================================================================================

                    U. S. Securities and Exchange Commission

                             WASHINGTON, D.C. 20549

                                  FORM 10-KSB/A
                                (AMENDMENT NO. 2)

                 ANNUAL REPORT UNDER SECTION 13 OR 15(D) OF THE
                         SECURITIES EXCHANGE ACT OF 1934

                  For the fiscal year ended December 31, 2004.

               TRANSITION REPORT UNDER 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.
                 (Name of Small Business Issuer in its Charter)

          DELAWARE                                            11-3027591
(State or Other Jurisdiction                                (IRS Employer
     of Incorporation)                                  Identification Number)

                           445 PARK AVENUE, SUITE 1028
                            NEW YORK, NEW YORK 10022
                    (Address of Principal Executive Offices)

         Issuer's Telephone Number (Including Area Code): (212) 829-5770

         Securities registered under Section 12(b) of the Exchange Act:

    Title of each class                Name of each exchange on which registered
    -------------------                -----------------------------------------
Common Stock, $.01 par value                              None

         Securities registered under Section 12(g) of the Exchange Act:

                                      None

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

     Check if there is no disclosure of delinquent filers in response to Item
405 of Regulation S-B contained in this form, and no disclosure will 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-KSB
or any amendment to this Form 10-KSB. [X]

     The issuer's revenues for its most recent fiscal year: $0.

     The aggregate market value of the voting common stock of the registrant
held by non-affiliates computed by reference to the price at which the stock was
sold on March 15, 2005 was approximately $10,275,873.

     The number of shares of Common Stock outstanding as of March 31, 2005 was
17,697,572.

     Transitional Small Business Disclosure Format (Check One): Yes [ ] No [X]
================================================================================
<PAGE>

                       NETWORK-1 SECURITY SOLUTIONS, INC.

                                EXPLANATORY NOTE

     This Amendment No. 2 on Form 10-KSB/A (the "Form 10-KSB/A") amends our
Annual Report on Form 10-KSB for the year ended December 31, 2004, as initially
filed with the Securities and Exchange Commission (the "SEC") on April 14, 2005,
and as amended on August 17, 2005, and is being filed to reflect the restatement
of our statements of operations for the years ended December 31, 2004 and
December 31, 2003, as discussed in Note B to the financial statements.

     As reported in our Form 8-K filed on November 15, 2005, following
discussions with the staff (the "Staff") of the SEC pertaining to comments to
our Annual Report on Form 10-KSB for 2004, we decided to restate our statements
of operations for the year ended December 31, 2004 to recognize a deemed
dividend with respect to an exchange transaction in April 2004 involving our
outstanding preferred stock (the "2004 Exchange Transaction") as a result of the
beneficial conversion feature in accordance with Emerging Issues Task Force
("EITF") Issue No. 00-27. Additionally, we concluded that the statement of
operations for the year ended December 31, 2003 should also be restated to
present the gain on sale of our software assets in May 2003 and revenues and
expenses associated with the software business as discontinued operations.

     This Form 10-KSB/A includes disclosure in Note E [1] to the financial
statements pertaining to the 2004 Exchange Transaction pursuant to which all
holders our outstanding Series E convertible preferred stock ("Series E") and
Series D convertible preferred stock ("Series D") exchanged their preferred
shares for shares of our common stock. The holders of our Series E and Series D
received 1.25 times the number of shares of common stock that each preferred
stockholder would have otherwise received upon conversion. This 2004 Exchange
Transaction had no effect on the balance sheet as of December 31, 2004.

     We are restating our statement of operations for the year ended December
31, 2004 to make the following changes:

     o    include a "Deemed Dividend on Preferred Stock Conversion" in the
          amount of $273,000;

     o    increase the net loss attributable to common stockholders by $273,000,
          to $3,405,000 from $3,132,000; and

     o    increase the net loss per common share to $(0.26) per share from
          $(0.24) per share basic and diluted.

     In addition, following discussions with the Staff of the SEC pertaining to
comments relating to our Annual Report on 10-KSB for the year ended December 31,
2004, we also concluded that the statement of operations for the year ended

                                                                               1
<PAGE>

December 31, 2003 should be restated to reclassify the gain on sale of assets
associated with the Company's software products in May 2003 (the "2003 Asset
Sale") and expenses and revenues related to the software business to
discontinued operations in accordance with Statement of Financial Accounting
Standards (SFAS) No. 144. This reclassification has no effect on the net loss,
net loss attributable to common stockholders or net loss per common share -
basic and diluted. The 2003 Asset Sale had no impact on the balance sheet as of
December 31, 2003.

     The reclassification to discontinued operations pertaining to the 2003
Asset Sale and revenue and expenses related to our software business and the
restatement of the Company's statement of operations for the year ended December
31, 2003 resulted in the following changes:


     o    "Gain on sale of assets" of $415,000 and revenues of $218,000, cost of
          services of $51,000 and general and administrative expenses of
          $613,000 were reclassified to "Loss from discontinued operations" of
          $(31,000);

     o    General and administrative expenses were reduced from $1,208,000 to
          $595,000 to include only such expenses from continuing operations;

     o    inclusion of "Loss from continuing operations" of $(583,000) and "Loss
          from discontinued operations" of $(31,000); and

     o    inclusion of "Loss per common share - basic and diluted from
          continuing operations" of $(0.07) and "Loss per common share basic and
          diluted from discontinued operations" of $(0.00).

     This Form 10-KSB/A also amends the 10-KSB initially filed on April 14, 2005
to provide additional disclosure under Item 8A "Controls and Procedures".

     Except for the foregoing amended information required to reflect the
effects of the restated statements of operation and additional disclosure under
Item 8A hereof, this Form 10-KSB/A continues to describe conditions as presented
in the original report on Form 10-KSB filed on April 14, 2005. This Form
10-KSB/A does not reflect events occurring after the filing of the Form 10-KSB
on April 14, 2005 or modify or update these disclosures, including exhibits on
the Form 10-KSB affected by subsequent events. Information not affected by the
restatement is unchanged and reflects the disclosures made at the time of the
original filing of the Form 10-KSB on April 14, 2005. Accordingly, this Form
10-KSB/A should be read in conjunction with our filings made with the SEC
subsequent to the filing of the original Form 10-KSB on April 14, 2005,
including any amendments to those filings.

                                                                               2
<PAGE>

                       NETWORK-1 SECURITY SOLUTIONS, INC.
                         2004 FORM 10-KSB ANNUAL REPORT

                                TABLE OF CONTENTS

                                                                            Page

Part 1........................................................................1
------

     Item 1.   Description of Business........................................1
     -------   -----------------------

               Risk Factors...................................................6
               ------------

     Item 2.   Description of Property.......................................11
     -------   -----------------------

     Item 3.   Legal Proceedings.............................................11
     -------   -----------------

     Item 4.   Submission of Matters to a Vote of Security Holders...........12
     -------   ---------------------------------------------------

Part II......................................................................12
-------

     Item 5.   Market For Common Equity, Related Stockholder Matters and
     -------   ----------------------------------------------------------
               Small Business Issuer Purchases of Equity Securities..........12
               ----------------------------------------------------

     Item 6.   Management's Discussion and Analysis or Plan of Operation.....14
     -------   ---------------------------------------------------------

     Item 7.   Financial Statements..........................................18
     -------   --------------------

     Item 8.   Changes in and Disagreements with Accountants on
     -------   -------------------------------------------------
               Accounting and Financial Disclosure...........................18
               -----------------------------------

     Item 8A.  Controls and Procedures.......................................19
     --------  -----------------------

     Item 8B.  Other Information.............................................19
     --------  -----------------

Part III.....................................................................19
--------

     Item 9.   Directors and Executive Officers..............................19
     -------   --------------------------------

     Item 10.  Executive Compensation........................................23
     --------  ----------------------

     Item 11.  Security Ownership of Certain Beneficial Owners and
     --------  ---------------------------------------------------
               Management and Related Stockholder Matters....................27
               ------------------------------------------

     Item 12.  Certain Relationships and Related Transactions................30
     --------  ----------------------------------------------

     Item 13.  Exhibits List and Reports on Form 8-K.........................32
     --------  -------------------------------------

     Item 14.  Principal Accountant Fees and Services........................34
     --------  --------------------------------------

Signatures...................................................................35
----------

                                                                               i
<PAGE>

                                     PART I

     THIS ANNUAL REPORT ON FORM 10-KSB CONTAINS CERTAIN STATEMENTS WHICH ARE
FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF THE SAFE HARBOR PROVISIONS OF
SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED, AND SECTION 21E OF THE
SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. 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 THE SECTION
ENTITLED "RISK FACTORS THAT MAY AFFECT FUTURE RESULTS" IN ITEM 1 OF THIS REPORT
AS WELL AS THOSE RISKS DISCUSSED ELSEWHERE IN THIS REPORT.

ITEM 1. DESCRIPTION OF BUSINESS.

     OVERVIEW

     The principal business of the Company is the acquisition, development,
licensing and protection of its intellectual property. The Company presently
owns six patents covering various telecommunications and data networking
technologies. The Company's 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 its patents as well as
with other users of the technology who benefit directly from the technology
including corporate, educational and governmental entities.

     On November 18, 2003, the Company acquired a portfolio of
telecommunications and data networking patents (the "Patent Portfolio") from
Merlot Communications, Inc., a broadband communications solutions provider. In
February 2004, following the acquisition of the Patent Portfolio and its review
of applicable markets, the Company commenced initial efforts to license its
Patent Portfolio. The Patent Portfolio consists of six patents issued by the
U.S. Patent Office that relate to various telecommunications and data networking
technologies and includes, among other things, patents covering 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) and the control of
power delivery over LANs for the purpose of remotely powering network devices.

                                                                               1
<PAGE>

     THE PATENTS

     The Company's 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.

     The Company's future success is largely dependent upon its proprietary
technologies, its ability to protect its intellectual property rights and
consummate license agreements with respect to its Patent Portfolio. The
complexity of patent and common law, combined with the Company's limited
resources, create risk that its efforts to protect its proprietary technologies
may not be successful. The Company cannot be assured that its patents will be
upheld, or that third parties will not invalidate its patents. In March 2004,
PowerDsine Inc. commenced litigation against the Company seeking, among other
things, a declaratory judgment that the Company's patent covering remote
delivery of power over Ethernet cables (U.S. Patent No. 6,218,930) is invalid
(See "Risk Factors - We Face Uncertainty As To The Outcome of Litigation with
PowerDsine" and Item 3 "Legal Proceedings").

     In February 2004, the Company initiated its licensing efforts relating to
its patent (U.S. Patent No. 6,218,930) covering the control of power delivery
over Ethernet cables (the "Remote Power Patent"). The Remote Power Patent
application 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 Remote Power Patent
expires on March 11, 2019.

     As of March 31, 2004, the Company transmitted letters to approximately 85
companies offering licenses to the Remote Power Patent. To date the Company has
not entered into any license agreements with third parties.

     The Company was incorporated under the laws of the State of Delaware in
July 1990. The Company's offices are located at 445 Park Avenue, Suite 1028, New
York, New York 10022 and its telephone number is (212) 829-5770.

                                                                               2
<PAGE>

     HISTORICAL BUSINESS

     From June 1995 until December 2002, the Company developed, marketed,
licensed and supported a suite of security software products designed to prevent
unauthorized access to information residing on networked servers, desktops and
laptops. In May 2003, the Company completed the sale of its security software
technology and related intellectual property to an unaffiliated foreign
corporation for an aggregate consideration of $415,000. In November 2003, the
Company entered the intellectual property licensing business following its
acquisition of the Patent Portfolio.

     MARKET OVERVIEW

     Management has determined that the Company's initial licensing efforts will
be focused on its 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 360,000 individual
members in approximately 175 countries. The Standards Association of the IEEE is
responsible for the creation of global industry standards for a broad range of
technology industries. In 1999, at the urging of several industry vendors, the
IEEE formed a task force to facilitate the adoption of a standardized
methodology for the delivery of remote power over Ethernet networks which would
insure interoperability among vendors of switches and terminal devices. 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 cables. 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"). The Company believes its 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, will be 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 cable 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 on-going power - a function that would be difficult and
expensive to implement if each phone required AC outlets.

                                                                               3
<PAGE>

     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. International Data
Corporation (IDC) forecasts that the annual PoE sales will reach 134 million PSE
switch ports (does not include midspan ports) by 2008 which equates to a 5 year
compound annual growth rate of 63%. A recent Gartner report estimates that PoE
port shipments more than tripled in 2004 and that price premiums for such ports
ranged from $45 to $65 per port and that 18% of all wiring closet switch ports
shipped in 2004 were PoE-enabled.

     The benefits of PoE are compelling as evidenced by the introduction of
products by such leading vendors as 3Com, Seimens, Nortel Networks and Avaya, as
well as many others. In February 2004, Cisco Systems, Inc., the world's largest
network switch manufacturer, announced that all of its switches will ultimately
be PoE enabled. PowerDsine, Inc., the world's leader in PoE technology and a
founding member of the IEEE Task Force that developed the Standard, and
Motorola, Inc., have announced a partnership to develop chip-based PoE solutions
thereby reducing cost and the number of components necessary to deliver
manufactured Standard compliant products.

     The Company believes the cost savings as well as the other benefits that
can be realized by utilizing the technology contained in the Remote Power Patent
may be of significant importance to the growth of the Wireless Local Area
Networking (WLAN) industry and Voice Over IP Telephony (VOIP) industry.
According to In-Stat/MDRs, a market research firm, purchases of wireless
hardware, including Access Points for IEEE 802.11b/g (Wi-Fi) networks, reached
$2.2 billion in 2002 and are expected to exceed $3.9 billion by 2006. A January
2004 market study by The Dell'Oro Group, a research firm, projects that annual
shipments of enterprise wireless LAN access points will grow from 882,000 units
in 2003 to 5.9 million units in 2008, representing a compound annual growth rate
of 46.2%.

     The VOIP market is currently one of the fastest growing segments in the
telecommunications industry. VOIP traffic has steadily increased over the last
several years and is being deployed by service providers and carriers worldwide.
IDC, a market research firm, estimates that worldwide IP telephone unit sales
are set to grow from 1.5 million units in 2003 to nearly 5 million units in 2007
and overall voice-over IP equipment, which in 2003 represented a market of $3.3
billion, is expected to grow at a compound annual growth rate of 45.0% to $15.1
billion by 2007.

     The ability to supply power to end-devices through Ethernet cables 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, the Company believes that PoE technology will become more widely used as
a method to power these end-devices.

     The Company also owns five (5) additional patents 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

                                                                               4
<PAGE>

communications control channels between network-connected devices in order to
support advanced applications on traditional data networks. The Company believes
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

     The Company's strategy is to capitalize on its Patent Portfolio through
entering into licensing arrangements with third parties including manufacturers
and users that utilize the Patent Portfolio's proprietary technologies as well
as any additional proprietary technologies covered by patents which may be
acquired by the Company in the future. The Company 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.

     The Company does not anticipate manufacturing products utilizing the Patent
Portfolio or any of the proprietary technologies contained in the Patent
Portfolio. Accordingly, the Company does not anticipate establishing a
manufacturing, sales or marketing infrastructure. Consequently, the Company
believes that its capital requirements will be less than the capital
requirements for companies with such infrastructure requirements.

     In connection with the Company's activities relating to the protection of
its Patent Portfolio, it may be necessary to assert patent infringement claims
against third parties that the Company believes are infringing its Patent
Portfolio. Such litigation may be costly and based on the Company's current
limited financial resources, it may not be able to pursue litigation as
aggressively as companies with substantially greater financial resources.

