Item
1. Financial Statements
QUEST
PATENT RESEARCH CORPORATION AND SUBSIDIARIES
UNAUDITED
CONSOLIDATED BALANCE SHEETS
|
|
September 30,
2016
|
|
|
December 31,
2015
|
|
|
|
|
|
|
|
|
ASSETS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current assets
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
157,570
|
|
|
$
|
331,506
|
|
Accounts receivable
|
|
|
109,307
|
|
|
|
41,552
|
|
Other current assets
|
|
|
2,359
|
|
|
|
5,924
|
|
Total current assets
|
|
|
269,236
|
|
|
|
378,982
|
|
|
|
|
|
|
|
|
|
|
Patents, net of accumulated amortization of $254,978 and $57,500, respectively
|
|
|
2,121,253
|
|
|
|
2,318,731
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
2,390,489
|
|
|
$
|
2,697,713
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDERS’ DEFICIT
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
Current liabilities:
|
|
|
|
|
|
|
|
|
Accounts payable and accrued liabilities
|
|
$
|
215,673
|
|
|
$
|
69,884
|
|
Loans payable – third party
|
|
|
163,000
|
|
|
|
163,000
|
|
Purchase price of patents, current portion
|
|
|
-
|
|
|
|
1,000,000
|
|
Accrued interest - loans payable third party
|
|
|
244,838
|
|
|
|
232,614
|
|
Total current liabilities
|
|
|
623,511
|
|
|
|
1,465,498
|
|
Non-current liabilities
|
|
|
|
|
|
|
|
|
Loan payable – related party, net of unamortized discount and debt issuance costs of $636,429 and $687,754
|
|
|
1,856,637
|
|
|
|
586,562
|
|
Purchase price of patents, long term – net of unamortized discount of $101,356 and $173,769
|
|
|
898,644
|
|
|
|
826,231
|
|
Total liabilities
|
|
|
3,378,792
|
|
|
|
2,878,291
|
|
|
|
|
|
|
|
|
|
|
Stockholders’ deficit:
|
|
|
|
|
|
|
|
|
Preferred stock – par value $.00003 – authorized 10,000,000 Shares – no shares issued and outstanding
|
|
|
-
|
|
|
|
-
|
|
Common stock, par value $0.00003; authorized 1,250,000,000 shares; shares issued and outstanding 313,038,334
|
|
|
9,391
|
|
|
|
9,391
|
|
Additional paid-in capital
|
|
|
14,232,882
|
|
|
|
14,232,882
|
|
Accumulated deficit
|
|
|
(15,233,128
|
)
|
|
|
(14,425,448
|
)
|
Total Quest Patent Research Corporation deficit
|
|
|
(990,855
|
)
|
|
|
(183,175
|
)
|
|
|
|
|
|
|
|
|
|
Non-controlling interest in subsidiary
|
|
|
2,552
|
|
|
|
2,597
|
|
|
|
|
|
|
|
|
|
|
Total stockholders’ deficit
|
|
|
(988,303
|
)
|
|
|
(180,578
|
)
|
|
|
|
|
|
|
|
|
|
Total liabilities and stockholders’ deficit
|
|
$
|
2,390,489
|
|
|
$
|
2,697,713
|
|
See
accompanying notes to unaudited consolidated financial statements.
QUEST
PATENT RESEARCH CORPORATION AND SUBSIDIARIES
UNAUDITED
CONSOLIDATED STATEMENT OF OPERATIONS
|
|
FOR THE
|
|
|
FOR THE
|
|
|
|
THREE MONTHS ENDED
|
|
|
NINE MONTHS ENDED
|
|
|
|
SEPTEMBER 30,
|
|
|
SEPTEMBER 30,
|
|
|
|
2016
|
|
|
2015
|
|
|
2016
|
|
|
2015
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
Licensed Sales
|
|
$
|
5,593
|
|
|
$
|
9,441
|
|
|
$
|
25,450
|
|
|
$
|
28,552
|
|
Patent licensing fees
|
|
|
375,000
|
|
|
|
90,000
|
|
|
|
375,000
|
|
|
|
110,000
|
|
Management fees
|
|
|
325,175
|
|
|
|
45,603
|
|
|
|
789,578
|
|
|
|
177,304
|
|
|
|
|
705,768
|
|
|
|
145,044
|
|
|
|
1,190,028
|
|
|
|
315,856
|
|
Operating expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of sales
|
|
|
960
|
|
|
|
4,010
|
|
|
|
14,273
|
|
|
|
11,065
|
|
Royalties
|
|
|
336,651
|
|
|
|
52,610
|
|
|
|
336,651
|
|
|
|
57,628
|
|
Management support services
|
|
|
108,625
|
|
|
|
18,729
|
|
|
|
805,325
|
|
|
|
49,074
|
|
Selling, general and administrative expenses
|
|
|
190,229
|
|
|
|
111,649
|
|
|
|
609,642
|
|
|
|
401,108
