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

                                   FORM 10-KSB

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

                  For the fiscal year ended December 31, 2000.

               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)

                       1601 TRAPELO ROAD, RESERVOIR PLACE
                          WALTHAM, MASSACHUSETTS 02451
                    (Address of Principal Executive Offices)

                   Issuer's telephone number : (781) 522-3400

         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                    Boston Stock Exchange

         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:  $1,147,000.

The aggregate market value of the Common Stock of the registrant held by
non-affiliates as of March 28, 2001 was approximately $5,329,000 based on the
average bid and asked prices for such Common Stock as reported on the Nasdaq
SmallCap Market.

The number of shares of Common Stock outstanding as of April 12, 2001 was
6,458,347.

Documents Incorporated by Reference:   None

Transitional Small Business Disclosure Format (Check One): Yes [ ] No [X]
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                                     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.


GENERAL

         Network-1 Security Solutions, Inc. (the "Company") develops, markets,
licenses and supports a family of network security software products designed to
provide comprehensive security to computer networks, including Internet based
systems and internal networks and computing resources. The Company's
CYBERWALLPLUS(TM) family of security software products enables an organization
to protect its computer networks from internal and external attacks and to
secure organizational communications over such internal networks and the
Internet. The Company's CYBERWALLPLUS suite of products was first introduced in
January 1999 and evolved from its prior FireWall/Plus suite of security software
products. The Company also offered its customers a full range of consulting
services in network security and network design through its professional
services group prior to its sale to Exodus Communications, Inc. (NASDAQ; EXDS)
in February 2000.

         The CYBERWALLPLUS family of security solutions is designed to protect
against Internet and Intranet based security threats and to address security
needs that arise from within internal networks that often utilize other network
transport protocols besides TCP/IP (the Internet network transport protocol)
including, among others, Novell's IPX, Digital Equipment's DECnet and IBM's SNA.
The Company's CYBERWALLPLUS family of network security products operates on the
Microsoft Windows NT and Windows 2000 operating system platforms. The filter
engine software technology of CYBERWALLPLUS, with its unique ability to handle
and filter all commonly used network transport protocols, provides organizations
with a highly secure and flexible security solution. Additionally, unlike most
firewall solutions which focus on an enterprise's connection to the Internet,
the CYBERWALLPLUS solution can be deployed throughout the enterprise; at the
perimeter to control access to and from the Internet, between internal networks
and on application servers and desktop PCs.

         Every day, more and more companies are turning to E-Business and
extranets as a way to obtain a competitive edge and broaden their markets. The
e-Business revolution is helping companies reduce costs, increase responsiveness
and provide

                                      -2-
<PAGE>

empowerment through immediate knowledge. However, by tying together previous
separate company networks and by inviting customers, partners and suppliers onto
their networks, companies have found that what were once closed and secure
enterprise networks are now becoming open networks.

         Within these new open networks, the traditional perimeters and network
boundaries have disappeared. The Company does not believe traditional perimeter
security devices such as firewalls can effectively secure all of a network's
resources which have embraced E-Business. The Company's CYBERWALLPLUS family of
products is designed to solve this problem by protecting data where it resides -
between the internal sub networks and inside the server itself - finally
allowing organizations to leverage the promise of electronic business, while
ensuring the safety of strategic data assets.

         Key elements of the Company's strategy are to:

      o  Focus on securing e-Business networks by replacing perimeter
         "chokepoint" firewalls with web server embedded firewalls and intrusion
         prevention software from the Company (CYBERWALLPLUS - SV);

      o  Emphasize the need for internal network security to secure e-Business
         networks. Internal network security is an important element of an
         effective multi-layer defense strategy to protect against external
         attacks, as the CSI/FBI 2000 Computer Security study indicates that
         approximately 33% of the organizations with perimeter firewalls were
         breached by outsiders. In addition, Internal network security is
         critical to protect enterprise resources from unwelcomed "insider"
         access. The same CSI/FBI 2000 study found that 79% of all breaches were
         from those with "insider" access;


      o  Implement a sales plan which includes a multi-channel distribution
         strategy, emphasizing selling direct to end customers and establishing
         and maintaining third-party resale relationships with OEMs, systems
         integrators and VARs in the United States and internationally.



         The Company was incorporated under the laws of the State of Delaware in
July 1990. The Company's executive offices are located at 1601 Trapelo Road,
Reservoir Place, Waltham, Massachusetts 02451 and its telephone number is (781)
522-3400. The Company's web site can be found at http://www.network-1.com.

                                      -3-
<PAGE>

INDUSTRY BACKGROUND

NETWORK SECURITY

         A critical resource of every organization is its information and its
ability to distribute and access information throughout the enterprise. Although
open computing environments have many business advantages, their accessibility
makes an organization's critical software applications and electronically stored
data vulnerable to security threats. Open computing environments are inherently
complex, typically involving a variety of hardware, operating systems, network
transport protocols and applications supplied by a multitude of vendors, making
these networks difficult to manage, monitor and protect from unauthorized access
or attack. The security risk associated with network computing is complicated by
the increasing popularity of the Internet, Intranets and Extranets (Intranets
which allow access to one or more users outside of the internal network). By
connecting an internal private network to the Internet, unauthorized third
parties are given a new means by which to access an organization's private
network. The combination of TCP/IP with other commonly used network transport
protocols within internal networks, increases the network security challenge
because of the various avenues of attack available to both internal and external
attackers.

         As a result of the explosive growth in network computing and Internet
use, as well as the use of Intranets and Extranets, protection of an
organization's network and data has become a significant economic concern for
businesses. The reported malicious attacks on various major online businesses
over the last year were estimated by Forrester Research to have cost more than
$1 billion. The heightened awareness to the potential threats of network
infrastructure attacks have caused multiple US government and industry
institutions to initiate active steps and programs aimed at enhancing network
security and pursuit of hackers by the authorities. According to FBI estimates,
U.S. companies suffer estimated losses of over $10 billion per year as a result
of unauthorized access to information and data. According to the 2000 Computer
Security Institute/FBI Computer Crime and Security Survey, 33% of the respondent
organizations with perimeter firewalls indicated break-ins by outsiders
validating that the single layer of defense that perimeter firewalls present is
insufficient protection. Additionally, 79% of the respondents reported
unauthorized access by insiders as a major source of breaches. The Company
believes that securing internal network areas and computing resources from
unauthorized access will become paramount to providing overall information
security by presenting multiple layers of defense against outsider threats and
adding the ability to protect from insider threats.

                                      -4-
<PAGE>

FIREWALLS

         A firewall is a security solution that enables an organization to
protect its computer resources from unauthorized access by internal and external
network users. Firewalls enforce access control security policies between a
trusted network and an untrusted network. Only authorized traffic as defined by
security policies is allowed access through the firewall. Firewalls are
predominantly utilized today to provide security for a network's perimeter by
preventing external breaches of the internal network (trusted network) from
untrusted external sources (the public network).

         Due to the significant growth in Internet connections, a number of
companies have introduced firewall products ("IP Firewalls") designed primarily
to protect an internal network using TCP/IP as the network transport protocol
from Internet based security threats or threats from within Intranets. IP
Firewalls can also filter other network transport protocols used specifically
with the IP routing protocol (such as UDP and ICMP). In addition, a limited
number of IP Firewalls have limited filtering capabilities for a small number of
non-IP based network transport protocols.

         Firewalls may also serve to provide access control between individual
sub-networks on an internal network or to control access between an internal
network and a selected outside party authorized to have access to the internal
network for limited purposes. IP Firewalls can accomplish this task to the
extent that TCP/IP is the network transport protocol being used within an
internal network as is the case with Intranets and Extranets. To the extent
other network transport protocols are utilized within such an internal network,
IP Firewalls will disallow all data utilizing any such network transport
protocol from passing through the firewall, thereby denying access entirely to a
party which is intended to have such access. This reduces the effectiveness of
IP Firewalls in a multi-protocol networked environment.

         In January 1999, the Company introduced a new suite of advanced
firewalls, which are specifically designed for use throughout an organization's
network - on servers and in multi-protocol Internet, Intranet and Extranet
environments. The Company is a technology leader in the area of distributed,
host-resident firewalls. Unlike IP firewalls, which typically operate as IP
routers that reside at an organization's perimeter and filter the IP protocol,
distributed firewalls reside on critical enterprise servers, personal computers
and workstations securing incoming and outgoing data traffic. Network-1
firewalls operate as a transparent bridge that can reside anywhere on the
enterprise network, and thereby filter all commonly used network transport
protocols (IP and non-IP).

         The Company's CYBERWALLPLUS family of security solutions is designed to
address security needs that arise from within internal networks utilizing
non-TCP/IP network transport protocols, including Novell's IPX, Digital
Equipment Corporation's DECnet and IBM's SNA, as well as to protect against
TCP/IP based Internet and Intranet security threats addressed by IP Firewalls.
The Company's CYBERWALLPLUS suite of products consists of a firewall designed to
control access to an organization's internal network from the public networks
(the "CYBERWALLPLUS - IP Edition"); a firewall controlling access between
internal networks (the "CYBERWALLPLUS - AP Edition"); a firewall controlling
access between the network and a trusted server (the "CYBERWALLPLUS - SV
Edition"); a firewall that controls access to enterprise-based and remotely
deployed personal

                                      -5-
<PAGE>

computers and workstations (the "CYBERWALLPLUS - WS Edition"); and a firewall
management application enabling the control and monitoring of many CYBERWALLPLUS
firewalls (the "CYBERWALLPLUS - Central Manager").


CYBERWALLPLUS TECHNOLOGY

         The Company's network security solutions are based upon its proprietary
CYBERWALLPLUS technology, which provides organizations enterprise-wide security
to protect against unauthorized access from the Internet as well as security for
internal sources of intrusion and breach. The following are key elements of the
Company's CYBERWALLPLUS solution:

         ENTERPRISE-WIDE DEPLOYMENT. Unlike most firewall solutions which focus
on an enterprise's connection to the Internet, the CYBERWALLPLUS solution, as a
result of its unique architecture, may be used throughout the enterprise; at the
perimeter to control access to and from the Internet, between internal networks
and on application servers, including web servers, and desktop PCs to protect
data residing on such servers and PCs. While firewall solutions must be
installed on dedicated computers, CYBERWALLPLUS can operate on Windows NT and
Windows 2000 workstations and servers without interfering with the normal
operation of such desktop computers or servers. As a result, the CYBERWALLPLUS
security solution can be installed on existing strategic computing resources
within the enterprise without incurring the expense of additional computing
hardware. CYBERWALLPLUS does not utilize significant server resources and may
therefore co-exist with other application software running on the host Windows
NT/2000 system.

         ADVANCE FILTERING SYSTEM. The architecture of Windows NT/2000 includes
two operating modes, the "user" system itself and "kernel" modes. The
CYBERWALLPLUS Filter Engine is implemented in kernel mode to maximize
performance and to provide maximum security from network intrusion to the host
operating system environment. Using proprietary kernel-level software code
developed by the Company, CYBERWALLPLUS Interceptor Shim and Filter Engine
introduce a security layer between the network hardware drivers and the Windows
NT operating system. CYBERWALLPLUS filters all network packet traffic before it
reaches the host system. Incoming data packets enter the host through the
network interface card and its associated hardware driver and are immediately
passed to the CYBERWALLPLUS Interceptor Shim, which redirects them to the Filter
Engine. The Filter Engine, using a proprietary high-speed, real-time security
policy enforcement language, checks the packet content and its context against a
user defined security policy rule database to determine whether the packet
should be allowed to enter (or exit) the system. Packets permitted access are
then re-inspected against an integrated database of intrusion signatures that
fend off a variety of denial-of-service and surveillance attacks used by
hackers.

         MULTI-LAYER SECURITY. The Company's CYBERWALLPLUS family of products
employs stateful inspection and filtering technology which provides advanced
security for TCP/IP related network transport protocols and applications.
Stateful filtering involves the knowledge of states of protocols at specific
transaction intervals during the network connection between two communicating
applications between specific systems. Transaction states

                                      -6-
<PAGE>

occur at Link, Network, Transport and Application layers of the communications
over a computer network, and CYBERWALLPLUS can detect conditions that violate
the required or expected state of one or a simultaneous series of protocols.
CYBERWALLPLUS incorporates frame, packet, byte stream and stateful inspection
capabilities in the security management of network connections. The Company
believes that CYBERWALLPLUS's multi-layer approach to security greatly
strengthens the security of trusted network resources and the host Windows
NT/2000 system itself.

         MULTI-PROTOCOL CAPABILITY. A unique aspect of CYBERWALLPLUS is its
ability to provide multi-protocol filtering not available from network security
products offered by other firewall vendors. CYBERWALLPLUS has the advantage of
filtering not only TCP/IP, but also a multitude of other network transport
protocols.  In a PC-based environment, multiple network transport protocols
often co-exist, as Windows NT/2000 itself comes pre-equipped with TCP/IP, IPX
(Novell), NetBEUI (LAN Manager) and AppleTalk. In addition, certain applications
require the use of non-TCP/IP protocols to operate between sub-networks on an
enterprise network. The multi-protocol filtering capability of CYBERWALLPLUS is
effective in securing web systems that access information via non-IP protocols.
While some commercially available routers allow basic packet filtering for
multiple network transport protocols, the Company believes its multi-protocol
advanced filtering capabilities offer superior features to router based
solutions, such as a graphical user interface, extensive logging, reporting and
alarming and security policy time management.

