UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
| x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the Quarterly Period Ended March 31, 2014
Or
| ¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number: 000-54638
PATENT PROPERTIES, INC.
(Exact name of registrant as specified in its charter)
| | | |
| Delaware | | 30-0342273 |
(State or Other Jurisdiction of Incorporation or Organization) | | (I.R.S. Employer Identification No.) |
| | |
Two High Ridge Park Stamford, Connecticut | | 06905 |
| (Address of Principal Executive Offices) | | (Zip Code) |
(203) 461-7200
(Registrant’s telephone number, including area code)
(Former name and former address, if changed since last report)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
| | | | | | | |
| Large accelerated filer | | ¨ | | Accelerated filer | | ¨ |
| | | | |
| Non-accelerated filer | | ¨ (Do not check if a smaller reporting company) | | Smaller reporting company | | x |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act): Yes¨ No x
As of May 15, 2014, there were 20,741,572 shares of the issuer’s common stock outstanding.
PATENT PROPERTIES, INC. AND SUBSIDIARIES
From 10-Q
Table of Contents
PATENT PROPERTIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands)
| | | March 31, | | | December 31, | |
| | | 2014 | | | 2013 | |
| | | (unaudited) | | | | |
| ASSETS | | | | | | | | |
| Current Assets: | | | | | | | | |
| Cash | | $ | 22,134 | | | $ | 24,703 | |
| Accounts receivable | | | 13 | | | | 12 | |
| Prepaid and other current assets | | | 541 | | | | 525 | |
| Total current assets | | | 22,688 | | | | 25,240 | |
| Other Assets: | | | | | | | | |
| Investments, at cost | | | 250 | | | | 250 | |
| | | | | | | | | |
| TOTAL ASSETS | | $ | 22,938 | | | $ | 25,490 | |
| | | | | | | | | |
| LIABILITIES AND STOCKHOLDERS’ EQUITY | | | | | | | | |
| Current Liabilities: | | | | | | | | |
| Accounts payable | | $ | 419 | | | $ | 634 | |
| Accrued expenses | | | 570 | | | | 703 | |
| TOTAL LIABILITIES | | | 989 | | | | 1,337 | |
| | | | | | | | | |
| COMMITMENTS AND CONTINGENCIES | | | | | | | | |
| | | | | | | | | |
| STOCKHOLDERS’ EQUITY | | | | | | | | |
| Preferred stock, $0.001 par value, 15,000,000 shares authorized | | | - | | | | - | |
| Series B Convertible Preferred stock, $0.001 par value, 14,999,000 shares designated, issued and outstanding as of March 31, 2014 and December 31, 2013, respectively | | | 15 | | | | 15 | |
| Common stock, $0.001 par value, 100,000,000 shares authorized; 21,134,744 shares issued as of March 31, 2014 and December 31, 2013, respectively | | | 21 | | | | 21 | |
| Treasury stock, 393,172 shares, at cost | | | (840 | ) | | | (840 | ) |
| Additional paid-in capital | | | 41,159 | | | | 37,398 | |
| Accumulated deficit | | | (18,406 | ) | | | (12,441 | ) |
| TOTAL STOCKHOLDERS’ EQUITY | | | 21,949 | | | | 24,153 | |
| | | | | | | | | |
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY | | $ | 22,938 | | | $ | 25,490 | |
The accompanying unaudited notes are an integral part of these condensed consolidated financial statements.
PATENT PROPERTIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in Thousands, except per share amounts)
(Unaudited)
| | | Three Months Ended March 31, | |
| | | 2014 | | | 2013 | |
| Revenues: | | | | | | | | |
| Licensing fees | | $ | - | | | $ | 12 | |
| Patent sales | | | - | | | | 940 | |
| Total revenues | | | - | | | | 952 | |
| | | | | | | | | |
| Legal and consulting contingency fees | | | - | | | | 375 | |
| | | | | | | | | |
| Net revenue | | | - | | | | 577 | |
| | | | | | | | | |
| Operating expenses: | | | | | | | | |
| Other legal and consulting fees | | | 72 | | | | 615 | |
| Patent prosecution and maintenance fees | | | 215 | | | | 203 | |
| Compensation and benefits | | | 1,603 | | | | 310 | |
| Professional fees | | | 3,826 | | | | - | |
| General and administrative | | | 259 | | | | 36 | |
| Total operating expenses | | | 5,975 | | | | 1,164 | |
| | | | | | | | | |
| Operating net loss | | | (5,975 | ) | | | (587 | ) |
| | | | | | | | | |
| Other income | | | | | | | | |
| Interest income | | | 10 | | | | - | |
| | | | | | | | | |
| Net loss | | $ | (5,965 | ) | | $ | (587 | ) |
| | | | | | | | | |
| Net loss per common share: | | | | | | | | |
| Basic | | $ | (0.30 | ) | | $ | (0.08 | ) |
| Diluted | | $ | (0.30 | ) | | $ | (0.08 | ) |
| | | | | | | | | |
| Weighted average common shares outstanding: | | | | | | | | |
| Basic | | | 19,915 | | | | 7,668 | |
| Diluted | | | 19,915 | | | | 7,668 | |
The accompanying unaudited notes are an integral part of these condensed consolidated financial statements.
