Network-1 Technologies, Inc. — Q2 2018 Form 10-Q
Business context and period. The company develops, licenses and protects intellectual property. This unaudited report covers the three and six months ended June 30, 2018; comparisons are with the corresponding 2017 periods. Its portfolio included 55 patents, with revenue historically dependent on licensing its Remote Power patent.
Financial results
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Revenue | $471,000 | $4,862,000 | $19,934,000 | $11,083,000 |
| Operating income (loss) | $(1,004,000) | $2,337,000 | $9,879,000 | $5,590,000 |
| Net income (loss) | $(564,000) | $1,544,000 | $8,037,000 | $3,812,000 |
| Basic EPS | $(0.02) | $0.06 | $0.34 | $0.16 |
| Diluted EPS | $(0.02) | $0.06 | $0.31 | $0.14 |
| Operating cash flow | Not presented by quarter | Not presented by quarter | $8,379,000 | $2,168,000 |
Q2 revenue fell $4.391 million year over year, and the company swung to an operating and net loss. Six-month revenue and earnings rose largely because of a $12.7 million Juniper fully-paid license and $6.32 million from selling its Avaya unsecured claim. Excluding those items, six-month royalty-bearing license revenue was $914,000, down from $8.783 million.
Q2 gross margin is not stated as a percentage; revenue less costs of revenue was $338,000. For the six-month period, revenue less costs of revenue was $12.542 million. These figures include significant contingent legal fees and executive incentive compensation, so they are not a measure of recurring operating performance.
At June 30, cash and cash equivalents were $32.959 million and other investments were $26.997 million, totaling $59.956 million. Working capital was $58.064 million; total assets were $62.718 million and total liabilities were $2.384 million. The filing reports no long-term debt. Six-month investing cash outflow was $24.030 million, primarily purchases of short-term investments; financing cash outflow was $2.491 million, including dividends and share repurchases. Cash declined $18.142 million to $32.959 million as funds were shifted into investments.
Material changes and unusual items
- The November 2017 HP jury verdict found certain Remote Power patent claims invalid and not infringed. Cisco, Dell, Netgear and other major licensees stopped ongoing royalty payments. The company recognized only $471,000 of royalty-bearing revenue in Q2 versus $2.562 million a year earlier; for six months, the respective amounts were $914,000 and $8.783 million.
- Juniper paid $12.7 million in January 2018 for a fully-paid license. The company also sold its $37.5 million allowed unsecured claim against Avaya for $6.32 million.
- Six-month costs of revenue rose to $7.392 million, including $6.395 million of contingent legal fees and $997,000 of incentive compensation to the CEO. Professional fees also increased, primarily due to patent litigation.
- The company adopted Topic 606 revenue recognition on January 1, 2018 using the modified retrospective method; prior-period figures were not restated.
Outlook, risks and contingencies
- Management said existing cash and projected licensing revenue from existing licensees should fund operations for the foreseeable future, but provided no quantified revenue or earnings guidance and described future revenue as uncertain.
- The company’s motions challenging the HP verdict were awaiting court decisions as of the filing. An adverse court ruling, unsuccessful appeal, or arbitration ruling relieving licensees of royalty obligations could materially harm business, results and cash flow. If successful, the company says it could recover ongoing and previously unpaid royalties.
- The Remote Power patent expires in March 2020. The board’s semiannual $0.05-per-share dividend policy was anticipated to continue through March 2020 only while Remote Power royalties continued; the board could modify or discontinue dividends depending on litigation and royalty outcomes. A further $0.05 dividend was declared July 26, 2018 for payment September 20, 2018.
- After quarter-end, on August 11, 2018, a court granted Facebook summary judgment of non-infringement in the Mirror Worlds patent case. The company disagreed and was evaluating alternatives, including appeal.
- Google/YouTube litigation remained stayed while patent review proceedings continued. The Federal Circuit had remanded some Cox patent review issues to the PTAB while leaving other findings undisturbed.
- Patent licensing revenue is concentrated and dependent on litigation outcomes and licensee payments. At June 30, four licensees represented approximately 84% of royalty receivables. The company also disclosed $27.86 million of cash above FDIC insurance limits.
- The company reported no off-balance-sheet arrangements and no material change in disclosure controls; management concluded disclosure controls were effective.
Most important facts for investors to verify
- Current status and final outcomes of the HP motions, any appeal, and disputes or arbitration over suspended Remote Power royalties, especially Cisco’s obligations.
- Whether licensees resume payments and whether any deferred royalties are ultimately collectible; distinguish recurring royalties from the Juniper and Avaya one-time proceeds.
- Impact of the August 2018 Facebook judgment and any appeal, plus subsequent developments in the Google/YouTube proceedings.
- Cash and investment composition, investment valuations and concentration, and the company’s capacity to maintain dividends and repurchases if royalty income remains depressed.
- Potential recovery of the remaining Polycom installments, which may not be payable if asserted patent claims are ultimately found invalid.