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, 2022, and the results of its operations
and comprehensive income (loss) for the three and nine month periods ended September 30, 2022 and September 30, 2021, changes
in stockholders’ equity for the nine month periods ended September 30, 2022 and September 30, 2021, and its cash flows
for the nine month periods ended September 30, 2022 and September 30, 2021. 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, 2021 included in the Company’s Annual Report on Form
10-K filed with the Securities and Exchange Commission on March 30, 2022. The results of operations for the three and nine months ended
September 30, 2022 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 subsidiaries,
Mirror Worlds Technologies, LLC. and HFT Solutions, LLC.
On
March 17, 2022, the Company formed HFT Solutions, LLC for the purpose of acquiring its HFT patent portfolio (see Note G[2] hereof). All
intercompany balances and transactions have been eliminated in consolidation.
[2]
BUSINESS
The
Company is engaged in the development, licensing and protection of its intellectual property assets. The Company presently owns ninety-six
(96) patents including (i) 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 after such identification; (ii) the M2M/IoT patent portfolio
(the “M2M/IoT Patent Portfolio”) relating to, among other things, enabling technology for authenticating, provisioning and
using embedded sim technology in next generation IoT, Machine-to-Machine, and other mobile devices, including smartphones, tablets and
computers; (iii) the HFT patent portfolio (the “HFT Patent Portfolio”) covering certain advanced technologies relating to
high frequency trading, which inventions specifically address technological problems associated with speed and latency and provide critical
latency gains in trading
systems where the difference between success and failure may be measured in nanoseconds; (iv) 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; and (v) the remote power patent (the “Remote Power Patent”) covering 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.
NOTE
A – BASIS OF PRESENTATION AND NATURE OF BUSINESS (continued)
The
Company had been dependent upon its Remote Power Patent for a significant portion of its revenue. The Company no longer receives licensing
revenue for its Remote Power Patent for any period subsequent to March 7, 2020 (the expiration date of the patent). The Company’s
future revenue is largely dependent on its ability to monetize its other patent assets.
The
Company’s current strategy includes continuing to pursue licensing opportunities for its patent portfolios. In addition, the Company
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.
During
the period December 2018 through August 2022, the Company made an aggregate investment of $7,000,000 in ILiAD Biotechnologies, LLC (“ILiAD”),
a clinical stage biotechnology company with an exclusive license to sixty-two (62) patents. During the three and nine months ended
September 30, 2022, the Company recorded a gain on its investment in ILiAD of $3,727,000 due to an observable transaction price and dilution
of the Company’s ownership of ILiAD with respect to an ILiAD private offering as well as a gain on conversion of its convertible
note from ILiAD of $271,000 (see Note J and Note B[5] to our unaudited condensed consolidated financial statements included herein).
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 legal fees and related costs, 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, 2022, the Company maintained a cash balance of
$2,597,000 in excess of the FDIC insured limit. As of September 30, 2022 and December 31, 2021, the Company had cash equivalents of $16,721,000
and $33,385,000, respectively.
NOTE
B – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
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.
The
Company’s marketable securities are comprised of certificates of deposit, with original maturity greater than three months from
date of purchase, government securities, fixed income mutual funds, and a corporate bond. 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,
government securities, 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 income (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. |
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, 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.
NOTE
B – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
| [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
a sale of an equity method investment by the Company, the difference between sales proceeds and the carrying amount of the equity
investment is recognized in profit or loss. Upon the issuance of securities by the equity method investee in an observable price
transaction, the Company will account for the share issuance by an investee as if the Company had sold a proportionate share of its
investment in the transaction and records a gain or loss associated with the Company’s dilution of its investment with respect
to the transaction. As such the Company will increase or decrease its basis in the non-marketable equity of the investee and record a gain or
loss associated with the dilution of the investment basis based on the fair value indicated by the issuance of the securities. The
resulting gain or loss related to the dilution is recorded within other income or expense in the Company’s unaudited condensed
consolidated statements of operations and comprehensive income (loss).
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. As of
September 30, 2022, the Company had total deferred tax assets generated from the Company’s activities totaling $803,000. The Company’s
deferred tax assets were offset by a valuation allowance of $533,000 as it was determined that it is more likely than not that certain
deferred tax assets will not be realized. The Company also had a deferred tax liability of $1,246,000, resulting in a net deferred tax
liability position of $976,000.
NOTE
B – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
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, 2022.
