Notes
to Unaudited Condensed Consolidated Financial Statements
NOTE
A – BASIS OF PRESENTATION AND NATURE OF BUSINESS
[1]
BASIS OF PRESENTATION
The
accompanying condensed consolidated financial statements are unaudited, but, in the opinion of the management of Network-1 Technologies,
Inc. (the “Company”), contain all adjustments consisting only of normal recurring items which the Company considers necessary
for the fair presentation of the Company’s financial position as of September 30, 2021, and the results of its operations
and comprehensive income (loss) for the three and nine month periods ended September 30, 2021 and September 30, 2020,
changes in stockholders’ equity for the three and nine month periods ended September 30, 2021 and September 30, 2020,
and its cash flows for the nine month period ended September 30, 2021 and September 30, 2020. The unaudited condensed
consolidated financial statements included herein have been prepared in accordance with the accounting principles generally accepted
in the United States of America (U.S. GAAP) for interim financial information and the instructions to Form 10-Q and Regulation S-X. Accordingly,
certain information and footnote disclosures normally included in the consolidated financial statements prepared in accordance with U.S.
GAAP may have been omitted pursuant to such rules and regulations, although management believes that the disclosures are adequate to
make the information presented not misleading. These unaudited condensed consolidated financial statements should be read in conjunction
with the audited consolidated financial statements for the year ended December 31, 2020 included in the Company’s Annual Report
on Form 10-K filed with the Securities and Exchange Commission on March 31, 2021. The results of operations for the three and nine months
ended September 30, 2021 are not necessarily indicative of the results of operations to be expected for the full year.
The
accompanying unaudited condensed consolidated financial statements include accounts of the Company and its wholly-owned subsidiary, Mirror
Worlds Technologies, LLC.
[2]
BUSINESS
The
Company is engaged in the development, licensing and protection of its intellectual property assets. The Company presently owns eighty-eight
(88) patents including (i) the remote power patent (the “Remote Power Patent”) covering the delivery of power over Ethernet
(PoE) cables for the purpose of remotely powering network devices, such as wireless access ports, IP phones and network based cameras;
(ii) the Mirror Worlds patent portfolio (the “Mirror Worlds Patent Portfolio”) relating to foundational
technologies
that enable
unified
search
and indexing,
displaying
and archiving
of documents
in a computer
system;
(iii) the Cox patent portfolio (the “Cox Patent Portfolio”) relating to enabling technology for identifying media content
on the Internet and taking further actions to be performed based on such identification; and (iv) the M2M/IoT patent portfolio (the “M2M/IoT
Patent Portfolio”) relating to, among other things, enabling technology for authenticating, provisioning and using embedded sim
cards in next generation IoT, Machine-to-Machine, and other mobile devices, including smartphones, tablets and computers.
NOTE
A – BASIS OF PRESENTATION AND NATURE OF BUSINESS (continued)
Until
March 7, 2020, when the Remote Power Patent expired, the Company had been actively engaged in licensing its Remote Power Patent (U.S.
Patent No. 6,218,930). As a result of the expiration of the Remote Power Patent, the Company no longer receives licensing revenue for
its Remote Power Patent for any period subsequent to the expiration date (March 7, 2020). However, subsequent to the expiration date
of the Remote Power Patent, the Company has received and may continue to receive licensing revenue from certain licensees for periods
prior to March 7, 2020. On March 30, 2021, the Company entered into an amendment (the “Amendment”) to the Settlement and
License Agreement, dated May 25, 2011, between the Company and Cisco (the “Agreement”). Pursuant to the Amendment, Cisco
paid $18,692,000 to the Company to resolve a dispute relating to Cisco’s contractual obligation to pay royalties under the Agreement
to the Company for the period beginning in the fourth quarter of 2017 through March 7, 2020 (when the Remote Power Patent expired) with
respect to licensing the Remote Power Patent (see Note I[2] hereof). In addition, on July 26, 2021, the Company entered into a settlement
agreement with Hewlett-Packard pursuant to which Hewlett-Packard paid the Company $17,000,000 in full settlement of a patent litigation
(see Note I[2] hereof). The Company also believes that NETGEAR, Inc. (“Netgear”), another licensee of the Remote Power Patent,
is obligated to pay the Company royalties that accrued but were not paid during the same period. The Company has commenced litigation
against Netgear (see Note I[5] hereof).
The
Company’s current strategy includes continuing to pursue licensing opportunities for its intellectual property assets. In addition,
the Company continually reviews opportunities to acquire or license additional intellectual property as well as other strategic alternatives.
The Company’s patent acquisition and development strategy is to focus on acquiring high quality patents which management believes
have the potential to generate significant licensing opportunities as the Company has achieved with respect to its Remote Power Patent
and Mirror Worlds Patent Portfolio. In addition, the Company may also enter into strategic relationships with third parties to develop,
commercialize, license or otherwise monetize their intellectual property.
