Network-1 Technologies, Inc. — Q2 2015 Form 10-Q
Business context and period. The filing covers the quarter and six months ended June 30, 2015. Network-1 develops, licenses and protects intellectual property, and its revenue principally comes from royalties on its Remote Power (Power over Ethernet) patent. The company reported 19 license agreements for that patent and stated it had generated more than $78 million in licensing revenue since May 2007. Cisco remained its largest licensee.
Financial performance and position
| Metric | Three months ended June 30, 2015 | Six months ended June 30, 2015 |
|---|---|---|
| Royalty revenue | $1.747 million, down 66% from $5.166 million | $7.374 million, down 24% from $9.657 million |
| Gross profit / gross margin | $1.269 million / 72.6%; prior-year margin 70.8% | $5.207 million / 70.6%; prior-year margin 70.8% |
| Operating income (loss) | $(337,000), versus $2.501 million | $1.983 million, versus $4.644 million |
| Net income (loss) | $(220,000), or $(0.01) per basic and diluted share | $1.310 million; $0.06 basic and $0.05 diluted per share |
| Operating cash flow | Not reported separately for the quarter | $1.521 million, versus $2.317 million |
For Q2, the operating margin was approximately (19.3%), compared with 48.4% in Q2 2014; for the first half it was 26.9%, versus 48.1%. Interest income was $12,000 for Q2 and $33,000 for the first half. The Q2 tax benefit was $105,000; first-half income tax expense was $706,000.
At June 30, cash and cash equivalents were $16.751 million, marketable securities $1.067 million, royalty receivables $1.841 million, and working capital $18.939 million. Total assets were $26.902 million and total liabilities $886,000. The filing reports no long-term debt. Cash decreased $911,000 during the first half; investing activities used $35,000 and financing activities used $2.397 million, primarily for share repurchases. The company repurchased 1,083,200 shares for approximately $2.374 million in the first half.
Material changes versus the prior comparable period
- Q2 revenue fell $3.419 million year over year, principally because Q2 2014 included $3.281 million of additional Cisco royalties agreed following an audit. Excluding that audit adjustment, Q2 revenue declined 7.3%. For the first half, excluding the adjustment, revenue increased 16% year over year.
- First-half operating income declined $2.661 million and net income declined $1.687 million. Management attributed the operating-income decrease primarily to the prior-year Cisco audit revenue.
- General and administrative expense increased $1.011 million in the first half, reflecting a $386,000 Lifestreams investment impairment, $261,000 of expense related to terminating a services agreement, and higher litigation costs.
- Cash declined from $17.662 million at year-end 2014 to $16.751 million. Working capital nevertheless increased by $918,000, primarily as current liabilities decreased, partly offset by higher royalty receivables and lower cash.
Outlook, risks, contingencies and unusual items
- Management said existing cash and projected royalties under current licenses should fund operations for the foreseeable future, while cautioning that this may not be the case. No quantified revenue or earnings guidance was provided.
- Revenue concentration is substantial: Cisco represented 79% of Q2 revenue and 84% of first-half revenue. Cisco royalties depend on product sales and continued validity of relevant Remote Power patent claims; the agreement provides annual caps of $8 million through 2015 and $9 million thereafter, but actual royalties may be lower. Cisco represented about 75% of royalty receivables at June 30.
- Patent validity and litigation outcomes are material risks. Google and YouTube’s challenges to Cox portfolio patents led the PTAB to institute four inter partes reviews; the related cases were stayed. A separate Google covered-business-method petition was pending at the filing date, and that case was also stayed.
- The PTAB denied Sony’s covered-business-method petition concerning the Remote Power patent on July 1, 2015, but an ex parte reexamination remained ongoing. On August 10, 2015, the Federal Circuit affirmed the PTAB’s earlier decision upholding the patent against other challengers. These developments occurred after June 30 and are reported in the filing.
- In the Mirror Worlds litigation, a July 7, 2015 court ruling rejected defendants’ Kessler-doctrine dismissal arguments; the filing states trial dates were set for July 2016. The matters remain subject to further proceedings and potential challenges.
- Settlements with Samsung, Huawei and ShoreTel included $1.35 million of aggregate payments from settlements entered after June 30; the company expected to record those payments as revenue in the quarter ending September 30, 2015.
- The Lifestreams investment was written down by $386,000 to $190,000 after the investee defaulted on notes and had not completed material financing. Management cautioned that realization of the estimated fair value was not assured.
- The company had approximately $23.329 million of net operating loss carryforwards, but their use may be limited by tax rules, including potential ownership-change limitations. Cash balances also included $16.129 million above FDIC insurance limits.
Important facts for investors to verify
- How Cisco royalties and the revenue mix evolve, including the effect of quarterly royalty-rate mechanics and the concentration in a small number of licensees.
- The status and outcomes of the Remote Power patent reexamination, Cox portfolio reviews and litigation, and Mirror Worlds proceedings.
- Whether the reported $1.35 million of post-quarter settlements was recognized in Q3 2015 as anticipated.
- The recoverability of the remaining $190,000 Lifestreams investment and the realizability and availability of deferred tax assets and NOLs.
- Cash use, repurchase activity and the company’s ability to sustain operations if royalty receipts decline; management’s liquidity outlook is not a guarantee.