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses
|
|
|
636,465
|
|
|
|
186,998
|
|
|
|
1,765,891
|
|
|
|
518,875
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss from operations
|
|
|
69,303
|
|
|
|
(41,954
|
)
|
|
|
(575,863
|
)
|
|
|
(203,019
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other Income and (expenses)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other income
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
32,182
|
|
Income tax
|
|
|
-
|
|
|
|
155
|
|
|
|
(2,150
|
)
|
|
|
(3,021
|
)
|
Interest expense
|
|
|
(74,333
|
)
|
|
|
(4,075
|
)
|
|
|
(229,712
|
)
|
|
|
(12,225
|
)
|
Total Other Income and (expenses)
|
|
|
(74,333
|
)
|
|
|
(3,920
|
)
|
|
|
(231,862
|
)
|
|
|
16,936
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
|
(5,030
|
)
|
|
|
(45,874
|
)
|
|
|
(807,725
|
)
|
|
|
(186,083
|
)
|
Net income (loss) attributable to non-controlling interest in subsidiaries
|
|
|
240
|
|
|
|
(44
|
)
|
|
|
45
|
|
|
|
(489
|
)
|
Net loss attributable to Quest Patent Research Corporation
|
|
$
|
(4,790
|
)
|
|
$
|
(45,918
|
)
|
|
$
|
(807,680
|
)
|
|
$
|
(186,572
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings (loss) per share basic and diluted
|
|
$
|
(0.00
|
)
|
|
$
|
(0.00
|
)
|
|
$
|
(0.00
|
)
|
|
$
|
(0.00
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average shares outstanding – basic and diluted
|
|
|
313,038,334
|
|
|
|
263,038,334
|
|
|
|
313,038,334
|
|
|
|
261,389,982
|
|
See
accompanying notes to unaudited consolidated financial statements.
QUEST
PATENT RESEARCH CORPORATION AND SUBSIDIARIES
UNAUDITED
CONSOLIDATED STATEMENT OF CASH FLOWS
|
|
FOR THE
|
|
|
|
NINE MONTHS ENDED
|
|
|
|
SEPTEMBER 30,
|
|
|
|
2016
|
|
|
2015
|
|
|
|
|
|
|
|
|
Cash flows from operating activities:
|
|
|
|
|
|
|
Net loss
|
|
$
|
(807,725
|
)
|
|
$
|
(186,083
|
)
|
Adjustments to reconcile net loss to net cash used in operating activities:
|
|
|
|
|
|
|
|
|
Amortization of debt discounts
|
|
|
123,738
|
|
|
|
-
|
|
Share-based compensation
|
|
|
-
|
|
|
|
63,000
|
|
Gain on settlement of accounts payable
|
|
|
-
|
|
|
|
(32,182
|
)
|
Depreciation and amortization
|
|
|
197,478
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
Changes in operating assets and liabilities
|
|
|
|
|
|
|
|
|
Accrued interest expense
|
|
|
105,974
|
|
|
|
-
|
|
Accounts receivable
|
|
|
(67,755
|
)
|
|
|
(6,781
|
)
|
Other current assets
|
|
|
3,565
|
|
|
|
816
|
|
Accounts payable and accrued expenses
|
|
|
145,789
|
|
|
|
79,274
|
|
|
|
|
|
|
|
|
|
|
Net cash used in operating activities
|
|
|
(298,936
|
)
|
|
|
(81,956
|
)
|
|
|
|
|
|
|
|
|
|
Cash flows from financing activities:
|
|
|
|
|
|
|
|
|
Proceeds from loan – related party
|
|
|
125,000
|
|
|
|
-
|
|
Net cash provided by financing activities
|
|
|
125,000
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
Net increase (decrease) in cash and cash equivalents
|
|
|
(173,936
|
)
|
|
|
(81,956
|
)
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents at beginning of year
|
|
|
331,506
|
|
|
|
91,690
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents at end of year
|
|
$
|
157,570
|
|
|
$
|
9,734
|
|
|
|
|
|
|
|
|
|
|
Supplemental disclosure of cash flow information:
|
|
|
|
|
|
|
|
|
Cash paid during the year for:
|
|
|
|
|
|
|
|
|
Income taxes
|
|
|
2,150
|
|
|
|
-
|
|
Interest
|
|
|
-
|
|
|
|
-
|
|
Non-cash investing and financing activity:
|
|
|
|
|
|
|
|
|
Loan proceeds paid directly from lender to seller of patents
|
|
|
1,000,000
|
|
|
|
-
|
|
See
accompanying notes to unaudited consolidated financial statements.