PATENT PROPERTIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands)
(Unaudited)
| | | Three Months Ended March 31, | |
| | | 2014 | | | 2013 | |
| Cash Flows from Operating Activities: | | | | | | | | |
| Net loss | | $ | (5,965 | ) | | $ | (587 | ) |
| Adjustments to reconcile net loss to net cash used in operating activities: | | | | |
| Net contribution from (net distribution to) related party shareholder | | | 81 | | | | (138 | ) |
| Stock-based compensation | | | 3,680 | | | | - | |
| Changes in operating assets and liabilities: | | | | | | | | |
| Decrease (increase) in: | | | | | | | | |
| Accounts receivable | | | (1 | ) | | | 801 | |
| Prepaid and other current assets | | | (16 | ) | | | (27 | ) |
| Increase (decrease) in: | | | | | | | | |
| Accounts payable | | | (215 | ) | | | 122 | |
| Accrued expenses | | | (133 | ) | | | (171 | ) |
| Net cash used in operating activities | | | (2,569 | ) | | | - | |
| | | | | | | | | |
| Net change in cash | | | (2,569 | ) | | | - | |
| Cash: | | | | | | | | |
| Beginning | | $ | 24,703 | | | $ | - | |
| Ending | | $ | 22,134 | | | $ | - | |
The accompanying unaudited notes are an integral part of these condensed consolidated financial statements.
NOTE 1 – BUSINESS ORGANIZATION AND NATURE OF OPERATIONS
Patent Properties, Inc. and Subsidiaries (the "Company") was previously known as GlobalOptions Group, Inc. (a Delaware corporation) with a wholly owned subsidiary GlobalOptions, Inc. On July 11, 2013, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) pursuant to which, on September 18, 2013 (the “Closing Date”) Walker Digital Holdings, LLC (“Walker Holdings”), a wholly-owned subsidiary of Walker Digital, LLC (“Walker Digital”) became a wholly-owned subsidiary of the Company (the “Merger”). As a result of the Merger, the Company is now a holding company with its primary operations conducted through Walker Holdings, as more fully discussed below, although the Company anticipates that Walker Holdings will transfer a patent licensing system to us or another of our subsidiaries. Although the Company has not yet completed development of the system and while no assurances may be given that it will be completed and able to be commercialized to create value, the Company believes that patent licensing is a large market characterized by significant price inefficiency and discontinuity between the participating parties. Subsequent to the Closing Date, Walker Holdings changed its name to Inventor Holdings, LLC (“IH LLC”). Under the transaction, Walker Digital received shares of the Company’s common stock and shares of a new Series B Preferred Stock, resulting in Walker Digital (after giving effect to the resale transaction described below under “Recent Developments”) owning approximately 49% of the economic interest and approximately 82.5% of the voting interest in the Company. Walker Digital may also receive an additional 2,166,667 shares of common stock, subject to certain performance conditions ("Contingency Shares").
Prior to the merger, Walker Digital Licensing and Enforcement (“Walker Licensing”) was a business segment of Walker Digital and was engaged in developing and commercializing patents and other intellectual property assets created by Walker Digital, which was the research and development lab founded and led by Jay Walker. Walker Licensing generated revenues from the granting of intellectual property rights for the use of, or pertaining to, patented technologies. It also monetized its intellectual property to include the sale of select patent assets.
On June 3, 2013, IH LLC f/k/a Walker Holdings, was formed as a limited liability company in the State of Delaware. Walker Digital was the sole member of IH LLC. Immediately prior to the closing of the Merger, Walker Digital contributed Walker Licensing’s assets and business to IH LLC. In connection with the Merger, the Company acquired IH LLC and Walker Digital transferred ownership of the intellectual property assets that were primary to Walker Licensing’s business to IH LLC. All improvements to those assets, together with any intellectual property produced in connection with the patent licensing system under development, were assigned pursuant to an Invention Assignment Agreement with Mr. Walker.
Simultaneously with the closing of the Merger, we completed the closing of a private placement (the “Placement”) of units, each consisting of one newly issued share of common stock and one warrant to purchase half a share of newly issued common stock, at the price of $3.00 per unit, to unaffiliated, accredited third parties. The investors in the Placement collectively purchased 3,960,615 shares of common stock and warrants to purchase 1,980,318 shares of common stock for consideration net of offering costs of $11.7 million. The warrants issued to the investors are exercisable for a period of three years at a purchase price of $3.00 per share of our common stock and are subject to a call option in favor of the Company. It is a condition to our right to exercise its call option that, prior to the exercise of the call option, the closing price of our common stock equals or exceeds $6.00 per share for any 20 trading days within any period of 30 consecutive trading days. The Placement was made to a limited number of accredited investors and was deemed to be exempt from registration.
Nature of Business
The Company develops, licenses and otherwise enforces patented technologies. The Company generates revenues from the granting of intellectual property rights for the use of, or pertaining to, patented technologies. The Company also monetizes its intellectual property to include the sale of select patent assets. Patent protection is a key part of the Company’s business model, because it provides the Company with a period of exclusive ownership during which the Company can recoup risk capital and generate a profit from inventions. As an entrepreneurially driven entity, the Company is committed to a flexible approach when it comes to business models, deal terms and allocations of risk. The Company is also creating an innovative licensing solution for the mass market of patent owners and users. As of March 31, 2014, the Company has developed the specifications for the licensing system and the products associated with it. On May 8, 2014, the Company entered into an Agreement with Innography, Inc. to supply several important components of the system (see Note 8).
NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information, the instructions to Form 10-Q and the rules and regulations of the SEC. Accordingly, since they are interim statements, the accompanying condensed consolidated financial statements do not include all of the information and notes required by GAAP for annual financial statements, but reflect all adjustments consisting of normal, recurring adjustments, that are necessary for a fair presentation of the financial position, results of operations and cash flows for the interim periods presented. In the opinion of the Company’s management, all adjustments, consisting of only normal and recurring adjustments, necessary for a fair presentation of the financial position and the results of operations for the periods presented have been included. Interim results are not necessarily indicative of results for a full year. The condensed consolidated financial statements and notes should be read in conjunction with the financial statements and notes for the year ended December 31, 2013 included in the Company’s Form 10-K filed with the Securities and Exchange Commission on March 31, 2014.
