UNITED
STATES
 SECURITIES
AND EXCHANGE COMMISSION
 Washington,
D.C. 20549
 
  
  FORM
10-K
 
 xANNUAL REPORT PURSUANT TO SECTION 13
OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 
 For the
fiscal year ended December 31, 2008.
 
 o   
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 Registrant as Specified in Its Charter)
  
 Delaware                                                                                                        11-3027591
 (State or
Other
Jurisdiction                                                                                         (IRS
Employer
 of
Incorporation)                                                                                              Identification
Number)
 445
Park Avenue, Suite 1018
 New
York, New York 10022
 (Address
of Principal Executive Offices)
 
 Registrant’s
telephone number, including area code:  (212) 829-5770
 
 Securities
registered under Section 12(b) of the Act:
    Title of Each
      Class
                    
                    Name of Each
      Exchange on Which RegisteredNone
                    
                    None
   Securities
registered under Section 12(g) of the Act:
    Common Stock, $.01
      par value(Title of
      Class)






Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.  Yes o   No
x
  Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Securities Exchange Act of
1934.  Yes o   No
x
  Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 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
o
  Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K (Section 229.405) is not contained herein, and will not be
contained, to the best of registrant’s knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K.  x
  Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer or a smaller reporting
company.  See definitions of “large accelerated filer,” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.
  Large
accelerated filer o                                                                                               Accelerated
filer  o
 Non-accelerated
filer   o                                                                                               Smaller
Reporting Company  x
  Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Act).  Yes o    No
x
  The
aggregate market value of the voting and non-voting common stock of the
registrant held by non-affiliates computed by reference to the price at which
the stock was last sold on June 30, 2008 was approximately
$14,790,645.
  The
number of shares of Registrant’s common stock outstanding as of March 31, 2009
was 24,135,557.
  
 
 NETWORK-1
SECURITY SOLUTIONS, INC.
 2008
FORM 10-K
  TABLE
OF CONTENTS
  Page No.
 PART
      IItem
      1.
                                            Business
                                            2Item
      1A.
                                            Risk
      Factors
                                            9Item
      1B.
                                            Unresolved
      Staff Comments
                                            15Item
      2.
                                            Properties
                                            15Item
      3.
                                            Legal
      Proceedings
                                            15Item
      4.
                                            Submission
      of Matters to a Vote of Security Holders
                                            17PART
      IIItem
      5
                                            Market
      for Registrant’s Common Equity, Related Stockholder Matters and Issuer
      Purchases of Equity Securities
                                            17Item
      6.
                                            Selected
      Financial Data
                                            18Item
      7.
                                            Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
                                            19Item
      7A.
                                            Quantitative
      and Qualitative Disclosures About Market Risk
                                            22Item
      8.
                                            Financial
      Statements and Supplementary Data
                                            23Item
      9.
                                            Changes
      in and Disagreements with Accountants on Accounting and Financial
      Disclosure
                                            23Item
      9A.
                                            Controls
      and Procedures
                                            23Item
      9B.
                                            Other
      Information
                                            24PART
      IIIItem
      10.
                                            Directors,
      Executive Officers and Corporate Governance
                                            25Item
      11.
                                            Executive
      Compensation
                                            29Item
      12.
                                            Security
      Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters
                                            34Item
      13.
                                            Certain
      Relationships and Related Transactions and Director
      Independence
                                            37Item
      14.
                                            Principal
      Accountant Fees and Services
                                            39PART
      IVItem
      15.
                                            Exhibits
      and Financial Statement Schedules
                                            40SIGNATURES
                                            
                                            42
     1
 PART
I
  THIS ANNUAL REPORT ON FORM 10-K
CONTAINS CERTAIN STATEMENTS WHICH ARE FORWARD-LOOKING STATEMENTS THAT ARE
STATEMENTS THAT INCLUDE INFORMATION BASED UPON BELIEF OF OUR MANAGEMENT, AS WELL
AS ASSUMPTIONS MADE BY AND INFORMATION AVAILABLE TO
MANAGEMENT.  STATEMENTS CONTAINING TERMS SUCH AS “BELIEVES”,
“EXPECTS”, “ANTICIPATES”, “INTENDS” OR SIMILAR WORDS ARE INTENDED TO IDENTIFY
FORWARD LOOKING STATEMENTS.  ACTUAL RESULTS, EVENTS AND CIRCUMSTANCES
(INCLUDING FUTURE PERFORMANCE, RESULTS AND TRENDS) COULD DIFFER MATERIALLY FROM
THOSE SET FORTH IN SUCH STATEMENTS DUE TO VARIOUS RISKS AND UNCERTAINTIES,
INCLUDING BUT NOT LIMITED TO, THOSE DISCUSSED IN ITEM 1A RISK FACTORS OF THIS
REPORT AS WELL AS THOSE RISKS DISCUSSED ELSEWHERE IN THIS REPORT.
 
  ITEM
1.  BUSINESS.
 
 Overview
  Our
principal business is the acquisition, development, licensing and protection of
our intellectual property.  We presently own six patents issued by the
U.S. Patent Office that relate to various telecommunications and data networking
technologies (the “Patent Portfolio”) and include, among other things, patents
covering the control of power delivery over local area networks (“LANs”) for the
purpose of remotely powering network devices over Ethernet (“PoE”) networks and
systems and methods for the transmission of audio, video and data over LANS in
order to achieve higher quality of service (“QoS”).  Our strategy is
to pursue licensing and strategic business alliances with companies in
industries that manufacture and sell products that make use of the technologies
underlying our Patent Portfolio as well as with other users of the technologies
who benefit directly from the technologies including corporate, educational and
governmental entities.
  To date,
our efforts with respect to our Patent Portfolio have focused on licensing our
patent (U.S. Patent No. 6,218,930) covering the control of power delivery over
Ethernet cables (the “Remote Power Patent”).  In August, 2007, as part
of a settlement agreement relating to our litigation with D-Link, we entered
into a license agreement with D-Link pertaining to our Remote Power Patent (See
“Legal Proceedings - D-Link Litigation”).  In February 2008, we
commenced patent infringement litigation against several major data networking
equipment manufacturers including Cisco Systems, Inc. and 7 other defendants
(See “Legal Proceedings - Pending Litigation Against Major Data Networking
Equipment Manufacturers”).  On August 13, 2008, as part of our new
agreement with Microsemi Corp - Analog Mixed Signal Group Ltd. (“Microsemi
Analog”), Microsemi Corporation (“Microsemi”), the parent company of Microsemi
Analog, entered into a License agreement with us with respect to our Remote
Power Patent (See “Business - Licensing Program”). As of March 31,
2009, we had entered into a total of 5 license agreements with respect to our
Remote Power Patent.
  At least
for the next twelve months, we do not presently anticipate licensing efforts for
our other patents besides our Remote Power Patent.  We may seek to
acquire additional patents in the future.
   2
 The
Patents
  Our
Patent Portfolio consist of the following patents:
  U.S. Patent No.
6,218,930:  Apparatus and method for remotely powering access
equipment over a 10/100 switched Ethernet network;
  U.S. Patent No.
6,577,631:  Communication switching module for the transmission
and control of audio, video, and computer data over a single network
fabric;
  U.S. Patent No.
6,574,242:  Method for the transmission and control of audio,
video, and computer data over a single network fabric;
  U.S. Patent No.
6,570,890:  Method for the transmission and control of audio,
video, and computer data over a single network fabric using Ethernet
packets;
  U.S. Patent No.
6,539,011:  Method for initializing and allocating bandwidth in
a permanent virtual connection for the transmission and control of audio, video,
and computer data over a single network fabric; and
  U.S. Patent No.
6,215,789:  Local area network for the transmission and control
of audio, video, and computer data.
  In August
2008, we were issued European Patent No. 1086556 titled “Integrated Voice and
Data Communications over a Local Area Network” which covers the same technology
as covered by our U.S. QoS family of patents.  The Patent has issued
in France, Germany, Spain, United Kingdom and Ireland.  We have also
been notified that the Canadian Intellectual Property Office has issued a Notice
of Allowance for this patent and we anticipate its issuance in Canada by the end
of the second quarter this year.
  Our
future success is largely dependent upon our proprietary technologies, our
ability to protect our intellectual property rights and consummate license
agreements with respect to our Patent Portfolio.  The complexity of
patent and common law, combined with our limited resources, create risk that our
efforts to protect our patents may not be successful.  We cannot be
assured that our patents will be upheld, or that third parties will not
invalidate our patents.  We face uncertainty as to the outcome of our
litigation commenced in February 2008 against several major data networking
equipment manufacturers pertaining to our Remote Power Patent.  (See
Risk Factors “We face uncertainty as to the outcome of our litigation with major
data networking equipment manufacturers”).
  The
provisional patent application for our Remote Power Patent was filed on March
11, 1999 and the patent was granted by the U.S. Office of Patent and Trademark
on April 21, 2001.  The patent expires on March 11, 2020.
  We were
incorporated under the laws of the State of Delaware in July
1990.  Our offices are located at 445 Park Avenue, Suite 1018, New
York, New York 10022 and our telephone number is (212) 829-5770.
  3
 Market
Overview – Remote Power Patent
  Our
licensing efforts are currently focused on our Remote Power
Patent.  Our Remote Power Patent (U.S. Patent No. 6,218,930) relates
to several technologies which describe a methodology for controlling the
delivery of power to certain devices over an Ethernet network.
  The
Institute of Electrical and Electronic Engineers (IEEE) is a non-profit,
technical professional association of more than 370,000 individual members in
approximately 160 countries. The Standards Association of the IEEE is
responsible for the creation of global industry standards for a broad range of
technology industries.  In 2000, at the urging of several industry
vendors, the IEEE formed a task force to facilitate the adoption of a
standardized methodology for the delivery of remote power over Ethernet networks
which would insure interoperability among vendors of switches and terminal
devices.  On June 13, 2003 the IEEE Standards Association approved the
802.3af Power over Ethernet standard (the “Standard”), which covers technologies
deployed in delivering power over Ethernet networks.  The Standard
provides for the Power Sourcing Equipment (PSE) to be deployed in switches or as
standalone midspan hubs to provide power to remote devices such as wireless
access points, IP phones and network-based cameras. The technology is commonly
referred to as Power over Ethernet (“PoE”).  We believe that our
Remote Power Patent covers several of the key technologies covered by the
Standard.
  Ethernet
is the leading local area networking technology in use today.  PoE
technology allows for the delivery of power over Ethernet cables rather than by
separate power cords.  As a result, a variety of network devices,
including IP telephones, wireless LAN Access Points, web-based network security
cameras, data collection terminals and other network devices, are able to
receive power over existing data cables without the need to modify the existing
infrastructure to facilitate the provision of power for such devices through
traditional AC outlets.  Advantages such as lower installation costs,
remote management capabilities, lower maintenance costs, centralized power
backup, and flexibility of device location as well as the advent of worldwide
power compatibility, create the possibility of PoE becoming widely adopted in
networks throughout the world.
  PoE
provides numerous benefits including quantifiable returns on
investment.  The cost of hiring electricians to pull power cables to
remote locations used for access points or security cameras can rival or exceed
the cost of the devices.  Another key benefit is the need for Voice
over IP power reliability in the face of power failures.  Using PoE
enables data center power supply systems to ensure ongoing power – a function
that would be difficult and expensive to implement if each phone required AC
outlets.
  These and
other advantages such as remote management capabilities, lower maintenance
costs, and flexibility of device location have led to forecasts that PoE will be
widely adopted in networks throughout the world.  The benefits of PoE
are compelling as evidenced by the introduction of products by such leading
vendors such as Cisco Systems, Foundry Networks, Extreme Networks, 3Com,
Siemens, Nortel Networks and Avaya, as well as many others.
  The
ability to supply power to end-devices over Ethernet networks can be applied to
other end-devices, such as advanced security cameras, RFID card readers, laptop
computers, personal digital assistants and portable digital music
players.  As the desire to connect more end-devices to the Ethernet
network grows, we believe that PoE technology will become more widely used as a
method to power these end-devices.
  4
 Additional
Patents
  We also
own five (5) additional patents, besides our Remote Power Patent, covering
various methodologies that provide for allocating bandwidth and establishing
Quality of Service for delay sensitive data, such as voice, on packet data
networks.  Quality of Service issues become important when data
networks carry packets that contain audio and video which may require priority
over data packets traveling over the same network.  Covered within
these patents are also technologies that establish bi-directional communications
control channels between network-connected devices in order to support advanced
applications on traditional data networks.  We believe that potential
licensees of the technologies contained in these patents would be vendors
deploying applications that require the low latency transport of delay sensitive
data such as video over data networks.
  Network-1
Strategy
  Our
strategy is to capitalize on our Patent Portfolio by entering into licensing
arrangements with third parties including manufacturers and users that utilize
our Patent Portfolio’s proprietary technologies as well as any additional
proprietary technologies covered by patents which may be acquired by us in the
future.  We will also seek to enter into licensing arrangements with
users of the proprietary technologies, including corporate, educational and
governmental entities in those cases where the patent rights extend to the users
of the technologies contained in manufactured products.
  We do not
anticipate manufacturing products utilizing our Patent Portfolio or any of the
proprietary technologies contained in our Patent Portfolio. Accordingly, we do
not anticipate establishing a manufacturing, sales or marketing
infrastructure.  Consequently, we believe that our capital
requirements will be less than the capital requirements for companies with such
infrastructure requirements.
  In
connection with our activities relating to the protection of our Patent
Portfolio, it may be necessary to assert patent infringement claims against
third parties that we believe are infringing our Patent Portfolio, as is the
case with our litigation against eight (8) major data networking equipment
manufacturers (“Legal Proceedings – Pending Litigation Against Major Data
Networking Equipment Manufacturers”) and as we previously asserted against
D-Link (See “Legal Proceedings - D-Link Settlement”).
       5
 Licensing
  In
February 2004, we commenced licensing efforts with respect to our Remote Power
Patent.  We believe that potential licensees include, among others,
Wireless Local Area Networking (WLAN) equipment manufacturers, Local Area
Networking (LAN) equipment manufacturers, Voice Over IP Telephony (VOIP)
equipment manufacturers, and Network Camera manufacturers.  In
addition, we believe that additional potential licensees include users of the
equipment embodying the PoE technology covered by our Remote Power Patent,
including corporate, educational and federal, state and local government users,
as we believe that they are significant beneficiaries of the technologies
covered by our Remote Power Patent.
  ThinkFire
Agreement
  On
November 30, 2004, we entered into a Master Services Agreement (the “Agreement”)
with ThinkFire Services USA, Ltd. (“ThinkFire”) pursuant to which ThinkFire has
been granted the exclusive (except for direct efforts by us and related
companies) worldwide rights to negotiate license agreements for our Remote Power
Patent with respect to certain potential licensees agreed to between the
parties.  Either we or ThinkFire may terminate the Agreement upon 60
days notice for any reason or upon 30 days notice in the event of a material
breach.  We have agreed to pay ThinkFire a fee not to exceed 20% of
the royalty payments received from license agreements consummated by ThinkFire
on our behalf after we recover our expenses.
  Licensing
Program
  As of
March 31, 2009, we had transmitted letters to approximately 250 companies
offering licenses to our Remote Power Patent.  In addition, in
September 2005 we initiated an industry-wide Power Up Licensing program that
offered licenses for our Remote Power Patent to “early adopters” that included
royalty rates and related fees at a discount from our standard royalty rates and
fees for a limited time period.  The Power Up licensing program
continued until May 2007.  No licenses were granted under the Power Up
licensing program.
  On June
25, 2008 we announced the introduction of a Special Licensing Program for our
Remote Power Patent.  We entered into 3 license agreements as part of
our Special Licensing Program.  Our Special Licensing Program was of
limited duration (through December 31, 2008) and was implemented on an
industry-wide basis to offer discounted running royalty rates and exceptions to
our standard licensing terms and conditions for our Remote Power Patent to
vendors of finished products that comply with the PoE Standard, including
equipment defined in the PoE Standard as Power Sourcing Equipment (PSE) and
Powered Devices (PD).  The Special Licensing Program was available to
all vendors of PoE equipment including those companies that are defendants in
our pending patent litigation against eight major data equipment
manufacturers.  Our agreement with Microsemi Corp. - Analog Mixed
Signal Group Ltd. (“Microsemi”), dated June 17, 2008, among other things,
enabled Microsemi to assist its customers’ evaluation of our Remote Power Patent
and the terms being made available to vendors of PoE equipment pursuant to our
Special Licensing Program.
    6
 Microsemi
License
  On August
13, 2008, as part of our Special Licensing Program and our agreement with
Microsemi Corp-Analog Mixed Signal Group Ltd. (“Microsemi-Analog”), previously
PowerDsine Ltd, entered into in June 2008, Microsemi Corporation (“Microsemi”),
the parent company of Microsemi-Analog, entered into a license agreement with us
with respect to our Remote Power Patent.  The license agreement
provides that Microsemi is obligated to pay us quarterly royalty payments of 2%
of the sales price for certain of its Midspan PoE products for the full term of
our Remote Power Patent (March 2020).
  D-Link
License
  In August
2007, we agreed to licensing terms with D-Link Corporation and D-Link Systems
(collectively, “D-Link”) as part of a settlement agreement of our patent
infringement litigation against D-Link in the United States District Court for
the Eastern District of Texas, Tyler Division for infringement of our Remote
Power Patent (See “Legal Proceedings - D-Link Settlement”).
  The
license terms include the agreement by D-Link to license our Remote Power Patent
for its full term which expires in March 2020, and the payment of monthly
royalty payments (beginning as of May 26, 2007) based upon a running royalty
rate of 3.25% of the net sales of D-Link branded Power over Ethernet products,
including those products which comply with the IEEE 802.3af and 802.3at
Standards.  The royalty rate is subject to adjustment beginning the
second quarter of 2008 to a royalty rate consistent with other similarly
situated licensees of our Remote Power Patent that may vary according to units
and volumes of licensed products sold.  In addition, D-Link paid us an
upfront payment upon signing of the license agreement of
$100,000.  The products covered by the license include D-Link Power
over Ethernet enabled switches, wireless access points, and network security
cameras, among others.
  Legal
Representation
  In
February 2008, we entered into an agreement with Dovel & Luner, LLP pursuant
to which such firm provides legal services to us with respect to our litigation
commenced in February 2008 against eight major data networking equipment
manufacturers, pending in the United States District Court for the Eastern
District of Texas, Tyler Division, for infringement of our Remote Power Patent
(See “Legal Proceedings”).  The terms of our agreement with Dovel
& Luner, LLP provide for fees of a maximum aggregate cash payment of $1.5
million plus a contingency fee of up to 24% depending upon when an outcome is
achieved.
  With
respect to our litigation against D-Link, which was settled in May 2007, we
utilized the services of Blank Rome LLP, on a full contingency basis and also
the services of Potter Mitton, P.C. (Tyler, Texas) on an hourly basis to serve
as local counsel.  In accordance with our contingency fee agreement
with Blank Rome LLP, we will pay legal fees to Blank Rome LLP equal to 25% of
the royalty revenue received by us from our license agreement with D-Link after
we recover our expenses related to the litigation.
     7
 Competition
  The
telecommunications and data networking licensing market is characterized by
intense competition and rapidly changing business conditions, customer
requirements and technologies.  Although we believe that we have
enforceable patents relating to telecommunications and data networking, there
can be no assurance that our Patent Portfolio will be upheld or that third
parties will not invalidate any or all of the patents in our Patent
Portfolio.  In addition, our current and potential competitors may
develop technologies that may be more effective than our proprietary
technologies or that would render our technologies less marketable or
obsolete.  We may not be able to compete successfully.
  In
addition, other companies may develop competing technologies that offer better
or less expensive alternatives to PoE and the other technologies covered by our
Patent Portfolio.  Several companies have notified the IEEE that they
may have patents and proprietary technologies that are covered by the
Standard.   In the event any of those companies asserts claims
relating to our patents, the licensing royalties available to us may be
limited.  Moreover, technological advances or entirely different
approaches developed by one or more of our competitors or adopted by various
standards groups could render our Remote Power Patent obsolete, less marketable
or unenforceable.
  Description
of Property
  We
currently lease office space in New York City at a cost of $3,400 per month
under a lease which expires in June 2010.
  Employees
and Consultants
  As of
March 31, 2009, we had one full-time employee, no part-time employees and
three consultants.
  
