Edgar Filing: NETWORK 1 SECURITY SOLUTIONS INC

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U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

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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, 2005

[_] 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.
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(EXACT NAME OF SMALL BUSINESS ISSUER AS SPECIFIED IN ITS CHARTER)

DELAWARE 11-3027591
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(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)

445 Park Avenue, Suite 1028, New York, New York 10022
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(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)

212-829-5770
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(Issuer's Telephone Number)

Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes [X] No [_]

The number of shares of Common Stock, $.01 par value per share, outstanding as
of July 28, 2005 was 17,697,572.

Transitional Small Business Disclosure Format (check one): Yes [_] No [X]

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NETWORK-1 SECURITY SOLUTIONS, INC.

INDEX

Page No.
--------

PART I. FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS
Condensed Balance Sheets as of June 30, 2005 (unaudited)
and December 31, 2004............................................... 3

Condensed Statements of Operations for the three and six
months ended June 30, 2005 and 2004 (unaudited)..................... 4

Condensed Statements of Cash Flows for the six months
ended June 30, 2005 and 2004 (unaudited)............................ 5

Notes to Condensed Financial Statements............................. 6

Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION........... 13

Item 3. CONTROLS AND PROCEDURES............................................. 20

PART II. OTHER INFORMATION

Item 1. Legal Proceedings................................................... 21

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds......... 21

Item 3. Defaults Upon Senior Securities..................................... 21

Item 4. Submission of Matters to a Vote of Security Holders................. 21

Item 5. Other Information................................................... 22

Item 6. Exhibits and Reports on Form 8-K.................................... 22

SIGNATURES................................................................... 23

NETWORK-1 SECURITY SOLUTIONS, INC.
CONDENSED BALANCE SHEETS

JUNE 30, DECEMBER 31,
2005 2004
============ ============
(UNAUDITED)

ASSETS
------
Current assets:
Cash and cash equivalents $ 1,473,000 $ 2,177,000
Prepaid expenses and other current assets 54,000 100,000
------------ ------------

Total current assets 1,527,000 2,277,000

Patents 89,000 92,000
Security Deposit 6,000 --
------------ ------------
$ 1,622,000 $ 2,369,000
============ ============
LIABILITIES
-----------
Current liabilities:
Accounts payable $ 88,000 $ 437,000
Accrued expenses and other current liabilities 479,000 505,000
------------ ------------

Total current liabilities 567,000 942,000
------------ ------------

Liability to be settled with equity instrument -- 294,000
------------ ------------

Commitments and contingencies

STOCKHOLDERS' EQUITY
--------------------
Common stock - $0.01 par value ; authorized 50,000,000 shares;
17,697,572 shares issued and outstanding at June 30, 2005 and
17,097,572 at December 31, 2004 177,000 171,000

Additional paid-in capital 44,827,000 43,951,000
Accumulated deficit (43,949,000) (42,989,000)
------------ ------------

1,055,000 1,133,000
------------ ------------
$ 1,622,000 $ 2,369,000
============ ============

See notes to condensed financial statements 3

NETWORK-1 SECURITY SOLUTIONS, INC.
CONDENSED STATEMENT OF OPERATIONS

THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
---------------------------- ----------------------------
2005 2004 2005 2004
------------ ------------ ------------ ------------

Operating expenses:
General and administrative
Patent Costs $ 242,000 $ 218,000 $ 480,000 $ 582,000
500,000

LOSS BEFORE INTEREST INCOME (242,000) (218,000) (980,000) (582,000)
Interest income - net 13,000 -- 20,000 1,000
------------ ------------ ------------ ------------

Net Loss (229,000) (218,000) (960,000) (581,000)
============ ============ ============ ============

Deemed dividend on additional warrant
antidilutution adjustment -- -- (6,000) --

Net loss attributable to common stockholders $ (229,000) $ (218,000) $ (966,000) $ (581,000)
------------ ------------ ------------ ------------

LOSS PER COMMON SHARE: BASIC AND DILUTED $ (0.01) $ (0.02) $ (0.05) $ (0.05)
============ ============ ============ ============

WEIGHTED AVERAGE SHARES: BASIC AND DILUTED 17,697,572 14,129,308 17,657,793 11,221,883
============ ============ ============ ============

See notes to condensed financial statements 4

NETWORK-1 SECURITY SOLUTIONS, INC.
CONDENSED STATEMENT OF CASH FLOWS
(Unaudited)

SIX MONTHS ENDED JUNE 30,
============================
2005 2004
============ ============

Cash flows from operating activities:
Net loss $ (960,000) $ (581,000)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 3,000 3,000
Valuation adjustment for outstanding stock options (32,000) 78,000
Issuance of options and warrants for services rendered 20,000 --

Changes in:
Prepaid expenses and other current assets 46,000 49,000
Security Deposits (6,000) --
Accounts payable, accrued expenses and other
current liabilities (375,000) (79,000)
------------ ------------

Net cash used in operating activities (1,304,000) (530,000)
------------ ------------

Cash Flows from Investing Activities -- --
------------ ------------
Cash Flows from Financing Activities Issuance of Common Stock 600,000 --
------------ ------------

NET DECREASE IN CASH AND CASH EQUIVALENTS (704,000) (530,000)
Cash and cash equivalents, beginning of period 2,177,000 984,000
------------ ------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 1,473,000 $ 454,000
============ ============

