U.S. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-QSB [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1999 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ______ TO ______ COMMISSION FILE NUMBER 1-14896 NETWORK-1 SECURITY SOLUTIONS, INC. (EXACT NAME OF SMALL BUSINESS ISSUER AS SPECIFIED IN ITS CHARTER) DELAWARE 11-3027591 (STATE OR OTHER JURISDICTION OF (IRS EMPLOYER IDENTIFICATION NO.) INCORPORATION OR ORGANIZATION) 1601 TRAPELO ROAD, RESERVOIR PLACE, WALTHAM, MASSACHUSETTS 02451 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) 781-522-3400 (ISSUER'S TELEPHONE NUMBER) Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes /X/ No / / As of July 31, 1999 there were 4,372,375 shares of Common Stock, $.01 par value per share, and 562,836 shares of Series C Convertible Preferred Stock, $.01 par value per share, outstanding. Transitional Small Business Disclosure Format (check one): Yes [ ] No [X] NETWORK-1 SECURITY SOLUTIONS, INC. INDEX
Page No. PART I. FINANCIAL INFORMATION Item 1. FINANCIAL STATEMENTS Balance Sheets as of June 30, 1999 (unaudited) and December 31, 1998 ...............................................3 Statements of Operations for the three and six months ended June 30, 1999 and 1998 (unaudited) .....................4 Statement of Stockholders' Equity (Deficiency) for the six months ended June 30, 1999 (unaudited) and for the year ended December 31, 1998 ...........................................................................5 Statements of Cash Flows for the six months ended June 30, 1999 and 1998 (unaudited) ...............................6 Notes to Financial Statements.......................................................................................7 Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION...........................................................8 PART II. OTHER INFORMATION Item 1. Legal Proceedings..................................................................................................14 Item 2. Changes in Securities and Use of Proceeds..........................................................................14 Item 3. Defaults Upon Senior Securities....................................................................................14 Item 4. Submission of Matters to a Vote of Security Holders................................................................14 Item 5. Other Information..................................................................................................15 Item 6. Exhibits and Reports on Form 8-K...................................................................................15 SIGNATURES..................................................................................................................16
NETWORK-1 SECURITY SOLUTIONS, INC. BALANCE SHEETS
June 30, 1999 December 31, 1998 (Unaudited) (Audited) ---------- ---------- ASSETS Current assets: Cash and cash equivalents $2,667,000 $6,423,000 Accounts receivable - net of allowance for doubtful accounts of $160,000 and $151,000 respectively 492,000 249,000 Prepaid expenses and other current assets 234,000 119,000 ---------- ---------- Total current assets 3,393,000 6,791,000 Equipment and fixtures 697,000 415,000 Capitalized software costs - net 855,000 925,000 Security deposits 82,000 37,000 ---------- ---------- $5,027,000 $8,168,000 ========== ========== LIABILITIES Current liabilities: Accounts payable $494,000 $420,000 Accrued expenses and other current liabilities 683,000 406,000 Deferred revenue 78,000 103,000 ---------- ---------- Total current liabilities 1,255,000 929,000 ---------- ---------- Commitments and contingencies STOCKHOLDERS' EQUITY Preferred stock - $.01 par value; authorized 5,000,000 shares; Series A -10% cumulative, none issued and outstanding Series B - 500,000 shares, none issued and outstanding Series C - 562,836 shares issued and outstanding 6,000 6,000 Common stock - $.01 par value; authorized 25,000,000 shares; 4,372,375 and 4,366,520 shares issued and outstanding 44,000 44,000 Additional paid-in capital 20,896,000 20,819,000 Unearned portion of compensatory stock options (220,000) (383,000) Accumulated deficit (16,954,000) (13,247,000) ---------- ---------- 3,772,000 7,239,000 ---------- ---------- $5,027,000 $8,168,000 ========== ==========
See notes to financial statements -3- NETWORK-1 SECURITY SOLUTIONS, INC. STATEMENTS OF OPERATIONS UNAUDITED
