See Item I. Description of Business - D-Link Settlement). In February
2008, we commenced patent infringement litigation against several major data
networking equipment manufacturers including Cisco Systems, Inc. and 7 other
defendants (See Item 3. "Legal Proceedings").
At least for the next twelve months, we do not presently anticipate
licensing efforts for our other patents besides our Remote Power Patent. We may
seek to acquire additional patents in the future.
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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;
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 patents may not be successful. We cannot be assured that our patents
will be upheld, or that third parties will not invalidate our patents. We face
uncertainty as to the outcome of our litigation commenced in February 2008
against several major data networking equipment manufacturers pertaining to our
Remote Power Patent. (See Risk Factors "We face uncertainty as to the outcome of
litigation with major data networking equipment manufacturers").
The patent application for our Remote Power Patent was filed on March 11,
1999 and the patent was granted by the U.S. Office of Patent and Trademark on
April 21, 2001. The patent expires on March 11, 2020.
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.
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MARKET OVERVIEW - REMOTE POWER PATENT
Our licensing efforts are currently focused on our Remote Power Patent. Our
Remote Power Patent (U.S. Patent No. 6,218,930) relates to several technologies
which 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 370,000 individual
members in approximately 160 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, 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 which 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 networks. 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 that 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, are 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 cables 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. The benefits of PoE
are compelling as evidenced by the introduction of products by such leading
vendors such as Cisco Systems, Foundry Networks, Extreme Networks, 3Com,
Siemens, Nortel Networks and Avaya, as well as many others.
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The ability to supply power to end-devices over Ethernet networks 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.
ADDITIONAL 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.
NETWORK-1 STRATEGY
Our strategy is to capitalize on our Patent Portfolio by entering into
licensing arrangements with third parties including manufacturers and users that
utilize our Patent Portfolio's proprietary technologies as well as any
additional proprietary technologies covered by patents 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 our Patent Portfolio
or any of the proprietary technologies contained in our 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, as is the
case with our litigation against several major data networking equipment
manufacturers (See Item 3. "Legal Proceedings -Major Data Networking Equipment
Manufacturers Litigation") and as we previously asserted against D-Link (See
Item I. "Description of Business - D-Link Settlement").
LICENSING
In February 2004, we commenced licensing efforts with respect to 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
5
technology covered by our Remote Power Patent, including corporate, educational
and federal, state and local government users, as we believe that they are
significant beneficiaries of the technologies covered by our 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 and
related companies) 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 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.
Licensing Program
As of March 31, 2008, we transmitted letters to approximately 85 companies
offering licenses to our Remote Power Patent. In addition, in September 2005 we
initiated an industry wide Power Up Licensing program that offered licenses for
our Remote Power Patent to "early adopters" that included royalty rates and
related fees at a discount from our standard royalty rates and fees for a
limited time period. The Power Up licensing program continued until May 2007. No
licenses were granted under the Power Up licensing program.
We are continuing to offer licenses to our Remote Power Patent to vendors
of Power over Ethernet productions at our standard royalty terms and conditions.
D-Link License
In August 2007, we agreed to final licensing terms with D-Link Corporation
and D-Link Systems (collectively, "D-Link") as part of a settlement agreement of
our patent infringement litigation against D-Link in the United States District
Court for the Eastern District of Texas, Tyler Division for infringement of our
Remote Power Patent (See Item 3. "Legal Proceedings").
The license terms include the agreement by D-Link to license our Remote
Power Patent for its full term which expires in March 2020, and the payment of
monthly royalty payments (beginning as of May 26, 2007) based upon a running
royalty rate of 3.25% of the net sales of D-Link branded Power over Ethernet
products, including those products which comply with the IEEE 802.3af and
802.3at Standards. The royalty rate is subject to adjustment beginning the
second quarter of 2008 to a royalty rate consistent with other similarly
situated licensees of our Remote Power Patent that may vary according to units
and volumes of licensed products sold. In addition, D-Link paid us an upfront
payment upon signing of the license agreement of $100,000.
The products covered by the settlement include D-Link Power over Ethernet
enabled switches, wireless access points, and network security cameras, among
others.
6
Legal Representation
In February 2008, we entered into an agreement with Dovel & Luner, LLP
pursuant to which such firm provides legal services to us with respect to our
litigation commenced in February 2008 against several major data networking
equipment manufacturers, pending in the United States District Court for the
Eastern District of Texas, Tyler Division, for infringement of our Remote Power
Patent (See Item 3. "Legal Proceedings"). The terms of our agreement with Dovel
& Luner, LLP provide for fees of a maximum aggregate cash payment of $1.5
million plus a contingency fee of up to 24% depending upon when an outcome is
achieved.
With respect to our litigation against D-Link, which was settled in May
2007, we utilized the services of Blank Rome, LLP, on a full contingency basis
and also the services of Potter Mitton, P.C. (Tyler, Texas) on an hourly basis
to serve as local counsel. In accordance with our contingency fee agreement with
Blank Rome LLP we will pay legal fees to Blank Rome LLP equal to 25% of the
royalty revenue received by us from our license agreement with D-Link after we
recover our expenses related to the litigation.
COMPETITION
The telecommunications and data networking licensing market is
characterized by intense competition and rapidly changing business conditions,
customer requirements and technologies. Our current and potential competitors
have longer operating histories, greater name recognition and possess
substantially greater financial, technical, marketing and other competitive
resources than us. Although we believe that we have enforceable patents relating
to telecommunications and data networking, there can be no assurance that our
Patent Portfolio will be upheld or that third parties will not invalidate any or
all of the patents in our 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 our 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 asserts 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 March 31, 2008, we had one full time employee, no part time employees
and three consultants.
7
RISK FACTORS THAT MAY AFFECT FUTURE RESULTS
We operate in a highly competitive environment that involves a number of
risks, some of which are beyond our control. The following discussion highlights
the most material of the risks.
WE HAVE A HISTORY OF LOSSES AND MODEST REVENUE FROM CURRENT OPERATIONS.
We have incurred substantial operating losses since our inception, which
has resulted in an accumulated deficit of $(49,277,000) as of December 31, 2007.
For the years ended December 31, 2007 and 2006, we incurred net losses of
$(2,998,000) and $(1,958,000), respectively. We have financed our operations
primarily by sales of equity securities. We had revenue of $232,000 from
operations for the year ended December 31, 2007 and no revenue from operations
for the year ended December 31, 2006. Our ability to achieve revenue and
generate positive cash flow from operations is dependent upon consummating
licensing agreements with respect to our patented technologies. In August 2007,
as part of our settlement agreement pertaining to our patent infringement
litigation against D-Link Corporation and D-Link Systems (collectively,
"D-Link"), we entered into our first license agreement for our Remote Power
Patent with D-Link. (See Note J[1] - Litigation to our Financial Statements). We
may not be successful in achieving additional 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 material revenue or generate positive cash flow from operations from our
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 $5,489,000
at March 15, 2008 will more likely than not be sufficient to satisfy our
operations and capital requirements until at least December 31, 2009. 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 December 31, 2009. Our inability to obtain additional
financing when needed, absent generating sufficient cash from licensing
arrangements, would have a material adverse effect on our company, requiring us
to curtail or possibly cease our operations. In addition, any additional equity
financing may involve substantial dilution to the interests of our then existing
stockholders.
OUR 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. To date, we have only entered into one license
agreement with a third party with respect to our patented technology (See Note
J[1]-Litigation to our Financial Statements). Accordingly, we have a 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
8
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 sufficient 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 entered into only one license agreement with
respect to our Remote Power Patent as part of our settlement agreement with
D-Link. (See Note J[1]-Litigation to our Financial Statements). Our inability to
consummate additional licensing agreements and achieve material 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.
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.
9
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 and in April 2007 we entered into a settlement agreement with the
D-Link parties (See Note J[1]-Litigation to our Financial Statements). In
addition, in February 2008 we commenced patent litigation against Cisco Systems,
Inc. and several other major data networking equipment manufacturers which is
currently pending in the United States District Court for the Eastern District
of Texas, Tyler Division (See Item 3. "Legal Proceedings"). 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, as had been asserted by the
defendants in the aforementioned pending litigation in Texas with us. 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.
OUR SETTLEMENT WITH D-LINK MAY NOT RESULT IN SIGNIFICANT ROYALTIES AND DOES
NOT NECESSARILY MEAN WE WILL ACHIEVE ADDITIONAL LICENSE AGREEMENTS OR MATERIAL
REVENUE.
In August 2007 we finalized the settlement agreement with respect to our
patent litigation against D-Link Corporation and D-Link Systems, Incorporated
pending in the United States District Court for the Eastern District of Texas,
Tyler Division, for infringement of our Remote Power Patent. Under the terms of
the settlement, D-Link entered into a license agreement for our Remote Power
Patent the terms of which include monthly royalty payments of 3.25% (beginning
May 2007) of the net sales of D-Link Power over Ethernet products, including
those products which comply with the IEEE 802.3af and 802.3at Standards, for the
full life of our Remote Power Patent, which expires in March 2020. For the year
ended December 31, 2007 (which included royalty payments from May 2007) we
received $232,000 of royalty payments from D-Link pursuant to the license
agreement. The royalty rate will be subject to adjustment beginning after the
first quarter of 2008 to a rate consistent with other similarly situated
licensees of the Remote Power Patent based on units of shipments of licensed
products. In addition, D-Link paid us $100,000 upon signing of the Settlement
Agreement. Notwithstanding the settlement and our license agreement with the
D-Link parties, there is no assurance that we will achieve significant royalty
revenue from D-Link, that we will be able to achieve additional license
agreements with third parties relating to our Remote Power Patent or any of our
other patents, or that such license arrangements will result in material revenue
to us.
10
WE FACE UNCERTAINTY AS TO THE OUTCOME OF OUR LITIGATION AGAINST MAJOR DATA
NETWORKING EQUIPMENT MANUFACTURERS.
In February 2008, we commenced litigation against several major data
networking equipment manufacturers in the United States District Court for the
Eastern District of Texas, Tyler Division, for infringement of our Remote Power
Patent. The defendants in the lawsuit include Cisco Systems, Inc., Cisco
Linksys, LLC, Enterasys Networks, Inc., 3COM Corporation, Inc., Extreme
Networks, Inc., Foundry Networks, Inc., Netgear, Inc. and Adtran, Inc. We seek
injunctive relief and monetary damages for infringement based upon reasonable
royalties as well as treble damages for the defendant's continued willful
infringement of the Remote Power Patent. To date all of the defendants, other
than Netgear, Inc., have answered the complaint and asserted that they do not
infringe any valid claim of our Remote Power Patent, and further asserted that,
based on several different theories, the patent claims are invalid or
unenforceable. In addition to these defenses, the defendants also asserted
counterclaims for, among other things, non-infringement, invalidity, and
unenforceability of our Remote Power Patent. In the event that the court
determines that our Remote Power Patent is not valid or enforceable, and/or that
the defendants do not infringe, any such determination would have a material
adverse effect on us.
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 370,000 individual
members in approximately 160 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, among others, 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. 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 material revenue and profits from our Remote Power Patent.
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 our 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 of up to 20% of the royalty payments received from
11
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.
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 or that such parties may
not be deemed to infringe 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. In February 2007, we entered into a new two (2) year employment
agreement with Mr. Horowitz pursuant to which he continues to serve as our
Chairman and Chief Executive Officer (See Note I[1] to our Financial
Statements). We do not maintain key-man life insurance on the life of Mr.
Horowitz. We believe that the loss of the services of Mr. Horowitz would have a
material adverse effect on our business and prospects.
12
RISKS RELATED TO LOW PRICED STOCKS.
Our common stock currently trades on the OTC Bulletin Board under the
symbol NSSI. Since the trading price of our common stock is below $5.00 per
share, our common stock is considered a penny stock. SEC regulations generally
define a penny stock to be an equity security that is not listed on Nasdaq or a
national securities exchange and that has a market value of less than $5.00 per
share, subject to certain exceptions. 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
EFFECT THE MARKET PRICE FOR OUR COMMON STOCK.
As of March 31, 2008, there are outstanding options and warrants to
purchase an aggregate of 11,553,356 shares of our common stock at exercise
prices ranging from $.12 to $10.00. 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.
OUR STOCK PRICE MAY BE VOLATILE.
The market price of our common stock is likely to be highly volatile and
could fluctuate widely in price in response to various factors, many of which
are beyond our control, including the following:
o our ability to successfully enforce and/or defend our Remote Power
Patent;
13
o our ability to enter into favorable license agreements with third
parties with respect to our Remote Power Patent;
o our ability to achieve material revenue and profits;
o our ability to raise capital when needed;
o sales of our common stock;
o our ability to execute our business plan;
o technology changes;
o legislative, regulatory and competitive developments; and
o economic and other external factors.
In addition, the securities markets have from time to time experienced
significant price and volume fluctuations that are unrelated to the operating
performance of particular companies. These market fluctuations may also
materially and adversely affect the market price of our common stock.
ADDITIONAL STOCK OFFERINGS MAY DILUTE CURRENT STOCKHOLDERS.
We may need to issue additional shares of our capital stock or securities
convertible or exercisable for shares of our capital stock, including preferred
stock, options or warrants. The issuance of additional capital stock may dilute
the ownership of our current stockholders.
ITEM 2. DESCRIPTION OF PROPERTY
We currently lease office space in New York City at a cost of $3,300 per
month. The lease which expires in June 2008 has been extended for one year at a
cost of $3,400 per month.
