sec document
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 MARCH 31, 2003
[ ] 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)
445 Park Avenue, Suite 1028, New York, New York 10022
(Address of principal executive offices)
212-829-5770
(Issuer's telephone number)
As of October 30 , 2003 there were 8,314,458 shares of Common Stock, $.01 par
value per share, 231,054 shares of Series D Convertible Preferred Stock, $.01
par value per share, and 2,483,508 shares of Series E Convertible Preferred
Stock, $.01 par value per share, outstanding.
Transitional Small Business Disclosure Format (check one):
Yes [ ] No [X]
See notes to condensed financial statements
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NETWORK-1 SECURITY SOLUTIONS, INC.
INDEX
PART I. FINANCIAL INFORMATION Page No.
Item 1. CONDENSED FINANCIAL STATEMENTS
Condensed Balance Sheets as of March 31, 2003
(unaudited) and December 31, 2002..............................3
Condensed Statements of Operations for the three months ended
March 31, 2003 and 2002 (unaudited)............................4
Condensed Statements of Cash Flows for the three months ended
March 31, 2003 and 2002 (unaudited)............................5
Notes to Condensed Financial Statements...........................6
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION........10
Item 3. CONTROLS AND PROCEDURES..........................................12
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................................12
Item 2. Changes in Securities and Use of Proceeds........................12
Item 3. Defaults Upon Senior Securities..................................12
Item 4. Submission of Matters to a Vote of Security Holders..............12
Item 5. Other Information................................................12
Item 6. Exhibits and Reports on Form 8-K.................................12
SIGNATURES................................................................14
See notes to condensed financial statements
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Network-1 Security Solutions, Inc.
Condensed Balance Sheets
March 31, December 31,
2003 2002
----------- -------------
(Unaudited) (Audited)
----------- ---------
ASSETS
Current assets:
Cash and cash equivalents $ 1,576,000 $ 2,029,000
Accounts receivable 6,000
Prepaid expenses and other current assets 67,000 96,000
------------ ------------
Total current assets 1,643,000 2,131,000
Equipment and fixtures 22,000
Security deposits 8,000
------------ ------------
$ 1,643,000 $ 2,161,000
============ ============
LIABILITIES
Current liabilities:
Accounts payable $ 21,000 $ 193,000
Accrued expenses and other current liabilities 623,000 610,000
Deferred revenue 176,000 218,000
------------ ------------
Total current liabilities 820,000 1,021,000
------------ ------------
Liability to be settled with equity instrument 14,000 55,000
------------ ------------
Commitments and contingencies
STOCKHOLDERS' EQUITY
Preferred stock - $0.01 par value, 10,000,000 shares authorized,
Series D - convertible, voting, authorized 1,250,000 shares;
231,054 shares issued and outstanding at March 31, 2003 and
December 31, 2002, liquidation preference of $705,000 at
March 31, 2003 and December 31, 2002 2,000 2,000
Series E - convertible, authorized 3,500,000 shares; 2,483,508
shares issued and outstanding at March 31, 2003 and December
31, 2002, liquidation preference of $5,265,000 at March 31,
2003 and December 31, 2002 25,000 25,000
Common stock - $0.01 par value ; authorized 50,000,000 shares;
8,314,458 shares issued and outstanding at March 31, 2003 and
December 31, 2002 83,000 83,000
Additional paid-in capital 41,397,000 41,397,000
Accumulated deficit (40,698,000) (40,422,000)
------------ ------------
Total stockholders' capital deficit 809,000 1,085,000
------------ ------------
$ 1,643,000 $ 2,161,000
============ ============
See notes to condensed financial statements
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Network-1 Security Solutions, Inc.