         TRANSPARENCY. CYBERWALLPLUS may be operated in a transparent
("stealth") mode. In this mode, CYBERWALLPLUS has no network address (i.e., it
is not visible on the network) and therefore cannot be identified for attack.
The Company believes that this feature provides additional security to the host
system because when a firewall has a network address, it can be located and is
more susceptible to attack. CYBERWALLPLUS provides full firewall protection
while operating in transparent mode, except that remote management is not
permitted.

         CENTRALIZED MANAGEMENT. Through its CYBERWALLPLUS - Central product,
the CYBERWALLPLUS suite permits centralized management and monitoring that
allows a network manager to manage and monitor multiple firewalls from a local
or remote location. Accordingly, large and geographically dispersed firewall
networks may be managed from a single location.

         CUSTOMIZED SECURITY POLICIES. CYBERWALLPLUS also allows customized
security policies for individual departments, applications and individual
systems and personnel within the network. Network managers may apply security
rules to any edition of the CYBERWALLPLUS products so that individual systems,
protocols, applications, frames and many other network entities are either
explicitly denied or provided with authorized access to protected entities.

         EASE OF USE. CYBERWALLPLUS was designed to be easily installed,
configured and managed by a network or system manager with minimal or no
security skills. CYBERWALLPLUS may be installed and configured by use of the
graphical user interface (GUI) by simply pointing and clicking the mouse. To
facilitate implementation, CYBERWALLPLUS comes pre-programmed with a wide
variety of frequently used default

                                      -7-
<PAGE>

security policies (templates) which require
the customer to simply select one of the rule sets and save the selection.

PRODUCTS

         In January 1999, the Company introduced a family of CYBERWALLPLUS
products for Windows NT which offers a broad range of network security
solutions. The CYBERWALLPLUS family of products includes the CYBERWALLPLUS - IP
Edition, CYBERWALLPLUS - SV Edition, CYBERWALLPLUS - WS Edition, CYBERWALLPLUS -
AP Edition and CYBERWALLPLUS - Central Manager. All products are currently
shipping. Through the first quarter of 1999, the Company's main product was
CYBERWALLPLUS's predecessor product line, FireWall/Plus. The Company first
introduced the FireWall/Plus Enterprise Edition for Windows NT in January 1997.
As of December 31, 2000, the Company had licensed one or more of its
FireWall/Plus or CYBERWALLPLUS family of software products to over 450
customers.

         CYBERWALLPLUS - IP. This product is an IP network firewall, for
perimeter Internet and internal Intranet applications. The product operates on a
Windows NT/2000 host, running on Intel - Pentium or Compaq platforms and
provides high performance, ease-of-use and support for "stealth" operations. A
fully functional 28-day evaluation copy of the product may be downloaded from
the Company's web site.

         CYBERWALLPLUS - SV. While Windows NT/2000 provides many useful and
important security features, the operating system does not specifically include
firewall-class packet filtering features for network security. Industry concern
over limitations in Windows NT/2000 network security is well documented. Systems
and network administrators have been required to work around the limited network
security controls within Windows NT/2000 by placing the computer systems behind
external firewalls, thereby increasing exposure to network attack and cost.
Because the server-based CYBERWALLPLUS - SV operates in the kernel of the host's
operating system, Windows NT/2000 administrators have an easy-to-use, flexible
tool to implement powerful network access controls and intrusion detection
facilities not featured in Windows NT/2000. CYBERWALLPLUS - SV adds a range of
robust security capabilities not currently provided within Windows NT/2000,
including stateful packet inspection, protocol and address filtering for any
protocol (including IP, IPX, AppleTalk, and NetBEUI that ship with Windows NT),
built-in network intrusion detection and prevention, and comprehensive audit
logging. These powerful features not only protect servers from unauthorized
network access, but also detect and prevent malicious "denial of service" and
surveillance scanning.

         CYBERWALLPLUS - WS. A distributed host-resident firewall that secures
an organization's personal computers and workstations, CYBERWALLPLUS - WS offers
the centralized management that personal firewalls lack. Securing PCs and
workstation connected directly to the corporate network or remotely via
high-speed Internet access, CYBERWALLPLUS - WS enables consistent security
policies to be deployed and managed across the network. CYBERWALLPLUS - WS is an
enterprise class firewall that offers fine-grain access control, centralized
deployment, reporting, and monitoring, transparent operation, minimal
performance overhead, and low technical support costs.

         CYBERWALLPLUS - AP. Using CYBERWALLPLUS - AP (Any Protocol),
departmental

                                      -8-
<PAGE>

networks and other internal network domains may be securely interconnected by an
organization's multi-protocol backbone network. The AP Edition of CYBERWALLPLUS
supports over 4,500 protocols, including proprietary protocols that may exist in
financial, manufacturing, power utility or airline networks. The Company's
unique filter engine in CYBERWALLPLUS allows for the easy addition of additional
IP and non-IP protocols to the firewall's security rules and policies. The AP
product operates on a Windows NT/2000 host running on Intel - Pentium or Compaq
platforms.

         CYBERWALLPLUS - Central Manager. Rounding out the CYBERWALLPLUS
offering is the central management application used to configure and monitor
multiple remote firewalls. The software was released in December 1999 and is key
to the adoption of CYBERWALLPLUS by large enterprise customers and OEM's. The
product can run on Windows NT/2000 and Windows 98.

CUSTOMERS

         The Company's customers represent a wide range of industries and
institutions, both commercial and government, which consider networked-data
resources to be among the most important assets within their organizations. As
of December 31, 2000, the Company had licensed one or more of its network
security products to over 450 customers. Customers for FireWall/Plus and
CYBERWALLPLUS products have included The Sabre Group Inc., ("Sabre"), Electronic
Data Systems Corporation ("EDS"), BMC Software, Inc. (BMC), TRW, Inc., National
Semiconductor Corp., Atlantic Richfield Company and related entities ("ARCO"),
GTE Government Systems Corporation, and a major lab of the Dept. of Energy, as
well as government agencies and others. During the year ended December 31, 2000,
revenues from BMC accounted for 12% of the Company's revenues, respectively.

         During the years ended December 31, 2000 and 1999, revenue from
international customers (licenses and service to foreign end users and
international distributors) accounted for 11% and 13% of the Company's revenues,
respectively.

SALES AND MARKETING

         The Company's sales and marketing plan is focused on educating the
market about the need to implement a multi-layered network security plan which
consists of a multi-channel distribution and promotion strategy to create
consumer awareness of the Company and of the capabilities and benefits of the
Company's CYBERWALLPLUS product solutions.

MULTI-CHANNEL DISTRIBUTION.

         In-House Sales and Marketing Team. The Company's internal sales,
support and marketing team are responsible for soliciting potential customers
and providing pre-sales technical support to customers, as well as supporting
third-party distribution channels. The Company is actively shifting its direct
sales focus to enterprise (Fortune 1000) sales. Although the Company's in-house
sales force will continue to solicit potential customers,

                                      -9-
<PAGE>

its primary responsibility is expected to evolve to supporting third-party
distribution channels.

         Third-Party Distribution Channels. A key element of the Company's
distribution strategy is to establish and maintain relationships with
third-party distributors within the United States and internationally. By
engaging such third-party distributors, the Company is able to utilize the
end-user sales and support infrastructure of these channels.

         The Company currently has relationships with thirty-five (35) national,
regional and local systems integrators, VARs and resellers in North America,
including GTSI and EDS a worldwide system integrator. The Company currently has
relationships with twenty-nine (29) international system integrators, VARs,
resellers and distributors including, among others, the following countries:
Japan, United Kingdom, Germany, Peoples Republic of China, the Netherlands,
Korea, Russia, Argentina, Peru, Brazil, Australia , Columbia, Switzerland and
South Africa.

         The Company's agreements with resellers generally grants the right to
market the Company's products in specified territories on a non-exclusive basis,
are terminable on short notice and do not prohibit the reseller from selling
products that are competitive with the Company's products.

         The Company intends to continue to seek to establish relationships with
additional third-party distributors, large system integrators and VARs with the
necessary resources to successfully distribute the Company's CYBERWALLPLUS
products.

         The Company also seeks to enter into OEM or licensing arrangements
whereby the Company grants to an OEM or other third party the right to
incorporate and/or bundle a specific technology made by the Company with the
OEM's or other third-party's products.

ADVERTISING AND PROMOTION

         The Company advertises and promotes its products through print
advertising, Internet web site advertising, public relations, direct marketing
efforts and participation in trade shows and seminars which target IT
management, security and system administrators and network system integrators.

         The Company's web site, http://www.network-1.com, includes a
description of the Company's CYBERWALLPLUS family of products and enables
visitors to the site to download a fully functional CYBERWALLPLUS for a 28-day
trial. The Company continues to add content to the web site, such as product
information, including a user guide, network security industry information and
additional content specific to distributors and end users. The web site has
download capabilities for the trial version of the product and product version
updates. The web site also includes announcements from the Company including
press releases and new marketing materials.

                                      -10-
<PAGE>

PROFESSIONAL SERVICES

         The Company has designed, planned, audited and implemented numerous
networks worldwide for a broad spectrum of clients, including Fortune 500
companies, small companies with modest requirements, federal, state and foreign
governments and utilities, as well as education and research institutions.

         On February 9, 2000, the Company entered into an Asset Purchase
Agreement with Exodus Communications, Inc. ("Exodus") pursuant to which its
professional services business was sold for an aggregate consideration of $3.815
million. The Company has reclassified all of its consulting service revenues and
related expenses as revenue and expenses from discontinued operations. See Note
G to Financial Statements. In connection with this sale, all seven (7) employees
of the Company's professional services business agreed to become employees of
Exodus. Such employees included Dr. William Hancock, the Company's former Chief
Technology Officer and Robert Russo, the Company's former Vice President of
Professional Services. Effective upon the closing of the sale, the Company
granted stock options to the seven employees for the purchase of 104,063 shares
at $2.91 per share and accelerated the vesting of 24,556 options that would have
otherwise expired, with exercise prices ranging from $1.50 to $6.50 to the
employees of PSG. In connection therewith, the Company incurred a compensation
charge of $794,000 based upon the intrinsic value of the portion of the options
vesting at such date. The balance of the options vested one year after the
closing and an additional charge of $230,000 was incurred at such date. In
connection with such sale, the Company agreed not to offer any professional or
consulting services competitive with those services offered by Exodus for a
period of two years from the closing date. In addition, the Company, as part of
the sale paid an aggregate of $140,000 to the former employees employed by
Exodus after the one year anniversary of the sales transaction.

         The decision of the Board of Directors of the Company in November 1999
to sell the Company's Professional Services Group resulted in the classification
of the results of operations and net assets of this group as discontinued
operations in the Company's financial statements. Consulting services generated
77% and 62% of the Company's revenues for the years ended 1999 and 1998,
respectively. Consulting revenues for ARINC, Delphi Automotive, Inc. and R.W.
Johnston Pharmaceutical Research Institute accounted for 26%, 19% and 11% of the
Company's revenues for 1999, respectively.

CUSTOMER SERVICE AND SUPPORT

         The Company believes that customer service and support is critical to
retaining customers and attracting prospective customers. The Company provides
customer service and support through its internal post sale technical support
staff located at its Waltham, MA office. To date, the Company has not incurred
any material warranty expense. Customers receive telephone and email presale
support. Customers are required to purchase the Company's annual maintenance
program at an average annual cost of 15% of the then current purchase price
which includes technical assistance and

                                      -11-
<PAGE>

product updates. Technical support is provided 5 days a week from 8:00 AM to
6:00 PM EST by telephone and electronic mail (additional support is available).
In addition, the Company provides customers with fee-based on-site installation,
support and training. The Company provides its resellers with sales and
technical support.


PRODUCT DEVELOPMENT

         The Company believes that development of new products and enhancements
to existing products are essential for the Company to effectively compete in the
network security market. The Company's product development efforts are directed
toward enhancing its CYBERWALLPLUS family of security products, developing new
network security products and responding to emerging industry standards and
other technological changes including other operating systems. The Company
intends to introduce new application products for the network security market.
While the Company expects that certain of its new products will be developed
internally, the Company may, based on timing and cost considerations, expand its
product offerings through licensing arrangements or acquisitions. In addition,
the Company relies on external development resources for the development of
certain of its products and components.

         The Company also contracts with independent programming contractors and
third party consulting firms in its development efforts. Historically, a
substantial portion of the Company's research and development activities have
been undertaken by engaging independent programming contractors and third party
consulting firms due to it being unable to hire enough qualified programmers.
The Company intends to replace third-party consultants and independent
contractors by hiring additional software engineers and developers on a
full-time basis during 2001.

         During the years ended December 31, 2000 and 1999, the Company's total
product development costs, including the costs capitalized after technological
feasibility has been reached, were $1,808,000, and $1,828,000, respectively.