QUEST
PATENT RESEARCH CORPORATION
NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2016
NOTE
1 – DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION
The Company
is a Delaware corporation, incorporated on July 17, 1987 and has been engaged in the intellectual property monetization business
since 2008.
As used
herein, the “Company” refers to Quest Patent Research Corporation and its wholly and majority-owned and controlled
operating subsidiaries unless the context indicates otherwise. All intellectual property acquisition, development, licensing and
enforcement activities are conducted by the Company’s wholly and majority-owned and controlled operating subsidiaries.
The
accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles
generally accepted in the US (GAAP) for interim financial information and with the instructions to Form 10-Q and Rule 8-03 of
Regulation S-X. Accordingly, these interim financial statements do not include all of the information and notes required by
GAAP for complete financial statements. All adjustments (consisting of normal recurring items) necessary to present fairly
the Company’s consolidated financial position have been included. These interim financial statements should be read in
conjunction with the consolidated financial statements and accompanying notes included in our Annual Report on Form 10-K for
the year ended December 31, 2015. Certain prior-period amounts have been reclassified to conform to the current-period
presentation. Operating results for the interim periods presented herein are not necessarily indicative of the results that
may be expected for any other interim period or for the entire year.
NOTE
2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles
of consolidation and financial statement presentation
The consolidated
financial statements are prepared in accordance with U.S. generally accepted accounting principles (“US GAAP”) and
present the consolidated financial statements of the Company and its wholly owned and majority owned subsidiaries as of September
30, 2016.
The consolidated
financial statements include the accounts and operations of:
Quest
Patent Research Corporation
Wynn
Technologies, Inc.
Quest
Licensing Corporation (NY)
Quest
Licensing Corporation (DE) (wholly owned)
Quest
Packaging Solutions Corporation (90% owned)
Quest
Nettech Corporation (wholly owned)
Semcon
IP, Inc. (wholly owned)
Mariner
IC, Inc. (wholly owned)
IC
Kinetics, Inc. (wholly owned)
The operations
of Wynn Technologies Inc. are not included in the Company’s consolidated financial statements as there are significant contingencies
related to its control of Wynn Technologies Inc. The sole asset of Wynn Technologies Inc. is US Patent No. RE38,137E. Wynn Technologies
Inc. cannot transfer, assign, sell, hypothecate or otherwise encumber US Patent No. RE38,173E without the express written consent
of Sol Li, owner of 35% of Wynn Technologies Inc., unless, as of the date of such transfer, assignment, sale, hypothecation or
other encumbrance, Mr. Li has received a total of at least $250,000.
The Company
accounts for its 65% interest in Wynn Technologies, Inc. under the equity method whereby the investment accounts are increased
for contributions by the Company plus its 60% share of income pursuant to the contractual agreement which provide that Sol Li
retains 40% of the income, and reduced for distributions and its 60% share of losses incurred, respectively, with the restriction
whereby the account balances cannot go below zero.
Significant
intercompany transaction and balances have been eliminated in consolidation.
Inventor/Former
Owner Royalties and Contingent Legal/Litigation Finance Expenses
In connection
with the investment in certain patents and patent rights, certain of the Company’s operating subsidiaries may execute related
agreements which grant to the inventors and/or former owners of the respective patents or patent rights, the right to receive
a percentage of future net revenues (as defined in the respective agreements) generated as a result of licensing and otherwise
enforcing the respective patents or patent portfolios.
The Company’s
operating subsidiaries may retain the services of law firms that specialize in patent licensing and enforcement and patent law
in connection with their licensing and enforcement activities. These law firms may be retained on a contingent fee basis
whereby such law firms are paid a percentage of any negotiated fees, settlements or judgments awarded.
The Company’s
operating subsidiaries may engage funding sources that specialize in providing financing for patent licensing and enforcement. These
litigation finance firms may be engaged on a non-recourse basis whereby such litigation finance firms are paid a percentage of
any negotiated fees, settlements or judgments awarded in exchange for providing funding for legal fees and out of pocket expenses
incurred as a result of the licensing and enforcement activities.
The economic
terms of the inventor agreements, operating agreements, contingent legal fee arrangements and litigation financing agreements
associated with the patent portfolios owned or controlled by the Company’s operating subsidiaries, if any, including royalty
rates, contingent fee rates and other terms, vary across the patent portfolios owned or controlled by such operating subsidiaries. Inventor/former
owner royalties, payments to non-controlling interests, contingent legal fees expenses and litigation finance expenses fluctuate
period to period, based on the amount of revenues recognized each period, the terms and conditions of revenue agreements executed
each period and the mix of specific patent portfolios with varying economic terms and obligations generating revenues each period.
