UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

For the quarterly period ended September 30, 2017

or

For the transition period from ______ to ______            

Commission File Number 001-33008

 

PENDRELL CORPORATION

(Exact name of registrant as specified in its charter)

 

 

2300 Carillon Point, Kirkland, Washington 98033

(Address of principal executive offices including zip code)

(425) 278-7100

(Registrant’s telephone number, including area code)

 

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  ☒    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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ☒    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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No  ☒.

As of October 20, 2017, the registrant had 19,107,885 shares of Class A common stock and 5,366,000 shares of Class B convertible common stock outstanding.

 

 

 

 

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PENDRELL CORPORATION

FORM 10-Q

For the three and nine months ended September 30, 2017

INDEX

 

 

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PART I—FINANCIAL INFORMATION

 

Pendrell Corporation

Condensed Consolidated Balance Sheets

(In thousands, except share data, unaudited)

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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Pendrell Corporation

Condensed Consolidated Statements of Operations

(In thousands, except share and per share data, unaudited)

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 

 

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Pendrell Corporation

Condensed Consolidated Statement of Changes in Shareholders’ Equity

(In thousands, except share data, unaudited)

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 

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Pendrell Corporation

Condensed Consolidated Statements of Cash Flows

(In thousands, unaudited)

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.  

 

 

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Pendrell Corporation

Notes to Condensed Consolidated Financial Statements

(unaudited)

 

 

1. Nature of Business

These condensed consolidated financial statements include the accounts of Pendrell Corporation (“Pendrell”) and its consolidated subsidiaries (collectively referred to as the “Company”). Since 2011, the Company, through its consolidated subsidiaries, has invested in, acquired and developed businesses with unique technologies that are often protected by intellectual property (“IP”) rights, and that present the opportunity to address large, global markets. The Company’s subsidiaries focus on licensing their IP rights to third parties. The Company regularly evaluates its existing investments to determine whether retention or disposition is appropriate, and investigates new investment and business acquisition opportunities.

 

 

2. Basis of Presentation

Interim Financial Statements—The financial information included in the accompanying condensed consolidated financial statements is unaudited and includes all adjustments, consisting of normal recurring adjustments and accruals, considered necessary for a fair presentation in accordance with accounting principles generally accepted in the United States (“U.S.”) of America (“GAAP”). Certain information and footnote disclosures have been condensed or omitted. The financial information as of December 31, 2016 is derived from the Company’s audited consolidated financial statements and notes included in Item 8 in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2016 (“2016 Form 10-K”), filed with the U.S. Securities and Exchange Commission on March 15, 2017. The financial information included in this quarterly report should be read in conjunction with management’s discussion and analysis of financial condition and results of operations and the consolidated financial statements and notes included in the 2016 Form 10-K. Capitalized terms used and not otherwise defined in this quarterly report have the meanings given to them in the Company’s 2016 Form 10-K. Operating results and cash flows for the interim periods presented are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2017 or any interim period.

Capital Structure Change—On September 30, 2016, the Company underwent a reverse stock split at a ratio of 1-for-10 (the “2016 Reverse Split”). The share counts and per share data reported in the historical financial statements have been adjusted retrospectively as if the 2016 Reverse Split had been in effect for all periods presented.  Additionally, the exercise prices and the number of shares issuable under the Company’s stock-based compensation plans have been adjusted retrospectively to reflect the 2016 Reverse Split.

Principles of Consolidation and Basis of Presentation—The consolidated financial statements of the Company include the assets and liabilities of its wholly-owned subsidiaries and subsidiaries it controls or in which it has a controlling financial interest. All information in these financial statements is in U.S. dollars.

Noncontrolling interests on the consolidated balance sheets include third-party investments in entities that the Company consolidates, but does not wholly own. Noncontrolling interests are classified as part of equity and the Company allocates net income (loss), other comprehensive income (loss) and other equity transactions to its noncontrolling interests in accordance with their applicable ownership percentages. All intercompany transactions and balances have been eliminated in consolidation, including a $36.6 million loan from Pendrell to ContentGuard Holdings, Inc. (“ContentGuard”). In June 2017, the Company sold a 9% interest in ContentGuard. ContentGuard now has two minority shareholders, while Pendrell maintains an 81.1% ownership stake.