The
Company recognizes interest and penalties related to income tax in the income tax provision in the unaudited condensed consolidated statements
of operations and comprehensive income (loss).
U.S.
federal, state and local income tax returns prior to 2019 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 and reduced by certain
distributions to shareholders. For a corporation to be classified as a PHC, it must satisfy two tests: (i) 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 (ii) at least 60% of its adjusted ordinary gross income for
a taxable year consists of dividends, interest, royalties, annuities and rents (the “Income Test”).
During
the second half of 2022 through October 2022, based on available information concerning the Company’s shareholder ownership, the
Company did not satisfy the Ownership Test. However, the Company may subsequently be determined to be a PHC in 2022 or in future years
if it satisfies both the Ownership Test and Income Test. If the Company were to become a PHC in 2022 or any future year, it would be
subject to the 20% tax on its UPHCI. In such event, the Company may issue a special cash dividend to its shareholders in an amount equal
to the UPHCI rather than incur the 20% tax.
Under
ASC 842, the Company determines if an arrangement is a lease at inception. Right-of-Use (“ROU”) assets and related lease
obligations are recognized at commencement date based on the present value of remaining lease payments over the lease term. For this
purpose, the Company considers only payments that are fixed and determinable at the time of commencement. As most of the Company's leases
do not provide an implicit rate, the Company uses its incremental borrowing rate based on the information available at commencement date
in determining the present value of lease payments. The Company's determined incremental borrowing rate is a hypothetical rate based
on its understanding of what the Company's credit rating would be. The ROU asset also includes any
lease payments made prior to commencement and is recorded net of any lease incentives received and net of the deferred rent balance on
the date of implementation. The Company's lease terms may include options to extend or terminate the lease when it is reasonably certain
that it will exercise such options. As permitted under ASC 842, the Company has elected to not recognize ROU assets and related lease
obligations for leases with terms of twelve months or less.
NOTE
B – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Certain
amounts in prior periods’ unaudited condensed consolidated financial statements have been recast and reclassified to conform to
the current year’s presentation.
NOTE
C – PATENTS
The
Company’s intangible assets at September 30, 2022 include patents with estimated remaining economic useful lives ranging from 0.75
to 16.75 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 30, 2022 and December 31, 2021 were as follows:
Schedule of patent | |
| | | |
| | |
| |
September 30, 2022 | | |
December 31, 2021 | |
Gross carrying amount – patents | |
$ | 8,473,000 | | |
$ | 7,949,000 | |
Accumulated amortization – patents | |
| (6,798,000 | ) | |
| (6,565,000 | ) |
Patents, net | |
$ | 1,675,000 | | |
$ | 1,384,000 | |
Amortization
expense for the three months ended September 30, 2022 and 2021 was $82,000 and $74,000, respectively. Amortization expense for the nine
months ended September 30, 2022 and 2021 was $233,000 and $221,000, respectively. Future amortization of intangible assets, net is as
follows:
Schedule of future amortization of current intangible | | |
| | |
Twelve Months
Ended September 30, | |
2023 | | |
$ | 319,000 | |
2024 | | |
| 120,000 | |
2025 | | |
| 120,000 | |
2026 | | |
| 120,000 | |
2027 | | |
| 120,000 | |
Thereafter | | |
| 876,000 | |
Total | | |
$ | 1,675,000 | |
| | |
| | |
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. The
expiration dates within the Company’s HFT Patent Portfolio range from October 31, 2039 to November 1, 2039. All of the patents
within the Company’s Mirror Worlds Patent Portfolio expired. The Company’s Remote Power Patent expired on March 7, 2020.
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, 2022, there were 1,212,938 shares of common stock available for issuance under the 2013 Plan.
During
the three months ended September 30, 2022, the Company adopted the Network-1 2022 Stock Incentive Plan (“2022 Plan”), by
the Company’s Board of Directors on July 25, 2022 and its stockholders on September 20, 2022. The 2022 Plan provides for the grant
of any or all of the following types of awards: (a) stock options, (b) restricted stock units, (c) restricted stock, (d) deferred stock,
(e) stock appreciation rights, (f) unrestricted stock awards and (g) other stock-based awards. Awards under the 2022 Plan may be granted
singly, in combination, or in tandem. Subject to standard anti-dilution adjustments as provided, the 2022 Plan provides for an aggregate
of 2,300,000 shares of the Company’s common stock to be available for distribution. The Company’s Compensation Committee
generally has the authority to administer the 2022 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 2022 Plan may
be granted to employees, directors and consultants of the Company and its subsidiaries. As of September 30, 2022, 2,300,000 shares of
common stock available for issuance under the 2022 Plan.