NON-CASH TRANSACTIONS:

Non-employee compensation paid with equity stock options $ 262,000 $ 51,000
============ ============
Par value of Common stock issued on conversion of Series
D and E Preferred stock -- $ 67,000
============ ============

See notes to condensed financial statements 5

NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS

NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

[1] BASIS OF PRESENTATION:

The accompanying condensed financial statements as of June 30, 2005 and for the
three and six month periods ended June 30, 2005 and June 30, 2004, are
unaudited, but, in the opinion of the management of Network-1 Security
Solutions, Inc. (the "Company"), contain all adjustments consisting only of
normal recurring items which the Company considers necessary for the fair
presentation of the Company's financial position as of June 30, 2005, the
results of its operations and its cash flows for the three and six month periods
ended June 30, 2005 and 2004. The condensed financial statements included herein
have been prepared in accordance with the accounting principles generally
accepted in the United States of America for interim financial information and
the instructions to Form 10-QSB. Accordingly, certain information and footnote
disclosures normally included in the financial statements prepared in accordance
with accounting principles generally accepted in the United States of America
have been omitted pursuant to such rules and regulations, although management
believes that the disclosures are adequate to make the information presented not
misleading. These financial statements should be read in conjunction with the
audited financial statements for the year ended December 31, 2004 included in
the Company's Annual Report on Form 10-KSB filed with the Securities and
Exchange Commission. The results of operations for the six months ended June 30,
2005 and 2004 are not necessarily indicative of the results of operations to be
expected for the full year.

[2] BUSINESS:

(a) The principal business of the Company is the acquisition, development,
licensing and protection of its intellectual property. The Company presently
owns six patents (the "Patent Portfolio") covering various telecommunications
and data networking technologies including, among others, patents covering the
delivery of power over Ethernet cable for the purpose of remotely powering
network devices, and the transmission of audio, video and data over computer and
telephony networks. The Company's strategy is to pursue licensing and strategic
business alliances with companies in the industries that manufacture and sell
products that make use of the technologies underlying its patents as well as
with other users of the technology who benefit directly from the technology
including corporate, educational and governmental entities.

On November 18, 2003, the Company acquired the Patent Portfolio from Merlot
Communications, Inc., a broadband communications solutions provider. In February
2004, the Company initiated licensing efforts relating to one of its patents
(U.S. Patent No. 6,218,930) covering the remote delivery of power over Ethernet
cables (the "Remote Power Patent"). As of June 30, 2005, the Company transmitted
letters to approximately 85 companies offering licenses to the Remote Power
Patent. To date the Company has not entered into any license agreements with
third parties with respect to its Remote Power Patent.

NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS

[2] BUSINESS: (CONTINUED)

(b) As reflected in the accompanying financial statements, the Company has
incurred substantial losses and has experienced net cash outflows from
operations for 2004 and the three and six month periods ended June 30, 2005. For
the year ended December 31, 2004 and the three and six month periods ended June
30, 2005, the Company had no revenue from operations. The Company will continue
to have operating losses for the foreseeable future until it is successful in
licensing its patented technologies. The Company is dependent upon debt and
equity financing until it generates cash flows from operations. In December 2004
and January 2005, the Company completed a private placement of its equity
securities. As a result of such private placement, the Company has cash and cash
equivalents of $2,177,000 as of December 31, 2004 and $1,473,000 as of June 30,
2005. The Company believes its current cash position will more likely than not
be sufficient to satisfy the Company's operations and capital requirements until
September 2006, although there can be no assurance that such funds will not be
expended prior thereto. If necessary, the Company will take further action which
it believes is required to sustain its operations for the next twelve months.

[3] STOCK-BASED COMPENSATION:

The Company accounts for stock-based employee compensation under Accounting
Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to
Employees", and related interpretations. The Company has adopted the
disclosure-only provisions of Statement of Financial Accounting Standards
("SFAS") No. 123, "Accounting for Stock-Based Compensation" and SFAS No. 148,
"Accounting for Stock-Based Compensation - Transition and Disclosure", which was
released in December 2002 as an amendment of SFAS No. 123. The following table
illustrates the effect on net loss and net loss per share attributable to common
stockholders as if the fair value-based method of SFAS No. 123 had been applied
to all awards.

NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS

[3] STOCK-BASED COMPENSATION: (continued)

SIX MONTHS ENDED JUNE 30,
============================
2005 2004
============ ============

Reported net loss attributable to common stockholders $ (966,000) $ (581,000)
Stock-based employee compensation expense included in
the reported net loss, net of related tax effects -- --
Stock-based employee compensation determined under the
fair value-based method, net of related tax effects (433,000) (3,000)
------------ ------------

Pro forma net loss $ (1,399,000) $ (584,000)
============ ============
Loss per common share (basic and diluted):
As reported $ (0.05) $ (0.05)
============ ============

Pro forma $ (0.08) $ (0.05)
============ ============

The fair value of each option grant on the date of grant is estimated using
the Black-Scholes option-pricing utilizing the following weighted average
assumptions:

SIX MONTHS ENDED JUNE 30,
----------------------------
2005 2004
------------ ------------
Risk-free interest rates 3.95% 3.93%
Expected option life in years 3.00-7.00 3.00
Expected stock price volatility 220.65% 229.49%
Expected dividend yield 0.00% 0.00%

NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS

[4] REVENUE RECOGNITION:

The Company plans on recognizing revenue received from the licensing of its
intellectual property portfolio in accordance with Staff Accounting Bulletin No.
104, "Revenue Recognition" ("SAB No. 104") and related authoritative
pronouncements. Under this guidance, revenue is recognized when (i) persuasive
evidence of an arrangement exists, (ii) all obligations have been performed
pursuant to the terms of the license agreement, (iii) amounts are fixed or
determinable and (iv) collectibility of amounts is reasonably assured.