NOTE
B – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
|
|
[1]
|
Use
of Estimates and Assumptions
|
The
preparation of the unaudited condensed consolidated financial statements in conformity with U.S. GAAP requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the
date of the unaudited condensed consolidated financial statements, and the reported amounts of revenues and expenses during the reporting
periods. The significant estimates and assumptions made in the preparation of the Company’s unaudited condensed consolidated financial
statements include revenue recognition, income taxes, valuation of patents and equity method investments, including evaluation of the
Company’s basis difference. Actual results could be materially different from those estimates, upon which the carrying values were
based.
|
|
[2]
|
Cash
and Cash Equivalents
|
The
Company maintains cash deposits in high quality financial institutions insured by the Federal Deposit Insurance Corporation
(“FDIC”). Accounts at each institution are insured by the FDIC up to $250,000. At September 30, 2021, the Company
maintained a cash balance of $5,835,000 in excess of the FDIC insured limit.
The
Company considers all highly liquid short-term investments, including certificates of deposit and money market funds, that are purchased
with an original maturity of three months or less to be cash equivalents.
NOTE
B – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
|
|
[3]
|
Marketable
Securities
|
The
Company’s marketable securities are comprised of certificates of deposit with original maturity greater than three months from
date of purchase, fixed income mutual funds, and corporate bonds and notes. The Company’s marketable securities are measured at
fair value and are accounted for in accordance with ASU 2016-01. Unrealized holding gains and losses on certificates of deposit and fixed
income mutual funds are recorded in net realized and unrealized gain (loss) from investments on the unaudited condensed consolidated
statements of operations and comprehensive loss. Unrealized holding gains and losses, net of the related tax effect, on corporate bonds
and notes are excluded from earnings and are reported as a separate component of stockholders’ equity until realized. Dividend
and interest income are recognized when earned. Realized gains and losses are included in earnings and are derived using the specific
identification method for determining the cost of the marketable securities.
Under
ASC 606, revenue is recognized when the Company completes the licensing of its intellectual property to its licensees, in an amount that
reflects the consideration the Company expects to be entitled to in exchange for licensing its intellectual property.
The
Company determines revenue recognition through the following steps:
|
|
•
|
identification
of the license agreement;
|
|
|
•
|
identification
of the performance obligations in the license agreement;
|
|
|
•
|
determination
of the consideration for the license;
|
|
|
•
|
allocation
of the transaction price to the performance obligations in the contract; and
|
|
|
•
|
recognition
of revenue when the Company satisfies its performance obligations.
|
All
of the Company’s revenue for the nine months ended September 30, 2021 was as a result of (i) resolution of a contractual dispute
with a licensee to pay royalties to the Company pursuant to a royalty bearing license for the Remote Power Patent for the period beginning
in the fourth quarter of 2017 through March 7, 2020 (when the Remote Power Patent expired) and (ii) settlement of a patent litigation
with another licensee also involving the Remote Power Patent (see Note I[2] hereof).
The
Company relies on royalty reports received from third party licensees to record its revenue. From time to time, the Company may audit
or otherwise dispute royalties reported from licensees. Any adjusted royalty revenue as a result of such audits or dispute is recorded
by the Company in the period in which such adjustment is agreed to by the Company and the licensee or otherwise determined.
Revenue
from the Company’s patent licensing business is generated from negotiated license agreements. The timing and amount of revenue
recognized from each licensee depends upon a variety of factors, including the terms of each agreement and the nature of the obligations
of the parties. These agreements may include, but not be limited to, elements related to past infringement liabilities, non-refundable
upfront license fees, and ongoing royalties on licensed products sold by the licensee. Generally, in the event of a litigation settlement
related to the Company’s assertion of patent infringement involving its intellectual property, defendants will either pay (i) a
non-refundable lump sum payment for a non-exclusive fully-paid license (a “Fully-Paid License”), or (ii) a non-refundable
lump sum payment (license initiation fee) together with an ongoing obligation to pay quarterly or monthly royalties to the Company for
the life of the licensed patent (a “Royalty Bearing License”).
NOTE
B – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
The
Company’s license agreements, both Fully-Paid Licenses and Royalty Bearing Licenses, typically include some combination of the
following: (i) the grant of a non-exclusive license to manufacture and/or sell products covered by its patented technologies; (ii) the
release of the licensee from certain claims, and (iii) the dismissal of any pending litigation. The intellectual property rights granted
pursuant to these licenses typically extend until the expiration of the related patents. Pursuant to the terms of these agreements, the
Company typically has no further performance obligations with respect to the grant of the non-exclusive licenses. Generally,
the license agreements provide for the grant of the licenses, releases, and other obligations following execution of the agreement and
the receipt of the up-front lump sum payment for a Fully-Paid License or a license initiation fee for a Royalty Bearing License.
The
Company recognizes revenue from their Royalty Bearing Licenses in a manner consistent with the legal form of the arrangement, and in
accordance with the royalty recognition constraint that applies to licenses of IP for which some or all of the consideration is in the
form of sales or usage based royalty. Consequently, the Company recognizes revenue at the later of when (1) the subsequent sale occurs
or (2) the performance obligation to which some or all of the sales based royalty has been satisfied.