The Merger was accounted for as a “reverse merger.” Furthermore, the Merger was deemed to be a recapitalization of IH LLC, and as such, all capital accounts have been restated as if the Merger had occurred prior to the earliest period presented. IH LLC was deemed to be the acquirer in the Merger for accounting purposes. Consequently, the assets and liabilities and the historical operations of the Company that are reflected in the condensed consolidated financial statements prior to the Merger are those of IH LLC, and the condensed consolidated financial statements of the Company after completion of the Merger include the assets and liabilities of IH LLC, historical operations of IH LLC and operations of IH LLC from the Closing Date of the Merger.
Use of Estimates
The preparation of condensed consolidated financial statements in conformity with 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 condensed consolidated financial statements. Actual results could differ from these estimates. The Company's significant estimates and assumptions include stock-based compensation and the valuation allowance related to the Company's deferred tax assets. Certain of the Company's estimates could be affected by external conditions, including those unique to the Company and general economic conditions. It is reasonably possible that these external factors could have an effect on the Company's estimates and could cause actual results to differ from those estimates and assumptions.
Earnings per Share
Basic earnings per share (“EPS”) is computed by dividing net income applicable to common stock by the weighted-average number of common shares outstanding.
For purposes of calculating basic and diluted earnings per share, vested restricted stock awards are considered outstanding. Under the treasury stock method, diluted EPS reflects the potential dilution that could occur if securities or other instruments that are convertible into common stock were exercised or could result in the issuance of common stock. The following financial instruments were not included in the diluted loss per share calculation for the three months ended March 31, 2014 because their effect was anti-dilutive:
| | | As of March 31, 2014 | |
| Common Stock options | | | 2,570,000 | |
| Common Stock warrants | | | 1,980,318 | |
| Preferred Stock | | | 14,999,000 | |
| Contingency shares | | | 2,166,667 | |
| Excluded potentially dilutive securities | | | 21,715,985 | |
Revenue Recognition
Revenue is recognized when (i) persuasive evidence of an arrangement exists, (ii) all obligations have been substantially performed pursuant to the terms of the arrangement, (iii) amounts are fixed or determinable, and (iv) the collectability of amounts is reasonably assured.
Licensing Fees
We derive the majority of our revenue from patent licensing. In general, these revenue arrangements provide for the payment of contractually determined fees in consideration for the grant of certain intellectual property rights for patented technologies owned or controlled by the Company. Significantly all of the patent licenses are granted on the entire portfolio rather than individual patents. The intellectual property rights granted may be perpetual in nature, extending until the expiration of the related patents, or can be granted for a defined, relatively short period of time, with the licensee possessing the right to renew the agreement at the end of each contractual term for an additional minimum upfront payment. The Company recognizes licensing fees when there is persuasive evidence of a licensing arrangement, all obligations have been substantially performed, fees are fixed or determinable and collectability is reasonably assured.
An allowance for doubtful accounts is established based on the Company’s best estimate of the amount of probable credit losses in the Company’s existing license fee receivables, using historical experience. The Company reviews its allowance for doubtful accounts periodically. Past due accounts are reviewed individually for collectability. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote.
Patent Sales
All patents have been internally developed. Research and development cost, if any, are expensed as incurred. The Company monetizes its intellectual property to include the sale of select patent assets. As patent sales represents a component of the Company’s ongoing major or central operations and activities, the Company records the related proceeds as revenue. The Company recognizes the patent sales revenue when there is persuasive evidence of a sales arrangement, all obligations have been substantially performed, fees are fixed or determinable and collectability is reasonably assured. These requirements are generally fulfilled upon closing of the patent sale transaction.
Amounts related to revenue arrangements that do not meet the revenue recognition criteria described above are deferred until the revenue recognition criteria are met.
The Company assesses the collectability of fees receivable based on a number of factors, including past transaction history and credit-worthiness of licensees. If it is determined that collection is not reasonably assured, the fee is recognized when collectability becomes reasonably assured, assuming all other revenue recognition criteria have been met.
Software Development Costs
In accordance with Accounting Standards Codification ("ASC") 985-20 "Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed," development costs related to software products are expensed as incurred until the technological feasibility of the product has been established. Technological feasibility occurs when a working model is completed or a detail program design exists. After technological feasibility is established, additional costs are capitalized.
Contingent Legal and Consulting Fees
Contingent legal and consulting fees are expensed in the condensed consolidated statements of operations in the period that the related revenues are recognized. In instances where there are no recoveries from potential infringers, no contingent legal and consulting fees are required to be paid; however, the Company may be liable for certain out of pocket legal and consulting costs incurred pursuant to the underlying legal and consulting services agreement. Legal fees advanced by contingent law firms, if any, that are required to be paid in the event that no license recoveries are obtained are expensed as incurred and included in liabilities in the condensed consolidated balance sheets.
Investments
In cases where the Company’s investment is less than 20% of the outstanding voting stock and significant influence does not exist, the investment is carried at cost.
Income Taxes
As a result of the Merger, beginning on September 18, 2013, the Company’s results of operations are taxed as a C Corporation. Prior to the Merger, the Company’s operations were taxed as a limited liability company, whereby the Company elected to be taxed as a partnership and the income or loss was required to be reported by each respective member on their separate income tax returns.
The Company recognizes deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the financial statements or tax returns. Deferred tax liabilities and assets are determined based on the difference between the financial statement basis and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. The Company estimates the degree to which tax assets and credit carryforwards will result in a benefit based on expected profitability by tax jurisdiction. A valuation allowance for such tax assets and loss carryforwards is provided when it is determined to be more likely than not that the benefit of such deferred tax asset will not be realized in future periods. Tax benefits of operating loss carryforwards are evaluated on an ongoing basis, including a review of historical and projected future operating results, the eligible carryforward period, and other circumstances. If it becomes more likely than not that a tax asset will be used, the related valuation allowance on such assets would be reduced.
Revenue Concentrations
The Company considers significant revenue concentrations to be counterparties who account for 10% or more of the total revenues generated by the Company during the period. For the three months ended March 31, 2014, there was no revenue and for the three months ended March 31, 2013, the amount of revenue derived from counterparties representing more than 10% of our total revenues was 92% (with one counterparty representing 32% and a second representing 60%), respectively.
