ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
THIS QUARTERLY REPORT ON FORM 10-Q CONTAINS FORWARD-LOOKING STATEMENTS WHICH ARE STATEMENTS THAT INCLUDE INFORMATION BASED UPON BELIEF OF OUR MANAGEMENT, AS WELL AS ASSUMPTIONS MADE BY AND INFORMATION AVAILABLE TO MANAGEMENT. STATEMENTS CONTAINING TERMS SUCH AS “BELIEVES”, “EXPECTS”, “ANTICIPATES”, “INTENDS” OR SIMILAR WORDS ARE INTENDED TO IDENTIFY FORWARD LOOKING STATEMENTS. ACTUAL RESULTS, EVENTS AND CIRCUMSTANCES (INCLUDING FUTURE PERFORMANCE, RESULTS AND TRENDS) COULD DIFFER MATERIALLY FROM THOSE SET FORTH IN SUCH STATEMENTS DUE TO VARIOUS RISKS AND UNCERTAINTIES, INCLUDING, BUT NOT LIMITED TO, THOSE DISCUSSED ON PAGES 14-25 OF OUR ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2014 AND ON PAGE 31 OF OUR QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2015 FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MARCH 5, 2015 AND MAY 14, 2015, RESPECTIVELY.
OVERVIEW
Our principal business is the development, licensing and protection of our intellectual property assets. We presently own twenty-four (24) patents including (i) our Remote Power Patent covering the delivery of power over Ethernet cables for the purpose of remotely powering network devices, such as wireless access ports, IP phones and network based cameras; (ii) our Mirror Worlds Patent Portfolio relating to foundational technologies that enable unified search and indexing, displaying and archiving of documents in a computer system; (iii) our Cox Patent Portfolio relating to enabling technology for identifying media content on the Internet and taking further action to be performed based on such identification; and (iv) our QoS Patents covering systems and methods for the transmission of audio, video and data in order to achieve high quality of service (QoS) over computer and telephony networks. In addition, we continually review opportunities to acquire or license additional intellectual property.
We have been actively engaged in the licensing of our Remote Power Patent (U.S. Patent No. 6,218,930). We have entered into nineteen (19) license agreements with respect to our Remote Power Patent which, among others, include license agreements with Cisco Systems, Inc., Extreme Networks, Inc., Netgear, Inc., Microsemi Corporation, Motorola Solutions, Inc., NEC Corporation and Samsung Electronics Co., Ltd. and several other major data networking equipment manufacturers. Our current strategy includes continuing our licensing efforts with respect to our Remote Power Patent and our efforts to monetize the two patent portfolios (the Cox Patent Portfolio and the Mirror Worlds Patent Portfolio) we acquired in 2013. In addition, we continue to seek to acquire additional intellectual property assets to develop, commercialize, license or otherwise monetize such intellectual property. 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 acquisition 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. Our Remote Power Patent generated licensing revenue in excess of $78,000,000 from May 2007 through June 30, 2015.
On February 28, 2013, as part of our acquisition strategy, we acquired from Dr. Ingemar Cox, a technology leader in digital watermarking content identification, digital rights management and related technologies, four patents (as well as a pending patent application) (these patents together with subsequent related patent issuances comprise our Cox Patent Portfolio) for a purchase price of $1,000,000 in cash and 403,226 shares of our common stock. In addition, we are obligated to pay Dr. Cox 12.5% of the net proceeds generated by us from licensing, sale or enforcement of the patents (see Note J[2] to our financial statements included in this quarterly report). In 2014, we were issued three additional patents (U.S. Patent No. 8,640,179, U.S. Patent No. 8,656,441 and U.S. Patent No. 8,782,726) by the U.S. Patent and Trademark Office (“USPTO”) which are part of our Cox Patent Portfolio.
On May 21, 2013, Mirror Worlds Technologies, LLC, our wholly-owned subsidiary, acquired all of the patents previously owned by Mirror Worlds, LLC (which subsequently changed its name to Looking Glass LLC) including nine issued United States patents and five pending applications covering foundational technologies that enable unified search and indexing, displaying and archiving of documents in a computer system (these patents together with subsequent related patent issuances comprise our Mirror Worlds Patent Portfolio). The consideration we paid for the Mirror Worlds Patent Portfolio consisted of (i) $3,000,000 in cash, (ii) 5-year warrants to purchase 875,000 shares of our common stock at an exercise price of $1.40 per share, and (iii) 5-year warrants to purchase 875,000 shares of our common stock at an exercise price of $2.10 per share (the “Looking Glass Warrants”) (see Note J[2] to our financial statements included in this quarterly report). On June 3, 2014, we repurchased the Looking Glass Warrants from Looking Glass at a cost of $505,000. As part of the acquisition of the Mirror Worlds Patent Portfolio, we also entered into an agreement with Recognition Interface, LLC (“Recognition”), an entity that financed the commercialization of the Mirror Worlds Patent Portfolio prior to its sale to Mirror Worlds, LLC and also retained an interest in the licensing proceeds of the patent portfolio held by Mirror Worlds, LLC. Pursuant to the terms of our agreement with Recognition, Recognition received (i) 5-year warrants to purchase 250,000 shares of our common stock at an exercise price of $1.40 per share, and (ii) 5-year warrants to purchase 250,000 shares of our common stock at an exercise price of $2.10 per share. Recognition also received from us 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. In addition, Abacus and Associates, Inc., an entity affiliated with Recognition, received a 60-day warrant to purchase 500,000 shares of our common stock at an exercise price of $2.05 per share which it exercised in full on July 22, 2013 resulting in proceeds to us of $1,025,000. As a result of such warrant exercise and in accordance with our agreement with Recognition, we issued additional warrants to Recognition to purchase an aggregate of 250,000 shares of our common stock (125,000 shares at an exercise price of $2.10 per share and 125,000 shares at an exercise price of $1.40 per share).