Condensed Statements of Operations
(Unaudited)
Three Months Ended
March 31,
-----------------------
2003 2002
---- ----
Revenue:
Licenses $ 42,000 $ 68,000
Services 50,000
----------- -----------
Total Revenue 42,000 118,000
----------- -----------
Costs of revenue :
Amortization of software development costs 70,000
Cost of licenses 3,000
Cost of services 17,000 42,000
----------- -----------
Total cost of revenue 17,000 115,000
----------- -----------
Gross Profit 25,000 3,000
----------- -----------
Operating expenses :
Product development costs 439,000
Selling and marketing 619,000
General and administrative 305,000 495,000
----------- -----------
Total operating expenses 305,000 1,553,000
----------- -----------
Loss before interest income (280,000) (1,550,000)
Interest income - net 4,000 26,000
----------- -----------
Net loss $ (276,000) $(1,524,000)
=========== ===========
Loss per common share basic and diluted $ (0.03) $ (0.21)
=========== ===========
Weighted average common shares basic and diluted 8,314,458 7,109,367
=========== ===========
See notes to condensed financial statements
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Network-1 Security Solutions, Inc.
Condensed Statements of Cash Flows
(Unaudited)
Three Months Ended
March 31,
--------------------
2003 2002
---- ----
Cash flows from operating activities:
Net loss $ (276,000) $(1,524,000)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 22,000 107,000
Security Deposits written off 8,000 --
Issuance of options and warrants for services rendered (41,000) --
Changes in:
Accounts receivable 6,000 (32,000)
Prepaid expenses and other current assets 29,000 4,000
Accounts payable , accrued expenses and other current liabilities (159,000) 65,000
Deferred revenue (42,000) (3,000)
----------- -----------
Net cash used in operating activities (453,000) (1,383,000)
Cash flows from investing activities:
Acquisition of equipment and fixtures (72,000)
Capitalized software costs (90,000)
Security deposits (8,000)
-----------
Net cash used in investing activities (170,000)
-----------
Cash flows from financing activities:
Proceeds from exercise of options and warrants 133,000
-----------
Net cash provided by financing activities 133,000
---------- -----------
Net decrease in cash and cash equivalents (453,000) (1,420,000)
Cash and cash equivalents, beginning of period 2,029,000 7,121,000
----------- -----------
Cash and cash equivalents, end of period $ 1,576,000 $ 5,701,000
=========== ===========
See notes to condensed financial statements
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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 March 31, 2003 and
for the three month periods ended March 31, 2003 and March 31, 2002, are
unaudited, but, in the opinion of the management of Network-1 Security
Solutions, Inc. (the "Company"), contain all adjustments which the
Company considers necessary for the fair presentation of the Company's
financial position as of March 31, 2003, the results of its operations
and its cash flows for the three month periods ended March 31, 2003 and
March 31, 2002. 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, 2002
included in the Company's Annual Report on Form 10-KSB filed with the
Securities and Exchange Commission. The results of operations for the
three months ended March 31, 2003 and 2002 are not necessarily indicative
of the results of operations to be expected for the full year.
[2] BUSINESS:
Network-1 Security solutions, Inc ( the "Company" ) developed, marketed,
licensed and supported its proprietary network security software products
designed to provide comprehensive security to computer networks. The
Company also provided maintenance and training services.
In December 2002, the Company discontinued its software product line and
associated operations, ceased its product development and substantially
eliminated its sales and marketing efforts and during May 2003, sold
substantially all of its intellectual property. Through a series of
layoffs, the Company has reduced its workforce to a current level of one
employee and a consultant, The Company has closed its various offices
upon termination of leases during 2002 and 2003. Management is focusing
its efforts on seeking a merger candidate or other strategic transaction
for the Company.
[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 loss per share if the fair value-based method had been
applied to all awards.
