Business Context and Reporting Period
Network-1 Technologies, Inc. is an intellectual-property licensing and enforcement company. This unaudited Form 10-Q covers the three months ended March 31, 2017, compared with the three months ended March 31, 2016; balance-sheet figures are compared with December 31, 2016. The company reported 33 patents across its Remote Power, Mirror Worlds, Cox, and QoS portfolios.
Key Financial Metrics
| Metric | Q1 2017 | Q1 2016 |
|---|---|---|
| Revenue | $6.221 million | $5.190 million |
| Operating income | $3.253 million | $2.423 million |
| Net income | $2.268 million | $3.820 million |
| Basic and diluted EPS | $0.09 | $0.16 |
| Operating cash flow | $(2.777) million | $0.118 million |
| Cash dividends per share declared | $0.05 | None |
- Revenue was entirely reported as intellectual-property licensing revenue. Costs of revenue were $1.792 million; gross margin was approximately 71.2%, versus 71.4% in Q1 2016. Operating margin was approximately 52.3%, versus 46.7%.
- Cash and cash equivalents were $48.000 million at March 31, 2017, down from $50.918 million at year-end. Marketable securities were $1.064 million. Working capital was $53.820 million.
- Total assets were $57.750 million and total liabilities were $2.562 million. The company reported no long-term debt and no off-balance-sheet arrangements.
- Operating cash outflow reflected, among other items, a $4.141 million increase in royalty receivables and a $2.285 million decrease in accrued expenses. Financing cash flow was $(0.141) million, including a $1.209 million dividend payment and $1.068 million of proceeds from option and warrant exercises.
Changes Versus the Prior Comparable Period
- Revenue increased $1.031 million, or 20%, primarily from higher royalties under Remote Power Patent licenses. The number of royalty-bearing licensees increased to 16 from 13.
- Operating income increased $0.830 million. Operating expenses rose $0.201 million: higher costs of revenue and stock-based compensation were partly offset by lower patent amortization.
- Net income fell $1.552 million despite higher operating income, mainly because Q1 2016 included a $1.438 million deferred tax benefit, while Q1 2017 had $0.994 million of total income tax expense. The company said it used its remaining net operating loss carryforwards during 2016.
- Operating cash flow shifted from a $0.118 million inflow to a $2.777 million outflow. Cash declined by $2.918 million during the quarter.
Outlook, Commentary, and Risks
- Management said cash and projected licensing revenue from existing agreements should be sufficient to fund operations for the foreseeable future. No specific revenue or earnings guidance was provided.
- The regular semiannual dividend policy targets $0.05 per share in March and September, or $0.10 annually, and is anticipated to continue through March 2020 provided Remote Power Patent royalties continue.
- Revenue is highly concentrated: one licensee accounted for approximately 77% of Q1 2017 revenue, versus 91% in Q1 2016. Cisco was the largest royalty-bearing licensee; its royalties typically peak in the first quarter and decline during the year under the annual rate structure.
- Ongoing Remote Power royalties depend on the continued validity of certain patent claims. A May 2, 2017 court order found the asserted claims not invalid, prompting the remaining $2.3 million ALE settlement balance to become payable in three quarterly installments beginning July 2017; the company expected to record the balance as Q2 2017 revenue.
- Remote Power litigation against remaining defendants continued; Avaya’s bankruptcy filing stayed the case against Avaya, and the first trial was scheduled for November 6, 2017. The company also disclosed a May 2017 lawsuit against Facebook involving Mirror Worlds patents. Google and YouTube litigation remained stayed pending appeals of favorable Patent Trial and Appeal Board decisions.
- Patent duration is a material consideration: the Remote Power Patent expires in March 2020, QoS patents in June 2019, and Mirror Worlds patent expirations range from August 2017 to February 2020. Management also identified possible personal holding company tax exposure if applicable ownership and income tests are met.
- The company adopted ASU 2016-09 in Q1 2017, prospectively recognizing certain excess tax benefits in the tax provision. Management was assessing Topic 606 for adoption on January 1, 2018 and expected to complete its assessment by the end of Q2 2017.
Important Facts for Investors to Verify
- Whether Cisco and other major licensees continue paying royalties, and the effect of Cisco’s seasonal and declining-rate structure on subsequent quarters.
- Developments in Remote Power patent validity, pending trials, the stayed Avaya matter, and the Google/YouTube and Facebook litigation.
- Collection timing for the $7.020 million of royalty receivables, including the $1.000 million settlement payment due in October 2017, and the scheduled ALE and Polycom settlement installments.
- Whether the company maintains liquidity and its dividend policy as key patents approach expiration, and whether Topic 606 adoption changes reported results.