[5] LOSS PER SHARE:

Basic net loss per share is calculated by dividing the net loss by the weighted
average number of outstanding common shares during the period. Diluted loss per
share data includes the dilutive effects of options, warrants and convertible
securities. Potential shares of 10,782,080 and 11,142,244 for the three and six
month periods ending June 30, 2005 are antidilutive and are not included in the
calculation of diluted loss per share. Potential shares of 6,053,104 for the
three and six month periods ending June 30, 2004 are antidilutive and are not
included in the calculation of diluted loss per share. Such potential common
shares reflect options and warrants.

[6] CASH EQUIVALENTS:

The Company places cash investments in high quality financial institutions
insured by the Federal Deposit Insurance Corporation ("FDIC"). At June 30, 2005,
the Company maintained cash balance of approximately $1,459,000 in one financial
institution.

NOTE B - AMENDED PATENT PURCHASE AGREEMENT:

In November 2003, the Company acquired a portfolio of telecommunications and
data networking patents (six patents) from Merlot Communications, Inc.
("Merlot"). The purchase price for the Patent Portfolio was $100,000, paid in
cash. The cash price paid has been capitalized and is being amortized over the
remaining useful life of each patent. In addition, the Company has granted
Merlot a nonexclusive, royalty free, perpetual license for the term of each
patent to use the patents for the development, manufacture or sale of its own
branded products to end users. The Company had agreed to pay Merlot 20% of the
net income, as defined, after the first $4,000,000 of net income realized by the
Company on a per patent basis from the sale or licensing of the patents. On
January 18, 2005, the Company and Merlot amended the Patent Purchase Agreement
(the "Amendment") pursuant to which the Company paid additional purchase price
of $500,000 to Merlot in consideration for the restructuring of future
contingent payments to Merlot from the licensing or sale of the Patents. The
Amendment provides for future contingent payments by the Company to Merlot of
$1.0 million upon achievement of $25 million of Net Royalties (as defined), an
additional $1.0 million upon achievement of $50 million of Net Royalties and an
additional $500,000 upon achievement of $62.5 million of Net Royalties from
licensing or sale of the patents acquired from Merlot. Certain principal
stockholders of the Company and related parties are also principal stockholders
of Merlot and were also directors of Merlot at the time of the original

NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS

NOTE B - AMENDED PATENT PURCHASE AGREEMENT: (continued)

agreement in November 2003 and the Amendment. The Company has treated this
expenditure as an expense called Patent Costs for the six months ended June 30,
2005.

NOTE C - PRIVATE PLACEMENT

[1] On December 21, 2004, the Company completed the first closing of a private
placement of 2,085,000 shares of common stock and three-year warrants to
purchase 1,563,750 shares of common stock (warrants to purchase 1,042,500 shares
of common stock at an exercise price of $1.25 and warrants to purchase 521,250
shares of common stock at an exercise price of $1.75) for an aggregate purchase
price of $2,035,000, net of $50,000 issuance costs. On January 13, 2005, the
Company completed a second closing with respect to the private placement of
securities, which consisted of an additional 600,000 shares of common stock and
warrants to purchase an additional 450,000 shares of common stock for an
aggregate purchase price of $600,000. In connection with the private placement,
the Company issued to a finder, warrants to purchase 50,000 shares of common
stock at an exercise price of $1.00 expiring in December 2009. As part of the
private placement, the Company filed a registration statement on June 21, 2005,
to register the common stock and the shares issuable upon exercise of the
warrants.

[2] In connection with the private placement and anti-dilutive provisions for
the warrants previously issued to Falconstor Software, Inc., the Company issued
warrants to purchase an aggregate of 135,000 additional shares of common stock
at an exercise price of $1.00 per share expiring in October 2006. The associated
expense, which is treated as an imputed dividend, is based on the fair value of
these warrants using the Black-Scholes model utilizing the risk-free interest
rate of 3.01%, life of 2 years, volatility of 270% and dividend yield of 0%.
Such expense was $6,000 and is included in the accompanying statement of
operations for the six month period ended June 30, 2005.

NOTE D - LIABILITY TO BE SETTLED WITH EQUITY INSTRUMENTS

On April 18, 2002, in consideration of additional consulting and financial
advisory services, the Company issued to CMH Capital Management Corp., an entity
solely owned by Corey M. Horowitz, Chairman and Chief Executive Officer of the
Company, an option to purchase 750,000 shares of the common stock at an exercise
price of $1.20 per share, which was the market price of the Company's common
stock on the date of issuance. The options vest over a three-year period in
equal amounts of 250,000 per year beginning April 18, 2003. In addition, the
options shall vest in full in the event of a "change of control" or in the event
that the closing price of the Company's common stock reaches a minimum of $3.50
per share for 20 consecutive trading days. These options are treated as
contingent options and were originally priced in the quarter ended June 30, 2002
at $416,000. Subsequently, they are revalued at each balance sheet date. On
April 18, 2003, 250,000 of these options vested, having a fair value of $5,000.
Accordingly, $5,000 was reallocated to additional paid-in capital with a
corresponding reduction to the liability. On April 18, 2004, 250,000 of these
options vested having a fair value of $51,000. Accordingly, $51,000 was
reallocated to additional paid-in-capital with a corresponding reduction to the
liability. On April 18, 2005 the remaining 250,000 options vested

NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS

NOTE D - LIABILITY TO BE SETTLED WITH EQUITY INSTRUMENTS: (CONTINUED)

and were revalued from $294,000 at December 31, 2004 to $262,000 which was then
reallocated to additional paid in capital. Any increase or decrease in the
valuation has been reflected as an addition or reduction of general and
administrative expenses at each balance sheet date.

NOTE E - EQUITY TRANSACTION

During the three months ended June 30, 2005, the Company issued options to
purchase an aggregate of 125,000 shares of common stock to two consultants, for
services rendered, under its stock option plan. The options were valued at their
fair market value on the date of the grant and vest ratably under the terms of
the grant over the next two years.

NOTE F - COMMITMENTS AND CONTINGENCIES

On November 30, 2004, the Company entered into a master services agreement (the
"Agreement") with ThinkFire Services USA, Ltd. ("ThinkFire") pursuant to which
ThinkFire has been granted the exclusive worldwide rights (except for direct
efforts by the Company and related companies) to negotiate license agreements
for the Remote Power Patent with respect to certain potential licensees agreed
to between the parties. Either the Company or ThinkFire can terminate the
Agreement upon 60 days' notice for any reason or upon 30 days' notice in the
event of a material breach. The Company has agreed to pay ThinkFire a fee not to
exceed 20% of the royalty payments received from license agreements consummated
by ThinkFire on its behalf.

NOTE G - EMPLOYMENT ARRANGEMENTS AND OTHER AGREEMENTS

On November 26, 2004, the Company entered into an employment agreement with
Corey M. Horowitz pursuant to which he agreed to continue to serve as Chairman
and Chief Executive Officer of the Company for a two-year term at an annual base
salary of $250,000 for the first year and $275,000 for the second year. Mr.
Horowitz was also issued options to purchase an aggregate of 1,500,000 shares of
the Company's common stock consisting of (i) a ten (10) year fully vested option
to purchase 1,100,000 shares at an exercise price of $0.25 per share, and (ii) a
five-year option to purchase 400,000 shares at an exercise price of $0.68 per
share which vested 50% on the date of grant and 50% one year thereafter, subject
to acceleration upon a change of control. In addition, Mr. Horowitz will receive
a bonus of 5% of the Company's royalties or other payments received from
licensing its patents. This bonus will continue to be paid to Mr. Horowitz for a
period of five (5) years following the term of the employment agreement with
respect to licenses entered into by the Company during the term of the
employment agreement, provided that he has not been terminated by the Company
"for cause" or by Mr. Horowitz himself without "good reason".

Mr. Horowitz shall receive severance equal to 12 months base salary in the event
his employment is terminated "without cause" or by Mr. Horowitz for "good
reason". Mr. Horowitz was also granted certain anti-dilution rights which
provide that if at any time during the period

NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS

NOTE G - EMPLOYMENT ARRANGEMENTS AND OTHER AGREEMENTS: (CON'T)

ending December 31, 2005, in the event that the Company completes an offering of
its common stock or any securities convertible or exercisable into common stock,
he will receive, at the same price as the securities issued in the financing,
such number of additional stock options so that he maintains the derivative
ownership percentage (20.11%) of the Company based upon options and warrants
owned by him and CMH (exclusive of his ownership of shares of common stock) as
he owned as of the date of his employment agreement (November 26, 2004). As a
result of the closings of the private placement on December 31, 2004 and January
13, 2005 and in accordance with the anti-dilution protection afforded to Mr.
Horowitz in his employment agreement, Mr. Horowitz earned seven year options to
purchase an aggregate of 1,195,361 shares at an exercise price of $1.18 per
share. The Company did not recognize any compensation expense as the exercise
price for these options exceeded the market price.

NOTE H - LITIGATION

In March 2004, PowerDsine Inc. ("PowerDsine") commenced an action against the
Company in the United District Court, Southern District of New York, seeking a
declaratory judgment that the Company's patent (U.S. Patent No. 6,218,930)
covering the remote delivery of power over Ethernet is not infringed by
PowerDsine and/or its customers. PowerDsine further seeks an order permanently
enjoining the Company (i) from making any claims to any person or entity that
PowerDsine's products infringe the Remote Power Patent or contribute to
infringement of the patent, (ii) from interfering with or threatening to
interfere with the importation, sale, license or use of PowerDsine's power over
Ethernet components or products, and (iii) from instituting or prosecuting any
lawsuit or proceeding placing at issue the right of PowerDsine, its customers,
licensees, successors, or assigns to import, use or sell PowerDsine's power over
Ethernet components or products. The Company believes its Remote Power Patent is
valid and has meritorious defenses to the action. On December 1, 2004, the
Company moved to dismiss the declaratory judgment action asserting, among other
things, that there is no actual case or controversy because PowerDsine did not
have reasonable apprehension of suit at the time the case was filed, and
therefore the court lacks jurisdiction over the matter. On January 21, 2005, the
Company's motion to dismiss was denied. The Company is engaged in settlement
discussion with PowerDsine in an effort to resolve the litigation. In the event
the Company is unable to settle the litigation, the Company intends to
vigorously defend the action and take whatever actions are necessary to protect
its intellectual property. In the event, however, that the Court grants the
declaratory judgment and the Company's patent is determined to be invalid, such
a determination would have a material adverse effect on the Company.

ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION

THIS QUARTERLY REPORT ON FORM 10-QSB CONTAINS FORWARD-LOOKING STATEMENTS WITHIN
THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED (THE
"SECURITIES ACT"), AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS
AMENDED (THE "EXCHANGE ACT"). ACTUAL RESULTS, EVENTS AND CIRCUMSTANCES
(INCLUDING FUTURE PERFORMANCE, RESULTS AND TRENDS) COULD DIFFER MATERIALLY FROM
THOSE SET FORTH IN SUCH STATEMENTS DUE TO VARIOUS RISKS AND UNCERTAINTIES,
INCLUDING, BUT NOT LIMITED TO, THOSE DISCUSSED BEGINNING ON PAGES 15-20 OF THIS
QUARTERLY REPORT ON 10-QSB FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2005.

PLAN OF OPERATION

The principal business of the Company is the acquisition, development,
licensing and protection of its intellectual property. The Company presently
owns six patents covering various telecommunications and data networking
technologies (the "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. The Company's strategy is to pursue licensing and strategic
business alliances with companies in the industries that manufacture and sell
products that make use of the technologies underlying its patents as well as
with other users of the technology who benefit directly from the technology
including corporate, educational and governmental entities.

On November 18, 2003, the Company acquired the Patent Portfolio from
Merlot Communications, Inc., a broadband communications solutions provider. In
February 2004, following its review of applicable markets, the Company initiated
licensing efforts relating to one of its patents (U.S. Patent No. 6,218,930)
covering the remote delivery of power over Ethernet cable (the "Remote Power
Patent"). The Company has focused, and will continue to focus, its efforts on
licensing its Remote Power Patent. As of the date of this Report, the Company
has not entered into any license arrangement with respect to the Remote Power
Patent, although it is pursing such arrangements with third parties. During the
next 12 months, management does not anticipate licensing efforts for its other
patents besides the Remote Power Patent.

To date the Company has incurred significant losses and at June 30,
2005 had an accumulated deficit of $(43,949,000). For the year ended December
31, 2004, the Company incurred a net loss of $(1,953,000) and incurred a net
loss of $(960,000) for the six months ended June 30, 2005. Management
anticipates that the Company will continue to incur losses until it enters into
material license agreements with respect to its patented technologies. The
Company has not achieved any revenue from its technology licensing business. To
date the Company has not entered any licensing agreements with third parties
with respect to its Remote Power Patent or the Company's other patented
technologies. The Company's inability to consummate license agreements and
achieve revenue from its patented technologies would have a material adverse
effect on its operations and its ability to continue business.

The Company does not currently have any revenue from operations. The
success of the Company and its ability to generate revenue is largely dependent
on its ability to consummate licensing arrangements with third parties. In
November 2004, the Company entered into an agreement with ThinkFire Services
USA, Ltd. ("ThinkFire") pursuant to which ThinkFire has been granted the
exclusive worldwide rights to negotiate license agreements for the Remote Power
Patent with certain agreed-upon potential licensees. 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.

The Company's success depends on its ability to protect its
intellectual property rights. In the future, it may be necessary for the Company
to commence patent litigation against third parties whom it believes require a
license to its patents. In addition, the Company may be subject to third-party
claims seeking to invalidate its patents, as is the case with the action
commenced by PowerDsine against the Company relating to the Remote Power Patent
as discussed below. These types of claims, with or without merit, may subject
the Company to costly litigation and diversion of management's focus. In
addition, based on the Company's limited financial resources, it may not be able
to pursue litigation as aggressively as competitors with substantially greater
financial resources. Based on the Company's limited financial resources, it may
be necessary to engage third party professionals on a contingency basis pursuant
to which such parties would be entitled to share in the proceeds of any
successful enforcement of its intellectual property rights. If third parties
making claims against the Company seeking to invalidate its patent are
successful, they may be able to obtain injunctive or other equitable relief,
which effectively could block its ability to license or otherwise capitalize on
its proprietary technologies. Successful litigation against the Company
resulting in a determination that its patents are invalid would have a material
adverse effect on the Company.

The Company faces uncertainty as to the outcome of its litigation with
PowerDsine. Although the Company is currently involved in discussions with
PowerDsine in an effort to resolve the litigation, the Company may not be able
to achieve a satisfactory settlement. In the event that the Company is unable to
settle the litigation, the Company intends to vigorously defend the lawsuit and
take whatever actions are necessary to protect its intellectual property.