Inventor/former owner royalties, contingent legal fees expenses and litigation finance expenses will continue to fluctuate and
may continue to vary significantly period to period, based primarily on these factors. The agreements with the funding sources
provide that we have no liability or obligation to the funding source, other than with respect to their interest in the proceeds
of the recovery, if any.
Going
Concern
As shown
in the accompanying financial statements, the Company has an accumulated deficit of $15,233,128 and negative working capital of
$354,725 as of September 30, 2016. Because of the Company’s continuing losses, the working capital deficiency, the uncertainty
of future revenue, the Company’s low stock price and the absence of a trading market in its common stock, and the ability
of the Company to raise funds in equity market or from lenders is severely impaired. These conditions raise substantial doubt
as to the Company’s ability to continue as a going concern. Although the Company may seek to raise funds and to obtain third
party funding for litigation to enforce its intellectual property rights, the availability of such funds is uncertain. The financial
statements do not include any adjustments that might result from the outcome of this uncertainty.
NOTE
3 – SHORT-TERM AND LONG-TERM DEBT
The following
table shows the Company’s short-term and long-term debt at September 30, 2016 and December 31, 2015.
|
|
September 30,
|
|
|
December 31,
|
|
|
|
2016
|
|
|
2015
|
|
Short term debt:
|
|
|
|
|
|
|
Loans payable – third party
|
|
$
|
163,000
|
|
|
$
|
163,000
|
|
|
|
|
|
|
|
|
|
|
Long term debt:
|
|
|
|
|
|
|
|
|
Loans payable – related party
|
|
|
|
|
|
|
|
|
Gross
|
|
|
2,375,000
|
|
|
|
1,250,000
|
|
Accrued Interest
|
|
|
118,066
|
|
|
|
24,316
|
|
Unamortized discount
|
|
|
(636,429
|
)
|
|
|
(687,754
|
)
|
Net loans payable – related party
|
|
$
|
1,856,637
|
|
|
$
|
586,562
|
|
Short
term debt
The loan
payable – third party is a demand loan made by former officers and directors, who are unrelated third parties at September
30, 2016 and December 31, 2015, in the amount of $163,000. The loans are payable on demand plus accrued interest at 10% per annum. These
third parties are also shareholders, but their stockholdings are not significant. See Note 6.
Long-term
debt
The loan
payable at September 30, 2016 represents the principal amount of the Company’s 10% note to United Wireless Holdings, Inc.
(“United Wireless”) due September 30, 2020, in the amount of $2,375,000 pursuant to securities purchase agreement
dated October 22, 2015 more fully described in our Annual Report on Form 10-K for the year ended December 31, 2015. The increase
in the loan amount reflects the second $1,000,000 installment of the purchase price of the patents and release of $125,000 cash
proceeds to the Company. Because of its stock ownership in the Company and its right to elect a director of the Company, United
Wireless is treated as a related party. Prior to the consummation of the transactions described in this Note 3, the Company had
no relationship with United Wireless.
NOTE
4 – STOCKHOLDERS’ EQUITY
Increase
in Authorized Common Stock
On January
22, 2016, the Company amended and restated its certificate of incorporation to increase its authorized common stock from 390,000,000
shares to 1,250,000,000 shares. The Company’s financial statements at December 31, 2015 reflect this increase.
Issuance
of Common Stock and Options
Pursuant
to the restated employment agreement dated November 30, 2014, the Company issued to its chief executive officer a stock grant
for 30,000,000 shares which vested on January 15, 2015. For the period ended September 30, 2015 the Company recognized compensation
expense of $63,000, representing closing price of the common stock on the vesting date. There was no stock-based compensation
expense for the nine months ended September 30, 2016.
As of
September 30, 2016, there was no unamortized option expense associated with compensatory options.
A summary
of the status of the Company's stock options and changes is set forth below:
|
|
Number
of Options
(#)
|
|
|
Weighted
Average Exercise
Price ($)
|
|
|
Weighted
Average Remaining Contractual Life (Years)
|
|
Balance - December 31, 2015
|
|
|
50,000,000
|
|
|
|
0.03
|
|
|
|
4.75
|
|
Granted
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Expired
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Cancelled
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Balance – September 30, 2016
|
|
|
50,000,000
|
|
|
|
0.03
|
|
|
|
4.00
|
|
Warrants
A summary
of the status of the Company's stock warrants and changes is set forth below:
|
|
Number
of Warrants
(#)
|
|
|
Weighted
Average Exercise
Price ($)
|
|
|
Weighted
Average Remaining Contractual Life (Years)
|
|
Balance
- December 31, 2015
|
|
|
65,000,000
|
|
|
|
0.004
|
|
|
|
2.25
|
|
Granted
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Cancelled
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Expired
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Balance
– September 30, 2016
|
|
|
65,000,000
|
|
|
|
0.004
|
|
|
|
1.50
|
|
NOTE
5 – NON-CONTROLLING INTEREST
The following
table reconciles equity attributable to the non-controlling interest related to Quest Packaging Solutions Corporation.