Stock Based Compensation
The Company measures the cost of services received in exchange for an award of equity instruments based on the fair value of the award. For employees and directors, the fair value of the award is measured on the grant date and for non-employees, the fair value of the award is generally re-measured on interim financial reporting dates and vesting dates until the service period is complete. The fair value amount is then recognized over the period services are required to be provided in exchange for the award, usually the vesting period. The Company recognizes employee stock-based compensation expense on a straight line basis over the requisite service period for each separately vesting tranche of each award. Stock-based compensation expense is reflected within operating expenses in the condensed consolidated statements of operations.
Net Contribution (Distribution) to Related Party Shareholder
Net contribution (distribution) to related party shareholder consists of non-cash net transfers to/from Walker Digital in relation to cash pooling and various allocations.
NOTE 3 - INVESTMENTS
The Company received 57,000 shares of common stock in Tagged, Inc. as part of payment in connection with a license agreement. If on liquidation date (i.e. public offering or change of control), the grant value of the stock is less than $250 thousand (“grant value” or “floor value”), Tagged will pay the Company the difference between the $250 thousand floor value and the grant value. The investment is carried at cost and the cost was established as floor value.
NOTE 4 - SHARED SERVICES AGREEMENT
In connection with the Merger, the Company entered into a Shared Services Agreement (“Shared Services Agreement”) with Walker Digital Management (“WDM”), which became effective at the closing of the Merger. The cost of such services varies monthly based on the terms of the Shared Services Agreement. The incurred expenses prior to the Closing of the Merger, including but not limited to executive compensation, information technology services and supplies, administrative and general services and supplies and rent and utilities, are based either on specific attribution of those expenses or, where necessary and appropriate, based on the Company’s best estimate of an appropriate proportional allocation.
The following table represents expenses incurred under the Shares Services Agreement and contributed by WDM on behalf of the Company:
| (dollars in thousands) | | Three Months Ended
March 31, 2014 | | | Three Months Ended
March 31, 2013 | |
| Operating Expenses: | | | | | | | | |
| Compensation Expenses (1) | | $ | 9 | | | $ | 93 | |
| Rent and utilities | | | 27 | | | | 26 | |
| Office services and supplies | | | 9 | | | | 4 | |
| Telephone | | | 3 | | | | 2 | |
| Other | | | 8 | | | | 5 | |
| Insurance | | | - | | | | 1 | |
| Total Operating Expenses | | $ | 56 | | | $ | 131 | |
| (1) | Compensation expenses are net of services charged to WDM. During the three months ended March 31, 2014, and 2013, the Company charged approximately $16,000 and $0 of expenses, respectively, related to such services. |
As of March 31, 2014 and 2013, due from WDM included in prepaid and other current assets on the condensed consolidated balance sheets was $198,000 and $0, respectively.
NOTE 5 - COMMITMENTS AND CONTINGENCIES
Litigation
The Company is subject to claims, counterclaims and legal actions that arise in the ordinary course of business. Management believes that the ultimate liability with respect to these claims and legal actions, if any, will not have a material effect on the Company’s financial position, results of operations or cash flows. The Company recognizes a liability for a contingency when it is probable that liability has been incurred and when the amount of loss can be reasonably estimated. When a range of probable loss can be estimated, the Company accrues the most likely amount of such loss, at no less than the minimum of the range. As of March 31, 2014, the litigation accrual was not material.
Accrued Bonuses
As of March 31, 2014 and December 31, 2013, accrued bonuses included in accrued expenses on the consolidated balance sheets were $237,000 and $208,000, respectively. All accrued bonuses are discretionary in nature.
NOTE 6 - EQUITY
As of March 31, 2014, the Company had authorized and issued an aggregate of 100,000,000 shares of common stock, par value $0.001 per share. The Company, had authorized and issued an aggregate of 15,000,000 shares of preferred stock, par value $0.001 per share, 14,999,000 shares of which have been designated Series B Convertible Preferred Stock. As of March 31, 2014, there were 21,134,744 shares of the Company’s common stock issued and 20,741,572 outstanding. As of March 31, 2014, 14,999,000 shares of the Company’s Series B Convertible Preferred Stock were issued and outstanding.
Registration Rights
On September 18, 2013, upon the closing of a private placement (the “Placement”) of newly issued shares of the Company’s common stock and warrants, the Company entered into a registration rights agreement (the “Offering Registration Rights Agreement”) with the investors participating in the Placement. Under the terms of the Offering Registration Rights Agreement, the Company committed to file a registration statement covering the resale of the common stock issued in the Placement, as well as the common stock issuable on exercise of the warrants, within 30 calendar days from the Closing Date of the Placement (the “Filing Deadline”) and to use reasonable best efforts to cause the registration statement to become effective no later than the earlier of: (i) the 90th calendar day following the Closing Date, provided , that, if the Commission reviews and has written comments to the filed registration statement, then such date shall be the 180th calendar day following the Closing Date, and (ii) the 5th trading day following the date on which we are notified by the Commission that the registration statement will not be reviewed or is no longer subject to further review and comments and the effectiveness of the registration statement may be accelerated (the “Effective Deadline”).