The validity of our Remote Power Patent and certain patents within our Mirror Worlds Patent Portfolio and Cox Patent Portfolio are currently being challenged in patent infringement litigation pending in the courts and proceedings at the USPTO (see “Legal Proceedings” on pages 31-35 of this quarterly report and below). If certain claims of our Remote Power Patent are ultimately determined to be invalid, such a determination would have a material adverse effect on our business, financial condition and results of operations as our entire current revenue stream is dependent upon the continued validity of certain claims of our Remote Power Patent. If certain of our patents within our Mirror Worlds Patent Portfolio or Cox Patent Portfolio are ultimately determined to be invalid, such a determination could have a material adverse effect on our ability to grow our revenue and profits in the future.
On May 22, 2013, through our wholly-owned subsidiary, Mirror Worlds Technologies, LLC, we initiated patent litigation against Apple Inc., Microsoft, Inc., Hewlett-Packard Company, Lenovo Group Ltd., Lenovo (United States), Inc., Dell, Inc., Best Buy Co., Inc., Samsung Electronics America, Inc. and Samsung Telecommunications America L.L.C., in the United States District Court for the Eastern District of Texas, Tyler Division, for infringement of U.S. Patent No. 6,006,227 (part of the Mirror Worlds Patent Portfolio we acquired) (see “Legal Proceedings” at pages 32 and 33 hereof .
On April 4, 2014 and December 3, 2014, we initiated litigation against Google Inc. and YouTube, LLC in the United States District Court for the Southern District of New York for infringement of several of our patents within the Cox Patent Portfolio relating to the identification of media content on the Internet. The lawsuits allege that Google and YouTube have infringed and continue to infringe certain of our patents by making, using, selling and offering to sell unlicensed systems and related products and services, which include YouTube’s Content ID system. On June 23, 2015, the Patent Trial and Appeal Board (“PTAB”) of the USPTO issued an order instituting for trial each of four Inter Partes Review petitions filed with the PTAB seeking to invalidate certain claims of our patents at issue in our litigation against Google and YouTube. (see “Legal Proceedings” at pages 31-32 hereof).
In September 2011, we initiated patent litigation against sixteen (16) data networking equipment manufacturers in the United States District Court for the Eastern District of Texas, Tyler Division, for infringement of our Remote Power Patent. We have since settled the litigation against eight of the defendants (see “Legal Proceedings” at page 34 hereof and Note L[3] to our financial statements included in this quarterly report).
As a result of a settlement in July 2010 of patent litigation we had initiated against Cisco Systems, Inc. and Cisco-Linksys, LLC (collectively “Cisco”), we entered into non-exclusive licenses for our Remote Power Patent with Cisco and the other defendants. For the six months ended June 30, 2015 and June 30, 2014, our royalty revenue from Cisco constituted 84% and 92% of our revenue, respectively. For the three month period ended June 30, 2015 and June 30, 2014, our royalty revenue from Cisco constituted 79% and 92% of our revenue, respectively (See Note N to our financial statements included in this quarterly report). It is anticipated that one or a few of our licensees will continue to constitute a significant portion of our revenue in the forseeable future. In accordance with our Settlement and License Agreement, dated May 25, 2011, Cisco is obligated to pay us royalties (which began in the first quarter of 2011) based on its sales of PoE products up to maximum royalty payments per year of $8 million through 2015 and $9 million per year thereafter for the remaining term of the patent (March 2020). The royalty payments are subject to certain conditions including the continued validity of certain claims of our Remote Power Patent, and the actual royalty amounts received may be less than the caps stated above, as was the case in 2013 and 2012. Due to our annual royalty rate structure with Cisco which includes declining rates as the volume of PoE product sales increase during the year, royalties from Cisco are anticipated to be highest in the first quarter of the calendar year and decline for each of the remaining calendar quarters of the year. However, in 2014 we had greater royalty revenue from Cisco in the second quarter as compared to the first quarter because we recorded additional royalty revenue from Cisco in the second quarter as a result of our audit of Cisco completed in 2014 for the years ended December 31, 2013 and December 31, 2012 (see below and Note N to our financial statements included in this quarterly report).
In late December 2013, we exercised our right to audit the royalties paid to us by Cisco for the years 2012 and 2013 (the “Audit Period”) in accordance with our May 2011 license agreement with Cisco. As a result of the audit, Cisco agreed to pay us additional royalty payments pursuant to the May 2011 license agreement of $3,281,000 for the Audit Period and other periods covered by license agreement which were recorded as revenue in the three month period ended June 30, 2014, at the time the parties agreed to the amount of the additional royalty revenue (see Note N to our financial statements included in this quarterly report).