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NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
[3] STOCK-BASED COMPENSATION (CONTINUED)
Three Months Ended
March 31,
------------------------------
2003 2002
------------- -----------
(unaudited) (unaudited)
Reported net loss attributable to common stockholders $ (276,000) $(1,524,000)
Stock-based employee compensation expense included
in reported net loss, net of related tax effects -- --
Stock-based employee compensation determined under
the fair value-based method, net of related tax effects (1,000) (8,000)
------------- -----------
Pro forma net loss $ (277,000) $(1,532,000)
------------- -----------
Loss per common share (basic and diluted):
As reported $ (0.03) $ (0.21)
Pro forma $ (0.03) $ (0.22)
The fair value of each grant on the date of grant is estimated using the Black-Scholes option-pricing utilizing the
following weighted average assumptions :
Three Months Ended
March 31,
------------------------
2003 2002
---- ----
Risk-free interest rates 2.98 % 4.91 %
Expected option life in years 6.60 6.60
Expected stock price volatility 112.00 % 112.00 %
Expected dividend yield 0.00 % 0.00 %
[4] Revenue recognition:
License revenue is recognized upon either delivery of software or delivery
of a required software key. License revenue from distributors or resellers
is recognized as the distributor or reseller delivers software or the
required software key to end users or original equipment manufacturers.
Service revenues consist of maintenance and training services. Annual
renewable maintenance fees are a separate component of each contract and
are recognized ratably over the contract term. Training revenues are
recognized as such services are performed. Revenues from advanced license
fees are deferred until they are earned pursuant to the agreements.
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NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
[4] REVENUE RECOGNITION (CONTINUED):
In December 2002, the Company discontinued offering its security software
product line. On May 30, 2003, the Company completed the sale of its
CyberwallPLUS technology and assigned its rights under the Falconstor
Agreement to the purchaser. The Company recognized revenue totaling
$42,000 for the three months ended March 31, 2003, which had been
deferred at December 31, 2002.
[5] LOSS PER SHARE:
Basic loss per share is calculated by dividing the net loss by the
weighted average number of outstanding common shares during the period.
Diluted per share data includes the dilutive effects of options, warrants
and convertible securities. Potential shares of 17,627,953 and 20,588,254
at March 31, 2003 and 2002 respectively, are anti-dilutive, and are not
included in the calculation of diluted loss per share. Such potential
common shares reflect options, warrants, convertible preferred stock and
convertible notes.
[6] CASH AND CASH EQUIVALENTS:
The Company places cash investments in high quality financial
institutions insured by the Federal Deposit Insurance Corporation
("FDIC"). At March 31, 2003, the Company maintained cash balances of
$1,476,000 in excess of FDIC limits.
NOTE B - 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. ("CMH") an option to purchase 750,000 shares of the common stock at
an exercise price of $1.20 per share, which was the market price of the
Company's common stock on the date of issuance. Corey M. Horowitz,
Chairman of the Board of Directors of the Company, is the sole owner and
officer of CMH. The shares underlying the option shall vest over a
three-year period in equal amounts of 250,000 shares per year beginning
April 18, 2003. In addition, the shares underlying the option 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 valued utilizing the Black-Scholes option pricing
model at each balance sheet date. These options were originally priced in
the quarter ended June 30, 2002 at $416,000. Subsequently, these were
revalued to $55,000 at December 31, 2002 and $14,000 at March 31, 2003.
The decrease in valuation of $41,000 has been reflected as a reduction of
general and administrative expenses for the three months ended March 31,
2003.
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NETWORK-1 SECURITY SOLUTIONS, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
NOTE C - LITIGATION
In January 2003, the former Chief Financial Officer and a director of the
Company commenced a lawsuit against the Company for breach of his
employment agreement for $190,000. Management believes that it has
meritorious defenses to the claims asserted. Accordingly, the Company has
not accrued any amount at March 31, 2003 that might result from such
litigation.
NOTE D - SETTLEMENT WITH FORMER CHIEF EXECUTIVE OFFICER (THE "FORMER CEO")
In January 2003, the Former CEO of the Company commenced a lawsuit
against the Company for breach of his employment agreement for $200,000.
In June 2003, the Company entered into a settlement in which the Company
agreed to pay approximately $127,000 to the Former CEO in full settlement
of all claims asserted, which was charged to expense during the year
ended December 31, 2002. The amount was subsequently paid on June 13,
2003. In addition, as part of the settlement, the Former CEO agreed to
forfeit his options to purchase 1,200,000 shares of the Company's common
stock.