On December 21, 2004 and January 13, 2005, the Company completed a
private offering of its equity securities resulting in gross proceeds of
$2,685,000. At June 30, 2005, the Company had $1,473,000 of cash and cash
equivalents and working capital of $960,000. The Company anticipates, based on
currently proposed plans and assumptions, relating to its operations, that its
cash and cash equivalents of approximately $1,473,000 as of June 30, 2005 will
more likely than not be sufficient to satisfy the Company's operations and
capital requirements until September 2006. There can be no assurance, however,
that such funds will not be expended prior thereto. In the event the Company's
plans change, or its assumptions change, or prove to be inaccurate (due to
unanticipated expenses, difficulties, delays or otherwise), the Company may have
insufficient funds to support its operations prior to September 2006. The
Company's inability to consummate licensing arrangements with respect to its
Remote Power Patent and generate revenues therefrom on a timely basis or obtain
additional financing when

needed would have a material adverse effect on the Company, requiring it to
curtail or cease operations. In addition, any equity financing may involve
substantial dilution to the current stockholders of the Company.

RISK FACTORS THAT MAY AFFECT FUTURE RESULTS

The Company operates in a highly competitive environment that involves a number
of risks, some of which are beyond the Company's control. The following
discussion highlights the most material of the risks.

WE HAVE A HISTORY OF LOSSES AND NO REVENUE FROM CURRENT OPERATIONS.

We have incurred substantial operating losses since our inception, which has
resulted in an accumulated deficit of $(43,949,000) as of June 30, 2005. For the
years ended December 31, 2004 and 2003, we incurred net losses of $(1,953,000)
and $(614,000), respectively. For the six months ended June 30, 2005, we
incurred a net loss of $(960,000). We have financed our operations primarily by
sales of equity securities as well as the sale of our CyberWall PLUS security
software technology in May 2003. Since December 2002, when we discontinued our
security software products and following the commencement of our new technology
licensing business in November 2003, we have not had material revenue from
operations and for the year ended December 31, 2004 and the six months ended
June 30, 2005 we had no revenue from operations. Our ability to achieve revenue
and generate positive cash flow from operations is dependent upon consummating
licensing agreements with respect to our patented technology. We may not be
successful in achieving licensing agreements with third parties and our failure
to do so would have a material adverse effect on our business, financial
condition and results of operations. We may not be able to achieve revenue or
generate positive cash flow from operations from our new licensing business.

WE COULD BE REQUIRED TO STOP OPERATIONS IF WE ARE UNABLE TO DEVELOP OUR
TECHNOLOGY LICENSING BUSINESS OR RAISE CAPITAL WHEN NEEDED.

We anticipate, based on our currently proposed plans and assumptions relating to
our operations (including the timetable of, costs and expenses associated with
our continued operations), that our current cash position will more likely than
not be sufficient to satisfy our operations and capital requirements until
September 2006. However, we may expend our funds prior thereto. In the event our
plans change, or our assumptions change or prove to be inaccurate (due to
unanticipated expenses, difficulties, delays or otherwise), we could have
insufficient funds to support our operations prior to September 2006. Our
inability to obtain additional financing when needed, absent generating
sufficient cash from licensing arrangements, would have a material adverse
effect on the Company, requiring us to curtail or possibly cease our operations.
In addition, any additional equity financing may involve substantial dilution to
the interests of our then existing stockholders.

OUR NEW LICENSING BUSINESS MAY NOT BE SUCCESSFUL.

In November 2003, we entered the technology licensing business following our
acquisition of six patents relating to various telecommunications and data
networking technologies including, among others, patents covering the delivery
of remote power over Ethernet and the transmission of audio, video and data over
computer and telephony networks. Accordingly, we have a very limited history in
the technology licensing business upon which an evaluation of our prospects and
future performance can be made. Our prospects must be considered in light of the
risks, expenses and difficulties frequently encountered in the development,
operation and expansion of a new business based on patented technologies in a
highly specialized and competitive market. We may not be able to achieve revenue
or profitable operations from our new licensing business.

OUR FUTURE SOURCE OF LICENSING REVENUE IS UNCERTAIN.

In February 2004, we initiated our first licensing efforts relating to the
technologies in our remote power patent (U.S. Patent No. 6,218,930) (the "Remote
Power Patent"). To date, we have not entered into any licensing agreements with
third parties with respect to our Remote Power Patent or our other patented
technologies. Our inability to consummate licensing agreements and achieve
revenue from our patented technologies would have a material adverse effect on
our operations and our ability to continue our business. In addition, in the
event we consummate license arrangements with third parties, such arrangements
are not likely to produce a stable or predictable stream of revenue in the
foreseeable future. Furthermore, the success of our licensing efforts depends
upon the strength of our intellectual property rights.

WE ARE CURRENTLY RELYING UPON THE EFFORTS OF THINKFIRE TO CONSUMMATE LICENSING
AGREEMENTS FOR OUR REMOTE POWER PATENT WITH CERTAIN SELECT POTENTIAL LICENSEES.

On November 30, 2004, we entered into a Master Services Agreement (the
"Agreement") with ThinkFire Services USA, Ltd. ("ThinkFire") pursuant to which
we granted ThinkFire the exclusive (except for us and related companies)
worldwide rights to negotiate license agreements for the Remote Power Patent
with respect to certain potential licensees agreed between the parties. Either
we or ThinkFire can terminate the Agreement upon 60 days notice for any reason
or upon 30 days notice in the event of a material breach. We have agreed to pay
ThinkFire a fee not to exceed 20% of the royalty payments received from license
agreements consummated by ThinkFire on our behalf. ThinkFire may not be
successful in consummating license agreements on our behalf and even if such
agreements are consummated they may not result in significant royalty payments
to us.

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. In
addition, there is a risk that third parties may independently develop
substantially equivalent or superior technologies.