Three Months Ended June 30, Six Months Ended June 30, -------------------------- -------------------------- 1999 1998 1999 1998 ------------ ------------ ------------ ------------ Revenues: Licenses $ 43,000 $ 217,000 $ 113,000 $ 412,000 Services 477,000 346,000 790,000 490,000 ------------ ------------ ------------ ------------ Total revenues 520,000 563,000 903,000 902,000 Cost of revenues: Amortization of software development costs 135,000 134,000 270,000 267,000 Cost of licenses 13,000 84,000 30,000 128,000 Cost of services 460,000 197,000 774,000 272,000 ------------ ------------ ------------ ------------ Total cost of revenues 608,000 415,000 1,074,000 667,000 ------------ ------------ ------------ ------------ Gross (loss) profit (88,000) 148,000 (171,000) 235,000 Operating expenses: Product development 384,000 75,000 776,000 283,000 Selling and marketing 933,000 211,000 1,824,000 351,000 General and administrative 501,000 941,000 1,030,000 1,153,000 ------------ ------------ ------------ ------------ Total operating expenses 1,818,000 1,227,000 3,630,000 1,787,000 ------------ ------------ ------------ ------------ Loss from operations (1,906,000) (1,079,000) (3,801,000) (1,552,000) Interest income (expense) - net 29,000 (214,000) 94,000 (438,000) ============ ============ ============ ============ Net loss $(1,877,000) $(1,293,000) $(3,707,000) $(1,990,000) ============ ============ ============ ============ Loss per share - basic and diluted $ (0.43) $ (0.76) $ (0.85) $ (1.17) ============ ============ ============ ============ Weighted average number of shares outstanding - basic and diluted 4,372,375 1,706,037 4,371,957 1,699,120 ============ ============ ============ ============
See notes to financial statements -4- NETWORK-1 SECURITY SOLUTIONS, INC. STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIENCY)
Common Stock Preferred Stock ------------------- ----------------- Shares Amount Shares Amount --------- -------- ------- ------ Balance - December 31, 1997 1,706,037 $ 17,000 500,000 $5,000 Common stock options issued to Chief Executive Officer Amortization of compensatory stock options Issuance of Series C preferred stock 562,836 6,000 Issuance of common stock, warrants and options for services rendered and payment of liability 51,256 1,000 Warrants issued in connection with debt financing Repurchase and retirement of common shares (62,080) Conversion of warrants to stock at discount as part of debt re-financing 596,741 6,000 Conversion of Series B Preferred Stock 310,399 3,000 (500,000) (5,000) Acquisition of CommHome 64,167 Issuance of common stock for cash - initial public offering 1,700,000 17,000 Net loss --------- -------- ------- ------ Balance - December 31, 1998 4,366,520 44,000 562,836 6,000 Amortization of compensatory stock options Issuance of common stock and options for services rendered 5,855 Net Loss --------- -------- ------- ------ Balance - June 30, 1999 (Unaudited) 4,372,375 $ 44,000 562,836 $6,000 ========= ======== ======= ======
NETWORK-1 SECURITY SOLUTIONS, INC. STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIENCY)(CONTINUED)
Unearned Additional Portion of Paid-in Accumulated Compensatory Capital Deficit Stock Options Total ----------- ------------ ---------- ----------- Balance - December 31, 1997 $ 7,373,000 $ (7,470,000) $ (75,000) Common stock options issued to Chief Executive Officer 938,000 (938,000) 0 Amortization of compensatory stock options 555,000 555,000 Issuance of Series C preferred stock 2,949,000 2,955,000 Issuance of common stock, warrants and options for services rendered and payment of liability 499,000 500,000 Warrants issued in connection with debt financing 766,000 766,000 Repurchase and retirement of common shares (1,000) (1,000) Conversion of warrants to stock at discount as part of debt re-financing (6,000) 0 Conversion of Series B Preferred Stock 2,000 0 Acquisition of CommHome 385,000 385,000 Issuance of common stock for cash - initial public offering 7,914,000 7,931,000 0 Net loss (5,777,000) (5,777,000) ----------- ------------ ---------- ----------- Balance - December 31, 1998 20,819,000 (13,247,000) (383,000) 7,239,000 Amortization of compensatory stock options 163,000 163,000 Issuance of common stock and options for services rendered 77,000 77,000 Net Loss (3,707,000) (3,707,000) ----------- ------------ ---------- ----------- Balance - June 30, 1999 (Unaudited) $20,896,000 $(16,954,000) $ (220,000) $ 3,772,000 =========== ============ ========== ===========
See notes to financial statements -5- NETWORK-1 SECURITY SOLUTIONS, INC. STATEMENTS OF CASH FLOWS FOR THE SIX MONTHS ENDED
June 30, ----------------------------------- 1999 1998 (Unaudited) (Unaudited) ------------ ------------ Cash flows from operating activities: Net loss $ (3,707,000) $ (1,990,000) Adjustments to reconcile net loss to net cash used in operating activities: Amortization of debt discount 364,000 Issuance of common stock, options and warrants for services rendered 240,000 583,000 Provision for doubtful accounts 9,000 18,000 Depreciation and amortization 367,000 346,000 Changes in: Accounts receivable (252,000) (192,000) Prepaid expenses and other current assets (115,000) (5,000) Accounts payable, accrued expenses and other current liabilities 351,000 (1,000) Deferred revenue (25,000) 29,000 ------------ ------------ Net cash used in operating activities (3,132,000) (848,000) ------------ ------------ Cash flows from investing activities: Acquisitions of equipment and fixtures (379,000) (3,000) Capitalized software costs (200,000) (50,000) Security deposit (45,000) (5,000) ------------ ------------ Net cash used in investing activities (624,000) (58,000) ------------ ------------ Cash flows from financing activities: Proceeds from issuance of notes payable and warrants 1,750,000 Repayment of capital lease obligations (8,000) Purchase of Treasury Shares (1,000) Deferred Offering Costs (261,000) ------------ ------------ Net cash provided by financing activities 0 1,480,000 ------------ ------------ Net increase (decrease) in cash and cash equivalents (3,756,000) 574,000 Cash and cash equivalents - beginning of period 6,423,000 60,000 ------------ ------------ Cash and cash equivalents - end of period $ 2,667,000 $ 634,000 ============ ============ Supplemental disclosures of cash flow information: Cash paid during the period for Interest $ - $ 1,000 ============ ============
