Network-1 Technologies, Inc. — Q3 2015 Form 10-Q
Reporting period: Three and nine months ended September 30, 2015; unaudited. The company develops, licenses and protects intellectual property, with royalty revenue primarily from its Remote Power patent. The filing was signed November 16, 2015.
Financial results and liquidity
| Metric | Three months ended September 30 | Nine months ended September 30 |
|---|---|---|
| Royalty revenue | 2015: $3.008 million; 2014: $1.367 million | 2015: $10.382 million; 2014: $11.024 million |
| Gross profit | 2015: $2.081 million; 2014: $1.030 million | 2015: $7.288 million; 2014: $7.867 million |
| Operating income (loss) | 2015: $684,000; 2014: $(91,000) | 2015: $2.667 million; 2014: $4.553 million |
| Net income (loss) | 2015: $407,000; 2014: $(36,000) | 2015: $1.717 million; 2014: $2.961 million |
| Diluted earnings (loss) per share | 2015: $0.02; 2014: $(0.00) | 2015: $0.07; 2014: $0.11 |
- Q3 gross margin was approximately 69%, versus 75% a year earlier; nine-month gross margin was approximately 70%, versus 71%.
- Operating cash flow for the first nine months was $2.941 million, compared with $5.426 million in 2014. Investing activities used $36,000; financing activities used $2.555 million, primarily for share repurchases. Cash increased $350,000 to $18.012 million.
- At September 30, cash and cash equivalents were $18.012 million, marketable securities $1.079 million, and working capital $19.944 million. Total liabilities were $963,000; the company reported no long-term debt.
- Total assets were $27.310 million, down from $29.152 million at December 31, 2014. Royalty receivables were $1.700 million. Deferred tax assets declined to $3.815 million from $4.743 million.
Changes versus the prior comparable periods
- Q3 revenue rose 120%, largely reflecting $1.350 million from two Remote Power license agreements associated with litigation settlements. Excluding that settlement-related revenue, management said revenue increased 21% year over year.
- Nine-month revenue fell 6%, mainly because 2014 included $3.281 million of additional Cisco royalties following an audit. Excluding that audit revenue, 2015 revenue increased 34%, primarily reflecting $1.790 million from three litigation settlements.
- Nine-month net income declined to $1.717 million from $2.961 million. Management attributed lower operating income mainly to the prior-year Cisco audit revenue; excluding that audit, it said operating income increased 19%.
- Nine-month general and administrative expense increased by $1.258 million, including a $386,000 Lifestreams investment impairment, $261,000 related to terminating a services agreement, and higher litigation costs.
- The company repurchased 1,154,734 shares for approximately $2.529 million during the first nine months. Shares issued and outstanding at September 30 were 23,239,951, compared with 24,274,336 at year-end 2014.
Outlook, commentary, risks and unusual items
- Management said existing cash and projected licensing revenue were expected to fund operations for the foreseeable future, while cautioning that this may not be the case. No specific earnings or revenue guidance was provided.
- Revenue remains highly concentrated: Cisco represented 71% of nine-month 2015 revenue and 40% of Q3 revenue. Cisco also represented about 70% of royalty receivables at September 30. Management expects one or a few licensees to remain significant revenue sources.
- The Remote Power patent’s validity and continued royalty payments are material risks to the current revenue stream. The patent expires in March 2020; the filing describes several challenges and proceedings, including favorable USPTO and appellate outcomes for the company, while litigation against remaining defendants continued.
- Google/YouTube litigation concerning the Cox portfolio was stayed pending patent-review proceedings; the PTAB instituted four inter partes reviews and, after quarter-end, instituted a covered business method review on certain grounds.
- On November 6, 2015, after quarter-end, the company settled its Mirror Worlds litigation with Microsoft and its customers for $4.65 million. This subsequent event was not part of Q3 results; the settlement also dismissed the pending litigation against specified Microsoft customers. The Apple litigation remained pending, with trial scheduled for June 2016.
- The company recorded a $386,000 impairment on its Lifestreams investment, reducing its carrying value to $190,000; Lifestreams remained in default on its notes and had not completed material financing.
- Potential tax risks include limits on using approximately $22.540 million of net operating loss carryforwards and possible personal holding company status. The company said it did not meet the ownership test through the filing date, but would continue monitoring it.
- Cash held at financial institutions exceeded FDIC insurance limits by $17.758 million. Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Key facts for investors to verify
- Whether royalty revenue and cash collections remain resilient given Cisco’s revenue and receivable concentration, and the contractual conditions and annual caps on Cisco royalties.
- The timing, terms and accounting treatment of the $4.65 million Microsoft settlement, which occurred after September 30, and the status of the remaining Mirror Worlds and Remote Power litigation.
- Outcomes of patent reviews and litigation, including potential effects on patent validity, licensing revenue and the company’s ability to monetize its Cox and Mirror Worlds portfolios.
- Whether the $190,000 estimated Lifestreams investment value is recoverable and whether further impairment is possible.
- The company’s continued repurchases, patent amortization profile, tax-asset recoverability and exposure to a possible personal holding company tax.