NETWORK-1 Technologies, Inc.: Form 10-Q for the period ended Sep 30, 2023

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the financial statements and related notes contained elsewhere in this Quarterly Report on Form 10-Q.

OVERVIEW

Our principal business is the development, licensing and protection of our intellectual property assets. We presently own ninety-nine (99) U.S. patents and fourteen (14) foreign patents relating to: (i) our Cox Patent Portfolio relating to enabling technology for identifying media content on the Internet and taking further action to be performed after such identification; (ii) our M2M/IoT Patent Portfolio relating to, among other things, enabling technology for authenticating and using embedded Sim (Subscriber Identification Module) technology in next generation IoT, Machine-to-Machine and other mobile devices, including smartphones, tablets and computers as well as automobiles; (iii) our 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) our 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) our 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. In addition, we continually review opportunities to acquire or license additional intellectual property as well as other strategic alternatives.

With respect to our ninety-nine (99) U.S. patents, fifty-three(53) of such patents have expired. However, we can assert expired patents against third parties but only for past damages up to the patent expiration date. We currently have pending litigation involving expired patents including our Remote Power Patent and certain patents within our Cox and Mirror Worlds Patent Portfolios (see Note I to our unaudited condensed consolidated financial statements included herein).

At September 30, 2023, our principal sources of liquidity consisted of cash and cash equivalents and marketable securities of $44,568,000 and working capital of $44,267,000. Based on our cash position, we continually review opportunities to acquire additional intellectual property as well as evaluate other strategic opportunities.

To date we have invested $7,000,000 in ILiAD, a clinical stage biotechnology company with an exclusive license to sixty-seven (67) patents (see Note J to our unaudited condensed consolidated financial statements included herein). Our investment continues to involve significant risk and the outcome is uncertain.

On September 5, 2023, ILiAD announced the first-ever demonstration of protection against B. pertussis (whooping cough) colonization in a Phase 2b Human Challenge study of it BPZE1 vaccine.

We have been dependent upon our Remote Power Patent for a significant portion of our revenue. Our Remote Power Patent has generated licensing revenue in excess of $187,000,000 from May 2007 through September 30, 2023. We no longer receive licensing revenue for our Remote Power Patent for any period subsequent to March 7, 2020 (the expiration date of the patent). During the fourth quarter of 2022, we commenced separate litigation against ten defendants involving our Remote Power Patent for patent infringement for the period prior to March 7, 2020. During the nine months ended September 30, 2023, we entered into settlement agreements with five defendants with respect to the aforementioned litigation resulting in aggregate settlement payments made to the Company of $820,000 and a future conditional payment of $150,000 (see Note I[4] hereof). All of our revenue for the nine months ended September 30, 2023 was from these settlements. In addition, on October 9, 2023, we settled with an additional defendant for a payment to us of $1,500,000, which will be recorded as revenue in the fourth quarter of 2023. (see Note N our unaudited condensed consolidated financial statements included herein).

In addition, we have pending litigation involving certain patents within our Cox Patent Portfolio and have appealed the judgment of the District Court dismissing our litigation against Meta (Facebook) on the grounds of non-infringement involving certain patents within our Mirror Worlds Portfolio. We also intend to commence efforts to monetize certain patents within our M2M/IoT Patent Portfolio and HFT Patent Portfolio. We may not achieve successful outcomes of such litigation, the appeal, or future litigation involving our patent assets.

Our current strategy includes continuing our licensing efforts with respect to our intellectual property assets and the monetization of our patent portfolios. In addition, we continue to seek to acquire additional intellectual property assets to develop, commercialize, license or otherwise monetize. Our strategy includes working with inventors and patent owners to assist in the development and monetization of their patented technologies. We may also enter into strategic relationships with third parties to develop, commercialize, license or otherwise monetize their intellectual property. Our 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 we have achieved with respect to our Remote Power Patent and Mirror Worlds Patent Portfolio.

The significant components of expenses, when we have revenue, that may impact our net loss relate to contingent legal fees and expenses related to our patent litigation (see Note G[1] to our unaudited condensed consolidated financial statements included herein) and incentive compensation payable to our Chairman and Chief Executive Officer pursuant to his employment agreement (see Note H to our unaudited condensed consolidated financial statements included herein), both such components of expenses are based on a percentage of the revenue received by us as a result of litigation or otherwise.