See notes to financial statements -6- NETWORK-1 SECURITY SOLUTIONS, INC. NOTES TO FINANCIAL STATEMENTS 1. FINANCIAL STATEMENT PRESENTATION a. The financial statements included herein have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission with respect to Form 10-QSB. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures made herein are adequate to make the information contained herein not misleading. These interim financial statements and the notes thereto should be read in conjunction with the financial statements included in the Company's 10-KSB for the year ended December 31, 1998. In the Company's opinion, all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of the information shown have been included. b. The results of operations for the six months ended June 30, 1999 presented herein are not necessarily indicative of the results of operations that may be expected for the year ending December 31, 1999. c. Basic loss per share is calculated by dividing 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. As all potential common shares are anti-dilutive, they are not included in the calculation of diluted loss per share. -7- Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS THIS QUARTERLY REPORT ON FORM 10-QSB CONTAINS FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"), AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED (THE "EXCHANGE ACT"). ACTUAL RESULTS, EVENTS AND CIRCUMSTANCES (INCLUDING FUTURE PERFORMANCE, RESULTS AND TRENDS) COULD DIFFER MATERIALLY FROM THOSE SET FORTH IN SUCH STATEMENTS DUE TO VARIOUS FACTORS, RISKS AND UNCERTAINTIES, INCLUDING BUT NOT LIMITED TO RISKS ASSOCIATED WITH THE COMPANY'S FUTURE GROWTH AND OPERATING RESULTS, THE UNCERTAINTY OF MARKET ACCEPTANCE OF THE COMPANY'S PRODUCTS, TECHNOLOGICAL CHANGE, COMPETITIVE FACTORS AND GENERAL ECONOMIC CONDITIONS. Overview The Company develops, markets, licenses and supports a family of network security software products designed to provide comprehensive security to computer networks, including Internet based systems and internal networks and computing resources. The Company also offers to its customers a full range of consulting services in network security, network design and support. From inception (July 1990) through December 31, 1994, the Company was primarily engaged in providing consulting and training services. In 1995, the Company began to shift its focus from consulting and training to the development and marketing of network security software products. The Company introduced its first network software product (Firewall/Plus) in June 1995. In January 1999, the Company introduced its CyberwallPLUS(TM) family of network security products. Accordingly, the Company has a limited relevant operating history as a software developer upon which an evaluation of its prospects and future performance can be made. Such prospects must be considered in light of the risks, expenses and difficulties frequently encountered in the operation and expansion of a new business and the shift from research and product development to commercialization of products based on rapidly changing technologies in a highly specialized and emerging market. The Company will be required to significantly expand its product and development capabilities, introduce new products, introduce enhanced features to existing products, expand its in-house sales force, establish and maintain distribution channels through third-party vendors, increase marketing expenditures, and attract additional qualified personnel. In addition, the Company must adapt to the demands of an emerging and rapidly changing computer network security market, intense competition and rapidly changing technology and industry standards. There can be no assurance that the Company can successfully address such risks, and the failure to do so would have a material adverse effect on the Company's business, results of operations and financial condition. To date, the Company has incurred significant losses and, at June 30, 1999, had an accumulated deficit of $ 16,954,000. In addition, since June 30, 1999, the Company has continued to incur significant losses. Inasmuch as the Company has increased its level of activities following the consummation of its initial public offering in November 1998 and will be required to make significant expenditures in connection with its sales and marketing and continuing research and product development efforts, the Company anticipates that losses will continue until such time, if ever, as the Company is able to attain sales levels sufficient to support its operations. There can be no assurance that the Company will ever achieve profitable