Segment Information—The Company operates in and reports on one segment (IP management). Operating segments are based upon the Company’s internal organization structure, how its operations are managed, and the criteria used by its Chief Operating Decision Maker. Substantially all the Company’s revenue is generated by operations located within the U.S., and the Company does not have any long-lived assets located in foreign countries.

Use of Estimates—The preparation of 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 financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ materially from these estimates.

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On an ongoing basis, the Company evaluates its estimates, including among others, those related to the fair value of acquired intangible assets, the useful lives and potential impairment of intangible assets and property and equipment, the value of stock awards for the purpose of determining stock-based compensation expense, accrued liabilities (including bonus accruals), valuation allowances related to the ability to realize deferred tax assets, allowances for doubtful receivables, and certain tax liabilities. Estimates are based on historical experience and other factors, including the current economic environment as deemed appropriate under the circumstances. Estimates and assumptions are adjusted when facts and circumstances dictate. As future events and their effects cannot be determined with precision, actual results could differ significantly from these estimates. Any changes in estimates used to prepare these financial statements will be reflected in the financial statements in future periods.

Accounting Policies—There have been no material changes or updates in the Company’s existing accounting policies from the disclosures included in its 2016 Form 10-K.

Recent Accounting Pronouncements—In February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update (“ASU”) No. 2016-02, Leases (Topic 842), which requires companies that are lessees to recognize a right-of-use asset and lease liability for most leases that do not meet the definition of a short-term lease. For income statement purposes, leases will continue to be classified as either operating or financing. Classification will be based on criteria that are similar to those applied in current lease accounting. Compliance with this ASU is required for annual periods beginning after December 15, 2018, and interim periods therein. Early adoption is permitted. As the Company’s future minimum lease commitments as of September 30, 2017 are approximately $0.6 million, the Company believes the future adoption of this ASU will not have a material impact on its financial position, results of operations or cash flows.

In March 2016, the FASB issued ASU No. 2016-09, Compensation—Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting, to simplify certain provisions in stock compensation accounting, including provisions applicable to: (1) accounting for income taxes, (2) classification of excess tax benefits on the statement of cash flow, (3) forfeitures, (4) minimum statutory tax withholding requirements, (5) classification of employee taxes paid on the statement of cash flows when an employer withholds shares for tax withholding purposes, (6) the practical expedient for estimating the expected term and (7) intrinsic value. Compliance with this ASU is required for annual periods beginning after December 15, 2016, and interim periods therein. The adoption of this ASU on January 1, 2017 resulted in an adjustment to retained earnings and additional paid in capital of approximately $0.2 million due to a change in accounting for forfeitures.

Throughout the year ended December 31, 2016, the FASB issued a number of ASUs which provide further clarification to ASU No. 2014-09, Revenue (Topic 606): Revenue from Contracts with Customers, issued in May 2014, which supersedes existing revenue recognition guidance under GAAP. The core principle of ASU No. 2014-09 is to recognize as revenue the amount that an entity expects to be entitled for goods or services at the time the goods or services are transferred to customers. In August 2015, the FASB issued ASU No. 2015-14, which deferred the effective date of the amendments in ASU No. 2014-09 to the annual reporting period beginning after December 15, 2017, with early adoption permitted beginning January 1, 2017. The ASUs issued in 2016 related to ASU No. 2014-09 will become effective when the guidance in ASU No. 2014-09 becomes effective. The Company is continuing to assess the impact, if any, of implementing ASU No. 2014-09 and related ASUs as of January 1, 2018, and plans to adopt this ASU under the modified retrospective method where the cumulative effect is recognized at the date of initial application. As the Company’s patent licensing agreements generally provide no further obligation for the Company upon receipt of the applicable license fees, the fiscal 2018 adoption of ASU 2014-09 will have no impact to revenues previously reported but may require additional footnote disclosures.