14
ITEM 3. LEGAL PROCEEDINGS
Pending Litigation Against Major Data Networking Equipment Manufacturers
In February 2008, we commenced litigation against several major data
networking equipment manufacturers in the United States District Court for the
Eastern District of Texas, Tyler Division, for infringement of our Remote Power
Patent. The defendants in the lawsuit include Cisco Systems, Inc., Cisco
Linksys, LLC, Enterasys Networks, Inc., 3COM Corporation, Inc., Extreme
Networks, Inc., Foundry Networks, Inc., Netgear, Inc. and Adtran, Inc. We seek
injunctive relief and monetary damages for infringement based upon reasonable
royalties as well as treble damages for the defendant's continued willful
infringement of our Remote Power Patent. To date all of the defendants, other
than Netgear, Inc., have answered the complaint and asserted that they do not
infringe any valid claim of our Remote Power Patent, and further asserted that,
based on several different theories, the patent claims are invalid or
unenforceable. In addition to these defenses, the defendants also asserted
counterclaims for, among other things, non-infringement, invalidity, and
unenforceability of our Remote Power Patent. In the event that the Court
determines that our Remote Power Patent is not valid or enforceable, and/or that
the defendants do not infringe, any such determination would have a material
adverse effect on our company.
D-LINK SETTLEMENT
In August 2005, we commenced patent litigation against D-Link Corporation
and D-Link Systems, Incorporated (collectively "D-Link") in the United States
District Court for the Eastern District of Texas, Tyler division (Civil Action
No. 6:05W291), for infringement of our Remote Power Patent. Our complaint
sought, among other things, a judgment that our Remote Power Patent is
enforceable and has been infringed by the defendants. We also sought a permanent
injunction restraining the defendants from continued infringement, or active
inducement of infringement by others, of our Remote Power Patent.
In August 2007, we finalized the settlement of our patent infringement
litigation against D-Link. Under the terms of the settlement, D-Link entered
into a license agreement for our Remote Power Patent the terms of which include
monthly royalty payments of 3.25% of the net sales of D-Link Power over Ethernet
products, including those products which comply with the IEEE 802.3af and
802.3at Standards, for the full term of our Remote Power Patent, which expires
in March 2020. The royalty rate is subject to adjustment beginning after the
first quarter of 2008 to a rate consistent with other similarly situated
licensees of our Remote Power Patent based on units of shipments of licensed
products. In addition, D-Link paid us $100,000 upon signing of the Settlement
Agreement.
15
POWERDSINE SETTLEMENT
On November 16, 2005, we entered into a Settlement Agreement with
PowerDsine, Inc. (NASDAQ: PDSN) and PowerDsine Ltd. (collectively, "PowerDsine")
which dismissed, with prejudice, patent litigation brought by PowerDsine against
us in March 2004 in the United States District Court for the Southern District
of New York that sought a declaratory judgment that our Remote Power Patent
(U.S. Patent No. 6,218,930) was invalid and not infringed by PowerDsine and/or
its customers.
Under the terms of the Settlement Agreement, we agreed that we will not
initiate litigation against PowerDsine for its sale of Power over Ethernet (PoE)
integrated circuits. In addition, we agreed that we will not seek damages for
infringement from customers that incorporate PowerDsine integrated circuit
products in PoE capable Ethernet switches manufactured on or before April 30,
2006. PowerDsine has agreed that it will not initiate, assist or cooperate in
any legal action relating to the Remote Power Patent. We also agreed that we
will not initiate litigation against PowerDsine or its customers for
infringement of our Remote Power Patent arising from the manufacture and sale of
PowerDsine Midspan products for three years following the dismissal date.
Following such three year period, we may seek damages for infringement of our
Remote Power Patent from PowerDsine or its customers with respect to the
purchase and sale of Midspan products beginning 90 days following the dismissal
date of the litigation. The benefits afforded to PowerDsine under the Settlement
Agreement will cease in the event PowerDsine institutes, assists or cooperates
in any legal proceeding related to our Remote Power Patent adverse to us (unless
otherwise required by law to do so).
No licenses to use the technologies covered by our Remote Power Patent were
granted to PowerDsine or its customers under the terms of the settlement. The
Settlement Agreement further provides that PowerDsine is obligated to provide
each of its customers with written notice of the settlement which notice shall
disclose that no license for our Remote Power Patent has been provided to
PowerDsine's customers and that in order to combine, modify or integrate any
PowerDsine product with or into any other device or software, PowerDsine's
customers may need to receive patent license(s) for such third party patents
which is the customer's responsibility. For the full text of our Settlement
Agreement with PowerDsine, see Exhibit 10.1 of our Current Report on Form 8-K
filed with the Securities and Exchange Commission on November 17, 2005.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
16
PART II
ITEM 5. MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND SMALL
BUSINESS ISSUER PURCHASES OF EQUITY SECURITIES
MARKET INFORMATION. Our Common Stock currently trades on OTC Bulletin Board
under the symbol NSSI. The following table sets forth, for the periods
indicated, the range of the high and low closing bid prices for our Common Stock
as reported by the Pink Sheets LLC quotation service. Such prices reflect
inter-dealer quotations, without retail mark-up, mark-down or commission and may
not necessarily represent actual transactions.
YEAR ENDED DECEMBER 31, 2007 HIGH LOW
---- ---
Fourth Quarter $2.05 $1.33
Third Quarter $1.60 $1.44
Second Quarter $2.04 $1.55
First Quarter $1.75 $1.35
YEAR ENDED DECEMBER 31, 2006 HIGH LOW
---- ---
Fourth Quarter $1.65 $1.06
Third Quarter $1.37 $1.00
Second Quarter $1.42 $1.02
First Quarter $1.48 $ .93
On March 26, 2008, the closing price for the Common Stock as reported on
the OTC Bulletin Board was $1.25 per share. The number of record holders of our
Common Stock was 115 as of March 26, 2008.
DIVIDEND POLICY. We have never declared or paid any cash dividends on our
Common Stock and do not intend to declare or pay cash or other dividends in the
foreseeable future. The Board of Directors currently expects to retain any
future earnings, if any, for use in the operation and expansion of its business.
The declaration and payment of any future dividends will be at the discretion of
the Board of Directors and will depend upon a variety of factors, including
future earnings, if any, operations, capital requirements, our general financial
condition, the preferences of any series of Preferred Stock, our general
business conditions and future contractual restrictions on payment of dividends,
if any.
17
RECENT ISSUANCES OF UNREGISTERED SECURITIES. None.
ISSUER PURCHASES OF EQUITY SECURITIES. None.
EQUITY COMPENSATION PLAN INFORMATION
The following table summarizes share and exercise price information about
our equity compensation plans as of December 31, 2007.
----------------------------------------------------------------------------------------------------------
NUMBER OF
SECURITIES TO BE NUMBER OF SECURITIES
ISSUED UPON WEIGHTED- REMAINING AVAILABLE
EXERCISE OF AVERAGE FOR FUTURE ISSUANCE
OUTSTANDING EXERCISE PRICE UNDER EQUITY
OPTIONS, OF OUTSTANDING COMPENSATION PLANS
WARRANTS AND OPTIONS, (EXCLUDING SECURITIES
RIGHTS WARRANTS AND REFLECTED IN COLUMN)
(1) RIGHTS (1)
----------------------------------------------------------------------------------------------------------
Equity compensation plans approved
by security holders 3,902,370 $.95 0(1)
----------------------------------------------------------------------------------------------------------
Equity compensation plans not
approved by security holders 0 -- --
----------------------------------------------------------------------------------------------------------
Total 3,902,370 $.95 0(1)
----------------------------------------------------------------------------------------------------------
----------
(1) Our 1996 Amended and Restated Stock Option Plan provided for the issuance of options to purchase
up to 4,000,000 shares of our common stock. As of March 2006, no additional options could be issued under
the plan in accordance with its terms.
18
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS
THE FOLLOWING DISCUSSION AND ANALYSIS SHOULD BE READ IN CONJUNCTION WITH
OUR FINANCIAL STATEMENTS, INCLUDING THE NOTES THERETO, INCLUDED ELSEWHERE IN
THIS FORM 10-KSB. EXCEPT FOR THE HISTORICAL INFORMATION CONTAINED HEREIN, THIS
DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND
UNCERTAINTIES, INCLUDING, BUT NOT LIMITED TO, THOSE DISCUSSED IN THE SECTION
ABOVE ENTITLED "RISK FACTORS WHICH MAY AFFECT FUTURE RESULTS" IN ITEM 1 OF THIS
REPORT AS WELL AS THOSE RISKS DISCUSSED IN THIS SECTION AND ELSEWHERE IN THIS
REPORT. BECAUSE SUCH STATEMENTS INVOLVE RISKS AND UNCERTAINTIES, ACTUAL RESULTS
MAY DIFFER MATERIALLY FROM THOSE EXPRESSED OR IMPLIED BY SUCH FORWARD-LOOKING
STATEMENTS.
OVERVIEW
Our principal business is the acquisition, development, licensing and
protection of our intellectual property. We presently own six patents covering
various telecommunications and data networking technologies (the "Patent
Portfolio") including, among others, patents covering the delivery of power over
Ethernet for the purpose of remotely powering network devices, and the
transmission of audio, video and data over computer and telephony networks. Our
strategy is to pursue licensing and strategic business alliances with companies
in the industries that manufacture and sell products that make use of the
technologies underlying our patents as well as with other users of the
technology who benefit directly from the technology including corporate,
educational and governmental entities.
To date, our efforts with respect to our Patent Portfolio have focused on
licensing our patent (U.S. Patent No. 6,218,930) covering the control of power
delivery over Ethernet cables (the "Remote Power Patent"). In August, 2007, as
part of a settlement agreement relating to our litigation with D-Link, we
entered into a license agreement with D-Link pertaining to our Remote Power
Patent (See Item I. "Description of Business - D-Link Settlement"). In February
2008, we commenced patent infringement litigation against several major data
networking equipment manufacturers including Cisco Systems, Inc. and seven (7)
other defendants (See Item 3. "Litigation"). During the next 12 months we do not
presently anticipate licensing efforts for our other patents besides our Remote
Power Patent.
To date we have incurred significant losses and at December 31, 2007 had an
accumulated deficit of $(49,277,000). For the year ended December 31, 2007 and
December 31, 2006, we incurred net losses of $(2,998,000) and $(1,958,000),
respectively. We anticipate that we will continue to incur losses until we enter
into additional license agreements with respect to our patented technologies. We
have achieved revenue of $232,000 from our technology licensing business for the
year ended December 31, 2007 with respect to royalties pertaining to our Remote
Power Patent. Our inability to consummate additional material license agreements
and achieve revenue from our patented technologies would have a material adverse
effect on our operations and our ability to continue business.
19
Our success and ability to generate revenue is largely dependent on
our ability to consummate licensing arrangements with third parties. In November
2004, we entered into an agreement with ThinkFire Services USA, Ltd.
("ThinkFire") pursuant to which ThinkFire has been granted the exclusive
worldwide rights to negotiate license agreements for our Remote Power Patent
with certain agreed-upon potential licensees. We have agreed to pay ThinkFire a
fee of up to 20% of the royalty payments received from license agreements
consummated by ThinkFire on our behalf after we recover our expenses.
In August 2007 we finalized the settlement of our patent litigation against
D-Link in the United States District Court for the Eastern District of Texas,
Tyler Division, for infringement of our Remote Power Patent (U.S. Patent No.
6,218,930). Under the terms of the settlement, D-Link has agreed to license our
the Remote Power Patent the terms of which include monthly royalty payments of
3.25% of the net sales of D-Link branded Power over Ethernet products, including
those products which comply with the IEEE 802.3af and 802.3at Standards, for the
full life of our Remote Power Patent, which expires in March 2020. The royalty
rate is subject to adjustment beginning after the first quarter of 2008 to a
rate consistent with other similarly situated licensees of our Remote Power
Patent based on units of shipments of licensed products. In addition, D-Link
paid us $100,000 upon signing the settlement agreement. Notwithstanding the
settlement and our license agreement with D-Link, there is no assurance that we
will achieve significant royalty revenue from D-Link, that we will be able to
achieve additional license agreements with third parties relating to our Remote
Power Patent or our other patents, or that such license arrangements will result
in material revenue to us.
In February 2008, we commenced litigation against several major data
networking equipment manufacturers in the United States District Court for the
Eastern District of Texas, Tyler Division, for infringement of our Remote Power
Patent. The defendants in the lawsuit include Cisco Systems, Inc., Cisco
Linksys, LLC, Enterasys Networks, Inc., 3COM Corporation, Inc., Extreme
Networks, Inc., Foundry Networks, Inc., Netgear, Inc. and Adtran, Inc. We seek
injunctive relief and monetary damages for infringement based upon reasonable
royalties as well as treble damages for the defendant's continued willful
infringement of our Remote Power Patent. To date all of the defendants, other
than Netgear, Inc., have answered the complaint and asserted that they do not
infringe any valid claim of our Remote Power Patent, and further asserted that,
based on several different theories, the patent claims are invalid or
unenforceable. In addition to these defenses, the defendants also asserted
counterclaims for, among other things, non-infringement, invalidity, and
unenforceability of our Remote Power Patent. In the event that the Court
determines that our Remote Power Patent is not valid or enforceable, and/or that
the defendants do not infringe, any such determination would have a material
adverse effect on us.
20
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 2007 COMPARED TO YEAR ENDED DECEMBER 31, 2006
We had revenues of $232,000 for the year ended December 31, 2007 ("2007")
which were related to receipt of royalties from our license agreement with
D-Link. The Company had no revenues for the year ended December 31, 2006
("2006").