Non-Refundable
Up-Front Fees: Fully-Paid Licenses provide for a non-refundable up-front payment, for which the Company has no future obligations
or performance requirements, revenue is generally recognized when the Company has obtained the signed license agreement, all performance
obligations have been substantially performed, amounts are fixed and determinable, and collectability is reasonably assured. Revenue
from Fully-Paid Licenses may consist of one or more installments. The timing and amount of revenue recognized from each licensee depends
upon a number of factors including the specific terms of each agreement and the nature of the deliverables and obligations.
|
[5]
|
Equity Method
Investments
|
Equity
method investments are equity securities in entities the Company does not control but over which it has the ability to exercise significant
influence. These investments are accounted for under the equity method of accounting in accordance with ASC 323, Investments —
Equity Method and Joint Ventures (see Note J hereof). Equity method investments are measured at cost minus impairment,
if any, plus or minus the Company’s share of an investee’s income or loss. The Company’s proportionate share of the
income or loss from equity method investments is recognized on a one-quarter lag. When the Company’s carrying value in an equity
method investment is reduced to zero, no further losses are recorded in the Company’s financial statements unless the Company guaranteed
obligations of the investee company or has committed additional funding. When the investee company subsequently reports income, the Company
will not record its share of such income until it equals the amount of its share of losses not previously recognized. Upon sale of equity
method investments, the difference between sales proceeds and the carrying amount of the equity investment is recognized in profit or
loss.
The
Company includes in costs of revenue contingent legal fees payable to patent litigation counsel (see Note G[1] hereof), any other contractual
payments to third parties related to net proceeds from settlements (see Note G[2] hereof) and incentive bonus compensation payable to
its Chairman and Chief Executive Officer (see Note H[1] hereof).
NOTE
B – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
The
Company accounts for income taxes in accordance with Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC)
Topic 740, Income Taxes (ASC 740), which requires the Company to use the assets and liability method of accounting for income
taxes. Under the assets and liability method, deferred income taxes are recognized for the tax consequences of temporary (timing) differences
by applying enacted statutory tax rates applicable to future years to differences between financial statement carrying amounts and the
tax bases of existing assets and liabilities and operating loss and tax credit carry forwards. Under this accounting standard, the effect
on deferred income taxes of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation
allowance is recognized if it is more likely than not that some portion, or all, of a deferred tax asset will not be realized.
ASC
740-10, Accounting for Uncertainty in Income Taxes, defines uncertainty in income taxes and the evaluation of a tax position as
a two-step process. The first step is to determine whether it is more likely than not that a tax position will be sustained upon examination,
including the resolution of any related appeals or litigation based on the technical merits of that position. The second step is to measure
a tax position that meets the more-likely-than-not threshold to determine the amount of benefit to be recognized in the financial statements.
A tax position is measured at the largest amount of benefit that is greater than 50 percent likelihood of being realized upon ultimate
settlement. Tax positions that previously failed to meet the more-likely-than-not recognition threshold should be recognized in the first
subsequent period in which the threshold is met. Previously recognized tax positions that no longer meet the more-likely-than-not criteria
should be de-recognized in the first subsequent financial reporting period in which the threshold is no longer met. The Company had no
uncertain tax positions as of September 30, 2021.
U.S.
federal, state and local income tax returns prior to 2017 are not subject to examination by any applicable tax authorities, except that
tax authorities could challenge returns (only under certain circumstances) for earlier years to the extent they generated loss carry-forwards
that are available for those future years.
The
personal holding company (“PHC”) rules under the Internal Revenue Code impose a 20% tax on a PHC’s undistributed personal
holding company income (“UPHCI”), which means, in general, taxable income subject to certain adjustments. For a corporation
to be classified as a PHC, it must satisfy two tests: (1) that more than 50% in value of its outstanding shares must be owned directly
or indirectly by five or fewer individuals at any time during the second half of the year (after applying constructive ownership rules
to attribute stock owned by entities to their beneficial owners and among certain family members and other related parties) (the “Ownership
Test”) and (2) at least 60% of its adjusted ordinary gross income for a taxable year consists of dividends, interest, royalties,
annuities and rents (the “Income Test”). Based on net income of $15,257,000 for the nine months ended September 30,
2021, the Company is likely to have UPHCI for 2021 if it satisfies both the Ownership Test and Income Test for 2021. During the second
half of 2021 through September 30, 2021, the Company does not believe it satisfied the Ownership Test. If the Company satisfies the Ownership
Test during the second half of 2021 and the Income Test for 2021, and has UPHCI for 2021 (or in any subsequent year in which the tests
are satisfied), the Company would be subject to a 20% tax on the amount of UPHCI that it does not distribute to its shareholders. In
the event that the Company is determined to be a Personal Holding Company in 2021 (satisfying both the Ownership Test and Income Test)
and the Company has UPHCI for 2021, the Company may issue a special cash dividend to its shareholders in an amount equal to the UPHCI
rather than incur the 20% tax.
NOTE
B – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
|
|
[8]
|
New Accounting
Standards
|
Income
Taxes
In
December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740), Simplifying the Accounting for Income Taxes. The ASU removes
certain exceptions for performing intra-period allocation and calculating income taxes in interim periods. It also simplifies the accounting
for income taxes by requiring recognition of franchise tax partially based on income as an income-based tax, requiring reflection of
enacted changes in tax laws in the interim period and making improvements for income taxes related to employee stock ownership plans.