On July 20, 2012, an unknown third party filed with the USPTO a request for ex parte reexamination of certain claims of our Remote Power Patent. On September 5, 2012, the USPTO issued an order granting the reexamination. On October 14, 2014, the USPTO issued a Reexamination Certificate, rejecting a challenge to the patentability of our Remote Power Patent (U.S Patent No. 6,218,930). The Reexamination Certificate confirmed the patentability of the challenged claims of the Remote Power (claims 6, 8 and 9) without any amendment or modification. The USPTO also allowed fourteen new claims, bringing the total claims in the Remote Power Patent to twenty-three (23) claims. No claims were rejected.
Avaya Inc., Dell Inc., Sony Corporation of America and Hewlett Packard Co. were petitioners in three Inter Partes Review proceedings (which were joined together) (the “IPR Proceeding”) at the USPTO before the PTAB (see “Legal Proceedings” at pages 34 and 35 of this quarterly report). On May 22, 2014, the PTAB issued its Final Written Decision in our favor rejecting a challenge to the patentability of our Remote Power Patent. On July 24, 2014, the petitioners in the IPR Proceeding each filed a Notice of Appeal of the PTAB’s decision to the United States Court of Appeals for the Federal Circuit. On August 10, 2015, the United States Court of Appeals for the Federal Circuit affirmed the decision of the PTAB in our favor rejecting a challenge to the patentability of our Remote Power Patent.
On February 16, 2015, Sony Corporation of America filed a Petition for Covered Business Method Review (CBM) and a request for an ex parte reexamination with the USPTO seeking to invalidate certain claims of our Remote Power Patent. On April 3, 2015, the USPTO issued an order granting Sony’s request for an ex parte reexamination. If certain of the challenged claims in the ex parte reexamination of our Remote Power Patent are ultimately determined to be invalid by the USPTO (and such decision is not reversed by the United States Court of Appeals for the Federal Circuit), such a determination would have a material adverse effect on our business, financial condition and results of operations as our entire current revenue stream is dependent upon the continued validity of certain claims of our Remote Power Patent. On July 1, 2015, the PTAB of the USPTO issued a decision in our favor denying institution of the CBM Petition and rejected Sony’s challenge to the patentability of our Remote Power Patent.
At June 30, 2015, we had an impairment of $386,000 with respect to our investment in Lifestreams Technologies Corporation (See Note B and Note I to our financial statements included in this quarterly report) which has been included in general and administrative expenses in our Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) for the three and six months ended June 30, 2015. Our investment in Lifestreams Technologies Corporation has a carrying value at June 30, 2015 of $190,000 as compared to a carrying value of $576,000 at December 31, 2014. The carrying value of the investment was initially measured at cost and has been written down to fair value of $190,000 as of June 30, 2015 to reflects management’s assessment of the fair value of the investment. The impairment of $386,000 reflects a write-down of the full amount of our equity investment ($196,000) and 50% ($190,000) of our secured convertible note investment. There can be no assurance that we will be able to realize the fair value of the investment.
At June 30, 2015, we had net operating loss carryforwards (NOLs) totaling approximately $23,329,000 expiring through 2029, with a future tax benefit of approximately $8,165,000. At June 30, 2015 and December 31, 2014, $4,077,000 and $4,743,000, respectively, was recorded as deferred tax assets on our balance sheet. During the three month period ended June 30, 2015 as a result of a loss before taxes of $(325,000), $105,000 was recorded as an income tax reduction and our deferred assets were increased by $90,000 to $4,077,000. During the six months ended June 30, 2015, as a result of income (before taxes) for the period of $2,016,000, $706,000 was recorded as income tax expense and the deferred tax assets were reduced by $666,000 to $4,077,000. To the extent that we have taxable income in the future, we will report income tax expense and such expense attributable to federal income taxes will reduce the deferred tax assets reflected on our balance sheet. Management will continue to evaluate the recoverability of our NOLs and adjust the deferred tax assets accordingly. Utilization of NOLs can be subject to a substantial annual limitation due to ownership change limitations that could occur in the future, as required by Section 382 of the Internal Revenue Code of 1986, as amended, as well as similar state provisions.
RESULTS OF OPERATIONS
Three Months Ended June 30, 2015 Compared To Three Months Ended June 30, 2014
Revenue. We had revenue of $1,747,000 for the three months ended June 30, 2015 as compared to revenue of $5,166,000 for the three months ended June 30, 2014, which was related to the receipt of royalties pursuant to license agreements for our Remote Power Patent. The decrease in revenue of $3,419,000 for the three months ended June 30, 2015 was primarily due to $3,281,000 of additional royalty payments from Cisco for the three months ended June 30, 2014 as a result of our audit of Cisco (see Note N to our financial statements included in this quarterly report). Exclusive of the additional royalty revenue from the Cisco audit for three months ended June 30, 2014, revenue decreased $138,000 or 7.3% for the three months ended June 30, 2015 compared to the three months ended June 30, 2014.
Cost of Revenue. We had a cost of revenue of $478,000 and $1,506,000 for the three months ended June 30, 2015 and June 30, 2014, respectively. Included in the cost of revenue for the three months ended June 30, 2015 were contingent legal fees of $390,000 payable to our patent litigation counsel (see Note J[1] to our financial statements included in this quarterly report) and $87,000 of incentive (royalty bonus) compensation payable to our Chairman and Chief Executive Officer pursuant to his employment agreement (see Note K[1] to our financial statements included in this quarterly report). Included in the cost of revenue for the three months ended June 30, 2014 were contingent legal fees of $1,221,000 payable to our patent litigation counsel and $257,000 of incentive (royalty bonus) compensation payable to our Chairman and Chief Executive Officer pursuant to his employment agreement.