COMPETITION

         The network security market in general, and the firewall product market
in particular, is characterized by intense competition and rapidly changing
business conditions, customer requirements and technologies. The Company
believes that the principal competitive factors affecting the market for network
security products include security effectiveness, name recognition, scope of
product offerings, product features, distribution channels, price, ease of use
and customer service and support. Currently, the Company's principal competitors
include, among others, Network ICE, Check Point Software Technologies, Ltd.,
Network Associates, Inc., Internet Security Systems, Inc., SonicWall, Inc.,
Symantec Corp., Zonelabs, Inc. and WatchGuard Technologies, Inc.. Due to the
rapid expansion of the network security market, the Company may face competition
from new entrants.

                                      -12-
<PAGE>

         Most of the Company's current and potential competitors have longer
operating histories, greater name recognition, larger installed customer bases
and possess substantially greater financial, technical, marketing and other
competitive resources than the Company. As a result, the Company's competitors
may be able to adapt more quickly to new or emerging technologies and changes in
customer requirements or devote greater resources to the promotion and sale of
their products than the Company. While the Company believes that its
CYBERWALLPLUS products do not compete against manufacturers of other types of
security products (such as encryption and authentication products), potential
customers may perceive the products of such other companies as substitutes for
the Company's products. In addition, certain of the Company's competitors may
determine for strategic reasons to consolidate, to substantially lower the price
of their network security products or to bundle their products with other
products, such as hardware or other enterprise software products. Accordingly,
it is possible that new competitors and alliances among competitors may emerge
and rapidly acquire significant market share. The Company's current and
potential competitors may develop products that may be more effective than the
Company's current or future products, or the Company's products may be rendered
obsolete or less marketable by evolving technologies or changing consumer
demands, or the Company may otherwise be unable to compete successfully.
Increased competition for firewall and CYBERWALLPLUS products may result in
price reductions, reduced gross margins and may adversely effect the Company's
ability to gain market share, any of which would adversely effect the Company's
business, operating results and financial condition.


PROPRIETARY RIGHTS

         The Company's success is substantially dependent on its proprietary
technologies. The Company does not hold any patents and relies on copyright and
trade secret laws, non-disclosure agreements with employees, distributors and
customers, including "shrink wrap" license agreements that are not signed by the
customer, and technical measures to protect the ideas, concepts and
documentation of its proprietary technologies and know-how. Such methods may not
afford complete protection, and there can be no assurance that third parties
will not independently develop substantially equivalent or superior technologies
or obtain access to the Company's technologies, ideas, concepts and
documentation. In addition, confidentiality agreements between the Company and
its employees, distributors or customers may not provide meaningful protection
for the Company's proprietary information in the event of any unauthorized use
or disclosure. Any inability to protect its proprietary technologies could have
a material adverse effect on the Company. Furthermore, the Company may be
subject to additional risk as it enters into transactions in countries where
intellectual property laws are not well developed or are poorly enforced. Legal
protection of the Company's rights may be ineffective in such countries.

         The Company has applied for a U.S. trademark registration for the
CYBERWALLPLUS. Although the Company is not aware of any challenges to the
Company's rights to use this trademark, there can be no assurance that the use
of this mark would be upheld if challenged.

                                      -13-
<PAGE>

         Although the Company believes that its technologies and products have
been developed independently and do not infringe upon the proprietary rights of
others, there can be no assurance that the Company's technologies and products
do not infringe and that third parties will not assert infringement claims
against the Company in the future. The Company is not aware of any patent
infringement charge or any violation of other proprietary rights claimed by any
third party relating to the Company or the Company's products.

         As the number of security products being offered continues to increase,
the functionality of such products may further overlap, which could result in
increased infringement claims by software developers, including infringement
claims against the Company with respect to future products. The Company may not
be able to modify its products or obtain a license in a timely manner, upon
acceptable terms and conditions. In addition, the Company may not have the
financial or other resources necessary to defend a patent infringement or other
proprietary rights infringement action. Failure to do any of the foregoing could
have a material adverse effect on the Company, including possibly requiring the
Company to cease marketing its products.

EMPLOYEES

         As of April 13, 2001, the Company had 34 full time employees. None of
the Company's employees are represented by a labor union or are subject to a
collective bargaining agreement. The Company has not experienced any work
stoppages and considers its relationship with its employees to be good.

         Competition with respect to the recruitment of highly qualified
personnel in the software industry is intense and many of the Company's
competitors have significantly greater resources than the Company. The Company's
ability to attract and assimilate new personnel will be critical to the
Company's performance and there can be no assurance that the Company will be
successful in attracting or retaining the personnel it requires to enhance its
products, develop new products and conduct its operations successfully.

                                      -14-
<PAGE>

RISK FACTORS THAT MAY AFFECT FUTURE RESULTS

         The Company operates in a rapidly changing and 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 IF WE DO NOT ACHIEVE PROFITABILITY, WE
MAY NOT BE ABLE TO CONTINUE OUR BUSINESS IN THE FUTURE.

         We have incurred substantial operating losses since our inception,
which has resulted in an accumulated deficit of $26,482,000 as of December 31,
2000. For the years ended December 31, 2000 and 1999, we incurred net losses of
$4,789,000 and $6,946,000, respectively. We have financed our operations
primarily through the sales of equity and debt securities as well as the sale of
our professional services business in February 2000. Our expense levels are high
and our revenues are difficult to predict. We anticipate incurring additional
losses until we increase our client base and revenues. We may never achieve or
sustain significant revenues or profitability. If we are unable to achieve
increased revenues, we will continue to have losses and may not be able to
continue our operations.

         WE COULD BE REQUIRED TO CUT BACK OR STOP OPERATIONS IF WE ARE UNABLE TO
RAISE OR OBTAIN NEEDED FUNDING.

         Our ability to continue our current operations will depend on our
ability to raise additional funds through equity or debt financing no later than
December, 2001 (or earlier if the Company does not achieve certain revenue
assumptions). We are currently actively seeking financing, however we currently
do not have any definitive arrangements with respect to obtaining additional
financing and we may not be able to obtain such financing on commercially
reasonable terms, if at all. Our failure to obtain financing by December , 2001,
may cause us to substantially curtail or cease our current operations.

         WE HAVE NOT ACHIEVED SUBSTANTIAL REVENUE FROM SOFTWARE SALES.

         We have made only limited sales of our products. Our total revenues for
software licenses for the years ended December 31, 2000 and 1999 were $978,000
and $260,000, respectively.

         THE SALE OF OUR PROFESSIONAL SERVICES BUSINESS WILL HAVE AN ADVERSE
EFFECT ON FUTURE CASH FLOW AND REVENUES.

         In February 2000, we sold our professional services business to Exodus
Communications Inc. for $3.815 million in cash. As part of the transaction with
Exodus, we agreed not to offer any professional or consulting services for two
(2) years following the closing. The professional services business accounted
for 77% and 62% of our total

                                      -15-
<PAGE>

revenues during the fiscal years ended December 31, 1999 and 1998, respectively.
Accordingly, cash flow from operations has been and may continue to be
materially adversely effected from the sale of our professional services
business until, if ever, we generate sufficient revenue from the licensing of
our software products.

         OUR REVENUES DEPEND ON SALES OF OUR CYBERWALLPLUS PRODUCTS AND WE ARE
UNCERTAIN WHETHER THERE WILL BE BROAD MARKET ACCEPTANCE OF THESE PRODUCTS.

         Our revenue growth for the foreseeable future is dependent upon
increased sales of our CYBERWALLPLUS family of software products. Since the
introduction of our predecessor line of security products (FireWall/Plus) in
June 1995 through December 31, 2000, license revenue from these software
products has been $3,900,000 including a non-refundable pre-paid royalty of
$500,000 in 1997. Since the introduction of our CYBERWALLPLUS suite of products
in January 1999 through December 31, 2000, license revenue from our
CYBERWALLPLUS products was only $1,167,000. Our future financial performance
will depend upon the successful introduction and customer acceptance of our
CYBERWALLPLUS products as well as the development of new and enhanced versions
of this product. Revenue from products such as CYBERWALLPLUS depend on a number
of factors, including the influence of market competition, technological changes
in the network security market, our ability to design, develop and introduce
enhancements on a timely basis and our ability to successfully establish and
maintain distribution channels. If we fail to achieve broad market acceptance of
our CYBERWALLPLUS products, it would have a material adverse effect on our
business, operating results and financial condition.

         OUR INABILITY TO ENTER INTO STRATEGIC RELATIONSHIPS WITH INDIRECT
CHANNEL PARTNERS COULD HAVE A MATERIAL ADVERSE EFFECT ON US.

         As part of our sales and marketing efforts, we are seeking to develop
strategic relationships with indirect channel partners, such as original
equipment manufacturers and resellers. We have limited financial, personnel and
other resources to undertake extensive marketing activities ourselves.
Therefore, our prospects will depend on our ability to develop and maintain
strategic marketing relationships with indirect channel partners and their
ability to market and distribute our products. If we are unable to enter into
and maintain such arrangements or if such arrangements do not result in the
successful commercialization of our products, then this could have a material
adverse effect on our business, operating results and financial condition.

         WE MAY NOT BE ABLE TO SUCCESSFULLY COMPETE IN THE NETWORK SECURITY
MARKET.

         The network security market is characterized by intense competition and
rapidly changing business conditions, customer requirements and technologies.
The principal competitive factors affecting the market for network security
products include security effectiveness, scope of product offerings, name
recognition, product features, distribution channels, price, ease of use and
customer service and support. Most of our current and potential competitors have
longer operating histories, greater name recognition, larger

                                      -16-
<PAGE>

installed customer bases and possess substantially greater financial, technical
and marketing and other competitive resources than us. As a result, our
competitors may be able to adapt more quickly to new or emerging technologies
and changes in customer requirements or to devote greater resources to the
promotion and sale of their products than we may. In addition, certain of our
competitors may determine for strategic reasons to consolidate, to substantially
lower the price of their network security products or to bundle their products
with other products, such as hardware or other enterprise software products. Our
current and potential competitors may develop products that may be more
effective than our current or future products or that render our products
obsolete or less marketable. Increased competition for network security products
may result in price reductions and reduced gross margins and may adversely
effect our ability to gain market share, any of which would adversely affect the
Company's business, operating results and financial condition.

         OUR OPERATING RESULTS MAY FLUCTUATE QUARTERLY AND IF THEY WERE BELOW
THE EXPECTATIONS OF INVESTORS AND ANALYSTS, THE PRICE OF OUR STOCK WOULD LIKELY
BE ADVERSELY EFFECTED.

         We anticipate significant quarterly fluctuations in our operations in
the future, since our results are dependent on the volume and timing of orders,
which are difficult to predict. Customers' purchasing patterns and budgeting
cycles, as well as the introduction of new products, may also cause our
operating results to fluctuate. Therefore, comparing quarterly operating results
may not be meaningful and should not be relied on. Also, our operating results
may be below analysts' and investors' expectations in some future quarters,
which would likely have a material adverse effect on our common stock's price.

         WE ARE DEPENDENT ON A FEW KEY PERSONNEL AND WE NEED TO ATTRACT AND
RETAIN HIGHLY QUALIFIED TECHNICAL, SALES, MARKETING, DEVELOPMENT AND MANAGEMENT
PERSONNEL.

         Our success is largely dependent on the continued service of key
technical and senior management personnel. The loss of the services of one or
more of our key employees, in particular Avi A. Fogel, our President and Chief
Executive Officer, could have a material adverse effect on our business,
operating results and financial condition. We have an employment agreement with
Mr. Fogel that expires in May 2002.

         Our success will also depend on our ability to attract, train and
retain highly qualified technical, sales, marketing, development and managerial
personnel. There is considerable and often intense competition for the services
of such personnel. We may not be able either to retain our existing personnel or
acquire additional qualified personnel as and when needed. If we are unable to
hire and retain such personnel, our business, operating results and financial
condition could be materially adversely affected.

                                      -17-
<PAGE>

         WE MAY NOT BE ABLE TO ADEQUATELY PROTECT OUR PROPRIETARY TECHNOLOGY,
WHICH COULD RESULT IN LOWER REVENUES AND/OR PROFITS.

         We do not hold any patents and rely on copyright and trade secret laws,
non-disclosure agreements and contractual provisions to protect our proprietary
technology. These methods afford only limited protection. Despite the
precautions we take, unauthorized parties may attempt to copy or otherwise
obtain and use our proprietary technologies, ideas, know-how and other
proprietary information without authorization or may independently develop
technologies similar or superior to our technologies. Policing unauthorized use
of our products may be difficult and costly. Also, the laws of some foreign
countries do not protect our proprietary rights as much as the laws of the
United States. We are unable to predict whether our means of protecting our
proprietary rights will be adequate.

         We believe that our technologies have been developed independent of
others. Nevertheless, third parties may assert infringement claims against us
and our technologies may be determined to infringe on the intellectual property
rights of others. We could become liable for damages, be required to modify our
technologies or obtain a license if our technologies are determined to infringe
upon the intellectual property rights of others. We may not be able to modify
our technologies or obtain a license in a timely manner, if required, or have
the financial or other resources necessary to defend an infringement action. We
would be materially adversely effected if we fail to do any of the foregoing.

         WE CAN BE EXPOSED TO NUMEROUS POTENTIAL LIABILITY CLAIMS FOR DAMAGES
AND, IF OUR INSURANCE DOESN'T ADEQUATELY COVER LOSSES, THIS COULD HAVE A
MATERIAL ADVERSE EFFECT ON US.