  
         8
 ITEM
1A.   RISK FACTORS
  We
operate in a highly competitive environment that involves a number of risks,
some of which are beyond our control.  The following discussion
highlights the most material of the risks.
  We
have a history of losses and modest revenue from current
operations.
 
 We have
incurred substantial operating losses since our inception, which has resulted in
an accumulated deficit of $(50,895,000) as of December 31,
2008.  For the years ended December 31, 2008 and 2007, we incurred net
losses of $(1,618,000) and $(2,998,000), respectively.  We have
financed our operations primarily by sales of equity securities.  We
had revenue of $349,000 and $232,000 from operations for the years ended
December 31, 2008 and December 31, 2007, respectively.  Our
ability to achieve revenue and generate positive cash flow from operations is
dependent upon consummating licensing agreements with respect to our patented
technologies.  In August 2007, as part of our settlement agreement
pertaining to our patent infringement litigation against D-Link Corporation and
D-Link Systems (collectively, “D-Link”), we entered into our first license
agreement for our Remote Power Patent with D-Link. (See “Legal Proceedings -
D-Link Litigation”).  In August 2008, as part of our Special Licensing
Program and an agreement with Microsemi Corp-Analog Mixed Signal Group Ltd.
(previously PowerDsine Ltd.), a subsidiary of Microsemi Corporation
(“Microsemi”), Microsemi entered into a license agreement with us for our Remote
Power Patent with respect to certain of its Midspan PoE products (See “Legal
Proceedings – PowerDsine Settlement).  As of March 31, 2009,
we  have entered into 5 license agreements with respect to our Remote
Power Patent.  We may not be successful in achieving additional
material licensing agreements with third parties and our failure to do so would
have a material adverse effect on our business, financial condition and results
of operations.  We may not be able to achieve material revenue or
generate positive cash flow from operations from our licensing
business.
  We
could be required to stop operations if we are unable to develop our technology
licensing business or raise capital when needed.
 
 We
anticipate, based on our currently proposed plans and assumptions relating to
our operations (including the timetable of, costs and expenses associated with
our continued operations), that our cash position of $4,140,000 at March 1,
2009 will more likely than not be sufficient to satisfy our operations and
capital requirements until at least December 31, 2010.  However,
we may expend our funds prior thereto.  In the event our plans change,
or our assumptions change or prove to be inaccurate (due to unanticipated
expenses, difficulties, delays or otherwise), we could have insufficient funds
to support our operations prior to December 31, 2010.  Our
inability to obtain additional financing when needed, absent generating
sufficient cash from licensing arrangements, would have a material adverse
effect on us, requiring us to curtail or possibly cease our
operations.  In addition, any additional equity financing may involve
substantial dilution to the interests of our then existing
stockholders.
  Our
licensing business may not be successful.
  In
November 2003, we entered the technology licensing business following our
acquisition of six patents relating to various telecommunications and data
networking technologies including, among others, patents covering the delivery
of remote power over Ethernet and the transmission of audio, video and data over
computer and telephony
   9
 networks.  To
date, we have only entered into 5 license agreements with third parties with
respect to our patented technology (See “Business -
Licensing”).  Accordingly, we have a limited history in the technology
licensing business upon which an evaluation of our prospects and future
performance can be made.  Our prospects must be considered in light of
the risks, expenses and difficulties frequently encountered in the development,
operation and expansion of a new business based on patented technologies in a
highly specialized and competitive market.  We may not be able to
achieve sufficient revenue or profitable operations from our new licensing
business.
  Our
future source of licensing revenue is uncertain.
  In
February 2004, we initiated our first licensing efforts relating to the
technologies in our remote power patent (U.S. Patent No. 6,218,930) (the “Remote
Power Patent”).  To date, we have entered into 5 license
agreements with respect to our Remote Power Patent.  (See “Business -
Licensing”).  Our inability to consummate additional licensing
agreements and achieve material revenue from our patented technologies would
have a material adverse effect on our operations and our ability to continue our
business.  In addition, in the event we consummate license
arrangements with third parties, such arrangements may not produce a stable or
predictable stream of revenue in the foreseeable future.  Furthermore,
the success of our licensing efforts depends upon the strength of our
intellectual property rights.
  Our
success is dependent upon our ability to protect our proprietary
technologies.
  Our
success is substantially dependent upon our proprietary technologies and our
ability to protect our intellectual property rights.  We currently
hold 6 patents issued by the U.S. Patent Office that relate to various
telecommunications and data networking technologies and include among other
things, patents covering the delivery of power to certain devices over PoE
networks and the transmission of audio, voice and data over computer and
telephony 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.  If our
intellectual property rights are not upheld, such an event would have a material
adverse effect on us.
        10
 Any
litigation to protect our intellectual property or any third party claims to
invalidate our patents could have a material adverse effect on our
business.
  Our
success depends on our ability to protect our intellectual property
rights.  In August 2005, we commenced patent litigation against D-Link
Corporation and D-Link Systems, Incorporated for infringement of our Remote
Power Patent and in April 2007 we entered into a settlement agreement with the
D-Link parties (See “Legal Proceedings - D-Link Litigation”).  In
addition, in February 2008 we commenced patent litigation against Cisco Systems,
Inc. and seven other major data networking equipment manufacturers which is
currently pending in the United States District Court for the Eastern District
of Texas, Tyler Division (See “Legal Proceedings - Pending Litigation Against
Major Data Networking Equipment Manufacturers”).  In the future, it
may be necessary for us to commence patent litigation against additional third
parties whom we believe require a license to our patents.  In
addition, we may be subject to claims seeking to invalidate our patents, as
asserted by the defendants in the aforementioned pending litigation in Texas
with us.  These types of claims, with or without merit, may subject us
to costly litigation and diversion of management’s focus.  If we are
unsuccessful in enforcing and validating our patents and/or if third parties
making claims against us seeking to invalidate our patents are successful, they
may be able to obtain injunctive or other equitable relief, which effectively
could block our ability to license or otherwise capitalize on our proprietary
technologies.  Successful litigation against us resulting in a
determination that our patents are not valid or enforceable, and/or that third
parties do not infringe, would have a material adverse effect on
us.
  Our
license agreements with D-Link and Microsemi may not result in significant
royalties and do not necessarily mean we will achieve additional license
agreements or material revenue.
  In August
2007 we finalized the settlement agreement with respect to our patent litigation
against D-Link Corporation and D-Link Systems, Incorporated pending in the
United States District Court for the Eastern District of Texas, Tyler Division,
for infringement of our Remote Power Patent.  Under the terms of the
settlement, D-Link entered into a license agreement for our Remote Power Patent
the terms of which include monthly royalty payments of 3.25% (beginning May
2007) of the net sales of D-Link PoE products, including those products which
comply with the IEEE 802.3af and 802.3at Standards, for the full life of our
Remote Power Patent, which expires in March 2020.  The royalty rate is
subject to adjustment to a rate consistent with other similarly situated
licensees of the Remote Power Patent based on units of shipments of licensed
products.  In addition, D-Link paid us $100,000 upon signing of the
Settlement Agreement.  On August 13, 2008, as part of our Special
Licensing Program and our agreement with Microsemi Corp-Analog Mixed Signal
Group Ltd. (“Microsemi-Analog”) entered into in June 2008, Microsemi Corporation
(“Microsemi”), the parent company of Microsemi-Analog, entered into a license
agreement with us with respect to our Remote Power Patent.  The
license agreement provides that Microsemi is obligated to pay us quarterly
royalty payments of 2% of the sales price for certain of Microsemi’s Midspan PoE
products for the full term of our Remote Power Patent (March
2020).  For the year ended December 31, 2008, we received
aggregate royalty payments of $349,000 with respect to our license
agreements.  Notwithstanding our license agreements with the D-Link
and Microsemi, there is no assurance that we will achieve significant royalty
revenue from such license agreements, that we will be able to achieve additional
material license agreements with third parties relating to our Remote Power
Patent or any of our other patents, or that such license arrangements will
result in material revenue to us.
    11
 We
face uncertainty as to the outcome of our litigation against major data
networking equipment manufacturers.
  In
February 2008, we commenced litigation against eight major data networking
equipment manufacturers in the United States District Court for the Eastern
District of Texas, Tyler Division, for infringement of our Remote Power
Patent.  The defendants in the lawsuit include Cisco Systems, Inc.,
Cisco Linksys, LLC, Enterasys Networks, Inc., 3COM Corporation, Inc., Extreme
Networks, Inc., Foundry Networks, Inc., Netgear, Inc. and Adtran,
Inc.  We seek injunctive relief and monetary damages for infringement
based upon reasonable royalties as well as treble damages for the defendants’
continued willful infringement of our Remote Power Patent.  In their
answers to the Complaint, the defendants asserted that they do not infringe any
valid claim of our Remote Power Patent, and further asserted that, based on
several different theories, the patent claims are invalid or
unenforceable.  In addition to these defenses, the defendants also
asserted counterclaims for, among other things, non-infringement, invalidity,
and unenforceability of our Remote Power Patent.  In the event that
the Court determines that our Remote Power Patent is not valid or enforceable,
and/or that the defendants do not infringe, any such determination would have a
material adverse effect on us.
  Material
licensing revenues from our Remote Power Patent may be dependent upon the
applicability of the IEEE Standard.
  The
Institute of Electrical and Electronic Engineers (IEEE) is a non-profit,
technical professional association of more than 370,000 individual members in
approximately 160 countries.  The Standards Association of the IEEE is
responsible for the creation of global industry standards for a broad range of
technology industries.  In 2000, the IEEE formed a task force to
facilitate the adoption of a standardized methodology for the delivery of remote
power over Ethernet networks which would insure interoperability among vendors
of switches and terminal devices.  In June 2003, the IEEE Standards
Association approved the 802.3af Power Over Ethernet standard (the “Standard”),
which covers technologies deployed in delivering power over Ethernet cables
including whether deployed in switches or as standalone midspan hubs both of
which provide power to remote devices including, among others, wireless access
points, IP phones and network based cameras.  The technology is
commonly referred to as PoE.  We believe our Remote Power Patent
covers several of the key technologies covered by the
Standard.  However, there is a risk that as a result of litigation a
court may determine otherwise and such a determination would have a material
adverse effect on our ability to enter into license agreements and achieve
material revenue and profits from our Remote Power Patent.
  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 PoE 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.
  In
addition, other companies may develop competing technologies that offer better
or less expensive alternatives to PoE and the other technologies covered by our
Patent Portfolio.  Several companies have notified the IEEE that they
may have patents and proprietary technologies that are covered by the
Standard.   In the event any of those companies asserts claims
relating to our patents, the licensing royalties available to us may be
limited.  Moreover, technological advances or entirely different
approaches developed by one or more of our competitors or adopted by various
standards groups could render our Remote Power Patent obsolete, less marketable
or unenforceable.
  12
 Dependence
upon CEO and Chairman.
  Our
success is largely dependent upon the personal efforts of Corey M. Horowitz, our
Chairman and Chief Executive Officer and Chairman of the Board of
Directors.  Our employment agreement with Mr. Horowitz expired on
February 28, 2009.  Mr. Horowitz continues to serve as our
Chairman and Chief Executive Officer.  We are currently in discussions
with Mr. Horowitz with respect to a new employment agreement, but there is
no certainty that we will achieve a mutually acceptable agreement. We
believe that the loss of the services of Mr. Horowitz would have a material
adverse effect on our business and prospects.  We do not maintain
key-man life insurance on the life of Mr. Horowitz.
  Risks
related to low priced stocks.
  Our
common stock currently trades on the OTC Bulletin Board under the symbol
NSSI.  Since the trading price of our common stock is below $5.00 per
share, our common stock is considered a penny stock.  SEC regulations
generally define a penny stock to be an equity security that is not listed on
Nasdaq or a national securities exchange and that has a market value of less
than $5.00 per share, subject to certain exceptions.  SEC regulations
require broker-dealers to deliver to a purchaser of our common stock a
disclosure schedule explaining the penny stock market and the risks associated
with it. Various sales practice requirements are also imposed on broker-dealers
who sell penny stocks to persons other than established customers and accredited
investors (generally institutions).  Broker-dealers must also provide
the customer with current bid and offer quotations for the penny stock, the
compensation of the broker-dealer and monthly account statements disclosing
recent price information for the penny stock held in the customer’s
account.
  The
significant number of options and warrants outstanding may adversely effect the
market price for our common stock.
  As of
March 31, 2009, there are outstanding options and warrants to purchase an
aggregate of 12,164,882 shares of our common stock at exercise prices ranging
from $.12 to $10.00.  To the extent that outstanding options and
warrants are exercised, existing 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.
       13
 We
have a significant amount of authorized but unissued preferred stock, which may
affect the likelihood of a change of control in our company.
  Our Board
of Directors has the authority, without further action by the stockholders, to
issue 10,000,000 shares of preferred stock on such terms and with such rights,
preferences and designations as our Board of Directors may
determine.  Such terms may include restricting dividends on our common
stock, dilution of the voting power of our common stock or impairing the
liquidation rights of the holders of our common stock.  Issuance of
such preferred stock, depending on the rights, preferences and designations
thereof, may have the effect of delaying, deterring or preventing a change in
control.  In addition, certain “anti-takeover” provisions in Delaware
law may restrict the ability of our stockholders to authorize a merger, business
combination or change of control.
  Our
stock price may be volatile.
  The
market price of our common stock is likely to be highly volatile and could
fluctuate widely in price in response to various factors, many of which are
beyond our control, including the following:
  ●
              our
      ability to successfully enforce and/or defend our Remote
      PowerPatent;
  ●
              our
      ability to enter into favorable license agreements with third parties
      withrespect to our Remote Power
Patent;
  ●
              our
      ability to achieve material revenue and
profits;
  ●
              our
      ability to raise capital when
needed;
  ●
              sales
      of our common stock;
  ●
              our
      ability to execute our business
plan;
  ●
              technology
      changes;
  ●
              legislative,
      regulatory and competitive developments;
and
  ●
              economic
      and other external factors.
  In
addition, the securities markets have from time to time experienced significant
price and volume fluctuations that are unrelated to the operating performance of
particular companies.  These market fluctuations may also materially
and adversely affect the market price of our common stock.
  Additional
stock offerings may dilute current stockholders.
  We may
need to issue additional shares of our capital stock or securities convertible
or exercisable for shares of our capital stock, including preferred stock,
options or warrants.  The issuance of additional capital stock may
dilute the ownership of our current stockholders.
   14
 ITEM
1B.  UNRESOLVED STAFF COMMENTS
  None
 
  ITEM
2.   PROPERTIES
  We
currently lease office space in New York City at a cost of $3,400 per month
under a lease which expires in June 2010.
   ITEM
3.   LEGAL PROCEEDINGS
  Pending
Litigation Against Major Data Networking Equipment Manufacturers
 
 In
February 2008, we commenced litigation against eight major data networking
equipment manufacturers in the United States District Court for the Eastern
District of Texas, Tyler Division, for infringement of our Remote Power
Patent.  The defendants in the lawsuit include Cisco Systems, Inc.,
Cisco Linksys, LLC, Enterasys Networks, Inc., 3COM Corporation, Inc., Extreme
Networks, Inc., Foundry Networks, Inc., Netgear, Inc. and Adtran,
Inc.  We seek injunctive relief and monetary damages for infringement
based upon reasonable royalties as well as treble damages for the defendant’s
continued willful infringement of our Remote Power Patent.  All of the
defendants have answered the complaint and asserted that they do not infringe
any valid claim of our Remote Power Patent, and further asserted that, based on
several different theories, the patent claims are invalid or
unenforceable.  In addition to these defenses, the defendants also
asserted counterclaims for, among other things, non-infringement, invalidity,
and unenforceability of our Remote Power Patent.  In the event that
the Court determines that our Remote Power Patent is not valid or enforceable,
and/or that the defendants do not infringe, any such determination would have a
material adverse effect on our company.
  D-Link
Settlement
 