Gross Profit. The gross profit for the three months ended June 30, 2015 was $1,269,000 as compared to $3,660,000 for the three months ended June 30, 2014. The decreased gross profit of $2,391,000 or 65% for the three months ended June 30, 2015 was primarily due to decreased royalty revenue of $3,419,000 for the three months ended June 30, 2015 attributable to revenue from the Cisco audit for the three months ended June 30, 2014.
Operating Expenses. Operating expenses for the three months ended June 30, 2015 were $1,606,000 as compared to $1,159,000 for the three month period ended June 30, 2014. General and administrative expenses include, among other expenses, overhead expenses, and finance, accounting, legal and other professional services incurred by us. General and administrative expenses increased by $504,000 from $615,000 for the three months ended June 30, 2014 to $1,119,000 for the three months ended June 30, 2015, due primarily to an impairment of $386,000 of our investment in Lifestreams for the three months ended June 30, 2015 (see Note I and Note B to our financial statements included in this quarterly report) and increased legal costs from litigation. Amortization of patents was $413,000 for the three months ended June 30, 2015 as compared to $409,000 for the three months ended June 30, 2014. Stock-based compensation related to the issuance of stock options was $74,000 for the three months ended June 30, 2015 as compared to $135,000 for the three months ended June 30, 2014.
Interest Income. Interest income for the three months ended June 30, 2015 and June 30, 2014 was $12,000.
Operating Income (Loss). We had an operating loss of $(337,000) for the three months ended June 30, 2015 compared with an operating income of $2,501,000 for the three months ended June 30, 2014. The decreased operating income of $2,838,000 for the three months ended June 30, 2015 was primarily due to decreased revenue of $3,419,000 largely attributable to additional revenue of $3,281,000 from the Cisco audit for the three months ended June 30, 2014 and the impairment of $386,000 of our investment in Lifestreams for the three months ended June 30, 2015.
Income Taxes (Benefit). Benefits for federal, state and local income taxes of $(105,000) and $912,000 were recorded for the three months ended June 30, 2015 and June 30, 2014, respectively.
Deferred Tax Benefit/NOLs. At June 30, 2015, we had net operating loss carryforwards (NOLs) totaling approximately $23,329,000 expiring through 2029, with a future tax benefit of approximately $8,165,000. At June 30, 2015 and June 30, 2014, $4,077,000 and $4,093,000, respectively, has been recorded as deferred tax assets on our balance sheet. During the three month period ended June 30, 2015 as a result of a loss before taxes of $(325,000), $105,000 was recorded as an income tax reduction and our deferred tax assets were increased by $90,000 to $4,077,000.
Net Income. As a result of the foregoing, we realized a net loss of $(220,000) or $(0.01) per share (basic and diluted) for the three months ended June 30, 2015 compared with net income of $1,601,000 or $0.06 per share (basic and diluted) for the three months ended June 30, 2014.
RESULTS OF OPERATIONS
Six Months Ended June 30, 2015 Compared To Six Months Ended June 30, 2014
Revenue. We had revenue of $7,374,000 for the six months ended June 30, 2015 as compared to revenue of $9,657,000 for the six months ended June 30, 2014, which was related to the receipt of royalties pursuant to license agreements for our Remote Power Patent. The decrease in revenue of $2,283,000 or 24% for the six months ended June 30, 2015 was attributable to $3,281,000 of additional royalty payments from Cisco for the six months ended June 30, 2014 as a result of our audit of Cisco (see Note N to our financial statements included in this quarterly report). Exclusive of the additional royalty revenue from the Cisco audit for the six months ended June 30, 2014, revenue increased $998,000 or 16% for the six months ended June 30, 2015 as compared to the six months ended June 30, 2014.
Cost of Revenue. We had a cost of revenue of $2,167,000 and $2,820,000 for the six months ended June 30, 2015 and June 30, 2014, respectively. Included in the cost of revenue for the six months ended June 30, 2015 were contingent legal fees of $1,798,000 payable to our patent litigation counsel (See Note J[1] to our financial statements included in this quarterly report) and $368,000 of incentive (royalty bonus) compensation payable to our Chairman and Chief Executive Officer pursuant to his employment agreement (see Note K[1] to our financial statements included in this quarterly report). Included in the cost of revenue for the six months ended June 30, 2014 were contingent legal fees of $2,283,000 payable to our patent litigation counsel and $481,000 of incentive (royalty bonus) compensation payable to our Chairman and Chief Executive Officer pursuant to his employment agreement.
Gross Profit. The gross profit for the six months ended June 30, 2015 was $5,207,000 as compared to $6,837,000 for the six months ended June 30, 2014. The decreased gross profit of $1,630,000 or 24% for the six months ended June 30, 2015 was primarily due to additional revenue from the Cisco audit of $3,281,000 for the six months ended June 30, 2014 (see Note N to our financial statements included in this quarterly report).