We had a cost of royalties of $12,000 for 2007 which was related to the
payment of bonus compensation on the royalties pursuant to agreement with our
Chief Executive Officer. The gross profit for 2007 was $220,000 as compared to
no gross profit for 2006.
General and administrative expenses include overhead expenses, and finance,
accounting, legal and other professional services incurred by us. General and
administrative expenses increased by $444,000, from $1,548,000 for 2006 to
$1,992,000 for 2007, primarily attributable to increased legal fees and expenses
attributable to the D-Link litigation.
We incurred an operating loss of ($3,175,000) for 2007 compared with an
operating loss of ($2,027,000) for 2006. Included in the operating loss for 2007
was $1,403,000 in charges relating to non-cash compensation expenses as compared
to $479,000 for 2006. These losses were offset by interest earned of $177,000
and $69,000 for 2007 and 2006, respectively.
No provision for or benefit from federal, state or foreign income taxes was
recorded for 2007 and 2006 because we incurred net operating losses and fully
reserved our deferred tax assets as their future realization could not be
determined.
As a result of the foregoing, we incurred a net loss of $(2,998,000) for
2007 compared with a net loss of $(1,958,000) for 2006.
LIQUIDITY AND CAPITAL RESOURCES
We have financed our operations primarily from the sale of equity
securities. In April 2007, we completed a private offering of equity securities
resulting in gross proceeds of $5,000,000. In addition, during the fourth
quarter of 2007 we received $1,184,375 of cash proceeds from the exercise of
warrants issued in December 2004 and January 2005. We anticipate, based on
currently proposed plans and assumptions, relating to our operations, that our
cash and cash equivalents of approximately $5,489,000 as of March 15, 2008 will
more likely than not be sufficient to satisfy our operations and capital
requirements until at least December 31, 2009. There can be no assurance,
however, that such funds will not be expended prior thereto. In the event our
plans change, or our assumptions change, or prove to be inaccurate (due to
unanticipated expenses, difficulties, delays or otherwise), we may have
insufficient funds to support our operations prior to December 31, 2009. Our
inability to consummate licensing arrangements with respect to our Remote Power
Patent and generate revenues therefrom on a timely basis or obtain additional
financing when needed would have a material adverse effect on our company,
requiring us to curtail or cease operations. In addition, any equity financing
may involve substantial dilution to our current stockholders.
21
CRITICAL ACCOUNTING POLICIES:
Patents:
The Company owns a patent portfolio that relates to various
telecommunications and data networking technologies. The Company capitalizes the
costs associated with acquisition, registration and maintenance of the patents
and amortizes these assets over their remaining useful lives on a straight-line
basis. Any further payments made to maintain or develop the patents would be
capitalized and amortized over the balance of the useful life for the patents.
Impairment of long-lived assets:
In accordance with Statement of Financial Accounting Standards ("SFAS") No.
144, "Accounting for the Impairment or Disposal of Long-Lived Assets", the
Company records impairment losses on long-lived assets used in operations or
expected to be disposed of when indicators of impairment exist and the cash
flows expected to be derived from those assets are less than carrying amounts of
those assets.
Use of estimates:
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS:
See Note B [10] on page F-8 to the Financial Statements.
ITEM 7. FINANCIAL STATEMENTS
The financial statements required hereby are located on pages F-1 through
F-18 which follow Part III.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
On February 2, 2006, we dismissed Eisner LLP, as our principal independent
accountant to audit our financial statements. Eisner LLP's report on our
financial statements for the year ended December 31, 2004 did not contain an
adverse opinion or disclaimer opinion, and was not modified as to uncertainty,
audit scope or accounting principles. Eisner LLP did not audit our financial
statements for the year ended December 31, 2005 or issue a report thereon.
During the year ended December 31, 2005 and the subsequent interim period there
were no disagreements with Eisner LLP, whether or not resolved, on any matter of
accounting principles or practices, financial statement disclosure or auditing
scope or procedure, which, if not resolved to the satisfaction of Eisner LLP,
would have caused Eisner LLP to make reference to the
22
subject matter of the disagreement(s) in connection with its report on our
financial statements.
On February 2, 2006, we engaged Radin, Glass & Co., LLP as our new
principal independent accountant to audit our financial statements. We (or
anyone on our behalf) did not consult Radin, Glass & Co., LLP with respect to
the application of accounting principles to a specific completed or contemplated
transaction, or the type of audit opinion that might be rendered on our
financial statements.
ITEM 8A. CONTROLS AND PROCEDURES.
(a) Evaluation of Disclosure Controls and Procedures.
Our Chief Executive Officer and Chief Financial Officer have reviewed our
disclosure controls and procedures as of the end of the period covered by this
Annual Report on Form 10-KSB. Based upon this review, our officers concluded
that, as of the end of the period covered by this Annual Report on Form 10-KSB,
our disclosure controls and procedures are effective to ensure that information
required to be disclosed by us in the reports we file or submit under the
Securities Exchange Act of 1934 is recorded, processed, summarized and reported,
within the time periods specified in applicable rules and forms and is
accumulated and communicated to management, including our Chief Executive
Officer and Chief Financial Officer, to allow timely decisions regarding
required disclosure.
(b) Management's Annual Report on Internal Control Over Financial
Reporting
Our management is also responsible for establishing and maintaining
adequate "internal control over financial reporting" of the Company, as defined
in Rule 13a-15(f) of the Exchange Act. Internal control over financial reporting
is defined as a process designed by, or under the supervision of, the issuer's
principal executive and principal financial officer and effected by the
company's board of directors, management and other personnel, to provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with
generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (i) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (ii)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (iii) provide reasonable assurance regarding prevention or
timely detection of unauthorized acquisition, use, or disposition of the
company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the
degree of compliance with the policies or procedures may deteriorate.
23
Management of the Company, our Chief Executive Officer and Chief Financial
Officer, conducted an evaluation of the effectiveness of the Company's internal
control over financial reporting as of December 31, 2007 using the criteria set
forth by the Committee of Sponsoring Organizations of the Treadway Commission in
Internal Control - Integrated Framework. Management believes that this
evaluation provides a reasonable basis for its opinion. In connection with this
evaluation, Company management did not identify any material deficiencies. Based
upon that evaluation, our Chief Executive Officer and Chief Financial Officer
concluded that our internal controls over financial reporting were effective as
of the end of the period covered by this report.
This annual report does not include an attestation report of the Company's
independent registered public accounting firm regarding internal control over
financial reporting. Management's report was not subject to attestation by the
Company's independent registered public accounting firm pursuant to temporary
rules of the SEC that permit the Company to provide only management's report in
this annual report.
There was no change in our internal control over financial reporting that
occurred during the fiscal quarter ended December 31, 1007, that has materially
affected, or is reasonably likely to materially affect, our internal control
over financial reporting.
ITEM 8B. OTHER INFORMATION.
None.
24
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS; PROMOTERS, CONTROL PERSONS AND
CORPORATE GOVERNANCE; COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE
ACT.
NAME AGE POSITION
---- --- -----------------
Corey M. Horowitz 53 Chairman, Chief Executive Officer and
Secretary, Chairman of the Board of Directors
David C. Kahn 56 Chief Financial Officer
Robert Graifman 51 Director
Robert M. Pons 51 Director
Laurent Ohana 44 Director
COREY M. HOROWITZ became our Chairman and Chief Executive Officer in
December 2003. Mr. Horowitz has also served as our Chairman of our Board of
Directors since January 1996 and has been a member of our Board of Directors
since April 1994. In January 2003, Mr. Horowitz also became our Secretary. Mr.
Horowitz is also President and sole shareholder of CMH Capital Management Corp.
("CMH"), a New York investment advisory and merchant banking firm, which he
founded in September 1991. During the period June 2001 through December 2003,
CMH rendered financial advisory services to us. From January 1986 to February
1991, Mr. Horowitz was a general partner in charge of mergers and acquisitions
at Plaza Securities Co., a New York investment partnership.
DAVID C. KAHN, CPA, became our Chief Financial Officer in January 2004.
Since December 1989, Mr. Kahn has provided accounting and tax services on a
consulting basis to private and public companies. He also serves as a faculty
member of Yeshiva University in New York, a position he has held since August
2000.
ROBERT GRAIFMAN became a director of our company in December 2003. From
February 2001 through July 2007, Mr. Graifman served as Chairman and Chief
Executive Officer of TotalCat Group, Inc., an emissions control technology
company. Mr. Graifman also currently serves as Managing Member of Skyfarm
Management, LLC, a New Jersey based investment management company. From June
2000 to August 2003, Mr. Graifman served as Chief Financial Officer of Gilo
Ventures, LLP, a California based venture capital firm focused on emerging
technology companies.
ROBERT M. PONS became a director of our company in December 2003. Mr. Pons
is currently Senior Vice President of TMNG Global (NasdaqGM: TMNG), a leading
provider of professional services to the converging communications media and
entertainment industries and the capital formation firms that support it. From
January 2004 until April 2007, Mr. Pons served as President and Chief Executive
Officer of Uphonia, Inc. (PK:UPHN) (previously SmartServ Online, Inc.), a
wireless applications service provider. From August 2003 until January 2004, Mr.
Pons served as Interim Chief Executive Officer of SmartServ Online, Inc. on a
consulting basis. From March 1999 to August 2003, he was President of
FreedomPay, Inc., a wireless device
25
payment processing company. During the period January 1994 to March 1999, Mr.
Pons was President of Lifesafety Solutions, Inc., an enterprise software
company. Mr. Pons has over 20 years of management experience with
telecommunications companies including MCI, Inc., Sprint, Inc. and Geotek, Inc.
LAURENT OHANA became a director of our company in September 2005. Mr. Ohana
is currently the Managing Partner of Parkview Ventures LLC ("Parkview"), a
company engaged in merchant banking activities, including making investments in
and providing strategic advisory services to information technology firms in the
US and internationally. From 1999 to 2002, Mr. Ohana was the CEO of Inlumen,
Inc., a company engaged in providing private label web-based financial portals
to financial institutions. From 1994 to 2004, Mr. Ohana was the managing partner
of New Media Capital LLC, a technology venture capital and advisory firm. From
1987 to 1993, Mr. Ohana was a corporate attorney at Fried Frank Harris Shriver &
Jacobson.
The sister of Corey M. Horowitz's wife is married to Robert Graifman.
KEY CONSULTANT
JONATHAN GREENE has served as a consultant to our company since December
2004 providing technical and marketing analysis for our Patent Portfolio. Mr.
Greene also serves as a member of the Company's Technical Advisory Board. Since
April 2006, Mr. Greene has also served as a marketing consultant for Avatier
Corporation, a developer of identity management software. From August 2003 until
December 2004, he served as a consultant to Neartek, Inc., a storage management
software company (August 2003 until October 2003) and Kavado Inc., a security
software company (November 2003 until December 2004). From January 2003 until
July 2003, Mr. Greene served as Director of Product Management for FalconStor
Software, Inc., a storage management software company. From December 2001
through December 2002, Mr. Greene served as our Senior Vice President of
Marketing and Business Development, at a time when we were engaged in the
development, marketing and licensing of security software. From December 1999
until September 2001, he served as Senior Vice President of Marketing for
Panacya Inc., a vendor of service management software. Mr. Greene has also held
positions at System Management ARTS (SMARTS), Computer Associates, Cheyenne
Software and Data General.
COMMITTEES OF THE BOARD OF DIRECTORS
AUDIT COMMITTEE
Robert Graifman and Harry Schessel, both independent directors, served as
members of our Audit Committee during 2007. Mr. Schessel resigned as a director
and member of our Audit Committee on December 31, 2007. Our Audit Committee was
established by the Board of Directors in accordance with Section 3(a)58(A) of
the Securities Exchange Act of 1934. The duties of our Audit Committee include
consultations with our independent auditors at least annually to review the
scope and results of the annual audit; review with our independent auditors of
our quarterly reports on Form 10-QSB prior to filing, recommendations to the
Board regarding the independent auditors to be retained; and the auditors'
comments as to internal controls, accounting staff and management performance
and procedures in connection with audit and financial controls. The Audit
Committee has adopted a written Audit Committee Charter. Mr. Graifman is our
audit committee financial expert.
26
COMPENSATION COMMITTEE
Robert Pons is currently the sole member of our Compensation Committee and
served in that capacity for 2007. The Compensation Committee is responsible for
determining compensation for our executive officers, including bonuses and
benefits, and administration of our compensation programs, including our Stock
Option Plan.
LIMITATION ON LIABILITY AND INDEMNIFICATION MATTERS
Our Certificate of Incorporation limits the liability of directors to the
maximum extent permitted by Delaware law. Delaware law provides that directors
of a corporation will not be personally liable for monetary damages for breach
of their fiduciary duties as directors, except for liability (i) for any breach
of their duty of loyalty to the corporation or its stockholders, (ii) for acts
or omissions not in good faith or that involve intentional misconduct or a
knowing violation of law, (iii) for unlawful payments of dividends or unlawful
stock repurchases or redemptions as provided in Section 174 of the Delaware
General Corporation Law or (iv) for any transaction from which the director
derived an improper personal benefit. Our Bylaws provide that we shall indemnify
our directors, officers, employees and agents to the fullest extent permitted by
law. Our Bylaws also permit us to secure insurance on behalf of any officer,
director, employee or other agent for any liability arising out of his or her
actions in such capacity. We currently maintain directors and officers liability
insurance. At present, there is no pending litigation or proceeding involving
any of our directors, officers, employees or agents where indemnification will
be required or permitted. We are not aware of any threatened litigation or
proceeding that might result in a material claim for such indemnification.