         Since our products are used to prevent unauthorized access to and
attacks on critical enterprise information, we may be exposed to potential
liability claims for damage caused as a result of an actual or alleged failure
of an installed product. We cannot assure you that the provisions in our
standard license agreements designed to limit our exposure will be enforceable.
Our personnel often gain access to confidential and proprietary client
information. Any unauthorized use or disclosure of such information could result
in a claim for substantial damages. We can give no assurances that our insurance
policies will be sufficient to cover potential claims or that adequate levels of
coverage will be available in the future at a reasonable cost.

         POSSIBLE DELISTING OF OUR SECURITIES FROM NASDAQ SYSTEM; RISKS RELATING
TO LOW-PRICED STOCKS.

         Our common stock is listed on the Nasdaq SmallCap Market under the
symbol "NSSI." In order to continue to be listed on Nasdaq, however, we must
comply with certain maintenance standards (including, among others, a minimum
stock price of $1.00 and net tangible assets of a minimum $2,000,000). In the
event of a delisting, an investor could find it more difficult to dispose of or
to obtain accurate quotations as to the market value of our common stock.

                                      -18-
<PAGE>

         In addition, if our common stock were to become delisted from trading
on Nasdaq and the trading price of our common stock were to then be below $5.00
per share, our common stock could be considered a penny stock. SEC regulations
generally define a penny stock to be an equity security that is not listed on
Nasdaq or a national securities exchange and that has a market value of less
than $5.00 per share, subject to certain exceptions. The SEC regulations would
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. If
our common stock is no longer traded on Nasdaq and becomes subject to the
regulations applicable to penny stocks, investors may find it more difficult to
obtain timely and accurate quotes and execute trades in our common stock.

         THE SIGNIFICANT NUMBER OF OPTIONS, WARRANTS AND CONVERTIBLE SECURITIES
OUTSTANDING MAY ADVERSELY AFFECT THE MARKET PRICE FOR OUR COMMON STOCK.

         As of April 13, 2001, there are outstanding (i) options and warrants to
purchase an aggregate of 2,906,583 shares of our common stock at exercise prices
ranging from $1.00 to $10.125, (ii) 107,023 shares of Series D Convertible
Preferred Stock which are convertible at any time into an equal number of shares
of our common stock and (iii) debt in the principal amount of $ 663,930 which
can be converted into 217,678 shares of our Series D Preferred Stock (up to
252,053 shares if interest through the maturity of the promissory notes were
also converted into common stock at the same conversion price) and warrants to
purchase 217,678 shares of our common stock (up to 252,053 shares if you include
potential interest through the maturity of the promissory notes) at exercise
prices of $1.00 to $3.00 per share. To the extent that outstanding options,
warrants or convertible debt are exercised or converted, your percentage
ownership will be diluted and any sales in the public market of the common stock
underlying such options, warrants or convertible debt 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.

         As of the date hereof, our Board of Directors has the authority,
without further action by the stockholders, to issue 5,000,000 shares of
preferred stock (of which only 107,023 shares of Series D Preferred Stock are
outstanding as of the date hereof) on such terms and with such rights,
preferences and designations as the Board 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 subleases approximately 9,000 square feet of
office space in Waltham, Massachusetts, for its principal executive offices and
1,700 square feet of office space in Manchester, New Hampshire as a satellite
development office. The lease for the executive office space expires August 31,
2001, and requires the Company to make payments of approximately $22,000 per
month over the remaining term of the lease. The lease for the satellite
development office space expires February 28, 2004 and requires the Company to
make payments of approximately $2,100 per month over the term of the lease.

ITEM 3. LEGAL PROCEEDINGS

         None

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

         On November 9, 2000, a special meeting of stockholders of the Company
was held. At the special meeting, the stockholders approved a proposal to amend
the Company's 1996 Stock Option Plan (the "Plan") to increase the shares of
Common Stock reserved for issuance under the Plan from 1,800,000 to 2,535,000.
At the meeting, the number of shares cast for, against or withheld were as
follows: For - 3,431,963, Against - 245,159 and Withheld - 14,220.

                                      -20-
<PAGE>
                                     PART II

ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

         MARKET INFORMATION. The Company's Common Stock has traded since
November 12, 1998 on the NASDAQ SmallCap Market under the symbol "NSSI." The
following table sets forth, for the periods indicated, the range of the high and
low bid prices for the Common Stock as reported on NASDAQ. 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, 2000        HIGH            LOW
                                                    ---
Fourth Quarter                      $   5.25        $ 2.00
Third  Quarter                      $   8.8125      $ 4.00
Second Quarter                      $  12.8125      $ 2.6872
First  Quarter                      $  23.875       $ 8.125


YEAR ENDED DECEMBER 31, 1999        HIGH            LOW
                                                    ---
Fourth Quarter                      $ 10.8125       $ 1.50
Third  Quarter                      $  6.625        $ 1.625
Second Quarter                      $  6.875        $ 3.75
First  Quarter                      $  8.125        $ 6.00

         On March 28, 2001, the last sale price for the Common Stock as reported
on NASDAQ was $1.34 per share. The number of record holders of the Company's
Common Stock was 80 as of March 13, 2001. The Company believes that there are in
excess of 2,400 beneficial owners of its Common Stock.

         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 which may be designated in the future, the general
business conditions and future contractual restrictions on payment of dividends,
if any.

         RECENT ISSUANCES OF UNREGISTERED SECURITIES. On October 31, 2000, the
Company issued to Lipman Capital Group, Inc. in consideration for financial
public relations services a three (3) year

                                      -21-
<PAGE>

warrant to purchase an aggregate of 20,000 shares of the Company's Common Stock,
at an exercise price of $5.00. Two additional three (3) year warrants to
purchase an aggregate of 40,000 shares of the Company's Common Stock, at an
exercise price of $7.50 and $10.00 per share were issued under this agreement in
January and March 2001. On November 8, 2000, the Company issued to
BusinessDevelopment.com LLC in consideration for consulting services a two (2)
year warrant to purchase up to 200,000 shares of the Company's Common Stock at
an exercise price of $3.33 per share. The warrant vests based upon
introductions, transactions and revenues generated by the Company as a result of
relationships sourced by BusinessDevelopment.com LLC. None of the targets have
been attained as of December 31, 2000 and accordingly, no amounts have been
recorded in the financial statements.

                                      -22-
<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.

OVERVIEW

         The Company develops, markets, licenses and supports a family of
network security software products designed to provide comprehensive security to
computer networks, including Internet based systems and internal networks and
computing resources.The Company introduced its first network software product
(FireWall/Plus) in June 1995. In January 1999, the Company introduced its
CYBERWALLPLUS family of network security products. The Company has made only
limited sales of its CYBERWALLPLUS product, upon which an evaluation of its
prospects and future performance can be made. Such prospects must be considered
in light of the risks, expenses and difficulties frequently encountered in the
introduction of new products and the shift from research and product development
to commercialization of products based on rapidly changing technologies in a
highly specialized and emerging market. The Company will be required to
significantly expand its product and development capabilities, introduce new
products, introduce enhanced features to existing products, expand its in-house
sales force, establish and maintain distribution channels through third-party
vendors, increase marketing expenditures, and attract additional qualified
personnel. In addition, the Company must adapt to the demands of an emerging and
rapidly changing computer network security market, intense competition and
rapidly changing technology and industry standards. The Company may not be able
to successfully address such risks, and the failure to do so would have a
material adverse effect on the Company's business, results of operations and
financial condition.

         To date, the Company has incurred significant losses and, at December
31, 2000, had an accumulated deficit of $ 26,482,000. In addition, since
December 31, 2000, the Company has continued to incur significant operating
losses. The Company expects to incur substantial operating expenses in the
future to support its product development activities, as well as continue to
expand its domestic and international sales activities and marketing
capabilities.

                                      -23-
<PAGE>

         Management believes it currently has cash to fund its operations until
December 31, 2001 (or earlier if the Company does not achieve certain revenue
assumptions) (See "Liquidity and Capital Resources" on page 26 hereof). The
Company is currently seeking additional financing, but it may not be able to
secure such financing. The inability of the Company to obtain such financing
would have a material adverse effect on the Company requiring it to curtail or
possibly cease operations.

         In February 2000, the Company completed the sale of its professional
services business for a sales price of $3.815 million which included $1.115
million held in escrow subject to certain former employees of the Company
remaining employed by the purchaser for at least one year and the purchaser
securing certain minimum purchase orders within ninety (90) days of the closing.
See Note G to Financial Statements. The Company received $1,000,000 from escrow
following the one year anniversary of the transaction and is due an additional
$115,000 from the escrow. In connection with the sale, the Company agreed not to
offer any professional consulting services competitive with the purchaser until
the second anniversary of the closing. Effective upon the sale, the Company
granted options to acquire 104,063 shares of Common Stock at $2.91 per share to
certain employees of the professional services business. In connection
therewith, the Company incurred a compensation charge of $794,000 based upon the
intrinsic value of the portion of the options vesting at such date and
acceleration of other options. The balance of the options vest one year after
the closing provided that the employees are still employed by Exodus. An
additional charge of $230,000 was incurred on the one year anniversary date of
the closing. The sale has been accounted for by the Company as a sale of a
discontinued operation.

         The Company's software products have not yet achieved market
acceptance. The future success of the Company is largely dependent upon market
acceptance of its CYBERWALLPLUS family of software products. While the Company
believes that its family of software products offer advantages over competing
products for network security, license revenue from network security software
products since the introduction of FireWall/Plus (June 1995), a predecessor
product line, through December 31, 2000 has only been $3,900,000, including a
non-refundable pre-paid royalty of $500,000 in 1997. From January 1999 through
December 31, 2000, license revenue from CYBERWALLPLUS has only been $1,167,000.
CYBERWALLPLUS may not achieve significant market acceptance. Revenue from such
commercial products depend on a number of factors, including the influence of
market competition, technological changes in the network security market, the
Company's ability to design, develop and introduce enhancements on a timely
basis, and the ability of the Company to successfully establish and maintain
distribution channels. The failure of CYBERWALLPLUS to achieve significant
market acceptance as a result of competition, technological change or other
factors, would have a material adverse effect on the Company's business,
operating results and financial condition.

         The Company has committed significant product and development resources
to its CYBERWALLPLUS family of products. The Company's anticipated levels of
expenditures for product development are based on its plans for product
enhancements and new product development. The Company capitalizes and amortizes
software development costs in accordance with Statement of Financial Accounting
Standards No. 86. These costs consist of salaries, consulting fees and
applicable overhead.

                                      -24-
<PAGE>

RESULTS OF OPERATIONS

YEAR ENDED DECEMBER 31, 2000 COMPARED TO YEAR ENDED DECEMBER 31, 1999.

         Revenues increased by $753,000 or 191%, from $394,000 for the year
ended December 31, 1999 ("1999") to $1,147,000 for the year ended December 31,
2000("2000"). License revenues increased by $718,000 or 276%, from $260,000 for
1999 to $978,000 for 2000, as a result of the increased market acceptance of the
CYBERWALLPLUS line of products which was first shipped in March 1999. Service
revenues from maintenance and training increased by $35,000 or 26% from $134,000
in 1999 to $169,000 in 2000. The Company's revenues from customers in the United
States represented 87% of its revenues in 1999 and 89% of its revenues in 2000.

         Cost of revenues decreased $601,000 or 56%, from $1,081,000 for 1999 to
$480,000 for 2000, representing 274% and 42% of revenues, respectively. The
decrease in cost of revenues was primarily due to decreased amortization of
software development costs in 2000 and lower royalty cost associated with
licensed technology no longer used.

         Cost of licenses decreased $27,000 or 28%, from $95,000 for 1999 to
$68,000 for 2000, representing 37% and 7% of license revenues, respectively. The
decrease in the cost of licenses resulted primarily from lower royalty cost
associated with licensed technology no longer used and decreased royalties on
third party product sales.

         Amortization of software development costs decreased by $578,000 or
70%, from $825,000 for 1999 to $247,000 for 2000, representing 317% and 25% of
license revenues, respectively. The decrease in amortization of software
development costs in 2000 was due to the write-off of the unamortized
capitalized software costs in 1999 associated with the Company's predecessor
product line, FireWall/Plus, and other technology discontinued in 1999.

         Cost of services increased by $4,000 or 2%, from $161,000 for 1999 to
$165,000 for 2000, representing 120% and 98% of service revenues, respectively.
The decrease in cost of services as a percentage of service revenues was due
primarily to the increase of service revenues.

         The gross loss of $687,000 for 1999 changed to a gross profit of
$667,000 in 2000, an increase of $1,354,000, representing (174%) and 58% of
revenues, respectively. The increase in gross profit was primarily due to
increased license revenue of $718,000, and the decrease in amortization of
capitalized software of $578,000.

         Product development expenses increased by $8,000 or 1%, from $1,428,000
for 1999 to $1,436,000 for 2000, representing 362% and 125% of revenues,
respectively. The increase in product development costs was due primarily to
increased personnel costs. The use of outside consultants was reinstituted
during 2000 to maintain product schedules. During 1999 and 2000, the Company
capitalized $400,000 and $372,000, respectively, of additional software
development costs associated with the development and enhancement of its
CYBERWALLPLUS family of products.