 In August
2005, we commenced patent litigation against D-Link Corporation and D-Link
Systems, Incorporated (collectively “D-Link”) in the United States District
Court for the Eastern District of Texas, Tyler division, for infringement of our
Remote Power Patent.  Our complaint sought, among other things, a
judgment that our Remote Power Patent is enforceable and has been infringed by
the defendants.  We also sought a permanent injunction restraining the
defendants from continued infringement, or active inducement of infringement by
others, of our Remote Power Patent.
  In August
2007, we finalized the settlement of our patent infringement litigation against
D-Link.  Under the terms of the settlement, D-Link entered into a
license agreement for our Remote Power Patent the terms of which include monthly
royalty payments of 3.25% of the net sales of D-Link Power over Ethernet
products, including those products which comply with the IEEE 802.3af and
802.3at Standards, for the full term of our Remote Power Patent, which expires
in March 2020.  The royalty rate is subject to adjustment to a rate
consistent with other similarly situated licensees of our Remote Power Patent
based on units of shipments of licensed products.  In addition, D-Link
paid us $100,000 upon signing of the Settlement Agreement.
  PowerDsine
Settlement
  On
November 16, 2005, we entered into a Settlement Agreement with PowerDsine, Inc.
(NASDAQ: PDSN) and PowerDsine Ltd. (collectively, “PowerDsine”) which dismissed,
with prejudice, patent litigation brought by PowerDsine against us in March 2004
in the United States District Court for the Southern District of New York that
sought a declaratory judgment that our Remote Power Patent (U.S. Patent No.
6,218,930) was invalid and not infringed by PowerDsine and/or its
customers.
  15
 Under the
terms of the Settlement Agreement, we agreed that we will not initiate
litigation against PowerDsine for its sale of Power over Ethernet (PoE)
integrated circuits.  In addition, we agreed that we will not seek
damages for infringement from customers that incorporate PowerDsine integrated
circuit products in PoE capable Ethernet switches manufactured on or
before  April 30, 2006. PowerDsine has agreed that it will not
initiate, assist or cooperate in any legal action relating to the Remote Power
Patent.
  No
licenses to use the technologies covered by our Remote Power Patent were granted
to PowerDsine or its customers under the terms of the settlement.  The
Settlement Agreement further provides that PowerDsine is obligated to provide
each of its customers with written notice of the settlement which notice shall
disclose that no license for our Remote Power Patent has been provided to
PowerDsine’s customers and that in order to combine, modify or integrate any
PowerDsine product with or into any other device or software, PowerDsine’s
customers may need to receive patent license(s) for our Remote Power Patent
which is the customer’s responsibility.
  In June
2008 we entered into a new agreement with Microsemi Corp-Analog Mixed Signal
Group Ltd (“Microsemi Analog”), previously PowerDsine Ltd, a subsidiary of
Microsemi Corporation (“Microsemi”), a leading manufacturer of high performance
analog mixed-signal integrated circuits and high reliability semiconductors,
which, among other things, amended the prior Settlement Agreement entered into
between the parties in November 2005.  Under the new agreement, on
June 25, 2008 we announced the commencement of an industry-wide Special
Licensing Program for our Remote Power Patent to vendors of PoE
equipment.   The Special Licensing Program was of limited
duration (through December 31, 2008) and was implemented on an industry-wide
basis to offer discounted running royalty rates and exceptions to our standard
licensing terms and conditions for the Remote Power  Patent to PoE
vendors who were “early adopters” and entered into license agreements without
delay to avoid litigation and higher royalties. We entered into 3 license
agreements as part of our Special Licensing Program.  The new
agreement enabled Microsemi Analog to assist in its customers’ evaluation of the
Remote Power Patent and the terms being made available to vendors of PoE
equipment pursuant to our Special Licensing Program, an activity that was
previously prohibited by the 2005 Settlement Agreement with
PowerDsine.  As part of our Special Licensing Program and our
agreement with Microsemi Analog entered into in June 2008, Microsemi entered
into a license agreement, dated August 13, 2008, with us with respect to
the Remote Power Patent.  The license agreement provides that
Microsemi is obligated to pay us quarterly royalty payments of 2% of the sales
price for certain of Microsemi’s Midspan PoE products for the full term of the
Remote Power Patent (March 2020).
   ITEM
4.   SUBMISSION OF MATTERS TO A VOTE OF SECURITY
HOLDERS
  None
   16
 PART
II
  ITEM
      5.
                MARKET
      FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
      PURCHASES OF EQUITY
SECURITIES
  Market Information. Our
Common Stock currently trades on OTC Bulletin Board under the symbol
NSSI.  The following table sets forth, for the periods indicated, the
range of the high and low closing bid prices for our Common Stock as reported by
the Pink Sheets LLC quotation service.  Such prices reflect
inter-dealer quotations, without retail mark-up, mark-down or commission and may
not necessarily represent actual transactions.
  YEAR
      ENDED DECEMBER 31, 2008
                          HIGH
                          
                          LOWFourth
      Quarter
                          $0.70
                          
                          $0.38Third
      Quarter
                          $1.05
                          
                          $0.70Second
      Quarter
                          $1.29
                          
                          $0.85First
      Quarter
                          $1.50
                          
                          $1.14YEAR
      ENDED DECEMBER 31, 2007
                          HIGH
                          
                          LOWFourth
      Quarter
                          $2.05
                          
                          $1.33Third
      Quarter
                          $1.60
                          
                          $1.44Second
      Quarter
                          $2.04
                          
                          $1.55First
      Quarter
                          $1.75
                          
                          $1.35
 
  On
March 20, 2009, the closing price for the Common Stock as reported on the
OTC Bulletin Board was $0.60 per share. The number of record holders of our
Common Stock was 115 as of March 20, 2009.
  Dividend Policy. We have
never declared or paid any cash dividends on our Common Stock and do not intend
to declare or pay cash or other dividends in the foreseeable future. The Board
of Directors currently expects to retain any future earnings, if any, for use in
the operation and expansion of its business. The declaration and payment of any
future dividends will be at the discretion of the Board of Directors and will
depend upon a variety of factors, including future earnings, if any, operations,
capital requirements, our general financial condition, the preferences of any
series of preferred stock, our general business conditions and future
contractual restrictions on payment of dividends, if any.
   17
 Recent Issuances of Unregistered
Securities.  None.
  Issuer Purchases of Equity
Securities.None.
  Equity
Compensation Plan Information
  The following table summarizes share
and exercise price information about our equity compensation plans as of
December 31, 2008.
  Number
      of securities to be issued upon exercise of outstanding options, warrants
      and rights
                                        (1)
                                      Weighted-average
      exercise price of outstanding options, warrants and rights
                                      Number
      of securities remaining available for future issuance under equity
      compensation plans (excluding securities reflected in column)
      (1)Equity
      compensation plans approved by security holders
                                      3,858,895
                                      $0.90
                                      0(1)Equity
      compensation plans not approved by security holders
                                      0
                                      —
                                      —Total
                                      3,858,895
                                      $0.90
                                      0(1)__________
                                        (1)  Our
      1996 Amended and Restated Stock Option Plan provided for the issuance of
      options to purchase up to 4,000,000 shares of our common
      stock.  As of March 2006, no additional options could be issued
      under the plan in accordance with its
terms.
 
   ITEM
6.   SELECTED FINANCIAL DATA
 
 Not
required for a “smaller reporting company” as defined in Rule 12b-2 promulgated
under the Securities Exchange Act of 1934, as amended.
           18
 ITEM
7.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIALCONDITION AND RESULTS OF OPERATIONS
  THE
FOLLOWING DISCUSSION AND ANALYSIS SHOULD BE READ IN CONJUNCTION WITH OUR
FINANCIAL STATEMENTS, INCLUDING THE NOTES THERETO, INCLUDED ELSEWHERE IN THIS
FORM 10-K. EXCEPT FOR THE HISTORICAL INFORMATION CONTAINED HEREIN, THIS
DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND
UNCERTAINTIES, INCLUDING, BUT NOT LIMITED TO, THOSE DISCUSSED IN THE SECTION
ABOVE ENTITLED “RISK FACTORS” IN ITEM 1A OF THIS REPORT AS WELL AS THOSE RISKS
DISCUSSED IN THIS SECTION AND ELSEWHERE IN THIS REPORT. BECAUSE SUCH STATEMENTS
INVOLVE RISKS AND UNCERTAINTIES, ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE
EXPRESSED OR IMPLIED BY SUCH FORWARD-LOOKING STATEMENTS.
  Overview
  Our
principal business is the acquisition, development, licensing and protection of
our intellectual property. We presently own six patents covering various
telecommunications and data networking technologies (the “Patent Portfolio”)
including, among others, patents covering the delivery of power over Ethernet
for the purpose of remotely powering network devices, and the transmission of
audio, video and data over computer and telephony networks. Our strategy is to
pursue licensing and strategic business alliances with companies in the
industries that manufacture and sell products that make use of the technologies
underlying our patents as well as with other users of the technology who benefit
directly from the technology including corporate, educational and governmental
entities.
  To date,
our efforts with respect to our Patent Portfolio have focused on licensing our
patent (U.S. Patent No. 6,218,930) covering the control of power delivery over
Ethernet cables (the “Remote Power Patent”).  As of March 31, 2009, we
had entered into 5 license agreements with respect to our Remote Power
Patent.  In August, 2007, as part of a settlement agreement relating
to our litigation with D-Link, we entered into a license agreement with D-Link
pertaining to our Remote Power Patent (See Item I. “Business – Licensing -
D-Link License”).  In February 2008, we commenced patent infringement
litigation against several major data networking equipment manufacturers
including Cisco Systems, Inc. and seven (7) other defendants (See Item 3. “Legal
Proceedings”).  During the next 12 months we do not presently
anticipate licensing efforts for our other patents besides our Remote Power
Patent.
  To date
we have incurred significant losses and at December 31, 2008 had an accumulated
deficit of $(50,895,000).  For the year ended December 31, 2008 and
December 31, 2007, we incurred net losses of $(1,618,000) and $(2,998,000),
respectively.  We anticipate that we will continue to incur losses
until we enter into additional license agreements with respect to our patented
technologies.  We have achieved revenue of $349,000 from our
technology licensing business for the year ended December 31, 2008 with respect
to royalties pertaining to our Remote Power Patent.  Our inability to
consummate additional material license agreements and achieve revenue from our
patented technologies would have a material adverse effect on our operations and
our ability to continue business.
   19
 Our
success and ability to generate revenue is largely dependent on our ability to
consummate licensing arrangements with third parties.  In November
2004, we entered into an agreement with ThinkFire Services USA, Ltd.
(“ThinkFire”) pursuant to which ThinkFire has been granted the exclusive
worldwide rights to negotiate license agreements for our Remote Power Patent
with certain agreed-upon potential licensees.  We have agreed to pay
ThinkFire a fee of up to 20% of the royalty payments received from license
agreements consummated by ThinkFire on our behalf after we recover our
expenses.
  In August
2007 we finalized the settlement of our patent litigation against D-Link in the
United States District Court for the Eastern District of Texas, Tyler Division,
for infringement of our Remote Power Patent (U.S. Patent No.
6,218,930).  Under the terms of the settlement, D-Link has agreed to
license our Remote Power Patent the terms of which include monthly royalty
payments of 3.25% of the net sales of D-Link branded Power over Ethernet
products, including those products which comply with the IEEE 802.3af and
802.3at Standards, for the full life of our Remote Power Patent, which expires
in March 2020.  The royalty rate is subject to adjustment to a rate
consistent with other similarly situated licensees of our Remote Power Patent
based on units of shipments of licensed products.  In addition, D-Link
paid us $100,000 upon signing the settlement
agreement.  Notwithstanding the settlement and our license agreement
with D-Link, there is no assurance that we will achieve significant royalty
revenue from D-Link, that we will be able to achieve additional license
agreements with third parties relating to our Remote Power Patent or our other
patents, or that such license arrangements will result in material revenue to
us.
  In
February 2008, we commenced litigation against eight major data networking
equipment manufacturers in the United States District Court for the Eastern
District of Texas, Tyler Division, for infringement of our Remote Power
Patent.  The defendants in the lawsuit include Cisco Systems, Inc.,
Cisco Linksys, LLC, Enterasys Networks, Inc., 3COM Corporation, Inc., Extreme
Networks, Inc., Foundry Networks, Inc., Netgear, Inc. and Adtran,
Inc.  We seek injunctive relief and monetary damages for infringement,
based upon reasonable royalties as well as treble damages for the defendants’
continued willful infringement of our Remote Power Patent.  All of the
defendants have answered our complaint and asserted that they do not infringe
any valid claim of our Remote Power Patent, and further asserted that, based on
several different theories, the patent claims are invalid or
unenforceable.  In addition to these defenses, the defendants also
asserted counterclaims for, among other things, non-infringement, invalidity,
and unenforceability of our Remote Power Patent.  In the event that
the Court determines that our Remote Power Patent is not valid or enforceable,
and/or that the defendants do not infringe, any such determination would have a
material adverse effect on us.
  As part
of our Special Licensing Program and our agreement with Microsemi Corp-Analog
Mixed Signal Group Ltd. (“Microsemi-Analog”) entered into in June 2008,
Microsemi Corporation (“Microsemi”), the parent company of Microsemi-Analog,
entered into a license agreement, dated August 13, 2008, with us with
respect to the Remote Power Patent.  The license agreement provides
that Microsemi is obligated to pay us quarterly royalty payments of 2% of the
sales price for certain of Microsemi’s Midspan PoE products for the full term of
the Remote Power Patent (through March 2020).
    20
 RESULTS
OF OPERATIONS
  Year
Ended December 31, 2008 Compared To Year Ended December 31,
2007
  We had
revenues of $349,000 for the year ended December 31, 2008 (“2008”) as
compared to revenues of $232,000 for the year ended December 31, 2007
(“2007”) which increase in revenues was attributed to a full year of royalties
with respect to our license with D-Link and royalties from our license with
Microsemi entered into in August 2008.
  We had a
cost of royalties of $18,000 and $12,000 for 2008 and 2007, respectively, which
was related to the payment of bonus compensation on the royalties pursuant to an
employment agreement with our Chief Executive Officer.  The gross
profit for 2008 was $331,000 as compared to $220,000 for 2007.
  General
and administrative expenses include overhead expenses, finance, accounting,
legal and other professional services incurred by us.  General and
administrative expenses decreased by $219,000, from $1,992,000 for 2007 to
$1,773,000 for 2008 due primarily to decreased fees and expenses with respect to
litigation involving our Remote Power Patent.
  We
incurred an operating loss of ($1,729,000) for 2008 compared with an operating
loss of ($3,175,000) for 2007.  Included in the operating loss for
2008 was $287,000 in charges relating to non-cash compensation expenses as
compared to $1,403,000 for such non-cash compensation expenses for
2007.  These losses were offset by interest earned of $111,000 and
$177,000 for 2008 and 2007, respectively.
  No
provision for or benefit from federal, state or foreign income taxes was
recorded for 2008 and 2007 because we incurred net operating losses and fully
reserved our deferred tax assets as their future realization could not be
determined.
  As a
result of the foregoing, we incurred a net loss of $(1,618,000) for the 2008
compared with a net loss of $(2,998,000) for 2007.
   LIQUIDITY
AND CAPITAL RESOURCES
  We have
financed our operations primarily from the sale of equity
securities.  In April 2007, we completed a private offering of equity
securities resulting in gross proceeds of $5,000,000.  In addition,
during the fourth quarter of 2007 we received $1,184,375 of cash proceeds from
the exercise of warrants issued in December 2004 and January
2005.  We anticipate, based on currently proposed plans and
assumptions, relating to our operations, that our cash and cash equivalents of
approximately $4,140,000 as of March 1, 2009 will more likely than not be
sufficient to satisfy our operations and capital requirements until at least
December 31, 2010.  There can be no assurance, however, that such
funds will not be expended prior thereto. In the event our plans change, or our
assumptions change, or prove to be inaccurate (due to unanticipated expenses,
difficulties, delays or otherwise), we may have insufficient funds to support
our operations prior to December 31, 2010.  Our inability to
consummate licensing arrangements with respect to our Remote Power Patent and
generate revenues therefrom on a timely basis or obtain additional financing
when needed would have a material adverse effect on our company, requiring us to
curtail or cease operations. In addition, any equity financing may involve
substantial dilution to our current stockholders.
   21
 OFF-BALANCE
SHEET ARRANGEMENTS
  We do not
have any off-balance sheet arrangements.
  CONTRACTUAL
OBLIGATIONS
  We do not
have any long-term debt, capital lease obligations, operating lease obligations,
purchase obligations or other long-term liabilities.
  Critical Accounting
Policies:
  Patents:
  We own a
patent portfolio that relates to various telecommunications and data networking
technologies.  We capitalize the costs associated with acquisition,
registration and maintenance of the patents and amortize these assets over their
remaining useful lives on a straight-line basis.  Any further payments
made to maintain or develop the patents would be capitalized and amortized over
the balance of the useful life for the patents.
  Impairment
of long-lived assets:
  In
accordance with Statement of Financial Accounting Standards (“SFAS”)
No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”,
we record impairment losses on long-lived assets used in operations or expected
to be disposed of when indicators of impairment exist and the cash flows
expected to be derived from those assets are less than carrying amounts of those
assets.
  Use of
estimates:
  The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period.  Actual results could differ from those
estimates.
  Recently Issued Accounting
Pronouncements:
  See Note
B[10] on page F-8 to the Financial Statements.
  
 ITEM
7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKETRISK
  We do not
engage in transactions in derivative financial instruments or derivative
commodity instruments.  As of the date of this Report, our financial
instruments were not exposed to significant market risk due to interest rate
risk, foreign currency exchange risk, commodity price risk or equity price
risk.
  22
 ITEM
8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
  The
financial statements required hereby are located on pages F-1 through F-17 which
follow Part III.
  ITEM
9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON  ACCOUNTING
AND FINANCIAL DISCLOSURE.
  None.
  ITEM 9A.CONTROLS AND
PROCEDURES.
  (a)           Evaluation
of Disclosure Controls and Procedures.
  Our Chief
Executive Officer and Chief Financial Officer have reviewed our disclosure
controls and procedures as of the end of the period covered by this Annual
Report on Form 10-K.  Based upon this review, our officers concluded
that, as of the end of the period covered by this Annual Report on Form 10-K,
our disclosure controls and procedures are effective to ensure that information
required to be disclosed by us in the reports we file or submit under the
Securities Exchange Act of 1934 is recorded, processed, summarized and reported,
within the time periods specified in applicable rules and forms and is
accumulated and communicated to management, including our Chief Executive
Officer and Chief Financial Officer, to allow timely decisions regarding
required disclosure.
  (b) Management’s
Annual Report on Internal Control Over Financial Reporting
  Our
management is also responsible for establishing and maintaining adequate
“internal control over financial reporting” of the company, as defined in Rule
13a-15(f) of the Exchange Act.  Internal control over financial
reporting is defined as a process designed by, or under the supervision of, the
issuer’s principal executive and principal financial officer and effected by our
board of directors, management and other personnel, to provide reasonable
assurance regarding the reliability of financial reporting and the preparation
of financial statements for external purposes in accordance with generally
accepted accounting principles.  A company’s internal control over
financial reporting includes those policies and procedures that (i) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (ii)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (iii) provide reasonable assurance regarding prevention or
timely detection of unauthorized acquisition, use, or disposition of the
company’s assets that could have a material effect on the financial
statements.
  Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements.  Also, projections of any evaluation
of effectiveness to future periods are subject to the risk that controls may
become inadequate because of changes in conditions, or that the degree of
compliance with the policies or procedures may deteriorate.
  23
 Management,
our Chief Executive Officer and Chief Financial Officer, conducted an evaluation
of the effectiveness of our internal control over financial reporting as of
December 31, 2008 using the criteria set forth by the Committee of Sponsoring
Organizations of the Treadway Commission in Internal Control - Integrated
Framework.  Management believes that this evaluation provides a
reasonable basis for its opinion.  In connection with this evaluation,
our management did not identify any material deficiencies.  Based upon
that evaluation, our Chief Executive Officer and Chief Financial Officer
concluded that our internal controls over financial reporting were effective as
of the end of the period covered by this report.
  This
annual report does not include an attestation report of our independent
registered public accounting firm regarding internal control over financial
reporting.  Management’s report was not subject to attestation by our
independent registered public accounting firm pursuant to temporary rules of the
SEC that permit the Company to provide only management’s report in this annual
report.
  There was
no change in our internal control over financial reporting that occurred during
the fiscal quarter ended December 31, 2008, that has materially affected,
or is reasonably likely to materially affect, our internal control over
financial reporting.
  ITEM 9B.OTHER
INFORMATION.
  None.
            24
 PART
III
  ITEM
10.  DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE
GOVERNANCE.
  NAME
              
              AGE
              
              POSITIONCorey
      M. Horowitz
              
              54
              
              Chairman,
      Chief Executive Officer and Secretary, Chairman of the Board of
      DirectorsDavid
      C. Kahn
              