NOTE E - SUBSEQUENT EVENT
On May 30, 2003, the Company completed the sale of its CyberwallPLUS
technology and related intellectual property and an assignment of its
rights under the Falconstor Agreement to such purchaser for aggregate
proceeds of $415,000, which will be recognized as gain on the sale of
assets during the three months ending June 30, 2003.
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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 RISKS AND UNCERTAINTIES,
INCLUDING, BUT NOT LIMITED TO, THOSE DISCUSSED BEGINNING ON PAGE 10 OF OUR
ANNUAL REPORT ON FORM 10-KSB FOR THE YEAR ENDED DECEMBER 31, 2002.
OVERVIEW
Until December 2002, Network-1 Security Solutions, Inc. (the "Company")
developed, marketed and licensed security software products designed to prevent
unauthorized access to information residing on an enterprise's computers. In
December 2002, the Company discontinued offering its security software product
line as it was unable to achieve sufficient product revenue to support the
expenses of such operations. Management is focusing its efforts on seeking a
merger candidate or strategic transaction for the Company. In May 2003, the
Company completed the sale of its CyberwallPlus technology and related
intellectual property to an unrelated third party for $415,000.
Results of Operations:
THREE MONTHS ENDED MARCH 31, 2003 COMPARED TO THREE MONTHS ENDED MARCH 31, 2002
Revenues decreased by $76,000 or 64%, from $118,000 for the three months ended
March 31, 2002 to $42,000 for the three months ended March 31, 2003. The
Company's lack of license revenues for the first three months ended March 31,
2003 resulted from the Company's decision to discontinue its software product
line in December 2002. Revenues during the quarter were related to the
amortization of deferred maintenance revenues from customers who had elected to
purchase maintenance and support contracts in earlier periods.
The cost of revenues for the three months ended March 31, 2003 was $17,000. This
cost relates to one employee who provides services under the Company's
maintenance and support contracts. Amortization of software development costs
were $70,000 for the three months ended March 31, 2002. Cost of licenses
consists of software media (disks), documentation, product packaging, production
costs and product royalties. Cost of licenses were $3,000 for the three months
ended March 31, 2002. Cost of services consisted of salaries, benefits and
overhead associated with the technical support of maintenance contracts. Cost of
services were $42,000 for the three months ended March 31, 2002. The decrease in
the cost of revenue is directly a result of the Company's decision to
discontinue its software product line in December 2002.
Gross profit was $25,000 for the three months ended March 31, 2003 compared to a
gross profit of $3,000 for the three months ended March 31, 2002, representing
60% and 2.5% of revenues, respectively.
Product development consisted 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.
Product development expense was $439,000 for the three months ended March 31,
2002.
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Selling and marketing expenses consisted primarily of salaries, including
commissions, benefits, bonuses, travel, advertising, public relations,
consultants and trade shows. Selling and marketing expenses were $619,000 for
the three months ended March 31, 2002.
General and administrative expenses include employee costs, including salary,
benefits, 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 $190,000, from
$495,000 for the three months ended March 31, 2002 to $305,000 for the three
months ended March 31, 2003. Expenses during the quarter ended March 31, 2003
included expenses associated with the discontinuation of the Company's product
line and associated headcount reduction and general downsizing associated with
the termination of the Company's software product business. For the quarter
ended March 31, 2003, these expenses were offset by a $41,000 reversal of
expenses related to the valuation of warrants.
No provision for or benefit from federal, state or foreign income taxes was
recorded for three months ended March 31, 2003 and 2002 because the Company
incurred net operating losses and fully reserved its deferred tax assets as
their future realization could not be determined.
As a result of the foregoing, the Company had net loss of $276,000 for the three
months ended March 31, 2003 compared with a net loss of $1,524,000 for the three
months ended March 31, 2002.