In the Offering Registration Rights Agreement, the Company agreed to use reasonable best efforts to maintain the effectiveness of the registration statement until the earlier of (i) such time when all of the shares of common stock covered by such registration statement have been publicly sold by the holders and (ii) the date on which all of such shares are (A) sold pursuant to an effective registration statement; (B) are sold pursuant to Rule 144 under circumstances in which any legend borne by such shares are removed; or (C) such shares would be saleable pursuant to Rule 144 without restrictions on volume or manner of sale (which shall be no earlier than one (1) year from the Closing Date) (the “Effectiveness Period”). If (i) the registration statement is not filed on or prior to its Filing Deadline, (ii) the Company fails to have the registration statement declared effective prior to the Effective Deadline, or (iii) after the Effective Deadline, such registration statement ceases to remain continuously effective for more than 30 consecutive calendar days or more than an aggregate of 60 calendar days during any 12-month period (subject to certain grace periods), the Company will be liable to each holder, as partial liquidated damages, to pay an amount, payable monthly, equal to 1.0% of the aggregate purchase price paid by such holder in the Placement for the number of shares of unregistered shares registrable under the Offering Registration Rights Agreement then held by such holder. The maximum aggregate liquidated damages payable to a holder under the Offering Registration Rights Agreement is 10.0% of the aggregate amount of such holder’s investment in the Placement, and certain other limitations apply to the accrual of liquidated damages under the Offering Registration Rights Agreement. The liquidated damages pursuant to the terms of the Offering Registration Rights Agreement apply on a daily pro rata basis for any portion of a month prior to the cure of the event resulting in the incurrence of liquidated damages. The Company’s Form S-1 Registration Statement was filed with the Securities and Exchange Commission (the “SEC”) on October 17, 2013 and declared effective on February 13, 2014.
The Company accounts for our obligations under the Registration Rights Agreement in accordance with ASC 450 “Contingencies,” which requires us to record a liability if the contingent loss is probable and the amount can be estimated. Because the S-1 Registration Statement was declared effective on February 13, 2014, no accrual was deemed necessary as of March 31, 2014.
NOTE 7 - STOCK-BASED COMPENSATION
Total stock-based compensation to employees and non-employees for the three months ended March 31, 2014 and 2013 is presented in the following table:
| (dollars in thousands) | | Three Months Ended
March 31, 2014 | | | Three Months Ended
March 31, 2013 | |
| Employee Option Awards | | $ | 560 | | | $ | - | |
| Non-employee Option Awards | | | 32 | | | | - | |
| Non-employee Restricted Stock Awards | | | 3,088 | | | | - | |
| Total Compensation Expense | | $ | 3,680 | | | $ | - | |
Stock-based Compensation
Stock Options to Employees
In March 2014, the Company entered into a separation agreement with a former executive of the Company effective March 15, 2014. The agreement provided an accelerated vesting of one tranche of stock options awards previously granted to the executive. On the effective date, these options had an fair value of approximately $0.2 million utilizing the Black-Scholes option pricing model with the following assumptions used: contractual life of 1.7 years; volatility of 80.3%; dividends of 0%; and a risk free interest rate of 0.36%. The expense of the accelerated vesting of these outstanding stock options was included in stock-based compensation for the quarter ended March 31, 2014.
On February 14, 2014, the Company granted options for the purchase of 425,000 shares of its Common Stock at an exercise price of $3.60 per share, under the Incentive Plan, to an executive of the Company. The options have a term of 10 years. These options have an aggregate grant date fair value of approximately $1.1 million utilizing the Black-Scholes option pricing model with the following assumptions used: expected life of 6.5 years; volatility of 74.1%; dividends of 0%; and a risk free interest rate of 2.75%. The stock options vest on February 14, 2017. The expected life of the options was calculated using the simplified method, using the average of the contractual term and the vesting period. Due to the limited operating history of the Company, the expected volatility used to calculate the fair value of options granted during the three months ended March 31, 2014 was based on an index of comparable companies as permitted.
Stock Options to Non-employees
Stock-based compensation expense related to stock-based awards to non-employees is recognized as the stock-based awards are earned, generally through the provision of services. The Company believes that the fair value of the stock-based awards is more reliably measurable than the fair value of the services received. The fair value of the granted stock-based awards is calculated at each reporting date.
On February 3, 2014, the Company granted options to non-employees for the purchase of 60,000 shares of its Common Stock at an exercise price of $3.50 per share, under the Incentive Plan, to an executive of the Company. The options have a term of 10 years. These options have an aggregate grant date fair value of approximately $0.2 million utilizing the Black-Scholes option pricing model with the following assumptions used: remaining contractual life of 9.8 years; volatility of 71.3%, dividends of 0%; and a risk free interest rate of 2.73%. The stock options vest on December 31, 2014. Due to the limited operating history of the Company, the expected volatility used to calculate the fair value of options granted during the three months ended March 31, 2014 was based on an index of comparable companies as permitted.
Restricted Stock to Non-employees
On September 18, 2013, in connection with the amendment of a service agreement with a vendor pursuant to which the vendor reduced its future fees, the Company issued 1,445,000 shares of common stock to the vendor. The common stock vested on March 17, 2014. The Company recorded the pro rata portion of this non-employee award as a component of professional fees. The amounts recorded to such award were $3.1 million for the three months ended March 31, 2014.
A summary of the status of the Company’s stock option plans and the changes during the three months ended March 31, 2014, is presented in the table below:
(dollars in thousands)
| | | Number of Shares | | | Weighted Average
Exercise Price | | | Intrinsic
Value | | | Weighted Average
Remaining
Contractual Life
(in years) | |
| Outstanding at December 31, 2013 | | | 2,305,000 | | | $ | 3.96 | | | | 130 | | | | 9.3 | |
| Options granted | | | 585,000 | | | | 3.67 | | | | 176 | | | | 9.8 | |
| Options exercised | | | - | | | | | | | | | | | | | |
| Options cancelled | | | (320,000 | ) | | | 4.05 | | | | | | | | | |
| Outstanding at March 31, 2014 | | | 2,570,000 | | | | 3.89 | | | | 356 | | | | 8.8 | |
| | | | | | | | | | | | | | | | | |
| Options vested and expected to vest | | | 2,570,000 | | | | | | | | | | | | | |
| Options vested and exercisable | | | 300,000 | | | $ | 3.38 | | | | 180 | | | | 2.5 | |
As of March 31, 2014, the Company had unrecognized stock-based compensation expense related to all unvested stock options of $4.7 million, which is expected to be recognized over the remaining weighted-average vesting period of 2.63 years.