Balance as of December 31, 2015
|
|
$
|
2,597
|
|
Net income attributable to non-controlling interest
|
|
$
|
(45
|
)
|
Balance as of September 30, 2016
|
|
$
|
2,552
|
|
NOTE
6 – RELATED PARTY TRANSACTIONS
The Company
has at various times entered into transactions with related parties, including officers, directors and major shareholders, wherein
these parties have provided services, advanced or loaned money, or both, to the Company needed to support its daily operations.
The Company discloses all related party transactions.
During
2003, the Company received loans from then officers and directors, now unrelated third parties, in the amount of $79,490. The
loans are payable on demand plus accrued interest at 10% per annum. During 2014, all loan holders ceased to be related parties
as a result of employee separation agreements and director resignations. As a result, in 2014, approximately $54,490 in principal
on the loans was cancelled pursuant to a separation agreement and $25,000 in principal was reclassified as loans payable to third
parties upon resignation of the loan holder from the board.
During
the three and nine months ended September 30, 2016 and 2015, the Company contracted with an entity owned by the chief technology
officer for the provision of information technology services to the Company. The cost of such services were approximately $600
and $1,800 for the three and nine months ended September 30, 2015, respectively, and $600 and $1,800 for the three and nine months
ended September 30, 2016, respectively.
Item
2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
Our principal
operations include the development, acquisition, licensing and enforcement of intellectual property rights that are either owned
or controlled by us or one of our wholly owned subsidiaries. We currently own, control or manage eight intellectual property
portfolios, which principally consist of patent rights. As part of our intellectual property asset management activities
and in the ordinary course of our business, it has been necessary for either us or the intellectual property owner who we represent
to initiate, and it is likely to continue to be necessary to initiate patent infringement lawsuits and engage in patent infringement
litigation. To date, we have not generated any significant revenues from our intellectual property rights.
We seek
to generate revenue from three sources:
|
●
|
Patent
licensing fees relating to our intellectual property portfolio, which includes fees from the licensing of our intellectual
property, primarily from litigation relating to enforcement of our intellectual property rights.
|
|
●
|
Management
fees, which we receive for managing structured licensing programs, including litigation, related to our intellectual property
rights.
|
|
●
|
Licensed
packaging sales, which relate to the sale of licensed products
|
Because
of the nature of our business transactions to date, we recognize revenues from licensing upon execution of a license agreement
following settlement of litigation and not over the life of the patent. Thus, we would recognize revenue when we receive the license
fee or settlement payment. Although we intend to seek to develop portfolios of intellectual property rights that provide us
a continuing stream of revenue, to date we have not been successful in doing so, and we cannot give you any assurance that we
will be able to generate any significant revenue from licenses that provide a continuing stream of revenue. Thus, to the extent
that we continue to generate cash from single payment licenses, our revenue can, and is likely to, vary significantly from quarter
to quarter and year to year. Our gross profit from license fees reflects any royalties which we pay in connection with our license.
Fees generated
in connection with the management of litigation are paid to us by one of the third-party funding source in support of the litigation
seeking to enforce our intellectual property rights. Our agreement with the funding source provides that the funding source pays
the litigation costs and provides that this funding source receives a percentage of the recovery, thus reducing our recovery in
connection with any settlement of the litigation. As a result, in connection with litigation funded by the third party, we would,
if the litigation is successful, receive fees both for managing the litigation, if the agreement with the funding source provides
for such payments, and from a license of the intellectual property, which will be net of that portion of the recovery payable
to the funding source. To the extent that we have agreements with counsel and/or litigation funding sources pursuant to which
payments made to them represent a portion of the gross recovery, and such payment is contingent upon a recovery, our revenue from
litigation reflects the gross recovery from litigation as licensing fees, and payments to counsel and/or litigation funding sources
are reflected as cost of revenue. Our gross profit from management fees reflects payments to third party support services providers
which we pay in connection with management of the licensing program.
To a lesser
extent, we generate revenue from sale of packaging materials based on our TurtlePak
TM
technology. Our gross profit
from sales reflects the cost of contract manufacturing and labor. We did not generate any revenue from the TurtlePak
TM
Portfolio
other than from the sale of products using our technology.