              57
              
              Chief
      Financial OfficerRobert
      M. Pons
              
              52
              
              DirectorLaurent
      Ohana
              
              45
              
              Director
 
  Corey M. Horowitzbecame our
Chairman and Chief Executive Officer in December 2003.  Mr. Horowitz
has also served as our Chairman of our Board of Directors since January 1996 and
has been a member of our Board of Directors since April 1994.  In
January 2003, Mr. Horowitz also became our
Secretary.  Mr. Horowitz is also President and sole shareholder
of CMH Capital Management Corp. (“CMH”), a New York investment advisory and
merchant banking firm, which he founded in September 1991. During the period
June 2001 through December 2003, CMH rendered financial advisory services to
us.  From January 1986 to February 1991, Mr. Horowitz was a general
partner in charge of mergers and acquisitions at Plaza Securities Co., a New
York investment partnership.
  David C. Kahn, CPA, became
our Chief Financial Officer in January 2004.  Since December 1989, Mr.
Kahn has provided accounting and tax services on a consulting basis to private
and public companies.  He also serves as a faculty member of Yeshiva
University in New York, a position he has held since August 2000.
  Robert M. Pons became a
director of our company in December 2003.  Mr. Pons is currently
Senior Vice President of TMNG Global (NasdaqGM:TMNG), a leading provider of
professional services to the converging communications media and entertainment
industries and the capital formation firms that support it.  From
January 2004 until April 2007, Mr. Pons served as President and Chief Executive
Officer of Uphonia, Inc. (PK:UPHN) (previously SmartServ Online, Inc.), a
wireless applications service provider.  From August 2003 until
January 2004, Mr. Pons served as Interim Chief Executive Officer of SmartServ
Online, Inc. on a consulting basis.  From March 1999 to August 2003,
he was President of FreedomPay, Inc., a wireless device payment processing
company.  During the period January 1994 to March 1999, Mr. Pons was
President of Lifesafety Solutions, Inc., an enterprise software
company.  Mr. Pons has over 20 years of management experience with
telecommunications companies including MCI, Inc., Sprint, Inc. and Geotek,
Inc.
  Laurent Ohana became a
director of our company in September 2005.  Mr. Ohana is currently the
Managing Partner of Parkview Ventures LLC (“Parkview”), a company engaged in
merchant banking activities, including making investments in and providing
strategic advisory services to information technology firms in the US and
internationally.  From 1999 to 2002, Mr. Ohana was the CEO of Inlumen,
Inc., a company engaged in providing private label web-based financial portals
to financial institutions.  From 1994 to 2004, Mr. Ohana was the
managing partner of New Media Capital LLC, a technology venture capital and
advisory firm.  From 1987 to 1993, Mr. Ohana was a corporate attorney
at Fried Frank Harris Shriver & Jacobson.
  25
 Key
Consultant
  Jonathan Greene has served as
a consultant to our company since December 2004 providing technical and
marketing analysis for our Patent Portfolio.  Mr. Greene also
serves as a member of our Technical Advisory Board.  Since April 2006,
Mr. Greene has also served as a marketing consultant for Avatier
Corporation, a developer of identity management software.  From August
2003 until December 2004, he served as a consultant to Neartek, Inc., a storage
management software company (August 2003 until October 2003) and Kavado Inc., a
security software company (November 2003 until December 2004).  From
January 2003 until July 2003, Mr. Greene served as Director of Product
Management for FalconStor Software, Inc., a storage management software
company.  From December 2001 through December 2002, Mr. Greene
served as our Senior Vice President of Marketing and Business Development, at a
time when we were engaged in the development, marketing and licensing of
security software.  From December 1999 until September 2001, he served
as Senior Vice President of Marketing for Panacya Inc., a vendor of service
management software.  Mr. Greene has also held positions at
System Management ARTS (SMARTS), Computer Associates, Cheyenne Software and Data
General.
  Committees
of the Board of Directors
  Audit Committee
  We do not
have a separate audit committee.  Our Board of Directors functions as
our audit committee in accordance with Section 3(a)58(A) of the Securities
Exchange Act of 1934.  As part of our internal control procedures, our
two independent directors (Robert Pons and Laurent Ohana) receive quarterly and
annual financial statements and consult with our independent accountants prior
to filing such financial statements with the SEC.  In addition, Robert
Pons, an independent director, receives monthly financial information from our
Chief Financial Officer also as part of our internal control
procedures.  The Company does not have an audit committee financial
expert serving on its Board of Directors.
  Compensation
Committee
  Robert
Pons is currently the sole member of our Compensation Committee and served in
that capacity for 2008 and 2007.  The Compensation Committee is
responsible for recommending compensation for our executive officers (subject to
Board approval), including bonuses and benefits, and administration of our
compensation programs, including our Stock Option Plan.
    26
 Limitation
on Liability and Indemnification Matters
  Our
Certificate of Incorporation limits the liability of directors to the maximum
extent permitted by Delaware law.  Delaware law provides that
directors of a corporation will not be personally liable for monetary damages
for breach of their fiduciary duties as directors, except for liability (i) for
any breach of their duty of loyalty to the corporation or its stockholders, (ii)
for acts or omissions not in good faith or that involve intentional misconduct
or a knowing violation of law, (iii) for unlawful payments of dividends or
unlawful stock repurchases or redemptions as provided in Section 174 of the
Delaware General Corporation Law or (iv) for any transaction from which the
director derived an improper personal benefit.  Our Bylaws provide
that we shall indemnify our directors, officers, employees and agents to the
fullest extent permitted by law.  Our Bylaws also permit us to secure
insurance on behalf of any officer, director, employee or other agent for any
liability arising out of his or her actions in such capacity.  We
currently maintain directors and officers liability insurance.  At
present, there is no pending litigation or proceeding involving any of our
directors, officers, employees or agents where indemnification will be required
or permitted.  We are not aware of any threatened litigation or
proceeding that might result in a material claim for such
indemnification.
  Technical
Advisory Board
  In
November 2004 we established a Technical Advisory Board to assist us with our
strategic business plan of maximizing the value of our Patent
Portfolio.  Each member of the Technical Advisory Board received a
five (5) year option to purchase 17,500 shares (fully vested) of our common
stock at an exercise price equal to the closing price of the shares on the date
of appointment to the Technical Advisory Board.
  The
members of the Technical Advisory Board include:
  George Conant, former CEO and
Chairman of the Board of Directors of Merlot Communications, Inc., a
broadband communications solutions provider, during the period 2000 –
2006.  Prior to joining Merlot Communications, Inc., Mr. Conant
co-founded Xyplex, Inc., a manufacturer of data communications equipment and
network management software, where he held the positions of Vice President of
Engineering, Vice President of Technology and Chief Technology Officer. Prior to
Xyplex, Mr. Conant was employed by Digital Equipment Corporation, where he
worked as a network architect. Mr. Conant received a BS and a Masters in
theoretical mathematics from the University of Michigan.
  Ron Keenan,Electrical Engineer, Dapco
Industries,a developer and
manufacturer of ultrasonic test systems.  From 2006 to 2008, he was
CEO of IP Infotainment, Limited,a network services
company.  From 1997 until 2006, Mr. Keenan served as Chief
Technology Officer of Merlot Communications, Inc.  Mr. Keenan is an
expert on the convergence of telecommunications and data who, prior to
co-founding Merlot, founded QFR USA Corporation, a high-tech firm engaged in
developing custom ASICs for advanced and cost-effective communications
systems.  He had previously founded two other development
firms.  He also served as advanced engineering project director at
TIE/Communications, Inc., where he developed the TIE 612 Electronic Key System,
the first “skinny wire” telephone system and one of the largest selling key
systems in history.  Mr. Keenan received his BS in Electrical
Engineering from the Milwaukee School of Engineering and has more than 20 years
experience in advanced analog and digital design techniques.
   27
 Andrew Maslow, Director of
Industrial Affairs, Memorial Sloan-Kettering Cancer
Center.  Mr. Maslow heads the intellectual property activities
of Sloan-Kettering which includes licensing activities of the Center’s
technology and management of its patent portfolio.  Annual licensing
revenue exceeds $60 million.   Prior to joining Sloan-Kettering,
Mr. Maslow was Associate Director of the Office of Science and Technology of
Columbia University where he was responsible for the development, patenting and
licensing of inventions originating at the university.  Mr. Maslow is
a Registered Patent Attorney.
  Boris Katzenberg,Vice President Engineering, Aventura
Technology, Inc., a manufacturer of next generation video surveillance
solutions.  From 2003 to 2008, he was Senior Electrical Engineer,
Ortronics,Inc., a
structured cabling solutions provider.  Mr. Katzenberg has held
numerous positions during his 28-year career in the Telecom and Datacom
industries.  He has been a force in the fields of power delivery and
signal integrity systems, and has lent his expertise in the development of many
innovative and cutting-edge technologies.  From 1997 to 2002, he was a
senior electrical engineer at Merlot Communications, Inc., where he invented the
technology underlying our Remote Power Patent.  He has also been
active in the IEEE 802.3at Task Force, developing the next generation Power over
Ethernet standard and continues to be responsible for the evaluation of new
technologies and their development into viable products for Aventura Technology,
Inc.
  Jonathan Greenealso serves
as a member of the Technical Advisory Board (see page 26 hereof for a
description of Mr. Greene’s background).
  Director
Independence
  Two of
our three directors, Robert Pons and Laurent Ohana, are considered independent
directors based upon the standard of independence adopted by the Board of
Directors as promulgated under Rule 121A of the Company Guide of the American
Stock Exchange (“AMEX”).  While we are not listed on AMEX, our Board
has adopted its independence rules in making its determination of director
independence.
  Compensation
Committee Interlocks and Insider Participation
  Robert
Pons was the sole member of the Compensation Committee during the year ended
December 31, 2007.  No member of the Compensation Committee was at any
time during or prior to the year ended December 31, 2008, an officer or employee
of our company.  No interlocking relationship existed between Mr. Pons
and any member of our board of directors or Compensation Committee during that
period.
  
   28
 Section
16(a) Beneficial Ownership Reporting Compliance
  Section
16(a) of the Exchange Act requires that our executive officers, directors, and
persons who own more than 10% of our outstanding Common Stock file initial
reports of ownership and changes in ownership with the Securities and Exchange
Commission.  Officers, directors and greater than 10% stockholders are
required by Commission regulations to furnish us with copies of all Section
16(a) forms they file.  We believe that our executive officers,
directors, and greater than 10% stockholders complied with all required filings
during the year ended December 31, 2008.
  Code
of Ethics
  The Board
of Directors has adopted a Code of Ethics that applies to the principal
executive officers, principal financial officer, principal accounting officer or
controller, or persons performing similar functions.  The Code of
Ethics was filed as Exhibit 14 of the Company’s Annual Report on Form 10-KSB for
the year ended December 31, 2003.
   ITEM
11.  EXECUTIVE COMPENSATION
  The
following table summarizes compensation, for the year ended December 31, 2008,
awarded to, earned by or paid to our Chief Executive Officer (“CEO”) and to each
of our executive officers who received total compensation in excess of $100,000
for the year ended December 31, 2008 for services rendered in all capacities to
us (collectively, the “Named Executive Officers”).
  Summary
Compensation Table
  Annual
      Compensation
                
                Long
      Term Compensation AwardsName and Principal Position
                
                Year
                
                Salary ($)
                
                Bonus ($)
                
                
                Option Awards($)
                
                All
      Other
                  Compensation($)(1)
                
                Total($)Corey
      M. Horowitz
                  Chairman
      and Chief
                  Executive
      Officer
                
                2008
                
                $298,947
                
                $168,000(2)
                
                
                $190,763(3)
                
                —
                
                $657,710David
      C. Kahn
                  Chief
      Financial Officer
                
                2008
                
                $83,340(4)
                
                $15,000
                
                
                $31,863(5)
                
                —
                
                $130,203
  
 (1)
              We
      have concluded that the aggregate amount of perquisites and other personal
      benefits paid to either Mr. Horowitz or Mr. Kahn did not exceed
      $10,000.
  (2)
              Mr.
      Horowitz received the following bonus payments for 2008: (i) a
      discretionary annual bonus of $150,000 for 2008 which was paid in January
      2009 and (ii) royalty bonus compensation of $18,000 pursuant to his
      employment agreement.
  (3)
              In
      determining the grant date fair value under SFAS No.123R of a five (5)
      year option issued in February 2008 to Mr. Horowitz to purchase 375,000
      shares of common stock, we made the following assumptions: expected term
      of options – 5 years; risk free interest rate for the expected term of the
      options – 2.73%; expected volatility of the underlying stock – 39.35%; no
      expected dividends.
  (4)
              Consists
      of consulting fees paid to Mr. Kahn for his services as Chief Financial
      Officer.
  (5)
              In
      determining the grant date fair value under SFAS No. 123R of a five (5)
      year option issued in December 2008 to Mr. Kahn to purchase 100,000 shares
      of common stock, we made the following assumptions:  expected
      term of the options – 5 years; risk free interest rate for the expected
      term of the options – 1.55%; expected volatility of the underlying stock –
      69.45%; no expected dividends.
   29
 Narrative
Disclosure to Summary Compensation Table
  Employment
Agreements, Termination of Employment and Change-In-Control
Arrangements
  On
February 28, 2007, we entered into a new Employment Agreement with Corey M.
Horowitz pursuant to which Mr. Horowitz continued to serve as our Chairman and
Chief Executive Officer for a two year term at an annual base salary of $288,750
for the first year, increasing by 5% for the second year.  In
connection with his employment agreement, Mr. Horowitz was issued a five (5)
year option to purchase 375,000 shares of our common stock at an exercise price
of $1.46 per share which vested, on a quarterly basis over a one year period
subject to acceleration upon a change of control.  We also issued to
Mr. Horowitz on the one year anniversary date (February 28, 2008) an
additional five (5) year option to purchase 375,000 shares of our common stock
at an exercise price of $1.32 (the closing price of our common stock on the date
of grant), which option vested on a quarterly basis over a one year
period.  In addition to the aforementioned option grants, the Company
agreed to extend for an additional three (3) years the expiration dates of all
options and warrants (an aggregate of 2,620,000 shares) expiring in calendar
year 2007 and 2008 owned by Mr. Horowitz and CMH Capital Management Corp.
(“CMH”), an affiliate.  Under the terms of his Employment Agreement,
Mr. Horowitz receives bonus compensation in an amount equal to 5% of our
royalties or other payments (before deduction of payments to third parties
including, but not limited to, legal fees and expenses and third party license
fees) received from licensing its patents (including patents currently owned and
acquired or licensed on an exclusive basis during the period in which Mr.
Horowitz continues to serve as an executive officer of our company) (the
“Royalty Bonus Compensation”).  During 2008, Mr. Horowitz received
$18,000 of Royalty Bonus Compensation.  Mr. Horowitz shall also
receive bonus compensation equal to 5% of the gross proceeds from (i) the sale
of any of our patents or (ii) our merger with or into another corporation or
entity.  The Royalty Bonus Compensation shall continue to be paid to
Mr. Horowitz for the life of each of our patents with respect to licenses
entered into by us with third parties during Mr. Horowitz’s term of
employment or at anytime thereafter, whether Mr. Horowitz is employed by us or
not, provided,
that, Mr.
Horowitz’s employment (during the term of the Employment Agreement) has not been
terminated by us “For Cause” (as defined) or terminated by Mr. Horowitz without
“Good Reason” (as defined).  In the event that Mr. Horowitz’s
employment is terminated by us “Other Than For Cause” (as defined) or by Mr.
Horowitz for “Good Reason” (as defined), Mr. Horowitz shall be entitled to a
severance of 12 months base salary.
  In
accordance with his employment agreement, Mr. Horowitz also had certain
anti-dilution rights which provide that if at any time during the period ended
December 31, 2008, in the event that we completed an offering of our common
stock or any securities convertible or exercisable into common stock (exclusive
of securities issued upon exercise of outstanding options, warrants or other
convertible securities), Mr. Horowitz shall receive from us, at the same price
as the securities issued in the financing, such number of additional options to
purchase common stock so that he maintains the same derivative ownership
percentage (21.47%) of our company based upon options and warrants owned by Mr.
Horowitz and CMH (exclusive of ownership of shares of common stock by
Mr. Horowitz and CMH)as he owned as of the time of execution of his
employment agreement; provided, that, the
aforementioned anti-dilution
  30
 protection
was afforded to Mr. Horowitz up to a maximum financing(s) of $2.5
million.  In April 2007, with respect to our completion of a $5.0
million private offering, Mr. Horowitz was issued a five (5) year option to
purchase 732,709 shares of our common stock, at an exercise price of $1.67 per
share (the exercise price was reduced to $.68 per share in March 2009 as part of
our Board of Directors approval of adjustment of exercise prices of compensatory
options and warrants to purchase up to an aggregate of 5,029,945 shares – See
“Certain Relationships and Related Transactions and Director Independence”), in
accordance with the aforementioned anti-dilution provisions of his employment
agreement.
  On
February 28, 2009, our employment agreement with Mr. Horowitz
expired.  We are in discussions with Mr. Horowitz with respect to a
new employment agreement; however, there is no certainty that a mutually
acceptable agreement will be reached.  Mr. Horowitz continues to
serve as our Chairman and Chief Executive Officer.  We believe that
the loss of the services of Mr. Horowitz would have a material adverse
effect on our business and prospects.  (See Risk Factors – “Dependence
Upon CEO and Chairman”).
  On
December 18, 2008, we entered into an agreement with David C. Kahn
pursuant to which he continues to serve as our Chief Financial Officer through
December 31, 2010.  In consideration for his services, Mr. Kahn
is compensated at the rate of $7,292 per month for the year ended
December 31, 2009 and is compensated at the rate of $7,657 per month for
the year ended December 31, 2010.  In connection with the
agreement, Mr. Kahn was also issued a five (5) year option (the “Option”) to
purchase 100,000 shares of our common stock at an exercise price of $0.54 per
share.  The option vested 40,000 shares on the date of grant and the
balance of the shares (60,000) will vest on a quarterly basis in equal amounts
of 7,500 shares beginning March 31, 2009 through December 31,
2010.  Upon a “Change in Control” (as defined) all of the unvested
shares underlying the Option shall become 100% vested and immediately
exercisable.  The agreement further provides that we may terminate the
agreement at any time for any reason.  In the event Mr. Kahn’s
services are terminated without “Good Cause” (as defined), he will be entitled
to accelerated vesting of all unvested shares underlying the Option and the
lesser of (i) six months base monthly compensation or (ii) the remaining balance
of the monthly compensation payable through December 31, 2010.
  Director
Compensation
  We
compensated each director, who is not an employee of our company, by granting to
each such outside director (upon joining the Board) stock options to purchase
50,000 shares of our common stock, at an exercise price equal to the closing
price of our common stock on the date of grant, with the options vesting over a
one year period in equal quarterly amounts.  In addition, subject to
the discretion of the Compensation Committee and the Board of Directors, each
non-employee director is eligible to receive option grants for each year of
service as a director.  In December 2007, for services as a director
for 2008, each member of the Board of Directors (with the exception of Harry
Schessel who resigned in December 2007) was granted a five (5) year option to
purchase 25,000 shares at an exercise price of $1.45 per share (closing price of
our common stock on the date of grant), which option vested on a monthly basis
over a one year period, subject to continued service on the Board of
Directors.  In December 2008, for services as a Director for 2009,
each member of the
   31
 Board of
Directors was granted a five (5) year option to purchase 25,000 shares at an
exercise price of $0.51 per share (closing price of our common stock on the date
of grant) which option vests on a monthly basis over a one year period subject
to continued service on the Board of Directors.
  The
following table sets forth the compensation paid to all persons who served as
members of our board of directors (other than our Named Executive Officers)
during the year ended December 31, 2008.  No director who is also
a Named Executive Officer received any compensation for services as a director
in 2008.
  Name
                  