     MARKETING AND DISTRIBUTION

     In February 2004, the Company commenced licensing efforts for its Remote
Power Patent. The Company believes 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, the
Company believes that additional potential licensees include users of the
equipment embodying the PoE technology covered by its Remote Power Patent,
including corporate, educational and federal, state and local government users,
as they are significant beneficiaries of the technologies covered by the Remote
Power Patent.

     ThinkFire 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 (except for direct efforts by the
Company and related companies) worldwide rights to negotiate license agreements
for the Company's Remote Power Patent with respect to certain potential
licensees agreed to between the

                                                                               5
<PAGE>

parties. Either the Company 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. 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.

     COMPETITION

     The telecommunications and data networking licensing market is
characterized by intense competition and rapidly changing business conditions,
customer requirements and technologies. The Company's current and potential
competitors have longer operating histories, greater name recognition and
possess substantially greater financial, technical, marketing and other
competitive resources than the Company. Although Management believes that the
Company has enforceable patents relating to telecommunications and data
networking, there can be no assurance that the Patent Portfolio will be upheld
or that third parties will not invalidate any or all of the patents in the
Patent Portfolio. In addition, the Company's current and potential competitors
may develop technologies that may be more effective than the Company's
proprietary technologies or that would render the Company's technologies less
marketable or obsolete. The Company 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 the 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 assert claims relating to its patents, the
licensing royalties available to the Company may be limited. Moreover,
technological advances or entirely different approaches developed by one or more
of its competitors or adopted by various standards groups could render the
Company's Remote Power Patent obsolete, less marketable or unenforceable.

     EMPLOYEES AND CONSULTANTS

     As of March 31, 2005, the Company had one full time employee, no part time
employees and three consultants.



     RISK FACTORS THAT MAY AFFECT FUTURE RESULTS

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

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

     We have incurred substantial operating losses since our inception, which
has resulted in an accumulated deficit of $(42,989,000) as of December 31, 2004.
For the years ended December 31, 2004 and 2003, we incurred net losses of
$(1,953,000) and $(614,000), respectively. We have financed our operations
primarily by sales of equity securities as well as the sale of our CyberWall
PLUS security software technology in May 2003. Since December 2002, when we
discontinued our security software products and following the commencement of
our new technology licensing business in

                                                                               6
<PAGE>

November 2003, we have not had material revenue from operations and for the year
ended December 31, 2004 we had no revenue from operations. Our ability to
achieve revenue and generate positive cash flow from operations is dependent
upon consummating licensing agreements with respect to our patented technology.
We may not be successful in achieving licensing agreements with third parties
and our failure to do so would have a material adverse effect on our business,
financial condition and results of operations. We may not be able to achieve
revenue or generate positive cash flow from operations from our new licensing
business.

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

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

     OUR NEW LICENSING BUSINESS MAY NOT BE SUCCESSFUL.

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

     OUR FUTURE SOURCE OF LICENSING REVENUE IS UNCERTAIN.

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

                                                                               7
<PAGE>

predictable stream of revenue in the foreseeable future. Furthermore, the
success of our licensing efforts depends upon the strength of our intellectual
property rights.

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

     On November 30, 2004, we entered into a Master Services Agreement (the
"Agreement") with ThinkFire Services USA, Ltd. ("ThinkFire") pursuant to which
ThinkFire has been granted the exclusive (except for us and related companies)
worldwide rights to negotiate license agreements for the Remote Power Patent
with respect to certain potential licensees agreed between the parties. Either
we or ThinkFire can terminate the Agreement upon 60 days notice for any reason
or upon 30 days notice in the event of a material breach. We have agreed to pay
ThinkFire a fee not to exceed 20% of the royalty payments received from license
agreements consummated by ThinkFire on our behalf. There is no assurance that
ThinkFire will be successful in consummating license agreements on our behalf or
that such agreements will result in significant royalty payments to us.

     OUR SUCCESS IS DEPENDENT UPON OUR ABILITY TO PROTECT OUR PROPRIETARY
     TECHNOLOGIES.

     Our success is substantially dependent upon our proprietary technologies
and our ability to protect our intellectual property rights. We currently hold 6
patents issued by the U.S. Patent Office that relate to various
telecommunications and data networking technologies and include among other
things, patents covering the transmission of audio, voice and data over computer
and telephony networks and the delivery of remote PoE networks. We rely upon our
patents and trade secret laws, non-disclosure agreements with our employees,
consultants and third parties to protect our intellectual property rights. The
complexity of patent and common law, combined with our limited resources, create
risk that our efforts to protect our proprietary technologies may not be
successful. We cannot assure you that our patents will be upheld or that third
parties will not invalidate our patent rights. In the event our intellectual
property rights are not upheld, such an event would have a material adverse
effect on our company. In addition, there is a risk that third parties may
independently develop substantially equivalent or superior technologies.

     ANY LITIGATION TO PROTECT OUR INTELLECTUAL PROPERTY OR ANY THIRD PARTY
     CLAIMS TO INVALIDATE OUR PATENTS COULD HAVE A MATERIAL ADVERSE EFFECT ON
     OUR BUSINESS.

     Our success depends on our ability to protect our intellectual property
rights. In the future, it may be necessary for us to commence patent litigation
against third parties whom we believe require a license to our patents. In
addition, we may be subject to third-party claims seeking to invalidate our
patents, as is the case with the action commenced by PowerDsine relating to our
Remote Power Patent as discussed below. These types of claims, with or without
merit, may subject us to costly litigation and diversion of management's focus.
In addition, based on our limited financial resources, we may not be able to
pursue litigation as aggressively as others with substantially greater financial
resources. Based on our limited financial resources, it may be

                                                                               8
<PAGE>

necessary to engage third party professionals on a contingency basis pursuant to
which such parties would be entitled to share in the proceeds of any successful
enforcement of our intellectual property rights. If third parties making claims
against us seeking to invalidate our patent are successful, they may be able to
obtain injunctive or other equitable relief, which effectively could block our
ability to license or otherwise capitalize on our proprietary technologies.
Successful litigation against us resulting in a determination that our patents
are invalid would have a material adverse effect on our company.

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

     On March 31, 2004, PowerDsine Inc. ("PowerDsine") commenced an action
against us in the United District Court, Southern District of New York (Civil
Action No. 04 CV 2502) seeking a declaratory judgment that our Remote Power
Patent is invalid and is not infringed by PowerDsine and/or its customers.
PowerDsine further seeks an order permanently enjoining us (i) from making any
claims to any person or entity that PowerDsine's products infringe the Remote
Power Patent or contribute to infringement of the patent, (ii) from interfering
with or threatening to interfere with the importation, sale, license or use of
PowerDsine's PoE components or products, and (iii) from instituting or
prosecuting any lawsuit or proceeding placing at issue the right of PowerDsine,
its customers, licensees, successors, or assigns to import, use or sell
PowerDsine's PoE components or products. We believe our Remote Power Patent is
valid and that we have meritorious defenses to the action. On December 1, 2004,
we moved to dismiss the declaratory judgment action asserting, among other
things, that there is no actual case or controversy because PowerDsine did not
have reasonable apprehension of suit at the time the case was filed, and
therefore, the court lacks jurisdiction over the matter. On January 21, 2005 our
motion to dismiss was denied. We have engaged in settlement discussions with
PowerDsine in an effort to resolve the litigation. In the event that we are
unable to settle the litigation, we intend to vigorously defend the lawsuit and
take whatever actions are necessary to protect our intellectual property. In the
event, however, that the Court granted the declaratory judgment and our Remote
Power Patent was determined to be invalid, such a determination would have a
material adverse effect on us. Regardless of the outcome, this litigation may
subject us to significant costs and diversion of management time.

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

     The Institute of Electrical and Electronic Engineers (IEEE) is a
non-profit, technical professional association of more than 360,000 individual
members in approximately 175 countries. The Standards Association of the IEEE is
responsible for the creation of global industry standards for a broad range of
technology industries. In 1999, at the urging of several industry venders, the
IEEE formed a task force to facilitate the adoption of a standardized
methodology for the delivery of remote power over Ethernet networks which would
insure interoperability among vendors of switches and terminal devices. In June
2003, the IEEE Standards Association approved the 802.3af Power Over Ethernet
standard (the "Standard"), which covers technologies deployed in delivering
power over Ethernet cables including whether deployed in switches or as
standalone midspan hubs both of which provide power to remote devices including
wireless access points, IP phones and network based cameras. The technology is

                                                                               9
<PAGE>

commonly referred to as Power Over Ethernet ("PoE"). We believe our Remote Power
Patent covers several of the key technologies covered by the Standard. However,
there is a risk that as a result of litigation a court may determine otherwise
and such a determination would have a material adverse effect on our ability to
enter into license agreements and achieve revenue and profits from our Remote
Power Patent.

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

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

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

     The telecommunications and data networking technology market including,
transmission of audio, video and data over computer and telephony networks and
the delivery of remote power over Ethernet markets, are characterized by rapid
technological changes, changing customer requirements, frequent new product
introductions and enhancements, and evolving industry standards. The
introduction of products embodying new technologies and the emergence of new
industry standards may render our technologies obsolete or less marketable. To
the extent we are able to achieve revenue in the future, such revenue will be
derived from licensing our technologies based on existing and evolving industry
standards.

     DEPENDENCE UPON CEO AND CHAIRMAN.

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

     RISKS RELATED TO LOW PRICED STOCKS.

     Our common stock currently trades on the OTC Bulletin Board under the
symbol NSSI.OB. Since the trading price of our common stock is below $5.00 per
share, our common stock is considered a penny stock. SEC regulations generally
define a penny stock to be an equity security that is not listed on Nasdaq or a
national securities exchange and that has a market value of less than $5.00 per
share, subject to certain

                                                                              10
<PAGE>

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, 2005, there are outstanding (i) options and warrants to
purchase an aggregate of 10,710,905 shares of our common stock at exercise
prices ranging from $.12 to $10.13, and (ii) 207,630 additional shares of our
common stock which may be issued in the future under our stock option plan. To
the extent that outstanding options and warrants are exercised, stockholder
percentage ownership will be diluted and any sales in the public market of the
common stock underlying such options may adversely affect prevailing market
prices for our common stock.

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

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


ITEM 2. DESCRIPTION OF PROPERTY

     The Company currently leases office space in New York City at a cost of
$3,150 per month. The lease is for six months with automatic renewals unless
terminated upon 60 days notice.

ITEM 3. LEGAL PROCEEDINGS

     PowerDsine Litigation

     On March 31, 2004, PowerDsine Inc. commenced an action against the Company
in the United District Court, Southern District of New York (Civil Action No. 04
CV 2502) seeking a declaratory judgment that the Company's Remote Power Patent
(U.S. Patent No. 6,218,930) is not infringed by PowerDsine and/or its customers.
PowerDsine further seeks an order permanently enjoining the Company (i) from
making

                                                                              11
<PAGE>

any claims to any person or entity that PowerDsine's products infringe the
Remote Power Patent or contribute to infringement of the patent, (ii) from
interfering with or threatening to interfere with the importation, sale, license
or use of PowerDsine's PoE components or products, and (iii) from instituting or
prosecuting any lawsuit or proceeding placing at issue the right of PowerDsine,
its customers, licensees, successors, or assigns to import, use or sell
PowerDsine's PoE components or products. The Company believes its Remote Power
Patent is valid and it has meritorious defenses to the action. On December 1,
2004, we moved to dismiss the declaratory judgment action asserting, among other
things, that there is no actual case or controversy because PowerDsine did not
have reasonable apprehension of suit at the time the case was filed, and
therefore, the court lacks jurisdiction over the matter. On January 21, 2005 our
motion to dismiss was denied. The Company intends to vigorously defend the
action and take whatever actions are necessary to protect its intellectual
property. In the event, however, that the Court granted the declaratory judgment
and the patent was determined to be invalid, such a determination would have a
material adverse effect on the Company.

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

     None

                                     PART II

ITEM 5. MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND SMALL BUSINESS
ISSUER PURCHASES OF EQUITY SECURITIES

     MARKET INFORMATION. The Company's Common Stock currently trades on OTC
Bulletin Board under the symbol NSSI.OB. The following table sets forth, for the
periods indicated, the range of the high and low closing bid prices for the
Common Stock as reported. 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, 2004                        HIGH            LOW
                                                    ----            ---

Fourth Quarter                                      $1.25          $0.33
Third Quarter                                       $0.53          $0.05
Second Quarter                                      $0.25          $0.05
First Quarter                                       $0.39          $0.05

YEAR ENDED DECEMBER 31, 2003                        HIGH            LOW
                                                    ----            ---

Fourth Quarter                                      $0.22          $0.01
Third Quarter                                       $0.04          $0.01
Second Quarter                                      $1.06          $0.01
First Quarter                                       $0.16          $0.05

                                                                              12
<PAGE>

     On March 15, 2005, the last sale price for the Common Stock as reported on
the OTC Bulletin Board was $1.13 per share. The number of record holders of the
Company's Common Stock was 109 as of March 31, 2004.

     DIVIDEND POLICY. The Company has never declared or paid any cash dividends
on its Common Stock and does 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, the general
financial condition of the Company, the preferences of any series of Preferred
Stock, the general business conditions and future contractual restrictions on
payment of dividends, if any.

     RECENT ISSUANCES OF UNREGISTERED SECURITIES. No such issuances except as
disclosed in the Company's Current Report on Form 8-K filed on December 28,
2004.

     ISSUER PURCHASES OF EQUITY SECURITIES. None.

     EQUITY COMPENSATION PLAN INFORMATION

     The following table summarizes share and exercise price information about
the Company's equity compensation plans as of December 31, 2004.

<TABLE><CAPTION>
--------------------------------------- ---------------------------- --------------------------- -----------------------------------
                                         NUMBER OF SECURITIES TO BE                                 NUMBER OF SECURITIES REMAINING
                                          ISSUED UPON EXERCISE OF     WEIGHTED-AVERAGE EXERCISE  AVAILABLE FOR FUTURE ISSUANCE UNDER
                                            OUTSTANDING OPTIONS,         PRICE OF OUTSTANDING         EQUITY COMPENSATION PLANS
(A) RIGHTS COLUMN (A))                      WARRANTS AND RIGHTS         OPTIONS, WARRANTS AND     (EXCLUDING SECURITIES REFLECTED IN
--------------------------------------- ---------------------------- --------------------------- -----------------------------------
<S>                                             <C>                             <C>                           <C>
Equity compensation plans approved
   by security holders                           3,792,370                       $.94                          207,630
--------------------------------------- ---------------------------- --------------------------- -----------------------------------
Equity compensation plans not approved
   by security holders                                   0                         --                                0
--------------------------------------- ---------------------------- --------------------------- -----------------------------------
              Total                              3,792,370                       $.94                          207,630
--------------------------------------- ---------------------------- --------------------------- -----------------------------------
</TABLE>
                                                                              13
<PAGE>

ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION

     THE FOLLOWING DISCUSSION AND ANALYSIS SHOULD BE READ IN CONJUNCTION WITH
THE COMPANY'S FINANCIAL STATEMENTS, INCLUDING THE NOTES THERETO, INCLUDED
ELSEWHERE IN THIS FORM 10-KSB. 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 WHICH MAY AFFECT FUTURE RESULTS" IN ITEM 1 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.