Our annual and quarterly operating and financial results may fluctuate significantly from period to period as a result of a variety of factors that are outside our control, including the timing and our ability to achieve successful outcomes of our patent litigation, our ability and timing of consummating future license agreements for our intellectual property, and whether we will achieve a return on our investment in ILiAD and the timing of any such return.

Our future operating results may also be materially impacted by our ability to acquire high quality patents which management believes have the potential to generate significant licensing opportunities. In the future, we may not be able to identify or consummate such patent acquisitions or, if consummated, achieve significant licensing revenue with respect to such acquisitions.

In 2023 and future years we could be classified as a Personal Holding Company. If this is the case, we would be subject to a 20% tax on the amount of any undistributed personal holding company income (as defined) for such year that we do not distribute to our shareholders (see Note B[4] to our unaudited condensed consolidated financial statements included in this Quarterly Report).

RESULTS OF OPERATIONS

Three Months Ended September 30, 2023 Compared to Three Months Ended September 30, 2022

Revenue. We had no revenue for the three months ended September 30, 2023 and September 30, 2022.

Operating Expenses. Operating expenses for the three months ended September 30, 2023 were $859,000 as compared to $838,000 for the three months ended September 30, 2022. The increase in operating expenses was primarily due to higher general and administrative expenses of $93,000 offset by lower stock-based compensation expense of $53,000 compared to 2022.

General and administrative expenses were $679,000 for the three months ended September 30, 2023 as compared to $639,000 for the three months ended September 30, 2022. The increase in general and administrative expenses of $40,000 was primarily due to higher state franchise and capital-based taxes of $61,000.

Stock-based compensation decreased from $174,000 for the three months ended September 30, 2022 to $121,000 for the three months ended September 30, 2023 as a result of there being fewer outstanding RSU’s compared to the prior year period and the currently outstanding RSU’s in 2023 have a lower weighted-average grant date value compared to those outstanding in the prior year period.

Interest and Dividend Income. Interest and dividend income for the three months ended September 30, 2023 was $406,000 as compared to $321,000 for the three months ended September 30, 2022 primarily as a result of higher yielding fixed income investments due to rising interest rates.

Gain on Conversion of Note. For the three months ended September 30, 2022, we recorded a gain on conversion of our ILiAD convertible note of $271,000, as compared to $-0- for the three months ended September 30, 2023, as a result of ILiAD’s private offering in August 2022.

Gain on Equity Method Investment. For the three months ended September 30, 2022, we recorded a gain on our equity method investment in ILiAD of $3,727,000, as compared to $-0- for the three months ended September 30, 2023, as a result of the observable price transaction relating to ILiAD’s private offering in August 2022.

Realized and Unrealized Loss on Marketable Securities. For the three months ended September 30, 2023, we recorded realized and unrealized gains on marketable securities of $131,000, as compared to realized and unrealized losses on marketable securities of $268,000 for the three months ended September 30, 2022 largely due to less favorable market conditions for fixed income securities in 2022.

Income Taxes. For the three months ended September 30, 2023, we had a current tax benefit for federal, state and local income taxes of $13,000 and a deferred tax benefit of $31,000. For the three months ended September 30, 2022, we had a current tax benefit for federal, state and local income taxes of $274,000 and a deferred tax expense of $976,000.

Share of Net Losses of Equity Method Investee. We recognized $532,000 of net losses during the three month period ended September 30, 2023 related to our equity share of ILiAD net losses, as compared to a recognized net loss of $285,000 for the three months ended September 30, 2022 (see Note J to our unaudited condensed consolidated financial statements included herein).

Net Loss (Income). As a result of the foregoing, we realized a net loss of $810,000 or $0.03 per share basic and diluted for the three months ended September 30, 2023 compared with net income of $2,226,000 or $0.09 per share basic and diluted for the three months ended September 30, 2022. Our net income for the three months ended September 30, 2022 was primarily due to a $3,727,000 gain on our equity method investment in ILiAD, offset by deferred income taxes on such gain.

Nine Months Ended September 30, 2023 Compared to Nine Months Ended September 30, 2022

Revenue. We had revenue of $820,000 for the nine months ended September 30, 2023 as compared to no revenue for the nine months ended September 30, 2022. Our revenue for the nine months ended September 30, 2023 was from litigation settlements involving our Remote Power Patent (see Note I[4] to our unaudited condensed consolidated financial statements included herein).