The
Company intends to discontinue issuing awards under its 2013 Stock Incentive Plan as a result of the adoption of the 2022 Plan.
A
summary of restricted stock unit activity for the nine months ended September 30, 2022 is as follows (each restricted stock unit issued
by the Company represents the right to receive one share of the Company’s common stock):
Schedule of restricted stock unit activity | |
| | | |
| | |
| |
Number of Shares | | |
Weighted-Average
Grant Date Fair Value | |
Balance of restricted stock units outstanding at December 31, 2021 | |
| 12,500 | | |
$ | 3.36 | |
Grants of restricted stock units | |
| 670,000 | | |
| 1.94 | |
Vested restricted stock units | |
| (33,750 | ) | |
| (2.55 | ) |
Balance of restricted stock units outstanding at September 30, 2022 | |
| 648,750 | | |
$ | 1.91 | |
NOTE
D – STOCK-BASED COMPENSATION (continued)
Restricted
stock unit compensation expense was $174,000 and $65,000 for the three months ended September 30, 2022 and 2021, respectively. Restricted
stock unit expense was $407,000 and $183,000 for the nine months ended September 30, 2022 and 2021, respectively. Stock-based compensation
expense is included in general and administrative expenses on the unaudited condensed consolidated statement of operations and comprehensive
income (loss).
The
Company has an aggregate of $909,000 of unrecognized restricted stock unit compensation as of September 30, 2022 to be expensed over
a weighted average period of 2.56 years.
All
of the Company’s outstanding (unvested) restricted stock units have dividend equivalent rights. As of September 30, 2022 and December
31, 2021, there was $37,000 and $72,000, respectively, accrued for dividend equivalent rights which were included in other accrued expenses.
NOTE
E – EARNINGS (LOSS) PER SHARE
Basic
income (loss) per share is calculated by dividing the net income (loss) by the weighted average number of outstanding common shares during
the period. Diluted per share data includes the dilutive effects of options and restricted stock units. Potentially dilutive shares of
1,148,750 and 548,750 at September 30, 2022 and 2021, respectively, consisted of options and restricted stock units.
Computations
of basic and diluted weighted average common shares outstanding were as follows:
Schedule of Earnings per share | |
| | | |
| | | |
| | | |
| | |
| |
Nine Months Ended September 30, | | |
Three Months Ended September 30, | |
| |
2022 | | |
2021 | | |
2022 | | |
2021 | |
Weighted-average common shares outstanding – basic | |
| 23,830,702 | | |
| 24,136,506 | | |
| 23,765,089 | | |
| 23,934,361 | |
Dilutive effect of options and restricted stock units | |
| — | | |
| 470,736 | | |
| 300,635 | | |
| 385,870 | |
Weighted-average common shares outstanding – diluted | |
| 23,830,702 | | |
| 24,607,242 | | |
| 24,065,724 | | |
| 24,320,231 | |
Options and restricted stock units excluded from the computation of diluted loss per share because the
effect of inclusion would have been anti-dilutive | |
| 1,148,750 | | |
| — | | |
| — | | |
| — | |
NOTE
F – MARKETABLE SECURITIES
Marketable
securities as of September 30, 2022 and December 31, 2021 were composed of the following:
|
Schedule
of Marketable Securities September 30, 2022 |
| |
| | |
| | |
| | |
| |
| |
| | |
| | |
| | |
| |
Certificates of deposit | |
$ | 3,000,000 | | |
$ | — | | |
$ | (14,000 | ) | |
$ | 2,986,000 | |
Government securities | |
| 13,068,000 | | |
| — | | |
| (14,000 | ) | |
| 13,054,000 | |
Fixed income mutual funds | |
| 12,580,000 | | |
| — | | |
| (1,039,000 | ) | |
| 11,541,000 | |
Corporate bond | |
| 192,000 | | |
| — | | |
| (14,000 | ) | |
| 178,000 | |
Total marketable securities | |
$ | 28,840,000 | | |
$ | — | | |
$ | (1,081,000 | ) | |
$ | 27,759,000 | |
| |
| | | |
| | | |
| | | |
| | |
| |
| | |
| | |
| | |
| |
| |
| | |
| | |
| | |
| |
Fixed income mutual funds | |
$ | 14,462,000 | | |
$ | — | | |
$ | (137,000 | ) | |
$ | 14,325,000 | |
Corporate bonds and notes | |
| 813,000 | | |
| — | | |
| (12,000 | ) | |
| 801,000 | |
Total marketable securities | |
$ | 15,275,000 | | |
$ | — | | |
$ | (149,000 | ) | |
$ | 15,126,000 | |
NOTE
G – COMMITMENTS AND CONTINGENCIES
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
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.