                                      -25-
<PAGE>

         Sales and marketing expenses increased by $153,000 or 6%, from
$2,667,000 for 1999 to $2,820,000 for 2000, representing 677% and 246% of
revenues, respectively. The increase in sales and marketing expenses were due
primarily to increases in marketing personnel costs of $265,000 which was offset
by decreased international personnel costs of $107,000. The decrease in sales
and marketing expenses as a percentage of sales was due to the increase in the
Company's revenues.

         General and administrative expenses decreased by $94,000 or 5%, from
$1,921,000 for 1999 to $1,827,000 for 2000, representing 488% and 159% of
revenues for 1999 and 2000, respectively. The decrease in general and
administrative expenses in dollar amount was due primarily to a decrease of
$141,000 related to recognition of compensation expense related to options
issued to the Company's President and Chief Executive Officer in May 1998, which
was partially offset by increases in investor relations of $101,000 The decrease
in general and administrative expense as a percent of revenue was due primarily
to the increase in the Company's revenues.

         Interest income (net of interest expense of $3,000) for 1999 was
$142,000 compared with interest expense (net of interest income of $324,000) for
2000 of $1,258,000, representing (36%) and 110% of revenue for 1999 and 2000,
respectively. The increase in interest expense was due primarily to the fact
that the Company completed a Series D Preferred Stock, warrant and note
financing on December 22, 1999 which resulted in a small interest charge in 1999
and interest charges in 2000 of $1,582,000 including an interest charge of
$1,500,000 upon shareholder approval related to the excess of the market value
of the common stock (on the closing date of the December financing) issuable
upon conversion of the preferred stock and exercise of the warrants issuable
upon conversion of the notes.

         Loss from discontinued operations was $385,000 in 1999 compared with a
gain on the sale of discontinued operations of $1,885,000 in 2000. The
discontinued operations was sold on February 9, 2000 to Exodus Communications.
The loss in 1999 was attributed to an increase in personnel and travel-related
costs for the professional services division that was sold in February 2000.

         No provision for or benefit from federal, state or foreign income taxes
was recorded for 1999 or 2000 because the Company incurred net operating losses
for each year and fully reserved its deferred tax assets as their future
realization could not be determined.

         As a result of the foregoing, the net loss decreased by $2,157,000 or
31%, from $6,946,000 for 1999 to $4,789,000 for 2000.


LIQUIDITY AND CAPITAL RESOURCES

         The Company's capital requirements have been and will continue to be
significant. At December 31, 2000, the Company had $4,425,000 of cash and cash
equivalents and working capital of $3,039,000. The Company has financed its
operations primarily through sales of equity and debt securities, and the sale
of its professional services group. Net cash used in operating activities was
$5,504,000 during 1999 and $4,343,000

                                     -26-
<PAGE>

during 2000, respectively. Net cash used in operating activities for 1999 was
primarily attributable to a net loss from continuing operations of $6,561,000
and cash used in discontinued operations of $538,000 which was offset by
non-cash expenses including issuance of Common Stock and warrants for services
rendered of $410,000 and depreciation and amortization of $1,123,000. Net cash
used in operating activities in 2000 was primarily attributable to a net loss
from continuing operations of $6,674,000, which was partially offset by cash
provided by discontinued operations of $178,000 and non-cash expenses including
an interest charge from the Series D Preferred Stock of $1,500,000, issuance of
options and warrants for services rendered of $176,000 and depreciation and
amortization of $378,000.

         The Company's operating activities during 1999 and 2000 were financed
primarily with $1,750,000 of net proceeds from the issuance of $1,750,000
principal amount of notes and warrants to purchase 325,919 shares of Common
Stock in 1998 and the Company's initial public offering consummated on November
17, 1998 which resulted in $7,931,000 of net proceeds. In December 1999, the
Company consummated a $3.0 million private financing of preferred stock,
warrants and notes. In addition, in February 2000, the Company sold its
professional services business and received proceeds of $2.7 million. In
February 2001, the Company received an additional $1,000,000 from the sale and
is due an additional $115,000 from escrow. The Company also received $3.47
million from the exercise of stock options and warrants in 2000. The Company
does not currently have a line of credit from a commercial bank or other
institution.

         The Company anticipates, based on currently proposed plans and
assumptions (including the timetable of, costs and expenses associated with, and
success of, its marketing efforts), that its current cash balance approximately
$3,500,000 as of March 31, 2001 together with certain revenue assumptions from
operations, will be sufficient to satisfy the Company's operations and capital
requirements for the next nine (9) months from the date of this report (through
December 2001). 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 December 31, 2001. The Company is currently
seeking financing; however, it does not have any definitive arrangements with
respect to any additional financing. Consequently, additional financing may not
be available to the Company when needed, on commercially reasonable terms or at
all. The inability of the Company to obtain additional financing would have a
material adverse effect on the Company, requiring it to curtail and possibly
cease its operations. In addition, any additional equity financing may involve
substantial dilution to the interests of the Company's then existing
stockholders.

FLUCTUATIONS IN OPERATING RESULTS

         The Company anticipates significant quarterly fluctuations in its
operating results in the future. The Company generally ships orders for
commercial products as they are received and, as a result, does not have any
material backlog. As a result, quarterly revenues and operating results depend
on the volume and timing of orders received during the quarter, which are
difficult to forecast. Operating results may fluctuate on a

                                      -27-
<PAGE>

quarterly basis due to factors such as the demand for the Company's products,
purchasing patterns and budgeting cycles of customers, the introduction of new
products and product enhancements by the Company or its competitors, market
acceptance of new products introduced by the Company or its competitors and the
size, timing, cancellation or delay of customer orders, including cancellation
or delay in anticipation of new product introduction or enhancement. Therefore,
comparisons of quarterly operating results may not be meaningful and should not
be relied upon, nor will they necessarily reflect the Company's future
performance. Because of the foregoing factors, it is likely that in some future
quarters the Company's operating results will be below the expectations of
public market analysts and investors. In such event, the price of the Common
Stock would likely be materially adversely affected.

         The sales cycle for the Company's products can be lengthy and generally
commences at the time a prospective customer demonstrates an interest in
licensing a CYBERWALLPLUS solution, typically includes a 28-day free evaluation
period and ends upon execution of a purchase order by the customer. The length
of the sales cycle varies depending on the type and sophistication of the
customer and the complexity of the operating system.


YEAR 2000 ISSUE

         The Company did not incur material costs with respect to potential
software issues associated with the Year 2000.


ITEM 7. FINANCIAL STATEMENTS

         The financial statements required hereby are located on pages F-1
through F-16 which follow Part III.



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

         None.

                                    PART III


ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS, AND CONTROL PERSONS;
        COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT.

         The information required by this item is incorporated by reference from
the Company's definitive proxy statement to be filed not later than April 30,
2001 pursuant to Regulation 14A of the General Rules and Regulations under the
Securities Exchange Act of 1934 ("Regulation 14A").

                                      -28-
<PAGE>

ITEM 10. EXECUTIVE COMPENSATION

         The information required by this item is incorporated by reference from
the Company's definitive proxy statement to be filed not later than April 30,
2001 pursuant to Regulation 14A.

ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

         The information required by this item is incorporated by reference from
the Company's definitive proxy statement to be filed not later than April 30,
2001 pursuant to Regulation 14A.

ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

         The information required by this item is incorporated by reference from
the Company's definitive proxy statement to be filed not later than April 30,
2001 pursuant to Regulation 14A.

                                      -29-
<PAGE>

ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K

  (a)   Exhibits.

  Number         Description of Exhibit
  ------         ----------------------

  2.1            Merger Agreement, dated September 11, 1998, between the Company
                 and CommHome Systems Corporation(1)

  3.1            Certificate of Incorporation of the Company, as amended
                 (includes form of Certificate of Designation of Series C
                 Preferred Stock and Series D Preferred Stock)(2)

  3.2            By-laws of the Company, as amended(1)

  4.1            Form of Common Stock Certificate(1)

  4.2            Company's Stock Option Plan, as amended(1)

  10.1           Employment Agreement, dated May 18, 1998, between the Company
                 and Avi A. Fogel, and amendment, dated May 30, 1998(1)

  10.2           Employment Agreement, dated May 19, 1998, between the Company
                 and Murray P. Fish(1)

  10.3           Agreement, dated August 30, 1996, between the Company and CMH
                 Capital Management Corp. ("CMH"), with respect to advisory
                 services, and amendments, dated January 15, 1997, and January
                 30, 1997(1)

  10.4           Agreement, dated May 14, 1998, between the Company, CMH and
                 Applewood Associates, L.P. with respect to advisory services(1)

  10.5           Master Software License Agreement, dated November 10, 1997,
                 between the Company and Electronic Data System Corporation, and
                 amendment, dated May 29, 1998(1)

  10.6           Software Distribution Agreement, dated June 5, 1997, between
                 the Company and Trusted Information Systems, Inc.(1)

  10.7           Software Distribution Agreement, dated September 26, 1997,
                 between the Company and Trusted Information Systems, Inc.(1)

  10.8           Reseller Agreement, dated April 17, 1998, between the Company
                 and Aventail Software Corporation(1)

                                      -30-
<PAGE>

  10.9           Agreement, dated May 14, 1998, between the Company and CMH, in
                 connection with the issuance of shares for advisory fees(1)

  10.10          Exchange Agreement, dated July 8, 1998, between the Company and
                 certain of its holders of outstanding warrants and options(1)

  10.11          Employment Agreement, dated July 31, 1998, between the Company
                 and Joseph A. Donohue(1)

  10.12          Agreement, dated October 1, 1998, between the Company and CMH,
                 with respect to advisory services(1)

  10.13          Agreement, dated October 20, 1998, between the Company and
                 certain of its holders of promissory notes(1)

  10.14          Agreement of Sublease, dated December 24, 1998, between PAREXEL
                 International Corporation and the Company and Consent to
                 Sublease, dated January 14, 1999, between Boston Properties
                 Limited Partnership, PAREXEL International Corporation and the
                 Company(3)

  10.15          Securities Purchase Agreement, dated February 22, 1999 between
                 the Company and the investors including form of Certificate of
                 Designation of Series D Preferred Stock (Exhibit A), form of
                 Warrant (Exhibit B) and form of Promissory Note (Exhibit D)(4)

  10.16          Asset Purchase Agreement, dated February 9, 2000, between the
                 Company and Exodus Communications, Inc. including all exhibits
                 and schedules(5)

  10.17          Termination Agreement, dated February 9, 2000 between the
                 Company and William Hancock(2)

  10.18          Termination Agreement, dated February 7, 2000 between the
                 Company and Robert Russo(2)

  21.1           List of Subsidiaries of the Company(1)


      * Filed herewith.

      (1) Incorporated by reference to the exhibit to the Registrant's
Registration Statement on Form SB-2 (File Number 333-59617).

                                      -31-
<PAGE>

      (2) Incorporated by reference to the same numbered exhibit to Registrant's
Annual Report on Form 10-KSB for the year ended December 31, 1999.

      (3) Incorporated by reference to Exhibit 10.28 to Registrant's Form 8-K
filed on January 4, 2000.

      (4) Incorporated by reference to Exhibit 10.29 to Registrant's Form 8-K
filed on February 15, 2000.


      (b)   Reports on Form 8-K

         No reports on Form 8-K were filed during the last quarter of the period
covered by this Report.




























                                      -32-
<PAGE>

NETWORK-1 SECURITY SOLUTIONS, INC.




INDEX TO FINANCIAL STATEMENTS                                               PAGE
-----------------------------                                               ----

Independent auditors' report                                                 F-2

Balance sheets as of December 31, 2000 and 1999                              F-3

Statements of operations for the years ended
December 31, 2000 and 1999                                                   F-4

Statements of stockholders' equity (deficiency)
for the years ended December 31, 2000 and 1999                               F-5

Statements of cash flows for the years ended
December 31, 2000 and 1999                                                   F-6

Notes to financial statements                                                F-7






















                                                                             F-1
<PAGE>

INDEPENDENT AUDITORS' REPORT



Board of Directors and Stockholders
Network-1 Security Solutions, Inc.
Waltham, Massachusetts


We have audited the accompanying balance sheets of Network-1 Security Solutions,
Inc. (the "Company") as of December 31, 2000 and 1999 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 generally accepted auditing
standards. 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, 2000 and 1999 and the results of its operations and its cash
flows for each of the years then ended in conformity with generally accepted
accounting principles.





Richard A. Eisner & Company, LLP

New York, New York
February 21, 2001
















                                                                             F-2
<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.