TECHNICAL ADVISORY BOARD
In November 2004 we established a Technical Advisory Board to assist us
with our strategic business plan of maximizing the value of its Patent
Portfolio. Each member of the Technical Advisory Board received a five (5) year
option to purchase 17,500 shares (fully vested) of our common stock at an
exercise price equal to the closing price of the shares on the date of
appointment to the Technical Advisory Board.
The members of the Technical Advisory Board include:
GEORGE CONANT, FORMER CEO AND CHAIRMAN OF THE BOARD OF DIRECTORS OF MERLOT
COMMUNICATIONS, INC., a broadband communications solutions provider, during the
period 2000 - 2006. Prior to joining Merlot Communications, Inc., Mr. Conant
co-founded Xyplex, Inc., a manufacturer of data communications equipment and
network management software, where he held the positions of Vice President of
Engineering, Vice President of Technology and Chief Technology Officer. Prior to
Xyplex, Mr. Conant was employed by Digital Equipment Corporation, where he
worked as a network architect. Mr. Conant received a BS and a Masters in
theoretical mathematics from the University of Michigan.
RON KEENAN, CEO OF IP INFOTAINMENT, LIMITED, a network services company.
From 1997 until 2006, Mr. Keenan served as Chief Technology Officer of Merlot
Communications, Inc. Mr. Keenan is an expert on the convergence of
telecommunications and data who, prior to co-founding Merlot, founded QFR USA
Corporation, a high-tech firm engaged in developing custom ASICs for advanced
and cost-effective communications systems. He had previously founded two other
27
development firms. He also served as advanced engineering project director at
TIE/Communications, Inc., where he developed the TIE 612 Electronic Key System,
the first "skinny wire" telephone system and one of the largest selling key
systems in history. Mr. Keenan received his BS in Electrical Engineering from
the Milwaukee School of Engineering and has more than 20 years experience in
advanced analog and digital design techniques.
ANDREW MASLOW, DIRECTOR OF INDUSTRIAL AFFAIRS, MEMORIAL SLOAN-KETTERING
CANCER CENTER. Mr. Maslow heads the intellectual property activities of
Sloan-Kettering which includes licensing activities of the Center's technology
and management of its patent portfolio. Annual licensing revenue exceeds $60
million. Prior to joining Sloan-Kettering, Mr. Maslow was Associate Director of
the Office of Science and Technology of Columbia University where he was
responsible for the development, patenting and licensing of inventions
originating at the university. Mr. Maslow is a Registered Patent Attorney.
BORIS KATZENBERG, SENIOR ELECTRICAL ENGINEER, ORTRONICS, INC., A STRUCTURED
CABLING SOLUTIONS PROVIDER. Mr. Katzenberg has held numerous positions during
his 28-year career in the Telecom and Datacom industries. He has been a force in
the fields of power delivery and signal integrity systems, and has lent his
expertise in the development of many innovative and cutting-edge technologies.
From 1997 to 2002, he was a senior electrical engineer at Merlot Communications,
Inc., where he invented the technology underlying our Remote Power Patent. He
has also been active in the IEEE 802.3 at Task Force, developing the next
generation Power over Ethernet standard and continues to be responsible for the
evaluation of new technologies and their development into viable products for
Ortronics, Inc.
JONATHAN GREENE also serves as a member of the Technical Advisory Board
(see page 26 hereof for a description of Mr. Greene's background).
28
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Exchange Act requires that our executive officers,
directors, and persons who own more than 10% of our outstanding Common Stock
file initial reports of ownership and changes in ownership with the Securities
and Exchange Commission. Officers, directors and greater than 10% stockholders
are required by Commission regulations to furnish us with copies of all Section
16(a) forms they file. We believe that our executive officers, directors, and
greater than 10% stockholders complied with all required filings during the year
ended December 31, 2007.
CODE OF ETHICS
The Board of Directors has adopted a Code of Ethics that applies to the
principal executive officers, principal financial officer, principal accounting
officer or controller, or persons performing similar functions. The Code of
Ethics was filed as Exhibit 14 of the Company's Annual Report on Form 10-KSB for
the year ended December 31, 2003.
ITEM 10. EXECUTIVE COMPENSATION
The following table summarizes compensation, for the year ended December
31, 2007, awarded to, earned by or paid to the Company's Chief Executive Officer
("CEO") and to each of our executive officers who received total compensation in
excess of $100,000 for the year ended December 31, 2007 for services rendered in
all capacities to the Company (collectively, the "Named Executive Officers").
SUMMARY COMPENSATION TABLE
ANNUAL COMPENSATION LONG TERM COMPENSATION AWARDS
-------------------------------------------------- ----------------------------------
ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY ($) BONUS ($) OPTION AWARDS($) COMPENSATION($)(1) TOTAL($)
--------------------------- ---- ---------- --------- ---------------- ------------------ --------
Corey M. Horowitz 2007 $286,458 $162,000 (2) $655,000 ((3)) -- $1,103,458
Chairman and Chief
Executive Officer
2007 $ 89,380((4)) -- -- -- $ 89,380
David C. Kahn
Chief Financial Officer
-------------
(1) We have concluded that the aggregate amount of perquisites and other
personal benefits paid to either Mr. Horowitz or Mr. Kahn did not exceed
$10,000.
(2) Mr. Horowitz received the following bonus payments for 2007: (i) a
discretionary annual bonus of $150,000 for 2007 which was paid in
January 2008 and (ii) royalty bonus compensation of $12,000 pursuant to
his employment agreement.
(3) In determining the grant date fair value under SFAS No. 123R of (i) a
five (5) year option issued in February 2007 to Mr. Horowitz to purchase
375,000 shares of common stock and (ii) a five (5) year option issued in
April 2007 to Mr. Horowitz to purchase 732,709 shares of common stock,
we made the following assumptions: expected term of the options - 5
years, risk free interest rate for the expected term of the options -
4.52% and 4.67%; expected volatility of the underlying stock - 45.82%;
no expected dividends.
(4) Consists of consulting fees paid to Mr. Kahn for his services as Chief
Financial Officer.
29
NARRATIVE DISCLOSURE TO SUMMARY COMPENSATION TABLE
Employment Agreements, Termination of Employment and Change-In-Control
Arrangements
On February 28, 2007, we entered into a new Employment Agreement with Corey
M. Horowitz pursuant to which Mr. Horowitz continued to serve as our Chairman
and Chief Executive Officer for a two year term at an annual base salary of
$288,750 for the first year, increasing by 5% for the second year. In connection
with his employment agreement Mr. Horowitz was issued a five (5) year option to
purchase 375,000 shares of our common stock at an exercise price of $1.46 per
share which vested, on a quarterly basis over a one year period subject to
acceleration upon a change of control. We also issued to Mr. Horowitz on the one
year anniversary date (February 28, 2008) an additional five (5) year option to
purchase 375,000 shares of our common stock at an exercise price of $1.32 (the
closing price of our common stock on the date of grant), which option vests on a
quarterly basis over a one year period. In addition to the aforementioned option
grants, the Company agreed to extend for an additional three (3) years the
expiration dates of all options and warrants (an aggregate of 2,620,000 shares)
expiring in calendar year 2007 and 2008 owned by Mr. Horowitz and CMH Capital
Management Corp. ("CMH"), an affiliate. Under the terms of his Employment
Agreement, Mr. Horowitz receives bonus compensation in an amount equal to 5% of
our royalties or other payments (before deduction of payments to third parties
including, but not limited to, legal fees and expenses and third party license
fees) received from licensing its patents (including patents currently owned and
acquired or licensed on an exclusive basis during the period in which Mr.
Horowitz continues to serve as an executive officer of our company) (the
"Royalty Bonus Compensation"). During 2007, Mr. Horowitz received $12,000 of
Royalty Bonus Compensation. Mr. Horowitz shall also receive bonus compensation
equal to 5% of the gross proceeds from (i) the sale of any of our patents or
(ii) our merger with or into another corporation or entity. The Royalty Bonus
Compensation shall continue to be paid to Mr. Horowitz for the life of each of
the Company's patents with respect to licenses entered into by us with third
parties during Mr. Horowitz's term of employment or at anytime thereafter,
whether Mr. Horowitz is employed by us or not, provided, that, Mr. Horowitz's
employment has not been terminated by us "For Cause" (as defined) or terminated
by Mr. Horowitz without "Good Reason" (as defined). In the event that Mr.
Horowitz's employment is terminated by us "Other Than For Cause" (as defined) or
by Mr. Horowitz for "Good Reason" (as defined), Mr. Horowitz shall be entitled
to a severance of 12 months base salary.
In connection with his Employment Agreement, Mr. Horowitz has agreed not to
compete with us as follows: (i) during the term of the agreement and for a
period of 12 months thereafter if his employment is terminated other than for
cause (as defined) provided he is paid his 12 month base salary severance amount
and (ii) for a period of two years from the termination date, if terminated "For
Cause" by us or "Without Good Reason" by Mr. Horowitz. In accordance with his
employment agreement, Mr. Horowitz also has certain anti-dilution rights which
provide that if at any time during the period ended December 31, 2008, in the
event that we complete an offering of our common stock or any securities
convertible or exercisable into common stock (exclusive of securities issued
upon exercise of outstanding options, warrants or other convertible securities),
Mr. Horowitz shall receive from us, at the same price as the securities issued
in the financing, such number of additional options to purchase common stock so
that he maintains the same derivative ownership percentage (21.47%) of our
30
company based upon options and warrants owned by Mr. Horowitz and CMH (exclusive
of ownership of shares of common stock by Mr. Horowitz and CMH)as he owned as of
the time of execution of his employment agreement; provided, that, the
aforementioned anti-dilution protection was afforded to Mr. Horowitz up to a
maximum financing(s) of $2.5 million. In April 2007, with respect to our
completion of a $5.0 million private offering (See Note D[1] to our Financial
Statements], Mr. Horowitz was issued a five (5) year option to purchase 732,709
shares of our common stock, at an exercise price of $1.67, in accordance with
the aforementioned anti-dilution provisions of his employment agreement.
On December 20, 2006, we entered into an agreement with David C. Kahn
pursuant to which he continues to serve as our Chief Financial Officer through
December 31, 2008. In consideration for his services, Mr. Kahn was compensated
at the rate of $6,615 per month for the year ended December 31, 2007 and is
compensated at the rate of $6,945 per month for the year ended December 31,
2008. In connection with the agreement, Mr. Kahn was also issued a five (5) year
option (the "Option") to purchase 75,000 shares of our common stock at an
exercise price of $1.50 per share. The option vested 30,000 shares on the date
of grant and the balance of the shares (45,000) will vest on a quarterly basis
in equal amounts of 5,625 shares beginning March 31, 2007 through December 31,
2008. Upon a "Change in Control" (as defined) all of the unvested shares
underlying the Option shall become 100% vested and immediately exercisable. The
agreement further provides that we may terminate the agreement at any time for
any reason. In the event Mr. Kahn's services are terminated without "Good Cause"
(as defined), he will be entitled to accelerated vesting of all unvested shares
underlying the Option and the lesser of (i) six months base monthly compensation
or (ii) the remaining balance of the monthly compensation payable through
December 31, 2008.
31
DIRECTOR COMPENSATION
We compensated each director, who is not an employee of our company, by
granting to each such outside director (upon joining the Board) stock options to
purchase 50,000 shares of our common stock, at an exercise price equal to the
closing price of our common stock on the date of grant, with the options vesting
over a one year period in equal quarterly amounts. In addition, subject to the
discretion of the Compensation Committee and the Board of Directors, each
non-employee director is eligible to receive option grants for each year of
service as a director. In December 2007, each member of the Board of Directors
(with the exception of Harry Schessel who resigned in December 2007) were
granted the following options: (i) a five (5) year option to purchase 25,000
shares at an exercise price of $1.45 per share (closing price of our common
stock on the date of grant), which vested on the date of grant, for services as
a director for 2007 and (ii) a five (5) year option to purchase 25,000 shares at
an exercise price of $1.45 per share (closing price of our common stock on the
date of grant), which option vests on a monthly basis over a one (1) year
period, for services as a director for 2008.
The following table sets forth the compensation paid to all persons who
served as members of our board of directors (other than our named executive
officers) during the year ended December 31, 2007. No director who is also a
named executive officer received any compensation for services as a director in
2007.
Option Awards All other Total
Name ($) Compensation ($)
----------------------- ----------------- ---------------- -----------
Robert Graifman(1) $14,000 (2) $ -- $14,000
Robert Pons((1)) $14,000 (2) -- $14,000
Laurent Ohana(1) $14,000 (2) -- $14,000
Harry Schessel -- -- $ --
-------------
(1) In December 2007, Robert Graifman, Robert Pons and Laurent Ohana were
each granted a five (5) year option to purchase 25,000 shares of our
common stock (which vested on grant), at an exercise price of $1.45 per
share, for services as a Board member during 2007.
(2) In determining the grant date fair value of the option grants in
December 2007 under SFAS No. 123R, we made the following assumptions:
expected term of the options - five years; risk free interest rate for
the expected term of the options - 3.28%; expected volatility of the
underlying stock - 37.32%; no expected dividends.