ASU 2019-12 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2020. The adoption of
this standard did not have a material effect on the Company’s consolidated financial statements.
Equity
Securities
In
January 2020, the FASB issued ASU 2020-01, Investments – Equity Securities (Topic 321), Investments – Equity Method and
Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815). The ASU amends and clarifies certain interactions between the
guidance under Topic 321, Topic 323 and Topic 815, by reducing diversity in practice and increasing comparability of the accounting for
these interactions. The amendments in the ASU should be applied on a prospective basis. The ASU is effective for fiscal years beginning
after December 15, 2020, and interim periods within those fiscal years. The adoption of this standard did not have a material effect
on the Company’s consolidated financial statements.
Codification
Improvements
In
October 2020, the FASB issued ASU 2020-10, Codification Improvements. The amendments in Section B of this Update improve the consistency
of the Codification by including all disclosure guidance in the appropriate Disclosure Section. Section C of this Update contains Codification
improvements that vary in nature. The amendments in this Update should be applied retrospectively. This Update is effective for annual
periods beginning after December 15, 2020. The adoption of this standard did not have a material effect on the Company’s consolidated
financial statements.
NOTE
C – PATENTS
The
include patents with estimated remaining economic useful lives ranging from 1.75 to 12 years. For all periods presented, all of
the Company’s patents were subject to amortization. The gross carrying amounts and accumulated amortization related to acquired
intangible assets as of September, 2021 and December 31, 2020 were as follows
|
|
|
September 30, 2021
|
|
|
December 31, 2020
|
|
|
Gross carrying amount – patents
|
|
$
|
7,934,000
|
|
|
$
|
7,848,000
|
|
|
Accumulated amortization – patents
|
|
|
(6,490,000
|
)
|
|
|
(6,270,000
|
)
|
|
Patents, net
|
|
$
|
1,444,000
|
|
|
$
|
1,578,000
|
|
NOTE
C – PATENTS (continued)
Amortization
expense for the three months ended September 30,
2021 and 2020 was $74,000 and $72,000, respectively. Amortization expense for the nine months
ended September 30, 2021 and 2020 was $221,000 and $216,000, respectively. Future amortization
of intangible assets, net is as follows:
|
|
|
|
|
|
|
|
|
|
|
Twelve Months
Ended September 30,
|
|
|
|
2022
|
|
|
$
|
297,000
|
|
|
|
2023
|
|
|
|
297,000
|
|
|
|
2024
|
|
|
|
87,000
|
|
|
|
2025
|
|
|
|
87,000
|
|
|
|
2026 and thereafter
|
|
|
|
676,000
|
|
|
|
Total
|
|
|
$
|
1,444,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The
Company’s Remote Power Patent expired on March 7, 2020. All of the patents within the Company’s Mirror Worlds Patent Portfolio
have expired. All of the patents within the Cox Patent Portfolio expired in September 2021 except for two patents which expire in July
2023 and November 2023. The expiration dates of patents within the Company’s M2M/IoT Patent Portfolio range from September 2033
to May 2034.
NOTE
D – STOCK-BASED COMPENSATION
Restricted
Stock Units
The
2013 Stock Incentive Plan (“2013 Plan”) provides for the grant of any or all of the following types of awards: (a) stock
options, (b) restricted stock, (c) deferred stock, (d) stock appreciation rights, and (e) other stock-based awards including restricted
stock units. Awards under the 2013 Plan may be granted singly, in combination, or in tandem. Subject to standard anti-dilution adjustments
as provided, the 2013 Plan provides for an aggregate of 2,600,000 shares of the Company’s common stock to be available for distribution.
The Company’s Compensation Committee generally has the authority to administer the 2013 Plan, determine participants who will be
granted awards, the size and types of awards, the terms and conditions of awards and the form and content of the award agreements representing
awards. Awards under the 2013 Plan may be granted to employees, directors and consultants of the Company and its subsidiaries. As of
September 30, 2021, there were 1,832,308 shares of common stock available for issuance under the 2013 Plan.
NOTE
D – STOCK-BASED COMPENSATION (continued)
A
summary of restricted stock unit activity for the nine months ended September 30, 2021 is as follows (each restricted stock unit issued
by the Company represents the right to receive one share of the Company’s common stock):
|
|
|
Number of Shares
|
|
|
Weighted-Average
Grant Date Fair Value
|
|
|
Balance of restricted stock units outstanding at December 31, 2020
|
|
|
162,500
|
|
|
$
|
2.25
|
|
|
Grants of restricted stock units
|
|
|
45,000
|
|
|
|
3.51
|
|
|
Vested restricted stock units1
|
|
|
(158,750
|
)
|
|
|
(2.35
|
)
|
|
Balance of unvested restricted stock units at September 30, 2021
|
|
|
48,750
|
|
|
$
|
3.09
|
|
______________________________
1
Includes 125,000 shares of common stock subject to restricted stock units owned by the Company’s Chairman and Chief Executive
Officer which vested on July 14, 2021 and are subject to settlement after January 1, 2022 but not later than March 15, 2022 (see Note
H[1] hereof).