In March
2016, we entered into two funding agreements whereby a third party agreed to provide funds to us to enable us to implement a structured
licensing program, including litigation if necessary, for the power management/bus control portfolio, which is owned by our subsidiary
Semcon IP, Inc., and the anchor structure portfolio, which is owned by Mariner IC, Inc. These portfolios are two of the portfolios
we acquired from Intellectual Ventures Assets 16 LLC (“Intellectual Ventures”) in October 2015. We engaged counsel
on a partial contingency basis in connection with a proposed patent infringement action relating to these portfolios.
Following
the execution of the funding agreements and the engagement of counsel, in April 2016, (i) Semcon brought patent infringement suits
in the United States District Court for the Eastern District of Texas against Huawei Technologies, MediaTek Inc., STMicroelectronics
Inc., Texas Instruments Incorporated and ZTE Corporation, and (ii) Mariner IC brought patent infringement suits in the United
States District Court for the Eastern District of Texas against MediaTek Inc., Texas Instruments Incorporated, LG Electronics,
Inc., Toshiba Corporation, and Panasonic Corporation.
Pursuant
to the terms of the funding agreements and the partial contingency agreements with counsel, we do not have any liability or obligations
with respect to the costs associated with prosecuting the actions, and we do not receive any payments for any assistance which
we may provide in connection with the litigation. Both the funding source and counsel will participate in any recovery in these
lawsuits.
Results
of Operations
Three
and nine months ended September 30, 2016 and 2015
Revenues
for the three months ended September 30, 2016 were approximately $706,000, an increase of approximately $561,000, or 387%, from
the comparable period of 2015, which were approximately $145,000. Revenues for the nine months ended September 30, 2016 were approximately
$1,190,000, an increase of approximately $874,000, or 277%, from the comparable period of 2015, which was approximately $316,000.
The increase in revenue was primarily due to an increase in management fees of approximately $280,000 and approximately $612,000
for the three and nine months ended September 30, 2016 respectively from the comparable periods of 2015, relating to our services
in support of mobile data portfolio litigation which are paid by the firm that is providing the funding for the litigation. The
increase in revenue was also due to an increase in patent licensing fees of approximately $285,000 and approximately $265,000
for the three and nine months ended September 30, 2016 respectively from the comparable periods of 2015, relating to licenses
granted to our intellectual property portfolios. These management fees and patent licensing fees represent the only significant
source of revenue in the three- and nine-month periods ended September 30, 2016.
Operating
expenses for the three and nine months ended September 30, 2016 increased by approximately $449,000, or 240%, and by approximately
$1,247,000, or 240%, respectively, compared to the three and nine months ended September 30, 2015. Our principal operating expense
for the three months ended September 30, 2016 was royalties due to patent owners, legal counsel and litigation funding sources
under our inventor, legal fee and litigation financing agreements associated with our patent portfolios. Royalties were approximately
$337,000 for the three months ended September 30, 2016, and approximately $53,000 for the three months ended September 30, 2015,
respectively. Our principal operating expense for the nine months ended September 30, 2016 was management support services in
support of mobile data portfolio litigation which are paid by the firm that is providing the funding for the litigation. Management
support services were approximately $805,000 for the nine months ended September 30, 2016, and approximately $49,000 for the nine
months ended September 30, 2015, respectively. Due to the timing of payables and receivables, management fees exceeded management
support services paid during the nine-months ended September 30, 2016.
Other
income (expense) included interest expense of $74,333 and $229,712 for the three and nine months ended September 30, 2016, respectively,
and $4,075 and $12,225 for the three and nine months ended September 30, 2015, respectively. The increase in interest expense
primarily reflect the accrued interest on our note to United Wireless. Other income (expense) for the nine months ended September
30, 2015 included $32,182, reflecting the gain on the settlement of an account payable for less than the amount previously accrued.
As a result
of the foregoing, we sustained a net loss of approximately $5,000, or $0.000 per share (basic and diluted), for the three months
ended September 30, 2016 and a net loss of approximately $808,000, or $0.003 per share (basic and diluted), for the nine months
ended September 30, 2016, compared to net loss of approximately $46,000, or $0.000 per share (basic and diluted), for the three
months ended September 30, 2015 and a net loss of approximately $186,000, or $0.001 per share (basic and diluted), for the nine
months ended September 30, 2015.
Liquidity
and Capital Resources
At September
30, 2016, we had current assets of approximately $269,237, and current liabilities of approximately $623,511. Our current liabilities
include loans payable of $163,000 and accrued interest of $244,838 due to former directors and minority stockholders. Our agreement
with United Wireless requires United Wireless to lend us the funds to make the payments to Intellectual Ventures. As of September
30, 2016, we have an accumulated deficit of approximately $15,233,000 and a negative working capital of approximately $354,275.