32
OPTION GRANTS IN 2007
The following stock options granted to the Named Executive Officers
during the year ended December 31, 2007:
NUMBER OF
SECURITIES PERCENT OF TOTAL
UNDERLYING OPTIONS OPTIONS GRANTED TO EXERCISE EXPIRATION
NAME GRANTED EMPLOYEES IN 2007 PRICE DATE
---- ------- ----------------- ----- ----
Corey M. Horowitz 375,000 33.9% $1.46 2/28/2012
Chairman and 732,709 66.1% $1.67 4/16/2012
Chief Executive Officer
OUTSTANDING EQUITY AWARDS AT DECEMBER 31, 2007
The following table sets forth information relating to unexercised and
outstanding options for each Named Executive Officers as of December 31, 2007:
NUMBER OF SECURITIES
UNDERLYING UNEXERCISED OPTION
--------------------------------------
OPTION EXERCISE OPTION
NAME EXERCISABLE UNEXERCISABLE PRICE($) EXPIRATION DATE
Corey M. Horowitz
Chairman and CEO 375,000(1) -- $ 1.46 02/28/12
732,709(2) -- $ 1.67 04/16/12
1,195,361((3)) -- $ 1.18 03/06/12
400,000(4) -- $ .68 11/26/09
1,100,000(5) -- $ .25 11/26/14
515,218(6) -- $ .13 12/22/11
1,084,782((7)) -- $ .23 12/22/11
750,000(8)((20)) -- $ 1.20 04/18/10
250,000((9))(20) -- $ 1.48 10/08/10
300,000((10))((20)) -- $ .70 07/11/11
-- 10,625(1(8)) $ 3.0625 01/19/11
20,000(11) $ 6.00 10/20/11
10,000(12) $ 3.75 6/22/09
7,500(1(3)) $ 4.25 10/25/09
5,000(1(4)) $ 5.50 9/19/10
David Kahn
Chief Financial Officer 52,500((1)(5)) 22,500(1(9)) $ 1.50 12/20/11
75,000(1(6)) -- $ .80 08/04/10
35,000(17) -- $ .35 01/21/14
-------------
The vesting dates of the foregoing options are as follows: (1) 93,750 shares on
a quarterly basis beginning March 31, 2007 through December 31, 2007; (2) April
16, 2007; (3) March 16, 2005; (4) 200,000 shares on November 26, 2004 and
200,000 shares on November 26, 2005, (5) November 26, 2004; (6) December 22,
2003; (7) 434,782 shares on December 22, 2003, 250,000 shares on December 22,
2004, 200,000 shares on December 22, 2005, and 200,000 shares on December 22,
2006; (8) 250,000 shares on April 18, 2005, 250,000 shares on April 18, 2004 and
250,000 shares on April 18, 2005; (9) June 11, 2001; (10) July 11, 2001; (11) on
a quarterly basis in equal amounts beginning January 20, 1999 through October
20, 1999; (12) on a quarterly basis in equal amounts beginning September 12,
1999 through June 22, 2000; (13) on a quarterly basis in equal amounts beginning
January 25, 2000 through October 25, 2000; (14) on a quarterly basis in equal
amounts beginning December 19, 2000 through September 19, 2000; (15) 30,000
shares on December 20, 2006 and 5,625 on a quarterly basis beginning March 31,
2007 through December 31, 2008; (16) 30,000 shares on August 4, 2005 and 7,500
shares on a quarterly basis beginning September 30, 2005 through December 31,
2006; (17) 20,000 shares on January 21, 2004, 2,500 shares on the last day of
each month beginning January 31, 2004 through December 31, 2004; (18) 5,313
shares if the stock price reaches $10 per share and 5,312 shares if the stock
price reaches $15 per share; and (19) 5,625 shares on a quarterly basis
beginning March 31, 2007 through December 31, 2008.
(20) Includes options or warrants held by CMH Capital Management Corp., an
entity in which Mr. Horowitz is the sole owner, officer and director.
33
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The following table sets forth information regarding the beneficial
ownership of our common stock as of March 31, 2008 (i) each person known by us
to be the beneficial owner of more than 5% of our outstanding shares of common
stock, (ii) each of our directors, (iii) each of our executive officers, and
(iv) all of our executive officers and directors as a group.
NAME OF NUMBER OF SHARES PERCENTAGE OF SHARES
BENEFICIAL OWNER BENEFICIALLY OWNED BENEFICIALLY OWNED(2)
Corey M. Horowitz(3) 9,885,685 31.9%
CMH Capital Management Corp(4) 3,767,800 14.8%
Jonathan Auerbach((5)) 3,250,001 12.9%
Hound Partners, LLC((5)) 3,250,001 12.9%
Hound Performance, LLC((5)) 3,250,001 12.9%
Barry Rubenstein(6) 2,078,896 8.6%
Hound Partners Offshore Fund, L.P.(7)) 1,627,275 6.6%
Hound Partners, L.P. ((8)) 1,622,726 6.6%
Emigrant Capital Corporation ((9))
Paul Milstein Revocable 1998 Trust
New York Private Bank & Trust Corporation
Emigrant Bancorp. Inc.
Emigrant Savings Bank 1,312,500 5.4%
Eric Singer((10)) 1,248,840 5.1%
Robert Graifman(1(1)) 380,194 1.5%
David C. Kahn(1(2)) 133,125 *
Laurent Ohana(1(3)) 185,417 *
Robert Pons(1(4)) 135,417 *
All officers and directors as a group 10,719,838 33.8%
(5 Persons)
-------------
* Less than 1%.
(1) Unless otherwise indicated, we believe 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.
(2) 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
24,135,557 shares of our common stock outstanding.
34
(3) Includes (i) 343,803 shares of common stock held by Mr. Horowitz, (ii)
5,539,320 shares of common stock subject to currently exercisable stock
options held by Mr. Horowitz, (iii) 2,467,800 shares of common stock
held by CMH Capital Management Corp. ("CMH"), an entity solely owned by
Mr. Horowitz, (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) 67,471 shares
of common stock owned by Donna Slavitt, the wife of Mr. Horowitz, (vii)
165,000 shares of common stock held by two trusts and a custodian
account for the benefit of Mr. Horowitz's three children and (viii)
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 291,875 shares of common stock which are not currently
exercisable.
(4) Includes (i) 2,467,800 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 stock options.
Corey M. Horowitz, by virtue of being the sole officer, director and
shareholder of CMH, has the sole power to vote and dispose of the shares
of common stock owned by CMH.
(5) Includes (i) 1,081,817 shares of common stock and 540,909 shares of
common stock subject to currently exercisable warrants held by Hound
Partners, LP and (ii) 1,084,850 shares of common stock and 542,425
shares of common stock subject to currently exercisable warrants held by
Hound Partners Offshore Fund, LP. Jonathan Auerbach is the managing
member of Hound Performance, LLC and Hound Partners, LLC. Hound
Performance, LLC is the general partner of Hound Partners, LP and Hound
Partners Offshore Fund, L.P. Hound Partners, LLC is the investment
manager of Hound Partners, LP and Hound Partners Offshore Fund, L.P. The
securities may be deemed to be beneficially owned by Hound Performance,
LLC, Hound Partners LLC and Jonathan Auerbach. The aforementioned
beneficial ownership is based upon Schedule 13G jointly filed by Hound
Partners, LLC, Hound Performance, LLC, Hound Partners, L.P. and Hound
Partners Offshore Fund, LP, with the Securities and Exchange Commission
on April 26, 2007 and a Form 3 jointly filed by Hound Partners, LLC,
Hound Performance, LLC and Jonathan Auerbach with the Securities and
Exchange Commission on April 26, 2007. Jonathan Auerbach by virtue of
being the managing member of Hound Performance, LLC and Hound Partners,
LLC has the power to vote and dispose of the securities held by Hound
Partners, LP and Hound Partners Offshore Fund, L.P.
(6) Includes (i) 150,012 shares of common stock held by Mr. Rubenstein, (ii)
47,500 shares of common stock subject to currently exercisable stock
options held by Mr. Rubenstein, and (iii) 792,726, 583,483, 309,316,
194,810 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. 7 to Schedule 13D jointly filed by Mr.
Rubenstein and related parties with the Securities and Exchange
Commission on November 14, 2007 and a Form 4 filed by Mr. Rubenstein
with the Securities and Exchange Commission on October 26, 2007. Barry
Rubenstein and Woodland Services Corp. are the general partners of
35
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.
(7) Includes (i) 1,084,850 shares of common stock and (ii) 542,425 shares of
common stock subject to currently exercisable warrants held by Hound
Partners Offshore Fund, L.P.
(8) Includes (i) 1,081,817 shares of common stock and (ii) 540,909 shares of
common stock subject to currently exercisable warrants owned by Hound
Partners, LP.
(9) Includes (i) 1,125,000 shares of common stock and (ii) 187,500 shares of
common stock subject to currently exercisable warrants held by Emigrant
Capital Corporation ("Emigrant Capital"). Emigrant Capital is a wholly
owned subsidiary of Emigrant Savings Bank ("ESB"), which is a
wholly-owned subsidiary of Emigrant Bancorp, Inc ("EBI"). EBI is a
wholly-owned subsidiary of New York Private Bank & Trust Corporation
("NYPBTC"). The Paul Milstein Revocable 1998 Trust (the "Trust") owns
100% of the voting stock of NYPBTC. ESB, EBI, NYPBTC and the Trust each
may be deemed to be the beneficial owner of the shares of common stock
and warrants held by Emigrant Capital. The aforementioned is based upon
a Schedule 13G/A filed jointly by Emigrant Capital, ESB, EBI, NYPBTC,
the Trust and others with the Securities and Exchange Commission on
January 12, 2005. Howard Milstein, 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.
(10) Includes (i) 517,500 shares of common stock and 268,125 shares of common
stock subject to currently exercisable warrants owned by Singer
Opportunity Fund, L.P., (ii) 179,500 shares of common stock and 106,875
shares of common stock subject to currently exercisable warrants owned
by Singer Fund, L.P., (iii) 168,840 shares of common stock subject to
currently exercisable warrants owned by Mr. Singer and (iv) 8,000 shares
of common stock owned by Singer Congressional Fund, L.P. Singer Fund
Management, LLC makes all investment and voting decisions on behalf of
Singer Opportunity Fund, L.P., Singer Fund, L.P. and Singer
Congressional Fund, L.P. The aforementioned is based in part on a
Schedule 13G filed jointly by Singer Fund Management, LLC, Singer
Opportunity Fund, L.P., Singer Fund, L.P. and Singer Congressional Fund,
L.P. with the Securities and Exchange Commission on March 23, 2005. Eric
Singer, by virtue of being managing member of Singer Fund, L.P., Singer
Fund Management, LLC, and Singer Congressional Fund, L.P. has sole power
to vote and dispose of the securities owned by Singer Fund, L.P.
(11) Includes (i) 154,777 shares of common stock, (ii) 75,000 shares subject
to currently exercisable warrants and (iii) 150,417 shares subject to
currently exercisable stock options issued to Mr. Graifman. Does not
include options to purchase 14,583 shares of common stock held by Mr.
Graifman.
36
(12) Includes 133,125 shares of common stock subject to currently exercisable
stock options issued to Mr. Kahn. Does not include options to purchase
16,875 shares of common stock which are not currently exercisable.
(13) Includes 185,417 shares subject to currently exercisable options and
warrants issued to Mr. Ohana. Does not include options to purchase
14,583 shares of common stock held by Mr. Ohana.
(14) Includes 135,417 shares subject to currently exercisable stock options
issued to Mr. Pons. Does not include options to purchase 14,583 shares
of common stock held by Mr. Pons.
The Equity Compensation Plan information presented in Item 5 of this Annual
Report is incorporated herein in its entirety.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR
INDEPENDENCE
On December 20, 2006, we entered into an agreement with David C. Kahn
pursuant to which he agreed to continue to serve as our Chief Financial Officer
through December 31, 2008. In consideration for his services, Mr. Kahn was
compensated at the rate of $6,615 per month for the period through December 31,
2007 and is currently compensated at the rate of $6,945 per month for the year
ended December 31, 2008. See Item 10 "Executive Compensation-Employment
Agreements, Termination of Employment and Change-In-Control Arrangements" for
the detailed terms of our arrangement with Mr. Kahn.
On February 28, 2007, we entered into an Employment Agreement with Corey M.
Horowitz pursuant to which Mr. Horowitz continues to serve as our Chairman and
Chief Executive Officer for a two year term at an annual base salary of $288,750
for the first year with a 5% increase on the one year anniversary thereof. See
Item 10. "Executive Compensation-Employment Agreements, Termination of
Employment and Change-In-Control Arrangements" for the detailed terms of our
employment agreement with Mr. Horowitz.
On April 16, 2007, we issued to Corey M. Horowitz, our Chairman and Chief
Executive Officer, a five (5) year option to purchase 732,709 shares of our
common stock, at an exercise price of 1.67 per share, which option fully vested
on the date of issue. The aforementioned option was issued to Mr. Horowitz
pursuant to the anti-dilution provisions of his employment agreement as a result
of our completion of a $5,000,000 private placement in April 2007. (See Notes
D[1] and I[1] to our Financial Statements).
On February 28, 2008, in accordance with his employment agreement, we
issued to Corey M. Horowitz, our Chairman and Chief Executive Officer, an option
to purchase 375,000 shares of our common stock, at an exercise price of $1.32
per share, which option vests in equal quarterly amounts of 93,750 shares
beginning March 31, 2008 through December 31, 2008. (See "Item 10. Executive
Compensation - Employment Agreements, Termination of Employment and
Change-In-Control Arrangements).