Restricted
stock unit compensation expense was $65,000 and $85,000 for the three months ended September 30, 2021 and 2020, respectively. Restricted
stock unit compensation expense was $183,000 and $242,000 for the nine months ended September 30, 2021 and September 30, 2020.
The
Company has an aggregate of $94,000 of unrecognized restricted stock unit compensation as of September 30, 2021 to be expensed over a
weighted average period of 0.76 years.
All
of the Company’s outstanding (unvested) restricted stock units have dividend equivalent rights. As of September 30, 2021, there
was $72,000 accrued for dividend equivalent rights. As of December 31, 2020, there was $53,000 accrued for dividend
equivalent rights.
NOTE
E – EARNINGS (LOSS) PER SHARE
Basic
earnings (loss) per share is calculated by dividing the net loss by the weighted average number of outstanding common shares during the
period. Diluted earnings (loss) per share data includes the dilutive effects of options, warrants and restricted stock units. Potentially
dilutive shares of 548,750 and 726,250 at September 30, 2021 and 2020, respectively, consisted of options and restricted stock units.
Computations
of basic and diluted weighted average common shares outstanding were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended
September 30,
|
|
|
Three Months Ended
September 30,
|
|
|
|
|
2021
|
|
|
2020
|
|
|
2021
|
|
|
2020
|
|
|
Weighted-average common shares outstanding – basic
|
|
|
24,136,506
|
|
|
|
23,992,203
|
|
|
|
23,934,361
|
|
|
|
24,012,333
|
|
|
Dilutive effect of options and restricted stock units
|
|
|
470,736
|
|
|
|
—
|
|
|
|
385,870
|
|
|
|
509,375
|
|
|
Weighted-average common shares outstanding – diluted
|
|
|
24,607,242
|
|
|
|
23,992,203
|
|
|
|
24,320,231
|
|
|
|
24,521,708
|
|
|
Options and restricted stock units excluded from the computation of diluted loss per share because the effect of inclusion would have been anti-dilutive
|
|
|
—
|
|
|
|
726,250
|
|
|
|
—
|
|
|
|
—
|
|
NOTE
F – MARKETABLE SECURITIES
Marketable
securities as of September 30,
2021 and December 31, 2020 were composed of:
|
|
|
September 30, 2020
|
|
|
|
|
Cost
Basis
|
|
|
Gross Unrealized Gains
|
|
|
Gross Unrealized Losses
|
|
|
Fair Value
|
|
|
Fixed income mutual funds
|
|
$
|
12,313,000
|
|
|
$
|
3,000
|
|
|
$
|
—
|
|
|
$
|
12,316,000
|
|
|
Corporate bonds and notes
|
|
|
5,357,000
|
|
|
|
—
|
|
|
|
(6,000
|
)
|
|
|
5,351,000
|
|
|
Total marketable securities
|
|
$
|
17,670,000
|
|
|
$
|
3,000
|
|
|
$
|
(6,000
|
)
|
|
$
|
17,667,000
|
|
|
|
|
December 31, 2020
|
|
|
|
|
Cost
Basis
|
|
|
Gross Unrealized Gains
|
|
|
Gross Unrealized Losses
|
|
|
Fair Value
|
|
|
Certificates of deposit
|
|
$
|
3,534,000
|
|
|
$
|
7,000
|
|
|
$
|
—
|
|
|
$
|
3,541,000
|
|
|
Fixed income mutual funds
|
|
|
11,255,000
|
|
|
|
80,000
|
|
|
|
—
|
|
|
|
11,335,000
|
|
|
Corporate bonds and notes
|
|
|
4,500,000
|
|
|
|
18,000
|
|
|
|
(28,000
|
)
|
|
|
4,490,000
|
|
|
Total marketable securities
|
|
$
|
19,289,000
|
|
|
$
|
105,000
|
|
|
$
|
(28,000
|
)
|
|
$
|
19,366,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NOTE
G – COMMITMENTS AND CONTINGENCIES
[1]
Legal Fees
Russ,
August & Kabat provides legal services to the Company with respect to its patent litigation filed in May 2017 against Facebook, Inc.
in the U.S. District Court for the Southern District of New York relating to several patents within the Company’s Mirror Worlds
Patent Portfolio (see Note I[4] hereof). The terms of the Company’s agreement with Russ, August & Kabat provide for cash payments
on a monthly basis subject to a cap plus a contingency fee ranging between 15% and 24% of the net recovery (after deduction of expenses)
depending on the stage of the proceeding in which the result (settlement or judgment) is achieved. The Company is responsible for all
of the expenses incurred with respect to this litigation.
Russ,
August & Kabat also provides legal services to the Company with respect to its pending patent litigations filed in April 2014 and
December 2014 against Google Inc. and YouTube, LLC in the U.S. District Court for the Southern District of New York relating to certain
patents within the Company’s Cox Patent Portfolio (see Note I[3] hereof). The terms of the Company’s agreement with
Russ, August & Kabat provide for legal fees on a full contingency basis ranging from 15% to 30% of the net recovery (after deduction
of expenses) depending on the stage of the proceeding in which the result (settlement or judgment) is achieved. The Company is responsible
for all of the expenses incurred with respect to this litigation.
