NOTE A – NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

[1] BASIS OF PRESENTATION:

 

The accompanying condensed financial statements as of September 30, 2011 and for the three and nine month periods ended September 30, 2011 and September 30, 2010 are unaudited, but, in the opinion of the management of Network-1 Security Solutions, Inc. (the "Company"), contain all adjustments consisting only of normal recurring items which the Company considers necessary for the fair presentation of the Company's financial position as of September 30, 2011, and the results of its operations and its cash flows for the three and nine month periods ended September 30, 2011 and September 30, 2010. The condensed financial statements included herein have been prepared in accordance with the accounting principles generally accepted in the United States of America for interim financial information and the instructions to Form 10-Q. Accordingly, certain information and footnote disclosures normally included in the financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been omitted pursuant to such rules and regulations, although management believes that the disclosures are adequate to make the information presented not misleading. These financial statements should be read in conjunction with the audited financial statements for the year ended December 31, 2010 included in the Company's Annual Report on Form 10-K filed with the Securities and Exchange Commission. The results of operations for the three and nine months ended September 30, 2011 are not necessarily indicative of the results of operations to be expected for the full year.

 

[2] BUSINESS:

 

(a) The principal business of the Company is the acquisition, development, licensing and protection of its intellectual property. The Company presently owns six patents covering various telecommunications and data networking technologies including, among others, patents covering the delivery of power over Ethernet cables for the purpose of remotely powering network devices, and the transmission of audio, video and data over computer and telephony networks. The Company continually reviews opportunities to acquire or license additional intellectual property for the purpose of pursuing licensing opportunities related to its existing intellectual property portfolio or otherwise. The Company's strategy is to pursue licensing and strategic business alliances with companies in the industries that manufacture and sell products that make use of the technologies underlying its patents as well as with other users of the technology who benefit directly from the technology including corporate, educational and governmental entities. To date, the Company's efforts with respect to its intellectual property 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"). As of September 30, 2011, the Company had entered into 11 license agreements with respect to its Remote Power Patent which include, among others, license agreements with Cisco Systems, Inc. and Cisco-Linksys, Extreme Networks, Inc., Netgear, Inc. and several other major data networking equipment manufacturers (See Note D[2]), Microsemi Corporation (See Note D[4]) and D-Link (See Note D[3]). The Company's current strategy includes continuing to pursue licensing opportunities for the Remote Power Patent from vendors of Power over Ethernet equipment in order to resolve possible infringement of the Remote Patent by such vendors.

 

In addition, the Company may acquire additional intellectual property assets in the future to develop, commercialize, license or otherwise monetize such intellectual property. The Company may also enter into strategic relationships with third parties to develop, commercialize, license or otherwise monetize their intellectual property. The form of such relationships may vary depending upon the opportunity and may include, among other things, a strategic investment in such third party or the formation of a joint venture for the purpose of monetizing such third party's intellectual property assets.

 

(b)  As reflected in the accompanying financial statements, the Company had revenue of $1,222,000 and $32,560,000 for the three month period ended September 30, 2011 and September 30, 2010, respectively, and revenue of $6,611,000 and $32,850,000 for the nine month period ended September 30, 2011 and September 30, 2010, respectively.  The Company has been dependent upon royalty revenue from the licensing of its Remote Power Patent and equity financing to fund its operations.  The Company had cash and cash equivalents of $23,072,000 as of September 30, 2011. 

 

[3] STOCK-BASED COMPENSATION:

 

During the nine month period ended September 30, 2011 and September 30, 2010 the Company recorded non-cash compensation expense of $112,000 for the vested portion (187,500 shares) of options to purchase 750,000 shares issued to the Company's Chairman and Chief Executive Officer in June 2009 (See Note C). In addition, during the nine month period ended September 30, 2011 and September 30, 2010 the Company recorded non-cash compensation expense of $12,000 and $22,000, respectively, for the vested portion of options granted to its Chief Financial Officer, directors and consultants in prior years.

 

On April 16, 2010, the Company's Board of Directors extended for three years the expiration dates of certain outstanding options to purchase an aggregate of 955,000 shares of common stock, exercisable at $0.68 per share, which were to expire from between April 18, 2010 to September 16, 2010. Of these options, 750,000 are owned by CMH Capital Management Corp., an entity in which the Company's Chairman and Chief Executive Office is the sole officer, director and shareholder, and were re-issued, as extended, in the name of Corey M. Horowitz, 5,000 are owned by the Company's Chairman and Chief Executive Officer and 75,000 are owned by the Company's Chief Financial Officer. The Company incurred non-cash compensation charges of $153,000 with respect to the aforementioned option extensions. Also on April 16, 2010, the Company issued to two consultants aggregate options to purchase 200,000 shares of its common stock, at an exercise price of $0.90 per share. The non-cash compensation charges incurred with respect to such option grants was $73,000.

 

On February 2, 2011, the Company extended for three years the expiration dates of certain outstanding options issued to a consultant to purchase an aggregate of 75,000 shares of common stock at $0.68 per share. The Company incurred non-cash compensation charges of $5,000 with respect to this option extension.

 

During the nine month period ended September 30, 2011, the Company recorded non-cash compensation of $86,000 for the vested portion of options to purchase up to 430,000 shares of common stock issued to its Chief Financial Officer and two consultants.

On May 20, 2011, the Company extended the expiration dates for three years of options and warrants (expiring in 2011) to purchase an aggregate of 1,095,218 shares of common stock held by officers, directors and a third party and the Company recorded non-cash compensation of $54,000 with respect to such extensions.

 

 

[4] REVENUE RECOGNITION:

 

The Company recognizes revenue received from the licensing of its intellectual property 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. One licensee (Cisco Systems) constituted 75% and 90% of the Company's revenue for the three and nine month periods ended September 30, 2011.

 

[5] INCOME TAXES:

 

At September 30, 2011, the Company had net operating loss carryforwards (NOLs) totaling approximately $25,900,000 expiring between 2020 and 2030, with a future tax benefit of approximately $6,860,000. During the second quarter of 2011, as a result of the Company's recent results and projected future operating results, management determined that a portion of the NOL was more likely than not to be utilized resulting in a tax benefit of $7,000,000. Accordingly, $7,000,000 was recorded as a deferred tax benefit on the Company's balance sheet at June 30, 2011 and the Company recorded income of $7,000,000 or $0.29 per share (basic) for the six month period ended June 30, 2011 from the recording of this one-time, non-cash, income tax benefit. During the three month period ended September 30, 2011 as a result of income (before taxes) for the period of $421,000, $173,000 was recorded as income tax expense, of which $140,000 was a non-cash expense, and accordingly the deferred tax asset was reduced by $140,000 to $6,860,000. To the extent that the Company earns income in the future, it will report income tax expense and such expense attributable to federal income taxes will reduce the recorded income tax benefit asset reflected on the balance sheet. Management will continue to evaluate the recoverability of the NOL and adjust the deferred tax asset appropriately. Utilization of NOL credit carryforwards can be subject to a substantial annual limitation due to ownership change limitations that could occur in the future, as required by Section 382 of the Internal Revenue Code of 1986, as amended, as well as similar state provisions.