BALANCE SHEETS
<TABLE><CAPTION>
                                                                                      DECEMBER 31,
                                                                             ------------------------------
                                                                                 2000              1999
                                                                             ------------      ------------
<S>                                                                          <C>               <C>
ASSETS
Current assets:
   Cash and cash equivalents                                                 $  4,425,000      $  3,023,000
   Accounts receivable - net of allowance for doubtful
      accounts of $80,000 and $40,000, respectively                               227,000            65,000
   Prepaid expenses and other current assets                                      153,000           155,000
   Due from purchaser of discontinued operations                                   59,000
   Due from officer                                                                                  88,000
                                                                             ------------      ------------
        Total current assets                                                    4,864,000         3,331,000

Equipment and fixtures                                                            437,000           425,000
Capitalized software costs - net                                                  625,000           500,000
Security deposits                                                                  81,000            82,000
Net assets of discontinued operations                                                               258,000
                                                                             ------------      ------------
                                                                             $  6,007,000      $  4,596,000
                                                                             ============      ============
LIABILITIES
Current liabilities:
   Notes payable - related parties                                           $    326,000      $    525,000
   Notes payable - others                                                         343,000           975,000
   Accounts payable                                                               224,000           320,000
   Accrued expenses and other current liabilities                                 696,000           546,000
   Interest payable - related parties                                              27,000             1,000
   Interest payable - others                                                       28,000             2,000
   Deferred revenue                                                               181,000            58,000
                                                                             ------------      ------------
        Total current liabilities                                               1,825,000         2,427,000
                                                                             ------------      ------------
Commitments and contingencies

STOCKHOLDERS' EQUITY
Preferred stock - $.01 par value; 5,000,000 shares authorized;
   Series A - 10% cumulative, authorized 250,000 shares; none issued and outstanding
   Series B - authorized 500,000 shares; none issued and outstanding
   Series C - authorized 750,000 shares; none issued and outstanding
   Series D - convertible, voting, authorized 1,250,000 shares;
      115,220 and 491,803 shares issued and outstanding at December 31,
      2000 and 1999 respectively, liquidation preference of $351,000 and
      $1,500,000 at December 31, 2000 and 1999, respectively                        1,000             5,000
Common stock - $.01 par value; authorized 25,000,000 shares;
   6,448,363 and 4,935,211 shares issued and outstanding                           65,000            50,000
Additional paid-in capital                                                     30,705,000        23,941,000
Unearned portion of compensatory stock options and warrants                      (107,000)         (134,000)
Accumulated deficit                                                           (26,482,000)      (21,693,000)
                                                                             ------------      ------------
                                                                                4,182,000         2,169,000
                                                                             ------------      ------------
                                                                             $  6,007,000      $  4,596,000
                                                                             ============      ============
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS                                            F-3
<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.

STATEMENTS OF OPERATIONS
<TABLE><CAPTION>
                                                                               YEAR ENDED
                                                                              DECEMBER 31,
                                                                     ------------------------------
                                                                         2000              1999
                                                                     ------------      ------------
<S>                                                                  <C>               <C>
Revenues:
   Licenses                                                          $    978,000      $    260,000
   Services                                                               169,000           134,000
                                                                     ------------      ------------
      Total revenues                                                    1,147,000           394,000
                                                                     ------------      ------------
Cost of revenues:
   Amortization of software development costs                             247,000           825,000
   Cost of licenses                                                        68,000            95,000
   Cost of services                                                       165,000           161,000
                                                                     ------------      ------------
      Total cost of revenues                                              480,000         1,081,000
                                                                     ------------      ------------
Gross profit (loss)                                                       667,000          (687,000)
                                                                     ------------      ------------
Operating expenses:
   Product development costs                                            1,436,000         1,428,000
   Selling and marketing                                                2,820,000         2,667,000
   General and administrative                                           1,827,000         1,921,000
                                                                     ------------      ------------
      Total operating expenses                                          6,083,000         6,016,000
                                                                     ------------      ------------
Loss from continuing operations before interest income (expense)       (5,416,000)       (6,703,000)
Interest income                                                           324,000           145,000
Interest expense                                                       (1,018,000)           (2,000)
Interest expense - related parties                                       (564,000)           (1,000)
                                                                     ------------      ------------
Loss from continuing operations                                        (6,674,000)       (6,561,000)
                                                                     ------------      ------------
Loss from discontinued operations                                                          (385,000)
Gain on sale of discontinued operations, net of operating losses
   during phase-out period                                              1,885,000
                                                                     ------------      ------------
                                                                        1,885,000          (385,000)
                                                                     ------------      ------------
NET LOSS                                                               (4,789,000)       (6,946,000)
Imputed dividend on preferred stock                                                      (1,500,000)
                                                                     ------------      ------------
NET LOSS APPLICABLE TO COMMON STOCK                                  $ (4,789,000)     $ (8,446,000)
                                                                     ============      ============
PER COMMON SHARE - BASIC AND DILUTED:
   Loss per share from continuing operations                         $      (1.12)     $      (1.83)
   Income (loss) per share from discontinued operations                       .32             (0.09)
                                                                     ------------      ------------
   Loss per share                                                    $      (0.80)     $      (1.92)
                                                                     ============      ============
WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING                    5,984,165         4,394,178
                                                                     ============      ============
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS                                            F-4
<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.

STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE><CAPTION>

                                       SERIES D CONVERTIBLE
                                         PREFERRED STOCK                      COMMON STOCK
                                 ------------------------------      -----------------------------
                                    SHARES            AMOUNT            SHARES           AMOUNT
                                 ------------      ------------      ------------     ------------
<S>                              <C>               <C>               <C>              <C>
BALANCE - DECEMBER 31, 1998           562,836      $      6,000         4,366,520     $     44,000
Amortization of compensatory
   stock options
Issuance of common stock and
   options for services
   rendered and payment of
   liability                                                                5,855
Beneficial conversion
   feature of Series D
   preferred stock
Conversion of Series C
   preferred stock                   (562,836)           (6,000)          562,836            6,000
Issuance of Series D
   preferred stock                    491,803             5,000
Net loss
                                 ------------      ------------      ------------     ------------

BALANCE - DECEMBER 31, 1999           491,803             5,000         4,935,211           50,000
Amortization of compensatory
   stock options
Conversion of Series D
   preferred stock                   (376,583)           (4,000)          376,583            4,000
Exercise of employee and
   nonemployee stock options                                              470,051            5,000
Exercise of warrants                                                      384,091            4,000
Conversion of notes and
   accrued interest                                                       282,427            2,000
Compensation charge for
   issuance of nonqualified
   stock options
Compensation charge for
   accelerated vesting of
   options
Beneficial conversion
   feature of Series D
   preferred stock
   underlying notes payable
   and related debt discount
Issuance of warrants and
   options for services
Unearned portion of
   compensatory warrants
Net loss
                                 ------------      ------------      ------------     ------------
BALANCE - DECEMBER 31, 2000           115,220      $      1,000         6,448,363     $     65,000
                                 ============      ============      ============     ============





                                                     UNEARNED
                                                    PORTION OF
                                  ADDITIONAL       COMPENSATORY
                                   PAID-IN        STOCK OPTIONS       ACCUMULATED
                                   CAPITAL         AND WARRANTS         DEFICIT          TOTAL
                                 ------------      ------------      ------------     ------------
BALANCE - DECEMBER 31, 1998      $ 20,819,000      $   (383,000)     $(13,247,000)    $  7,239,000
Amortization of compensatory
   stock options                                        249,000                            249,000
Issuance of common stock and
   options for services
   rendered and payment of
   liability                          161,000                                              161,000
Beneficial conversion
   feature of Series D
   preferred stock                  1,500,000                          (1,500,000)               0
Conversion of Series C
   preferred stock                                                                               0
Issuance of Series D
   preferred stock                  1,461,000                                            1,466,000
Net loss                                                               (6,946,000)      (6,946,000)
                                 ------------      ------------      ------------     ------------

BALANCE - DECEMBER 31, 1999        23,941,000          (134,000)      (21,693,000)       2,169,000
Amortization of compensatory
   stock options                                        108,000                            108,000
Conversion of Series D
   preferred stock                                                                               0
Exercise of employee and
   nonemployee stock options        2,255,000                                            2,260,000
Exercise of warrants                1,207,000                                            1,211,000
Conversion of notes and
   accrued interest                   859,000                                              861,000
Compensation charge for
   issuance of nonqualified
   stock options                      525,000                                              525,000
Compensation charge for
   accelerated vesting of
   options                            269,000                                              269,000
Beneficial conversion
   feature of Series D
   preferred stock
   underlying notes payable
   and related debt discount        1,500,000                                            1,500,000
Issuance of warrants and
   options for services                68,000                                               68,000
Unearned portion of
   compensatory warrants               81,000           (81,000)                                 0
Net loss                                                               (4,789,000)      (4,789,000)
                                 ------------      ------------      ------------     ------------
BALANCE - DECEMBER 31, 2000      $ 30,705,000      $   (107,000)     $(26,482,000)    $  4,182,000
                                 ============      ============      ============     ============
</TABLE>

SEE NOTES TO FINANCIAL STATEMENTS                                            F-5
<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.

STATEMENTS OF CASH FLOWS
<TABLE><CAPTION>
                                                                                            YEAR ENDED
                                                                                            DECEMBER 31,
                                                                                   ------------------------------
                                                                                       2000              1999
                                                                                   ------------      ------------
<S>                                                                                <C>               <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
   Loss from continuing operations                                                 $ (6,674,000)     $ (6,561,000)
   Adjustments to reconcile loss from continuing operations to net cash
      used in operating activities:
        Interest charge from Series D convertible preferred stock                     1,500,000
        Interest accrued and converted to Series D convertible preferred stock           30,000
        Issuance of common stock and warrants for services rendered                      68,000           161,000
        Provision for doubtful accounts                                                  40,000           (71,000)
        Amortization of compensatory stock options                                      108,000           249,000
        Depreciation and amortization                                                   378,000         1,123,000
        Changes in:
           Accounts receivable                                                         (202,000)           83,000
           Prepaid expenses and other current assets                                      2,000           (36,000)
           Accounts payable, accrued expenses and other current liabilities              54,000           104,000
           Interest payable                                                              52,000             3,000
           Deferred revenue                                                             123,000           (21,000)
                                                                                   ------------      ------------
   Net cash used in continuing operating activities                                  (4,521,000)       (4,966,000)
   Cash provided by (used in) discontinued operations                                   178,000          (538,000)
                                                                                   ------------      ------------
              Net cash used in operating activities                                  (4,343,000)       (5,504,000)
                                                                                   ------------      ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
   Acquisitions of equipment and fixtures                                              (143,000)         (363,000)
   Capitalized software costs                                                          (372,000)         (400,000)
   Loan to officer                                                                       88,000           (88,000)
   Security deposit                                                                       1,000           (45,000)
   Proceeds from sale of discontinued operations                                      2,700,000
                                                                                   ------------      ------------
              Net cash provided by (used in) investing activities                     2,274,000          (896,000)
                                                                                   ------------      ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
   Proceeds from exercise of options and warrants                                     3,471,000
   Proceeds from issuance of notes payable and warrants                                                 1,500,000
   Proceeds from issuance of Series D convertible preferred stock                                       1,500,000
                                                                                   ------------      ------------
              Net cash provided by financing activities                               3,471,000         3,000,000
                                                                                   ------------      ------------

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                                  1,402,000        (3,400,000)
Cash and cash equivalents - beginning of year                                         3,023,000         6,423,000
                                                                                   ------------      ------------
CASH AND CASH EQUIVALENTS - END OF YEAR                                            $  4,425,000      $  3,023,000
                                                                                   ============      ============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
   Noncash transaction:
      Issuance of common stock in connection with conversion of notes payable      $    831,000
      Issuance of common stock in connection with payment of deferred salary                         $     32,000
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS                                            F-6
<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.

NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2000 AND 1999

NOTE A - THE COMPANY AND BASIS OF PRESENTATION

Network-1 Security Solutions, Inc. (the "Company") develops, markets, licenses
and supports its proprietary network security software products designed to
provide comprehensive security to computer networks. The Company also provides
maintenance and training services. The Company also provided consulting services
in network security and network design through its Professional Services Group
which was sold in February 2000 and is being accounted for as a discontinued
operation (see Note G).

NOTE B - SIGNIFICANT ACCOUNTING POLICIES

[1]   CASH EQUIVALENTS:

      The Company considers all highly liquid short-term investments purchased
      with a 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. Service revenues consist of maintenance and
      training services. Annual renewable maintenance fees are a separate
      component of each contract, and are recognized ratably over the contract
      term. Training revenues are recognized as such services are performed.

[3]   EQUIPMENT AND FIXTURES:

      Equipment and fixtures are stated at cost and are depreciated using the
      straight-line method over their estimated useful lives of five years.

[4]   SOFTWARE DEVELOPMENT COSTS:

      Costs to maintain developed programs and development costs incurred to
      establish the technological feasibility of computer software are expensed
      as incurred. The Company capitalizes costs incurred in producing computer
      software after technological feasibility of the software has been
      established through the date that the software is ready for general
      release to customers. Such costs are amortized based on current and
      estimated future revenue of each product with an annual minimum equal to
      the straight-line amortization over the remaining estimated economic life
      of the product. The Company estimates the economic life of its software to
      be three years. At each balance sheet date, the unamortized capitalized
      software costs of each product are compared with the net realizable value
      of that product and any excess capitalized costs are written off.








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

NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2000 AND 1999

NOTE B - SIGNIFICANT ACCOUNTING POLICIES  (CONTINUED)

[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 for any tax benefits which are not expected to be realized.

[6]   LOSS PER SHARE:

      Basic loss per share is calculated by dividing the net loss by the
      weighted average number of outstanding common shares during the year.
      Diluted per share data includes the dilutive effects of options, warrants
      and convertible securities. Potential common shares of 3,308,708 and
      4,117,079 at December 2000 and 1999 are anti-dilutive, and are not
      included in the calculation of diluted loss per share. Such potential
      common shares reflect options, warrants, convertible preferred stock and
      convertible notes. For the year ended December 31, 1999, the loss per
      share is increased by the value of the beneficial conversion feature on
      the Series D Preferred Stock which is accounted for as a preferred stock
      dividend (see Note F).