In December 2007, our Board of Directors extended the expiration date of
warrants to purchase an aggregate of 2,013,750 shares of our common stock (the
37
"Warrants") issued to investors in our private offering completed in December
2004 and January 2005. The Warrants were exercisable for (i) an aggregate of
1,342,500 shares at an exercise price of $1.25 per share (the "$1.25 Warrants")
and (ii) and aggregate of 671,250 shares at an exercise price of $1.75 per share
(the "$1.75 Warrants"). Investors in the aforementioned private offering
included two of our principal stockholders, Emigrant Capital Corporation
(invested $750,000 and received 375,000 $1.25 Warrants and 187,500 1.75
Warrants) and Eric Singer, (through two affiliated entities invested an
aggregate of $500,000 and received 250,000 $1.25 Warrants and 125,000 $1.75
Warrants), as well as one of our directors, Robert Graifman (invested $100,000
and received 50,000 $1.25 Warrants and 25,000 $1.75 Warrants). The Warrants were
scheduled to expire on December 21, 2007 or January 13, 2008 (three (3) years
from the date of issuance). The extended expiration dates and adjusted exercise
prices were as follows:
o The expiration date of the Warrants (both the $1.25 Warrants and
the $1.75 Warrants) was extended until March 14, 2008.
o In addition, to the extent the holders exercised in full their
$1.25 Warrants no later than December 21, 2007, such holders were
afforded an extension of the expiration date of their $1.75 Warrants
until May 21, 2010 such that the exercise price of the $1.75 Warrants
will remain at $1.75 per share through March 31, 2009 and increased to
$2.00 per share if exercised thereafter until May 21, 2010, at which
time they will expire.
o To the extent holders exercised in full their $1.25 Warrants prior
to the new expiration date of March 14, 2008, the expiration date of
their $1.75 Warrants will be extended until December 15, 2008 and such
warrants will be exercisable at $2.00 per share beginning March 14,
2008.
In December 2007 (prior to December 21) 902,500 shares of 1.25 Warrants
were exercised by holders resulting in proceeds to us of $1,128,125.
On March 7, 2008, our Board further extended the expiration dates of our
remaining outstanding $1.25 Warrants and $1.75 Warrants as follows: (i) the
expiration date of our outstanding $1.25 Warrants was extended from March 14,
2008 until June 16, 2008 and the exercise price of such warrants was adjusted to
$1.30 per share and (ii) the expiration date of our $1.75 Warrants was extended
until December 15, 2008 and the exercise price of such warrants was adjusted to
$2.00 per share..
On December 21, 2007, our Board extended the expiration date of warrants
issued to Laurent Ohana, one of our directors, in December 2004, to purchase
50,000 shares of our common stock, from December 21, 2007 until May 21, 2010.
DIRECTOR INDEPENDENCE
Three of our four directors - Robert Pons, Robert Graifman and Laurent
Ohana are considered independent directors based upon the standard of
independence adopted by the Board of Directors as promulgated under Rule 121A of
the Company Guide of the American Stock Exchange ("AMEX"). Robert Graifman is
considered an
38
independent member of our audit committee under Rule 121A of the Company Guide
of AMEX and Rule 10A-3 under the Securities Exchange Act of 1934. While we are
not listed on AMEX, our Board has adopted its independence rules in making its
determination of director independence.
ITEM 13. EXHIBITS LIST
(a) Exhibits
10.2 Patents Purchase, Assignment and License Agreement, dated November
18, 2003, between the Company and Merlot Communications, Inc.
Previously filed as Exhibit 10.10 to the Company's Current Report on
Form 8-K filed December 3, 2003 and incorporated herein by
reference.
10.3 Letter Agreement, dated December 21, 2003, between the Company and
Corey M. Horowitz, including exhibits. Previously filed as Exhibit
10.3 to the Company's Annual Report on Form 10-KSB filed April 14,
2004 and incorporated herein by reference.
10.4 Letter Agreement dated January 22, 2004, between the Company and
David Kahn. Previously filed as Exhibit 10.4 to the Company's Annual
Report on Form 10-KSB filed April 14, 2004 and incorporated herein
by reference.
10.5 Exchange Agreement, dated April 13, 2004, between the Company and
its Preferred Stockholders. Previously filed as Exhibit 10.5 to the
Company's Annual Report on Form 10-KSB filed April 14, 2004 and
incorporated herein by reference.
10.6 Employment Agreement, dated November 26, 2004, between the Company
and Corey M. Horowitz. Previously filed as Exhibit 10.1 to the
Company's Current Report on Form 8-K filed December 1, 2004 and
incorporated herein by reference.
10.7 Master Services Agreement, dated November 30, 2004, between the
Company and ThinkFire Services USA, Ltd. Previously filed as Exhibit
10.1 to the Company's Current Report on Form 8-K filed December 2,
2004 and incorporated herein by reference.
10.8 Securities Purchase Agreement, dated December 21, 2004, between
Company and the investors. Previously, filed as Exhibit 10.1 to the
Company's Current Report on Form 8-K filed December 28, 2004 and
incorporated herein by reference.
10.9 Securities Purchase Agreement, dated January 13, 2005, between the
Company and the investors. Previously filed as Exhibit 10.2 to the
Company's Current Report on Form 8-K filed on January 20, 2005 and
incorporated herein by reference.
10.10 Amendment to Patents Purchase, Assignment and License Agreement,
dated January 18, 2005, between the Company and Merlot
Communications, Inc. Previously filed January 24, 2005 as Exhibit
10.1 to the Company's Current Report on Form 8-K filed on January
18, 2005 and incorporated herein by reference.
39
10.11 Agreement, dated August 4, 2005, between the Company and David C.
Kahn. Previously filed as Exhibit 10.1 to the Company's Current
Report on Form 8-K filed August 9, 2005 and incorporated herein by
reference.
10.12 Agreement, dated August 9, 2005, between the Company and Blank Rome
LLP. Previously filed as Exhibit 10.1 to the Company's Current
Report on Form 8-K filed on August 11, 2005 and incorporated herein
by reference.
10.13 Settlement Agreement, dated November 16, 2005, among the Company,
PowerDsine Ltd and PowerDsine, Inc. Previously filed as Exhibit 10.1
to the Company's Current Report on Form 8-K filed November 17, 2005
and incorporated herein by reference.
10.14 Agreement, dated December 20, 2006, between the Company and David C.
Kahn, previously filed as Exhibit 10.1 to the Company's Current
Report on Form 8-K filed December 22, 2006 and incorporated herein
by reference.
10.15 Employment Agreement, dated February 28, 2007, between the Company
and Corey M. Horowitz previously filed as Exhibit 10.1 to the
Company's Current Report on Form 8-K filed March 6, 2007 and
incorporated herein by reference.
10.16 Securities Purchase Agreement, dated April 16, 2007, between the
Company and the investors (including exhibits). Previously filed as
Exhibit 10.1 to the Company's Current Report on Form 8-K filed April
20, 2007 and incorporated herein by reference.
10.17 Settlement Agreement, dated as of May 25, 2007, between the Company
and D-Link Corp. and D-Link Systems, Inc., previously filed as
Exhibit 10.1 to the Company's Current Report on Form 8-K, filed on
August 21, 2007 and incorporated herein by reference.
14 Code of Ethics. Previously filed as Exhibit 14 to the Company's
Annual Report on Form 10-KSB for the year ended December 31, 2004
filed on April 14, 2004 and incorporated herein by reference.
23.1* Consent of Radin Glass Co., LLP, Independent Registered Public
Accounting Firm.
31.1* Section 302 Certification of Chief Executive Officer.
31.2* Section 302 Certification of Chief Financial Officer.
32.1* Section 906 Certification of Chief Executive Officer.
32.2* Section 906 Certification of Chief Financial Officer.
--------------------------------------------------------------------------------
* Filed herewith
40
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
AUDIT FEES
Radin, Glass & Co., LLP, our company's independent accountant, billed us
aggregate fees of approximately $69,000 for the years ended December 31, 2007
and December 31, 2006, respectively, for review of financial statements included
in our Form 10-QSB's and for other services in connection with statutory or
regulatory filings for the year ended December 31, 2007, and for the audit of
our annual financial statements for the year ended December 31, 2007 and
December 31, 2006.
AUDIT RELATED FEES, TAX FEES AND ALL OTHER FEES
Radin, Glass & Co., LLP did not render any other professional service other
than those discussed above for the years ended December 31, 2007 or December 31,
2006.
41
SIGNATURES
In accordance with the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the registrant caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized, in the City of New
York, State of New York, on the 10th day of April 2008.
NETWORK-1 SECURITY SOLUTIONS, INC.
By /s/ Corey M. Horowitz
-------------------------------------
Corey M. Horowitz
Chairman and Chief Executive Officer
In accordance with the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the registrant caused this report to be signed
on its behalf by the following persons in the capacities and on the dates
indicated:
NAME TITLE DATE
---- ----- ----
/s/ Corey M. Horowitz Chairman and Chief Executive April 10, 2008
--------------------------- Officer, Chairman of the Board of
Corey M. Horowitz Directors (principal executive
officer)
/s/ David Kahn Chief Financial Officer (principal April 10, 2008
--------------------------- financial officer)
David Kahn
/s/ Robert Graifman Director April 10, 2008
---------------------------
Robert Graifman
/s/ Robert Pons Director April 10, 2008
---------------------------
Robert Pons
/s/ Laurent Ohana Director April 10, 2008
---------------------------
Laurent Ohana
42
NETWORK-1 SECURITY SOLUTIONS, INC.
FINANCIAL STATEMENTS
DECEMBER 31, 2007 AND 2006
NETWORK-1 SECURITY SOLUTIONS, INC.
PAGE
----
INDEX TO FINANCIAL STATEMENTS
Report of independent registered public accounting firm F-1
Balance sheets as of December 31, 2007 and 2006 F-2
Statements of operations for the years ended December 31, 2007 and 2006 F-3
Statements of changes in stockholders' equity for the years ended December 31, 2007 and 2006 F-4
Statements of cash flows for the years ended December 31, 2007 and 2006 F-5
Notes to financial statements F-6
NETWORK-1 SECURITY SOLUTIONS, INC.
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, 2007 and 2006 and the related statements of operations,
changes in stockholders' equity and cash flows for 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 audit 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 referred to above present fairly, in
all material respects, the financial position of Network-1 Security Solutions,
Inc. as of December 31, 2007 and 2006, and the results of its operations and its
cash flows for the years then ended in conformity with accounting principles
generally accepted in the United States of America.
/s/ Radin, Glass & Co., LLP
New York, New York
March 25, 2008
F-1
NETWORK-1 SECURITY SOLUTIONS, INC.
BALANCE SHEETS
DECEMBER 31,
----------------------------
2007 2006
------------ ------------
CURRENT ASSETS
Cash and cash equivalents $ 5,928,000 $ 1,797,000
Royalty and interest receivable 23,000 4,000
Prepaid insurance 71,000 74,000
------------ ------------
Total current assets 6,022,000 1,875,000
------------ ------------
OTHER ASSETS:
Patent, net of accumulated amortization of $28,000 and
$21,000, respectively 72,000 79,000
Security deposits 6,000 17,000
------------ ------------
Total Other Assets 78,000 96,000
------------ ------------
TOTAL ASSETS $ 6,100,000 $ 1,971,000
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 103,000 $ 350,000
Accrued expenses 264,000 219,000
------------ ------------
TOTAL LIABILITIES 367,000 569,000
------------ ------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Common stock, $0.01 par value; authorized 50,000,000 shares;
24,135,557 and 19,764,724 issued and outstanding in 2007
and 2006, respectively 241,000 197,000
Additional paid-in capital 54,769,000 47,484,000
Accumulated deficit (49,277,000) (46,279,000)
------------ ------------
TOTAL STOCKHOLDERS' EQUITY 5,733,000 1,402,000
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 6,100,000 $ 1,971,000
============ ============
See notes to financial statements F-2
NETWORK-1 SECURITY SOLUTIONS, INC.
STATEMENTS OF OPERATIONS
YEAR ENDED
DECEMBER 31,
----------------------------
2007 2006
------------ ------------
ROYALTY REVENUE $ 232,000 --
COST OF REVENUE 12,000 --
------------ ------------
GROSS PROFIT 220,000 --
------------ ------------
OPERATING EXPENSES:
General and administrative $ 1,992,000 $ 1,548,000
Non-cash compensation 1,403,000 479,000
------------ ------------
TOTAL OPERATING EXPENSES 3,395,000 2,027,000
------------ ------------
OPERATING LOSS (3,175,000) (2,027,000)
OTHER INCOME (EXPENSES):
Interest income, net 177,000 69,000
------------ ------------
LOSS BEFORE INCOME TAXES (2,998,000) (1,958,000)
INCOME TAXES -- --
------------ ------------
NET LOSS $ (2,998,000) $ (1,958,000)
============ ============
Net Loss Per Share - Basic and Diluted $ (0.13) $ (0.10)
============ ============
Weighted average number of common shares outstanding -
Basic and Diluted 22,250,144 18,952,137
============ ============
See notes to financial statements F-3
NETWORK-1 SECURITY SOLUTIONS, INC.