     RESTATEMENT OF PREVIOUSLY ISSUED 2004 AND 2003 FINANCIAL STATEMENTS

     As described in Note B to the financial statements, in November 2005 the
Company decided to restate its statements of operations for the years ended
December 31, 2004 and December 31, 2003. The Company decided to restate its
statement of operations for the year ended December 31, 2004 to recognize a
deemed dividend with respect to an exchange transaction in April 2004 involving
its outstanding preferred stock (the "2004 Exchange Transaction") as a result of
the beneficial conversion feature in accordance with Emerging Issues Task Force
("EITF") Issue No. 00-27. Additionally, the Company concluded that the statement
of operations for the year ended December 31, 2003 should be restated to present
the gain on sale of its software assets in May 2003 (the "Asset Sale") and
revenues and expenses associated with the software business as discontinued
operations.

     The Company's restatement of its statement of operations for the year ended
December 31, 2004 resulted in the following changes: the inclusion of a "Deemed
Dividend on Preferred Stock Conversion" in the amount of $273,000; an increase
of the net loss attributable to common stockholders by $273,000, to $3,405,000
from $3,132,000; and an increase of the net loss per common share to $(0.26) per
share from $(0.24) per share basic and diluted.

     In addition, the reclassification to discontinued operations pertaining to
the 2003 Asset Sale and revenue and expenses related to our software business
and the restatement of the Company's statement of operations for the year ended
December 31, 2003 resulted in the following changes: "Gain on sale of assets" of
$415,000 and revenues of $218,000, cost of services of $51,000 and general and
administrative expenses of $613,000 related to the Company's software business
were reclassified to "Loss from discontinued operations" of $(31,000); General
and administrative expenses were reduced from $1,208,000 to $595,000 to include
only such expenses from continuing operations; inclusion of "Loss from
continuing operations" of $583,000 and "Loss from discontinued operations" of
$31,000; and inclusion of "Loss per common share - basic and diluted from
continuing operations" of $(0.07) and "Loss per common share basic and diluted
from discontinued operations" of $(0.00). The reclassification has no effect on
the net loss, net loss attributable to

                                                                              14
<PAGE>

common stockholders or net loss per common share - basic and diluted. The 2003
Asset Sale had no impact on the balance sheet as of December 31, 2003.

     OVERVIEW

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

     On November 18, 2003, the Company acquired a portfolio of
telecommunications and data networking patents (the "Patent Portfolio") from
Merlot Communications, Inc., a broadband communications solutions provider. The
Patent Portfolio consists of six patents issued by the U.S. Patent Office that
relate to various telecommunications and data networking technologies and
includes, among other things, patents covering the transmission of audio, video
and data over computer and telephony networks and the delivery of power over
Ethernet networks for the purpose of remotely powering network devices.

     In February 2004, the Company initiated licensing efforts relating to one
of its patents (U.S. Patent No. 6,218,930) covering the remote delivery of power
over Ethernet cable (the "Remote Power Patent"). As of the date of this Report,
the Company has not entered into any license arrangement with respect to the
Remote Power Patent, although it is pursing such arrangements with third
parties. The Company does not currently have any revenue from operations. The
success of the Company and its ability to achieve revenue is largely dependent
on its ability to consummate licensing arrangements with third parties. In
November 2004, the Company entered into an agreement with ThinkFire Services
USA, Ltd. ("ThinkFire") pursuant to which ThinkFire has been granted the
exclusive worldwide rights to negotiate license agreements for the Remote Power
Patent with certain agreed-upon potential licensees. The Company has agreed to
pay ThinkFire a fee not to exceed 20% of the royalty payments received from
license agreements consummated by ThinkFire on its behalf.

     The Company's success depends on its ability to protect its intellectual
property rights. In the future, it may be necessary for the Company to commence
patent litigation against third parties who it believes are infringing its
patents. In addition, third parties may seek to invalidate the Company's
patents, as is the case with the action commenced by PowerDsine (see Item 3
"Legal Proceedings"). The costs of litigation are significant and based on the
Company's limited financial resources, it may be necessary to engage attorneys
on a contingency basis pursuant to which counsel would be entitled to share in
the proceeds of any successful enforcement of the Company's intellectual
property rights. If third parties making claims against the Company seeking to
invalidate the Company's patents are successful, they may be able to obtain
injunctive or other equitable relief, which could effectively block the
Company's ability to license or otherwise capitalize on its proprietary
technologies. If the Company is not successful in protecting its patents in
litigation and its patents are determined to be invalid, such determinations
would have a material adverse effect on the Company.

                                                                              15
<PAGE>

     On December 21, 2004 and January 13, 2005, the Company completed a private
offering of its equity securities resulting in gross proceeds of $2,685,000. The
Company anticipates that such proceeds will more likely than not be sufficient
to support its operations until September 2006. (See "Liquidity and Capital
Resources" at page 18 hereof)

     To date the Company has incurred significant losses and at December 31,
2004, had an accumulated deficit of $(42,989,000). At March 31, 2005, the
Company had approximately $1,722,000 of cash and cash equivalents. Management
believes that based on its current cash position, the Company has sufficient
capital to fund its operations until September 2006, although there is no
assurance that the Company will not have sufficient capital prior to such date.
(See "Liquidity and Capital Resources" at page 18 hereof).

CRITICAL ACCOUNTING POLICIES:

     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 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", 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 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 C [10] on page F-9 to the Financial Statements.

                                                                              16
<PAGE>

     RESULTS OF OPERATIONS


YEAR ENDED DECEMBER 31, 2004 COMPARED TO YEAR ENDED DECEMBER 31, 2003.

     The Company had no revenues for the year ended December 31, 2004 ("2004")
and the year ended December 31, 2003 ("2003").

     On May 30, 2003, the Company completed the sale of its CyberwallPlus
technology and related intellectual property (the "Assets") for $415,000. The
carrying value of the Assets were written down to zero in the third quarter of
2002. The gain on sale of the Assets of $415,000 and expenses and revenues
related to the software business has been included in "Loss from discontinued
operations". The loss from discontinued operations was $(31,000) for 2003.

     General and administrative expenses include employee costs, including
salary, benefits, travel and other related expenses associated with management,
finance and accounting operations, and legal and other professional services
provided to the Company. General and administrative expenses increased by
$1,361,000 or 70%, to $1,956,000 in 2004 from $595,000 in 2003. The increase in
general and administrative expenses was primarily due to an increase in legal
and other professional fees incurred in connection with the acquisition of the
patent portfolio and related licensing efforts as well as the recognition of
expenses relating to the valuation of stock options issued by the Company.

     The loss from continuing operations increased by $1,370,000 from $(583,000)
for 2003 to $(1,953,000) for 2004 because of an increase in general and
administrative expenses of $1,361,000 as discussed above.

     Interest income decreased by $9,000 or 75% to $3,000 in 2004 from $12,000
in 2003 primarily due to the increased funds used for operations and a decrease
in funds available for short term investments.

     The Company recognized a deemed dividend of $273,000 with respect to an
exchange transaction in April 2004 involving outstanding preferred stock as a
result of a beneficial conversion feature. This deemed dividend increased the
net loss attributable to common stockholder by $273,000 to $3,405,000 for 2004.

     On December 21, 2004, the Company extended the exercise period for warrants
to purchase 1,352,152 shares of Common Stock issued in connection with a
financing in December 1999. The associated expense with respect to the warrant
extension was recorded as a deemed dividend in the amount of $1,179,000 in 2004
causing the net loss attributable to common stockholders to increase by such
amount.

     No provision for or benefit from federal, state or foreign income taxes was
recorded for 2004 or 2003 since the Company incurred net operating losses for
each year and fully reserved its deferred tax assets as their future realization
could not be determined.

                                                                              17
<PAGE>

     As a result of the foregoing, the net loss was $1,953,000 for 2004 as
compared to a net loss of $614,000 for 2003.

     LIQUIDITY AND CAPITAL RESOURCES

     At December 31, 2004, the Company had $2,177,000 of cash and cash
equivalents and working capital of $1,335,000. The Company has financed its
operations primarily through the sale of equity and debt securities, and the
sale of its security software technology in May 2003. Net cash used in operating
activities was $842,000 in 2004 as compared to $1,360,000 in 2003. Net cash used
in operating activities for 2004 was primarily attributable to the net loss of
$1,953,000, an increase in accounts payable, accrued expenses and other current
liabilities of $344,000 and the expenses related to the valuation of stock
options and warrants.

     Net cash used in investing activities during 2004 was financed with the
remaining funds of $415,000 received from the sale of its CyberwallPlus software
and related intellectual property in May 2003. The Company does not currently
have a line of credit from a commercial bank or other institution.

     In December 2004 and January 2005, the Company completed a private offering
of its equity securities, consisting of an aggregate of 2,685,000 shares of
common stocks and warrants to purchase an aggregate of 2,013,750 shares of
common stock, resulting in gross proceeds to the Company of $2,685,000.

     The Company anticipates, based on currently proposed plans and assumptions,
relating to its operations that its cash balance of approximately $1,722,000 as
of March 31, 2005 will more likely than not be sufficient to satisfy the
Company's operations and capital requirements until September 2006. There can be
no assurance, however, that such funds will not be expended prior thereto. In
the event the Company's plans change, or its assumptions change, or prove to be
inaccurate (due to unanticipated expenses, difficulties, delays or otherwise),
the Company may have insufficient funds to support its operations prior to
September 2006. The Company is currently pursuing licensing opportunities for
its Remote Power Patent, however, to date the Company has not entered into any
such licensing arrangements. The Company's inability to consummate licensing
arrangements and derive revenues therefrom on a timely basis or obtain
additional financing when needed would have a material adverse effect on the
Company, requiring it to curtail or cease operations. In addition, any equity
financing may involve substantial dilution to the stockholders of the Company.


ITEM 7. FINANCIAL STATEMENTS

     The financial statements required hereby are located on pages F-1 through
F-18 which follow Part III.

ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.

     None.

                                                                              18
<PAGE>

ITEM 8A. CONTROLS AND PROCEDURES.

     (a) Evaluation of Disclosure Controls and Procedures.

     The Company's Chief Executive Officer and Chief Financial Officer have
reviewed the disclosure controls and procedures of the Company as of the end of
the period covered by this Annual Report on Form 10-KSB. Based upon this review,
these officers concluded that, as of the end of the period covered by this
Annual Report on Form 10-KSB, the Company's disclosure controls and procedures
are effective to ensure that information required to be disclosed by the Company
in the reports it files or submits under 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 the Company's Chief Executive Officer and Chief Financial Officer, to
allow timely decisions regarding required disclosure.

     (b) Changes in Internal Controls.

     There were no significant changes in the Company's internal controls over
financial reporting that have materially affected, or are reasonably likely to
materially affect these controls during the last fiscal quarter included in this
report or from the end of the reporting period to the date of this Annual Report
on Form 10-KSB.

ITEM 8B. OTHER INFORMATION.

     None.

                                    PART III

ITEM 9. DIRECTORS AND EXECUTIVE OFFICERS.

       NAME            AGE                   POSITION
       ----            ---                   --------
Corey M. Horowitz       50       Chairman and Chief Executive Officer, Chairman
                                 of the Board of Directors
David C. Kahn           53       Chief Financial Officer
Harry B. Schessel       40       Director
Robert Graifman         48       Director
Robert M. Pons          48       Director

                                                                              19
<PAGE>

     COREY M. HOROWITZ became Chairman and Chief Executive Officer of the
Company in December 2003. Mr. Horowitz has also served as Chairman of the Board
of Directors of the Company since January 1996 and has been a member of the
Board of Directors since April 1994. In January 2003, Mr. Horowitz also became
Secretary of the Company. 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 the
Company. 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 Chief Financial Officer of the Company 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.

     HARRY B. SCHESSEL has been a director of the Company since July 2001. Since
July 2002, Mr. Schessel has been a real estate developer. From July 2001 until
July 2002, Mr. Schessel was employed at Kroll, Inc. ("Kroll") as the Global
Practice Leader for the Information Security Group. From June 2000 to July 2001,
Mr. Schessel advised security companies, including Kroll, in the areas of
strategy, operations, marketing and business development and also as a
consultant to investment banking firms and venture capital firms for purposes of
evaluating investments in the information security industry. From March 2000
until June 2000, Mr. Schessel was Vice President of Cybersafe, Inc., a security
software company. In June 1997, Mr. Schessel co-founded Centrax, Inc., a company
engaged in the development and marketing of intrusion detection software, and
was employed from June 1997 until its sale in March 1999 in various capacities,
including Chief Operating Officer and Executive Vice President.

     ROBERT GRAIFMAN became a director of the Company in December 2003. Mr.
Graifman currently serves as Managing Member of Skyfarm Management, LLC, a New
Jersey based investment management company, and also as a Managing Member of
Federal Autocat Recycling, LLC, a resource reclamation and recycling Company.
From June 2000 to August 2003, Mr. Graifman also served as Chief Financial
Officer of Gilo Ventures, LLP, a California based venture capital firm focused
on emerging technology companies.

     ROBERT M. PONS became a director of the Company in December 2003. Mr. Pons
currently serves as President and Chief Executive Officer of SmartServ Online,
Inc. (OTCBB:SSRV),a wireless applications service provider, a position he has
held since January 2004. 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.

     COREY M. HOROWITZ and ROBERT GRAIFMAN are brothers-in-law.

                                                                              20
<PAGE>

COMMITTEES OF THE BOARD OF DIRECTORS

     During 2004, Harry Schessel and Robert Graifman (beginning March 2004)
served as members of the Audit Committee. Messrs. Schessel and Graifman are the
current members of the Audit Committee. Mr. Graifman is the audit committee
financial expert. The Audit Committee meets with the Company's independent
auditors at least annually to review the scope and results of the annual audit;
reviews with the Company's independent auditors the Company's quarterly reports
on Form 10-QSB prior to filing, recommends to the Board the independent auditors
to be retained; and receives and considers the auditors' comments as to internal
controls, accounting staff and management performance and procedures in
connection with audit and financial controls. The Audit Committee has adopted a
written Audit Committee Charter. During 2004, Harry Schessel and Robert Pons
(beginning March 2004) served as members of the Compensation Committee until Mr.
Schessel no longer served as of November 2004. Mr. Pons is currently the sole
member of the Compensation Committee. The Compensation Committee is responsible
for determining compensation for the executive officers of the Company,
including bonuses and benefits, and administration of the Company's compensation
programs, including the Company's Stock Option Plan.

LIMITATION ON LIABILITY AND INDEMNIFICATION MATTERS

     The Company's 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. The
Company's Bylaws provide that the Company shall indemnify its directors,
officers, employees and agents to the fullest extent permitted by law. The
Company's Bylaws also permit the Company 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. The Company currently maintains liability
insurance for its officers and directors. At present, there is no pending
material litigation or proceeding involving any director, officer, employee or
agent of the Company where indemnification will be required or permitted. The
Company is not aware of any threatened litigation or proceeding that might
result in a material claim for such indemnification.

                                                                              21
<PAGE>

TECHNICAL ADVISORY BOARD

     In November 2004 the Company established a Technical Advisory Board to
assist the Company with its strategic business plan of maximizing the value of
its Patent Portfolio. Each member of the Technical Advisory Board received a 5
year option to purchase 17,500 shares (fully vested) of the Company's Common
Stock at an exercise price of $.54 per share.

     The initial members of the Technical Advisory Board include:

     George Conant, Chief Executive Officer of Merlot Communications, Inc., a
broadband communications solutions provider. 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
roles of Vice President of Engineering, Vice President of Technology and Chief
Technology Officer. Prior to Xyplex, Mr. Conant was with 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, 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.

     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.