NOTE
G – COMMITMENTS AND CONTINGENCIES (continued)
On
March 25, 2022, the Company completed the acquisition of a new patent portfolio (HFT Patent Portfolio) consisting of six U.S. patents
and two pending U.S. patents covering certain advanced technologies relating to high frequency trading, which inventions specifically
address technological problems associated with speed and latency and provide critical latency gains in trading systems where the difference
between success and failure may be measured in nanoseconds. The Company paid the seller $500,000 at the closing and has an obligation
to pay the seller an additional $500,000 in cash and $375,000 of the Company’s common stock (up to a maximum of 375,000 shares)
upon achieving certain milestones with respect to the patent portfolio. The Company also has an additional obligation to pay the seller
15% of the first $50 million of net proceeds (after deduction of expenses) generated by the patent portfolio and 17.5% of net proceeds
greater than $50 million. On May 10, 2022, the Company received an additional patent issuance from the U.S. Patent and Trademark Office
related to the HFT Patent Portfolio.
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: Obligated to pay recognition, net proceeds (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 and nine months ended September 30, 2022 and 2021.
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.
The
Company has one operating lease for its principal office space in New Canaan, Connecticut that will expire on April 30, 2025.
There
are no material residual guarantees associated with any of the Company’s leases and there are no significant restrictions or covenants
included in the Company’s lease agreements.
The
calculated incremental borrowing rate was approximately 4.2%, which was calculated based on remaining lease term of 3 years as of May
1, 2022. The remaining lease term as of September 30, 2022 was approximately 2.6 years.
There
was no sublease rental income for the three and nine months ended September 30, 2022, and the Company is not the lessor in any lease
arrangement, and there were no related-party lease agreements.
NOTE
G – COMMITMENTS AND CONTINGENCIES (continued)
Right
of use lease assets and related lease obligations for the Company’s operating leases were recorded in the unaudited condensed consolidated
balance sheet as follows:
Schedule of operating leases obligations | |
| | | |
| | |
| |
As of | | |
As of | |
| |
September 30, 2022 | | |
December 31, 2021 | |
Operating lease right-of-use assets | |
$ | 177,000 | | |
$ | — | |
| |
| | | |
| | |
Operating lease obligations – current | |
| 72,000 | | |
| — | |
Operating lease obligations – non-current | |
| 111,000 | | |
| — | |
Total lease obligations | |
$ | 183,000 | | |
$ | — | |
| |
| | | |
| | |
The
table below presents certain information related to the Company’s lease costs for the period ended:
Schedule of leases cost | |
| | | |
| | | |
| | | |
| | |
| |
For the Three Months Ended September 30, | | |
For the Nine Months Ended September 30, | |
| |
2022 | | |
2021 | | |
2022 | | |
2021 | |
Operating lease cost | |
$ | 18,000 | | |
$ | — | | |
$ | 30,000 | | |
$ | — | |
Short-term lease cost | |
| 10,000 | | |
| 30,000 | | |
| 46,000 | | |
| 86,000 | |
Total lease cost | |
$ | 28,000 | | |
$ | 30,000 | | |
$ | 76,000 | | |
$ | 86,000 | |
Future
lease payments included in the measurement of lease liabilities on the unaudited condensed consolidated balance sheet as of September
30, 2022, were as follows:
Schedule of future minimum leases payments | | |
| | |
| | |
Operating Leases | |
2022 – remaining period | | |
$ | 24,000 | |
2023 | | |
| 73,000 | |
2024 | | |
| 73,000 | |
2025 | | |
| 24,000 | |
Total future minimum lease payments | | |
| 194,000 | |
Less imputed interest | | |
| (11,000 | ) |
Total operating lease liability | | |
$ | 183,000 | |
NOTE
H - EMPLOYMENT ARRANGEMENTS AND OTHER AGREEMENTS
[1]
On March 22, 2022, the Company entered into a new employment agreement (“Agreement”) with its Chairman and Chief Executive
Officer, pursuant to which he continues to serve as the Company’s Chairman and Chief Executive Officer for a four year term (“Term”),
at an annual base salary of $535,000 which shall be increased by 3% per annum during the term of the Agreement. The Agreement established
an annual target bonus of $175,000 for the Chairman and Chief Executive Officer based upon performance.