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2007 AND 2006
COMMON STOCK ADDITIONAL
-------------------------- PAID-IN ACCUMULATED
SHARES AMOUNT CAPITAL DEFICIT TOTAL
------------ ------------ ------------ ------------ ------------
Balance - December 31, 2005 17,697,572 $ 177,000 $ 44,896,000 $(44,321,000) $ 752,000
Exercise of Warrants 1,987,152 20,000 2,109,000 -- 2,129,000
Issuance of common stock for services 80,000 -- 120,000 -- 120,000
Granting of options -- -- 359,000 -- 359,000
Net loss -- -- (1,958,000) (1,958,000)
------------ ------------ ------------ ------------ ------------
Balance - December 31, 2006 19,764,724 197,000 47,484,000 (46,279,000) 1,402,000
Reclassification 1,000 (1,000) -- --
Exercise of options and warrants 1,037,500 10,000 1,191,000 -- 1,201,000
Sales of common stock, net of
finder's fee of $275,000 3,333,333 33,000 4,692,000 -- 4,725,000
Granting of options and extensions of
options -- -- 1,403,000 -- 1,403,000
Net loss -- -- -- (2,998,000) (2,998,000)
------------ ------------ ------------ ------------ ------------
Balance - December 31, 2007 24,135,557 $ 241,000 $ 54,769,000 $(49,277,000) $ 5,733,000
============ ============ ============ ============ ============
See notes to financial statements F-4
NETWORK-1 SECURITY SOLUTIONS, INC.
STATEMENTS OF CASH FLOWS
YEAR ENDED
DECEMBER 31,
----------------------------
2007 2006
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (2,998,000) $ (1,958,000)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 18,000 8,000
Stock-based compensation 1,403,000 359,000
Issuance of common stock for services -- 120,000
Changes in operating assets and liabilities:
Royalty and interest receivable (19,000) (1,000)
Prepaid insurance 3,000 8,000
Accounts payable and accrued expenses (202,000) 206,000
------------ ------------
NET CASH USED IN OPERATING ACTIVITIES (1,795,000) (1,258,000)
------------ ------------
CASH FLOWS USED IN INVESTING ACTIVITIES:
Purchase of property and equipment -- (12,000)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock, net of finders
fee of $275,000 4,725,000 --
Proceeds from exercise of options and warrants 1,201,000 2,129,000
------------ ------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 5,926,000 2,129,000
------------ ------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 4,131,000 859,000
CASH AND CASH EQUIVALENTS, Beginning 1,797,000 938,000
------------ ------------
CASH AND CASH EQUIVALENTS, Ending $ 5,928,000 $ 1,797,000
============ ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the years for:
Interest $ 4,000 $ 1,000
============ ============
Taxes -- --
See notes to financial statements F-5
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2007 AND 2006
NOTE A - THE COMPANY
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") and
includes, among other things, patents covering the control of power delivery
over Ethernet networks for the purpose of remotely powering network devices and
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). The
Company's strategy is to pursue licensing and strategic business alliances with
companies that manufacture and sell products that make use of the technologies
underlying the Patent Portfolio as well as with other users of the technologies
who benefit directly from the technologies including corporate, educational and
governmental entities. To date, the Company's efforts with respect to its Patent
Portfolio have focused on licensing its patent (U.S. Patent No. 6,218,930)
covering the control of power delivery over Ethernet cables (the "Remote Power
Patent"). At least for the next twelve months, the Company does not currently
anticipate licensing efforts for its other patents besides its Remote Power
Patent. The Company may seek to acquire additional patents in the future.
NOTE B -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:
The Company recognizes revenue received from the licensing of its
intellectual property portfolio in accordance with Staff Accounting
Bulletin No. 104, "Revenue Recognition" ("SAB No. 104") and related
authoritative pronouncements. 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.
[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, 2007 and 2006, 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.
F-6
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2007 AND 2006
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
[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 11,553,356 and
9,281,481 at December 31, 2007 and 2006, 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 and warrants.
[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.
[9] STOCK-BASED COMPENSATION:
Effective January 1, 2006, the Company adopted SFAS No. 123 (revised
2004), SHARE BASED PAYMENT, or SFAS 123(R), which is a revision of
Statement No. 123 ("SFAS 123") ACCOUNTING FOR STOCK BASED COMPENSATION.
SFAS 123(R) supersedes Accounting Principles Board ("APB") No. 25,
ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES ("APB 25"), and amends Financial
Accounting Standards Board ("FASB") Statement No. 95 STATEMENT OF CASH
FLOWS. SFAS 123(R) requires all share-based payments to employees,
including grants of employee stock options, to be recognized in the
income statement based on their fair values.
F-7
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2007 AND 2006
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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:
YEAR ENDED
DECEMBER 31,
----------------------------------
2007 2006
-------------- --------------
Risk-free interest rates 3.28 - 4.67% 4.51 - 4.57%
Expected option life in years 5 YEARS 5 TO 10 YEARS
Expected stock price volatility 37.32 - 45.92% 48.45 - 69.82%
Expected dividend yield 0.00% 0.00%
The weighted average fair value on the option grant date during the years
ended December 31, 2007 and 2006 were $0.82 and $0.77 per option,
respectively.
[10] RECENTLY ISSUED ACCOUNTING STANDARDS:
In September 2006, the FASB issued SFAS No. 157 "Fair Value Measures"
("SFAS 157"). SFAS 157 defines fair value, establishes a framework for
measuring fair value, and expands disclosures about fair value
measurements. This statement applies under other accounting
pronouncements that require or permit fair value measurements, however it
does not apply to SFAS 123R. This Statement shall be effective for
financial statements issued for fiscal years beginning after November 15,
2007, and interim periods within those fiscal years. The Company does not
believe that SFAS 157 will have a material impact on its financial
position, results of operations or cash flows.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for
Financial Assets and Financial Liabilities ("SFAS 159"). SFAS 159
provides companies with an option to report selected financial assets and
liabilities at fair value. SFAS 159 also establishes presentation and
disclosure requirements designed to facilitate comparisons between
companies that choose different measurement attributes for similar types
of assets and liabilities and to provide additional information that will
help investors and other financial statement users to more easily
understand the effect of the Company's choice to use fair value on its
earnings. Finally, SFAS 159 requires entities to display the fair value
of those assets and liabilities for which the Company has chosen to use
fair value on the face of the balance sheet. SFAS 159 is effective as of
the beginning of an entity's first fiscal year beginning after November
15, 2007. Early adoption is permitted. The Company does not believe that
SFAS No. 159 will have a material impact on its financial position,
results of operations or cash flows.
In December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interest
In Consolidated Financial Statements" (SFAS 160). SFAS 160 requires all
entities to report noncontrolling (minority) interests in subsidiaries in
the same way as equity in the consolidated financial statement. Moreover,
SFAS 160 eliminates the diversity that currently exists in accounting for
transactions between an entity and noncontrolling interests by requiring
they be treated as equity transactions. This statement is effective for
fiscal years beginning after December 15, 2008. The Company does not
believe that SFAS No. 160 will have a material impact on its financial
position, results of operations, or cash flows.
F-8
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2007 AND 2006
NOTE C- 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 licensing of the patents. On January 18, 2005,
the Company and Seller amended the Patent Purchase Agreement (the "Amendment")
pursuant to which the Company paid additional purchase price of $500,000 to
Seller in consideration for the restructuring of future contingent payments to
Seller from the licensing or sale of the Patents. Such $500,000 has been
recorded as an expense in the accompanying statement of operations. The
Amendment provides for future contingent payments by the Company to Seller 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. Amortization expense
amounted to $7,000 each for the years ended December 31, 2007 and December 31,
2006.
NOTE D - STOCKHOLDERS' EQUITY
[1] PRIVATE PLACEMENT:
On April 16, 2007, the Company sold in a private placement 3,333,333
shares of common stock at a price of $1.50 per share or an aggregate
purchase price of $5,000,000 and five (5) year warrants to purchase
1,666,667 shares of common stock, at an exercise price of $2.00 per
share. In connection with the private placement the Company paid
placement agent fees of $275,000 and issued warrants to purchase an
aggregate of 360,000 shares of common stock (240,000 shares exercisable
at $1.50 per share and 120,000 shares exercisable at $2.00 per share).
[2] 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, provided for the granting of both incentive and non-qualified
options to purchase common stock of the Company. A total of 4,000,000
were eligible to be issued under the 1996 Plan. As of March 2006, in
accordance with the terms of the plan, no further options were eligible
to be issued under the 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 were set by the
Compensation Committee in its discretion.
F-9
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2007 AND 2006
NOTE D - STOCKHOLDERS' EQUITY (CONTINUED)
The following table summarizes stock option activity for the years ended
December 31:
2007 2006
----------------------------------------- -----------------------------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
OPTIONS EXERCISE OPTIONS EXERCISE
OUTSTANDING PRICE OUTSTANDING PRICE
-------------------------- ------------- -------------------------- -------------
Options outstanding at beginning of year 6,667,731 (a)(b) $ 0.89 6,337,731 (c) $ 0.87
Granted 1,282,709 (d)(e)(f)(g) 1.58 330,000 (a)(b) 1.40
Cancelled/expired/Exercised 90,000 0.18 --
------------- -------------
Options outstanding at end of year 7,860,440 1.01 6,667,731 0.89
============= =============
Options exercisable at end of year 7,703,565 $ 0.99 6,562,106 0.87
============= =============
(a) Includes an aggregate of 30,000 and 150,000 ten-year and five-year stock
options issued to directors on February 2, 2006 and December 20, 2006,
respectively, at exercise prices of $1.31 and $1.50 per share. The
Company recorded non-cash compensation of $8,000 and $132,000 relating to
the issuance of these options for the years ended December 31, 2007 and
2006, respectively.
(b) Includes 75,000 five-year stock options issued to each of the Chief
Financial Officer and a consultant to the Company on December 20, 2006
and February 2, 2006, respectively, at exercise prices of $1.50 and $1.20
per share. The Company recorded non-cash compensation of $31,000 and
$68,000 relating to the issuance of these options for the years ended
December 31, 2007 and 2006, respectively.
(c) In 2003, the Company granted 1,084,782 stock options to the Chairman and
Chief Executive Officer in connection with his employment agreement, of
which 200,000 stock options were vested in 2006. Accordingly, the Company
recorded non-cash compensation of $42,000 relating to these options in
accordance with SFAS 123 (R).
(d) Includes an aggregate of 75,000 five-year stock options granted to
directors on December 21, 2007, at exercise prices of $1.45 per share.
The Company recorded non-cash compensation of $42,000 relating to the
issuance of these options for the year ended December 31, 2007 since none
of these options were vested in 2007.
(e) Includes 100,000 five-year stock options granted to a consultant to the
Company on December 21, 2007, at exercise prices of $1.45 per share. The
Company recorded non-cash compensation of $-0- relating to the issuance
of these options for the year ended December 31, 2007 since none of the
options were vested in 2007.
(f) In 2007, the Company granted 375,000 stock options to the Chairman and
Chief Executive Officer in connection with his employment agreement,
which were fully vested in 2007. Accordingly, the Company recorded
non-cash compensation of $252,000 relating to these options in accordance
with SFAS 123 (R).
(g) In 2007 the Company granted 732,709 stock options to the Chairman and
Chief Executive Officer in connection with the anti-dilution provision of
his employment agreement. Accordingly, the Company recorded non-cash
compensation of $403,000 relative to these options in 2007.
F-10
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2007 AND 2006
NOTE D - STOCKHOLDERS' EQUITY (CONTINUED)
The following table presents information relating to all stock options
outstanding and exercisable at December 31, 2007:
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 7,537,215 $ 0.85 4.19 7,414,715 $ 0.84
$3.00 - $3.75 146,625 3.44 2.31 112,250 3.56
$4.13 - $5.69 77,100 5.08 2.08 77,100 5.08
$6.00 - $6.88 89,500 6.21 2.13 89,500 6.21
$10.00 10,000 10.00 2.21 10,000 10.00
----------- -----------
7,860,440 1.01 4.11 7,703,565 0.99
=========== ===========
[3] WARRANTS:
As of December 31, 2007, the following are the outstanding warrants to
purchase shares of the Company's common stock:
NUMBER
OF EXERCISE
WARRANTS PRICE EXPIRATION DATE
----------- -------- ------------------------
300,000 0.70 July 11, 2011 (a)
50,000 1.00 May 21, 2010 (b)(e)
342,500 1.25 March 14, 2008 (b)(f)
52,500 1.25 March 14, 2008 (c)(g)
250,000 1.48 October 8, 2011 (a)
240,000 1.50 April 16, 2012 (d)
171,250 1.75 December 15, 2008 (b)(h)
350,000 1.75 May 21, 2010 (b)(i)
26,250 1.75 December 15, 2008 (c)(j)
123,750 1.75 May 21, 2010 (c)(k)
1,786,667 2.00 April 16, 2012 (d)
-----------
3,692,917
===========
(a) Issued to CMH Capital Management Corp. in 2001, a company owned by the
Chairman and Chief Executive Officer.
(b) Issued in connection with December 2004 private offering of common stock.
(c) Issued in connection with the January 2005 private offering of common
stock.
(d) Issued in connection with the April 2007 private offering of common
stock.
(e) These warrants were to expire on December 21, 2007 and were extended to
May 21, 2010.
(f) These warrants were to expire on December 21, 2007 and were extended to
March 14, 2008.
F-11
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2007 AND 2006
NOTE D - STOCKHOLDERS' EQUITY (CONTINUED)
(g) These warrants were to expire on January 12, 2008 and were extended to
March 14, 2008.
(h) These warrants were to expire on December 21, 2007 and were extended to
December 15, 2008.
(i) These warrants were to expire on December 21, 2007 and were extended to
May 20, 2010.
(j) These warrants were to expire on January 12, 2008 and were extended to
December 15, 2008.
(k) These warrants were to expire on January 12, 2008 and were extended to
May 20, 2010.
In 2007 and 2006 warrants to purchase 947,500 and 1,987,152 shares of
common stock were exercised for $1,184,000 and $2,129,000, respectively.
