Network-1 Security Solutions, Inc. — Q1 2013 Form 10-Q
Reporting period: Three months ended March 31, 2013; comparative period is Q1 2012. The filing describes the company’s business as acquiring, developing, licensing, and protecting intellectual property, with revenue primarily from its Remote Power Patent. Financial statements are unaudited.
Financial performance and position
| Metric | Q1 2013 | Q1 2012 or prior balance-sheet date |
|---|---|---|
| Royalty revenue | $4.064 million | $4.425 million |
| Gross profit / gross margin | $2.839 million / 69.8% | $3.039 million / 68.7% |
| Operating income / operating margin | $2.049 million / 50.4% | $2.358 million / 53.3% |
| Net income / net margin | $1.392 million / 34.3% | $1.923 million / 43.5% |
| Basic / diluted EPS | $0.06 / $0.05 | $0.08 / $0.07 |
| Operating cash flow | $(311,000) | $(271,000) |
| Cash and cash equivalents | $19.811 million | $21.983 million at Dec. 31, 2012 |
| Working capital | $22.788 million | $22.702 million at Dec. 31, 2012 |
| Total liabilities | $1.685 million | $825,000 at Dec. 31, 2012 |
There was no reported debt. Operating cash use reflected a $3.276 million increase in royalty receivables and other assets, partly offset by higher payables and accrued expenses. Investing cash outflow included $1.010 million for patents; financing cash outflow included $851,000 of share repurchases. Cash declined by $2.172 million during the quarter. The company reported $542,000 in marketable securities in addition to cash.
Changes versus the prior period
- Revenue declined $361,000, or 8%, year over year. Management attributed most of the decline to lower litigation-settlement initiation fees ($258,000 versus $565,000); excluding those fees, revenue decreased 1.4%.
- Gross profit fell 6.6%, while operating expenses rose $109,000 to $790,000, primarily due to legal and professional costs related to patent acquisitions and potential acquisitions.
- Net income decreased $531,000. Income tax expense increased to $663,000 from $444,000, including a $615,000 reduction in the deferred tax asset.
- In February, the company settled with Allied Telesis and NEC, which agreed to license the Remote Power Patent and pay initiation fees and royalties. The company also acquired four media-content identification patents and a pending application for $1 million cash and 403,226 shares, with the seller entitled to 12.5% of related net proceeds.
- The company repurchased 709,200 shares for approximately $851,000, at an average price of $1.20 per share; the shares were cancelled. The repurchase authorization was increased to $5 million, with approximately $1.45 million remaining under the program at quarter-end.
Outlook, risks, and contingencies
- Management said cash and projected licensing revenue from existing agreements should fund operations for the foreseeable future, while cautioning that this may not be the case. No specific revenue or earnings guidance was provided.
- Cisco represented 86% of Q1 2013 revenue, versus 81% in Q1 2012. Management said Cisco royalties are generally highest in Q1 and decline through the year under the agreement’s annual rate structure.
- Revenue depends on the continued validity of the Remote Power Patent, which expires in March 2020. Two Inter Partes Review petitions sought cancellation of certain claims, and an ex parte reexamination had been requested; the reexamination was stayed pending the review proceedings. The USPTO had not yet determined whether either review would proceed to trial. Certain defendants’ patent litigation was stayed pending disposition of the review proceedings.
- The Cisco license includes conditions and obligations; a material breach by the company could allow Cisco to stop royalty payments. Actual Cisco royalties may be below contractual annual caps.
- The company had approximately $23.087 million of net operating loss carryforwards and a $5.579 million deferred tax asset. Use of NOLs may be limited by ownership-change rules; management said it would continue assessing recoverability.
- Cash deposits exceeded FDIC insurance limits by approximately $19.561 million. The company reported no off-balance-sheet arrangements and no material changes in internal control over financial reporting.
Important facts for investors to verify
- Developments and outcomes in the Remote Power Patent reviews and litigation, including whether claims remain enforceable.
- Cisco royalty receipts, their quarterly seasonality, and the impact of the customer concentration and contractual conditions.
- Collection timing of the $3.909 million royalty receivable balance and the drivers of negative operating cash flow.
- Progress and costs associated with the newly acquired media-content patents, including any licensing proceeds and the seller’s 12.5% net-proceeds entitlement.
- Remaining repurchase authorization, potential future repurchases, and the effect of ongoing share-based compensation and equity issuances.
- The filing contains an apparent date inconsistency: the litigation discussion says the court granted the stay on March 5, 2012, although it describes a motion filed in January 2013 and elsewhere refers to the stay as occurring in 2013.