In May 2017, the FASB issued ASU No. 2017-09, Compensation—Stock Compensation (Topic 718)-Scope of Modification Accounting, which provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting. Unless the changes in terms or conditions meet all three criteria outlined in the guidance, modification accounting should be applied. The three criteria relate to changes in the terms and conditions that affect the fair value, vesting conditions, or classification of a share-based payment award. Compliance with this ASU is required for annual periods beginning after December 15, 2017. Early adoption is permitted. The adoption of this ASU in 2017 did not have an impact on the Company’s financial position, results of operations or cash flows.

 

 

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3. Accounts Receivable (Current and Non-current)

Accounts receivable consist primarily of amounts billed to customers under licensing arrangements. Since 2011, the Company has not incurred any material losses on its accounts receivable.

A significant portion of the Company’s current accounts receivable balance is due from Toshiba Memory Corporation (“TMC”), which prior to 2017 was a division of Toshiba Corporation (“Toshiba”). Based on the Company’s assessment of various reports, including Toshiba’s unaudited financial results, as well as the ongoing activities of TMC, the Company believes that no allowance for doubtful accounts is required for its receivable from TMC. The Company will continue to evaluate its position as new information becomes available.

 

 

4. Other Receivables

From acquisition through the year ended December 31, 2014, the Company attempted to develop a strategy to commercialize a proprietary micro-propagation technology (designed to facilitate the production on a commercial scale of certain plants, particularly timber bamboo) through its former subsidiary, Provitro Biosciences LLC (“Provitro”), but did not generate revenue from the technology.

In January 2015, the Company discontinued its efforts to commercialize the Provitro™ technology and in September 2015, the Company sold Provitro’s facility and related tangible assets for $2.0 million.  The purchase price was paid in installments of which $0.1 million was paid immediately, $0.4 million was received in January 2016, $0.9 million was received in August 2016 and $0.6 million was received in January 2017.

 

 

5. Accrued expenses

The following table summarizes accrued expenses (in thousands):

 

 

 

6. Commitments and Contingencies

Purchase and Lease Commitments— The Company has operating lease agreements for its offices in Kirkland, Washington and Finland.

Litigation— In the opinion of management, except for those matters described below and elsewhere in this report, to the extent so described, litigation, contingent liabilities and claims against the Company in the normal course of business are not expected to involve any judgments or settlements that would be material to the Company’s financial condition, results of operations or cash flows.

There have been no material changes to the legal proceedings disclosures included under Part I, Item 3 of the Company’s 2016 Form 10-K other than the following update, with capitalized terms having the meaning given to them in the Form 10-K:

MTL Enforcement Actions— In 2016, Western Digital Corporation (“Western Digital”) acquired SanDisk Corporation.  In June 2017, Memory Technologies, LLC, a subsidiary of Pendrell Corporation, and Western Digital entered into a settlement and patent license agreement. The agreement fully resolves all pending litigation between the parties and grants Western Digital a license to patents relating to memory and storage technologies.

ContentGuard Enforcement Actions— ContentGuard appealed the judgments in the Google Litigation and Apple Litigation to the Federal Circuit Court. On July 12, 2017, the Federal Circuit Court affirmed both adverse judgments, bringing those actions to conclusion.

 

 

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7. Shareholders’ Equity

On March 9, 2017, the Company agreed to redeem 2,432,923 shares of the Company’s Class A Stock from Highland Crusader Offshore Partners, L.P. in a private transaction at a price of $6.55 per share.

In March 2017, the Board of Directors (the "Board") of the Company approved and recommended that the Company’s shareholders approve a 1-for-100 reverse stock split of the Company’s shares of Class A Stock and Class B common stock (collectively, the “Common Stock”), to be effective no earlier than the fourth quarter of 2017 (the "2017 Reverse Split"), to enable the Company to (i) terminate the registration of the Class A Stock under the Securities Exchange Act of 1934, as amended (the “Exchange Act”); (ii) cease to be a reporting company under the Exchange Act; and (iii) terminate its Nasdaq listing if, after the 2017 Reverse Split, there are fewer than 300 record holders of Class A Stock. At the Company’s annual meeting of shareholders on June 14, 2017, the Company’s shareholders approved the 2017 Reverse Split and authorized the Board to implement the 2017 Reverse Split in the fourth quarter of 2017.