     Jonathan Greene, Vice President of Marketing at Kovado, Inc., a security
software company. In his 20-year career Mr. Greene has established and grown
product lines in such diverse market segments as network systems, storage
management, security and network management. In senior product management roles
with Data General and Cheyenne Software he founded product lines that yielded
several hundred million dollars in revenue. At System Management ARTS (SMARTS)
he developed and managed major OEM deals which dramatically grew corporate
revenue while simultaneously launching several new products. Prior to joining
Kavado, Inc., Mr. Greene was senior vice president of marketing and business
development for

                                                                              22
<PAGE>

the Company. He holds a BS in engineering from Rensselaer Polytechnic Institute
and an MBA from the Johnson School at Cornell University.

SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

     Section 16(a) of the Exchange Act requires the Company's executive
officers, directors, and persons who own more than 10% of the Company's
outstanding Common Stock to 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
the Company with copies of all Section 16(a) forms they file. The Company
believes that its executive officers, directors, and greater than 10%
stockholders complied during the year ended December 31, 2004.

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 10. EXECUTIVE COMPENSATION

     The following table summarizes compensation, for the fiscal years
indicated, awarded to, earned by or paid to the Company's Chief Executive
Officer ("CEO") and to each of its executive officers (collectively, the "Named
Executive Officers") who received annual salary and bonus in excess of $100,000
for the year ended December 31, 2004 for services rendered in all capacities to
the Company.

     SUMMARY COMPENSATION TABLE
<TABLE><CAPTION>
                                                      ANNUAL COMPENSATION                LONG TERM COMPENSATION AWARDS
                                             ----------------------------------------   -------------------------------
                                                                                          SHARES
                               YEAR ENDED                              OTHER ANNUAL     UNDERLYING     ALL OTHER ANNUAL
NAME AND PRINCIPAL POSITION    DECEMBER 31    SALARY($)    BONUS($)   COMPENSATION(1)   OPTIONS(#)     COMPENSATION(1)
---------------------------    -----------   -----------   --------   ---------------   ----------     ---------------
<S>                               <C>        <C>              <C>            <C>         <C>                      <C>
Corey M. Horowitz                 2004       $218,970                                    1,500,000
    Chairman and Chief            2003       $210,000(2)       --             --         1,600,000                 --
    Executive Officer             2002             --          --             --                --                 --
</TABLE>
-------------------------
(1)  The Company has concluded that the aggregate amount of perquisites and
     other personal benefits paid to Mr. Horowitz did not exceed the lesser of
     ten percent (10%) of such individual's annual salary and bonus for each
     fiscal year indicated or $50,000.

(2)  On December 22, 2003, Mr. Horowitz became Chairman and Chief Executive
     Officer of the Company. CMH Capital Management Corp. ("CMH"), the sole
     stockholder and officer of which is Mr. Horowitz, rendered financial
     consulting services from June 2001 until December 2003 and was paid
     consulting fees of $205,398 for 2003 which is included in Mr. Horowitz's
     salary. Mr. Horowitz's salary for 2003 includes (i) his salary for December
     2003 as Chairman and Chief Executive Officer and (ii) consulting fees
     received by CMH for the period January 2003 until December 2003.

                                                                              23
<PAGE>

EMPLOYMENT CONTRACTS, TERMINATION OF EMPLOYMENT AND CHANGE-IN-CONTROL
ARRANGEMENTS

     On November 26, 2004, the Company entered into an Employment Agreement with
Corey M. Horowitz pursuant to which Mr. Horowitz continued to serve as Chairman
and Chief Executive Officer of the Company for a two year term at an annual base
salary of $250,000 for the first year and $275,000 for the second year. Mr.
Horowitz was also issued options to purchase an aggregate of 1,500,000 shares of
the Company's common stock consisting of (i) a ten (10) year option to purchase
1,100,000 shares at an exercise price of $.25 per share which fully vested on
the date of grant and (ii) a five year option to purchase 400,000 at an exercise
price of $.68 per share which vested 50% on the date of grant and 50% one year
thereafter, subject to acceleration upon a change of control. In addition, under
the terms of his Employment Agreement, Mr. Horowitz shall receive bonus
compensation in an amount equal to 5% of Network-1's royalties or other payments
received from licensing its patents. 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 merger of the Company with or into another
corporation or entity. The aforementioned bonus compensation shall continue to
be paid to Mr. Horowitz for a period of five (5) years following the term of the
Employment Agreement with respect to licenses entered into by the Company with
third parties during the term of the Employment Agreement, 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 connection with his Employment Agreement, Mr. Horowitz has agreed not to
compete with the Company as follows: (i) during the term of the agreement and
for a period of 12 months thereafter if his employment is terminated other than
for cause (as defined) provided he is paid his 12 month base salary severance
amount and (ii) for a period of two years from the termination date, if
terminated "For Cause" or "Without Good Reason." In accordance with his
employment agreement, Mr. Horowitz also has certain anti-dilution rights which
provide that if at any time during the period ended December 31, 2005, in the
event that the Company completes an offering of its common stock or any
securities convertible or exercisable into common stock, 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 (20.11%) of the Company based
upon options and warrants owned by Mr. Horowitz and exclusive of his ownership
of shares of Common Stock as he owned as of the time of execution of his
employment agreement (November 2004).

     On January 22, 2004, the Company entered into an agreement with David C.
Kahn pursuant to which he agreed to serve as Chief Financial Officer of the
Company for the year ending December 31, 2004 on a consulting basis, in
consideration for annual compensation of $54,000. In addition, Mr. Kahn was also
granted a ten-year option to purchase 50,000 shares of Common Stock, at an
exercise price of $.35 per share, of which 20,000 shares vested on the date of
grant and the balance vested on an

                                                                              24
<PAGE>

equal monthly basis through December 31, 2004. Mr. Kahn continues to currently
serve as Chief Financial Officer of the Company.

DIRECTOR COMPENSATION

     The Company has compensated each director, who is not an employee of the
Company, by granting to each outside director (upon joining the Board) stock
options to purchase 50,000 shares of Common Stock, at an exercise price equal to
the closing price of the Common Stock on the date of grant, with the options
vesting over a one year period in equal quarterly amounts. In addition, each
non-employee director receives an option grant to purchase 7,500 shares of
Common Stock for each year of service after the first year as a member of the
Board of Directors. Such options vest over a one year period in equal quarterly
amounts. In addition to the aforementioned option grants, directors may be
granted additional options at the discretion of the Board of Directors and the
Compensation Committee.

OPTION GRANTS IN 2004

     The following stock options were granted to the Named Executive Officers
during the year ended December 31, 2004:

                        NUMBER OF
                         SHARES          % OF TOTAL        EXERCISE
                       UNDERLYING     OPTIONS GRANTED TO   PRICE PER  EXPIRATION
                    OPTIONS GRANTED  EMPLOYEES IN 2004(1)  SHARE (2)     DATE
                    ---------------  --------------------  ---------  ----------
Corey M. Horowitz     1,100,000(2)           73.3%           $.25     11/26/2014
                        400,000(2)           26.7%           $.68     11/26/2009

-------------------
(1)  The number of options granted to employees during the year ended December
     31, 2004 used to compute this percentage is based on 400,000 incentive
     stock options and 1,100,000 non-qualified stock options.

(2)  All options were granted at an exercise price equal to the fair market
     value of the Company's Common Stock at the date of grant, as determined by
     the Board of Directors except for the grant to Corey M. Horowitz of options
     to purchase 1,100,000 shares of Common Stock at an exercise price of $.25
     per share (at a time when the fair market value was $.62 per share).

                                                                              25
<PAGE>

     FISCAL YEAR-END OPTION VALUES

     No options were exercised by the Named Executive Officers during the year
ended December 31, 2004. The following table sets forth information relating to
the fiscal year-end value of unexercised options held by the Named Executive
Officers on an aggregated basis:

                               Number of
                         Securities Underlying          Value of Unexercised
                          Unexercised Options           In-the-Money Options
                             at 12/31/2004            at Fiscal Year-End ($)(1)
                      ---------------------------   ----------------------------
        Name          Exercisable   Unexercisable   Exercisable    Unexercisable
        ----          -----------   -------------   -----------    -------------
Corey M. Horowitz(2)   3,677,720       860,625       $1,972,839       $632,500

-------------------
(1)  Options are "in-the-money" if the market price of the Common Stock on
     December 30, 2004 ($1.08) exceeds the exercise price of such options. The
     value of such options is calculated by determining the difference between
     the aggregate market price of the Common Stock underlying the options on
     December 30, 2004 (last trading day of the year) and the aggregate exercise
     price of such options.

(2)  Includes (i) warrants to purchase 85,220 shares held by Mr. Horowitz and
     (ii) warrants to purchase 300,000 shares of Common Stock held by CMH
     Capital Management Corp., an entity in which Mr. Horowitz is the sole owner
     and officer.

                                                                              26
<PAGE>

ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS

     The following table sets forth information regarding the beneficial
ownership of the Company's shares of Common Stock as of March 31, 2005 (i) each
person known by the Company to be the beneficial owner of more than 5% of the
outstanding shares of Common Stock, (ii) each director and nominee, (iii) each
of the executive officers of the Company, and (iv) all executive officers and
directors of the Company as a group.

    NAME AND ADDRESS(1) OF             NUMBER OF SHARES    PERCENTAGE OF SHARES
       BENEFICIAL OWNER               BENEFICIALLY OWNED   BENEFICIALLY OWNED(2)

Corey M. Horowitz(3)                        8,334,281              36.9%
CMH Capital Management Corp. (4)            4,167,800              21.9%
Barry Rubenstein(5)                         3,792,915              21.3%
Irwin Lieber (6)                            2,098,002              11.8%
Barry Fingerhut (7)                         2,008,598              11.3%
Emigrant Capital Corporation (8)
  Paul Milstein Revocable 1998 Trust
  New York Private Bank & Trust Corporation
  Emigrant Bancorp. Inc.
  Emigrant Savings Bank                     1,312,500               7.2%

Wheatley Partners II, L.P. (9)              1,280,207               7.2%
First New York Securities L.L.C.(10)        1,206,800               6.8%
Singer Food Management, LLC(11)             1,063,480               5.9%
Robert Graifman(12)                           279,700               1.6%
Harry B. Schessel (13)                        125,000                *
David C. Kahn (14)                             50,000                *
Robert Pons(15)                                50,000                *
All officers and directors as a group       8,838,981              39.2%
 (5 Persons)
---------------------

     * Less than 1%.

(1)  Except as otherwise indicated, the address for each beneficial owner is c/o
     Network-1 Security Solutions, Inc., 445 Park Avenue, Suite 1028, New York,
     New York 10022.

(2)  Unless otherwise indicated, the Company believes 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. 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 17,697,572 shares of Common Stock outstanding.

(3)  Includes (i) 475,053 shares of Common Stock held by Mr. Horowitz, (ii)
     3,502,697 shares of Common Stock subject to currently exercisable stock
     options held by Mr.

                                                                              27
<PAGE>

     Horowitz, (iii) 2,867,800 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) 85,220 shares of Common Stock subject
     to currently exercisable warrants held by Mr. Horowitz, (vii) 78,720 shares
     of Common Stock owned by Donna Slavitt, the wife of Mr. Horowitz, (viii)
     22,500 shares of Common Stock held by two trusts and a custodian account
     for the benefit of Mr. Horowitz's three children and (ix) 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 610,625 shares
     of Common Stock which are not currently exercisable. The address of CMH
     Capital Management Corp. is 445 Park Avenue, New York, New York 10022.

(4)  Includes (i) 2,867,800 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.

(5)  Includes (i) 1,280,207 shares of Common Stock held by Wheatley Partners II,
     L.P., (ii) 194,280 shares of Common Stock held by Wheatley Partners, L.P.,
     (iii) 16,868 shares of Common Stock held by Wheatley Foreign Partners,
     L.P., (iv) 150,012 shares of Common Stock held by Mr. Rubenstein, (v)
     47,500 shares of common stock subject to currently exercisable stock
     options held by Mr. Rubenstein, (vi) 49,664 shares of Common Stock subject
     to currently exercisable warrants held by Mr. Rubenstein, (vii) 829,226,
     619,983, 309,316, 294,810 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. 6 to Schedule 13D jointly filed by
     Mr. Rubenstein and related parties with the Securities and Exchange
     Commission on January 3, 2005 and Form 4s filed by Mr. Rubenstein with the
     Securities and Exchange Commission on December 21, 2004 and February 17,
     2005. Barry Rubenstein is a general partner of Wheatley Partners II, L.P.
     and a member of the general partner of each of Wheatley Partners, L.P. and
     Wheatley Foreign Partners, L.P. Barry Rubenstein and Woodland Services
     Corp. are the general partners of Woodland Venture Fund and Seneca
     Ventures. Barry Rubenstein is the President and sole director of Woodland
     Services Corp. Marilyn Rubenstein is the wife of Barry Rubenstein. Mr.
     Rubenstein disclaims beneficial ownership of the shares of Common Stock
     held by Wheatley Partners II, L.P., Wheatley Partners, L.P. and Wheatley
     Foreign Partners, L.P., except to the extent of his equity interest
     therein. The address of Barry Rubenstein is 68 Wheatley Road, Brookville,
     New York 11545. The address of Wheatley Partners II, L.P. and Wheatley
     Partners, L.P. is 60 Cuttermill Road, Great Neck, New York 11021. The
     address of Wheatley Foreign Partners, L.P. is c/o Fiduciary Trust, One
     Capital Place, Snedden Road, P.O. Box 162, Grand Cayman, British West
     Indies. The address for Woodland Venture Fund, Seneca Ventures, Brookwood
     Partners, L.P. and Woodland Partners is c/o Barry Rubenstein, 68 Wheatley
     Road, Brookville, New York 11545.

(6)  Includes (i) 1,280,207 shares of Common Stock held by Wheatley Partners II,
     L.P., (ii) 194,280 shares of Common Stock held by Wheatley Partners, L.P.,
     (iii) 16,868 shares of Common Stock held by Wheatley Foreign Partners,
     L.P., (iv) 509,483 shares of Common Stock owned by Mr. Lieber, (v) 47,500
     shares of Common Stock subject to currently exercisable stock options owned
     by Mr. Lieber, and (vi) 49,664 shares of Common Stock subject to currently
     exercisable warrants owned by Mr. Lieber. Does not include options to
     purchase 11,875 shares of Common Stock owned by Mr. Lieber which

                                                                              28
<PAGE>

     are not currently exercisable. The aforementioned beneficial ownership by
     Mr. Lieber is based upon Amendment No. 6 to Schedule 13D jointly filed by
     Mr. Lieber and related parties with Securities and Exchange Commission on
     January 3, 2005 and Form 4s filed with the Securities and Exchange
     Commission on December 21, 2004 and February 17, 2005. Mr. Lieber disclaims
     beneficial ownership of the shares of Common Stock held by Wheatley
     Partners II, L.P., Wheatley Partners, L.P. and Wheatley Foreign Partners,
     L.P., except to the extent of his equity interest therein. The address of
     Irwin Lieber is c/o Wheatley Partners, II, L.P., 80 Cuttermill Road, Great
     Neck, New York 11021.

(7)  Includes (i) 1,280,207 shares of Common Stock held by Wheatley Partners,
     II, L.P., (ii) 194,280 shares of Common Stock held by Wheatley Partners,
     L.P., (iii) 16,868 shares of Common Stock held by Wheatley Foreign
     Partners, L.P., and (iv) 517,243 shares of Common Stock owned by Mr.
     Fingerhut. Mr. Fingerhut disclaims beneficial ownership of the shares of
     Common Stock held by Wheatley Partners II, L.P., Wheatley Partners, L.P.
     and Wheatley Foreign Partners, L.P., except to the extent of his equity
     interest therein. The address of Barry Fingerhut is c/o Wheatley Partner,
     II, L.P., 80 Cuttermill Road, Great Neck, New York 11021.