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 the future, it may be necessary for us to commence patent litigation against
third parties whom we believe require a license to our patents. In addition, we
may be subject to third-party claims seeking to invalidate our patents, as is
the case with the action commenced by PowerDsine relating to our Remote Power
Patent as discussed below. These types of claims, with or without merit, may
subject us to costly litigation and diversion of management's focus. In
addition, based on our limited financial resources, we may not be able to pursue
litigation as aggressively as competitors with substantially greater financial
resources. Based on our limited financial resources, it may be necessary for us
to engage third party professionals on a contingency basis pursuant to which
such parties would be entitled to share in the proceeds of any successful
enforcement of our intellectual property rights. If third parties making claims
against us seeking to invalidate our patent are successful, they may be able to
obtain injunctive or other equitable relief, which effectively could block our
ability to license or otherwise capitalize on our proprietary technologies.
Successful litigation against us resulting in a determination that our patents
are invalid would have a material adverse effect on our company.

WE FACE UNCERTAINTY AS TO THE OUTCOME OF LITIGATION WITH POWERDSINE.

In March 2004, PowerDsine Inc. ("PowerDsine") commenced an action against us in
the United District Court, Southern District of New York (Civil Action No. 04 CV
2502) seeking a declaratory judgment that our Remote Power Patent is invalid and
is not infringed by PowerDsine and/or its customers. PowerDsine further seeks an
order permanently enjoining us (i) from making any claims to any person or
entity that PowerDsine's products infringe the Remote Power Patent or contribute
to infringement of the patent, (ii) from interfering with or threatening to
interfere with the importation, sale, license or use of PowerDsine's PoE
components or products, and (iii) from instituting or prosecuting any lawsuit or
proceeding placing at issue the right of PowerDsine, its customers, licensees,
successors, or assigns to import, use or sell PowerDsine's PoE components or
products. We believe our Remote Power Patent is valid and that we have
meritorious defenses to the action. On December 1, 2004, we moved to dismiss the
declaratory judgment action asserting, among other things, that there is no
actual case or controversy because PowerDsine did not have reasonable
apprehension of suit at the time the case was filed, and therefore, the court
lacks jurisdiction over the matter. On January 21, 2005 our motion to dismiss
was denied. We are engaged in settlement discussions with PowerDsine in an
effort to resolve the litigation. In the event that we are unable to settle the

litigation, we intend to vigorously defend the lawsuit and take whatever actions
are necessary to protect our intellectual property. In the event, however, that
the Court granted the declaratory judgment and our Remote Power Patent was
determined to be invalid, such a determination would have a material adverse
effect on us. Regardless of the outcome, this litigation may subject us to
significant costs and diversion of management time.

MATERIAL LICENSING REVENUES FROM OUR REMOTE POWER PATENT MAY BE DEPENDENT UPON
THE APPLICABILITY OF THE IEEE STANDARD.

The Institute of Electrical and Electronic Engineers (IEEE) is a non-profit,
technical professional association of more than 360,000 individual members in
approximately 175 countries. The Standards Association of the IEEE is
responsible for the creation of global industry standards for a broad range of
technology industries. In 1999, 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. In June
2003, the IEEE Standards Association approved the 802.3af Power Over Ethernet
standard (the "Standard"), which covers technologies deployed in delivering
power over Ethernet cables including whether deployed in switches or as
standalone midspan hubs both of which provide power to remote devices including
wireless access points, IP phones and network based cameras. The technology is
commonly referred to as Power Over Ethernet ("PoE"). We believe our Remote Power
Patent covers several of the key technologies covered by the Standard. However,
there is a risk that as a result of litigation a court may determine otherwise
and such a determination would have a material adverse effect on our ability to
enter into license agreements and achieve revenue and profits from our Remote
Power Patent.

WE FACE INTENSE COMPETITION AND WE MAY NOT BE ABLE TO SUCCESSFULLY COMPETE.

The telecommunications and data networking market is characterized by intense
competition and rapidly changing business conditions, customer requirements and
technologies. Our current and potential competitors have longer operating
histories, greater name recognition and possess substantially greater financial,
technical, marketing and other competitive resources than us. Although we
believe that we have rights to enforceable patents relating to
telecommunications and data networking, there can be no assurance that third
parties will not invalidate any or all of our patents. In addition, the
telecommunications and data networking industries may develop technologies that
may be more effective than our proprietary technologies or that render our
technologies less marketable or obsolete.

OUR MARKETS ARE SUBJECT TO RAPID TECHNOLOGICAL CHANGE AND OUR TECHNOLOGIES FACE
POTENTIAL TECHNOLOGY OBSOLESCENCE.

The telecommunications and data networking technology market including,
transmission of audio, video and data over computer and telephony networks and
the delivery of remote power over Ethernet markets, are characterized by rapid
technological changes, changing customer requirements, frequent new product
introductions and enhancements, and evolving industry

standards. The introduction of products embodying new technologies and the
emergence of new industry standards may render our technologies obsolete or less
marketable. To the extent we are able to achieve revenue in the future, such
revenue will be derived from licensing our technologies based on existing and
evolving industry standards.

DEPENDENCE UPON CEO AND CHAIRMAN.