On September 20, 2017, the Board set November 30, 2017 as the effective date for the 2017 Reverse Split, but reserved the right to delay or cancel the 2017 Reverse Split if the 2017 Reverse Split will not reduce the number of record holders of Class A Stock below 300, or if the Board determines that the 2017 Reverse Split is no longer in the best interests of the Company or its shareholders. The Board also authorized the de-registration and de-listing of the Class A Stock from Nasdaq promptly after completion of the 2017 Reverse Split, and clarified that the Company does not currently plan to publish financial information following the expiration of the Company’s reporting obligations under the Exchange Act.

 

8. Stock-based Compensation

The Company records stock-based compensation on stock options, stock appreciation rights, restricted stock awards, restricted stock units and other stock awards issued to employees, directors, consultants and/or advisors based on the estimated fair value on the date of grant and recognizes compensation cost over the requisite service period for awards expected to vest.

On January 1, 2017, the Company elected to change its accounting policy for calculating stock-based compensation based on forfeiture estimates to one that recognizes forfeitures when they occur. ASU 2016-09 permits this one-time policy change, but requires the change to be adopted utilizing the modified retrospective approach, with a cumulative effect adjustment recorded to retained earnings. The adoption of this change in accounting for forfeitures on January 1, 2017 resulted in an adjustment to retained earnings and additional paid in capital of approximately $0.2 million.

Stock-based compensation expense included in the condensed consolidated statements of operations for the three and nine months ended September 30, 2017 and 2016 was as follows (in thousands):

 

 

Stock Options—The Company’s stock option activity for the nine months ended September 30, 2017 is summarized as follows:

 

 

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Restricted Stock—The Company’s restricted stock activity for the nine months ended September 30, 2017 is summarized as follows:

 

 

 

 

9. Contract Termination Costs

Pursuant to the 2013 agreement under which the Company acquired the bulk of its memory and storage technologies portfolio, the Company shared a significant portion of the revenue generated from memory patents with the seller. On February 23, 2017, the seller agreed to relinquish its future revenue share in exchange for an up-front payment and future installment payments. This agreement resulted in a one-time charge of $3.2 million to expense in the first quarter of 2017 and will significantly reduce the Company’s “Cost of revenues” on future memory patent revenue. The final installment payment associated with the termination comes due in 2018 and is reflected in “Accrued expenses.”

 

 

10. Gain on Contingency

During 2012, as part of the Company’s exit from the satellite business, the Company sold its partially completed medium earth orbit satellites, related equipment, and contracts. In February 2016, the final scheduled payment for those assets became payable, resulting in the recognition of a $2.0 million gain on contingency for the nine months ended September 30, 2016. The Company received the final scheduled payment in April 2016.

 

 

11. Income Taxes

For the three months ended September 30, 2017, the Company recorded a tax provision of $49,000 related to foreign taxes withheld on revenue generated from license agreements executed with third party licensees domiciled in a foreign jurisdiction. The Company had no foreign taxes withheld during the three and nine months ended September 30, 2016. In general, foreign taxes withheld may be claimed as a deduction on future U.S. corporate income tax returns, or as a credit against future U.S. federal income tax liabilities, subject to certain limitations. However, due to uncertainty regarding the Company’s ability to utilize the deduction or credit resulting from the foreign withholding, the Company established a full valuation allowance against the related deferred tax asset.