Dovel
& Luner, LLP provided legal services to the Company with respect to its patent litigation filed in September 2011 against sixteen
(16) data networking equipment manufacturers in the U.S. District Court for the Eastern District of Texas, Tyler (see Note I[1] hereof).
The terms of the Company’s agreement with Dovel & Luner LLP essentially provided for legal fees on a full contingency basis
ranging from 12.5% to 35% (with certain exceptions) of the net recovery (after deduction for expenses) depending on the stage of the
preceding in which a result (settlement or judgment) is achieved. The Company is responsible for a certain portion of the expenses incurred
with respect to the litigation. As of September 30, 2021, the Company had accrued expenses and contingent liabilities of $46,000 owed
to Dovel & Luner, LLP with respect to the litigation.
NOTE
G – COMMITMENTS AND CONTINGENCIES (continued)
Dovel
& Luner, LLP also provided legal services to the Company with respect to the litigation settled in July 2010 against Cisco and several
other major data networking equipment manufacturers (see Note I[2] hereof). The terms of the Company’s agreement with Dovel &
Luner, LLP with respect to this litigation provided for legal fees of a maximum aggregate cash payment of $1.5 million plus a contingency
fee of 24% (based on the settlement being achieved at the trial stage). With respect to royalty payments received from Cisco in accordance
with the Company’s Settlement and License Agreement with Cisco, as amended, the Company has an obligation to pay Dovel & Luner,
LLP (including local counsel) 24% of such royalties received. For the three and nine months ended September 30, 2021, the Company incurred
aggregate contingent legal fees to Dovel & Luner, LLP with respect to the litigation of $5,760,000 and $10,245,000, respectively.
For the three and nine months ended September 30, 2020, the Company incurred aggregate contingent legal fees to Dovel & Luner, LLP
with respect to the litigation of $1,385,000 and $1,421,000, respectively. The Company was responsible for a portion of the expenses
incurred with respect to the litigation. As of September 30, 2021, the Company had no accrued expenses owed to Dovel & Luner, LLP
with respect to the litigation.
[2]
Patent Acquisitions
In
connection with the Company’s acquisition of its Cox Patent Portfolio, the Company is obligated to pay Dr. Cox 12.5% of the
net proceeds (after deduction of expenses) generated by the Company from licensing, sale or enforcement of the patent portfolio.
As
part of the
acquisition
of the Mirror Worlds Patent Portfolio, the Company also
entered
into an
agreement
with Recognition
Interface, LLC (“Recognition”) pursuant
to which Recognition received
from the Company an
interest
in the
net proceeds
realized
from the monetization
of the Mirror Worlds Patent
Portfolio,
as follows:
(i) 10% of the
first
$125 million of net proceeds;
(ii) 15% of the
next $125 million
of net proceeds;
and (iii) 20% of any
portion of the
net proceeds
in excess
of $250 million. Since entering into the agreement
with Recognition in May 2013, the Company has paid Recognition an aggregate of $3,127,000 with respect to such net proceeds interest
related to the Mirror Worlds Patent Portfolio. No such payments were made by the Company to Recognition during the three months ended
September 30, 2021 and 2020.
In
connection with the Company’s acquisition of its M2M/IoT Patent Portfolio, the Company is obligated to pay M2M 14% of the first
$100 million of net proceeds (after deduction of expenses) and 5% of net proceeds greater than $100 million from Monetization Activities
(as defined) related to the patent portfolio. In addition,
M2M will be entitled to receive from the Company $250,000 of additional consideration upon the occurrence of certain future events related
to the patent portfolio.
NOTE
H - EMPLOYMENT ARRANGEMENTS AND OTHER AGREEMENTS
[1] The
Company's Chairman and Chief Executive Officer currently serves on an at-will basis at an annual base salary of $535,000. The Company's
Chairman and Chief Executive Officer had served pursuant to a five-year employment agreement with the Company which expired in
July 2021 (the "Prior Agreement"). Under certain terms of the Prior Agreement which survived its expiration, so long
as the Chairman and Chief Executive Officer continues to serve as an executive officer of the Company, whether pursuant to the
agreement or otherwise, the Chairman and Chief Executive Officer receives incentive compensation in an amount equal to 5% of the
Company's gross royalties or other payments from Licensing Activities (as defined) (without deduction of legal fees or any other
expenses) with respect to its Remote Power Patent and a 10% net interest (gross royalties and other payments after deduction of
all legal fees and litigation expenses related to licensing, enforcement and sale activities, but in no event shall he receive
less than 6.25% of the gross recovery) of the Company's royalties and other payments relating to Licensing Activities with respect
to patents other than the Remote Power Patent (including the Mirror Worlds Patent Portfolio, Cox Patent Portfolio and M2M/IoT Patent
Portfolio) (collectively, the "Incentive Compensation"). During the three months ended September 30, 2021 and 2020,
the Chairman and Chief Executive Officer earned Incentive Compensation of $850,000 and $208,000,
respectively. During the nine months ended September 30, 2021 and 2020, the Chairman and Chief Executive Officer earned Incentive
Compensation of $1,785,000 and $218,000, respectively.