operations. -8- During the period May 1998 through November 1998, the Company first employed certain members of senior management, including Avi A. Fogel, President and Chief Executive Officer, Robert P. Olsen, Vice President of Marketing, Murray P. Fish, Chief Financial Officer and Secretary, Joseph A. Donohue, Vice President of Engineering, and Lance Westbrook, Vice President of Sales. The Company's software products have not yet achieved market acceptance. The future success of the Company is largely dependent upon market acceptance of its CyberwallPLUS(TM) family of software products. While the Company believes that its CyberwallPLUS(TM) family of software products offer advantages over competing products for network security, license revenue from network security software products since their introduction (June 1995) through June 30, 1999 has only been $2,775,000, including a non-refundable pre-paid royalty of $500,000 in 1997. In addition, during the three and six month periods ended June 30, 1999 and the year ended December 31,1998 license revenues from software products decreased as compared to the three and six month periods ended June 30, 1998 and the year ended December 31,1997, respectively. Since its introduction in March 1999, license revenue from CyberwallPLUS(TM) has been only $54,000. Service revenues from product maintenance were $63,000 for the six months ended June 30, 1999. There can be no assurance that CyberwallPLUS(TM) will gain significant market acceptance. Revenue from such commercial products depend on a number of factors, including the influence of market competition, technological changes in the network security market, the Company's ability to design, develop and introduce enhancements on a timely basis, and the ability of the Company to successfully establish and maintain distribution channels. The failure of CyberwallPLUS(TM) to achieve significant market acceptance, as a result of competition, technological change or other factors, would have a material adverse effect on the Company's business, operating results and financial condition. The Company has committed significant product and development resources to its CyberwallPLUS(TM) family of products. The Company's anticipated levels of expenditures for product development are based on its plans for product enhancements and new product development. The Company capitalizes and amortizes software development costs in accordance with Statement of Financial Accounting Standards No. 86. These costs consist of salaries, consulting fees and applicable overhead. The Company has used a portion of the proceeds from its public offering to significantly increase its product development expenditures. During the three month period ended June 30, 1999 the Company completed several strategic alliances: o A co-marketing agreement with Entrust(R) Technologies, that will use Network-1's CyberwallPLUS technology to enhance the security of the Entrust/ PKI(TM) Server products running on Windows NT; o A partnership with EnerNet Associates, Inc. to provide secure networking solutions for the power industry; and o A strategic relationship with Microsoft through Microsoft's Security Partners Program to enhance the security of Windows NT. The Company also continued to expand its Professional Services team to meet its customers needs. Professional services revenues increased 52% for the quarter ended June 30, 1999 as compared to the quarter ended March 31, 1999 and increased 61% for the six months ended June 30, 1999 as compared to the six months ended June 30, 1998. -9- RESULTS OF OPERATIONS SIX MONTHS ENDED JUNE 30, 1999 COMPARED TO SIX MONTHS ENDED JUNE 30, 1998 Revenues increased by $1,000, from $902,000 for the six months ended June 30, 1998 to $903,000 for the six months ended June 30, 1999, primarily as a result of an increase in consulting revenues during the six months ended June 30, 1999 which were offset by lower product revenues. License revenues decreased by $299,000 or 73%, from $412,000 for the six months ended June 30, 1998 to $113,000 for the six months ended June 30, 1999, primarily due to lower product licensing revenue from FireWallPlus which was replaced by its successor product line, CyberwallPLUS which was announced in January 1999 and commenced shipping in March 1999. Service revenues increased by $300,000 or 61%, from $490,000 for the six months ended June 30, 1998 to $790,000 for the six months ended June 30, 1999. Service revenues from consulting increased by $303,000 or 71%, from $424,000 for the six months ended June 30, 1998 to $727,000 for the six months ended June 30, 1999. The increase in service revenues was attributable to three large consulting projects serviced during the six months ended June 30, 1999. Service revenues from product maintenance decreased by $3,000 or 5%, from $66,000 for the six months ended June 30, 1998 to $63,000 for the six months ended June 30, 1999. The Company's revenues from customers in the United States represented 98% and 99% of the Company's revenues during the six months ended June 30, 1998 and 1999, respectively. Cost of revenues consists of cost of licenses, amortization