                  Option
      Awards
                      ($)
                  
                  
                  All
      other
                      Compensation
                  
                  
                  Total
                      ($)Robert
      Pons(1)
                  
                  $
                  12,000
                  (2)
      (3)
                  
                  
                  —
                  
                  
                  $
                  12,000
                  (3)Laurent
      Ohana(1)
                  
                  $
                  12,000
                  (2)
      (3)
                  
                  
                  —
                  
                  
                  $
                  12,000
                  (3)Robert
      Graifman(1)
                  
                  $
                  12,000
                  (2)
                  
                  $
                  —
                  
                  
                  $
                  12,000
 ___________________________
 (1)
              In
      January 2008, Robert Graifman, Robert Pons and Laurent Ohana were each
      granted a five (5) year option to purchase 25,000 shares of our common
      stock (which vested on grant), at an exercise price of $1.45 per share,
      for services to be rendered as a Board member during
      2008.  Mr. Graifman resigned as a Board member on
      June 23, 2008.
  (2)
              In
      determining the grant date fair value of the option grants in January 2008
      under SFAS No. 123R, we made the following
      assumptions:  expected term of the options – five years; risk
      free interest rate for the expected term of the options – 3.28%; expected
      volatility of the underlying stock – 37.32%; no expected
      dividends.
  (3)
              Does
      not include the fair value of options to purchase 25,000 shares of our
      common stock granted on December 1, 2008 to each of Robert Pons and
      Laurent Ohana since the options vest on a quarterly basis beginning March
      1, 2009.
  Option
Grants in 2008
  The
following stock options were granted to the Named Executive Officers during the
year ended December 31, 2008:
  Name
              
              Number
      of Securities Underlying Options Granted
              
              Percent
      of Total Options Granted to Employees in 2008
              
              Exercise
      Price
              
              Expiration
      DateCorey
      M. Horowitz
                Chairman
      and CEO
              
              375,000
              
              79%
              
              $1.32
              
              2/28/2013David
      Kahn
                Chairman
      and
                Chief
      Executive Officer
              
              100,000
              
              21%
              
              $0.54
              
              12/18/2013
 
 32
 Outstanding
Equity Awards at December 31, 2008
  The
following table sets forth information relating to unexercised and outstanding
options for each Named Executive Officer as of December 31,
2008:
  Number
      of Securities
                      Underlying
      Unexercised OptionName
                  
                  Exercisable
                  
                  
                  Unexercisable
                  
                  
                  Option
      Exercise Price ($)
                  
                  Option
      Expiration DateCorey
      M. Horowitz
                    Chairman
      and CEO
                  
                  
                  375,000
                  (1)
                  
                  
                  --
                  
                  
                  $
                  1.46
                  
                  02/28/12732,709
                  (2)
                  
                  
                  --
                  
                  
                  $
                  1.67
                  
                  04/16/121,195,361
                  (3)
                  
                  
                  --
                  
                  
                  $
                  1.18
                  
                  03/16/12400,000
                  (4)
                  
                  
                  --
                  
                  
                  $
                  .68
                  
                  11/26/091,100,000
                  (5)
                  
                  
                  --
                  
                  
                  $
                  .25
                  
                  11/26/14515,218
                  (6)
                  
                  
                  --
                  
                  
                  $
                  .13
                  
                  12/22/111,084,782
                  (7)
                  
                  
                  --
                  
                  
                  $
                  .23
                  
                  12/22/11750,000
                  (8)(20)
                  
                  
                  --
                  
                  
                  $
                  1.20
                  
                  04/18/10250,000
                  (9)(20)
                  
                  
                  --
                  
                  
                  $
                  1.48
                  
                  10/08/10300,000
                  (10)(20)
                  
                  
                  --
                  
                  
                  $
                  .70
                  
                  07/11/11--
                  
                  
                  
                  10,625(18)
                  
                  
                  $
                  3.0625
                  
                  01/19/1120,000
                  (11)
                  
                  
                  --
                  
                  
                  $
                  6.00
                  
                  10/20/1110,000
                  (12)
                  
                  
                  --
                  
                  
                  $
                  3.75
                  
                  6/22/097,500
                  (13)
                  
                  
                  --
                  
                  
                  $
                  4.25
                  
                  10/25/095,000
                  (14)
                  
                  
                  --
                  
                  
                  $
                  5.50
                  
                  9/19/10375,000
                  (15)
                  
                  
                  --
                  
                  
                  $
                  1.32
                  
                  2/28/13David
      Kahn
                    Chief
      Financial Officer
                  
                  
                  75,000
                  (16)
                  
                  
                  --
                  
                  
                  $
                  1.50
                  
                  12/20/1175,000
                  (17)
                  
                  
                  --
                  
                  
                  $
                  .80
                  
                  08/04/1047,500
                  
                  
                  
                  52,500(19)
                  
                  
                  $
                  .54
                  
                  12/18/13
 
 The
vesting dates of the foregoing options are as follows:  (1) 93,750
shares on a quarterly basis beginning March 31, 2007 through December 31, 2007;
(2) April 16, 2007; (3) March 16, 2005; (4) 200,000 shares on November 26, 2004
and 200,000 shares on November 26, 2005, (5) November 26, 2004; (6) December 22,
2003; (7) 434,782 shares on December 22, 2003, 250,000 shares on December 22,
2004, 200,000 shares on December 22, 2005, and 200,000 shares on December 22,
2006; (8) 250,000 shares on April 18, 2005, 250,000 shares on April 18, 2004 and
250,000 shares on April 18, 2005; (9) June 11, 2001; (10) July 11, 2001; (11) on
a quarterly basis in equal amounts beginning January 20, 1999 through October
20, 1999; (12) on a quarterly basis in equal amounts beginning September 12,
1999 through June 22, 2000; (13) on a quarterly basis in equal amounts beginning
January 25, 2000 through October 25, 2000; (14) on a quarterly basis in equal
amounts beginning December 19, 2000 through September 19, 2000; (15) 93,750
shares on a quarterly basis beginning March 31, 2008 through December 31, 2008;
(16) December 20, 2006; (17) 30,000 shares on August 4, 2005 and 7,500 shares on
a quarterly basis beginning September 30, 2005 through December 31, 2006; (18)
5,313 shares if the stock price reaches $10 per share and 5,312 shares if the
stock price reaches $15 per share; (19) 7,500 shares on a quarterly basis
beginning March 31, 2009 through December 31, 2010; and (20) includes
options or warrants held by CMH Capital Management Corp., an entity in which Mr.
Horowitz is the sole owner, officer and director.
  On March
11, 2009, as part of adjustments to compensatory options and warrants to
purchase an aggregate of 5,029,945 shares of common stock approved by the Board
of Directors, the exercise prices of all of the options included in the table
above with an exercise price above $0.68 per share were adjusted to $0.68 per
share.
  
  33
 ITEM
      12.
                SECURITY
      OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
      STOCKHOLDER MATTERS
  The
following table sets forth information regarding the beneficial ownership of our
common stock as of March 31, 2009 (i) each person known by us to be the
beneficial owner of more than 5% of our outstanding shares of common stock, (ii)
each of our directors, (iii) each of our executive officers, and (iv) all of our
executive officers and directors as a group.
  NAME
      OF
                          BENEFICIAL OWNER
                        
                        NUMBER
      OF SHARES
                          BENEFICIALLY OWNED
                        
                        PERCENTAGE
      OFSHARES    
      BENEFICIALLYOWNED(2)Corey
      M. Horowitz(3)
                        
                        10,166,935
                        
                        32.5%CMH
      Capital Management Corp(4)
                        
                        3,767,800
                        
                        14.8%Jonathan
      Auerbach(5)
                        
                        3,279,917
                        
                        12.9%Hound
      Partners, LLC(5)
                        
                        3,279,917
                        
                        12.9%Hound
      Performance, LLC(5)
                        
                        3,279,917
                        
                        12.9%Steven
      D. Heinemann(6)
                        
                        2,360,252
                        
                        9.7%Barry
      Rubenstein (7)
                        
                        2,078,896
                        
                        8.6%Hound
      Partners Offshore Fund, L.P.(8)
                        
                        1,737,802
                        
                        7.0%Hound
      Partners, L.P.(9)
                        
                        1,542,115
                        
                        6.3%Woodland
      Services Corp. (10)
                        
                        1,376,209
                        
                        5.7%Emigrant
      Capital Corporation (11)
                          Paul
      Milstein Revocable 1998 Trust
                          New
      York Private Bank & Trust Corporation
                          Emigrant
      Bancorp. Inc.
                          Emigrant
      Savings Bank
                        
                        1,312,500
                        
                        5.4%Laurent
      Ohana(12)
                        
                        206,250
                        
                        *David
      C. Kahn(13)
                        
                        197,500
                        
                        *Robert
      Pons(14)
                        
                        156,250
                        
                        *All
      officers and directors as a group
                          (4
      Persons)
                        
                        10,726,935
                        
                        33.7% _____________________________________
 
 *                 Less
than 1%.
 
 (1)
              Unless
      otherwise indicated, we believe that all persons named in the above table
      have sole voting and investment power with respect to all shares of common
      stock beneficially owned by them.  Unless otherwise indicated
      the address for each listed beneficial owner is c/o Network-1 Security
      Solutions, Inc., 445 Park Avenue, Suite 1018, New York, New York
      10022.
  34
 (2)
              A
      person is deemed to be the beneficial owner of securities that can be
      acquired by such person within 60 days from the date hereof upon the
      exercise of options, warrants or convertible securities. Each beneficial
      owner’s percentage ownership is determined by assuming that options,
      warrants and convertible securities held by such person (but not those
      held by any other person) and which are exercisable or convertible within
      60 days have been exercised and converted.  Assumes a base of
      24,135,557 shares of our common stock
  outstanding.
  (3)
              Includes
      (i) 343,803 shares of common stock held by Mr. Horowitz, (ii) 5,820,570
      shares of common stock subject to currently exercisable stock options held
      by Mr. Horowitz, (iii) 2,467,800 shares of common stock held by CMH
      Capital Management Corp. (“CMH”), an entity solely owned by Mr. Horowitz,
      (iv) 550,000 shares of common stock subject to currently exercisable
      warrants held by CMH, (v) 750,000 shares of common stock subject to
      currently exercisable options held by CMH, (vi) 67,471 shares of common
      stock owned by Donna Slavitt, the wife of Mr. Horowitz, (vii) 165,000
      shares of common stock held by two trusts and a custodian account for the
      benefit of Mr. Horowitz’s three children and (viii) 2,291 shares of common
      stock held by Horowitz Partners, a general partnership of which Mr.
      Horowitz is a partner. Does not include options to purchase 10,625 shares
      of common stock which are not currently
  exercisable.
  (4)
              Includes
      (i) 2,467,800 shares of common stock, (ii) 550,000 shares of common
      stock subject to currently exercisable warrants and (iii) 750,000 shares
      of common stock subject to currently exercisable stock
      options.  Corey M. Horowitz, by virtue of being the sole
      officer, director and shareholder of CMH, has the sole power to vote and
      dispose of the shares of common stock owned by
  CMH.
  (5)
              Includes
      (i) 1,057,215 shares of common stock and 484,900 shares of common stock
      subject to currently exercisable warrants held by Hound Partners, L.P. and
      (ii) 1,139,368 shares of common stock and 598,434 shares of common stock
      subject to currently exercisable warrants held by Hound Partners Offshore
      Fund, L.P.  Jonathan Auerbach is the managing member of Hound
      Performance, LLC and Hound Partners, LLC.  Hound Performance,
      LLC is the general partner of Hound Partners, L.P. and Hound Partners
      Offshore Fund, L.P.  Hound Partners, LLC is the investment
      manager of Hound Partners, L.P. and Hound Partners Offshore Fund,
      L.P.  The securities may be deemed to be beneficially owned by
      Hound Performance, LLC, Hound Partners LLC and Jonathan
      Auerbach.  The aforementioned beneficial ownership is based upon
      Amendment No.1 to Schedule 13G jointly filed by Hound Partners, LLC, Hound
      Performance, LLC, Jonathan Auerbach, Hound Partners, L.P. and Hound
      Partners Offshore Fund, L.P., with the Securities and Exchange Commission
      on February 13, 2009 and a Form 4 jointly filed by Hound Partners,
      LLC and Hound Performance, LLC and Jonathan Auerbach with the Securities
      and Exchange Commission on August 8, 2008.  Jonathan Auerbach,
      by virtue of being the managing member of Hound Performance, LLC and Hound
      Partners, LLC, may be deemed to have the sole power to vote and dispose of
      the securities held by Hound Partners, L.P. and Hound Partners Offshore
      Fund, L.P.  The address for Hound Partners, LLC is 101 Park
      Avenue, 47th
      Floor, New York, New York 10178.
  (6)
              Includes
      (i) 2,268,585 shares of common stock and (ii) 91,667 shares of common
      stock subject to currently exercisable warrants owned by
      Mr. Heinemann.  The aforementioned beneficial ownership is
      based upon Amendment No. 1 to Schedule 13G filed by Mr. Heinemann
      with the Securities and Exchange Commission on
      February 11,2009.  The address for Mr. Heinemann is
      c/o First New York Securities, L.L.C., 90 Park Avenue, 5th
      Floor, New York, New York 10016.
  35
 (7)
              Includes
      (i) 150,012 shares of common stock held by Mr. Rubenstein, (ii) 47,500
      shares of common stock subject to currently exercisable stock options held
      by Mr. Rubenstein, and (iii) 792,726, 583,483, 309,316, 194,810 and 1,049
      shares of common stock held by Woodland Venture Fund, Seneca Ventures,
      Woodland Partners, Brookwood Partners, L.P. and Marilyn Rubenstein,
      respectively.  Does not include options to purchase 11,875
      shares of common stock held by Mr. Rubenstein which are not currently
      exercisable.  The aforementioned beneficial ownership by Mr.
      Rubenstein is based upon Amendment No. 7 to Schedule 13D jointly filed by
      Mr. Rubenstein and related parties with the Securities and Exchange
      Commission on November 14, 2007 and a Form 4 filed by Mr. Rubenstein with
      the Securities and Exchange Commission on October 26,
      2007.  Barry Rubenstein and Woodland Services Corp. are the
      general partners of Woodland Venture Fund and Seneca Ventures. Barry
      Rubenstein is the general partner of Brookwood Partners,
      L.P.  Barry Rubenstein is the President and sole director of
      Woodland Services Corp. Marilyn Rubenstein is the wife of Barry
      Rubenstein.  Barry Rubenstein, by virtue of being a General
      Partner of Woodland Venture Fund, Seneca Ventures and Brookwood Partners,
      L.P. and the President and sole director of Woodland Services Corp., may
      be deemed to have the sole power to vote and dispose of the securities
      held by Woodland Venture Fund, Seneca Ventures, Woodland Partners and
      Brookwood Partners, L.P.  The address of Barry Rubenstein is 68
      Wheatley Road, Brookville, New York
11545.
  (8)
              Includes
      (i) 1,139,368 shares of common stock and (ii) 598,434 shares of common
      stock subject to currently exercisable warrants held by Hound Partners
      Offshore Fund, L.P.  Jonathan Auerbach, by virtue of being the
      managing member of Hound Performance, LLC and Hound Partners, LLC, may be
      deemed to have the power to vote and dispose of securities held by Hound
      Partners Offshore Fund, L.P.  The address of Hound Partners
      Offshore Fund, L.P. is c/o Citco Fund Services (Curacao) N.V., P.O. Box
      4774, Willemstad, Curacao, Netherlands
Antilles.
  (9)
              Includes
      (i) 1,057,215 shares of common stock and (ii) 484,900 shares of common
      stock subject to currently exercisable warrants owned by Hound Partners,
      LP.  Jonathan Auerbach, by virtue of being the managing member
      of Hound Performance, LLC and Hound Partners, LLC, may be deemed to have
      the sole power to vote and dispose of the securities held by Hound
      Partners, L.P.  The address of Hound Partners, L.P. is 101 Park
      Avenue, 47th
      Floor, New York, New York 10178.
  (10)
              Includes
      (i) 792,726 shares of common stock owned by Woodland Venture Fund and (ii)
      583,483 shares of common stock owned by Seneca
      Ventures.  Woodland Services Corp. and Barry Rubenstein are the
      general partners of Woodland Venture Fund and Seneca
      Ventures.  The aforementioned beneficial ownership of Woodland
      Services Corp. is based upon Amendment No. 7 to Schedule 13D jointly filed
      by Woodland Services Corp. and related parties with the Securities and
      Exchange Commission on November 14, 2007.  Barry Rubenstein, by
      virtue of being President and the sole director of Woodland Services
      Corp., may be deemed to have the sole power to vote and dispose of the
      shares owned by Woodland Services Corp.  The address of Woodland
      Services Corp. is 68 Wheatley Road, Brookville, New York
      11545.
  36
 (11)
              Includes
      (i) 1,125,000 shares of common stock and (ii) 187,500 shares of common
      stock subject to currently exercisable warrants held by Emigrant Capital
      Corporation (“Emigrant Capital”).  Emigrant Capital is a wholly
      owned subsidiary of Emigrant Savings Bank (“ESB”), which is a wholly-owned
      subsidiary of Emigrant Bancorp, Inc. (“EBI”).  EBI is a
      wholly-owned subsidiary of New York Private Bank & Trust Corporation
      (“NYPBTC”).  The Paul Milstein Revocable 1998 Trust (the
      “Trust”) owns 100% of the voting stock of NYPBTC.  ESB, EBI,
      NYPBTC and the Trust each may be deemed to be the beneficial owner of the
      shares of common stock and warrants held by Emigrant
      Capital.  The aforementioned is based upon a Schedule 13G/A
      filed jointly by Emigrant Capital, ESB, EBI, NYPBTC, the Trust and others
      with the Securities and Exchange Commission on January 12,
      2005.  Howard Milstein, by virtue of being an officer of New
      York Private Bank and Trust Corporation and trustee of the Paul Milstein
      Revocable 1998 Trust, both indirect owners of Emigrant Capital
      Corporation, may be deemed to have sole power to vote and dispose of the
      securities owned by Emigrant Capital Corporation.  The address
      of Emigrant Capital Corporation is 6 East 43rd
      Street, 8th
      Floor, New York, New York 10017.
  (12)
              Includes
      206,250 shares subject to currently exercisable options and warrants
      issued to Mr. Ohana.  Does not include options to purchase
      18,750 shares of common stock held by Mr. Ohana which are not
      currently exercisable.
  (13)
              Includes
      197,500 shares of common stock subject to currently exercisable stock
      options issued to Mr. Kahn.  Does not include options to
      purchase 52,500 shares of common stock which are not currently
      exercisable.
  (14)
              Includes
      156,250 shares subject to currently exercisable stock options issued to
      Mr. Pons. Does not include options to purchase 18,750 shares of common
      stock held by Mr. Pons which are not currently
      exercisable.
  The
Equity Compensation Plan information presented in Item 5 of this Annual Report
is incorporated herein in its entirety.
   ITEM
13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS  AND
DIRECTOR INDEPENDENCE
  On
February 28, 2007, we entered into an Employment Agreement with
Corey M. Horowitz pursuant to which Mr. Horowitz continued to serve as
our Chairman and Chief Executive Officer for a two year term (expiring
February 28, 2009) at an annual base salary of $288,750 for the first year
with a 5% increase on the one year anniversary thereof.  In accordance
with his employment agreement, on February 28, 2007, we issued to Mr. Horowitz a
five (5) year option to purchase 375,000 shares of our common stock, at an
exercise price of $1.46 per share, which option vested in equal quarterly
amounts of 93,950 shares beginning March 31, 2007 through December 31,
2007.  (See. “Executive Compensation - Narrative Disclosure to
Summary Compensation Table - Employment Agreements, Termination of Employment
and Change-In-Control Arrangements” for the detailed terms of our employment
agreement with Mr. Horowitz).
  37
 On
April 16, 2007, we issued to Corey M. Horowitz, our Chairman and Chief
Executive Officer, a five (5) year option to purchase 732,709 shares of our
common stock, at an exercise price of $1.67 per share, which option fully vested
on the date of issue.  The aforementioned option was issued to
Mr. Horowitz pursuant to the anti-dilution provisions of his employment
agreement as a result of our completion of a $5,000,000 private placement in
April 2007.  (See “Executive Compensation –  Narrative
Disclosure to Summary Compensation Table - Employment Agreement, Termination of
Employment and Change-in-Control Arrangements).
  On
February 28, 2008, in accordance with our employment agreement with Corey
M. Horowitz, we issued to Mr. Horowitz an additional five (5) year option
to purchase 375,000 shares of our common stock, at an exercise price of $1.32
per share, which option vests in equal quarterly amounts of 93,750 shares
beginning March 31, 2008 through December 31, 2008.  (See
“Executive Compensation – Narrative Disclosure to Summary Compensation
Table - Employment Agreements, Termination of Employment and Change-In-Control
Arrangements).
  On
December 18, 2008, we entered into an agreement with David C. Kahn
pursuant to which he continues to serve as our Chief Financial Officer through
December 31, 2010.  In consideration for his services, Mr. Kahn
is compensated at the rate of $7,292 per month for the year ended
December 31, 2009 and will be compensated at the rate of $7,657 per month
for the year ended December 31, 2010.  In connection with the
agreement, Mr. Kahn was also issued a five (5) year option to purchase 100,000
shares of our common stock at an exercise price of $0.54 per
share.  The option vested 40,000 shares on the date of grant and the
balance of the shares (60,000) will vest on a quarterly basis in equal amounts
of 7,500 shares beginning March 31, 2009 through December 31,
2010.  Upon a “Change in Control” (as defined) all of the unvested
shares underlying the option shall become 100% vested and immediately
exercisable.  The agreement further provides that we may terminate the
agreement at any time for any reason.  In the event Mr. Kahn’s
services are terminated without “Good Cause” (as defined), he will be entitled
to accelerated vesting of all unvested shares underlying the Option and the
lesser of (i) six months base monthly compensation or (ii) the remaining balance
of the monthly compensation payable through December 31, 2010.
  On March
11, 2009 our Board of Directors approved adjustments to the exercise prices and
terms of certain of our outstanding options and warrants as
follows:
  (i)
              the
      exercise prices of certain outstanding compensatory options and warrants
      issued to officers, directors, consultants and others to purchase an
      aggregate of 5,029,945 shares of common stock were adjusted to an exercise
      price of $0.68 per share (closing price of the Company’s common stock on
      March 11, 2009) including options and warrants to purchase an aggregate of
      4,031,195 shares held by Corey M. Horowitz, our Chairman and Chief
      Executive Officer, and an affiliated entity, options to purchase an
      aggregate of 150,000 shares held by David Kahn, our Chief Financial
      Officer, and options and warrants to purchase an aggregate of 200,000 and
      100,000 shares held by Laurent Ohana and Robert Pons, respectively, two of
      our directors;
  (ii)
              the
      exercise price of outstanding warrants to purchase an aggregate of 473,750
      shares of common stock (including warrants to purchase 187,500 shares
      owned by Emigrant Capital Corporation, one of our principal stockholders),
      issued as part of the Company’s private placement completed in December
      2004 and January 2005, which exercise price is scheduled to increase to
      $2.00 per share on March 31, 2009 (from $1.75 per
      share)  adjusted to an exercise price of $1.75 for the remaining
      exercise period of such warrants (May 21, 2010), subject to the adjustment
      set forth in item (iv) below;
  38
 (iii)
              the
      exercise price of warrants to purchase an aggregate of 1,666,667 shares of
      common stock, (including warrants to purchase 484,900 shares owned by
      Hound Partners, L.P., warrants to purchase 598,434 shares owned by Hound
      Partners Offshore Fund, L.P. and warrants to purchase 66,667 shares of
      common stock owned by Steven Heimmann, all such parties are principal
      stockholders of our Company), at an exercise price of $2.00 per share,
      which warrants were issued as part of the Company’s private placement
      completed in April 2007, were adjusted to an exercise price of $1.75 per
      share for the remaining exercise period of such warrants (April 16, 2012),
      subject to the adjustments set forth in item (iv) below;
    and
 