[7]   USE OF ESTIMATES:

      The preparation of financial statements in conformity with generally
      accepted accounting principles 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 receivable,
      accounts payable and accrued expenses approximate their fair value due to
      the short period to maturity of these instruments. The Company believes
      its notes payable approximate fair value based on current yields for
      similar debt instruments with similar terms.

[9]   STOCK-BASED COMPENSATION:

      The Company accounts for its employee stock-based compensation plans under
      Accounting Principles Board Opinion No. 25 ("APB No. 25"), "Accounting for
      Stock Issued to Employees" and related interpretations. Under the
      provisions of APB No. 25, compensation cost for stock options is measured
      as the excess, if any, of the estimated market value of the Company's
      common stock at the date of the grant over the amount an employee must pay
      to acquire the stock. The Company has adopted the disclosure-only
      provisions of Statement of Financial Accounting Standards (SFAS) No.123,
      "Accounting for Stock-Based Compensation."

[10]  ADVERTISING COSTS:

      Advertising costs are expensed as incurred. Advertising expense was
      $387,000 and $303,000 for the years ended December 31, 2000 and 1999,
      respectively.

[11]  RECLASSIFICATION:

      Certain prior year amounts have been reclassified to conform with the
      current year presentation.

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

NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2000 AND 1999


NOTE C - EQUIPMENT AND FIXTURES

Equipment and fixtures are summarized as follows:

                                                       DECEMBER 31,
                                               ---------------------------
                                                   2000           1999
                                               ------------   ------------
      Office and computer equipment            $    535,000   $    416,000
      Furniture and fixtures                        114,000         90,000
                                               ------------   ------------
                                                    649,000        506,000
      Less accumulated depreciation                (212,000)       (81,000)
                                               ------------   ------------
                                               $    437,000   $    425,000
                                               ============   ============

Depreciation expense was $131,000 and $298,000 for the years ended December 31,
2000 and 1999, respectively.

NOTE D - CAPITALIZED SOFTWARE COSTS
                                                        YEAR ENDED
                                                       DECEMBER 31,
                                               ---------------------------
                                                   2000           1999
                                               ------------   ------------
      Balance, beginning of year (net of
         accumulated amortization)             $    500,000   $    925,000
      Additions                                     372,000        400,000
      Amortization                                 (247,000)      (825,000)
                                               ------------   ------------
      Balance, end of year (net of
         accumulated amortization)             $    625,000   $    500,000
                                               ============   ============

Amortization expense in 1999 includes a write-off of $213,000 associated with a
predecessor product line and other technology which is no longer being used.

NOTE E - NOTES PAYABLE

In December 1999, the Company raised $3,000,000 through the issuance of
convertible notes payable and Series D convertible preferred stock (See Note
F[1]).

In December 1999, the Company issued $1,500,000 of convertible promissory notes
(the "Notes") bearing interest at 8%, which mature in December 2001 ($525,000 of
which was payable to related parties). The Notes were convertible into 491,803
shares of Series D preferred stock of the Company (570,492 shares if interest
through the maturity of the notes is considered) and an equal number of
five-year warrants to purchase 491,803 shares of Common Stock (570,492 shares if
interest through the maturity of the notes is considered) at an exercise price
of $3.00 per share, subject to certain adjustments. The conversion price of the
Series D preferred stock ($1,500,000) and the exercise price of the warrants
($1,475,000) was less than the aggregate market price ($5,102,000) of the common
stock obtainable upon conversion and exercise on the date of the private
placement. Accordingly, upon approval of the conversion feature by a majority
vote of the stockholders of the Company in April 2000, the Company incurred an
interest charge of $1,500,000, representing the beneficial conversion feature of
the preferred stock, limited to the $1,500,000 proceeds received on the issuance
of the notes.

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

NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2000 AND 1999


NOTE E - NOTES PAYABLE  (CONTINUED)

During the fiscal year ended December 31, 2000, $831,000 of the above notes,
including $199,000 to related parties and $30,000 of accrued interest payable on
the notes, including $12,000 payable to related parties were converted, at a
conversion price of $3.05 per share, into 282,427 shares of Series D convertible
preferred stock and an equal number of five year warrants. The preferred stock
then converted into 282,427 shares of common stock.

NOTE F - STOCKHOLDERS' EQUITY

[1]   PREFERRED STOCK:

      Pursuant to the private placement discussed in Note E, in December 1999
      the Company received $1,500,000 from the sale of 491,803 shares of Series
      D convertible preferred stock at $3.05 per share including 172,129 shares
      to related parties. Such stock is convertible into common shares on a one
      to one basis, has identical voting rights as the Company's common stock,
      and is entitled to equivalent dividend rights as those paid on shares of
      common stock obtainable on conversion. The holders of the Series D
      convertible preferred stock are entitled to a liquidation preference of
      $3.05 per share plus any declared but unpaid dividends before any payments
      are made to holders of common stock, in the event of liquidation,
      dissolution or winding up of the Company. In connection therewith, the
      Company also issued five-year warrants to purchase 491,803 shares of
      common stock at an exercise price of $3.00 per share. The exercise price
      of the warrants was reduced to $1.00 because the Company did not achieve a
      specified revenue target. Holders of warrants for 444,857 shares,
      including 424,411 warrants obtained upon conversion of notes and accrued
      interest (Note E), waived such reduction. Of these warrants, 147,149 were
      exercised during 2000. The additional $2.00 paid on exercise of the
      warrants, has been included in additional paid-in capital

      The conversion price of the preferred stock ($1,500,000) was less than the
      aggregate market price ($2,551,000) of the common stock obtainable on
      conversion on the date of the private placement. In addition, the exercise
      price of the warrants ($1,475,000) was less than the aggregate market
      price ($2,551,000) of the common stock obtainable on exercise on the date
      of the private placement. Accordingly, the value of the warrants and the
      beneficial conversion feature of the preferred stock, limited to the
      $1,500,000 proceeds received on the issuance, was accounted for as an
      imputed dividend on the preferred stock at the date of issuance.

      During the year ended December 31, 1999, 562,836 shares of Series C
      convertible preferred stock were converted into 562,836 shares of common
      stock.

[2]   STOCK OPTIONS:

      During 1996, the Board of Directors and stockholders approved the adoption
      of the 1996 Stock Option Plan (the "1996 Plan"). The 1996 Plan, as
      amended, provides for the granting of both incentive and non-qualified
      options to purchase common stock of the Company.

      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
      optionee owning more than 10% of the voting stock of the Company) ("10%
      stockholder"). The option price for incentive stock options can not 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
      are set by the Compensation Committee in its discretion.

      At a special meeting of the shareholders on November 9, 2000, an amendment
      to the 1996 Plan was approved increasing the number of shares in the plan
      by 735,000 shares to a total of 2,535,000 shares.

      In January, 2001, the Company issued 220,270 incentive stock options and
      41,575 non-qualified stock options to employees, directors and an outside
      vendor. These options are exerciseable at $3.00 per share and 246,345 of
      these options vest when the trading price of the Company's stock is at
      least $10.00 for five consecutive trading days. The remaining options vest
      over four years.

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

NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2000 AND 1999


NOTE F - STOCKHOLDERS' EQUITY  (CONTINUED)

[2]   STOCK OPTIONS:  (CONTINUED)

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

<TABLE><CAPTION>
                                                                        2000                            1999
                                                            ---------------------------     ---------------------------
                                                                              WEIGHTED                        WEIGHTED
                                                                              AVERAGE                         AVERAGE
                                                              OPTIONS         EXERCISE        OPTIONS         EXERCISE
                                                            OUTSTANDING        PRICE        OUTSTANDING        PRICE
                                                            -----------     -----------     -----------     -----------
      <S>                                                   <C>             <C>             <C>             <C>
      Options outstanding at beginning of year                1,641,924         $4.16         1,200,826         $5.01
      Granted                                                   721,163          6.19           747,630          3.34
      Exercised                                                (470,051)         4.81
      Cancelled                                                (290,194)         5.27          (306,532)         5.09
                                                            -----------                     -----------
      Options outstanding at end of year                      1,602,842 (a)      4.94         1,641,924 (a)      4.16
                                                            ===========                     ===========
      Options exercisable at end of year                        793,092          4.22           923,864          4.40
                                                            ===========                     ===========


(a)   Includes 294,879 options issued outside the 1996 Plan (Note H[3])
</TABLE>

      The following table presents information relating to stock options
      outstanding and exercisable at December 31, 2000:

<TABLE><CAPTION>
                                                  WEIGHTED    WEIGHTED                                             WEIGHTED
             RANGE OF                             AVERAGE     AVERAGE                        AVERAGE
             EXERCISE                OPTIONS      EXERCISE   REMAINING        OPTIONS        EXERCISE
              PRICES               OUTSTANDING     PRICE    LIFE IN YEARS   EXERCISABLE       PRICE
       --------------------        -----------     ------    -----------    -----------       ------
       <S>                         <C>             <C>       <C>            <C>               <C>
       $  1.50  -  $   2.91          555,735       $ 2.31       5.45           337,437        $ 2.26
       $  3.00  -  $   3.75          225,600         3.58       8.90           129,870          3.73
       $  4.13  -  $   5.69          277,750         5.51       9.15            67,101          5.60
       $  6.00  -  $  6.875          300,757         6.13       7.99           212,744          6.07
       $ 10.00  -  $ 10.125          243,000        10.12       9.38            45,940         10.11
                                   -----------                              -----------
                                   1,602,842         4.94       7.65           793,092          4.22
                                   ===========                              ===========
</TABLE>


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

NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2000 AND 1999


NOTE F - STOCKHOLDERS' EQUITY  (CONTINUED)

[2]   STOCK OPTIONS:  (CONTINUED)

      The weighted average fair value at date of grant for options granted,
      including the accelerated vesting of options for PSG employees (Note G),
      during the year ended December 31, 2000 and 1999, were $6.46 and $3.28 per
      option, respectively. The fair value of options at date of grant was
      estimated using the Black-Scholes option pricing model utilizing the
      following weighted average assumptions:
                                                        DECEMBER 31,
                                                     ----------------
                                                      2000      1999
                                                     ------    ------
      Risk-free interest rates                        5.64%     5.99%
      Expected option life in years                      6         6
      Expected stock price volatility                  113%       90%
      Expected dividend yield                            0%        0%

      The Company recognized $902,000 and $249,000, during 2000 and 1999,
      respectively, of compensation costs related to employee stock options. In
      2000, $794,000 of these costs was charged against the gain on sale of
      discontinued operations.

      Had the Company elected to recognize compensation cost based on the fair
      value of the options at the date of grant as prescribed by SFAS 123, net
      loss applicable to common stock for the years ended December 31, 2000 and
      1999 would have been $(6,905,000) and $(9,557,000) or $(1.15) per share
      and $(2.17) per share, respectively.

[3]   WARRANTS:

      As of December 31, 2000, the Company has the following outstanding
warrants to purchase shares of common stock:

              NUMBER OF       EXERCISE
               WARRANTS        PRICE           EXPIRATION DATE
               --------        -----        -----------------------
                110,278        $1.00        December 22, 2004
                 62,080        1.61         October 11, 2003 - January 15, 2004
                 62,856        2.42         May 18, 2003 - April 4, 2004
                297,708        3.00         December 22, 2004
                100,104        6.44         March 14, 2006 - February 24, 2007
                170,000        9.30         November 12, 2003
                 93,120        9.66         March 14, 2006
                200,000        3.33         November 8, 2002 (a)
                 20,000        5.00         October 31, 2003 (b)
             ----------
              1,116,146
             ==========

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

NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2000 AND 1999


NOTE F - STOCKHOLDERS' EQUITY  (CONTINUED)


[3]   WARRANTS:  (CONTINUED)

      (a)  In November 2000, the Company entered into a business development
           agreement with a marketing company and issued 200,000 warrants to
           purchase the Company's common stock. The warrants expire in November
           2002, have an exercise price of $3.33, and have a cashless exercise
           provision. The warrants vest as specified performance and revenue
           targets are attained, none of which have been attained as of December
           31, 2000 and accordingly, no amounts have been recorded in the
           financial statements. Expense will be recorded as the targets are
           attained. The expense could be substantial depending upon, among
           other factors, the fair market value of the Company's stock on the
           dates the targets are obtained.

      (b)  Represents warrants issued pursuant to a consulting agreement with an
           advisory firm. Under the agreement, entered into on October 31, 2000,
           the Company is required to pay a monthly fee and issue 60,000
           warrants. The warrants have exercise prices ranging from $5.00 to
           $10.00, expire three years after issuance, and are issued 1/3 at the
           inception of the agreement, 1/3 at 60 days, and 120 days after
           inception. The warrants were valued at $108,000 using the
           Black-Scholes option pricing model using the following weighted
           average assumptions on the dates of the first issuance and as of
           December 31, 2000 respectively: risk free interest rate of 5.60,
           volatility of 113%, dividend yield of 0 and expected life of three
           years. The value of the warrants is being amortized and charged to
           expense ratably over the six month term of the agreement, and $27,000
           has been charged to expense as of December 31, 2000. The total value
           of the warrants, and therefore the expense related to the agreement
           is subject to change depending on the risk free interest rate,
           volatility, and market price of the Company's common stock on the
           dates of the second and third issuances, due in January and March
           2001.