of software development costs and cost of services. Cost of licenses consist of software media (disks), documentation, product packaging, production costs, product royalties and the cost of hardware associated with sales of FireWall/Plus Premier Version. Cost of licenses decreased by $98,000 or 77%, from $128,000 for the six months ended June 30, 1998 to $30,000 for the six months ended June 30, 1999, representing 31% and 27% of license revenues, respectively. The decrease in cost of licenses in dollar amount was due to the decrease in license revenue and a decrease in royalties due on third party product sales. Cost of licenses as a percentage of license revenues may fluctuate from period to period due to changes in product mix, changes in the number or size of transactions recorded in a given period or an increase or decrease in licenses of products which would require the Company to pay royalties to third parties. Amortization of software development costs increased by $3,000 from $267,000 for the six months ended June 30, 1998 to $270,000 for the six months ended June 30, 1999, representing 65% and 239% of license revenues, respectively. Cost of services consist of salaries, benefits and overhead associated with consulting services and maintenance. Cost of services increased by $502,000 or 185%, from $272,000 for the six months ended June 30, 1998 to $774,000 for the six months ended June 30, 1999, representing 56% and 98% of service revenues, respectively. The increase in cost of services in dollar amount resulted primarily from hiring and travelling costs related to increases in employees and consulting time expended which was not billable to the customer. Cost of services as a percentage of license revenues may fluctuate from period to period due to changes in consultant headcount, costs relating to hiring new consultants or an increase or decrease in number of projects being worked. Gross profit (loss) decreased from $235,000 for the six months ended June 30, 1998 to ($171,000) for the six months ended June 30, 1999, representing 26% and (19%) of revenues, -10- respectively. The decrease in gross profit was due to decreased license revenues and the increase in cost of services as a result of increased hiring costs. Product development consists of salaries, benefits, bonuses, travel and related costs of the Company's product development personnel, including consulting fees, the costs of computer equipment used in product and technology development and third-party development contracts. Product development expenses increased $493,000 or 174%, from $283,000 for the six months ended June 30, 1998 to $776,000 for the six months ended June 30, 1999, representing 31% and 86% of revenues, respectively. Total product developments costs, including capitalized costs of $50,000 and $200,000, were $333,000 and $976,000 for the six months ended June 30, 1998 and June 30, 1999, respectively. The increase in total product development costs was due to the salaries, related employment costs and operational costs of establishing the new development team in Waltham, MA. Sales and marketing expenses consist primarily of salaries, including commissions, benefits, bonuses, travel, advertising, public relations, consultants and trade shows. Selling and marketing expenses increased by $1,473,000 or 420%, from $351,000 for the six months ended June 30, 1998 to $1,824,000 for the six months ended June 30, 1999, representing 39% and 202% of revenues, respectively. The increase in selling and marketing expenses was due primarily to available funding for marketing as a result of the Company's completion of its initial public offering and the release of its new product line, CyberwallPLUS. General and administrative expenses include employee costs, including salary, benefits, bonuses, travel and other related expenses associated with management, finance and accounting operations, and legal and other professional services provided to the Company. General and administrative expenses decreased by $123,000 or 11%, from $1,153,000 for the six months ended June 30, 1998 to $1,030,000 for the six months ended June 30, 1999, representing 128% and 114% of revenues, respectively. The decrease in general and administrative expenses was due primarily to decreases in non-cash compensation for services of $343,000 which was offset by increased salaries and expenses related to the hiring of the executive officers of the Company in May 1998, increased professional fees and recruiting fees, telephone and the costs associated with moving and setting up the new corporate headquarters. Interest expense was $438,000 for the six months ended June 30, 1998 and the Company had interest income of $94,000 for the six months ended June 30, 1999. The decrease in interest expense and the increase in interest income was due to the conversion of the majority of the Company's debt to equity concurrent with the consumation of the Company's initial public offering and the utilization of a portion of the proceeds of the offering to pay the remaining debt. No provision for or benefit from federal, state or foreign income taxes was recorded