 (iv)
              in
      the event that any holders of the above referenced outstanding warrants,
      issued as part of our December 2004/January 2005 or our April 2007 private
      placements, exercise such warrants at anytime up to and including December
      31, 2009, the exercise price of all such warrants shall adjust to $1.25
      per share.
 
 On
March 17, 2009, our Board of Directors extended the expiration dates until
December 31, 2009 of outstanding warrants to purchase an aggregate of
395,000 shares of common stock, exercisable at $1.45 per share, and outstanding
warrants to purchase an aggregate of 197,500 shares of common stock, exercisable
at $2.00 per share, which expiration dates were scheduled to expire on
March 17, 2009 and March 31, 2009, respectively.  These
warrants were issued as part of our private placement completed in December 2004
and January 2005.
  
 ITEM
14.  PRINCIPAL ACCOUNTANT FEES AND SERVICES
  Audit
Fees
  Radin,
Glass & Co., LLP, our company’s independent accountant, billed us aggregate
fees of approximately $68,000 and $69,000 for the years ended December 31, 2008
and December 31, 2007, respectively, for review of financial statements included
in our Form 10-QSB’s and 10-Q’s and for other services in connection with
statutory or regulatory filings for the year ended December 31, 2008, and
for the audit of our annual financial statements for the year ended
December 31, 2008 and December 31, 2007.
  Audit
Related Fees, Tax Fees and All Other Fees
  Radin,
Glass & Co., LLP did not render any other professional service (other than
those discussed above for the years ended December 31, 2008 or December 31,
2007) except for review of our documentation pertaining to Section 404 of
Sarbanes-Oxley Act of 2002 for which Radin, Glass & Co., LLP billed us
$7,500.
       39
 NETWORK-1
SECURITY SOLUTIONS, INC.













PageIndex
      to Financial StatementsReport
      of independent registered public accounting firm
                    F-1Balance
      sheets as of December 31, 2008 and 2007
                    F-2Statements
      of operations for the years ended December 31, 2008 and
      2007
                    F-3Statements
      of changes in stockholders’ equity for the years ended December 31,
      2008 and 2007
                    F-4Statements
      of cash flows for the years ended December 31, 2008 and
      2007
                    F-5Notes
      to financial statements
                    F-6































NETWORK-1 SECURITY
SOLUTIONS, INC.


REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM





Board of
Directors and Stockholders


Network-1
Security Solutions, Inc.





We have
audited the accompanying balance sheets of Network-1 Security Solutions, Inc. as
of December 31, 2008 and 2007 and the related statements of operations, changes
in stockholders’ equity and cash flows for the years then ended. These financial
statements are the responsibility of the Company’s management. Our
responsibility is to express an opinion on these financial statements based on
our audits.





We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audits to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.





In our
opinion, the financial statements referred to above present fairly, in all
material respects, the financial position of Network-1 Security Solutions, Inc.
as of December 31, 2008 and 2007, and the results of its operations and its cash
flows for the years then ended in conformity with accounting principles
generally accepted in the United States of America.








/s/
Radin, Glass & Co., LLP




New York,
New York


March 25,
2009

















F-1
 
 NETWORK-1 SECURITY
SOLUTIONS, INC.


Balance
Sheets





December
      31,2008
              
              
              2007CURRENT
      ASSETSCash and cash
      equivalents
              
              $
              4,484,000
              
              
              $
              5,928,000Royalty and interest
      receivable
              
              
              78,000
              
              
              
              23,000Prepaid
    insurance
              
              
              71,000
              
              
              
              71,000Total current
      assets
              
              
              4,633,000
              
              
              
              6,022,000OTHER
      ASSETS:Patent,
      net of accumulated amortization
              
              
              100,000
              
              
              
              72,000Security
      deposits
              
              
              6,000
              
              
              
              6,000Total
      Other Assets
              
              
              106,000
              
              
              
              78,000TOTAL ASSETS
              
              $
              4,739,000
              
              
              $
              6,100,000LIABILITIES
      AND STOCKHOLDERS’ EQUITYCURRENT
      LIABILITIES:Accounts
payable
              
              $
              86,000
              
              
              $
              103,000Accrued
expenses
              
              
              251,000
              
              
              
              264,000TOTAL
    LIABILITIES
              
              
              337,000
              
              
              
              367,000COMMITMENTS
      AND CONTINGENCIESSTOCKHOLDERS’
      EQUITYCommon
      stock, $0.01 par value; authorized 50,000,000 shares;
                24,135,557 and 24,135,557
      issued and outstanding in 2008 and 2007,respectively
              
              
              241,000
              
              
              
              241,000Additional paid-in
      capital
              
              
              55,056,000
              
              
              
              54,769,000Accumulated
    deficit
              
              
              (50,895,000
              )
              
              
              (49,277,000
              )TOTAL STOCKHOLDERS’
      EQUITY
              
              
              4,402,000
              
              
              
              5,733,000TOTAL LIABILITIES AND
      STOCKHOLDERS’ EQUITY
              
              $
              4,739,000
              
              
              $
              6,100,000








F-2
 
 NETWORK-1 SECURITY
SOLUTIONS, INC.


Statements
of Operations





Year
      Ended
                  December
      31,2008
              
              
              2007ROYALTY
      REVENUE
              
              $
              349,000
              
              
              $
              232,000COST
      OF REVENUE
              
              
              18,000
              
              
              
              12,000GROSS PROFIT
              
              
              331,000
              
              
              
              220,000OPERATING
      EXPENSES:General
      and administrative
              
              $
              1,773,000
              
              
              $
              1,992,000Non-cash
      compensation
              
              
              287,000
              
              
              
              1,403,000TOTAL OPERATING
      EXPENSES
              
              
              2,060,000
              
              
              
              3,395,000OPERATING LOSS
              
              
              (1,729,000
              )
              
              
              (3,175,000
              )OTHER
      INCOME (EXPENSES):Interest income,
      net
              
              
              111,000
              
              
              
              177,000LOSS BEFORE INCOME
      TAXES
              
              
              (1,618,000
              )
              
              
              (2,998,000
              )INCOME
      TAXES
              
              
              —
              
              
              
              —NET LOSS
              
              $
              (1,618,000
              )
              
              $
              ( 2,998,000
              )Net
      Loss Per Share - Basic and Diluted
              
              $
              (0.07
              )
              
              $
              (0.13
              )Weighted
      average common shares outstanding
                Basic and
    Diluted
              
              
              24,135,557
              
              
              
              22,250,144







F-3


NETWORK-1 SECURITY
SOLUTIONS, INC.




Statements
of Changes in Stockholders’ Equity


For
the Years Ended December 31, 2008 and 2007





AdditionalCommon
      Stock
              
              
              Paid-in
              
              
              AccumulatedShares
              
              
              Amount
              
              
              Capital
              
              
              Deficit
              
              
              TotalBalance
      – December 31, 2007
              
              
              19,764,572
              
              
              $
              197,000
              
              
              $
              47,484,000
              
              
              $
              (46,279,000
              )
              
              $
              1,402,000Reclassification
              
              
              —
              
              
              
              1,000
              
              
              
              (1,000
              )
              
              
              —
              
              
              
              —Exercise
      of options and warrants
              
              
              1,037,500
              
              
              
              10,000
              
              
              
              1,191,000
              
              
              
              —
              
              
              
              1,201,000Sales
      of common stock, net of placement agents fees of $275,000
              
              
              3,333,333
              
              
              
              33,000
              
              
              
              4,692,000
              
              
              
              —
              
              
              
              4,725,000Granting
      of options and extension of options
              
              
              —
              
              
              
              —
              
              
              
              1,403,000
              
              
              
              —
              
              
              
              1,403,000Net
      loss
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (2,998,000
              )
              
              
              (2,998,000
              )Balance
      – December 31, 2007
              
              
              24,135,557
              
              
              
              241,000
              
              
              
              54,769,000
              
              
              
              (49,277,000
              )
              
              
              5,733,000Granting
      of options
              
              
              —
              
              
              
              —
              
              
              
              287,000
              
              
              
              —
              
              
              
              287,000Net
      loss
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (1,618,000
              )
              
              
              (1,618,000
              )Balance
      – December 31, 2008
              
              
              24,135,557
              
              
              $
              241,000
              
              
              $
              55,056,000
              
              
              $
              (50,895,000
              )
              
              $
              4,402,000








F-4
 NETWORK-1 SECURITY
SOLUTIONS, INC.





Statements
of Cash Flows





Year
      Ended
                      December 31,2008
                    
                    
                    2007CASH
      FLOWS FROM OPERATING ACTIVITIES:Net loss
                    
                    $
                    (1,618,000
                    )
                    
                    $
                    (2,998,000
                    )Adjustments to reconcile net
      loss to net cash provided by (used in)
operatingactivities:Depreciation and
      amortization
                    
                    
                    7,000
                    
                    
                    
                    18,000Stock-based
      compensation
                    
                    
                    287,000
                    
                    
                    
                    1,403,000Source (use) of cash from
      changes in operating assets and liabilities:Royalty and interest
      receivable
                    
                    
                    (55,000
                    )
                    
                    
                    (19,000
                    )Prepaid
    insurance
                    
                    
                    —
                    
                    
                    
                    3,000Accounts payable and accrued
      expenses
                    
                    
                    (30,000
                    )
                    
                    
                    (202,000
                    )NET CASH PROVIDED BY (USED IN)
      OPERATING ACTIVITIES
                    
                    
                    (1,409,000
                    )
                    
                    
                    (1,795,000
                    )CASH
      FLOWS USED IN INVESTING ACTIVITIES:
                      Patent costs
      incurred
                    
                    
                    (35,000
                    )
                    
                    
                    —CASH
      FLOWS FROM FINANCING ACTIVITIES:Proceeds from issuance of
      common stock, net of placement agent fees of $275,000
                    
                    
                    —
                    
                    
                    
                    4,725,000Proceeds from exercise of
      options and warrants
                    
                    
                    —
                    
                    
                    
                    1,201,000NET CASH PROVIDED BY FINANCING
      ACTIVITIES
                    
                    
                    —
                    
                    
                    
                    5,926,000NET INCREASE IN CASH AND CASH
      EQUIVALENTS
                    
                    
                    (1,444,000
                    )
                    
                    
                    4,131,000CASH
      AND CASH EQUIVALENTS, Beginning
                    
                    
                    5,928,000
                    
                    
                    
                    1,797,000CASH
      AND CASH EQUIVALENTS, Ending
                    
                    $
                    4,484,000
                    
                    
                    $
                    5,928,000SUPPLEMENTAL
      DISCLOSURE OF CASH FLOW INFORMATION:Cash paid during the years
      for:Interest
                    
                    $
                    4,000
                    
                    
                    $
                    4,000Taxes
                    
                    $
                    31,000
                    
                    
                    $
                    6,000









F-5


NETWORK-1 SECURITY
SOLUTIONS, INC.
  Notes
to Financial Statements


December
31, 2008 and 2007




Note
A - The Company


Network-1
Security Solutions, Inc. (the “Company”) is engaged in the acquisition,
licensing and protection of its intellectual property and proprietary
technologies.  The Company owns six patents covering various
telecommunications and data networking technologies (the “Patent Portfolio”) and
includes, among other things, patents covering the control of power delivery
over Ethernet networks for the purpose of remotely powering network devices and
systems and methods for the transmission of audio, video and data over local
area networks (LANS) in order to achieve higher quality of service
(QoS).   The Company’s strategy is to pursue licensing and
strategic business alliances with companies that manufacture and sell products
that make use of the technologies underlying the Patent Portfolio as well as
with other users of the technologies who benefit directly from the technologies
including corporate, educational and governmental entities.  To date,
the Company’s efforts with respect to its Patent Portfolio have focused on
licensing its patent (U.S. Patent No. 6,218,930) covering the control of power
delivery over Ethernet cables (the “Remote Power Patent”).  At least
for the next twelve months, the Company does not currently anticipate licensing
efforts for its other patents besides its Remote Power Patent.  The
Company may seek to acquire additional patents in the future.








Note
B –Summary of Significant Accounting Policies





[1]
            Cash
      equivalents:





The
Company considers all highly liquid short-term investments purchased with an
original maturity of three months or less to be cash equivalents.





[2]
            Revenue recognition:





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





[3]
            Patents:





The
Company owns a Patent Portfolio that relates to various telecommunications and
data networking technologies.  The Company capitalizes the costs
associated with acquisition, registration and maintenance of the patents and
amortizes these assets over their remaining useful lives on a straight-line
basis.  Any further payments made to maintain or develop the patents
would be capitalized and amortized over the balance of the useful life of the
patents.





[4]
            Impairment
      of long-lived assets:





In
accordance with Statement of Financial Accounting Standards (“SFAS”)
No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,”
intangible assets with finite lives are tested for impairment whenever events or
circumstances indicate that the carrying amount may not be
recoverable.  Accordingly, the Company records impairment losses on
long-lived assets used in operations or expected to be disposed of when
indicators of impairment exist and the undiscounted cash flows expected to be
derived from those assets are less than carrying amounts of those
assets.  During the years ended December 31, 2008 and 2007, there
was no impairment to its patents.





[5]
            Income
      taxes:





The
Company utilizes the liability method of accounting for income
taxes.  Under such method, deferred tax assets and liabilities are
recognized for the future tax consequences attributable to differences between
the financial statement carrying amounts of existing assets and liabilities and
their respective tax bases.  Deferred tax assets and liabilities are
measured using enacted tax rates in effect at the balance sheet
date.  The resulting asset or liability is adjusted to reflect enacted
changes in tax law.  Deferred tax assets are reduced, if necessary, by
a valuation allowance when the likelihood of realization is not
assured.