(8)  Includes (i) 750,000 shares of Common Stock and (ii) 562,500 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. The principal
     business address of Emigrant Capital, ESB, EBI, NYPBTC and the Trust is 6
     East 43rd Street, New York, New York 10017.

(9)  Includes 1,280,207 shares of Common Stock. Does not include (i) 2,415,544,
     720,631, 728,391, 139,393 and 140,945 shares of Common Stock beneficially
     owned by Barry Rubenstein, Irwin Lieber, Barry Fingerhut, Jonathan Lieber
     and Seth Lieber, respectively, each of whom is a general partner of
     Wheatley Partners II, L.P. and (ii) an aggregate of 194,328 shares of
     Common Stock subject to currently exercisable warrants and options owned by
     Barry Rubenstein (97,164 shares) and Irwin Lieber (97,164 shares). Each of
     Messrs. Rubenstein, I. Lieber, Fingerhut, J. Lieber and S. Lieber disclaims
     beneficial ownership of the securities held by Wheatley Partners II, L.P.,
     except to the extent of their equity interest therein. Jonathan Lieber and
     Seth Lieber each beneficially own less than 1% of the outstanding Common
     Stock of the Company exclusive of shares beneficially owned by Wheatley
     Partners II, L.P., Wheatley Partners, L.P. and Wheatley Foreign Partners,
     L.P. and as such have not been included in the beneficial ownership table.
     Wheatley Partners II, L.P.'s business address is 80 Cuttermill Road, Great
     Neck, New York 11021.

(10) Includes (i) 874,000 shares of Common Stock owned together by First New
     York Securities, LLC ("FNY") and (ii) an aggregate of 332,800 shares of
     Common Stock owned by Jay Goldstein (150,000 shares), Douglas Lipton and
     his wife (132,800 shares), and Michael Marvin (50,000 shares), all
     employees of FNY. The aforementioned is based upon an Amended Schedule 13G
     filed jointly by the parties with the SEC on March 22, 2004 and a Form 4
     filed by FNY on the same date.

                                                                              29
<PAGE>

(11) Includes (i) 405,000 shares of Common Stock and 187,500 shares of Common
     Stock subject to currently exercisable warrants owned by Singer Fund, L.P.,
     (ii) 282,980 shares of Common Stock and 187,500 shares of Common Stock
     subject to currently exercisable warrants owned by Singer Fund, L.P., and
     (iii) 500 shares of Common Stock owned by Singer Congressional Fund, L.P.
     Singer Fund Management, LLC makes all investment and voting decisions on
     behalf of Singer Opportunity Fund, L.P., Singer Fund, L.P. and Singer
     Congressional Fund, L.P. The aforementioned is based on a Schedule 13G
     filed jointly by Singer Fund Management, LLC, Singer Opportunity Fund,
     L.P., Singer Fund, L.P. and Singer Congressional Fund, L.P. with the
     Securities and Exchange Commission on March 23, 2005. The principal
     business address of Singer Fund Management, LLC is 650 Fifth Avenue, New
     York, New York 10019.

(12) Includes (i) 154,700 shares of Common Stock, (ii) 75,000 shares subject to
     currently exercisable warrants and (iii) 50,000 shares subject to currently
     exercisable stock options issued to Mr. Graifman pursuant to the Stock
     Option Plan.

(13) Includes 125,000 shares of Common Stock subject to currently exercisable
     stock options issued to Mr. Schessel pursuant to the Stock Option Plan.

(14) Includes 50,000 shares of Common Stock subject to currently exercisable
     stock options issued to Mr. Kahn pursuant to the Stock Option Plan.

(15) Includes 50,000 shares subject to currently exercisable stock options
     issued to Mr. Pons pursuant to the Stock Option Plan.

     The Equity Compensation Plan information presented in Item 5 of this Annual
Report is incorporated herein in its entirety.


ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     During the year ended December 31, 2003 the Company paid CMH Capital
Management Corp ("CMH") a monthly fee of $17,500 in consideration for financial
advisory and consulting services rendered. Corey M. Horowitz, Chairman, Chief
Executive Officer, Chairman of the Board of Directors and a principal
stockholder of the Company, is the sole officer, director and stockholder of
CMH. In addition, in connection with such financial advisory and consulting
services, CMH was reimbursed for expenses during 2003 in the amount of $41,000,
including the allocable portion of rent for office space in New York City. In
December 2003, the Company employed Mr. Horowitz as Chairman and Chief Executive
Officer at which time CMH no longer provided financial and advisory services to
the Company. At the time of commencement of his employment as Chairman and Chief
Executive Officer in December 2003, the Company issued to Mr. Horowitz five (5)
year options to purchase an aggregate of 1,600,000 shares of common stock
(1,084,782 shares at an exercise price of .23 per share and options to purchase
515,218 shares at an exercise price of $.13 per share. In November 2004, the
Company entered into a two year employment agreement with Mr. Horowitz pursuant
to which he continued to serve as Chairman and Chief Executive Officer, and the
Company issued additional options to Mr. Horowitz to purchase 1,500,000 shares
of common stock. (See Item 10. "Executive Compensation - Employment Contracts,
Termination of Employment and Change-In-Control Arrangements" at page 24 hereof.

                                                                              30
<PAGE>

     In October 2001, the Company entered into a ten-year License and
Distribution Agreement (the "Agreement") with Falconstor Software, Inc.
("Falconstor"), an investor in the Company's private offering of securities
completed in October 2001. On May 30, 2003, as part of the Company's sale of its
software assets, the Company assigned its rights under the Agreement to the
purchaser of such assets (See Note H[3] to the Financial Statements).
Falconstore was a principal stockholder of the Company at the time of the
aforementioned transactions. In addition, two of the Company's principal
stockholders were also principal stockholders of Falconstor at the time of sale
the Company's software assets.

     In February 2003, the Company closed its principal offices in Waltham,
Massachusetts and moved its principal offices to space in New York City occupied
by CMH. Network-1 pays rent on a month to month basis of $3,000 per month for
its principal offices in New York City.

     On November 18, 2003, the Company entered into an agreement (the
"Agreement") with Merlot Communications, Inc. ("Merlot"), a broadband
communications solutions provider, pursuant to which the Company acquired six
patents (the "Patent Portfolio") relating to various telecommunications and data
networking technologies from Merlot, for a purchase price of $100,000 and
contingent future payments equal to 20% of the net income (as defined in the
Agreement) of the Company from the sale or licensing of the Patents after the
Company achieves $4.0 million of net income for each patent comprising the
Patent Portfolio ("Future Contingent Payments"). In addition, the Agreement
provided the Company with an option to terminate the Net Profit Payments, at any
time between January 1, 2007 through March 31, 2007, and from January 1 through
March 31 of each year thereafter, by making payments to Merlot in an amount
equal to the greater of (i) two times the payment due for the twelve month
period following the notice of termination or (ii) $3.0 million plus 10% for
each additional year starting January 1, 2008. On January 18, 2005, the Company
and Merlot entered into an amendment to the Agreement (the "Amendment") pursuant
to which the Company paid $500,000 to Merlot in consideration for the
restructuring of the Future Contingent Payments to Merlot from the licensing or
sale of the Patent Portfolio. The Amendment provides for future contingent
payments by the Company to Merlot of $1.0 million upon achievement of $25
million of Net Royalties (as defined), an additional $1.0 million upon
achievement of $50 million of Net Royalties and an additional $500,000 upon
achievement of $62.5 million of Net Royalties from licensing or sale of the
patents acquired from Merlot. Wheatley Partners, II, L.P. and its affiliates and
related parties, who are principal stockholders of the Company, owned a majority
of the outstanding voting stock of Merlot at the time of the Agreement and the
Amendment and Barry Rubenstein and Irwin Lieber, principal stockholders of the
Company and general partners of Wheatley Parties II, L.P., were also directors
of Merlot at the time of the Agreement and Amended Agreement but abstained from
voting.

     On April 13, 2004, the Company as part of a recapitalization entered into
an exchange agreement with each of its outstanding holders of preferred stock
pursuant to which such holders exchanged an aggregate of 2,714,562 shares of
Preferred Stock (231,054 shares of Series D Preferred Stock and 2,483,508 shares
of Series E Preferred Stock) for an aggregate of 6,698,118 shares of Common
Stock. Holders of preferred stock received 1.25 shares of Common Stock for each
share of Common

                                                                              31
<PAGE>

Stock such holders would have received based upon the conversion rate of their
Preferred Stock. The holders of preferred stock participating in the exchange
included among the 27 holders, CMH (1,084,935 shares of Series E Preferred
Stock), Donna Slavitt, the wife of Corey M. Horowitz (35,377 shares of Series E
Preferred Stock), Barry Rubenstein, his wife and affiliated entities exclusive
of Wheatley entities (471,686 shares of Series E Preferred Stock and 139,747
shares of Series D Preferred Stock), Wheatley Partners II, L.P. (94,339 shares
of Series E Preferred Stock), Wheatley Partners, L.P. (86,792 shares of Series E
Preferred Stock) and Wheatley Foreign Partners, L.P. (7,547 shares of Series E
Preferred Stock), Irwin Lieber (165,094 shares of Series E Preferred Stock and
34,689 shares of Series D Preferred Stock) and Barry Fingerhut (165,094 shares
of Series D Preferred Stock and 34,689 shares of Series D Preferred Stock).

     On December 21, 2004, the Company extended the exercise period for
outstanding warrants to purchase 1,352,152 shares of Common Stock (the "1999
Warrants") for an additional period of one year or until December 22, 2005. The
1999 Warrants were originally issued as part of a private offering completed by
the Company in December 1999. Corey M. Horowitz owns warrants to purchase 85,220
shares as part of the 1999 Warrants.

     On December 21, 2004 and January 13, 2005, the Company completed a private
offering of an aggregate of 2,685,000 shares of common stock and three year
warrants to purchase 2,013,750 shares of common stock for an aggregate purchase
price of $2,685,000 paid by investors (the "Private Offering"). As part of the
Private Offering, the Company agreed to file a registration statement on or
before June 21, 2005 to register for resale the Common Stock (including the
shares issuable upon exercise of the warrants). Investors in the Private
Offering included Robert Graifman (100,000 shares of Common Stock and warrants
to purchase 75,000 shares of Common Stock), a director of the Company. As a
result of completion of the Private Offering, in accordance with the
anti-dilution provisions of the Employment Agreement, dated November 26, 2004,
between Corey M. Horowitz and the Company, in March 2005, Mr. Horowitz was
issued a seven year option to purchase 960,197 shares of Common Stock at an
exercise price of $1.18 per share.

ITEM 13. EXHIBITS LIST AND REPORTS ON FORM 8-K

     (a) Exhibits

     10.2   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.

     10.3   Letter Agreement, dated December 21, 2003, between the Company and
            Corey M. Horowitz, including exhibits. Previously filed as Exhibit
            10.3 to the Company's Annual Report on Form 10-KSB filed April 14,
            2004 and incorporated herein by reference.

     10.4   Letter Agreement dated January 22, 2004, between the Company and
            David Kahn. Previously filed as Exhibit 10.4 to the Company's Annual

                                                                              32
<PAGE>

            Report on Form 10-KSB filed April 14, 2004 and incorporated herein
            by reference.

     10.5   Exchange Agreement, dated April 13, 2004, between the Company and
            its Preferred Stockholders. Previously filed as Exhibit 10.5 to the
            Company's Annual Report on Form 10-KSB filed April 14, 2004 and
            incorporated herein by reference.

     10.6   Employment Agreement, dated November 26, 2004, between the
            Registrant and Corey M. Horowitz. Previously filed as Exhibit 10.1
            to the Company's Current Report on Form 8-K filed December 1, 2004
            and incorporated herein by reference.

     10.7   Master Services Agreement, dated November 30, 2004, between the
            Registrant 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.

     10.8   Securities Purchase Agreement, dated December 21, 2004, between
            Registrant 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.

     10.9   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.

     10.10  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.

     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 Eisner 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.


     (b) Reports on Form 8-K

     The following Current Reports on Form 8-K were filed by the Company during
the quarter ended December 31, 2004:

                                                                              33
<PAGE>

     (i)  On December 1, 2004, the Company filed a Current Report on Form 8-K
          with respect to its employment agreement with Corey M. Horowitz,
          Chairman and Chief Executive Officer.

     (ii) On December 2, 2004, the Company filed a Current Report on Form 8-K
          with respect to its Master Services Agreement with ThinkFire Services
          USA, Ltd.; and

     (iii) On December 28, 2004, the Company filed a Current Report on Form 8-K
          with respect to its Securities Purchase Agreement relating to its
          private offering of securities completed on December 21, 2004.

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

AUDIT FEES

     Eisner LLP billed the Company aggregate fees of $81,361 and $88,000 for the
year ended December 31, 2004 and December 31, 2003, respectively, for the audit
of the Company's annual financial statements and review of financial statements
included in the Company's Form 10-QSB's and for other services in connection
with statutory or regulatory filings. Before Eisner LLP was engaged to render
audit services for the Company, the engagement was pre-approved by the Company's
Audit Committee.

AUDIT RELATED FEES, TAX FEES AND ALL OTHER FEES

     Eisner LLP did not render any other professional service other than those
discussed above for the year ended December 31, 2004 or December 31, 2003.



















                                                                              34
<PAGE>


                                   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 23rd day of November 2005.



                                       NETWORK-1 SECURITY SOLUTIONS, INC.

                                       By  /s/ Corey M. Horowitz
                                           -------------------------------
                                           Corey M. Horowitz
                                           Chairman 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    Chairman and Chief Executive          November 23, 2005
---------------------    Officer, Chairman of the Board
Corey M. Horowitz        of Directors (principal executive
                         officer)


/s/ David Kahn           Chief Financial Officer               November 23, 2005
---------------------
David Kahn


/s/ Harry Schessel       Director                              November 23, 2005
---------------------
Harry Schessel


/s/ Robert Graifman      Director                              November 23, 2005
---------------------
Robert Graifman


/s/ Robert Pons          Director                              November 23, 2005
---------------------
Robert Pons


                                                                              35
<PAGE>

                       NETWORK-1 SECURITY SOLUTIONS, INC.

                              FINANCIAL STATEMENTS

                           DECEMBER 31, 2004 AND 2003

<PAGE>

NETWORK-1 SECURITY SOLUTIONS, INC.


                                                                            PAGE
                                                                            ----

INDEX TO FINANCIAL STATEMENTS

   Report of independent registered public accounting firm                   F-1

   Balance sheets as of December 31, 2004 and 2003                           F-2

   Statements of operations for the years ended December 31,
     2004 and 2003                                                           F-3

   Statements of stockholders' equity for the years ended December 31,
     2004 and 2003                                                           F-4

   Statements of cash flows for the years ended December 31, 2004
     and 2003                                                                F-5

   Notes to financial statements                                             F-6
<PAGE>

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, 2004 and 2003, and the related statements of operations,
stockholders' equity and cash flows for each of 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 audit 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 enumerated above present fairly, in all
material respects, the financial position of Network-1 Security Solutions, Inc.
as of December 31, 2004 and 2003, and the results of its operations and its cash
flows for each of the years then ended in conformity with accounting principles
generally accepted in the United States of America.


