Network-1 Technologies, Inc. — Q1 2015 Form 10-Q
Reporting period: Three months ended March 31, 2015; unaudited. Network-1 develops, licenses, and protects intellectual property. Its reported royalties primarily came from licensing its Remote Power Patent. Results for this quarter are not necessarily indicative of full-year results.
Financial results
| Metric | Q1 2015 | Q1 2014 | Change |
|---|---|---|---|
| Royalty revenue | $5.627 million | $4.491 million | +25% |
| Gross profit / margin | $3.938 million / 70.0% | $3.177 million / 70.7% | Profit +24% |
| Operating expenses | $1.618 million | $1.034 million | +56% |
| Operating income / margin | $2.320 million / 41.2% | $2.143 million / 47.7% | Income +8% |
| Net income / diluted EPS | $1.530 million / $0.06 | $1.396 million / $0.05 | Income +10% |
| Operating cash flow | $(1.638) million | $(0.227) million | Greater cash use |
Revenue growth reflected higher royalties, including a fully paid license associated with a settlement in the Remote Power Patent litigation. Gross profit rose, but gross margin declined modestly as cost of revenue increased. Higher G&A and stock-based compensation contributed to lower operating and net margins. Interest income was $21,000 versus $9,000; income tax expense was $811,000 versus $756,000.
Liquidity, capital and balance sheet
- At March 31, cash and cash equivalents were $14.112 million, marketable securities were $1.099 million, current assets were $20.993 million, and working capital was $18.926 million. Working capital increased $905,000 from year-end.
- Total liabilities were $2.067 million, all current; the company reported no long-term debt. Management said existing cash and projected royalties from current licenses were expected to fund operations for the foreseeable future, while cautioning this might not be the case.
- Cash declined $3.550 million during the quarter. Investing cash use was $30,000. Financing cash use was $1.882 million, primarily share repurchases.
- Operating cash use reflected a $4.353 million increase in royalty receivables, partly offset in the cash-flow reconciliation by noncash expenses. Cisco accounted for about 85% of quarterly revenue and 85% of royalty receivables at quarter-end.
- The company repurchased 828,600 shares for $1.866 million before commissions, at an average $2.25 per share; the cash-flow statement reports $1.882 million of repurchases. Shares issued and outstanding declined to 23,445,736 at March 31 from 24,274,336 at December 31, 2014. The filing reports 23,439,685 shares outstanding as of May 14, 2015.
Material changes and unusual items
- Royalty revenue increased $1.136 million year over year. Cisco royalties were 85% of revenue, down from 91% in Q1 2014; the filing warns that one or a few licensees are expected to remain a significant revenue source.
- G&A increased $507,000, primarily from higher legal and professional fees and a $261,000 expense related to terminating the ThinkFire services agreement. Stock-based compensation rose to $100,000 from $27,000.
- On March 11, the company paid a Seller creditor $900,000 to satisfy a contingent payment obligation. In March, it also settled with Samsung for a fully paid license to the Remote Power Patent for the patent’s remaining life.
- The company recorded $3.281 million of additional Cisco audit royalties in Q2 2014, not in the current quarter; this prior-period item affects comparisons with 2014 annual and quarterly trends.
- Deferred tax assets decreased to $3.987 million from $4.743 million. The company reported $22.796 million of tax-loss carryforwards, with a stated future tax benefit of approximately $7.751 million; use may be limited by ownership-change rules.
Outlook, risks and contingencies
- No quantified revenue or earnings guidance was provided. Management’s liquidity outlook depends on cash on hand and anticipated licensing revenue.
- The business depends on the Remote Power Patent, which expires in March 2020. Its validity remains subject to a pending Federal Circuit appeal and a Sony-requested USPTO reexamination; the USPTO also had not decided whether to institute Sony’s covered business method review. The filing states that invalidation of relevant claims could materially harm the business because current revenue depends on them.
- Google and YouTube challenged Cox Portfolio patents through USPTO review petitions; Google filed an additional covered business method petition in April 2015. Litigation also continued over Mirror Worlds patents against Apple, Microsoft and other defendants. Outcomes and recoveries are uncertain.
- Patent enforcement entails contingent legal fees and litigation expenses. The filing reported no off-balance-sheet arrangements and no long-term debt or other long-term contractual obligations of the types listed in its MD&A.
- The company held $13.857 million of cash above FDIC insurance limits at March 31. Its Lifestreams investment, carried at $576,000, had no readily determinable fair value; related convertible notes matured March 31, 2015, and conversion had not been elected by the company at quarter-end.
Most important facts for investors to verify
- Whether royalty receipts and receivables convert to cash as expected, and how revenue concentration in Cisco evolves.
- Developments in the Remote Power Patent appeal, reexamination, and covered business method review, as well as the Cox and Mirror Worlds litigation.
- The sustainability of licensing revenue as patents approach expiration and whether newer portfolios generate material monetization.
- The effect of recurring legal fees, executive royalty-based compensation, buybacks, and contingent obligations on cash and earnings.
- Recoverability and potential ownership-change limits on deferred tax assets and the carrying value or conversion outcome of the Lifestreams investment.