NOTE
H - EMPLOYMENT ARRANGEMENTS AND OTHER AGREEMENTS (continued)
In
addition, pursuant to the Agreement, the Company granted the Chairman and Chief Executive Officer, under its 2013 Plan, 600,000 restricted
stock units (the “RSUs”, each RSU awarded by the Company to its officers, directors and consultants represents a contingent
right to receive one share of the Company’s common stock) which terms provided for vesting in four tranches, as follows: (1)
175,000 RSUs of which 100,000 RSUs shall vest on March 22, 2023 and 75,000 RSUs shall vest on March 22, 2024, subject to the Chairman
and Chief Executive Officer’s continued employment by the Company through each such vesting date (the “Employment Condition”)
(“Tranche 1”); (2) 150,000 RSUs shall vest if at any time during the term of the Agreement that the Company’s common
stock (the “Common Stock”) achieves a closing price for twenty (20) consecutive trading days (“Closing Price”)
of a minimum of $3.50 per share (subject to adjustment for stock splits) and the Employment Condition is satisfied through the date such
minimum per share Closing Price is achieved (“Tranche 2”); (3) 150,000 RSUs shall vest if at any time during the term
of the Agreement that the Common Stock achieves a Closing Price of a minimum of $4.00 per share (subject to adjustment for stock splits)
and the Employment Condition is satisfied through the date such minimum per share Closing Price is achieved (“Tranche 3”);
and (4) 125,000 RSUs shall vest if at any time during the term of the Agreement, that the Common Stock achieves a Closing Price of a
minimum of $4.50 per share (subject to adjustment for stock splits) and the Employment Condition is satisfied through the date such minimum
per share Closing Price is achieved (“Tranche 4”). In the event of a Change of Control (as defined), Termination
Other Than for Cause (as defined) or a termination by the Chairman and Chief Executive Officer for Good Reason (as defined), in each
case prior to the last day of the term of the Agreement, the vesting of all unvested RSUs shall accelerate (and not be subject to any
conditions) and all RSUs shall become immediately fully vested. All RSUs granted by the Company to its officers, directors or consultants
have dividend equivalent rights.
Under
the terms of the Agreement (which terms are substantially the same as the prior employment agreement with the Chairman and Chief Executive
Officer), 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 shall also receive 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 all of the Company’s patent portfolios and its investment in ILiAD Biotechnologies)
(collectively, the “Incentive Compensation”). During the three and nine months ended September 30, 2022, the Chairman and
Chief Executive Officer did not earn any Incentive Compensation. During the three and nine months ended September 30, 2021, the Chairman
and Chief Executive Officer earned Incentive Compensation of $850,000 and $1,785,000, respectively.
The
Incentive Compensation shall continue to be paid to the Chairman and Chief Executive Officer for the life of each of the Company’s
patents with respect to licenses entered into with third parties during the term of his employment or at any time thereafter, whether
he is employed by us or not; provided, that, the employment of the Chairman and Chief Executive Officer has not been terminated by the
Company “For Cause” (as defined) or terminated by him without “Good Reason” (as defined). In the event of a merger
or sale of substantially all of the Company’s assets,
NOTE
H - EMPLOYMENT ARRANGEMENTS AND OTHER AGREEMENTS (continued)
the
Company has the option to extinguish the right of the Chairman and Chief Executive Officer to receive future Incentive Compensation by
payment to him of a lump sum payment, in an amount equal to the fair market value of such future interest as determined by an independent
third party expert if the parties do not reach agreement as to such value. In the event that the Chairman and Chief Executive Officer’s
employment is terminated by the Company “Other Than For Cause” (as defined) or by him for “Good Reason” (as defined),
the Chairman and Chief Executive Officer shall also be entitled to (i) a lump sum severance payment of 12 months base salary, (ii) a
pro-rated portion of the $175,000 target bonus provided bonus criteria have been satisfied on a pro-rated basis through the calendar
quarter in which the termination occurs and (iii) accelerated vesting of all unvested options, RSUs or other awards.