F-6
 
 NETWORK-1 SECURITY
SOLUTIONS, INC.
  Notes
to Financial Statements
 December
31, 2008 and 2007
    Note
B – Summary of Significant Accounting
Policies  (continued)





[6]
            Net
      Loss per share:





Basic net
loss per share is calculated by dividing the net loss by the weighted average
number of outstanding common shares during the year.  Diluted per
share data includes the dilutive effects of options, warrants and convertible
securities.  Potential common shares of 12,164,882 and 11,553,356 at
December 31, 2008 and 2007, respectively, are not included in the
calculation of diluted loss per share because its effect will be
anti-dilutive.  Such potential common shares are options and
warrants.





[7]
            Use
      of estimates:





The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period.  Actual results could differ from those
estimates.





[8]
            Financial
      instruments:





The
carrying amounts of cash and cash equivalents, accounts payable and accrued
expenses approximate their fair value due to the short period to maturity of
these instruments.





[9]
            Stock-based
      compensation:





Effective
January 1, 2006, the Company adopted SFAS No. 123 (revised 2004), Share Based Payment, or SFAS
123(R), which is a revision of Statement No. 123 (“SFAS 123”) Accounting for Stock Based
Compensation. SFAS 123(R) supersedes Accounting Principles Board (“APB”)
No. 25, Accounting for
Stock Issued to Employees (“APB 25”), and amends Financial Accounting
Standards Board (“FASB”) Statement No. 95 Statement of Cash Flows. SFAS
123(R) requires all share-based payments to employees, including grants of
employee stock options, to be recognized in the income statement based on their
fair values.




























F-7


NETWORK-1 SECURITY
SOLUTIONS, INC.
  Notes
to Financial Statements
 December
31, 2008 and 2007









[10]
            Recently
      issued accounting standards:





In
December 2007, the FASB issued SFAS No. 141R, Business Combinations, which
replaces SFAS No. 141. The statement retains the purchase method of
accounting for acquisitions, but requires a number of changes, including changes
in the way assets and liabilities are recognized in the purchase accounting. It
also changes the recognition of assets acquired and liabilities assumed arising
from contingencies, requires the capitalization of in-process research and
development at fair value, and requires the expensing of acquisition-related
costs as incurred. SFAS No. 141R is effective for fiscal year beginning
after December 15, 2008 and the Company believes the adoption of
SFAS No. 141R will not have a material impact on its financial
statements.




In
December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in
Consolidated Financial Statements – an amendment of ARB No. 51,
which changes the accounting and reporting for minority interests. Minority
interests will be recharacterized as noncontrolling interests and will be
reported as a component of equity separate from the parent’s equity, and
purchases or sales of equity interests that do not result in a change in control
will be accounted for as equity transactions. In addition, net income
attributable to the noncontrolling interest will be included in net income and,
upon a loss of control, the interest sold, as well as any interest retained,
will be recorded at fair value with any gain or loss recognized in net income.
SFAS No. 160 is effective for fiscal year beginning after December 15,
2008. The Company believes the adoption of SFAS No. 160 will not have
a material impact on our financial statements.




In March
2008, the FASB issued SFAS No. 161, Disclosures about Derivative
Instruments and Hedging Activities – an amendment of FASB Statement
No. 133,which requires additional disclosures about the objectives
of derivative instruments and hedging activities, the method of accounting for
such instruments under SFAS No. 133 and its related interpretations, and a
tabular disclosure of the effects of such instruments and related hedged items
on our financial position, financial performance, and cash flows. SFAS
No. 161 is effective for fiscal year beginning after December 15, 2008. The
Company believes the adoption of SFAS No. 161 will not have a material
impact on our financial statements.




In
February 2008, the FASB issued FASB Staff Position 157-2, Effective Date of FASB Statement
No. 157,which delays the effective date of SFAS No. 157 to
fiscal years beginning after November 15, 2008, for all nonfinancial assets and
nonfinancial liabilities, except for items that are recognized or disclosed at
fair value in the financial statements on a recurring basis (at least annually).
The Company believes the adoption of the delayed items of SFAS No. 157 will
not have a material impact on our financial statements.



























F-8
 
 NETWORK-1 SECURITY
SOLUTIONS, INC.
  Notes
to Financial Statements
 December
31, 2008 and 2007


Note
C- Patents





In
November 2003, the Company acquired a portfolio of telecommunications and data
networking patents (six patents) from Merlot Communications, Inc. (the “Seller”)
in which certain principal stockholders of the Company owned a majority of the
Seller’s voting stock at the time of the transaction.  The purchase
price for the Patent Portfolio was $100,000, paid in cash. As additional
consideration for the purchase, the Company granted the Seller a nonexclusive,
royalty free, perpetual license for the term of each patent to use the patents
for the development, manufacture or sale of its own branded products to end
users.  The cash price paid has been capitalized and is being
amortized over the remaining useful life of each patent.  The Company
had agreed to pay the Seller 20% of the net income, as defined, after the first
$4,000,000 of net income realized by the Company on a per patent basis from the
sale or licensing of the patents.  On January 18, 2005, the
Company and Seller amended the Patent Purchase Agreement (the “Amendment”)
pursuant to which the Company paid additional purchase price of $500,000 to
Seller in consideration for the restructuring of future contingent payments to
Seller from the licensing or sale of the Patents.  Such $500,000 has
been recorded as an expense in the accompanying statement of
operations.  The Amendment provides for future contingent payments by
the Company to Seller of $1.0 million upon achievement of $25 million of Net
Royalties (as defined), an additional $1.0 million upon achievement of $50
million of Net Royalties and an additional $500,000 upon achievement of $62.5
million of Net Royalties from licensing or sale of the patents acquired from
Merlot.  Amortization expense amounted to $7,000 each for the years
ended December 31, 2008 and December 31, 2007.







Note
D - Stockholders’ Equity





[1]
            Private
      Placement:





On April
16, 2007, the Company sold in a private placement 3,333,333 shares of common
stock at a price of $1.50 per share or an aggregate purchase price of $5,000,000
and five (5) year warrants to purchase 1,666,667 shares of common stock, at an
exercise price of $2.00 per share.  In connection with the private
placement the Company paid placement agent fees of $275,000 and issued warrants
to purchase an aggregate of 360,000 shares of common stock (240,000 shares
exercisable at $1.50 per share and 120,000 shares exercisable at $2.00 per
share).





[2]
            Stock
      options:





During
1996, the Board of Directors and stockholders approved the adoption of the 1996
Stock Option Plan (the “1996 Plan”).  The 1996 Plan, as amended,
provided for the granting of both incentive and non-qualified options to
purchase common stock of the Company.  A total of 4,000,000 were
eligible to be issued under the 1996 Plan.  As of March 2006, in
accordance with the terms of the plan, no further options were eligible to be
issued under the Plan.





The term
of options granted under the 1996 Plan may not exceed ten years (five years in
the case of an incentive stock option granted to an employee/director owning
more than 10% of the voting stock of the Company) (“10%
stockholder”).  The option price for incentive stock options cannot be
less than 100% of the fair market value of the shares of common stock at the
time the option is granted (110% for a 10% stockholder).  Option terms
and vesting periods were set by the Compensation Committee in its
discretion.








F-9


NETWORK-1 SECURITY
SOLUTIONS, INC.
  Notes
to Financial Statements
 December
31, 2008 and 2007






Note
D- Stockholders’ equity (continued)





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





Year
      EndedDecember
      31,2008
                  
                  2007Risk-free
      interest rates
                  1.55%
      - 3.28%
                  
                  3.28
      – 4.67%Expected
      option life in years
                  5  years
                  
                  5
      yearsExpected
      stock price volatility
                  37.32%
      – 69.45%
                  
                  37.32
      – 45.92%Expected
      dividend yield
                  0.00%
                  
                  0.00%





The
weighted average fair value on the option grant date during the years ended
December 31, 2008 and 2007 were $0.47 and $0.82 per option,
respectively.





The
following table summarizes stock option activity for the years ended
December 31:


2008
                              
                              
                              2007Weighted
                              
                              
                              
                              
                              
                              WeightedAverage
                              
                              
                              
                              
                              
                              AverageOptions
                              
                              
                              Exercise
                              
                              
                              Options
                              
                              
                              ExerciseOutstanding
                              
                              
                              Price
                              
                              
                              Outstanding
                              
                              
                              PriceOptions
      outstanding at beginningof
      year
                              
                              
                              7,860,440
                              
                              
                              $
                              1.01
                              
                              
                              
                              6,667,731
                              
                              
                              $
                              0.89Granted
                              
                              
                              667,500
                              
                              
                              
                              1.16
                              
                              
                              
                              1,282,709
                              
                              
                              
                              1.58Cancelled/expired/exercised
                              
                              
                              55,975
                              
                              
                              
                              4.70
                              
                              
                              
                              90,000
                              
                              
                              
                              0.18Options
      outstanding at end of year
                              
                              
                              8,471,965
                              
                              
                              
                              1.00
                              
                              
                              
                              7,860,440
                              
                              
                              
                              1.01Options
      exercisable at end of year
                              
                              
                              8,216,340
                              
                              
                              $
                              0.99
                              
                              
                              
                              7,703,565
                              
                              
                              
                              0.99





During
the years ended December 31, 2008 and 2007, the Company granted an aggregate of
667,500 and 1,282,709 5-year options to its officer, directors and consultants,
respectively.  The fair value of these options based on Black-Scholes
option-pricing model amounted to $314,000 and $1,048,000, respectively, for the
2008 and 2007 grants.  The Company recorded non-cash compensation of
$241,000 and $697,000 for vesting portion of these options for the years ended
December 31, 2008 and 2007, respectively.  The Company also
recognized non-cash compensation of $28,000 and $335,000 in 2008 and 2007,
respectively, for the options that were granted in prior years but vested in
2008 and 2007.









F-10
 
 NETWORK-1 SECURITY
SOLUTIONS, INC.
  Notes
to Financial Statements
 December
31, 2008 and 2007


Note
D- Stockholders’ equity (continued)





The
following table presents information relating to all stock options outstanding
and exercisable at December 31, 2008:





WeightedWeighted
                
                
                Average
                
                
                
                
                
                WeightedRange
      of
                
                
                
                
                
                Average
                
                
                Remaining
                
                
                
                
                
                AverageExercise
                
                
                Options
                
                
                Exercise
                
                
                Life
      in
                
                
                Options
                
                
                ExercisePrice
                
                
                Outstanding
                
                
                Price
                
                
                Years
                
                
                Exercisable
                
                
                Price$0.12
      - $2.91
                
                
                
                8,190,340
                
                
                $
                0.87
                
                
                
                3.28
                
                
                
                7,969,090
                
                
                $
                0.87$3.00
      - $3.75
                
                
                
                146,625
                
                
                
                3.44
                
                
                
                1.31
                
                
                
                112,250
                
                
                
                3.56$4.13
      - $5.69
                
                
                
                59,500
                
                
                
                4.93
                
                
                
                1.56
                
                
                
                59,500
                
                
                
                4.93$6.00
      - $6.88
                
                
                
                65,500
                
                
                
                6.29
                
                
                
                1.61
                
                
                
                65,500
                
                
                
                6.29$10.00
                
                
                
                10,000
                
                
                
                10.00
                
                
                
                1.21
                
                
                
                10,000
                
                
                
                10.008,471,965
                
                
                
                1.00
                
                
                
                3.22
                
                
                
                8,216,340
                
                
                
                0.99







[3]
            Warrants:





As of
December 31, 2008, the following are the outstanding warrants to purchase
shares of the Company’s common stock:




Numberof
                          
                          
                          ExerciseWarrants
                          
                          
                          Price
                          
                          Expiration
      Date300,000
                          
                          
                          
                          0.70
                          
                          July
      11, 201150,000
                          
                          
                          
                          1.00
                          
                          May
      21, 2010342,500
                          
                          
                          
                          1.45
                          
                          March
      31, 200952,500
                          
                          
                          
                          1.45
                          
                          March
      31, 2009250,000
                          
                          
                          
                          1.48
                          
                          October
      8, 2011240,000
                          
                          
                          
                          1.50
                          
                          April
      16, 2012350,000
                          
                          
                          
                          1.75
                          
                          May
      21, 2010123,750
                          
                          
                          
                          1.75
                          
                          May
      21, 2010171,250
                          
                          
                          
                          2.00
                          
                          March 17,
      200926,250
                          
                          
                          
                          2.00
                          
                          March 17,
      20091,786,667
                          
                          
                          
                          2.00
                          
                          April
      16, 20123,692,917








In 2007
warrants to purchase 947,500 shares of common stock were exercised for
$1,184,000.





F-11
 
 NETWORK-1 SECURITY
SOLUTIONS, INC.
  Notes
to Financial Statements
 December
31, 2008 and 2007


Note
E - Commitments and Contingencies





[1]
            Services
      agreement:





On
November 30, 2004, the Company entered into a master services agreement
(the “Agreement”) with ThinkFire Services USA, Ltd. (“ThinkFire”) pursuant to
which ThinkFire has been granted the exclusive


worldwide
rights (except for direct efforts by the Company and related companies) to
negotiate license agreements for the Remote Power Patent with respect to certain
potential licensees agreed to between the parties.  Either the Company
or ThinkFire can terminate the Agreement upon 60 days’ notice for any reason or
upon 30 days’ notice in the event of a material breach.  The Company
has agreed to pay ThinkFire a fee not to exceed 20% of the royalty payments
received from license agreements consummated by ThinkFire on its behalf after
the Company recovers its expenses.





[2]
            Legal
      fees:





Dovel
& Luner, LLP provides legal services to the Company with respect to the
Company’s patent litigation against several major data networking equipment
manufacturers which is pending in the Eastern District of Texas (See Note
J[1]).  The terms of the Company’s agreement with Dovel & Luner,
LLP provides for legal fees of a maximum aggregate cash payment of $1.5 million
plus a contingency fee of up to 24% depending upon when an outcome is
achieved.





With
respect to the Company’s litigation against D-Link, which was settled in May
2007 (See Note J[2]), the Company utilized the services of Blank Rome, LLP, on a
full contingency basis and also the services of Potter Mitton, P.C. (Tyler,
Texas) on an hourly basis to serve as local counsel.  In accordance
with the Company’s contingency fee agreement with Blank Rome LLP, the Company
will pay legal fees to Blank Rome LLP equal to 25% of the royalty revenue
received by the Company from its license agreement with D-Link after it recovers
its expenses related to the litigation.





[3]
            Operating
      leases:





The
Company leases its principal office space in New York City at a monthly rent of
approximately $3,000 which lease expires in June 2010.





Rental
expense for the years ended December 31, 2008 and 2007 aggregated $39,000
and $38,000, respectively.





[4]
            Savings
      and investment plan:





The
Company has a Savings and Investment Plan which allows participants to make
contributions by salary reduction pursuant to Section 401(k) of the Internal
Revenue Code of 1986.  The Company also may make discretionary annual
matching contributions in amounts determined by the Board of Directors, subject
to statutory limits.  The Company did not make any contributions to
the 401(k) Plan during the years ended December 31, 2008 and
2007.





[5]
            Flex
      Plan





The
Company adopted a Flexible Benefits Plan for the benefit of its employees in
December 2008.








F-12
 
 NETWORK-1 SECURITY
SOLUTIONS, INC.
  Notes
to Financial Statements
 December
31, 2008 and 2007


Note
F - Income Taxes





At
December 31, 2008, the Company has available net operating loss
carryforwards to reduce future federal taxable income of approximately
$46,329,000 for tax reporting purposes, which expire from 2009 through
2028.





Pursuant
to the provisions of the Internal Revenue Code, future utilization of these past
losses is subject to certain limitations based on changes in the ownership of
the Company’s stock that have occurred.





The
principal components of the net deferred tax assets are as follows:





Year
      EndedDecember
      31,2008
                    
                    
                    2007Deferred
      tax assets:Net operating loss
      carryforwards
                    
                    $
                    17,300,000
                    
                    
                    $
                    16,800,000Options and warrants not yet
      deducted, for tax purposes
                    
                    
                    820,000
                    
                    
                    
                    705,00018,120,000
                    
                    
                    
                    17,505,000Valuation
      allowance
                    
                    
                    (18,120,000
                    )
                    
                    
                    (17,505,000
                    )Net
      deferred tax assets
                    
                    $
                    0
                    
                    
                    $
                    0





The
Company has recorded a valuation allowance for the full amount of its deferred
tax assets as the likelihood of the future realization cannot be presently
determined.  The valuation allowance increased by $615,000 in 2008 and
$1,192,000 in 2007.





The
reconciliation between the taxes as shown and the amount that would be computed
by applying the statutory federal income tax rate to the loss before income
taxes is as follows:





Year
      EndedDecember
      31,2008
                    
                    2007Income
      tax benefit - statutory rate
                    (34.0)%
                    
                    (34.0)%State
      and local, net
                    (3.5)%
                    
                    (3.5)%Valuation
      allowance on deferred tax assets
                    37.5%
                    
                    37.5%








Note
G - Concentrations





The
Company places its cash investments in high quality financial institutions
insured by the Federal Deposit Insurance Corporation (“FDIC”).  At
December 31, 2008, the Company maintained cash balances of $4,234,000 in
excess of FDIC limits.





F-13
 
 NETWORK-1 SECURITY
SOLUTIONS, INC.
  Notes
to Financial Statements
 December
31, 2008 and 2007


Note
H - Related Party Transactions





[1]
            In
      December 2007, the Company extended the expiration date of warrants to
      purchase an aggregate of 2,013,750 shares of its common stock (the
      “Warrants”) issued to investors in the Company’s private offering
      completed in December 2004 and January 2005.  The Warrants were
      exercisable for (i) an aggregate of 1,342,500 shares at an exercise price
      of $1.25 per share (the “$1.25 Warrants”) and (ii) and aggregate of
      671,250 shares at an exercise price of $1.75 per share (the “$1.75
      Warrants”).  Investors in the aforementioned private offering
      included two principal stockholders of the Company, who invested an
      aggregate of $1,250,000 and as part of the offering received an aggregate
      of 625,000 $1.25 Warrants and 312,500 $1.75 Warrants, and a then director
      of the Company, who invested $100,000 and received 50,000 $1.25 Warrants
      and 25,000 $1.75 Warrants as part of the offering.  The Warrants
      were scheduled to expire on December 21, 2007 or January 13,
      2008 (three (3) years from the date of issuance).  The
      expiration date of the Warrants (both the $1.25 Warrants and the $1.75
      Warrants) was extended until March 14, 2008.  In addition,
      to the extent the holders exercised in full their $1.25 Warrants no later
      than December 21, 2007, such holders were afforded an extension of
      the expiration date of their $1.75 Warrants until May 21, 2010 such
      that the exercise price of the $1.75 Warrants will remain at $1.75 per
      share through March 31, 2009 and increase to $2.00 per share if
      exercised thereafter until May 21, 2010, at which time they will
      expire.  In December 2007 (prior to December 21) holders of
      $1.25 Warrants to purchase 902,500 shares were exercised which resulted in
      proceeds to the Company of $1,128,125.  As a result of further
      action by the Company’s Board of Directors, the expiration dates and
      exercise prices of remaining outstanding $1.25 Warrants (exercisable to
      purchase 395,000 shares) and the $1.75 Warrants (exercisable to purchase
      197,500 shares) held by holders of such $1.25 Warrants, have been amended
      as follows:  (i) the expiration date of outstanding $1.25
      Warrants was extended until March 31, 2009 and the exercise price of
      such warrants was adjusted to $1.45 per share and (ii) the expiration date
      of $1.75 Warrants was extended until December 15, 2008 and the exercise
      price of such warrants was adjusted to $2.00 per
  share.