for the six months ended June 30, 1998 or the six months ended June 30, 1999 because the Company incurred net operating losses during each period and fully reserved its deferred tax assets as their future realization could not be determined. As a result of the foregoing, the net loss increased by $1,717,000 or 86%, from $1,990,000 for the six months ended June 30, 1998 to $3,707,000 for the six months ended June 30, 1999. -11- Liquidity and Capital Resources The Company's capital requirements have been and will continue to be significant, and its cash requirements have been exceeding its cash flow from operations. At June 30, 1999, the Company had $2,667,000 of cash and cash equivalents and a working capital of $2,138,000. The Company has financed its operations primarily through net proceeds from the consummation of its initial public offering in November 1998, and prior thereto by private sales of equity and debt securities. Net cash used in operating activities was $848,000 and $3,132,000 during the six months ended June 30, 1998 and 1999, respectively. Net cash used in operating activities for the six months ended June 30, 1998 was primarily attributable to a net loss of $1,990,000 and an increase in accounts receivable of $192,000 which was partially offset by amortization of debt discount of $364,000, issuance of Common Stock and warrants for services rendered of $583,000 and depreciation and amortization of $346,000. Net cash used in operating activities for the six months ended June 30, 1999 was primarily attributable to a net loss of $3,707,000 and an increase in accounts receivable of $252,000 which was partially offset by increases in accounts payable, accrued expenses and other current liabilities of $351,000, issuance of Common Stock and warrants for services rendered of $240,000 and depreciation and amortization of $367,000. The Company's operating activities during the six months ended June 30, 1998 were financed primarily with $1,750,000 of proceeds from the issuance of $1,750,000 principal amount of notes and warrants to purchase 325,919 shares of Common Stock. The Company's operating activities for the six months ended June 30, 1999 were primarily financed with the proceeds from the initial public offering consummated in November 1998. The Company does not currently have a line of credit from a commercial bank or other institution. The Company anticipates, based on currently proposed plans and assumptions relating to the implementation of its business plan (including the timetable of, costs and expenses associated with, and success of, its marketing efforts), that the net proceeds of its public offering, together with projected revenues from operations, will be sufficient to satisfy the Company's operations and capital requirements through November 1999. There can be no assurance, however, that such funds will not be expended prior thereto due to unanticipated changes in economic conditions or other unforeseen circumstances. In the event the Company's plans change or its assumptions change or prove to be inaccurate (due to unanticipated expenses, difficulties, delays or otherwise) or projected revenues otherwise prove to be insufficient to fund the implementation of the Company's business plan or working capital requirements, the Company could be in need of additional financing sooner than currently anticipated. The Company is currently seeking additional financing but the Company has no current commitment with respect to any additional financing. Consequently, there can be no assurance that any additional financing will be available to the Company when needed, on commercially reasonable terms or at all. Any inability to obtain additional financing when needed would have a material adverse effect on the Company, requiring it to curtail and possibly cease its operations. In addition, any additional equity financing may involve substantial dilution to the interests of the Company's then existing stockholders. In June and July 1999, the Company took certain steps to reorganize its operations in order to reduce expenses. Such reorganization included the closing of its Texas office and consolidation of its operations in Massachusetts, closing of certain sales offices and the reduction of the number of employees from 46 to 34 or a 26 percent reduction. -12- Year 2000 Issue The Company has assessed the potential software issues associated with the Year 2000 and believes its software products are Year 2000 compliant and, therefore, does not expect to incur material costs related thereto. With regard to internal computing resources utilized in its operations, the Company does not expect to incur material costs to make such resources year 2000 compliant. Fluctuations in Operating Results The Company anticipates significant quarterly fluctuations in its operating results in the future. The Company generally ships orders for commercial products as they are received and, as a result, does not have any material backlog. As a result, quarterly revenues and operating results depend on the volume and timing of orders received during the quarter, which are difficult to forecast. Operating