F-12
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2007 AND 2006
NOTE E - 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 after the Company recovers its
expenses.
[2] LEGAL FEES:
With respect to the Company's litigation against D-Link, which was
settled in May 2007 (See Note J[1]), the Company utilized the services of
Blank Rome, LLP, on a full contingency basis and also the services of
Potter Mitton, P.C. (Tyler, Texas) on an hourly basis to serve as local
counsel. In accordance with the Company's contingency fee agreement with
Blank Rome LLP, the Company will pay legal fees to Blank Rome LLP equal
to 25% of the royalty revenue received by the Company from its license
agreement with D-Link after it recovers its expenses related to the
litigation.
[3] OPERATING LEASES:
The Company leases its principal office space in New York City at a
monthly rent of approximately $3,000 for a one year period ended June
2008.
Rental expense for the years ended December 31, 2007 and 2006 aggregated
$39,000 and $38,000, respectively.
[4] 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,
2007 and 2006.
F-13
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2007 AND 2006
NOTE F - INCOME TAXES
At December 31, 2006, the Company has available net operating loss carryforwards
to reduce future federal taxable income of approximately $45,364,000 for tax
reporting purposes, which expire from 2009 through 2027.
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:
YEAR ENDED
DECEMBER 31,
----------------------------
2007 2006
------------ ------------
Deferred tax assets:
Net operating loss carryforwards $ 16,800,000 $ 16,136,000
Options and warrants not yet deducted,
for tax purposes 705,000 177,000
Other -0- -0-
------------ ------------
17,505,000 16,313,000
Valuation allowance (17,505,000) (16,313,000)
------------ ------------
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 $1,192,000 in 2007
and $1,618,000 in 2006.
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,
----------------------------
2007 2006
------------ ------------
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 G - CONCENTRATIONS
The Company places its cash investments in high quality financial institutions
insured by the Federal Deposit Insurance Corporation ("FDIC"). At December 31,
2007, the Company maintained cash balances of $5,828,000 in excess of FDIC
limits.
F-14
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2007 AND 2006
NOTE H - RELATED PARTY TRANSACTIONS
[1] In December 2007, the Company extended the expiration date of warrants to
purchase an aggregate of 2,013,750 shares of our common stock (the
"Warrants") issued to investors in the Company's private offering
completed in December 2004 and January 2005. The Warrants were
exercisable for (i) an aggregate of 1,342,500 shares at an exercise price
of $1.25 per share (the "$1.25 Warrants") and (ii) and aggregate of
671,250 shares at an exercise price of $1.75 per share (the "$1.75
Warrants"). Investors in the aforementioned private offering included two
principal stockholders of the Company, who invested an aggregate of
$1,250,000 and as part of the offering received an aggregate of 625,000
$1.25 Warrants and 312,500 $1.75 Warrants, and a director of the Company,
who invested $100,000 and received 50,000 $1.25 Warrants and 25,000 $1.75
Warrants as part of the offering. The Warrants were scheduled to expire
on December 21, 2007 or January 13, 2008 (three (3) years from the date
of issuance). The expiration date of the Warrants (both the $1.25
Warrants and the $1.75 Warrants) was extended until March 14, 2008. In
addition, to the extent the holders exercised in full their $1.25
Warrants no later than December 21, 2007, such holders were afforded an
extension of the expiration date of their $1.75 Warrants until May 21,
2010 such that the exercise price of the $1.75 Warrants will remain at
$1.75 per share through March 31, 2009 and increased to $2.00 per share
if exercised thereafter until May 21, 2010, at which time they will
expire. In December 2007 (prior to December 21) holders of $1.25 Warrants
to purchase 902,500 shares were exercised which resulted in proceeds to
the Company of $1,128,125. To the extent the remaining holders exercised
in full their $1.25 Warrants prior to the new expiration date of March
14, 2008, the expiration date of their $1.75 Warrants was extended until
December 15, 2008 and such warrants will be exercisable at $2.00 per
share beginning March 14, 2008.
[2] On December 21, 2007, the Company extended the expiration date of
warrants issued in December 2004 to a director of the Company, to
purchase 50,000 shares of our common stock, from December 21, 2007 until
May 21, 2010.
NOTE I - EMPLOYMENT ARRANGEMENTS AND OTHER AGREEMENTS
[1] On February 28, 2007, the Company entered into a new Employment Agreement
with Corey M. Horowitz pursuant to which Mr. Horowitz continued to serve
as Chairman and Chief Executive Officer for a two year term at an annual
base salary of $288,750 for the first year, increasing by 5% for the
second year. In connection with his employment agreement, Mr. Horowitz
was issued a five (5) year option to purchase 375,000 shares of common
stock at an exercise price of $1.46 per share which vests, on a quarterly
basis over a one year period subject to acceleration upon a change of
control. The Company also issued to Mr. Horowitz on the one year
anniversary date (February 28, 2007) an additional five (5) year option
to purchase a minimum of 375,000 shares of common stock at an exercise
price equal to the closing price of our common stock on the date of
grant, which option will vest on a quarterly basis over a one year
period. In addition to the aforementioned option grants, the Company
agreed to extend for an additional three (3) years the expiration dates
of all options and warrants (an aggregate of 2,620,000 shares) expiring
in calendar year 2007 and 2008 owned by Mr. Horowitz and CMH Capital
Management Corp. ("CMH"), an affiliate. Under the terms of his Employment
Agreement, Mr. Horowitz shall receive bonus compensation in an amount
equal to 5% of Company royalties or other payments (before deduction of
payments to third parties including, but not limited to, legal fees and
expenses and third party license fees) received from licensing its
patents (including patents currently owned and acquired or licensed on an
exclusive basis during the period in which Mr. Horowitz continues to
serve as an executive officer of the Company) (the "Royalty Bonus
Compensation"). During 2007, Mr. Horowitz received $12,000 of Royalty
Bonus Compensation. Mr. Horowitz shall also receive bonus compensation
equal to 5% of the gross proceeds from (i) the sale of any of the
Company's patents or (ii) the Company's merger with or into another
corporation or entity. The Royalty Bonus Compensation shall continue to
be paid to Mr. Horowitz for the life of each of the Company's patents
with respect to licenses entered into by us with third parties during Mr.
Horowitz's term of employment or at anytime thereafter, whether Mr.
Horowitz is employed by the Company or not, provided, that, Mr.
Horowitz's employment has not been terminated by the Company "For Cause"
(as defined) or terminated by Mr. Horowitz without "Good Reason" (as
defined). In the event that
F-15
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2007 AND 2006
NOTE I - EMPLOYMENT ARRANGEMENTS AND OTHER AGREEMENTS (CONTINUED)
Mr. Horowitz's employment is terminated by the Company "Other Than For
Cause" (as defined) or by Mr. Horowitz for "Good Reason" (as defined),
Mr. Horowitz shall be entitled to a severance of 12 months base salary.
In accordance with his employment agreement, Mr. Horowitz also has
certain anti-dilution rights which provide that if at any time during the
period ended December 31, 2008, in the event that the Company completes
an offering of its common stock or any securities convertible or
exercisable into common stock (exclusive of securities issued upon
exercise of outstanding options, warrants or other convertible
securities), Mr. Horowitz shall receive from the Company, at the same
price as the securities issued in the financing, such number of
additional options to purchase common stock so that he maintains the same
derivative ownership percentage (21.47%) of the Company based upon
options and warrants owned by Mr. Horowitz and CMH (exclusive of
ownership of shares of common stock by Mr. Horowitz and CMH) owned as of
the time of execution of his employment agreement; provided, that, the
aforementioned anti-dilution protection shall be afforded to Mr. Horowitz
up to maximum financings of $2.5 million. In April 2007, with respect to
the Company's completion of a $5.0 million private placement (See Note
D[1]), Mr. Horowitz was issued a five (5) year option to purchase 732,709
shares of common stock, at an exercise price of $1.67 per share in
accordance with the aforementioned anti-dilution provision of his
employment agreement.
[2] On December 20, 2006, the Company entered into a new agreement with David
Kahn pursuant to which he agreed to continue to serve as Chief Financial
Officer through December 31, 2008. In consideration for his services, Mr.
Kahn is compensated at the rate of $6,615 per month for the period
through December 31, 2007 and $6,945 per month for the year ended
December 31, 2008. Mr. Kahn was also issued a five (5) year option to
purchase 75,000 shares of common stock at an exercise price of $1.50 per
share. The option vested 30,000 shares on the date of grant and the
balance of the shares (45,000) vest on a quarterly basis in equal amounts
of 5,625 shares beginning March 31, 2007 through December 31, 2008. The
agreement further provides that the Company may terminate the agreement
at any time for any reason. In the event Mr. Kahn's services are
terminated without "Good Cause" (as defined), he will be entitled to
accelerated vesting of all unvested shares underlying the option and the
lesser of (i) six months base monthly compensation or (ii) the remaining
balance of the monthly compensation payable through December 31, 2008.
F-16
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2007 AND 2006
NOTE J - LITIGATION
[1] In August 2005, the Company commenced patent litigation against D-Link
Corporation and D-Link Systems, Incorporated (collectively "D-Link") in
the United States District Court for the Eastern District of Texas, Tyler
division (Civil Action No. 6:05W291), for infringement of the Company's
Remote Power Patent. The complaint sought, among other things, a judgment
that the Company's Remote Power Patent is enforceable and has been
infringed by the defendants. The Company also sought a permanent
injunction restraining the defendants from continued infringement, or
active inducement of infringement by others, of the Remote Power Patent.
In August 2007, the Company finalized the settlement of its patent
infringement litigation against D-Link. Under the terms of the
settlement, D-Link entered into a license agreement for the Company's
Remote Power Patent the terms of which include monthly royalty payments
of 3.25% of the net sales of D-Link Power over Ethernet products,
including those products which comply with the IEEE 802.3af and 802.3at
Standards, for the full term of our Remote Power Patent, which expires in
March 2020. The royalty rate is subject to adjustment beginning after the
first quarter of 2008 to a rate consistent with other similarly situated
licensees of the Remote Power Patent based on units of shipments of
licensed products. In addition, D-Link paid the Company $100,000 upon
signing of the Settlement Agreement.
[2] On November 17, 2005 the Company entered into a Settlement Agreement with
PowerDsine, Inc and PowerDsine Ltd. which dismisses, with prejudice, a
civil action brought by PowerDsine in the United States District Court
for the Southern District of New York that sought a declaratory judgment
that U.S. Patent No. 6,218,930 (the "Remote Power Patent") owned by the
Company was invalid and not infringed by PowerDsine and/or its customers.
Under the terms of the Settlement Agreement, the Company has agreed that
it will not initiate litigation against PowerDsine for its sale of Power
over Ethernet (PoE) integrated circuits. In addition, the Company has
agreed that it will not seek damages for infringement from customers that
incorporate PowerDsine integrated circuit products in PoE capable
Ethernet switches manufactured on or before April 30, 2006. PowerDsine
has agreed that it will not initiate, assist or cooperate in any legal
action relating to the Remote Power Patent. The Company also agreed that
it will not initiate litigation against PowerDsine or its customers for
infringement of the Remote Power Patent arising from the manufacture and
sale of PowerDsine Midspan products for three years following the
dismissal date. Following such three year period, the Company may seek
damages for infringement of the Remote Power Patent from PowerDsine or
its customers with respect to the purchase and sale of Midspan products
beginning 90 days following the dismissal date.
NOTE K - SUBSEQUENT EVENTS
[1] In February 2008, the Company commenced litigation against several major
data networking equipment manufacturers in the United States District
Court for the Eastern District of Texas, Tyler Division, for infringement
of the Company's Remote Power Patent. The defendants in the lawsuit
include Cisco Systems, Inc., Cisco Linksys, LLC, Enterasys Networks,
Inc., 3COM Corporation, Inc., Extreme Networks, Inc., Foundry Networks,
Inc., Netgear, Inc. and Adtran, Inc. The Company seeks injunctive relief
and monetary damages for infringement based upon reasonable royalties as
well as treble damages for the defendants continued willful infringement
of the Remote Power Patent. To date all of the defendants, other than
Netgear, Inc., have answered the complaint and asserted that they do not
infringe any valid claim of the Remote Power Patent, and further asserted
that, based on several different theories, the patent claims are invalid
or unenforceable. In addition to these defenses, the defendants also
asserted counterclaims for, among other things, non-infringement,
invalidity, and unenforceability of the Remote Power Patent. In the event
that the courts determine that the Remote Power Patent is not valid or
enforceable, and/or that the defendants do not infringe, any such
determination would have a material adverse effect on the Company.
F-17
NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2007 AND 2006
NOTE K - SUBSEQUENT EVENTS (CONTINUED)
[2] Dovel & Luner, LLP provides legal services to the Company with respect to
the above referenced litigation (See Note K[1]). The terms of the
Company's agreement with Dovel & Luner, LLP provides for legal fees of a
maximum aggregate cash payment of $1.5 million plus a contingency fee of
up to 24% depending upon when an outcome is achieved.
[3] On March 7, 2008, the Company further extended the expiration dates of
its outstanding $1.25 Warrants and $1.75 Warrants (See Note H[1]) as
follows: (i) the expiration date of the $1.25 Warrants was extended from
March 14, 2008 until June 16, 2008 and the exercise price of such
warrants was adjusted to $1.30 per share and (ii) the expiration date of
our $1.75 Warrants was extended until December 15, 2008 and the exercise
price of such warrants was adjusted to $2.00 per share.
F-18