Other than salary to our chief executive officer, we do not contemplate any other material operating expense in the near future
other than normal general and administrative expenses, including expenses relating to our status as a public company filing reports
with the SEC.
We cannot
assure you that we will be successful in generating future revenues, in obtaining additional debt or equity financing or that
such additional debt or equity financing will be available on terms acceptable to us, if at all, or that we will be able to obtain
any third party funding in connection with any of our intellectual property portfolios. We have no credit facilities.
We
have an agreement with a funding source which is providing litigation financing in connection with our pending litigation
relating to our mobile data portfolio, and we have two agreements with a second funding source which is providing litigation
financing in connection with our pending litigation relating to our power management/bus control and anchor structure
portfolios. We cannot predict the success of any pending or future litigation. Our obligations to United Wireless are not
contingent upon the success of any litigation. If we fail to generate a sufficient recovery in these actions (net of any
portion of any recovery payable to the funding source or our legal counsel) in a timely manner to enable us to pay United
Wireless on the outstanding loans and the additional loans which United Wireless has agreed to make to us, we would be in
default under our agreements with United Wireless which could result in United Wireless obtaining ownership of the three
subsidiaries which own the patent rights we acquired from Intellectual Ventures. Our agreements with the funding sources
provide that the funding sources will participate in any recovery which is generated. We believe that our financial
condition, our history of losses and negative cash flow from operations, and our low stock price make it difficult for us to
raise funds in the debt or equity markets.
As noted
below, there is a substantial doubt about our ability to continue as a going concern.
Significant
Accounting Policies and Estimates
The discussion
and analysis of our financial condition and results of operations is based upon our financial statements that have been prepared
in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial
statements requires us to make estimates and judgments that affect the reported amounts of assets and liabilities. On an on-going
basis, we evaluate our estimates including the allowance for doubtful accounts, the salability and recoverability of our products,
income taxes and contingencies. We base our estimates on historical experience and on other assumptions that we believe to be
reasonable under the circumstances, the results of which form our 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.
Management
believes the following critical accounting policies affect the significant judgments and estimates used in the preparation of
the financial statements.
Principles
of Consolidation
The condensed
consolidated financial statements are prepared in accordance with US GAAP and present the financial statements of the Company
and our wholly-owned subsidiary. In the preparation of our consolidated financial statements, intercompany transactions and balances
are eliminated.
Use
of Estimates and Assumptions
The preparation
of financial statements in conformity with generally accepted accounting principles in the United States of America requires management
to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates.
Fair
Value of Financial Instruments
We adopted
Financial Accounting Standards Board (“FASB”) ASC 820, “Fair Value Measurements and Disclosures”, for
assets and liabilities measured at fair value on a recurring basis. ASC 820 establishes a common definition for fair value to
be applied to existing US GAAP that require the use of fair value measurements which establishes a framework for measuring fair
value and expands disclosure about such fair value measurements.
ASC 820
defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction
between market participants at the measurement date. Additionally, ASC 820 requires the use of valuation techniques that
maximize the use of observable inputs and minimize the use of unobservable inputs. These inputs are prioritized below:
|
Level 1:
|
Observable
inputs such as quoted market prices in active markets for identical assets or liabilities
|
|
|
|
|
Level 2:
|
Observable
market-based inputs or unobservable inputs that are corroborated by market data
|
|
|
|
|
Level 3:
|
Unobservable
inputs for which there is little or no market data, which require the use of the reporting entity’s own assumptions.
|
In addition,
FASB ASC 825-10-25 “Fair Value Option” was effective for January 1, 2008. ASC 825-10-25 expands opportunities
to use fair value measurements in financial reporting and permits entities to choose to measure many financial instruments and
certain other items at fair value.
Stock-based
Compensation
The Company
accounts for share-based awards issued to employees in accordance with Accounting Standards Codification (ASC) 718, “Compensation-Stock
Compensation.” Accordingly, employee share-based payment compensation is measured at the grant date, based on the fair value
of the award, and is recognized as an expense over the requisite service period, which is normally the vesting period. Share-based
compensation to directors is treated in the same manner as share-based compensation to employees, regardless of whether the directors
are also employees. The Company accounts for share-based compensation to persons other than employees in accordance with FASB
ASC 505-50. Equity instruments issued to other than employees are valued at the earlier of a commitment date or upon completion
of the services, based on the fair value of the equity instruments and is recognized as expense over the service period. The Company
estimates the fair value of share-based payments using the Black Scholes option-pricing model for common stock options and warrants
and the closing price of the Company’s common stock for common share issuances.