The Company anticipates it will not have a U.S. federal income tax liability in 2017. However, the Company recorded an income tax provision for the nine months ended September 30, 2017, in the amount of $0.6 million primarily because, as of the filing of this report, the Company believes it will be subject to the U.S. Personal Holding Company tax in 2017. As discussed in more detail below, the U.S. Personal Holding Company tax is assessed on undistributed personal holding company income (“UPHCI”) of a personal holding company (“PHC”).  The Board may elect to distribute to shareholders all or a portion of the UPHCI before the end of the year to eliminate or reduce the tax obligation.  Under U.S. tax law, any distribution to shareholders that reduces the Company’s UPHCI will be fully taxable as a dividend.   If the Board elects to make the distribution, all or a portion of the income tax provision and related liability will be reversed.

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Personal Holding Company Determination- The Internal Revenue Code imposes an additional tax on undistributed income of a PHC. In general, a corporation is a PHC if 50% or more of its outstanding shares, measured by value, are owned directly or indirectly by five or fewer individual shareholders at any time during the second half of the year (“Concentrated Ownership”) and at least 60% of its adjusted ordinary gross income is personal holding company income (“PHCI”). Broadly, PHCI includes items such as dividends, interest, rents and royalties, among others. For a corporate subsidiary, Concentrated Ownership is determined by reference to direct and indirect ownership, including through attribution to individual shareholders of the parent corporation(s), and the subsidiary’s income is subject to additional tests to determine whether its income renders the subsidiary a PHC. If a corporation is a PHC, generates positive net PHCI and does not distribute to its shareholders a proportionate dividend in the full amount of the net PHCI, then the undistributed net PHCI is taxed (at 20% under current law).

Due to the significant number of shares held by the Company’s largest shareholders and the type of income that the Company generates, the Company must continually assess the Concentrated Ownership of Pendrell and its consolidated subsidiary ContentGuard. For 2017, Pendrell has met the Concentrated Ownership test. As of October 25, 2017, the Company believes ContentGuard has not met the Concentrated Ownership test for 2017 due to the 18.9% interest held by its minority shareholders. However, ContentGuard’s Ownership Concentration could change at any point during the remainder of the year. If ContentGuard becomes a PHC in 2017 and does not distribute to its shareholders a proportionate dividend in the full amount of its net PHCI, then the undistributed amount will be taxed at 20%.

 

 

12. Income (Loss) per Share

Basic income (loss) per share is calculated based on the weighted average number of Common Shares outstanding during the period. Diluted income (loss) per share is calculated by dividing the income (loss) allocable to common shareholders by the weighted average Common Shares outstanding plus potential dilutive Common Shares. Prior to the satisfaction of vesting conditions, unvested restricted stock awards are considered contingently issuable and are excluded from weighted average Common Shares outstanding used for computation of basic income (loss) per share.

Potential dilutive Common Shares consist of the incremental Class A Stock issuable upon the exercise of outstanding stock options (both vested and non-vested) and unvested restricted stock awards and units, calculated using the treasury stock method. The calculation of dilutive shares outstanding excludes out-of-the-money stock options (i.e., such options’ exercise prices were greater than the average market price of the Company’s Class A Stock for the period) because their inclusion would have been anti-dilutive.

The following table sets forth the computation of basic and diluted income (loss) per share (in thousands, except share and per share data):

 

 

 

 

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The following discussion and analysis should be read in conjunction with our condensed consolidated financial statements and accompanying notes included elsewhere in this quarterly report and the audited consolidated financial statements and notes included in our 2016 Form 10-K.

Special Note Regarding Forward-Looking Statements

With the exception of historical facts, the statements contained in this management’s discussion and analysis are “forward-looking” statements. All of these forward-looking statements are subject to risks and uncertainties that could cause the actual results of Pendrell Corporation (“Pendrell,” together with its consolidated subsidiaries, “us” or “we”) to differ materially from those contemplated by the relevant forward-looking statements. Factors that might cause or contribute to such a difference include, but are not limited to, those discussed in the section entitled “Risk Factors” (Part II, Item 1A of this Form 10-Q) and elsewhere in this quarterly report. The forward-looking statements included in this document are made only as of the date of this report, and we undertake no obligation to publicly update these forward-looking statements to reflect subsequent events or circumstances.