Eisner LLP


New York, New York
February 22, 2005

With respect to Notes B and C[9]
November 20, 2005


SEE NOTES TO FINANCIAL STATEMENTS                                            F-1
<PAGE>

NETWORK-1 SECURITY SOLUTIONS, INC.

BALANCE SHEETS

<TABLE><CAPTION>
                                                                                           DECEMBER 31,
                                                                                  ------------------------------
                                                                                      2004              2003
                                                                                  ------------      ------------
<S>                                                                               <C>               <C>
ASSETS
Current assets:
   Cash and cash equivalents                                                      $  2,177,000      $    984,000
   Prepaid expenses and other current assets                                           100,000            86,000
                                                                                  ------------      ------------

        Total current assets                                                         2,277,000         1,070,000

Patents                                                                                 92,000            99,000
                                                                                  ------------      ------------

                                                                                  $  2,369,000      $  1,169,000
                                                                                  ============      ============

LIABILITIES
Current liabilities:
   Accounts payable                                                               $    437,000      $     78,000
   Accrued expenses and other current liabilities                                      505,000           520,000
                                                                                  ------------      ------------

        Total current liabilities                                                      942,000           598,000

Liability to be settled with equity instrument                                         294,000            54,000

Commitments and contingencies (Note E)

STOCKHOLDERS' EQUITY
Preferred stock - $.01 par value; 10,000,000 shares authorized; Series D -
   convertible, voting, authorized 1,250,000 shares; 0 and 231,054
      shares issued and outstanding at December 31, 2004 and 2003,
      respectively; liquidation preference of $705,000 at December 31, 2003                                2,000
   Series E - convertible, authorized 3,500,000 shares; 0 and 2,483,508
      shares issued and outstanding at December 31, 2004 and 2003,
      respectively; liquidation preference of $5,265,000 at December 31, 2003                             25,000
Common stock - $.01 par value; authorized 50,000,000 shares; 17,097,572
   and 8,314,458 shares issued and outstanding at December 31, 2004 and
   2003, respectively                                                                  171,000            83,000
Additional paid-in capital                                                          43,951,000        41,443,000
Accumulated deficit                                                                (42,989,000)      (41,036,000)
                                                                                  ------------      ------------

                                                                                     1,133,000           517,000
                                                                                  ------------      ------------

                                                                                  $  2,369,000      $  1,169,000
                                                                                  ============      ============
</TABLE>

SEE NOTES TO FINANCIAL STATEMENTS                                            F-2
<PAGE>

NETWORK-1 SECURITY SOLUTIONS, INC.

STATEMENTS OF OPERATIONS
<TABLE><CAPTION>
                                                                                      YEAR ENDED
                                                                                      DECEMBER 31,
                                                                             ------------------------------
                                                                                 2004              2003
                                                                             ------------      ------------
<S>                                                                          <C>               <C>
Operating expenses:                                                           AS RESTATED       As restated
                                                                             (See Note B)      (See Note B)

General and administrative                                                   $  1,956,000           595,000
                                                                             ------------      ------------

Operating Loss                                                                 (1,956,000)         (595,000)

Interest income                                                                     3,000            12,000
                                                                             ------------      ------------

Loss from continuing operations                                                (1,953,000)         (583,000)

Loss from discontinued operations                                                                   (31,000)
                                                                                               ------------

NET LOSS                                                                       (1,953,000)         (614,000)
                                                                                               ------------
Deemed Dividend on Conversion of common to Preferred                             (273,000)
Deemed dividend on extension of warrants to preferred stockholders             (1,179,000)
                                                                             ------------

Net loss attributable to common stockholders                                 $ (3,405,000)     $   (614,000)
                                                                             ============      ============

NET LOSS PER COMMON SHARE - BASIC AND DILUTED FROM CONTINUING OPERATIONS     $      (0.26)     $      (0.07)
                                                                             ============      ============


NET LOSS PER COMMON SHARE - BASIC AND FULLY DILUTED FROM DISCONTINUED
OPERATIONS                                                                                     $      (0.00)
                                                                             $      (0.26)     $      (0.07)
NET LOSS PER COMMON SHARE-BASIC AND DILUTED
WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING                           13,184,551         8,314,458
                                                                             ============      ============
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS                                            F-3
<PAGE>

NETWORK-1 SECURITY SOLUTIONS, INC.

STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE><CAPTION>
                                      SERIES D CONVERTIBLE               SERIES E CONVERTIBLE
                                        PREFERRED STOCK                     PREFERRED STOCK                     COMMON STOCK
                                 ------------------------------      ------------------------------      ---------------------------
                                    SHARES            AMOUNT            SHARES            AMOUNT           SHARES          AMOUNT
                                 ------------      ------------      ------------      ------------      ----------     ------------
<S>                              <C>               <C>               <C>               <C>               <C>            <C>
BALANCE - DECEMBER 31, 2002           231,054      $      2,000         2,483,508      $     25,000       8,314,458     $     83,000
Issuance of stock options to
consultants                                               5,000
Issuance of options for
compensation to an employee
director
Net loss
                                 ------------      ------------      ------------      ------------      ----------     ------------

BALANCE - DECEMBER 31, 2003           231,054             2,000         2,483,508            25,000       8,314,458           83,000
Conversion of Series D and E
preferred stock into common stock    (231,054)           (2,000)       (2,483,508)          (25,000)      6,698,114           67,000
Issuance of stock options to
consultants
Sale of common stock                                                                                      2,085,000           21,000
Issuance of options for
services
Issuance of options to an
employee director
Extension of warrants issued
to preferred stockholders
Net loss
                                 ------------      ------------      ------------      ------------      ----------     ------------

BALANCE - DECEMBER 31, 2004                 0      $          0                 0      $          0      17,097,572     $    171,000
                                 ============      ============      ============      ============      ==========     ============

                                  ADDITIONAL
                                   PAID-IN         ACCUMULATED
                                   CAPITAL           DEFICIT            TOTAL
                                 ------------      ------------      ------------
BALANCE - DECEMBER 31, 2002      $ 41,397,000      $(40,422,000)     $  1,085,000
Issuance of stock options to
consultants                                                                 5,000
Issuance of options for
compensation to an employee
director                               41,000                              41,000
Net loss                                               (614,000)         (614,000)
                                 ------------      ------------      ------------

BALANCE - DECEMBER 31, 2003        41,443,000       (41,036,000)          517,000
Conversion of Series D and E
preferred stock into common stock     (40,000)                                  0
Issuance of stock options to
consultants                            51,000                              51,000
Sale of common stock                2,014,000                           2,035,000
Issuance of options for                61,000                              61,000
services
Issuance of options to an
employee director                     422,000                             422,000
Extension of warrants issued
to preferred stockholders
Net loss                                             (1,953,000)       (1,953,000)
                                 ------------      ------------      ------------

BALANCE - DECEMBER 31, 2004      $ 43,951,000      $(42,989,000)     $  1,133,000
                                 ============      ============      ============
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS                                            F-4
<PAGE>

NETWORK-1 SECURITY SOLUTIONS, INC.

STATEMENTS OF CASH FLOWS
<TABLE><CAPTION>

                                                                                         DECEMBER 31,
                                                                                ------------------------------
                                                                                    2004              2003
                                                                                ------------      ------------
<S>                                                                             <C>               <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
   Net loss                                                                     $ (1,953,000)     $   (614,000)

Adjustments to reconcile net loss to net cash used in operating activities:
      Issuance of options to an employee director                                    422,000            41,000
      Valuation adjustment for outstanding stock options                             291,000             4,000
      Issuance of options for services                                                61,000
      Gain on sale of assets of discontinued operations                                               (415,000)
      Depreciation and amortization                                                    7,000            23,000

Changes in:
        Accounts receivable                                                                              6,000
        Prepaid expenses and other current assets                                    (14,000)           10,000
        Security deposits                                                                                8,000
        Accounts payable, accrued expenses and other current liabilities             344,000          (205,000)
        Deferred revenue                                                                              (218,000)
                                                                                ------------      ------------

           Net cash used in operating activities                                    (842,000)       (1,360,000)
                                                                                ------------      ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
   Acquisition of patents                                                                             (100,000)
   Proceeds from sale of assets of discontinued operations                                             415,000
                                                                                                  ------------

           Net cash provided by investing activities                                                   315,000
                                                                                                  ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
   Proceeds from sale of common stock                                              2,085,000
   Expenses in connection with issuance of common stock                              (50,000)
                                                                                ------------

           Net cash provided by financing activities                               2,035,000
                                                                                ------------

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                               1,193,000        (1,045,000)
Cash and cash equivalents - beginning of year                                        984,000         2,029,000
                                                                                ------------      ------------

CASH AND CASH EQUIVALENTS - END OF YEAR                                         $  2,177,000      $    984,000
                                                                                ============      ============

NON-CASH TRANSACTIONS:
   Non-employee compensation paid with stock options                            $     51,000      $      5,000
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS                                            F-5
<PAGE>

NETWORK-1 SECURITY SOLUTIONS, INC.

NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003

NOTE A - THE COMPANY

[1]    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"). As part of its new business strategy following the
       acquisition of the Patent Portfolio in November 2003, the Company offers
       licenses to third parties for the technologies covered by its patents. In
       February 2004, the Company initiated its licensing efforts relating to
       its Patent Portfolio. As of December 31, 2004, the Company has not
       entered into any licensing arrangements with respect to its Patent
       Portfolio.

       Prior to the acquisition of the Patent Portfolio, the Company's business
       consisted of development, marketing, and licensing of network security
       software products designed to provide comprehensive security to computer
       networks. The Company also provided support, maintenance and training
       services related to its software products. In December 2002, the Company
       discontinued its software product line and associated operations, ceased
       its product development and eliminated its sales and marketing efforts
       and during May 2003, sold substantially all of its intellectual property
       related to its security software. This is shown as discontinued
       operations in 2003

[2]    As reflected in the accompanying financial statements, the Company has
       incurred substantial losses and has experienced net cash outflows from
       operations. In 2004, the Company had no revenue from operations. The
       Company will continue to have operating losses for the foreseeable future
       until it is successful in licensing its patented technology. The Company
       is dependent upon debt and equity financing until it generates cash flows
       from operations. As discussed in Note E[2], the Company completed the
       first closing of a private placement of its securities in December 2004.
       As a result of such private placement, the Company has cash and cash
       equivalents of $2,177,000 as of December 31, 2004.

       Also, as discussed in Note M[1], in January 2005 the Company completed a
       second closing of the private placement of its equity securities and
       received a gross proceeds of $600,000. If necessary, the Company will
       take further action which it believes is required to sustain its
       operations for the next twelve months.

NOTE B - RESTATEMENT

The Company has restated its statements of operations for the years ended
December 31, 2004 and December 31, 2003, following comments received from the
staff (the "Staff") of the Division of Corporation Finance of the Securities and
Exchange Commission ("SEC") and the resulting discussions with the staff
pertaining to the Company's Annual Report on Form 10-KSB for the year ended
December 31, 2004 initially filed with the SEC on April 14, 2005.

As disclosed in Note E [1] pertaining to the Company's April 2004 exchange
transaction pursuant to which all holders the Company's outstanding Series E
convertible preferred stock ("Series E") and Series D convertible preferred
stock ("Series D") (collectively, the Series E and Series D, the "Preferred
Stock") exchanged their preferred shares for shares of common stock of the
Company (the "2004 Exchange Transaction"). The holders of the Series E and
Series D received 1.25 times the number of shares of common stock that each
preferred stockholder would have otherwise received upon conversion. The Staff
of the SEC commented on the Company's accounting of the 2004 Exchange
Transaction which included discussions concerning whether or not the Preferred
Stock contained a "beneficial conversion feature" which should be accounted for
under Emerging Issues Task Force Issue No. (EITF) 00-27 as a deemed dividend and
included in the net loss attributable to common stockholders and the per share
amounts.


                                                                             F-6
<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.

NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003

NOTE B - RESTATEMENT (CONTINUED)

The Company has restated its statement of operations for the year ended December
31, 2004 to recognize a deemed dividend as a result of the beneficial conversion
feature in accordance with EITF 00-27 based upon the fair market value of the
common stock on the date of the closing of the 2004 Exchange Transaction. The
2004 Exchange Transaction resulted in the following changes to the statements of
operations for the year ended December 31, 2004:

     o    "Deemed Dividend on Preferred Stock Conversion" in the amount of
          $273,000;
     o    an increase in the net loss attributable to common stockholders by
          $273,000, to $3,405,000 from $3,132,000; and
     o    an increase in the net loss per common share to $(0.26) per share from
          $(0.24) per share basic and diluted.

The effect of the restatement to recognize the deemed dividend on the amounts
previously reported in the Company's statements of operations included in the
Company's Form 10-KSB for the year ended December 31, 2004 are as follows:

                                                           Year Ended
                                                        December 31, 2004
                                                 ------------------------------
                                                As Previously
                                                   Reported        As Restated
                                                 ------------      ------------
STATEMENTS OF OPERATIONS:
Deemed Dividend on Preferred Stock Conversion            --        $    273,000
Net Loss attributable to common stockholders     $ (3,132,000)     $ (3,405,000)
Net Loss per common share: basic and diluted     $      (0.24)     $      (0.26)

The restatement had no effect on the Company's balance sheet as of December 31,
2004 and the statements of stockholder's equity and cash flows for the year then
ended.

In addition, following discussions with the Staff of the SEC pertaining to
comments relating to the Company's Annual Report on Form 10-KSB for the year
ended December 31, 2004, the Company also concluded that the financial
statements for the year ended December 31, 2003 should be restated to reclassify
the gain on sale of assets associated with the Company's software products in
May 2003 and expenses and revenues related to the software business as
discontinued operations in accordance with Statement of Financial Accounting
Standards (SFAS) No. 144. This reclassification has no effect on the net loss,
net loss attributable to common stockholders or net loss per common share -
basic and diluted.

In May 2003, the Company completed the sale of its software and related
intellectual property for $415,000 (the "2003 Asset Sale"). The carrying value
of these assets was written down to zero in the third quarter of 2002. The
Company previously recorded the $415,000 as "Gain on Sale of Assets" in its
statements of operations.

The change to reflect the 2003 Asset Sale and discontinued operations, resulted
in the following changes to the statement of operations for the year ended
December 31, 2003:

     o    "Gain on sale of assets" of $415,000 and revenues of $218,000, cost of
          services of $51,000 and expenses of $613,000 were reclassified to
          "Loss from discontinued operations" of $(31,000);
     o    General and administrated expenses were reduced from $1,208,000 to
          $595,000 to include only such expenses from continuing operations;
     o    "Net Loss from continuing operations" of $(583,000) and "Loss from
          discontinued operations" of $(31,000); and
     o    "Net Loss per common share - basic and diluted from continuing
          operations" of $(0.07) and "Net Loss per common share basic and
          diluted from discontinued operations" of $(0.00).

                                                                             F-7
<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.

NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003

NOTE B - RESTATEMENT (CONTINUED)

     The effect of the restatement of the 2003 Asset Sale and discontinued
operations, on the amounts previously included in the Company's statements of
operations for the year ended December 31, 2003 are as follows:

<TABLE><CAPTION>
                                                                            Year Ended
                                                                         December 31, 2003
                                                                    ------------------------------
                                                                   As Previously
                                                                      Reported        As Restated
                                                                    ------------      ------------
<S>                                                                 <C>               <C>
STATEMENTS OF OPERATIONS:
Revenues:
         Licenses                                                   $    130,000              --
         Services                                                   $     88,000              --
Cost of Revenues:
         Cost of services                                           $     51,000              --
Gross profit                                                        $    167,000              --
Operating expenses - General and administrative                     $  1,208,000      $    595,000
Loss before interest income and gain on sale of assets              $ (1,041,000)             --
Operating Loss                                                              --        $   (595,000)
Gain on sale of assets                                              $    415,000              --
Net Loss from continuing operations                                         --        $   (583,000)
Net Loss from discontinued operations                                       --        $    (31,000)
Net Loss per common share - basic and diluted from continuing
operations                                                                  --        $      (0.07)
Net Loss per common share - basic and diluted from discontinued
operations                                                                  --        $      (0.00)
</TABLE>

The restatement had no effect on the Company's balance sheet as of December 31,
2003 and the statement of stockholder's equity for the year then ended.

NOTE C - 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:

       License revenue is recognized upon delivery of software or delivery of a
       required software key. License revenue from distributors or resellers is
       recognized as the distributor or reseller delivers software or the
       required software key to end users or original equipment manufacturers.
       Service revenues consist of maintenance and training services. Annual
       renewable maintenance fees are a separate component of each contract, and
       are recognized ratably over the contract term. Revenue from advance
       license fees are deferred until they are earned pursuant to agreements.

                                                                             F-8
<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.

NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003

NOTE C - SIGNIFICANT ACCOUNTING POLICIES  (CONTINUED)

[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, 2004 and 2003, 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.

[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 10,111,299 and
       11,495,493 at December 31, 2004 and 2003, 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, warrants,
       convertible preferred stock and convertible notes.

[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.

                                                                             F-9
<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.

NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003

NOTE C - SIGNIFICANT ACCOUNTING POLICIES  (CONTINUED)

[9]    STOCK-BASED COMPENSATION:

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

<TABLE><CAPTION>
                                                                       YEAR ENDED
                                                                       DECEMBER 31,
                                                              ------------------------------
                                                                  2004              2003
                                                              ------------      ------------
                                                              AS RESTATED
<S>                                                           <C>               <C>
          Reported net loss attributable to common
             Stockholders                                     $ (3,405,000)     $   (614,000)
          Stock-based employee compensation expense
             included in reported net loss                         422,000            41,000
          Stock-based employee compensation
             determined under the fair value-based method       (1,744,000)         (203,000)
                                                              ------------      ------------

          Pro forma net loss                                  $ (4,727,000)     $   (776,000)
                                                              ============      ============
          Net loss per common share (basic and diluted):
             As reported                                      $      (0.26)     $      (0.07)
                                                              ============      ============

             Pro forma                                        $      (0.36)     $      (0.09)
                                                              ============      ============
</TABLE>

       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:

<TABLE><CAPTION>
                                                           YEAR ENDED
                                                           DECEMBER 31,
                                              -------------------------------------
                                                    2004                  2003
                                              ---------------       ---------------
<S>                                           <C>                   <C>
          Risk-free interest rates              2.67 - 3.62%          2.74 - 5.07%
          Expected option life in years            3.00                  3.00
          Expected stock price volatility     111.88 - 231.34%      113.75 - 229.03%
          Expected dividend yield                  0.00%                 0.00%
</TABLE>

       The weighted average fair value on the option grant date during the years
       ended December 31, 2004 and 2003 were $0.37 and $0.19 per option,
       respectively.

                                                                            F-10
<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.

NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003

NOTE C - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

[10]   RECENTLY ISSUED ACCOUNTING STANDARDS:

       In December 2004, the Financial Accounting Standards Board ("FASB")
       issued Statement of Financial Accounting Standards No. 123R, "Share-Based
       Payment" ("SFAS 123R"), which replaces SFAS No. 123, "Accounting for
       Stock-Based Compensation," and supersedes APB Opinion No. 25, "Accounting
       for Stock Issued to Employees." This statement requires all share-based
       payments to employees be recognized in the financial statements based on
       their fair values on the date of grant. The Company currently uses the
       intrinsic value method to measure compensation expense for stock-based
       awards which requires a pro forma net income and earnings per share
       presentation as if the Company had used a fair-value based method
       provided by SFAS 123 to measure stock-based compensation. The Company is
       required to adopt SFAS 123R in the first quarter of 2006. The Company is
       evaluating the requirements of SFAS 123R and expects that any future
       issuance of options could upon its adoption have a material impact on the
       Company's results of operations and earnings (loss) per share.

       In November of 2004, the FASB issued SFAS No. 151, "Inventory Costs,"
       which amends the guidance in ARB No. 43, Chapter 4, "Inventory Pricing,"
       to clarify the accounting for abnormal amounts of idle facility expense,
       freight, handling costs, and wasted material (spoilage). This statement
       requires that those items be recognized as current-period charges
       regardless of whether they meet the criterion of "so abnormal" as stated
       in ARB No. 43. Additionally, SFAS 151 requires allocation of fixed
       production overheads to the costs of conversion be based on the normal
       capacity of the production facilities. The Company is required to adopt
       the provision of SFAS No. 151 in the third quarter of 2006. The Company
       does not expect SFAS 151 to have a material impact on its results of
       operations or financial condition.

       In December of 2004, the FASB issued SFAS No. 153, "Exchanges of
       Nonmonetary Assets - An Amendment of APB Opinion No. 29 ("SFAS 153").
       SFAS 153 eliminates the exception for nonmonetary exchanges of similar
       productive assets and replaces it with a general exception for exchanges
       of nonmonetary assets that do not have commercial substance. SFAS 153 is
       effective for the fiscal periods beginning after June 15, 2005 and is
       required to be adopted by the Company in the first quarter of 2006. The
       Company does not expect that the adoption of SFAS 153 will have a
       material impact on the Company's results of operations or financial
       condition.

       Financial Accounting Standards Board Interpretation No. 46,
       "Consolidation of Variable Interest Entities" (FIN No. 46) was originally
       issued in January 2003 and was subsequently revised in December 2003. FIN
       No. 46 attempts to clarify the application of Accounting Research
       Bulletin No. 51, Consolidated Financial Statements, to certain entities
       in which equity investors do not have the characteristics of a
       controlling financial interest or do not have sufficient equity at risk
       for the entity to finance its activities without additional subordinated
       financial support. The Company does not believe that it has any
       involvement with variable interest entities that are required to be
       consolidated under FIN No. 46.

NOTE D- 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. The cash
price paid has been capitalized and is being amortized over the remaining useful
life of each patent. In addition, the Company has granted 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 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

                                                                            F-11
<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.

NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003

NOTE D - PATENTS (CONTINUED)

licensing of the patents. The Company also has an option to terminate these
payments for each of the patents, commencing January 1, 2007 through March 31,
2007, and for each January 1 through March 31 period thereafter, by paying the
greater of: (i) two times the payment due for the 12 months immediately
following the notice of termination for each patent; or (ii) $3 million plus an
extra 10% for each additional year starting the fourth year after the closing of
the patent agreement for each patent. In January 2005, this agreement was
amended (see Note M[2]).

For the years ended December 31, 2004 and 2003, the Company has not derived any
income from sale or licensing of these patents.

          Balance - January 1, 2003
             Additions                           $    100,000
             Amortization                              (1,000)

          Balance - December 31, 2003                  99,000
             Amortization                              (7,000)

          Balance - December 31, 2004            $     92,000

NOTE E - STOCKHOLDERS' EQUITY

[1]    PREFERRED STOCK:

       In April 2004, the Company entered into an exchange agreement with the
       holders of all of the Company's outstanding shares of Series E ("Series
       E") and Series D ("Series D") convertible preferred stock to exchange
       2,483,508 shares of Series E for 6,208,770 shares of common stock and
       231,054 shares of Series D for 489,348 shares of common stock. As an
       inducement for agreeing to such conversion, the holders of the Series E
       and Series D received 1.25 times the number of shares of common stock
       that each preferred stockholder would have otherwise received upon
       conversion. The holders of preferred stock participating in the exchange
       included, among others, CMH Capital Management Corp. ("CMH") (1,084,935
       of Series E shares), the wife of Corey M. Horowitz, CEO of the Company
       (35,377 of Series E shares) and other principal stockholders of the
       Company (990,552 of Series E shares and 209,125 of Series D shares). Upon
       closing of the exchange agreement, there were no outstanding shares of
       preferred stock. Corey M. Horowitz, Chairman and Chief Executive Officer
       and a principal stockholder of the Company, is the sole owner and officer
       of CMH.

[2]    PRIVATE PLACEMENT:

       On December 21, 2004, the Company completed a private placement of
       2,085,000 shares of common stock and three-year warrants to purchase
       1,563,750 shares of common stock (warrants to purchase 1,042,500 shares
       of common stock at an exercise price of $1.25 and warrants to purchase
       521,250 shares of common stock at an exercise price of $1.75) for an
       aggregate purchase price of $2,035,000, net of $50,000 issuance costs.
       The Company issued to a finder, warrants to purchase 50,000 shares of
       common stock at an exercise price of $1.00 expiring in December 2009. As
       part of the private placement, the Company agreed to file a registration
       statement on or before June 21, 2005, to register the common stock and
       the shares issuable upon exercise of the warrants.

       In connection with the private placement and anti-dilutive provisions for
       the warrants previously issued to Falconstor, the Company issued warrants
       to purchase 128,713 additional shares of common stock at an exercise
       price of $1.01 expiring in October 2006 (see Note I[3]). The associated
       expense of $147,000, as an imputed dividend, is based on the fair value
       of these warrants using the Black-Scholes model utilizing the risk-free
       interest rate of 3.01%, life of 2 years, volatility of 270% and dividend
       yield of 0% and is included in the accompanying statement of operations
       for the year ended December 31, 2004.

                                                                            F-12
<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.

NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003

NOTE E - STOCKHOLDERS' EQUITY  (CONTINUED)

[3]    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, provides for the granting of both incentive and non-qualified
       options to purchase common stock of the Company. A total of 4,000,000
       shares are provided for under the 1996 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 are set by the
       Compensation Committee in its discretion.

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

<TABLE><CAPTION>
                                                            2004                                  2003
                                                -----------------------------         ---------------------------
                                                                      WEIGHTED                           WEIGHTED
                                                                      AVERAGE                            AVERAGE
                                                  OPTIONS             EXERCISE          OPTIONS          EXERCISE
                                                OUTSTANDING            PRICE          OUTSTANDING          PRICE
                                                ----------            -------         ----------          -------
<S>                                              <C>                  <C>              <C>                 <C>
       Options outstanding at beginning
          of year                                3,272,370            $ 0.99           3,154,498           $ 2.25
       Granted                                   2,365,628(c)(d)        0.62           1,860,000(a)          0.19
       Cancelled/expired                                                              (1,742,128)(b)         2.42
                                                ----------                            ----------

       Options outstanding at end of year        5,637,998              0.84           3,272,370             0.99
                                                ==========                            ==========

       Options exercisable at end of year        4,007,995              0.80           1,964,545             1.30
                                                ==========                            ==========
</TABLE>

       (a) Includes five-year options to purchase 1,600,000 shares of the
           Company's common stock issued to Corey M. Horowitz, Chairman and
           Chief Executive Officer, in connection with an agreement in December
           2003 (see Note I[1]) as follows: (i) incentive stock options to
           purchase 1,084,782 shares of common stock, at an exercise price of
           $0.23 per share, of which 434,782 options vested immediately, 250,000
           options vested on December 22, 2004 and 200,000 options each vest on
           December 22, 2005 and December 22, 2006 and (ii) non-qualified stock
           options to purchase 515,218 shares of common stock, at an exercise
           price of $0.13 per share, which vested immediately. The Company
           recognized $41,000 of expense in 2003 related to the 515,218 options
           representing the difference between the exercise price of the options
           and the market price on the date of grant.

       (b) Includes ten-year options to purchase 1,200,000 shares of the
           Company's common stock at an exercise price of $1.65 per share issued
           in March 2002, in connection with a two-year employment agreement
           with Richard J. Kosinski, as Chief Executive Officer and President.
           In July 2003, all of these options issued were forfeited in
           connection with the settlement of a lawsuit by Mr. Kosinski against
           the Company.

       (c) Includes options issued to Mr. Horowitz with respect to his two-year
           employment agreement entered into with the Company in November 2004,
           to purchase an aggregate of 1,500,000 shares of common stock
           consisting of (i) ten-year non-qualified options to purchase
           1,100,000 shares at an exercise price of $0.25 per share fully vested
           on the date of grant and (ii) five-year incentive stock options to
           purchase 400,000 shares at an exercise price of $0.68 per share which
           vested 50% on the date of grant and 50% one year thereafter, subject
           to acceleration upon a change of control (see Note J[3]). The Company
           recognized $407,000 of expense in 2004 related to the 1,100,000
           options representing the difference between the exercise price of the
           option and the market price on the date of grant. The Company did not
           recognize compensation expense for 400,000 options as the exercise
           price exceeded the market price on the date of grant.

                                                                            F-13
<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.

NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003

NOTE E - STOCKHOLDERS' EQUITY (CONTINUED)

[3]    STOCK OPTIONS: (CONTINUED)

       (d) Includes 745,628 stock options to be issued to Mr. Horowitz (Note
           J[3]). The Company recognized $15,000 of expense in 2004 related to
           these options representing the difference between the exercise price
           and the market price.

       (e) The following table presents information relating to all stock
           options outstanding and exercisable at December 31, 2004:

<TABLE><CAPTION>
                                                                  WEIGHTED
                                                WEIGHTED          AVERAGE                              WEIGHTED
          RANGE OF                               AVERAGE         REMAINING                             AVERAGE
          EXERCISE              OPTIONS         EXERCISE          LIFE IN            OPTIONS           EXERCISE
           PRICE               OUTSTANDING       PRICE             YEARS            EXERCISABLE         PRICE
           -----               -----------       -----             -----            -----------         -----
<S>     <C>                    <C>               <C>               <C>              <C>                 <C>
        $0.12 - $2.91           5,322,273        $ 0.60             8.12             3,765,445          $ 0.48
        $3.00 - $3.75             146,625          3.44             5.55               112,250            3.56
        $4.13 - $5.69              69,600          5.17             5.09                30,800            5.16
        $6.00 - $6.88              89,500          6.22             4.49                89,500            6.22
       $10.00 - $10.13             10,000         10.00             5.25                10,000           10.00
                               ----------                                           ----------
                                5,637,998          0.84             7.95             4,007,995            0.80
                               ==========                                           ==========
</TABLE>

       On April 18, 2002, in consideration of additional consulting and
       financial advisory services, the Company issued to CMH an option to
       purchase 750,000 shares of the common stock at an exercise price of $1.20
       per share, which was the market price of the Company's common stock on
       the date of issuance. The options vest over a three-year period in equal
       amounts of 250,000 per year beginning April 18, 2003. In addition, the
       options shall vest in full in the event of a "change of control" or in
       the event that the closing price of the Company's common stock reaches a
       minimum of $3.50 per share for 20 consecutive trading days. These options
       are treated as contingent options and were originally priced in the
       quarter ended June 30, 2002 at $416,000. Subsequently, they are revalued
       at each balance sheet date. On April 18, 2003, 250,000 of these options
       vested, having a fair value of $5,000. Accordingly, $5,000 was
       reallocated to additional paid-in capital with a corresponding reduction
       to the liability. On April 18, 2004, 250,000 of these options vested
       having a fair value of $51,000. Accordingly, $51,000 was reallocated to
       additional paid-in-capital with a corresponding reduction to the
       liability. The options to purchase the remaining 250,000 shares continue
       to be treated as contingent options and are valued utilizing the
       Black-Scholes option-pricing model at each balance sheet date. At
       December 31, 2004, the 250,000 unvested options were valued at $294,000.
       Any increase or decrease in the valuation has been reflected as an
       addition or reduction of general and administrative expenses at each
       balance sheet date.