results may fluctuate on a quarterly basis due to factors such as the demand for the Company's products, purchasing patterns and budgeting cycles of customers, the introduction of new products and product enhancements by the Company or its competitors, market acceptance of new products introduced by the Company or its competitors and the size, timing, cancellation or delay of customer orders, including cancellation or delay in anticipation of new product introduction or enhancement. In addition, the Company's consulting revenues tend to fluctuate as projects, which may continue over several quarters, are undertaken or completed. Therefore, comparisons of quarterly operating results may not be meaningful and should not be relied upon, nor will they necessarily reflect the Company's future performance. Because of the foregoing factors, it is likely that in some future quarters the Company's operating results will be below the expectations of public market analysts and investors. In such event, the price of the Common Stock would likely be materially adversely affected. -13- PART II. OTHER INFORMATION Item 1. LEGAL PROCEEDINGS. None Item 2. CHANGES IN SECURITIES AND USE OF PROCEEDS. Use of Proceeds. On November 12, 1998, the Company's registration statement on Form SB-2, as amended (file number 333-59617), relating to its initial public offering (the "Offering") was declared effective by the Securities and Exchange Commission. Whale Securities Co., L.P. acted as the underwriter in connection with the Offering which was consummated on November 17, 1998. In connection with the Offering, the Company registered, issued and sold 1,700,000 shares of Common Stock (excluding 255,000 shares of Common Stock subject to the underwriter's over-allotment option which was not exercised), at an initial public offering price of $6.00 per share resulting in net proceeds of $7,931,000, after payment of underwriting discounts and commissions and offering expenses of $2,269,000. Additionally, the Company registered 170,000 shares of Common Stock underlying warrants to purchase Common Stock sold by the Company to the underwriter for $100. The warrants are exercisable for a four-year period commencing on November 12, 1999 at a price of $9.30 per share. Since November 17, 1998 (the date of consummation of the Offering) through June 30, 1999, the Company used the net proceeds of the Offering as follows: $2,247,000 for sales and marketing, $1,160,000 for software development, $546,000 for payment of past due trade payables, $585,000 for repayment of outstanding indebtedness (including $132,000 for repayment of indebtedness to officers, directors and 10% or more stockholders and affiliates) $200,000 for purchase of office, telecommunications and computer equipment, $158,000 for expenses related to establishing new executive offices and $1,692,000 for working capital and general corporate purposes. Item 3. DEFAULTS UPON SENIOR SECURITIES. None. Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. On June 25, 1999, the Company's annual meeting of stockholders was held. At the annual meeting, the stockholders approved the following matters: 1. The following individuals listed below were elected directors of the Company to serve until the next annual meeting of stockholders and the election and qualification of their successors. The number of votes cast for or withheld were as follows: Nominee For Withheld ------- --- -------- Avi A. Fogel 4,322,173 20,470 William Hancock 4,336,643 6,000 Corey M. Horowitz 4,336,643 6,000 Barry Rubenstein 4,336,643 6,000 Irwin Lieber 4,336,643 6,000 Marcus J. Ranum 4,336,643 6,000 -14- 2. An amendment to the Company's 1996 Stock Option Plan to increase the number of shares available for issuance thereunder by 750,000 shares to an aggregate of 1,800,000 shares. 3,205,871 shares were voted in favor of the amendment, 44,220 shares were voted against the amendment, and 4,454 shares abstained from voting. Item 5. OTHER INFORMATION. None. Item 6. EXHIBITS AND REPORTS ON FORM 8-K. Exhibits The exhibits in the following table have been filed as part of this Quarterly Report on Form 10-QSB: Exhibit Number Description of Exhibit --------------------- ------------------------------- 10.28 Employment Agreement, dated May 15, 1999, between the Company and Robert Russo. 27 Financial data schedule for six month period ended June 30, 1999. No reports on Form-8-K were filed during the six months ended June 30, 1999. -15- SIGNATURES In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. NETWORK-1 SECURITY SOLUTIONS, INC. By: /s/ Avi A. Fogel ------------------------------- Avi A. Fogel, President and Chief Executive Officer (Principal Executive Officer) Date: August 12, 1999 By: /s/ Murray P. Fish ------------------------------- Murray P. Fish Chief Financial Officer (Principal Financial and Accounting Officer) Date: August 12, 1999 -16- EXHIBIT INDEX Exhibit Number Description of Exhibit --------------------- ------------------------------- 10.28 Employment Agreement, dated May 15, 1999, between the Company and Robert Russo. 27 Financial data schedule for six month period ended June 30, 1999. -17-