Operating Expenses. Operating expenses for the nine months ended September 30, 2023 were $3,004,000 as compared to $2,569,000 for the nine months ended September 30, 2022. The increase in operating expenses of $435,000 was primarily due to an increases in general and administrative expenses of $258,000 and costs of revenue of $232,000 related to contingent legal fees and incentive bonus compensation in connection with the litigation settlements, offset somewhat by a reduction in professional fees of $58,000.

General and administrative expenses were $2,070,000 for the nine months ended September 30, 2023 as compared to $1,812,000 for the nine months ended September 30, 2022. The increase in general and administrative expenses for the nine months ended September 30, 2023 was primarily due to severance and other benefits in the amount of $112,000 paid to our former Chief Financial Officer and increases in payroll taxes of $110,000, state franchise taxes of $91,000 and NYSE fees of $54,000. These increases were offset somewhat by reductions in office rent of $40,000 and employee benefits costs of $43,000.

Operating Loss. We had an operating loss of $2,184,000 for the nine months ended September 30, 2023 compared with an operating loss of $2,569,000 for the nine months ended September 30, 2022. The operating loss decrease of $385,000 was due to revenue of $820,000 from litigation settlements offset by increased operating expenses $435,000.

Interest and Dividend Income. Interest and dividend income for the nine months ended September 30, 2023 was $1,161,000 as compared to interest and dividend income of $532,000 for the nine months ended September 30, 2022. The increase in interest and dividend income of $629,000 for the nine months ended September 30,2023 was primarily due to higher yielding fixed income investments due to higher interest rates in 2023.

Gain on Conversion of Note. For the nine months ended September 30, 2022, we recorded a gain on conversion of our ILiAD convertible note of $271,000, as compared to $0 for the nine months ended September 30, 2023, as a result of ILiAD’s private offering in August 2022.

Gain on Equity Method Investment. For the nine months ended September 30, 2022, we recorded a gain on our equity method investment in ILiAD of $3,727,000, as compared to $0 for the nine months ended September 30, 2023, as a result of the observable price transaction relating to ILiAD’s private offering in August 2022.

Realized and Unrealized Loss on Marketable Securities. For the nine months ended September 30, 2023, we recorded realized and unrealized gains on marketable securities of $420,000 as compared to realized and unrealized losses on marketable securities of $1,358,000 due to unfavorable market conditions for fixed income securities for the nine months ended September 30, 2022.

Income Taxes. For the nine months ended September 30, 2023, we had a current tax benefit for federal, state and local income taxes of $13,000 and a deferred tax benefit of $278,000. For the nine months ended September 30, 2022, we had a current tax benefit for federal, state and local income taxes of $274,000 and a deferred tax expense of $422,000.

Share of Net Losses of Equity Method Investee. We recognized $1,597,000 of net losses during the nine month period ended September 30, 2023 related to our equity share of ILiAD net losses, as compared to recognized net losses of $1,073,000 for the nine months ended September 30, 2022 (see Note J to our unaudited condensed consolidated financial statements included herein). The increase in our equity share of the ILiAD net losses of $524,000 for the nine months ended September 30, 2023 includes an additional loss of $42,000 recorded on a one quarter lag basis as a result of audited financial information received from ILiAD for the year ended December 31, 2022 (see Note B[1] hereof).

Net Loss. As a result of the foregoing, we realized a net loss of $1,909,000 or $0.08 per share basic and diluted for the nine months ended September 30, 2023 compared with a net loss of $618,000 or $0.03 per share basic and diluted for the nine months ended September 30, 2022. Our net loss for the nine months ended September 30, 2022 was materially less primarily due to the $3,727,000 gain on our equity investment in ILiAD and the gain on conversion of the ILiAD note of $271,000 in 2022, offset by an increase in investment and interest income in 2023 of $2,407,000 and a reduction of income taxes in 2023 of $439,000.

LIQUIDITY AND CAPITAL RESOURCES

We have financed our operations primarily from revenue from licensing our patents. At September 30, 2023, our principal sources of liquidity consisted of cash and cash equivalents and marketable securities of $44,568,000 and working capital of $44,267,000. Based on our current cash position, we believe that we will have sufficient cash to fund our operations for the next twelve months and the foreseeable future.

Working capital decreased by $3,092,000 at September 30, 2023 to $44,267,000 as compared to working capital of $47,359,000 at December 31, 2022. The decrease in working capital was primarily due to dividend payments of $2,371,000, reductions in current liabilities of $955,000 and increased operating expenses of $326,000. These uses of working capital were offset somewhat by interest income of $1,161,000.