Operating Expenses. Operating Expenses for the six month period ended June 30, 2015 were $3,224,000 as compared to $2,193,000 for the six month period ended June 30, 2014. General and administrative expenses include, among other expenses, overhead expenses and finance, accounting, legal and other professional services incurred by us. General and administrative expenses increased by $1,011,000 from $1,213,000 for the six months ended June 30, 2014 to $2,224,000 for the six months ended June 30, 2015 due primarily to an impairment of $386,000 of our investment in Lifestreams (See Note I to our financial Statements in this quarterly report), a payment of $261,000 relating to termination of our services agreement with ThinkFire (see Note J(4)) and increased legal costs related to litigation. Amortization of patents was $826,000 for the six months ended June 30, 2015 as compared to $818,000 for the six months ended June 30, 2014. Stock-based compensation expense related to the issuance of stock options was $174,000 for the six months ended June 30, 2015 as compared to $162,000 for the six months ended June 30, 2014.
Interest Income. Interest income for the six months ended June 30, 2015 was $33,000 as compared to interest income of $21,000 for the six months ended June 30, 2014.
Operating Income. We had an operating income of $1,983,000 for the six months ended June 30, 2015 compared with operating income of $4,644,000 for the six months ended June 30, 2014. The decrease in operating income of $2,661,000 was primarily due to additional revenue as a result of the Cisco audit for the six months ended June 30, 2014 (see Note N to our financial statements included in this quarterly report).
Income Taxes (Benefit). Benefits for federal, state and local income taxes of $706,000 and $1,668,000 were recorded for the six months ended June 30, 2015 and June 30, 2014, respectively.
Deferred Tax Benefit/NOLs. At June 30, 2015, we had net operating loss carryforwards (NOLs) totaling approximately $23,329,000 expiring through 2029, with a future tax benefit of approximately $8,165,000. At June 30, 2015 and June 30, 2014, $4,077,000 and $4,093,000 and were recorded as deferred tax assets on our balance sheet. During the six month period ended June 30, 2015 as a result of income before taxes of $2,016,000, $706,000 was recorded as income tax expense and our deferred tax assets were reduced by $666,000 to $4,077,000.
Net Income. As a result of the foregoing, we realized net income of $1,310,000 or $0.06 per share (basic) and $0.05 per share (diluted) for the six months ended June 30, 2015 compared with net income of $2,997,000 or $0.12 per share (basic) and $0.11 per share (diluted) for the six months ended June 30, 2014.
LIQUIDITY AND CAPITAL RESOURCES
We have financed our operations primarily from royalty revenue from licensing our Remote Power Patent. At June 30, 2015, our principal sources of liquidity consisted of cash and cash equivalents of $16,751,000, marketable securities of $1,067,000 and working capital of $18,939,000. We believe based on our current cash position and projected licensing revenue from our existing license agreements that we will have sufficient cash to fund our operations for the foreseeable future, although this may not be the case.
Working capital increased by $918,000 to $18,939,000 at June 30, 2015 as compared to working capital of $18,021,000 at December 31, 2014. The increase in working capital was primarily due to reduced accounts payable and accrued expenses of $1,325,000 and an increase in royalty receivables of $592,000, partially offset by decreased cash and cash equivalents of $911,000.
Net cash provided by operating activities for the six months ended June 30, 2015 decreased by $796,000 to $1,521,000 compared to net cash provided by operating activities of $2,317,000 for the six months ended June 30, 2014. The decrease in net cash provided by operating activities for the six months ended June 30, 2015 was primarily due to reduced revenue for the period.
The net cash used in investing activities for the six months ended June 30, 2015 was $35,000 for additional patent costs.
Net cash used in financing activities for the six months ended June 30, 2015 was $2,397,000, which related to our repurchase of common stock as part of our share repurchase program.
We maintain our cash primarily in money market accounts. 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, operating lease obligations (except as disclosed in Note J[5] to our financial statements included in this quarterly report), purchase obligations or other long-term liabilities to our condensed consolidated financial statements included in this quarterly report.
CRITICAL ACCOUNTING POLICIES
The Company’s discussion and analysis of its financial condition, results of operations, and cash flow are based on the Company’s unaudited condensed consolidated financial statements which have been prepared in accordance with U.S. GAAP. The preparation of the financial statements included in this quarterly report on Form 10-Q requires us to make estimates and judgments that affect the reported amounts of assets, fair value of investments, liabilities, revenues and expenses, and related disclosure of contingent liabilities. On an on-going basis, the Company evaluates these estimates, including those related to intangible assets, deferred income taxes, income taxes payable, valuation of other investments and contingencies and litigation. Additionally, the Company uses assumptions and estimates in calculations to determine stock-based compensation and the valuation of warrants. The Company bases its estimates on historical experience and on various other assumptions that it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. For a comprehensive list of our critical accounting policies please see Note B of our financial statements included in this quarterly report.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not Applicable
ITEM 4. CONTROLS AND PROCEDURES.
(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 June 30, 2015 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
ITEM 1: LEGAL PROCEEDINGS
Cox Patent Portfolio – Google and YouTube Legal Proceedings
On April 4, 2014, we initiated litigation against Google Inc. and YouTube, LLC in the United States District Court for the Southern District of New York for infringement of several of our patents within our Cox Patent Portfolio 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 our patents by making, using, selling and offering to sell unlicensed systems and related products and services, which include YouTube’s Content ID system. In May 2014, the defendants filed an answer to our complaint and asserted defenses of non-infringement and invalidity.
