Network-1 Technologies, Inc. — Q2 2014 Form 10-Q
Business and period: Intellectual-property development, licensing and enforcement company; quarter and six months ended June 30, 2014. Results are unaudited. Revenue is primarily royalties from the Remote Power Patent.
Financial performance
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Royalty revenue | $5.166 million | $1.907 million | $9.657 million | $5.971 million |
| Gross profit / margin | $3.660 million / 70.8% | $1.360 million / 71.3% | $6.837 million / 70.8% | $4.199 million / 70.3% |
| Operating income | $2.501 million | $0.449 million | $4.644 million | $2.498 million |
| Net income | $1.601 million | $0.782 million | $2.997 million | $2.174 million |
| Diluted EPS | $0.06 | $0.03 | $0.11 | $0.08 |
For the six months, operating cash flow was $2.317 million (prior year $1.877 million). Investing used $0.230 million; financing used $4.446 million, including $2.877 million for share repurchases, $1.064 million for shares delivered to fund withholding taxes, and $0.505 million to repurchase warrants. Cash and equivalents declined $2.359 million to $16.579 million. At June 30, current assets were $22.442 million and current liabilities $1.791 million; working capital was $20.651 million. The company reported no long-term debt.
Changes and notable items
- Q2 revenue rose $3.259 million year over year; six-month revenue increased 62%. A $3.281 million payment from Cisco following a royalty audit was recognized entirely in Q2 and was a major driver of the improvement.
- Cisco represented approximately 92% of six-month revenue, versus 84% in the comparable 2013 period. The company states that its business has depended on Remote Power Patent royalties.
- Six-month operating expenses increased to $2.193 million from $1.701 million, primarily as patent amortization rose following 2013 patent acquisitions. Six-month cost of revenue included $2.283 million in contingent legal fees and about $0.481 million in CEO incentive compensation.
- The company repurchased 1,480,239 shares in Q2 at an average $1.80 per share, costing approximately $2.657 million. The board authorized an additional $5 million under the repurchase program, bringing cumulative authorization to up to $12 million.
Outlook, risks and contingencies
No specific earnings or revenue guidance was provided. Management said cash and projected licensing revenue from existing agreements should fund operations for the foreseeable future, while cautioning this may not be the case.
- The Patent Trial and Appeal Board rejected challenges to the Remote Power Patent in May 2014; petitioners appealed to the Federal Circuit in July. A separate reexamination is also pending, and the Remote Power litigation against several manufacturers remains stayed.
- Pending matters include infringement suits involving Google and YouTube and the Mirror Worlds portfolio defendants. Outcomes and recoveries are uncertain; the filing does not quantify potential recoveries.
- The Cisco license is subject to conditions, including continued patent validity and company compliance; a material breach could permit Cisco to stop paying royalties. Annual royalty caps are $8 million through 2015 and $9 million thereafter, but actual receipts may be lower.
- The company reported approximately $22.855 million of net operating loss carryforwards and a $4.093 million deferred tax asset. Use of carryforwards may be limited by ownership-change rules.
- The independent audit firm advised it could not audit the company for 2014; no replacement had been selected as of the filing date. Management reported disclosure controls effective and no material change in internal control during the quarter.
Investor verification priorities
- Assess how much revenue and cash generation is repeatable after excluding the one-time $3.281 million Cisco audit adjustment, and monitor Cisco concentration.
- Track patent validity, appeals, litigation stays and costs, and whether any new licenses or recoveries result.
- Confirm appointment of a new independent auditor and completion of the 2014 audit.
- Review ongoing share repurchases, liquidity needs, and the recoverability and potential limitations of tax attributes.