NOTE G - DISCONTINUED OPERATIONS

On February 9, 2000, the Company completed the sale of its Professional Services
Group ("PSG") to Exodus Communications, Inc. ("Exodus") for $4.0 million in
cash, of which $1.3 million was held in escrow subject to certain conditions.
Release to the Company of cash held in escrow was conditioned upon (i) as to
$1,000,000 certain PSG employees remaining employed by Exodus for at least one
year and (ii) as to $300,000, to the extent purchase orders or commitments are
secured by Exodus from certain customers within 90 days of the closing, up to a
maximum of $300,000. PSG provided consulting services in network security and
network design. Effective upon the sale, the Company granted options to acquire
104,063 shares of common stock at $2.91 per share and accelerated the vesting of
24,556 options that would have otherwise expired, with exercise prices ranging
from $1.50 to $6.50 to certain employees of PSG. In connection therewith, the
Company incurred a compensation charge of $794,000 based upon the intrinsic
value of the portion of the options vesting at such date. The balance of the
options vest one year after the closing provided that the employees are still
employed by Exodus. In addition, the Company agreed to pay an aggregate of 14%
of the $1,000,000 of escrow proceeds to the former employees provided that they
remained with Exodus for at least one year. Charges relating to the options and
the remittance of 14% of the escrow proceeds are reflected as reductions of the
gain on sale of discontinued operations.

In the first quarter of 2000, Exodus secured $59,000 of purchase orders from the
designated customers and the Company recognized the related gain. In February
2001, the Company received $1,000,000 released from the escrow since the PSG
employees remained employed by Exodus for one year, and agreed to accept
$115,000 as satisfaction of the remaining $300,000 escrow. The options vesting
in February 2001, were valued at $230,000 using the Black-Sholes option pricing
model using the following assumptions on the date of vesting: risk free interest
rate of 5.38%, volatility of 112.58%, dividend yield of 0 and expected life of
six years. The completion of the sale will result in an additional net gain
recognized in 2001 of approximately $686,000.

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

NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2000 AND 1999

NOTE G - DISCONTINUED OPERATIONS   (CONTINUED)

The results of PSG have been reported separately as discontinued operations in
the consolidated statement of operations and net assets of PSG have been
segregated in the accompanying balance sheets. Components of amounts reflected
in the statement of operations and balance sheets are presented below.

                                          YEAR ENDED
                                          DECEMBER 31,
                               --------------------------------
                                   2000                1999
                               ------------        ------------
      Accounts receivable                          $    317,000
      Fixed assets                                       52,000
      Accrued expenses                                  (66,000)
      Deferred revenue                                  (45,000)
                                                   ------------
                                                   $    258,000
                                                   ============

      Revenue                  $    148,000        $  1,284,000
      Cost of revenue              (143,000)         (1,353,000)
      Operating expenses            (32,000)           (316,000)
                               ------------        ------------
                                    (27,000)           (385,000)
      Gain on sale of
      discontinued operations     1,912,000
                               ------------        ------------
                               $  1,885,000        $   (385,000)
                               ============        ============

NOTE H - COMMITMENTS AND CONTINGENCIES

[1]   OPERATING LEASES:

      The Company leases office facilities in Massachusetts and New Hampshire
      under operating leases which expire in 2001 and 2004, respectively. Rental
      commitments for the remaining terms of the leases are as follows:

                   YEAR ENDING
                   DECEMBER 31,
                   ------------
                     2001 .............  $    182,542
                     2002 .............        25,004
                     2003 .............        25,429
                     2004 .............         4,250
                                         ------------
                                         $    237,225
                                         ============

      Rental expense for the years December 31, 2000 and 1999 aggregated
$223,000 and $268,000, respectively.

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

NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2000 AND 1999


NOTE H - COMMITMENTS AND CONTINGENCIES  (CONTINUED)

[2]   SOFTWARE DISTRIBUTION AGREEMENTS:

      (a)  Pursuant to a software distribution agreement entitling the Company
           to incorporate certain technology into its software, $100,000 of
           royalty payable was accrued as of December 31, 2000.

      (b)  Pursuant to an agreement under which certain technology was developed
           for the Company, royalty payments of up to $100,000 may be payable.
           As of December 31, 2000 royalties owed pursuant to such agreement
           were not significant.

[3]   EMPLOYMENT AGREEMENTS:

      In May 1998, the Company entered into an employment agreement with its
      President and Chief Executive Officer which provides for a base salary of
      $150,000, subject to annual increases of up to 20% by the Board of
      Directors at its discretion. Effective May 2000, the base salary under the
      agreement was increased to $185,000. The agreement also provides for an
      annual bonus of up to $50,000 as determined by the Board of Directors in
      its discretion. The agreement expires in May 2002. In connection
      therewith, the Company granted the President a five-year option to
      purchase 294,879 shares of the Company's common stock at an exercise price
      of $2.42 per share. The option vests 34% immediately and then 22% per year
      thereafter. As the estimated fair value of the Company's common stock at
      the date of grant of the option ($5.60 per share) was in excess of the
      exercise price, the Company will incur aggregate compensation expense of
      approximately $938,000 over the service period, of which $912,000 has been
      charged to expense through December 31, 2000.

      The Company has employment agreements with two other officers providing
      each with annual salaries of $150,000 through May and July, 2001. These
      agreements provide for the granting of bonuses at the discretion of the
      Board of Directors, as well as options to purchase shares of common stock.

      Aggregate salary commitments pursuant to employment agreements are
      $329,000 and $69,000 for 2001 and 2002, respectively.

[4]   SAVINGS AND INVESTMENT PLAN:

      The Company has a Savings and Investment Plan which allows participants to
      make contributions by salary reduction pursuant to Section 401(k) of the
      Internal Revenue Code of 1986. The Company also may make discretionary
      annual matching contributions in amounts determined by the Board of
      Directors, subject to statutory limits. The Company did not make any
      contributions to the 401(k) Plan during the years ended December 31, 2000
      and 1999.

NOTE I - INCOME TAXES

At December 31, 2000, the Company has available net operating loss carryforwards
to reduce future federal taxable income of approximately $19,607,000 for tax
reporting purposes, which expire from 2009 through 2020. 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.

                                                                            F-15
<PAGE>
NETWORK-1 SECURITY SOLUTIONS, INC.

NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2000 AND 1999

NOTE I - INCOME TAXES  (CONTINUED)

The principal components of deferred tax assets and valuation allowance are as
follows:
                                                        YEAR ENDED
                                                       DECEMBER 31,
                                              ------------------------------
                                                  2000              1999
                                              ------------      ------------
      Deferred tax assets:
         Net operating loss carryforwards     $  7,353,000      $  6,400,000
         Options and warrants not yet
           deducted, for tax purposes              418,000
         Other                                      96,000
                                              ------------      ------------
                                                 7,867,000         6,400,000
      Valuation allowance                       (7,867,000)       (6,400,000)
                                              ------------      ------------
      Net deferred tax asset                  $          0      $          0
                                              ============      ============

The Company has recorded a valuation allowance for the full amount of its
deferred tax assets as the likelihood of its future realization cannot be
presently determined. The valuation allowance was increased by $1,467,000 in
2000 and $1,884,000 in 1999.

The difference between the tax benefit and the amount that would be computed by
applying the statutory federal income tax rate to loss before taxes is
attributable to the following:
                                                        YEAR ENDED
                                                       DECEMBER 31,
                                              ------------------------------
                                                  2000              1999
                                              ------------      ------------

      Income tax benefit - statutory rate           (34.0)%           (34.0)%
      State and local, net                           (3.5)             (3.5)
      Permanent difference - interest
         charge representing beneficial
         conversion feature on
         preferred stock                             11.7
      Increase in valuation allowance on
         deferred tax assets                         30.6              37.5
      Other                                          (4.8)
                                              ------------      ------------
                                                       0.0%              0.0%
                                              ============      ============
NOTE J - CONCENTRATIONS

[1]   For the year ended December 31, 2000, sales of approximately $136,000
      (12%) was from one customer. Accounts receivable at December 31, 2000
      includes $80,000 (35%) from this customer.

[2]   For the years ended December 31, 2000 and 1999, export sales of the
      Company's products amounted to approximately $125,000 and $52,000,
      respectively.

[3]   The Company places its cash investments in high quality financial
      institutions insured by the Federal Deposit Insurance Corporation
      ("FDIC"). At December 31, 2000 the Company maintained cash balances in
      excess of the FDIC limit of $4,630,000.

                                                                            F-16




                                   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
Waltham, Commonwealth of Massachusetts, on the 16th day of April 2001.


         NETWORK-1 SECURITY SOLUTIONS, INC.


         By:   /S/ AVI A. FOGEL
               ----------------------------------------------------
                Avi A. Fogel, President 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/ AVI A. FOGEL             President, Chief Executive           April 16, 2001
   ----------------------    Officer and Director
    Avi A. Fogel             (principal executive officer)

/S/ MURRAY P. FISH           Chief Financial Officer              April 16, 2001
   ----------------------    (principal financial officer
    Murray P. Fish            and principal accounting officer)

/S/ COREY M. HOROWITZ        Chairman of the Board of Directors   April 16, 2001
   ----------------------
    Corey M. Horowitz

/S/ EMANUEL PEARLMAN         Director                             April 16, 2001
   ----------------------
    Emanuel Pearlman

/S/ MARCUS RANUM             Director                             April 16, 2001
   ----------------------
    Marcus Ranum


<PAGE>

                                  EXHIBIT INDEX

  Number         Description of Exhibit
  ------         ----------------------

  2.1            Merger Agreement, dated September 11, 1998, between the Company
                 and CommHome Systems Corporation(1)

  3.1            Certificate of Incorporation of the Company, as amended
                 (includes form of Certificate of Designation of Series C
                 Preferred Stock and Series D Preferred Stock)(2)

  3.2            By-laws of the Company, as amended(1)

  4.1            Form of Common Stock Certificate(1)

  4.2            Company's Stock Option Plan, as amended(1)

  10.1           Employment Agreement, dated May 18, 1998, between the Company
                 and Avi A. Fogel, and amendment, dated May 30, 1998(1)

  10.2           Employment Agreement, dated May 19, 1998, between the Company
                 and Murray P. Fish(1)

  10.3           Agreement, dated August 30, 1996, between the Company and CMH
                 Capital Management Corp. ("CMH"), with respect to advisory
                 services, and amendments, dated January 15, 1997, and January
                 30, 1997(1)

  10.4           Agreement, dated May 14, 1998, between the Company, CMH and
                 Applewood Associates, L.P. with respect to advisory services(1)

  10.5           Master Software License Agreement, dated November 10, 1997,
                 between the Company and Electronic Data System Corporation, and
                 amendment, dated May 29, 1998(1)

  10.6           Software Distribution Agreement, dated June 5, 1997, between
                 the Company and Trusted Information Systems, Inc.(1)

  10.7           Software Distribution Agreement, dated September 26, 1997,
                 between the Company and Trusted Information Systems, Inc.(1)

  10.8           Reseller Agreement, dated April 17, 1998, between the Company
                 and Aventail Software Corporation(1)

  10.9           Agreement, dated May 14, 1998, between the Company and CMH, in
                 connection with the issuance of shares for advisory fees(1)

  10.10          Exchange Agreement, dated July 8, 1998, between the Company and
                 certain of its holders of outstanding warrants and options(1)

  10.11          Employment Agreement, dated July 31, 1998, between the Company
                 and Joseph A. Donohue(1)

  10.12          Agreement, dated October 1, 1998, between the Company and CMH,
                 with respect to advisory services(1)

  10.13          Agreement, dated October 20, 1998, between the Company and
                 certain of its holders of promissory notes(1)

  10.14          Agreement of Sublease, dated December 24, 1998, between PAREXEL
                 International Corporation and the Company and Consent to
                 Sublease, dated January 14, 1999, between Boston Properties
                 Limited Partnership, PAREXEL International Corporation and the
                 Company(3)

  10.15          Securities Purchase Agreement, dated February 22, 1999 between
                 the Company and the investors including form of Certificate of
                 Designation of Series D Preferred Stock (Exhibit A), form of
                 Warrant (Exhibit B) and form of Promissory Note (Exhibit D)(4)

  10.16          Asset Purchase Agreement, dated February 9, 2000, between the
                 Company and Exodus Communications, Inc. including all exhibits
                 and schedules(5)

  10.17          Termination Agreement, dated February 9, 2000 between the
                 Company and William Hancock(2)

  10.18          Termination Agreement, dated February 7, 2000 between the
                 Company and Robert Russo(2)

  21.1           List of Subsidiaries of the Company(1)


      * Filed herewith.

      (1) Incorporated by reference to the exhibit to the Registrant's
Registration Statement on Form SB-2 (File Number 333-59617).

      (2) Incorporated by reference to the same numbered exhibit to Registrant's
Annual Report on Form 10-KSB for the year ended December 31, 1999.

      (3) Incorporated by reference to Exhibit 10.28 to Registrant's Form 8-K
filed on January 4, 2000.

      (4) Incorporated by reference to Exhibit 10.29 to Registrant's Form 8-K
filed on February 15, 2000.