Network-1 Technologies, Inc. — Q3 2017 Form 10-Q
Reporting period: Three and nine months ended September 30, 2017; filed November 14, 2017. The unaudited company develops, licenses and protects intellectual property, with revenue largely dependent on patent licensing and enforcement.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Revenue | $3.237 million | $34.326 million | $14.320 million | $59.963 million |
| Operating income | $1.018 million | $16.084 million | $6.608 million | $31.573 million |
| Net income | $648,000 | $10.832 million | $4.460 million | $22.882 million |
| Diluted EPS | $0.02 | $0.43 | $0.17 | $0.93 |
- Reported revenue fell sharply year over year, primarily because 2016 included large fully paid license settlements and, for the nine-month comparison, a $17.5 million professional-liability settlement. Excluding those items, management said revenue increased 59% in Q3 and 27.5% for the nine-month period, mainly on higher ongoing Remote Power Patent royalties.
- Q3 revenue included approximately $970,000 from fully paid licenses and license initiation fees; nine-month revenue from these items was approximately $3.270 million. Ongoing Remote Power royalties were $2.263 million for Q3 and $11.046 million for the nine months, versus $7.426 million and $14.663 million, respectively, in 2016.
- Gross profit, derived as revenue less cost of revenue, was approximately $2.273 million (70% of revenue) in Q3 and $9.981 million (70%) for the nine months. These comparisons reflect the variable legal fees, executive incentive compensation and other proceeds-based costs included in cost of revenue.
- Nine-month cash provided by operating activities was $3.937 million, down from $37.140 million. Investing activities used $50,000; financing activities used $2.540 million, including $2.421 million of dividends and $1.131 million of net share repurchases, partly offset by option and warrant proceeds. Cash increased $1.347 million to $52.265 million.
- At September 30, cash and cash equivalents were $52.265 million, marketable securities $1.064 million, working capital $54.101 million, and total liabilities $3.116 million. The company reported no long-term debt and no off-balance-sheet arrangements. Total assets were $58.535 million.
- The company declared and paid semiannual dividends of $0.05 per share in March and September 2017. It repurchased 275,593 shares for approximately $1.125 million during the nine months; $3.875 million remained authorized for repurchases at September 30.
Changes, outlook and material matters
- Management said existing cash and projected licensing receipts should fund operations for the foreseeable future. No specific revenue or earnings guidance was provided. The Remote Power Patent expires in March 2020; management expected the semiannual dividend to continue through March 2020 only if royalties continue.
- Revenue remains concentrated: three licensees generated approximately 75% of both Q3 and nine-month 2017 revenue. Cisco was the largest ongoing royalty licensee, representing 43% of Q3 ongoing royalty revenue. The company also reported substantial concentration of royalty receivables among three licensees.
- Significant subsequent event: On November 13, 2017, after quarter-end, a jury found certain Remote Power Patent claims invalid and not infringed by Hewlett-Packard. The company warned that a verdict or final judgment could relieve some licensees, including Cisco, from royalty obligations and materially harm results. The outcome and effect on existing licenses were unresolved in the filing.
- After quarter-end, Juniper agreed to pay $13.25 million for a fully paid Remote Power Patent license. Avaya’s bankruptcy court approved a settlement that included a $40 million unsecured claim; the company cited an estimated recovery of about 18.9% under the proposed plan but warned that recovery could be substantially lower and was not assured. These events were not included in September 30 results.
- Litigation also included a Facebook action over Mirror Worlds patents and stayed Google/YouTube actions involving the Cox portfolio; appeals in the latter matters were pending. Cisco’s ongoing royalties are subject to contractual conditions, and the filing warns a material breach by the company could permit Cisco to stop paying.
- The company reported no patent impairment. It had 36 patents, with several key portfolios nearing expiration: Mirror Worlds patents expire from April 2018 to February 2020, QoS patents in June 2019, and the Remote Power Patent in March 2020. The company had no remaining net operating loss carryforwards. Management said adoption of the new revenue standard, planned for January 1, 2018, was not expected to have a material effect.
Important facts for investors to verify
- Developments and final judgments concerning the Hewlett-Packard verdict, including any effect on Cisco and other licensees’ ongoing royalty payments.
- Actual recovery and timing of Network-1’s $40 million Avaya bankruptcy claim, and receipt and accounting for the Juniper settlement.
- Royalty concentration, Cisco’s contribution, and the durability of recurring revenue as the Remote Power Patent approaches its March 2020 expiration.
- Results and timing of the Facebook and Google/YouTube proceedings, as well as the company’s ability to monetize other patent portfolios or acquire replacement assets.
- Capacity to sustain dividends and repurchases in light of lower reported operating cash flow and the dependence on licensing receipts.