In
connection with the Agreement, the Chairman and Chief Executive Officer has also agreed not to compete with the Company as follows: (i)
during the term of the Agreement and for a period of 12 months thereafter if his employment is terminated “Other Than For Cause”
(as defined) provided he is paid his 12 month base salary severance amount and (ii) for a period of two years from the termination date,
if terminated “For Cause” by the Company or “Without Good Reason” by the Chairman and Chief Executive Officer.
[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 AND DISPUTES
[1]
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.
[2]
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.
[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 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 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.
NOTE
I – LEGAL PROCEEDINGS AND DISPUTES (continued)
[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 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.
On
March 7, 2022, the District Court entered a ruling granting in part and denying in part a motion for summary judgment by Facebook. In
its ruling the Court (i) denied Facebook’s motion that the asserted patents were invalid by concluding that all asserted claims
were patent eligible under §101 of the Patent Act and (ii) granted summary judgment of non-infringement in favor of Facebook
and dismissed the case. The Company strongly disagrees with the decision of the District Court on non-infringement and on April 4,
2022, the Company filed a notice of appeal to the U.S. Court of Appeals for the Federal Circuit. On April 18, 2022, Facebook filed a
notice of cross-appeal with respect to the Court’s ruling on validity. On September 19, 2022, the Company filed its brief on the
appeal.
[5]
On December 15, 2020, the Company filed a lawsuit against NETGEAR, Inc. (“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 (the “Agreement”)
for failure to make royalty payments, and provide corresponding royalty reports, to the Company based on sales of Netgear’s PoE
products. On October 22, 2021, Netgear filed a Demand for Arbitration at the American Arbitration Association (“AAA”) seeking
to arbitrate certain issues raised in the litigation. The Company objected to jurisdiction at the AAA. On April 1, 2022, the Court denied
Netgear’s motion to compel arbitration. On April 22, 2022, Netgear filed a counterclaim in the Court action alleging that the Company
breached the Agreement by not offering Netgear lower royalties. On September 22, 2022, the arbitration brought by Netgear was dismissed
by the AAA on jurisdiction grounds.
NOTE
J – INVESTMENT
During
the period December 2018 through August 2022, the Company made an aggregate investment of $7,000,000 in ILiAD Biotechnologies, LLC (“ILiAD”),
a privately held clinical stage biotechnology company dedicated to the prevention and treatment of human disease caused by Bordetella
pertussis. ILiAD is developing key technologies that focus on validating its proprietary intranasal vaccine, BPZE1, for the prevention
of pertussis (whooping cough). At September 30, 2022, the Company owned approximately 6.9% of the outstanding units of ILiAD on a non-fully
diluted basis and 6.4% of the outstanding units on a fully diluted basis (after giving effect to the exercise or conversion of all outstanding
options, warrants and convertible notes). In connection with its initial 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.
On
August 24, 2022, ILiAD completed a private financing of $42,836,000
of Class D units, of which a multi-national pharmaceutical company invested $30,000,000
(the “Financing”). As part of the Financing, the Company invested an additional $1,000,000.
This private financing represented an observable price transaction in accordance with ASC 323, and resulted in dilution in the
Company’s ownership in the investee (ILiAD). In accordance with ASC 323-10-40-1 the Company accounted for the
dilution as if it had sold a portion of its investment. As a result, the Company increased the carrying value of its ILiAD
investment by $3,727,000 and recognized an unrealized gain based on the excess of the fair value of the securities issued by ILiAD
over the carrying value of the Company’s diluted shares. The unrealized gain of $3,727,000
as a result of the securities issuance by ILiAD in the Financing is reflected in the Company’s unaudited condensed
consolidated statements of operations and comprehensive income (loss) for the three and nine months ended September 30,
2022.
The
Company has accounted for the transaction in accordance with ASC 323-10-40-1, which states that an equity method investor (the
Company) shall account for a share issuance by an investee (ILiAD) as if the investor had sold a proportionate share of its
investment in the transaction and records a gain or loss associated with the dilution of its investment. The difference between the
securities of ILiAD owned by the Company and the securities sold in the Financing were not material. Accordingly, the Company valued
its securities at the observable transaction price. Any gain or loss to the investor resulting from an investee’s share
issuance shall be recognized in earnings.
In
addition, as part of the Financing, the Company converted its convertible note in the principal amount of $1,000,000
plus accrued interest of $86,000,
in accordance with its terms, into equity of ILiAD and has accounted for this investment under the equity method of accounting. The
Company recognized an unrealized gain on conversion of $271,000
based on the observable price transaction which was recognized in its unaudited condensed consolidated statements of operations and
comprehensive income (loss) for the three and nine months ended September 30, 2022.