Liquidity and Capital Resources
At March 31, 2003, the Company had $1,576,000 of cash and cash equivalents and
working capital of $823,000. Net cash used in operating activities was $453,000
during the three months ended March 31, 2003 and net cash used in operating
activities was $1,383,000 during the three months ended March 31, 2002. Net cash
used in operating activities for the three months ended March 31, 2003 was
primarily attributable to the net loss of $276,000 which was partially offset by
the reversal of a non-cash expense of $41,000 attributable to the valuation of
warrants and depreciation and amortization expense of $22,000 and a decrease in
accounts payable, accrued expenses and other current liabilities of $159,000. In
May 2003, the Company received $415,000 from the sale of its CyberwallPlus
technology and related intellectual property.
The Company's operating activities during the three months ended March 31, 2003
were financed primarily with the remaining funds raised in the 2001 financing of
$6,765,000. 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, that
its cash balance of approximately $1,344,000 as of September 30, 2003 will be
sufficient to satisfy the Company's limited operations until at least September
2004. 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 2004. In the third and fourth quarters of 2002,
the Company instituted certain measures to reduce its overhead including
decreasing its headcount from 39 employees to its current level of two employees
and one consultant and the closing of its China development office and its
Taiwan sales office. In December 2002 the Company discontinued its product
offering in order to preserve cash as the Company continues to seek a merger or
other strategic transaction. In May 2003, the Company completed the sale of its
CyberwallPlus technology and related intellectual property for $415,000. The
Company is actively engaged in seeking merger candidates or a strategic
transaction. There is, however, no assurance that the Company will consummate
such a transaction, or that any such transaction will be successful. The
inability of the Company to consummate a merger transaction or other strategic
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transaction would have a material adverse effect on the Company. In addition,
any such merger or strategic transaction may involve substantial dilution to the
interests of the Company's existing stockholders.
Item 3: Controls and Procedures.
Based on his evaluation, as of a date within 90 days of the filing of this Form
10-QSB, the Company's Interim Chief Executive Officer and Chief Financial
Officer has concluded that the Company's controls and procedures (as defined in
Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) are
effective.
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS.
In January 2003, Richard J. Kosinski, former Chief Executive Officer, President
and a director, and Murray P. Fish, former Chief Financial Officer and a
director, commenced lawsuits against the Company in the Commonwealth of
Massachusetts, County of Essex, Superior Court, seeking severance and bonus
compensation and other benefits allegedly due them of $200,000 and $190,000
respectively. Messrs. Kosinski and Fish also moved for an order of attachment,
temporary restraining order and preliminary injunction to prevent the Company
from transferring an aggregate of $400,000 of its funds pending the outcome of
the lawsuits. In February 2003, the Court denied plaintiffs' motions.
In June 2003, the Company entered into a settlement agreement with Mr. Kosinski
pursuant to which the Company paid Mr. Kosinski the sum of $127,000 in full
settlement of all claims asserted by him in the litigation. In addition, as part
of the settlement, Mr. Kosinski agreed to forfeit options to purchase 1,200,000
shares of the Company's Common Stock.
The Company intends to vigorously defend the lawsuit by Mr. Fish seeking
$190,000 in severance, bonus and other benefits allegedly due him and believes
it has meritorious defenses to the claims asserted.
Item 2. CHANGES IN 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 Certification of Interim Chief Executive Officer and Chief
Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
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32.1 Certification of Interim Chief Executive Officer and Chief
Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
(b) Reports of Form 8-K.
(1) On January 6, 2003, the Company reported under Item 5 of Form
8-K that it had issued a press release announcing further budget cuts so that
its cash will be sufficient to fund operations through 2003.
(2) On January 10, 2003, the Company reported under Item 5 of Form
8-K that it had issued a press release announcing (i) the election of Edward
James as Interim Chief Executive Officer and Chief Financial Officer of the
Company, and (ii) the termination of Richard Kosinksi, as President and Chief
Executive Officer, and Murray Fish, as Chief Financial Officer and Secretary of
the Company.
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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/ Edward James
----------------
Edward James, Interim Chief Executive Officer and Chief Financial Officer
(Principal Executive, Financial and Accounting Officer)
Date: October 31, 2003
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