Overview

For the past five years, through our consolidated subsidiaries, we have invested in, acquired and monetized IP rights.  During the third quarter of 2017, we entered into a licensing agreement with The Walt Disney Company through our ContentGuard subsidiary that provides Disney the right to use ContentGuard’s digital rights management (DRM) technology to digitally distribute its motion pictures to theaters around the world. Disney joins Warner Bros and Sony Entertainment as licensees of ContentGuard’s technology. Meanwhile, ContentGuard continues its dialogue with movie studios and distributors of digital entertainment.

In addition to our efforts with ContentGuard’s digital cinema initiative, we continue talks with manufacturers and suppliers of memory and storage devices about licensing our memory and storage patents.  We have licensed five of the largest suppliers and a number of smaller suppliers.  

While we continue to monetize our IP assets, we are focusing primarily on identifying and evaluating new business opportunities.  We target opportunities that demonstrate a potential for reliable cash flow and significant growth.  We have identified multiple opportunities, but our acquisition efforts have been hindered by extremely high valuations and corresponding seller expectations. We have reduced our cost structure to allow us to take a thoughtful and measured approach in our evaluation of these opportunities.

We anticipate additional cost reductions in 2018 from de-registering and de-listing our Class A Stock. We also believe the de-registration and de-listing will simplify our operations and present opportunities that are unavailable to a reporting company.  Our board of directors set November 30, 2017 as the effective date for the reverse stock split that is designed to facilitate de-registration and de-listing, but reserved the right to delay or cancel the reverse stock split if it will not reduce our number of record holders below 300 or is otherwise not in the best interests of the company or our shareholders.  We do not currently plan to publish financial information following the expiration of our reporting obligations under the Securities Exchange Act of 1934.  

Critical Accounting Policies

Critical accounting policies require difficult, subjective and complex judgments, often because of the need to make estimates about the effect of matters that are inherently uncertain. The judgments and uncertainties affecting the application of these policies include significant estimates and assumptions made by us using information available at the time the estimates are made. Actual results could differ materially from those estimates. Our critical accounting policies involve judgments associated with our accounting for the fair value of financial instruments, asset impairment, valuation of intangible assets, contract settlements, revenue recognition, stock-based compensation, income taxes, contingencies and business combinations. There have been no significant changes to our critical accounting policies disclosed in our 2016 Form 10-K.

New Accounting Pronouncements

See Note 2 – “Basis of Presentation” of the Notes to Condensed Consolidated Financial Statements (Part I, Item 1 of this Form 10-Q) for further discussion.

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Results of Operations

The following table is provided to facilitate the discussion of our results of operations for the three and nine months ended September 30, 2017 and 2016 (in thousands):

 

 

Revenue. We generated revenue of $5.4 million for the three months ended September 30, 2017. No revenue was generated during the three months ended September 30, 2016, as no licensing transactions or other patent monetization activity was consummated during that period.

Revenue of $40.6 million for the nine months ended September 30, 2017 decreased by $17.9 million, or 31%, as compared to $58.5 million for the nine months ended September 30, 2016. The decrease was primarily due to larger licensing transactions during the nine months ended September 30, 2016 as compared to 2017.

Cost of revenues. We incurred cost of revenues of $48,000 for the three months ended September 30, 2017 compared to zero for the three months ended September 30, 2016. No revenue was generated during the three months ended September 30, 2016, resulting in no corresponding cost of revenue.

Cost of revenues of $0.3 million for the nine months ended September 30, 2017 decreased by $17.7 million, or 98%, as compared to $18.0 million for the nine months ended September 30, 2016. The decrease was primarily due to lower revenue share obligations. Prior to 2017, we shared revenue with the party from whom we acquired the bulk of our memory patents. In early 2017, that party relinquished its future revenue share rights in exchange for an up-front payment and future installment payments. This resulted in a one-time charge of $3.2 million to expense in our first quarter of 2017 (see “Contract termination costs” below), but has significantly reduced our “Cost of revenues” from our memory patents.  