NOTE
H - EMPLOYMENT ARRANGEMENTS AND OTHER AGREEMENTS (continued)
[2]
The Company’s Chief Financial Officer serves on an at-will basis at an annual base salary of $175,000 and is eligible
to receive incentive or bonus compensation on an annual basis in the discretion of the Company’s Compensation Committee.
[3]
The Company’s Executive Vice President serves on an at-will basis at an annual base salary of $200,000 and is eligible to receive
incentive or bonus compensation on an annual basis in the discretion of the Company’s Compensation Committee.
NOTE
I – LEGAL PROCEEDINGS
[1]
On July 26, 2021, the Company agreed to settle its
patent litigation against Hewlett-Packard Company and Hewlett-Packard Enterprise Company (collectively, “HP”) pending in
the U.S. District Court for the Eastern District of Texas, Tyler Division, for infringement of the Company’s Remote Power Patent.
Under the terms of the settlement agreement, Hewlett-Packard Enterprise Company paid the Company $17,000,000 in full settlement of the
litigation and HP received a fully paid license and release to the Remote Power Patent for its full term, which applies to sales of Power
over Ethernet (“PoE”) products by HP and its wholly-owned subsidiary Aruba Networks, LLC.
[2]
On March 30, 2021, the Company entered into an amendment (the “Amendment”) to the
Settlement and License Agreement, dated May 25, 2011, between the Company and Cisco (the “Agreement”). Pursuant to the Amendment,
Cisco paid $18,692,000 to the Company to resolve a dispute relating to Cisco’s contractual obligation to pay royalties under the
Agreement to the Company for the period beginning in the fourth quarter of 2017 through March 7, 2020 (when the Remote Power Patent expired)
with respect to licensing the Remote Power Patent.
[3]
On April 4, 2014 and December 3, 2014, the Company initiated litigation against Google Inc. (“Google”) and YouTube,
LLC (“YouTube”) in the U.S. District Court for the Southern District of New York for infringement of several of its patents
within its Cox Patent Portfolio acquired from Dr. Cox (see Note G[2] hereof) which relate to the identification of media content on the
Internet. The lawsuit alleges that Google and YouTube have infringed and continue to infringe certain of the Company’s patents
by making, using, selling and offering to sell unlicensed systems and related products and services, which include YouTube’s Content
ID system. The litigations against Google
NOTE
I – LEGAL PROCEEDINGS (continued)
and
YouTube were subject to court ordered stays which were in effect from July 2, 2015 until January 2, 2019 as a result of proceedings
at the Patent Trial and Appeal Board (PTAB) and the appeals of PTAB Final Written Decisions to the U.S Court of Appeals for the Federal
Circuit. Pursuant to a Joint Stipulation and Order Regarding Lifting of Stays, entered on January 2, 2019, the parties agreed, among
other things, that the stays with respect to the litigations were lifted. In January 2019, the two litigations against Google and YouTube
were consolidated. Discovery has been substantially completed and a trial date has not yet been set.
[4]
On May 9, 2017, Mirror Worlds Technologies, LLC, the Company’s wholly-owned subsidiary, initiated litigation against Facebook,
Inc. (“Facebook”) in the U.S. District Court for the Southern District of New York, for infringement of U.S. Patent No. 6,006,227,
U.S. Patent No. 7,865,538 and U.S. Patent No. 8,255,439 (among the patents within the Company’s Mirror Worlds Patent Portfolio).
The lawsuit alleged that the asserted patents are infringed by Facebook’s core technologies that enable Facebook’s Newsfeed
and Timeline features. The lawsuit further alleged that Facebook’s unauthorized use of the stream-based solutions of the Company’s
asserted patents has helped Facebook become the most popular social networking site in the world. On May 7, 2018, Facebook filed a motion
for summary judgment on non-infringement. On August 11, 2018, the Court issued an order granting Facebook’s motion for summary
judgment of non-infringement and dismissed the case. On August 17, 2018, the Company filed a Notice of Appeal to appeal the summary judgment
decision to the U.S. Court of Appeals for the Federal Circuit. On January 23, 2020, the U.S. Court of Appeals for the Federal Circuit
reversed the summary judgment finding of the District Court and remanded the litigation to the Southern District of New York for further
proceedings. Discovery has been substantially completed and a trial date has not yet been set.
[5]
On December 15, 2020, the Company filed a lawsuit against Netgear in the Supreme Court of the State of New York, County of New York,
for breach of a Settlement and License Agreement, dated May 22, 2009, with the Company for failure to make royalty payments, and provide
corresponding royalty reports, to the Company based on sales of Netgear’s PoE products.
[6]
On January 7, 2021, the Company filed a lawsuit against Plantronics, Inc., the successor entity to Polycom, Inc., in the Supreme
Court of the State of California, County of Santa Clara, for breach of a Settlement and License Agreement, dated September 29, 2016,
with the Company for the failure of Plantronics and Polycom to make royalty payments, and provide corresponding royalty reports, to the
Company based on sales of PoE products.