NOTE 8 - SUBSEQUENT EVENTS
On May 8, 2014 (the "Effective Date"), the Company entered into a Software as Service Agreement (the "Agreement") with Innography, Inc. ("Innography") under which the Company will have access to Innography’s proprietary web-based application software platforms and patent related data and analytics functionality in connection with the development and commercialization of the Company's patent licensing system.
The term of the Agreement commences on the Effective Date and continues until the two year anniversary of the Effective Date (the "Initial Term"). The Agreement may be renewed for up to three additional and consecutive one year renewal periods (each a "Renewal Term"). The Agreement will renew for the first and second Renewal Terms unless the Company elects to terminate the Agreement in advance of renewal and will renew for the third Renewal Term unless either party elects to terminate the agreement in advance of renewal. In the event of a change of control, as defined in the Agreement, of Innography, on or after June 30, 2015 Innography may terminate the then current term on 90 days notice (“Control Termination”). In the event of a Control Termination or if the Agreement is not renewed for an optional Renewal Term, or after the last of up to three Renewal Terms expires, the Company may renew for an additional one year period during which Innography will provide its services and reasonably assist the Company in migrating to a replacement service (the "Wind Down Term").
Concurrent with the execution of the Agreement, the Company paid a one-time fee of $200,000. In consideration for the access to Innography's software application, the Company will pay a fee of $350,000 on July 1, 2014, $500,000 on January 1, 2015 and $650,000 on July 1, 2015. For each Renewal Term the Company will pay semi-annual payments of $800,000 on January 1 and July 1, but the semi-annual payments may increase from $800,000 to $1,100,000 if the Company's semi-annual net revenues, as defined in the Agreement, exceed $15 million. In the event that the Wind Down Term extends beyond the fifth anniversary of the Effective Date, the semi-annual rates shall increase 20% for any portion of the Wind Down Term that occurs after the fifth anniversary of the Effective Date.
| ITEM 2. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
The following discussion and analysis of the financial condition and results of our operations should be read in conjunction with our financial statements and the notes to those statements. This discussion contains forward-looking statements reflecting our management’s current expectations that involve risks and uncertainties. Actual results and the timing of events may differ materially from those contained in these forward-looking statements due to a number of factors, including those discussed under the heading “Risk Factors” in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 31, 2014.
General
We, through our wholly-owned subsidiaries develop, license and otherwise enforce patented technologies. We are a development lab led by internationally recognized inventor and entrepreneur Jay Walker. Mr. Walker is best known as the founder of Priceline.com and has twice been named by TIME magazine as “one of the top 50 business leaders of the digital age.” Our mission is to use the tools of the digital age to create business systems that unlock extraordinary value for consumers and businesses. We generate revenues by granting intellectual property rights for the use of, or pertaining to, patented technologies. We also monetize our intellectual property through the sale of select patent assets. Patent protection is a key part of our business model, because it provides us with a period of exclusive ownership during which we can recoup our risk capital and generate a profit from our inventions. As an entrepreneurially driven company, we are committed to a flexible approach when it comes to business models, deal terms and allocations of risk.
We specialize in creating applications and business solutions that work with large-scale networks. We have partnered with Fortune 500 firms to bring our inventions to market. We also license other companies to do so. We derive revenue primarily from patent licensing and sales and technology solutions licensing and sales.
On July 11, 2013, we entered into an Agreement and Plan of Merger with GO Merger Sub LLC, the Company’s wholly-owned subsidiary (“Merger Sub”), Walker Digital, LLC (“Walker Digital”) and Walker Digital Holdings, LLC, a wholly-owned subsidiary of Walker Digital that has been re-named Inventor Holdings, LLC (“IH LLC”) pursuant to which, on September 18, 2013 (the “Closing Date”), Merger Sub merged with and into IH LLC (the “Merger”), with IH LLC surviving the Merger and becoming a wholly-owned subsidiary of the Company (the “Merger Agreement”). As a result of the Merger, we are now a holding company with our primary operations conducted through IH LLC, although we anticipate that IH LLC will transfer a patent licensing system to us or another of our subsidiaries. Although we have not yet completed development of the system and while no assurances may be given that it will be completed and able to be commercialized to create value for us, we believe that patent licensing is a large market characterized by significant price inefficiency and discontinuity between the participating parties.
Prior to the merger Walker Licensing was a business segment of Walker Digital and was engaged in developing and commercializing the patent and other intellectual property assets created by Walker Digital, which was the research and development lab founded and led by Jay Walker. Walker Licensing generated revenues from the granting of intellectual property rights for the use of, or pertaining to, patented technologies. It also monetized its intellectual property to include the sale of select patent assets.
On June 3, 2013, IH LLC f/k/a Walker Holdings, was formed as a limited liability company in the State of Delaware. Walker Digital was the sole member of IH LLC. Immediately prior to the closing of the Merger, Walker Digital contributed Walker Licensing’s assets and business to IH LLC. In connection with the Merger, we acquired IH LLC and Walker Digital transferred ownership of the intellectual property assets that were primary to Walker Licensing’s business to IH LLC. All improvements to those assets, together with any intellectual property produced in connection with the patent licensing system we are developing, will also be assigned pursuant to the Invention Assignment Agreement with Mr. Walker. While the terms of the Invention Assignment Agreement do not entitle us to any other intellectual property Mr. Walker may develop in the future, in view of his significant equity position in the Company and the Company’s platform for the protection of the intellectual property it holds, Mr. Walker may nevertheless determine to develop and commercialize intellectual property through the Company. The terms and conditions of any such transaction would be negotiated between Mr. Walker and our Audit Committee at the time of such determination.
