Network-1 Technologies, Inc. — 2013 Form 10-K
Reporting period: Fiscal year ended December 31, 2013; comparisons are with fiscal 2012. The company develops, licenses and protects intellectual property. Its sole revenue-generating portfolio was its Remote Power (Power over Ethernet) patent; it acquired the Cox and Mirror Worlds patent portfolios during 2013.
Key financial results
| Metric | 2013 | 2012 |
|---|---|---|
| Revenue | $8.017 million | $8.698 million |
| Gross profit / gross margin | $5.658 million / 70.6% | $6.096 million / 70.1% |
| Operating income / operating margin | $1.525 million / 19.0% | $3.333 million / 38.3% |
| Net income | $1.016 million | $2.626 million |
| Basic / diluted earnings per share | $0.04 / $0.04 | $0.10 / $0.09 |
| Cash provided by operating activities | $2.725 million | $2.673 million |
| Cash and cash equivalents at year-end | $18.938 million | $21.983 million |
| Working capital at year-end | $19.794 million | $22.702 million |
Revenue fell 7.8%, primarily reflecting lower royalties and license initiation fees of $258,000 versus $645,000 in 2012. Operating expenses rose to $4.133 million from $2.763 million, including $1.008 million of patent amortization following acquisitions (versus $9,000 in 2012) and higher legal costs. Net income declined about 61%. Gross margin edged up, but operating margin fell materially.
Investing cash outflow was $4.589 million, including $4.463 million for patents and other assets; financing cash outflow was $1.181 million, including $1.497 million of share repurchases, partly offset by $1.097 million of option and warrant exercise proceeds. Cash decreased by $3.045 million. The balance sheet reported total liabilities of $764,000 and no debt; management disclosed no off-balance-sheet arrangements. Year-end cash plus marketable securities was $19.468 million.
Changes, strategy and outlook
- Acquired the Cox portfolio for $1.0 million cash and 403,226 shares, plus 12.5% of net proceeds from its monetization. Acquired the Mirror Worlds portfolio for $3.0 million cash and warrants; Recognition also receives a share of its net monetization proceeds. The company reported $4.0 million in aggregate cash paid for patent acquisitions.
- At filing, the company reported 22 patents and was pursuing licensing of its Remote Power patent and monetization of the newly acquired portfolios. It had 16 Remote Power license agreements, while 12 licensees had ongoing royalty obligations.
- Cisco represented 77% of revenue in both 2013 and 2012. Remote Power licensing revenue was $8.017 million in 2013, down from $8.698 million. Cisco’s contractual annual royalty caps are $8 million through 2015 and $9 million thereafter through the patent’s March 2020 expiration; actual payments may be lower and depend on specified conditions.
- Management said current cash and projected licensing revenue were expected to fund operations for the foreseeable future, while cautioning that this might not be the case. No quantified revenue or earnings guidance was provided. The company did not plan to pay dividends in the foreseeable future.
- Net operating loss carryforwards were approximately $25.239 million, with a reported deferred tax asset of $5.659 million; use may be limited by ownership-change rules. The company repurchased 1,086,872 shares in 2013 for $1.486 million and authorized a further increase to its repurchase program.
Risks, contingencies and notable items
- The Remote Power patent’s validity was under challenge in an inter partes review; a hearing occurred January 9, 2014 and the decision was pending when the report was filed. An ex parte reexamination was also pending. The company stated that invalidation could end licensee royalty obligations and materially harm its business.
- Remote Power infringement litigation against networking-equipment manufacturers was stayed pending the patent review. Separate Mirror Worlds patent litigation against Apple, Microsoft and other defendants sought monetary damages; Apple and Microsoft asserted invalidity and non-infringement counterclaims. Outcomes and potential recoveries were uncertain.
- The business depended heavily on one patent and Cisco, with additional risks from litigation expense, patent challenges, technology obsolescence, competition for patent acquisitions and the company’s limited operating history in monetizing its newer portfolios.
- Patent acquisitions and enforcement involve contingent legal fees and other costs. The CEO’s compensation includes royalty-based incentive payments; he earned $397,000 under this arrangement in 2013.
- The company reported a clean audit opinion and management concluded disclosure controls and internal control over financial reporting were effective as of year-end.
Investor facts to verify
- Track the outcome and scope of the Remote Power patent review and reexamination, and any resulting effect on royalty payments.
- Reconcile Cisco’s 77% revenue concentration, royalty-rate terms and subsequent reported collections against the annual caps and contractual conditions.
- Assess litigation progress, legal expenses, contingent-fee obligations and any recoveries from the Remote Power and Mirror Worlds cases.
- Monitor whether the Cox and Mirror Worlds portfolios generate licensing revenue sufficient to justify acquisition, amortization and associated monetization costs.
- Review cash use, repurchases, dilution from outstanding options and warrants, and the realizability and possible limitations of the deferred tax asset.