                                                                            F-14
<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.

NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003

NOTE E - STOCKHOLDERS' EQUITY (CONTINUED)

[4]    WARRANTS:

       As of December 31, 2004, the following are the outstanding warrants to
       purchase shares of the Company's common stock:

                    NUMBER
                      OF         EXERCISE
                   WARRANTS        PRICE              EXPIRATION DATE
                   --------        -----              ---------------

                    100,104       $ 6.44      March 14, 2006 - February 24, 2007
                     93,120         9.66                March 14, 2006
                    300,000         0.70              July 11, 2011 (a)
                    250,000         1.48             October 8, 2006 (a)
                  1,245,972         1.11            December 22, 2005 (b)
                    106,180         1.00            December 22, 2005 (b)
                    628,713         1.01             October 2, 2006 (c)
                     66,621         2.03              April 13, 2006 (d)
                     64,352         2.00               July 2, 2006 (d)
                      4,489         2.10             October 1, 2006 (d)
                  1,042,500         1.25            December 21, 2007 (e)
                    521,250         1.75            December 21, 2007 (e)
                     50,000         1.00            December 21, 2009 (e)
                 ----------
                  4,473,301
                 ==========

       (a) Issued to CMH in 2001, a company owned by the Chairman and Chief
           Executive Officer.

       (b) Issued in connection with Series D preferred stock and notes in
           December 1999. As a result of private placement in December 2004, the
           warrant holders were entitled to additional warrants under
           antidilutive provisions. However, in lieu of such additional
           warrants, the Company and the warrant holders agreed to extend the
           term of the 1,352,152 warrants for an additional year until December
           22, 2005. The associated expense in connection with the extension of
           these warrants is shown as an imputed dividend in the accompanying
           statement of operations for the year ended December 31, 2004.

       (c) Issued in 2001 private offering of Series E preferred stock.

       (d) Issued to a software development company for services rendered (see
           Note F[4]).

       (e) Issued in connection with 2004 private offering of common stock (see
           Note E[2]).

NOTE F - 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.

                                                                            F-15
<PAGE>

NETWORK-1 SECURITY SOLUTIONS, INC.

NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003

NOTE F -  COMMITMENTS AND CONTINGENCIES  (CONTINUED)

[2]    OPERATING LEASES:

       The Company leases its principal office space in New York City at a
       monthly rent of $3,000.

       Rental expense for the years ended December 31, 2004 and 2003 aggregated
       $36,000 and $42,000, respectively (see Note I[1]).

[3]    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,
       2004 and 2003.

[4]    SOFTWARE DEVELOPMENT CONTRACT DISPUTE:

       The Company has a dispute with a software development company pertaining
       to the number of warrants the Company is required to issue for services
       rendered. The software development company has claimed they are entitled
       to approximately 325,000 additional warrants than the Company has
       included in the warrants outstanding in Note E[4]. The Company has
       included in accrued expenses any additional liability it reasonably
       expects to incur regarding this matter.

NOTE G - INCOME TAXES

At December 31, 2004, the Company has available net operating loss carryforwards
to reduce future federal taxable income of approximately $32,464,000 for tax
reporting purposes, which expire from 2009 through 2024. 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:

<TABLE><CAPTION>
                                                                                  YEAR ENDED
                                                                                  DECEMBER 31,
                                                                         ------------------------------
                                                                             2004              2003
                                                                         ------------      ------------
<S>                                                                      <C>               <C>
          Deferred tax assets:
             Net operating loss carryforwards                            $ 12,174,000      $ 11,687,000
             Options and warrants not yet deducted, for tax purposes          947,000           676,000
             Other                                                            126,000           146,000
                                                                         ------------      ------------

                                                                           13,247,000        12,509,000
          Valuation allowance                                             (13,247,000)      (12,509,000)
                                                                         ------------      ------------

          Net deferred tax assets                                        $          0      $          0
                                                                         ============      ============
</TABLE>

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 $738,000 in 2004 and
$230,000 in 2003.

                                                                            F-16
<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.

NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003

NOTE G - INCOME TAXES (CONTINUED)

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 ENDED
                                                              DECEMBER 31,
                                                          -------------------
                                                           2004         2003
                                                          ------       ------
          Income 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 H - CONCENTRATIONS

The Company places its cash investments in high quality financial institutions
insured by the Federal Deposit Insurance Corporation ("FDIC"). At December 31,
2004, the Company maintained cash balances of $2,077,000 in excess of FDIC
limits.

NOTE I - RELATED PARTY TRANSACTIONS

[1]    In November 2004, the Company entered into a two-year employment
       agreement with Corey M. Horowitz to continue to serve as Chairman and
       Chief Executive Officer at a base salary of $250,000 for the first year
       and $275,000 for the second year (see Note J[3]).

       During the year ended December 31, 2003, the Company paid CMH a monthly
       fee of $17,500 in consideration for financial advisory and consulting
       services rendered. Corey M. Horowitz, Chairman, Chief Executive Officer,
       and a principal stockholder of the Company, is the sole officer, director
       and stockholder of CMH. In addition, in connection with such financial
       advisory and consulting services, CMH was reimbursed for expenses in 2003
       in the amount of $41,000, including the allocated portion of rent for
       office space in New York City. In December 2003, the Company employed Mr.
       Horowitz as Chief Executive Officer at an annual salary of $210,000 at
       which time CMH no longer provided financial and advisory services to the
       Company. In addition, Mr. Horowitz received options to purchase 1,600,000
       shares of common stock (see Note E[3](a)).

[2]    In April 2004, the Company entered into an exchange agreement with the
       holders of all of the Company's outstanding shares of Series E and Series
       D convertible preferred stock to convert 2,483,508 shares of Series E
       into 6,208,770 shares of common stock and 231,054 shares of Series D into
       489,348 shares of common stock. As an inducement for agreeing to such
       conversion, the holders of the Series E and Series D received 1.25 times
       the number of shares of common stock that each preferred stockholder
       would have otherwise received upon conversion. The holders of preferred
       stock participating in the exchange included, among others, CMH
       (1,084,935 of Series E shares), the wife of Corey M. Horowitz (35,377 of
       Series E shares) and other principal stockholders of the Company (990,552
       of Series E shares and 209,125 of Series D shares). Upon closing of the
       agreement, there were no outstanding shares of preferred stock. As a
       result of this transaction the Company has imputed a dividend in the
       amount of $ 273,000.

[3]    The Company entered into a ten-year License and Distribution Agreement
       with Falconstor (the "Falconstor Agreement"), an investor in the
       Company's financing in 2001. This agreement required Falconstor to pay
       royalties after utilizing a non-refundable advance paid by them to the
       Company as a credit. On May 30, 2003, as part of the Company's sale of a
       portion of its assets, the Company assigned its rights under the
       Falconstor Agreement to the Purchaser of its software (Note K) and
       recognized as income the balance of the deferred revenue of $130,000 in
       2003. Two of the Company's principal stockholders were also principal
       stockholders of Falconstor.

                                                                            F-17
<PAGE>

NETWORK-1 SECURITY SOLUTIONS, INC.

NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003

NOTE I - RELATED PARTY TRANSACTIONS AND RELATIONSHIPS  (CONTINUED)

[4]    On December 21, 2004, the Company extended the exercise period for the
       1999 Warrants by an additional year until December 22, 2005. The 1999
       Warrants were originally issued as part of a private offering completed
       by the Company in December 1999. In connection with the extension of
       those warrants, the change in fair value of $1,032,000 using the
       Black-Scholes model utilizing the risk-free interest rate of 2.67%, life
       of 1 year, volatility of 174% and dividend yield of 0% was recorded as a
       deemed dividend in 2004. Corey M. Horowitz, Chairman and Chief Executive
       Officer of the Company, owns 85,220 warrants of the 1999 Warrants.

[5]    On December 21, 2004, the Company completed a private placement of
       2,085,000 shares of common stock and three year warrants to purchase
       1,563,750 shares of common stock for an aggregate purchase price of
       $2,035,000, net of $50,000 in issuance costs. An investor in the above
       private placement (100,000 shares of common stock and warrants to
       purchase 75,000 shares of common stock) is a director of the Company.

NOTE J - EMPLOYMENT ARRANGEMENTS AND OTHER AGREEMENTS

[1]    On December 22, 2003, the Company entered into an arrangement with Corey
       M. Horowitz to serve as the Chairman and Chief Executive Officer of the
       Company. At the time, the Company agreed to pay a salary of $210,000. In
       addition, Mr. Horowitz received options to purchase 1,600,000 shares of
       common stock (see Note E[3](a)).

[2]    In January 2004, the Company entered into an agreement with an individual
       to serve as the Company's Chief Financial Officer ("CFO"). The agreement
       expired on December 31, 2004 and provided for a base salary of $5,500 per
       month for the period January 22, 2004 through April 30, 2004, $4,500 per
       month for the period May 1, 2004 through August 31, 2004 and $3,500 per
       month from September 1, 2004 through December 31, 2004. In connection
       with his agreement, the CFO received options to purchase 50,000 shares of
       common stock of the Company at $0.35 per share under the Company's stock
       option plan, at the fair market value of the shares on the date of the
       grant. 20,000 of these options vested immediately and the balance vested
       on a monthly basis through December 31, 2004. The Company is in process
       of negotiating a new agreement with the CFO.

[3]    On November 26, 2004, the Company entered into an employment agreement
       with Corey M. Horowitz pursuant to which he agreed to continue to serve
       as Chairman and Chief Executive Officer of the Company for a two-year
       term at an annual base salary of $250,000 for the first year and $275,000
       for the second year. Mr. Horowitz was also issued options to purchase an
       aggregate of 1,500,000 shares of the Company's common stock consisting of
       (i) a ten (10) year fully vested option to purchase 1,100,000 shares at
       an exercise price of $0.25 per share, and (ii) a five-year option to
       purchase 400,000 shares at an exercise price of $0.68 per share which
       vested 50% on the date of grant and 50% one year thereafter, subject to
       acceleration upon a change of control (see Note E[3](c)). In addition,
       Mr. Horowitz will receive a bonus of 5% of the Company's royalties or
       other payments received from licensing its patents. This bonus will
       continue to be paid to Mr. Horowitz for a period of five (5) years
       following the term of the employment agreement with respect to licenses
       entered into by the Company during the term of the employment agreement,
       provided that he has not been terminated by the Company "for cause" or by
       Mr. Horowitz himself without "good reason". Mr. Horowitz shall receive
       severance equal to 12 months base salary in the event his employment is
       terminated "without cause" or by Mr. Horowitz for "good reason". Mr.
       Horowitz was also granted certain anti-dilution rights which provide that
       if at any time during the period ending December 31, 2005, in the event
       that the Company completes an offering of its common stock or any
       securities convertible or exercisable into common stock, he will receive,
       at the same price as the securities issued in the financing, such number
       of additional stock options so that he maintains the same ownership
       percentage of (20.11%) of the Company based upon options and warrants
       owned by him and CMH (exclusive of his ownership of shares of common
       stock) as he owned as of November 26, 2004. As a result of the closings
       of the private placement on December 31, 2004 and January 13, 2005 and in
       accordance with the anti-dilution protection afforded to Mr. Horowitz in
       his employment agreement, Mr. Horowitz earned

                                                                            F-18
<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.

NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003

NOTE J - EMPLOYMENT ARRANGEMENTS AND OTHER AGREEMENTS  (CONTINUED)

[3]    (continued)

       seven year options to purchase an aggregate of 960,197 shares at an
       exercise price of $1.18 per share, consisting of an option to purchase
       745,628 shares as a result of first closing on December 21, 2004 and an
       option to purchase 214,569 shares as a result of second closing of the
       private placement on January 13, 2005 (see Notes E[3](e) and M[3]).

NOTE K - DISCONTINUED OPERATIONS

On May 30, 2003, the Company completed the sale of its CyberwallPlus technology
and related intellectual property and assignment of its rights under the
Falconstar Agreement for aggregate proceeds of $415,000. The carrying value of
these assets was written down to zero in the third quarter of 2002. The gain
from the sale of assets have been shown as a reduction of the loss from
discontinued operations

NOTE L - LITIGATION

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

NOTE M - SUBSEQUENT EVENTS

[1]    On January 13, 2005, the Company completed a second closing with respect
       to a private placement of securities (see Note E[2]), which consisted of
       an additional 600,000 shares of common stock and warrants to purchase an
       additional 450,000 shares of common stock for an aggregate purchase price
       of $600,000.

[2]    On January 18, 2005, the Company and Merlot Communications, Inc.
       ("Merlot") entered into an amendment to the Patent Purchase Agreement
       (the "Amendment") pursuant to which the Company paid $500,000 to Merlot
       in consideration for the restructuring of future contingent payments to
       Merlot from the licensing or sale of the Patents. The Amendment provides
       for future contingent payments by the Company to Merlot of $1.0 million
       upon achievement of $25 million of Net Royalties (as defined), an
       additional $1.0 million upon achievement of $50 million of Net Royalties
       and an additional $500,000 upon achievement of $62.5 million of Net
       Royalties from licensing or sale of the patents acquired from Merlot.
       Certain principal officers/directors stockholders of the Company owned a
       majority of the outstanding voting stock of Merlot and were also
       directors of Merlot at the time of the Amendment.

                                                                            F-19
<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.

NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2004 AND 2003

NOTE M - SUBSEQUENT EVENTS  (CONTINUED)

[3]    On January 13, 2005, pursuant to the anti-dilution provisions of his
       employment agreement (see Note J[3]), Corey M. Horowitz, Chairman and
       Chief Executive Officer of the Company, earned an additional seven-year
       option to purchase 214,569 shares of common stock, at an exercise price
       of $1.18 per share, as a result of the Company's completion of a private
       offering of its securities. The Company did not recognize any
       compensation expense as the exercise price for these options exceeded the
       market price.





























                                                                            F-20
<PAGE>

                                  EXHIBIT INDEX
                                  -------------

Exhibits
--------
  10.2      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.

  10.3      Letter Agreement, dated December 21, 2003, between the Company and
            Corey M. Horowitz, including exhibits. Previously filed as Exhibit
            10.3 to the Company's Annual Report on Form 10-KSB filed April 14,
            2004 and incorporated herein by reference.

  10.4      Letter Agreement dated January 22, 2004, between the Company and
            David Kahn. Previously filed as Exhibit 10.4 to the Company's Annual
            Report on Form 10-KSB filed April 14, 2004 and incorporated herein
            by reference.

  10.5      Exchange Agreement, dated April 13, 2004, between the Company and
            its Preferred Stockholders. Previously filed as Exhibit 10.5 to the
            Company's Annual Report on Form 10-KSB filed April 14, 2004 and
            incorporated herein by reference.

  10.6      Employment Agreement, dated November 26, 2004, between the
            Registrant and Corey M. Horowitz. Previously filed as Exhibit 10.1
            to the Company's Current Report on Form 8-K filed December 1, 2004
            and incorporated herein by reference.

  10.7      Master Services Agreement, dated November 30, 2004, between the
            Registrant 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.

  10.8      Securities Purchase Agreement, dated December 21, 2004, between
            Registrant 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.

  10.9      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.

  10.10     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.

  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.


<PAGE>

  23.1*     Consent of Eisner 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.