Simultaneously with the closing of the Merger, we completed the closing of a private placement (the “Placement”) of units, each consisting of one newly issued share of common stock and one Warrant to purchase half a share of newly issued common stock, at the price of $3.00 per unit, to unaffiliated, accredited third parties. The investors in the Placement collectively purchased 3,960,615 shares of common stock and warrants to purchase 1,980,318 shares of common stock for total consideration, net of offering costs of $0.2 million, of $11.7 million . The Warrants issued to the investors are exercisable for a period of three years at a purchase price of $3.00 per share of our common stock and are subject to a call that permits the Company to redeem the Warrants if the closing price of our common stock equals or exceeds $6.00 per share for any 20 trading days within any period of 30 consecutive trading days. The Placement was made to a limited number of accredited investors and was deemed to be exempt from registration under Section 4(a)(2) of the Securities Act of 1933, as amended.
Overview
Our operating activities during the three months ended March 31, 2014 and 2013 were principally focused on the sale of patents, continued development, licensing and enforcement of the patent portfolios, including the continued pursuit of multiple ongoing technology licensing and enforcement programs and the commencement of new technology licensing and enforcement programs. Our revenues historically have fluctuated period to period, and can vary significantly, based on a number of factors including the following:
| · | the dollar amount of agreements executed each period, which can be driven by the nature and characteristics of the technology or technologies being licensed and the magnitude of infringement associated with a specific licensee; |
| · | the specific terms and conditions of agreements executed each period including the nature and characteristics of rights granted, and the periods of infringement or term of use contemplated by the respective payments; |
| · | fluctuations in the total number of agreements executed each period; |
| · | the timing, results and uncertainties associated with patent filings and other enforcement proceedings relating to our intellectual property rights; |
| · | the relative maturity of licensing programs during the applicable periods; and |
Counterparties refer to those parties who were defendants in patent infringement cases that had been brought by us. Certain of these cases have been settled by entering into patent sale agreements, which typically results in one-time payments to us that are recognized as revenues. For the three months ended March 31, 2014 and 2013, we did not enter into any patent sale agreements. All of the revenue was generated through settlement and non-exclusive license agreements. With one exception, all of the agreements provide for a one-time payment to the Company. The Company considers significant revenue concentrations to be counterparties who account for 10% or more of the total revenues generated by the Company during the period. For the three months ended March 31, 2014, there was no revenue and for the three months ended March 31, 2013, the amount of revenue derived from counterparties representing more than 10% of our total revenues was 92% (with one counterparty representing 32% and a second representing 60%), respectively. Generally we are willing to engage in settlement discussions with defendants at any appropriate time during the course of litigation. We will agree to settle a dispute with a defendant when we believe that such a settlement and the terms of the agreement are in the best interest of the Company and its shareholders.
Results of Operations
Three Months Ended March 31, 2014 Compared with Three Months Ending March 31, 2013
Net Loss
Net loss for the three months ended March 31, 2014 was $6.0 million, as compared to net loss of $0.6 million for the prior comparable period. Results for the three months ending March 31, 2014 included allocated costs totaling $0.1 million, general and administrative costs of $0.2 million, compensation and benefits of $1.6 million, professional fees of $3.8 million, other legal and consulting fees of $0.1 million, patent prosecution and maintenance fees of $0.2 million.
Results for the three months ended March 31, 2013 included allocated costs totaling $0.1 million, compensation and benefits of $0.3 million, other legal and consulting fees of $0.6 million, patent prosecution and maintenance fees of $0.2 million and direct costs of revenue of $0.4 million.
Revenues
($ in millions)
| | | Three Months
Ended March 31,
2014 | | | Three Months
Ended March 31,
2013 | | | % change | |
| Licensing fees | | $ | - | | | $ | 1.0 | | | | (100 | )% |
| Patent sales | | | - | | | | - | | | | n/a | |
| Total Revenue | | $ | - | | | $ | 1.0 | | | | (100 | )% |
We did not generate revenues during the three months ended March 31, 2014. We recognized revenues of $1.0 million for the three months ended March 31, 2013.
We did not generate revenue from licensing agreements during the three months ended March 31, 2014, as compared to three licensing agreements for the three months ended March 31, 2013.
Our revenues historically have fluctuated based on the number of patented technology portfolios, the timing and results of patent filings and our enforcement proceedings relating to our intellectual property rights. Although revenues from one or more of our patents or patent families may be significant in a specific reporting period, we believe that none of our patents or patent families are individually significant to our licensing and enforcement business as a whole.
Legal and Consulting Contingency Fees
There were no legal and consulting contingent fees for the three months ended March 31, 2014 and for the three months ended March 31, 2013 legal and consulting contingent fees were $0.4 million. As a percentage of revenue, legal and consulting contingent fees were 39% for the three months ended March 31, 2013. Our legal and consulting contingent fees are dependent upon the realization of revenue.
Licensing and Enforcement Expenses
($ in millions)
| | | Three Months
Ended March 31,
2014 | | | Three Months
Ended March 31,
2013 | | | % change | |
| Other legal and consulting fees | | $ | 0.1 | | | $ | 0.6 | | | | (88 | )% |
| Patent prosecution and maintenance costs | | | 0.2 | | | | 0.2 | | | | 5 | % |
| Total licensing and enforcement expenses | | $ | 0.3 | | | $ | 0.8 | | | | (65 | )% |
Other legal and consulting expenses for the three months ended March 31, 2014 and the three months ended March 31, 2013 were $0.1 million and $0.6 million, respectively. The decrease in other legal and consulting fees during the three months ended March 31, 2014 as compared to the three months ended March 31, 2013 was mainly attributable to the number of active patent infringement and licensing cases. As of March 31, 2014 and March 31, 2013, we had 19 and 24 active patent infringement and licensing cases, respectively. Such decrease in the number of cases is consistent with the decrease in other legal and consulting expenses. Other legal and consulting expenses fluctuate from period to period based on patent enforcement and prosecution activity associated with ongoing licensing and enforcement programs and the timing of the commencement of new licensing and enforcement programs in each period. We expect other legal and consulting expenses to continue to fluctuate period to period based on the factors summarized above, in connection with upcoming scheduled trial dates and our current and future patent development, licensing and enforcement activities.