[2]
            On
      December 21, 2007, the Company extended the expiration date of
      warrants issued in December 2004 to a director of the Company, to purchase
      50,000 shares of our common stock, from December 21, 2007 until May
      21, 2010.







Note
I - Employment Arrangements and Other Agreements





[1]
            On
      February 28, 2007, the Company entered into a new Employment
      Agreement with Corey M. Horowitz pursuant to which Mr. Horowitz continued
      to serve as Chairman and Chief Executive Officer for a two year term at an
      annual base salary of $288,750 for the first year, increasing by 5% for
      the second year.  In connection with his employment agreement,
      Mr. Horowitz was issued a five (5) year option to purchase 375,000 shares
      of common stock at an exercise price of $1.46 per share which vests, on a
      quarterly basis over a one year period subject to acceleration upon a
      change of control.  The Company also issued to Mr. Horowitz
      on the one year anniversary date (February 28, 2008) an additional five
      (5) year option to purchase a minimum of 375,000 shares of common stock at
      an exercise price equal to the closing price of our common stock on the
      date of grant, which option vested on a quarterly basis over a one year
      period.  In addition to the aforementioned option grants, the
      Company agreed to extend for an additional three (3) years the expiration
      dates of all options and warrants (an aggregate of 2,620,000 shares)
      expiring in calendar year 2007 and 2008 owned by Mr. Horowitz and CMH
      Capital Management Corp. (“CMH”), an affiliate.  In connection
      with such extensions the Company recorded non-cash compensation of
      $371,000 for 2007.  Under the terms of his Employment Agreement,
      Mr. Horowitz shall receive bonus compensation in an amount equal to 5% of
      Company royalties or other payments (before deduction of payments to third
      parties including, but not limited to, legal fees and expenses and third
      party license fees) received from licensing its patents (including patents
      currently owned and acquired or licensed on an exclusive basis during the
      period in which Mr. Horowitz continues to serve as an executive officer of
      the Company) (the “Royalty Bonus Compensation”).  During 2007,
      Mr. Horowitz received $12,000 of Royalty Bonus
      Compensation.  Mr. Horowitz shall also receive bonus
      compensation equal to 5% of the gross proceeds from (i) the sale of any of
      the Company’s patents or (ii) the Company’s merger with or into another
      corporation or entity.  The Royalty Bonus Compensation shall
      continue to be paid to Mr. Horowitz for the life of each of the
      Company’s patents with respect to licenses entered into by the Company
      with third parties during Mr. Horowitz’s term
  of





F-14
 
 NETWORK-1 SECURITY
SOLUTIONS, INC.
  Notes
to Financial Statements
 December
31, 2008 and 2007


Note
I - Employment Arrangements and Other Agreements (continued)





employment
or at anytime thereafter, whether Mr. Horowitz is employed by the Company or
not, provided,
that, Mr.
Horowitz’s employment has not been terminated by the Company “For Cause” (as
defined) or terminated by Mr. Horowitz without “Good Reason” (as
defined).  In the event that Mr. Horowitz’s employment is terminated
by the Company “Other Than For Cause” (as defined) or by Mr. Horowitz for “Good
Reason” (as defined), Mr. Horowitz shall be entitled to a severance of 12 months
base salary.





In
accordance with his employment agreement, Mr. Horowitz also received certain
anti-dilution rights which provide that if at any time during the period ended
December 31, 2008, in the event that the Company completes an offering of
its common stock or any securities convertible or exercisable into common stock
(exclusive of securities issued upon exercise of outstanding options, warrants
or other convertible securities), Mr. Horowitz shall receive from the Company,
at the same price as the securities issued in the financing, such number of
additional options to purchase common stock so that he maintains the same
derivative ownership percentage (21.47%) of the Company based upon options and
warrants owned by Mr. Horowitz and CMH (exclusive of ownership of shares of
common stock by Mr. Horowitz and CMH) owned as of the time of execution of
his employment agreement; provided, that, the
aforementioned anti-dilution protection shall be afforded to Mr. Horowitz up to
maximum financings of $2.5 million.  In April 2007, with respect to
the Company’s completion of a $5.0 million private placement (See Note D[1]),
Mr. Horowitz was issued a five (5) year option to purchase 732,709 shares of
common stock, at an exercise price of $1.67 per share in accordance with the
aforementioned anti-dilution provision of his employment agreement.





[2]
            On
      December 18, 2008, the Company entered into an agreement with
      David C. Kahn pursuant to which he continues to serve as the
      Company’s Chief Financial Officer through December 31,
      2010.  In consideration for his services, Mr. Kahn is
      compensated at the rate of $7,292 per month for the year ended
      December 31, 2009 and is compensated at the rate of $7,657 per month
      for the year ended December 31, 2010.  In connection with
      the agreement, Mr. Kahn was also issued a five (5) year option to purchase
      100,000 shares of the Company’s common stock at an exercise price of $0.54
      per share.  The option vested 40,000 shares on the date of grant
      and the balance of the shares (60,000) will vest on a quarterly basis in
      equal amounts of 7,500 shares beginning March 31, 2009 through
      December 31, 2010.  Upon a “Change in Control” (as defined)
      all of the unvested shares underlying the option shall become 100% vested
      and immediately exercisable.  The agreement further provides
      that the Company may terminate the agreement at any time for any
      reason.  In the event Mr. Kahn’s services are terminated
      without “Good Cause” (as defined), he will be entitled to accelerated
      vesting of all unvested shares underlying the option and the lesser of (i)
      six months base monthly compensation or (ii) the remaining balance of the
      monthly compensation payable through December 31,
    2010.







Note
J – Litigation





[1]
            In
      February 2008, the Company commenced litigation against several major data
      networking equipment manufacturers in the United States District Court for
      the Eastern District of Texas, Tyler Division, for infringement of the
      Company’s Remote Power Patent.  The defendants in the lawsuit
      include Cisco Systems, Inc., Cisco Linksys, LLC, Enterasys Networks, Inc.,
      3COM Corporation, Inc., Extreme Networks, Inc., Foundry Networks, Inc.,
      Netgear, Inc. and Adtran, Inc.  The Company seeks injunctive
      relief and monetary damages for infringement based upon reasonable
      royalties as well as treble damages for the defendants continued willful
      infringement of the Remote Power Patent.  The defendants, in
      their answers to the complaint asserted that they do not infringe any
      valid claim of the Remote Power Patent, and further asserted that, based
      on several different theories, the patent claims are invalid or
      unenforceable.  In addition to these defenses, the defendants
      also asserted counterclaims for, among other things, non-infringement,
      invalidity, and unenforceability of the Remote Power Patent.  In
      the event that the courts determine that the Remote Power Patent is not
      valid or enforceable, and/or that the defendants do not infringe, any such
      determination would have a material adverse effect on the
      Company.





F-15
 
 NETWORK-1 SECURITY
SOLUTIONS, INC.
  Notes
to Financial Statements
 December
31, 2008 and 2007


Note
J – Litigation (continued)





[2]
            In
      August 2005, the Company commenced patent litigation against D-Link
      Corporation and D-Link Systems, Incorporated (collectively “D-Link”) in
      the United States District Court for the Eastern District of Texas, Tyler
      division (Civil Action No. 6:05W291), for infringement of the Company’s
      Remote Power Patent.  The complaint sought, among other things,
      a judgment that the Company’s Remote Power Patent is enforceable and has
      been infringed by the defendants.  The Company also sought a
      permanent injunction restraining the defendants from continued
      infringement, or active inducement of infringement by others, of the
      Remote Power Patent.





In August
2007, the Company finalized the settlement of its patent infringement litigation
against D-Link.  Under the terms of the settlement, D-Link entered
into a license agreement for the Company’s Remote Power Patent the terms of
which include monthly royalty payments of 3.25% of the net sales of D-Link Power
over Ethernet products, including those products which comply with the IEEE
802.3af and 802.3at Standards, for the full term of the Company’s Remote Power
Patent, which expires in March 2020.  The royalty rate is subject to
adjustment to a rate consistent with other similarly situated licensees of the
Remote Power Patent based on units of shipments of licensed
products.  In addition, D-Link paid the Company $100,000 upon signing
of the Settlement Agreement.





[3]
            On
      November 16, 2005, the Company entered into a Settlement Agreement with
      PowerDsine, Inc and PowerDsine Ltd. which dismisses, with prejudice, a
      civil action brought by PowerDsine in the United States District Court for
      the Southern District of New York that sought a declaratory judgment that
      U.S. Patent No. 6,218,930 (the “Remote Power Patent”) owned by the Company
      was invalid and not infringed by PowerDsine and/or its
      customers.  Under the terms of the Settlement Agreement, the
      Company agreed that it will not initiate litigation against PowerDsine for
      its sale of Power over Ethernet (PoE) integrated circuits.  In
      addition, the Company has agreed that it will not seek damages for
      infringement from customers that incorporate PowerDsine integrated circuit
      products in PoE capable Ethernet switches manufactured on or before April
      30, 2006. PowerDsine agreed that it will not initiate, assist or cooperate
      in any legal action relating to the Remote Power
  Patent.





In June
2008, the Company entered into a new agreement with Microsemi Corp-Analog Mixed
Signal Group Ltd (“Microsemi Analog”), previously PowerDsine Ltd, a subsidiary
of Microsemi Corporation (“Microsemi”), a leading manufacturer of high
performance analog mixed-signal integrated circuits and high reliability
semiconductors, which, among other things, amended the prior Settlement
Agreement entered into between the parties in November 2005.  As part
of the Company’s Special Licensing Program and its agreement with Microsemi
Analog entered into in June 2008, Microsemi, entered into a license agreement,
dated August 13, 2008, with the Company with respect to the Remote Power
Patent.  The license agreement provides that Microsemi is obligated to
pay the Company quarterly royalty payments of 2% of the sales price for certain
of Microsemi’s Midspan PoE products for the full term of the Remote Power Patent
(March 2020).









F-16
 
 NETWORK-1 SECURITY
SOLUTIONS, INC.
  Notes
to Financial Statements
 December
31, 2008 and 2007


Note
K – Subsequent Events





[1]
            On
      March 11, 2009 the Board of Directors of the Company approved adjustments
      to the exercise prices and terms of certain of its outstanding options and
      warrants as follows:




(i)
            the
      exercise prices of certain outstanding compensatory options and warrants
      issued to officers, directors, consultants and others to purchase an
      aggregate of 5,029,945 shares of common stock were adjusted to an exercise
      price of $0.68 per share (closing price of the Company’s common stock on
      March 11, 2009) including options and warrants to purchase an aggregate of
      4,031,195 shares held by the Company’s Chairman and Chief Executive
      Officer, and an affiliated entity, options to purchase an aggregate of
      150,000 shares held by the Company’s Chief Financial Officer, and options
      and warrants to purchase an aggregate of 300,000 shares held by two
      directors of the Company;




(ii)
            the
      exercise price of outstanding warrants to purchase an aggregate of 473,750
      shares of common stock (including warrants to purchase 187,500 shares
      owned by a principal stockholder of the Company), issued as part of the
      Company’s private placement completed in December 2004/January 2005, which
      exercise price is scheduled to increase to $2.00 per share on March 31,
      2009 (from $1.75 per share)  adjusted to an exercise price of
      $1.75 for the remaining exercise period of such warrants (May 21, 2010),
      subject to the adjustment set forth in item (iv)
  below;




(iii)
            the
      exercise price of warrants to purchase an aggregate of 1,666,667 shares of
      common stock, (including warrants to purchase an aggregate of 1,150,001
      shares owned by three principal stockholders of the Company), at an
      exercise price of $2.00 per share, which warrants were issued as part of
      the Company’s private placement completed in April 2007, were adjusted to
      an exercise price of $1.75 per share for the remaining exercise period of
      such warrants (April 16, 2012), subject to the adjustments set forth in
      item (iv) below; and





(iv)
            in
      the event that any holders of the above referenced outstanding warrants,
      issued as part of the Company’s December 2004/January 2005 or the April
      2007 private placements, exercise such warrants at anytime up to and
      including December 31, 2009, the exercise price of all such warrants shall
      adjust to $1.25 per share.





[2]
            On
      March 17, 2009, the Board of Directors of the Company extended the
      expiration dates until December 31, 2009 of outstanding warrants to
      purchase an aggregate of 395,000 shares of common stock, exercisable at
      $1.45 per share, and outstanding warrants to purchase an aggregate of
      197,500 shares of common stock, exercisable at $2.00 per share, which
      expiration dates were scheduled to expire on March 17, 2009 and
      March 31, 2009, respectively.
































F-17


PART
IV




ITEM 15.  EXHIBITS AND
FINANCIAL STATEMENT SCHEDULES




(a)        Exhibits




10.1
              Patents
      Purchase, Assignment and License Agreement, dated November 18, 2003,
      between the Company and Merlot Communications, Inc.  Previously
      filed as Exhibit 10.10 to the Company’s Current Report on Form 8-K filed
      December 3, 2003 and incorporated herein by
  reference.




10.2
              Master
      Services Agreement, dated November 30, 2004, between the Company and
      ThinkFire Services USA, Ltd.  Previously filed as Exhibit 10.1
      to the Company’s Current Report on Form 8-K filed December 2, 2004 and
      incorporated herein by
reference.




10.3
              Securities
      Purchase Agreement, dated December 21, 2004, between Company and the
      investors.  Previously, filed as Exhibit 10.1 to the Company’s
      Current Report on Form 8-K filed December 28, 2004 and incorporated herein
      by reference.




10.4
              Securities
      Purchase Agreement, dated January 13, 2005, between the Company and the
      investors.  Previously filed as Exhibit 10.2 to the Company’s
      Current Report on Form 8-K filed on January 20, 2005 and incorporated
      herein by reference.




10.5
              Amendment
      to Patents Purchase, Assignment and License Agreement, dated January 18,
      2005, between the Company and Merlot Communications,
      Inc.  Previously filed January 24, 2005 as Exhibit 10.1 to the
      Company’s Current Report on Form 8-K filed on January 18, 2005 and
      incorporated herein by
reference.




10.6
              Agreement,
      dated August 4, 2005, between the Company and David C.
      Kahn.  Previously filed as Exhibit 10.1 to the Company’s Current
      Report on Form 8-K filed August 9, 2005 and incorporated herein by
      reference.




10.7
              Agreement,
      dated August 9, 2005, between the Company and Blank Rome
      LLP.  Previously filed as Exhibit 10.1 to the Company’s Current
      Report on Form 8-K filed on August 11, 2005 and incorporated herein by
      reference.




10.8
              Settlement
      Agreement, dated November 16, 2005, among the Company, PowerDsine Ltd and
      PowerDsine, Inc.  Previously filed as Exhibit 10.1 to the
      Company’s Current Report on Form 8-K filed November 17, 2005 and
      incorporated herein by
reference.




10.9
              Agreement,
      dated December 20, 2006, between the Company and David C. Kahn,
      previously filed as Exhibit 10.1 to the Company’s Current Report on Form
      8-K filed December 22, 2006 and incorporated herein by
      reference.




10.10
              Employment
      Agreement, dated February 28, 2007, between the Company and
      Corey M. Horowitz previously filed as Exhibit 10.1 to the Company’s
      Current Report on Form 8-K filed March 6, 2007 and incorporated
      herein by reference.






40


10.11
              Securities
      Purchase Agreement, dated April 16, 2007, between the Company and the
      investors (including exhibits).  Previously filed as Exhibit
      10.1 to the Company’s Current Report on Form 8-K filed April 20, 2007
      and incorporated herein by
reference.




10.12
              Settlement
      Agreement, dated as of May 25, 2007, between the Company and D-Link Corp.
      and D-Link Systems, Inc., previously filed as Exhibit 10.1 to the
      Company’s Current Report on Form 8-K, filed on August 21, 2007 and
      incorporated herein by
reference.




10.13
              Agreement,
      dated February 8, 2008, between the Company and Dovel & Luner,
      previously filed on February 13, 2008 as Exhibit 10.1 to the
      Company’s Current Report on Form 8-K and incorporated herein by
      reference.




10.14
              Letter
      Agreement dated June 17, 2008, between the Company and Microsemi
      Corp-Analog Mixed Signal Group Ltd., previously filed on June 23,
      2008 as Exhibit 10.1 to the Company’s Current Report on Form 8-K and
      incorporated herein by
reference.




10.15
              License
      Agreement, dated August 13, 2008, between the Company and Microsemi
      Corporation, previously filed on August 15, 2008 as Exhibit 10.1 to
      the Company’s Current Report on Form 8-K and incorporated herein by
      reference.




10.16
              Agreement,
      dated December 18, 2008, between the Company and David C. Kahn,
      previously filed on December 19, 2008 as Exhibit 10.1 to the
      Company’s Current Report on Form 8-K and incorporated herein by
      reference.




14
              Code
      of Ethics.  Previously filed as Exhibit 14 to the Company’s
      Annual Report on Form 10-KSB for the year ended December 31, 2004 filed on
      April 14, 2004 and incorporated herein by
  reference.




23.1*
              Consent
      of Radin Glass Co., LLP, Independent Registered Public Accounting
      Firm.




31.1*
              Section
      302 Certification of Chief Executive
Officer.




31.2*
              Section
      302 Certification of Chief Financial
Officer.




32.1*
              Section
      906 Certification of Chief Executive
Officer.




32.2*
              Section
      906 Certification of Chief Financial
Officer.









*Filed
herewith










41


SIGNATURES




In
accordance with the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized, in the City of New York,
State of New York, on the 31st day
of March 2009.




NETWORK-1
      SECURITY SOLUTIONS, INC.By:
                /s/ Corey
      M. HorowitzCorey
      M. HorowitzChairman
      and Chief Executive Officer










In
accordance with the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant caused this report to be signed on its
behalf by the following persons in the capacities and on the dates
indicated:







NAME
                                                        
                                                        TITLE
                                                        
                                                        DATE/s/
      Corey M. Horowitz
                                                            Corey
      M. Horowitz
                                                        
                                                        Chairman
      and Chief Executive Officer, Chairman of the Board of
      Directors
                                                          (principal
      executive officer)
                                                        
                                                        March 31,
      2009/s/
      David Kahn
                                                        
                                                        Chief
      Financial Officer (principal financial officer)
                                                        
                                                        March 31,
      2009David
      Kahn/s/
      Robert Pons
                                                        
                                                        Director
                                                        
                                                        March 31,
      2009Robert
      Pons/s/
      Laurent Ohana
                                                        
                                                        Director
                                                        
                                                        March 31,
      2009Laurent
      Ohana












42