For
the three months ended September 30, 2022 and 2021, the Company recorded an allocated net loss from its equity method investment in ILiAD
of $285,000 and $186,000, respectively. For the nine months ended September 30, 2022 and 2021, the Company recorded an allocated net
loss from its equity method investment in ILiAD totaling $1,073,000 and $632,000, respectively.
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, 2022 is due to an excess amount paid over the
book value of the investment totaling approximately $7,000,000 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, 2022, the Company has repurchased an aggregate of 9,162,427 shares of its common stock at an aggregate cost of
$17,647,631 (exclusive of commissions) or an average per share price of $1.93. During the three months ended September 30, 2022, the
Company repurchased an aggregate of 75,213 shares of its common stock at an aggregate cost of $174,530 (exclusive of commissions) or
an average per share price of $2.32. During the nine months ended September 30, 2022, the Company repurchased an aggregate of 178,293
shares of its common stock at an aggregate cost of $422,388 (exclusive of commission) or an average per share price of $2.37. At September
30, 2022, the dollar value of remaining shares that may be repurchased under the Share Repurchase Program was $3,508,374.
On
August 16, 2022, the Inflation Reduction Act of 2022 (the “IR Act”) was signed into federal law. The IR Act provides for,
among other things, a new U.S. federal 1% excise tax on certain repurchases of stock by publicly traded U.S. domestic corporations and
certain U.S. domestic subsidiaries of publicly traded foreign corporations occurring on or after January 1, 2023. The excise tax is imposed
on the repurchasing corporation itself, not its shareholders from which shares are repurchased. The amount of the excise tax is generally
1% of the fair market value of the shares repurchased at the time of the repurchase. However, for purposes of calculating the excise
tax, repurchasing corporations are permitted to net the fair market value of certain new stock issuances against the fair market value
of stock repurchases during the same taxable year. In addition, certain exceptions apply to the excise tax. The U.S. Department of Treasury
has been given authority to provide regulations and other guidance to carry out and prevent the abuse or avoidance of the excise tax.
NOTE
L – CONCENTRATIONS
The
Company had no revenue for the three and nine months ended September 30, 2022. 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. At September 30, 2022 and December 31, 2021, the Company had no royalty receivables.
NOTE
M – 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. The Company paid dividends consistent with its policy in 2021 and 2022. 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
N – RELATED PARTY TRANSACTION
On
June 1, 2022, the Company repurchased from a director, in a privately negotiated transaction, 41,500 shares of its common stock at a
purchase price of $2.42 per share or an aggregate consideration of $100,430.
NOTE
O – SUBSEQUENT EVENTS
[1]
On October 6, 2022, the Company commenced litigation against Arista Networks Inc., Fortinet, Inc., Honeywell International Inc. and
Ubiquiti Inc. in four separate actions filed in the United States District Court, District of Delaware for infringement of its Remote
Power Patent (U.S. Patent No. 6,218,930). The Company seeks monetary damages based upon reasonable royalties.
[2]
On October 27, 2022, the Company’s Chairman and Chief Executive Officer exercised a stock option to purchase 500,000 shares
of the Company’s common stock at an exercise price of $1.19 per share on a net exercise (or cashless) basis. In connection with
the net exercise of the stock option, the Company’s Chairman and Chief Executive Officer delivered 334,459 shares of common stock
(including 94,539 shares for withholding taxes) to the Company and received 165,541 net shares.
[3]
On October 27, 2022 and November 3, 2022, the Company commenced litigation against TP-Link USA Corporation and Hikvision USA,
Inc. in two separate actions filed in the United States District Court for the Central District of California for infringement of its
Remote Power Patent. The Company seeks monetary damages based upon reasonable royalties.
[4]
On November 4, 2022, the Company commenced litigation against Panasonic Holdings Corporation and Panasonic Corporation of North America
in an action filed in the United States District Court for the Eastern District of Texas (Marshall Division) for infringement of its
Remote Power Patent. The Company seeks monetary damages based on reasonable royalties.
[5]
On November 11, 2022, the Company commenced litigation against Antaira Technologies, LLC in the United States District Court for
the Central District of California for infringement of its Remote Power Patent. The Company seeks monetary damages based on reasonable
royalties.