Patent prosecution and maintenance expenses for the three months ended March 31, 2014 and March 31, 2013 were $0.2 million and $0.2 million, respectively. Patent prosecution and maintenance expenses may fluctuate from period to period based on the number of re-examinations in connection with patent prosecutions.
General and Administrative Expenses
($ in millions)
| | | Three Months
Ended March 31,
2014 | | | Three Months
Ended March 31,
2013 | | | % change | |
| Compensation and benefits | | | 1.6 | | | | 0.3 | | | | 417 | % |
| Professional fees | | | 3.8 | | | | - | | | | n/a | |
| General and administrative | | | 0.3 | | | | 0.0 | | | | 630 | % |
| Total general & administrative expenses | | $ | 5.7 | | | $ | 0.3 | | | | 1539 | % |
Compensation and benefits expense for the three months ended March 31, 2014 and for the three months ended March 31, 2013 were $1.6 million and $0.3 million, respectively. Compensation and benefits expense increased $1.3 million, or 417%, while total revenues decreased 100% for the three months ended March 31, 2014 as compared to the three months ended March 31, 2013. The increase in compensation and benefits is primarily attributable to the increased number of full time employees, the increase in accrued employee bonuses of $0.2 million and employee stock based compensation of $0.6 million.
Professional fees of $3.8 million relates to public company related costs and stock-based compensation expense on awards earned concurrent with the Merger. Stock based compensation amounted to $3.1 million and $0 for the three months ended March 31, 2014 and 2013, respectively. Public company related expenses amounted to approximately $0.7 million and $0 for the three months ended March 31, 2014 and 2013, respectively. Stock based compensation is related to the issuance of 1,445,000 shares of Common Stock to a vendor, IP Navigation in connection with the Merger. The Company had an existing service agreement with IP Navigation, a patent monetization firm. On September 18, 2013, in connection with the amendment of this service agreement IP Navigation reduced its future fees from 22.5% to 15% and we issued 1,445,000 shares of Common Stock to the vendor. The Common Stock vested in March 2014. We recorded the pro rata portion of this non-employee award as a component of professional fees. The fair value of the award amounted to $3.1 million during the three months ended March 31, 2014.
Critical Accounting Policies and Estimates
Our significant accounting policies are more fully described in Note 2 to our condensed consolidated financial statements. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, and expenses, and the related disclosures of contingent assets and liabilities. Actual results could differ from those estimates under different assumptions or conditions. The Company’s significant estimates and assumptions include stock-based compensation and the valuation allowance related to the Company’s deferred tax assets.
Liquidity and Capital Resources
Our current assets were $22.7 million at March 31, 2014, including $22.1 million of cash. Working capital amounted to $21.7 million as of March 31, 2013. The Company's cash and cash equivalents is sufficient to meet our liquidity needs for at least the next twelve months.
Cash used in operating activities was approximately $2.6 million for the three months ended March 31, 2014.
Contractual Obligations
We had no significant commitments for capital expenditures in 2013 or as of March 31, 2014. We have no committed lines of credit or other committed funding or long-term debt.
Off-Balance Sheet Transactions
We are not party to any off-balance sheet transactions. We have no guarantees or obligations other than those which arise out of normal business operations.
Recently Issued Accounting Pronouncements
We do not expect the adoption of recently issued accounting pronouncements to have a significant impact on its results of operations, financial position or cash flows.
Item 3. Quantitative and Qualitative Disclosures about Market Risk.
Not applicable.
Item 4. Controls and Procedures
Disclosure Controls and Procedures
As of March 31, 2014, we conducted an evaluation, under the supervision and participation of management including our chief executive officer and chief financial officer, of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) of the Securities Exchange Act of 1934, as amended). There are inherent limitations to the effectiveness of any system of disclosure controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives.
Based upon this evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures are effective at the reasonable assurance level as of March 31, 2014.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting during the quarter ended March 31, 2014 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings.
On May 13, 2014, a subsidiary of IH LLC filed suit alleging infringement of one or more claims of U.S. Patent Nos. 5,828,751, 6,282,648 and 6,289,453 against Centerpoint Energy Houston Electric, LLC and Itron, Inc. in the U.S. District Court for the Eastern District of Texas. The complaint seeks damages and injunctive relief.
Item 1A. Risk Factors.
Not required for a smaller reporting company.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
None.
Item 3. Default Upon Senior Securities.
None.
Item 4. Mine Safety Disclosures.
None.
Item 5. Other Information.
None.
Item 6. Exhibits.
The following is a list of exhibits filed as part of this Quarterly Report on Form 10-Q.
| Exhibit No. | |
| 31.1 | Certification of Principal Executive Officer Pursuant to Section 302 of The Sarbanes-Oxley Act of 2002. |
| 31.2 | Certification of Principal Financial Officer Pursuant to Section 302 of The Sarbanes-Oxley Act of 2002. |
| 32.1 | Certification of Principal Executive Officer Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002. |
| 32.2 | Certification of Principal Financial Officer Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002. |
| 101.INS | XBRL Instance Document. |
| 101.SCH | XBRL Taxonomy Schema. |
| 101.CAL | XBRL Taxonomy Extension Calculation Linkbase. |
| 101.DEF | XBRL Taxonomy Extension Definition Linkbase. |
| 101.LAB | XBRL Taxonomy Extension Label Linkbase. |
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| | PATENT PROPERTIES, INC. | |
| | | |
| Dated: May 15, 2014 | By: | /s/ Jonathan Ellenthal | |
| | | Jonathan Ellenthal | |
| | | Vice Chairman of the Board of Directors, Chief Executive Officer (Principal Executive Officer) | |
| | | | |
| Dated: May15, 2014 | By: | /s/ Karen Romaine | |
| | | Karen Romaine | |
| | | Chief Financial Officer (Principal Financial Officer and Accounting Officer) | |