On December 3, 2014, we initiated a second litigation against Google and YouTube in the United States District Court for the Southern District of New York for infringement of our newly issued patent (part of the Cox Patent Portfolio) relating to the identification and tagging of media content (U.S. Patent No. 8,904,464). The lawsuit alleges that Google and YouTube have infringed and continue to infringe the patent by making, using, selling and offering to sell unlicensed systems and products and services related thereto, which include YouTube’s content ID system. In January 2015, the defendants filed an answer to our complaint and asserted defenses of non-infringement and invalidity.
In December 2014, Google filed four petitions to institute Inter Partes Review proceedings at the PTAB of the USPTO pertaining to certain patents within our Cox Patent Portfolio asserted in the litigation filed in April 2014 as described above. In each of the four Inter Partes Review petitions, Google seeks to invalidate certain claims of our patents within the Cox Patent Portfolio which have been asserted in our litigation against Google and YouTube. On June 23, 2015, the PTAB issued an order instituting each of the four Inter Partes Review petitions for trial. As a result of instituting for trial the petitions for Inter Partes Review, the above referenced litigation that we commenced in April 2014 against Google and YouTube was stayed on July 2, 2015 until decisions are rendered by the PTAB following trial with respect to Inter Partes Review proceedings.
On April 13, 2015, Google filed a Petition for Covered Business Method Review (CBM) at the PTAB seeking to invalidate claims pertaining to our U.S. Patent No. 8,904,464, the patent asserted in our litigation against Google and YouTube filed on December 3, 2014 as referenced above. On July 20, 2015, we filed a Patent Owner’s Preliminary Responses to Google’s CBM Petition. The PTAB has not yet made a decision as to whether the CBM Petition will be instituted (and proceed to trial) or denied. The above referenced litigation that we commenced in December 2014 against Google and YouTube was stayed on July 2, 2015 pending a decision by the PTAB on whether or not to institute the CBM Petition.
Mirror Worlds Patent Portfolio Litigation
On May 23, 2013, through our wholly-owned subsidiary Mirror Worlds Technologies, LLC, we initiated patent litigation in the United States District Court for the Eastern District of Texas, Tyler Division, against Apple Inc., Microsoft, Inc., Hewlett-Packard Company, Lenovo Group Ltd., Lenovo (United States), Inc., Dell, Inc., Best Buy Co., Inc., Samsung Electronics America, Inc. and Samsung Telecommunications America L.L.C., for infringement of U.S. Patent No. 6,006,227 (the “’227” Patent”) (one of the patents we acquired as part of the acquisition of the Mirror Worlds Patent Portfolio – see Note J[2] to our financial statements included in this quarterly report). We seek, among other things, monetary damages based upon reasonable royalties. The lawsuit alleges that the defendants have infringed and continue to infringe the claims of the ‘227 Patent by making, selling, offering to sell and using infringing products including Mac OS and Windows operating systems and personal computers and tablets that include versions of those operating systems, and by encouraging others to make, sell, and use these products. In September 2013 and October 2013, the defendants filed their answers to our complaint. Defendants Apple and Microsoft also filed counterclaims for a declaratory judgment of non infringement of our ‘227 Patent and invalidity of our ‘227 Patent. On December 10, 2013, the litigation was severed into two consolidated actions, Mirror Worlds v. Apple, et al. (Case No. 6:13-cv-419), and Mirror Worlds v. Microsoft, et al., (Case No. 6:13-cv-941). On September 12, 2013, Microsoft and the other defendants in the consolidated action filed a motion to stay our claims against certain PC manufacturer defendants and transfer the litigation to the Western District of Washington, which motion was denied by the Court on September 29, 2014. On October 24, 2014, the defendants in the Mirror Worlds v. Microsoft, et al. action filed a Petition for a Writ of Mandamus in the United States Court of Appeals for the Federal Circuit directing the District Court to (i) stay our claims against certain PC manufacturer defendants, and (ii) transfer the case against Microsoft and the PC manufacturer defendants to the Western District of Washington. On January 7, 2015, the United States Court of Appeals for the Federal Circuit denied defendants’ petition for a Writ of Mandamus.
A Markman hearing (a hearing in which the Court interprets and rules on the scope and meaning of disputed patent claim language regarding the patent at issue) for the two consolidated actions was held on November 13, 2014. On January 14, 2015, the Court issued its claim construction order. The Court ruled on the meaning of seven disputed claim terms, adopted our proposed construction for four of the disputed claims, provided its own construction for two claim terms and adopted defendants’ proposed construction for one claim term. On December 8, 2014, Apple Inc. filed a motion for summary judgment asserting that our infringement claims are barred under the Kessler doctrine, asserting among other things, that the accused Apple products are “essentially the same” as products that were adjudged not to infringe the ‘227 patent in a prior legal proceeding by the prior owner of the Mirror Worlds patent portfolio against Apple(described below). On January 29, 2015, we filed a cross-motion for partial summary judgment that the Kessler doctrine does not apply to this case as a matter of law. On January 23, 2015, defendant Microsoft and certain PC manufacturer defendants filed a motion to dismiss our claims against them on the basis that our ‘227 Patent is invalid under 35 U.S.C. §101 asserting that the claims of the ‘227 patent are directed at an abstract idea and do not constitute patentable subject matter. On February 13, 2015, Apple Inc. filed a similar motion to dismiss our claims against it on the basis that the ‘227 Patent is invalid under 35 U.S.C. §101. On May 8, 2015, the Court granted the motion of Apple Inc. to stay discovery pending decisions on the Kessler motion and the §101 motions. On July 7, 2015, the Court issued a decision (i) denying Apple’s motion for summary judgment that our claim against it is barred by the Kessler doctrine, (ii) granted our cross-motion for partial summary judgment that the Kessler doctrine does not apply to this case as a matter of law, (iii) denied without prejudice the motions of Apple, Microsoft and other defendants for judgment on the pleadings that the ‘227 patent is invalid under 35 U.S.C.§101, and (iv) denied without prejudice our cross motion that the ‘227 Patent is not invalid under 35 U.S.C. Section 101 as a matter of law. On July 23, 2015, Apple made a motion to modify the Court’s order, dated July 7, 2015, denying Apple’s motion for summary judgment under the Kessler Doctrine and granting our cross motion for summary judgment under the Kessler doctrine, to certify the order for appeal to the United States Court of Appeals for the Federal Circuit. The stay has been lifted and trial dates for the two actions have been scheduled for July 2016.