Long-Lived
Assets
We review
for impairment whenever events or circumstances indicate that the carrying amount of assets may not be recoverable, pursuant to
guidance established in ASC 360-10-35-15, “Impairment or Disposal of Long-Lived Assets”. We recognize an impairment
loss when the sum of expected undiscounted future cash flows is less than the carrying amount of the asset. The amount of impairment
is measured as the difference between the asset’s estimated fair value and its book value.
Revenue
Recognition
We recognize
revenue in accordance with ASC Topic 605, “Revenue Recognition”. Revenue is recognized when (i) persuasive
evidence of an arrangement exists, (ii) all obligations have been substantially performed, (iii) amounts are fixed or determinable
and (iv) collectability of amounts is reasonably assured.
We consider
our licensing and enforcement activities as one unit of accounting under ASC 605-25, “Multiple-Element Arrangements”
as the delivered items do not have value to customers on a standalone basis, there are no undelivered elements and there is no
general right of return relative to the license. Under ASC 605-25, the appropriate recognition of revenue is determined for the
combined deliverables as a single unit of accounting and revenue is recognized upon delivery of the final elements, including
the license for past and future use and the release. Also due to the fact that the settlement element and license element for
past and future use are the major central business, we do not present these two elements as different revenue streams in its statement
of operations. We do not expect to provide licenses that do not provide some form of settlement or release.
Cost
of Revenue
Cost of
revenues mainly includes expenses incurred in connection with our patent enforcement activities, such as legal fees, consulting
costs, patent maintenance, royalty fees for acquired patents and other related expenses. Cost of revenue does not include
expenses related to product development, patent amortization, integration or support, as these are included in general and administrative
expenses.
Inventor/Former
Owner Royalties and Contingent Legal/Litigation Finance Expenses
In connection
with the investment in certain patents and patent rights, certain of our operating subsidiaries may execute related agreements
which grant to the inventors and/or former owners of the respective patents or patent rights, the right to receive a percentage
of future net revenues (as defined in the respective agreements) generated as a result of licensing and otherwise enforcing the
respective patents or patent portfolios.
Our operating
subsidiaries may retain the services of law firms that specialize in patent licensing and enforcement and patent law in connection
with their licensing and enforcement activities. These law firms may be retained on a contingent fee basis whereby such law
firms are paid a percentage of any negotiated fees, settlements or judgments awarded.
Our operating
subsidiaries may engage with funding sources that specialize in providing financing for patent licensing and enforcement. These
litigation finance firms may be engaged on a non-recourse basis whereby such litigation finance firms are paid a percentage of
any negotiated fees, settlements or judgments awarded in exchange for providing funding for a legal fees and out of pocket expenses
incurred as a result of the licensing and enforcement activities.
The economic
terms of the inventor agreements, operating agreements, contingent legal fee arrangements and litigation financing agreements
associated with the patent portfolios owned or controlled by our operating subsidiaries, if any, including royalty rates, contingent
fee rates and other terms, vary across the patent portfolios owned or controlled by such operating subsidiaries. Inventor/former
owner royalties, payments to non-controlling interests, contingent legal fees expenses and litigation finance expenses fluctuate
period to period, based on the amount of revenues recognized each period, the terms and conditions of revenue agreements executed
each period and the mix of specific patent portfolios with varying economic terms and obligations generating revenues each period.
Inventor/former owner royalties, contingent legal fees expenses and litigation finance expenses will continue to fluctuate and
may continue to vary significantly period to period, based primarily on these factors. To the extent that we have agreements
with counsel and/or litigation funding sources pursuant to which payments made to them represent a portion of the gross recovery,
and such payment is contingent upon a recovery, our revenue from litigation reflects the gross recovery from litigation as licensing
fees, and payments to counsel and/or litigation funding sources are reflected as cost of revenue.
Recent
Accounting Pronouncements
Management
does not anticipate that the recently issued but not yet effective accounting pronouncements will materially impact the Company’s
financial condition.
Going
Concern
We have
an accumulated deficit of $15,233,128 and negative working capital of $354,275 as of September 30, 2016. Because of our continuing
losses, our working capital deficiency, the uncertainty of future revenue, our obligations to Intellectual Ventures and United
Wireless, our low stock price and the absence of a trading market in our common stock, our ability to raise funds in equity market
or from lenders is severely impaired, and we may not be able to continue as a going concern. Although we may seek to raise funds
and to obtain third party funding for litigation to enforce our intellectual property rights, the availability of such funds in
uncertain. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
Off-balance
Sheet Arrangements
We have
not entered into any other financial guarantees or other commitments to guarantee the payment obligations of any third parties.
We have not entered into any derivative contracts that are indexed to our shares and classified as stockholder’s equity
or that are not reflected in our consolidated financial statements. Furthermore, we do not have any retained or contingent interest
in assets transferred to an unconsolidated entity that serves as credit, liquidity or market risk support to such entity.