Net cash used in operating activities for the nine months ended September 30, 2023 decreased by $4,427,000 from $5,180,000 for the nine months ended September 30, 2022 to $753,000 for the nine months ended September 30, 2023, primarily as a result of lower income taxes payable of $2,859,000.

Net cash provided by (used in) investing activities during the nine months ended September 30, 2023 increased by $26,588,000 to $11,350,000 as compared to $(15,238,000) for the nine months ended September 30, 2022, primarily as a result of net investment shifting from marketable securities to investments in securities classified as cash and cash equivalents.

Net cash used in financing activities for the nine months ended September 30, 2023 and 2022 was $3,159,000 and $2,915,000, respectively. The change of $244,000 primarily resulted from an increase in repurchases of treasury shares of $283,000 in 2023.

We maintain our cash in money market funds, government securities, certificates of deposit and short-term fixed income securities. Accordingly, we do not believe that our investments have significant exposure to interest rate risk.

OFF-BALANCE SHEET ARRANGEMENTS

We do not have any off-balance sheet arrangements.

CONTRACTUAL OBLIGATIONS

We do not have any long-term debt, capital lease obligations, purchase obligations or other long-term liabilities.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Our unaudited condensed consolidated financial statements are prepared in accordance with GAAP. The preparation of our financial statements included in this Quarterly Report on Form 10-Q 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 financial statements, and the reported amounts of revenues and expenses during the reporting periods. The significant estimates and assumptions made in the preparation of our unaudited condensed consolidated financial statements include revenue recognition, contingent legal fees and related expenses, income taxes, valuation of patents and equity method investments, including the evaluation of the Company’s basis difference. Actual results could be materially different from those estimates, upon which the carrying values were based. See also Note B to our unaudited condensed consolidated financial statements included in this quarterly report.

We believe our most critical accounting policies and estimates to be the following:

Equity Method Investments

Equity method investments are equity securities in entities that we do not control but over which we have 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 our share of an investee’s income or loss, and adjustments based on the investees observable price transactions, if any. Our proportionate share of the income or loss from equity method investments is recognized on a one-quarter lag. When our carrying value in an equity method investment is reduced to zero, no further losses are recorded in our financial statements unless we guaranteed obligations of the investee company or have committed additional funding. When the investee company subsequently reports income, we will not record our share of such income until it equals the amount of our share of losses not previously recognized. In the event the equity method investee enters into an observable price transaction, we will increase or decrease the carrying value in our equity method investment based on the transaction price. 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. In determining whether an equity method investment is impaired, we take into consideration a variety of factors including the operating and financial performance of the investee, the investee’s future business plans and projections, discussions with the investee’s management, and our intent and ability to hold the investment until it recovers in value. Accordingly, we make assumptions and estimates in assessing whether an impairment has occurred and if, in the future, our assumptions and estimates made in assessing the fair value of these investments change, this could result in a material decrease in the carrying value of the investment. This would cause us to write-down the carrying value of the investment and could have a material adverse effect on our results of operations in the period the impairment charge is taken.

Income Taxes

We account for income taxes in accordance with Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 740, Income Taxes (ASC 740), which requires us 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. In evaluating the need for a valuation allowance, we estimate future taxable income based on management business plans. This process involves significant management judgment about assumptions that are subject to change from period to period. Because the recognition of deferred tax assets requires management to make significant judgments about future earnings, the periods in which items will impact taxable income and the application of inherently complex tax laws, we have identified the assessment of deferred tax assets and the need for any related valuation allowance as a critical accounting estimate.

(a) Evaluation of Disclosure Controls and Procedures

Our Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934) as of the end of the period covered by this Quarterly Report on Form 10-Q. Based upon this review, these officers concluded that, as of the end of the period covered by this Quarterly Report on Form 10-Q, our disclosure controls and procedures are effective to ensure that information required to be disclosed by us in the reports we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the time periods specified in applicable rules and forms and is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure.

(b) Changes in Internal Controls

There was no change in our internal control over financial reporting that occurred during the fiscal quarter ended September 30, 2023 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Our operations and financial results are subject to various risks and uncertainties that could adversely affect our business, financial condition, results of operations and trading price of our common stock. Investors should carefully consider the risks described in this Quarterly Report on Form 10-Q for the three months ended September 30, 2023, and our Annual Report on Form 10-K for the year ended December 31, 2022 (pages 19-21), filed with the SEC on March 30, 2023.