Several patents in our Mirror Worlds Patent Portfolio that we acquired from Mirror Worlds, LLC (now Looking Glass LLC) on May 21, 2013 were the subject of prior litigation in Mirror Worlds, LLC v. Apple, Inc. (“Apple”) (No. 6:08-cv-00088). On October 1, 2010, a jury returned a verdict in that action in favor of Mirror Worlds upholding the validity of the three patents tried in the case (the ‘227 Patent, U.S. Patent Nos. 6,638,313 and 6,725,427), and finding that Apple had willfully infringed each of these patents. Further, the jury awarded Mirror Worlds $208.5 million in damages. After the trial, the district court vacated the jury verdict on direct infringement, having also dismissed the indirect infringement case at the end of plaintiff’s case-in-chief, because Mirror Worlds failed to present sufficient evidence of direct or indirect infringement. While the infringement, willfulness and damages verdicts were vacated at the trial level, the jury’s validity verdicts were not overturned. On appeal the United States Court of Appeals for the Federal Circuit upheld the district court ruling dismissing the indirect infringement case and overturning the jury verdict on direct infringement. The validity of the ‘227 Patent has also been reaffirmed by the USPTO since the trial in reexamination proceedings initiated by Apple resulting in two re-examination certificates which further validate the ‘227 Patent.
Remote Power Patent Legal Proceedings
In September 2011, we initiated patent litigation against sixteen (16) data networking equipment manufacturers in the United States District Court for the Eastern District of Texas, Tyler Division, for infringement of our Remote Power Patent. Named as defendants in the lawsuit, excluding affiliated parties, were Alcatel-Lucent USA, Inc., Allied Telesis, Inc., Avaya Inc., AXIS Communications Inc., Dell, Inc., GarrettCom, Inc., Hewlett-Packard Company, Huawei Technologies USA, Juniper Networks, Inc., Motorola Solutions, Inc., NEC Corporation, Polycom Inc., Samsung Electronics Co., Ltd., ShoreTel, Inc., Sony Electronics, Inc., and Transition Networks, Inc. We seek monetary damages based upon reasonable royalties. In March 2012, we reached settlement agreements with defendants Motorola Solutions, Inc. ("Motorola") and Transition Networks, Inc. ("Transition Networks"). In October 2012, we reached a settlement with defendant GarretCom, Inc (“GarretCom”). In February 2013, we reached settlement agreements with Allied Telesis, Inc. (“Allied Telesis”) and NEC Corporation (“NEC”). As part of the settlements, Motorola, Transition Networks, GarretCom, Allied Telesis and NEC each entered into a non-exclusive license agreement for our Remote Power Patent pursuant to which each such defendant agreed to license our Remote Power Patent for its full term (which expires in March 2020) and pay a license initiation fee and quarterly or annual royalties based on their sales of PoE products. In March 2015 and July 2015, we reached settlements with defendants Samsung Electronics Co., Ltd. (“Samsung”), Huawei Technologies Co., Ltd. (“Huawei”) and ShoreTel, Inc. (“ShoreTel”). Samsung and Huawei entered into a non-exclusive fully paid license agreement for our Remote Power Patent for its full term. ShoreTel entered into a non-exclusive license agreement for the Remote Power Patent for its full term and paid a license initiation fee and agreed to pay quarterly royalties based upon its sales of PoE products. As a result of the aforementioned settlements, there are currently eight remaining defendants.
On June 27, 2012, defendant Axis Communications made a motion to dismiss, or alternatively to sever, on the grounds of misjoinder. Several defendants joined in the motion. On January 17, 2013, the Court granted in part defendants’ motion by granting severance and consolidating all the actions for pre-trial issues, except venue. The litigation was stayed from March 2013 until January 2015 as a result of the then pending Inter Partes Review proceeding commenced by Avaya Inc., Dell Inc., Sony Corporation of America and Hewlett Packard Co. at the USPTO as described below. On June 1, 2015, the Court granted the motion of Sony Corporation of America (and several of its affiliate defendants) to stay the litigation pending application of a party following a decision of the PTAB of the USPTO whether to institute the Petition for Covered Business Method Review (CBM) (see reference to Sony CMB Petition below) The stay of the litigation remains in effect as of the date hereof.