Our success will largely be dependent upon the personal efforts of Corey M.
Horowitz, Chairman and Chief Executive Officer and Chairman of the Board of
Directors. On November 26, 2004, we entered into a two (2) year employment
agreement with Mr. Horowitz pursuant to which he continues to serve as our
Chairman and Chief Executive Officer. We do not maintain key man life insurance
on the life of Mr. Horowitz. The loss of the services of Mr. Horowitz would have
a material adverse effect on our business and prospects.

RISKS RELATED TO LOW PRICED STOCKS.

Our common stock currently trades on the OTC Bulletin Board under the symbol
NSSI.OB. Since the trading price of our common stock is below $5.00 per share,
our common stock is considered a penny stock. SEC regulations generally define a
penny stock to be an equity security that is not listed on Nasdaq or a national
securities exchange and that has a market value of less than $5.00 per share,
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 June 30, 2005, there are outstanding (i) options and warrants to purchase
an aggregate of 11,142,244 shares of our common stock at exercise prices ranging
from $.12 to $10.13, and (ii) 82,630 additional shares of our common stock which
may be issued in the future under our stock option plan. To the extent that
outstanding options and warrants are exercised, stockholder percentage ownership
will be diluted and any sales in the public market of the common stock
underlying such options may adversely affect prevailing market prices for our
common stock.

WE HAVE A SIGNIFICANT AMOUNT OF AUTHORIZED BUT UNISSUED PREFERRED STOCK, WHICH
MAY AFFECT THE LIKELIHOOD OF A CHANGE OF CONTROL IN OUR COMPANY.

Our Board of Directors has the authority, without further action by the
stockholders, to issue 10,000,000 shares of preferred stock on such terms and
with such rights, preferences and designations as our Board of Directors may
determine. Such terms may include restricting dividends on our common stock,
dilution of the voting power of our common stock or impairing the liquidation
rights of the holders of our common stock. Issuance of such preferred stock,
depending on the rights, preferences and designations thereof, may have the
effect of delaying, deterring or preventing a change in control. In addition,
certain "anti-takeover" provisions in Delaware law may restrict the ability of
our stockholders to authorize a merger, business combination or change of
control.

ITEM 3. CONTROLS AND PROCEDURES.

(a) Evaluation of Disclosure Controls and Procedures.

The Company's Chief Executive Officer and Chief Financial Officer have reviewed
the disclosure controls and procedures of the Company as of the end of the
period covered by this Quarterly Report on Form 10-QSB. Based upon this review,
these officers concluded that, as of the end of the period covered by this
Quarterly Report on Form 10-QSB, the Company's disclosure controls and
procedures are effective to ensure that information required to be disclosed by
the Company in the reports it files or submits under Securities and Exchange Act
of 1934 is recorded, processed, summarized and reported, within the time periods
specified in applicable rules and forms.

(b) Changes in Internal Controls.

There was no change in the Company's internal controls over financial reporting
that has materially affected, or is reasonably likely to materially affect, the
Company's internal controls over financial reporting during the last fiscal
quarter included in this report or from the end of the reporting period to the
date of this Quarterly Report on Form 10-QSB.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS.

In March 2004, PowerDsine Inc. ("PowerDsine") commenced an action against the
Company in the United District Court, Southern District of New York, seeking a
declaratory judgment that the Company's patent (U.S. Patent No. 6,218,930)
covering the remote delivery of power over Ethernet (the "Remote Power Patent")
is not infringed by PowerDsine and/or its customers. PowerDsine further seeks an
order permanently enjoining the Company (i) from making any claims to any person
or entity that PowerDsine's products infringe the Remote Power Patent or
contribute to infringement of the patent, (ii) from interfering with or
threatening to interfere with the importation, sale, license or use of
PowerDsine's power over Ethernet components or products, and (iii) from
instituting or prosecuting any lawsuit or proceeding placing at issue the right
of PowerDsine, its customers, licensees, successors, or assigns to import, use
or sell PowerDsine's power over Ethernet components or products. The Company
believes its Remote Power Patent is valid and has meritorious defenses to the
action. On December 1, 2004, the Company moved to dismiss the declaratory
judgment action asserting, among other things, that there is no actual case or
controversy because PowerDsine did not have reasonable apprehension of suit at
the time the case was filed, and therefore the court lacks jurisdiction over the
matter. On January 21, 2005, the Company's motion to dismiss was denied. The
Company is engaged in settlement discussions with PowerDsign in an effort to
resolve the litigation. In the event the Company is unable to settle the
litigation, the Company intends to vigorously defend the action and take
whatever actions are necessary to protect its intellectual property. In the
event, however, that the Court grants the declaratory judgment and the Company's
patent is determined to be invalid, such a determination would have a material
adverse effect on the Company.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

None.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES.

None.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

None.

ITEM 5. OTHER INFORMATION.

None.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.

(a) Exhibits

31.1 Controls and Procedure Certification of Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.

31.2 Controls and Procedure Certification of Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.

32.1 Certification of Chief Executive Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.

32.2 Certification of Chief Financial Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.

(b) Reports of Form 8-K

None.

SIGNATURES
----------

In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.

NETWORK-1 SECURITY SOLUTIONS, INC.

BY: /S/ COREY M. HOROWITZ
---------------------------
COREY M. HOROWITZ
CHAIRMAN AND CHIEF EXECUTIVE OFFICER

BY: /S/ DAVID C. KAHN
---------------------------
DAVID C. KAHN
CHIEF FINANCIAL OFFICER

DATDATE: AUGUST 2, 2005