NOTE
J – INVESTMENT
During
the period December 2018 through March 2021, the Company made an aggregate investment of $6,000,000 in ILiAD Biotechnologies, LLC (“ILiAD”),
a privately held clinical stage biotechnology company dedicated to the prevention of human disease caused by Bordetella pertussis with
a current focus on its proprietary intranasal vaccine BPZE1, for the prevention of pertussis (whooping cough). The aggregate investment
of $6,000,000 by the Company includes a $5,000,000 equity investment and a $1,000,000 investment in a convertible note (see below). At
September 30, 2021, the Company owned approximately 9.5% of the outstanding units of ILiAD on a non-fully diluted basis and 7.3% of the
outstanding units on a fully diluted basis (after giving effect to the exercise of all outstanding options and warrants). In connection
with its investment, the Company’s Chairman and Chief Executive Officer obtained a seat on ILiAD’s Board of Managers and
receives the same compensation for service on the Board of Managers as other non-management Board members.
NOTE
J – INVESTMENT (continued)
On
March 12, 2021, the Company invested an additional $1,000,000 in ILiAD as part of a private offering of up to $23,500,000 of convertible
notes (the “Notes”). The Notes have a maturity of three years with interest accruing at 6% per annum. The Notes
are required to be converted into a Qualified Financing (minimum financing of $15 million) at the lesser of (i) 80% of the price paid
per unit in such offering or (ii) a price based on an enterprise value of $176,000,000. In addition, the Notes shall convert in the event
of a merger at the lower of an enterprise value of $176,000,000 or the stated valuation of ILiAD in the merger transaction. In the event
of a change-in-control, noteholders will also have the option to have the Notes repaid except in a Qualified Offering or a stock-for-stock
merger.
For
the three months ended September 30, 2021, the Company recorded a net loss from its equity investment in ILiAD totaling $186,000. For
the nine months ended September 30, 2021, the Company recorded a net loss from its equity investment in ILiAD totaling $632,000.
The
difference between the Company’s share of equity in ILiAD’s net assets and the equity investment carrying value reported
on the Company’s unaudited condensed consolidated balance sheet at September 30, 2021 is due to an excess amount paid
over the book value of the equity investment totaling approximately $5,000,000 which is accounted for as equity method goodwill.
NOTE
K – STOCK REPURCHASES
On
June 8, 2021, the Board of Directors authorized an extension and increase of the Company’s share repurchase program (the “Share
Repurchase Program”) to repurchase up to $5,000,000 of common stock over the subsequent 24 month period. The common stock may be
repurchased from time to time in open market transactions or privately negotiated transactions in the Company’s discretion. The
timing and amount of the shares repurchased is determined by management based on its evaluation of market conditions and other factors.
The Share Repurchase Program may be increased, suspended or discontinued at any time. Since inception of the Share Repurchase Program
through September 30, 2021, the Company has repurchased an aggregate of 8,645,659 shares of its common stock at an aggregate cost of
$16,286,805 (exclusive of commissions) or an average per share price of $1.88. Except for the Company’s repurchase in May 2021
of 40,000 shares of its common stock from one of its directors at a price of $3.27 per share or an aggregate consideration of $130,800
in a privately negotiated transaction (see Note M below), the Company did not repurchase any shares of its common stock during the nine
months ended September 30, 2021. At September 30, 2021, the dollar value of remaining shares that may be repurchased under the Share
Repurchase Program was $4,869,200.
NOTE
L – CONCENTRATIONS
Revenue
from the Company’s Remote Power Patent constituted 100% of the Company’s revenue for the three and nine months ended September
30, 2021. Revenue from one licensee constituted 100% of the Company’s revenue for the three months ended September 30, 2021 and
revenue from two licensees constituted 100% of the Company’s revenue for the nine months ended September 30, 2021. Revenue from
one licensee constituted 100% of the Company’s revenue for the three months ended September 30, 2020 and 95% of the Company’s
revenue for the nine months ended September 30, 2020. At September 30, 2021 and December 31, 2020, the Company had no royalty receivables.
NOTE
M – RELATED PARTY TRANSACTION
On
May 27, 2021, the Company repurchased from a director of the Company 40,000 shares of its common stock at a purchase price of $3.27 per
share or aggregate consideration of $130,800.
NOTE
N – DIVIDEND POLICY
The
Company’s dividend policy consists of semi-annual cash dividends of $0.05 per share ($0.10 per share annually) which are anticipated
to be paid in March and September of each year. On February 23, 2021, the Company’s Board of Directors declared a semi-annual cash
dividend of $0.05 per share with a payment date of March 31, 2021 to all common shareholders of record as of March 16, 2021. On September
10, 2021, the Company’s Board of Directors declared a semi-annual cash dividend of $0.05 per share with a payment date of September
30, 2021 to common stockholders of record as of September 21, 2021. The Company’s dividend policy undergoes a periodic review by
the Board of Directors and is subject to change at any time depending upon the Company’s earnings, financial requirements and other
factors existing at the time.
NOTE
O – SUBSEQUENT EVENTS
On
October 26, 2021, the Company settled its litigation against Plantronics, Inc. in consideration for a payment of $337,000 (see
Note I[6] hereof).