On July 20, 2012, an unknown third party filed with the USPTO a request for ex parte reexamination of certain claims of our Remote Power Patent. On September 5, 2012, the USPTO issued an order granting the reexamination. On October 14, 2014, the USPTO issued a Reexamination Certificate, rejecting a challenge to the patentability of our Remote Power Patent (U.S Patent No. 6,218,930). The Reexamination Certificate confirms the patentability of the challenged claims of our Remote Power (claims 6, 8 and 9) without any amendment or modification. The USPTO also allowed fourteen (14) new claims, bringing the total claims in the Remote Power Patent to twenty-three (23) claims. No claims were rejected.
Avaya Inc., Dell Inc., Sony Corporation of America and Hewlett Packard Co. were petitioners in three Inter Partes Review proceedings (which were joined together) (the “IPR Proceeding”) at the USPTO before the PTAB involving our Remote Power Patent. Petitioners in the IPR Proceeding sought to invalidate certain claims of our Remote Power as unpatentable. A hearing on the merits of the IPR Proceeding was held on January 9, 2014. On May 22, 2014, the PTAB issued its Final Written Decision in our favor rejecting a challenge to the patentability of our Remote Power Patent. On July 24, 2014, the petitioners in the IPR Proceeding each filed a Notice of Appeal of the Patent Board’s decision to the United States Court of Appeals for the Federal Circuit. On August 10, 2015, the United States Court of Appeals for the Federal Circuit affirmed the decision of the PTAB in our favor rejecting a challenge to the patentability of our Remote Power Patent.
On February 16, 2015, Sony Corporation of America filed a Petition for Covered Business Method Review (CBM) and a request for an ex parte reexamination with the USPTO seeking to invalidate certain claims of our Remote Power Patent. On April 3, 2015, the USPTO issued an order granting Sony’s request for an ex parte reexamination of our Remote Power Patent. If certain of the challenged claims of our Remote Power Patent in the ex parte reexamination are ultimately determined to be invalid by the USPTO (and such decision is not reversed by the United States Court of Appeals for the Federal Circuit), such a determination would have a material adverse effect on our business, financial condition and results of operations as our entire current revenue stream is dependent upon the continued validity of certain claims of our Remote Power Patent. On July 1, 2015, the PTAB of the USPTO issued a decision in our favor denying institution of the CBM Petition filed by Sony and rejected a challenge to the patentability of our Remote Power Patent.
ITEM 1A. RISK FACTORS.
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. Our Annual Report on Form 10-K for the year ended December 31, 2014 (pages 14-25) filed with the Securities and Exchange Commission on March 5, 2015 and our Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2015 (page 31) filed with the Securities and Exchange Commission on May 14, 2015 include a discussion of our risk factors and should be carefully considered by investors.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
Recent Issuances of Unregistered Securities
There were no such issuances during the three month period ended June 30, 2015.
Stock Repurchases
On August 22, 2011, we announced that our Board of Directors approved a share repurchase program to repurchase up to $2,000,000 of shares of our common stock over the next 12 months ("Share Repurchase Program"). On June 17, 2015, our Board of Directors authorized its fifth increase to our Share Repurchase Program authorizing the repurchase of up to an additional $2.0 million of shares of our common stock over the subsequent 12 month period (for a total of up to $14.0 million since inception of the program in August 2011). The common stock may be repurchased from time to time in open market transactions or privately negotiated transactions in our 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 in August 2011 through June 30, 2015, we have repurchased an aggregate of 6,782,268 shares of our common stock at an average per share price of $1.64 or an aggregate cost of $11,131,253 (exclusive of commissions). During the six month period ended June 30, 2015, we repurchased 1,083,200 shares of our common stock at an average price per share of $2.19 or an aggregate cost of $2,374,146. During the three month period ended June 30, 2015, we repurchased 254,600 of our shares of common stock at an average price per share of $2.00 or an aggregate cost of $508,796 (exclusive of commissions).
|
Period
|
Total Number of
Shares Purchased
|
Average Price
Paid Per Share
|
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
|
Maximum Number (or Approximate Dollar Value) of Shares that May Yet Be Purchased Under the Plans or Programs1)
|
|
April 1 to April 30, 2015
|
126,400
|
$2.23
|
126,400
|
$3,095,141
|
|
May 1 to May 31, 2015
|
—
|
—
|
—
|
$3,095,141
|
|
June 1 to June 30, 2015
|
128,200
|
$1.77
|
128,200
|
$2,868,745
|
|
Total
|
254,600
|
$2.00
|
254,600
|
|
_________________
The dollar amounts in this column reflect an increase of $2,000,000 in our Share Repurchase Program approved by our Board of Directors June 17, 2015.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 5. OTHER INFORMATION.
None.
ITEM 6. EXHIBITS
(a) Exhibits
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31.1
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Controls and Procedure Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*
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31.2
|
Controls and Procedure Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*
|
|
|
32.1
|
Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*
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|
|
32.2
|
Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*
|
|
|
101
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Interactive data files:**
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101.INS
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XBRL Instance Document
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101.SCH
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XBRL Scheme Document
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101.CAL
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XBRL Calculation Linkbase Document
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| |
101.DEF
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XBRL Definition Linkbase Document
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| |
101.LAB
|
XBRL Label Linkbase Document
|
|
|
101.PRE
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XBRL Presentation Linkbase Document
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|
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_____________________________
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* Filed herewith
** Furnished herewith