Network-1 Technologies, Inc. — 2014 Form 10-K
Business context and period. This annual report covers the fiscal year ended December 31, 2014, compared with 2013. Network-1 develops, licenses and protects intellectual property. Its revenue came from licensing its Power over Ethernet (PoE) Remote Power Patent; the company reported no revenue yet from its Cox or Mirror Worlds portfolios. It had 24 patents and 16 Remote Power Patent licenses as of February 28, 2015.
Financial performance and position
| Metric | 2014 | 2013 | Change |
|---|---|---|---|
| Royalty revenue | $12.309 million | $8.017 million | +53.5% |
| Gross profit | $8.799 million | $5.658 million | +55.5% |
| Gross margin | 71.5% | 70.6% | +0.9 percentage points |
| Operating income | $2.723 million | $1.525 million | +78.6% |
| Operating margin | 22.1% | 19.0% | +3.1 percentage points |
| Net income | $1.766 million | $1.016 million | +73.8% |
| Basic and diluted EPS | $0.07 | $0.04 | — |
| Cash from operations | $5.762 million | $2.725 million | +$3.037 million |
- Revenue included $3.281 million of additional Cisco royalties agreed after an audit; excluding that item, 2014 royalties rose 12.6% to $9.028 million. Cisco represented 87% of 2014 revenue, versus 77% in 2013.
- Net income margin was 14.3%, compared with 12.7% in 2013. Cost of revenue was $3.510 million; operating expenses were $6.076 million, including $1.650 million of patent amortization and $900,000 of contingent patent cost.
- At year-end, cash and cash equivalents were $17.662 million, marketable securities $1.079 million, working capital $18.021 million, total assets $29.152 million and total liabilities $2.211 million. The filing reports no long-term debt.
- Cash declined $1.276 million during the year. Investing activities used $1.062 million; financing activities used $5.976 million, including $4.477 million for share repurchases and $505,000 to repurchase warrants.
Material changes and unusual items
- Revenue rose 53.5%, mainly due to the Cisco audit recovery and higher ongoing royalties. The one-time audit amount was recorded in the second quarter of 2014.
- Operating expenses increased from $4.133 million to $6.076 million, including higher general and administrative costs, increased patent amortization following 2013 acquisitions, and the $900,000 contingent patent cost accrued after reaching a royalty threshold.
- The company repurchased 2,335,740 shares during 2014 for approximately $4.439 million, at an average price of $1.90 per share. It also repurchased the former Mirror Worlds seller’s warrants for $505,000.
- Deferred tax assets fell to $4.743 million from $5.659 million. The company reported approximately $25.2 million of net operating loss carryforwards, subject to potential ownership-change limits.
Outlook, risks and contingencies
- Management gave no numerical revenue or earnings guidance. It said cash and projected royalties from existing licenses should fund operations for the foreseeable future, while cautioning that this may not be the case.
- The business depends on the continued validity and enforceability of the Remote Power Patent, which expires in March 2020. Cisco’s agreement provides annual royalty caps of $8 million through 2015 and $9 million thereafter, but actual payments may be lower and depend on patent validity and contractual conditions.
- Remote Power Patent challenges remained active: an appeal of the favorable May 2014 Patent Trial and Appeal Board decision was pending, and Sony filed a CBM petition and reexamination request in February 2015. The USPTO had not decided whether to accept the latter challenges.
- Patent suits involving the Remote Power, Mirror Worlds and Cox portfolios remained unresolved. The Remote Power case had a July 2016 trial date; Mirror Worlds cases had March 2016 trial dates. Google also sought review of Cox portfolio patents. Outcomes, costs and recoveries are uncertain.
- Other key risks include customer concentration, the absence of licensing revenue from the acquired portfolios to date, potentially material litigation expenses, competition for patent assets, technology changes, and the small operating team. The company had two full-time employees, one part-time employee and one consultant as of February 28, 2015.
- The company had $17.143 million of cash above FDIC insurance limits at year-end. A $380,200 Lifestreams convertible secured note investment was due March 31, 2015, with automatic conversion tied to a qualifying equity financing.
- Friedman LLP issued an unqualified audit opinion on the 2014 financial statements. Management concluded disclosure controls and internal control over financial reporting were effective; the auditor was not engaged to audit internal control. The prior auditor resigned because it could not continue public-company audits after its staff moved to another firm; the filing reports no disagreements or reportable events.
Investor verification priorities
- Check subsequent developments in the Remote Power Patent appeal and Sony challenges, and assess how dependent all current revenue is on this patent.
- Separate recurring Cisco royalties from the $3.281 million audit recovery; verify the royalty trend, concentration and contractual payment limits.
- Track the status, expected cost and potential recovery of the three patent litigation programs, including the patent validity and infringement defenses.
- Review the $900,000 contingent patent obligation, the Lifestreams note’s maturity and conversion conditions, and the recoverability of deferred tax assets and NOLs.
- Assess liquidity after repurchases, share dilution from outstanding options and warrants, and the substantial cash balance held above FDIC insurance limits.