Patent administration and related costs. Patent administration and related costs of $0.2 million for the three months ended September 30, 2017 remained flat as compared to $0.2 million for the three months ended September 30, 2016. Patent administration and related costs of $0.7 million for the nine months ended September 30, 2017 decreased by $0.1 million, or 6%, as compared to $0.8 million for the nine months ended September 30, 2016. The decrease was primarily due to a reduction in patent maintenance and prosecution costs resulting from the abandonment and sale of patents during the first nine months of 2017 and throughout 2016 that were not part of existing licensing programs.

Patent litigation. Patent litigation expenses of $0.1 million for the three months ended September 30, 2017 decreased by $0.2 million, or 79%, as compared to $0.3 million for the three months ended September 30, 2016. The decrease was primarily due to the settlement of our dispute with SanDisk in June 2017.

Patent litigation expenses of $8.5 million for the nine months ended September 30, 2017 increased by $4.8 million, or 129%, as compared to $3.7 million for the nine months ended September 30, 2016. The increase was primarily due to the contingent fees associated with our settlement and license agreement with SanDisk, partially offset by contingent fees incurred in 2016 associated with our settlement and license agreement with DirecTV.

General and administrative expenses. General and administrative expenses of $1.7 million for the three months ended September 30, 2017 decreased by $0.4 million, or 19%, as compared to $2.1 million for the three months ended September 30, 2016. The decrease was primarily due to reductions in employment expenses resulting from a lower headcount in 2017.

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General and administrative expenses of $5.2 million for the nine months ended September 30, 2017 decreased by $0.5 million, or 10%, as compared to $5.7 million for the nine months ended September 30, 2016. The decrease was primarily due to reductions in (i) employment expenses resulting from a lower headcount in 2017, (ii) professional fees and (iii) other expenses, partially offset by a discretionary bonus payment to the Company’s CEO in the first quarter of 2017.

Stock-based compensation. Stock-based compensation of $0.9 million for the three months ended September 30, 2017, increased by $0.3 million, or 57%, as compared to $0.6 million for the three months ended September 30, 2016. The increase was primarily due to a $0.3 million credit in the three months ended September 30, 2016 related to the reversal of stock-based compensation expense associated with employees that terminated during that period.

Stock-based compensation of $2.6 million for the nine months ended September 30, 2017 remained flat as compared to $2.6 million for the nine months ended September 30, 2016, as higher valued CEO performance awards offset a reduction in expense for awards that became fully vested in 2016.

Amortization of intangible assets. Amortization of intangible assets of $0.6 million for the three months ended September 30, 2017 decreased by $1.8 million, or 75%, as compared to $2.4 million for the three months ended September 30, 2016. Amortization of intangible assets of $1.8 million for the nine months ended September 30, 2017 decreased by $5.3 million, or 75%, as compared to $7.1 million for the nine months ended September 30, 2016.  The decrease in both the three and nine months was primarily due to patents being sold or becoming fully amortized as they reached their estimated useful life with no additional patents added to our portfolio.

Contract termination costs. Contract termination costs of $3.2 million for the nine months ended September 30, 2017 represent the cost associated with the buy-out of the revenue share agreement from the company that sold us the bulk of our memory patents in 2013.

Interest income. Interest income of $0.5 million for the three months ended September 30, 2017 increased by $0.3 million, or 192%, as compared to $0.2 million for the three months ended September 30, 2016. Interest income of $1.1 million for the nine months ended September 30, 2017 increased by $0.6 million, or 137%, as compared to $0.5 million for the nine months ended September 30, 2016.  The increase in both the three and nine months was primarily due to larger cash balances and higher interest rates in 2017 as compared to 2016.

Gain on contingency. Gain on contingency for the nine months ended September 30, 2016 was due to the receipt of the final contingent payment associated with the disposition of assets of our prior satellite business in April 2016.

Other expense. Other expense for the three and nine months ended September 30, 2017 and 2016 was due to losses on foreign currency transactions.

Income taxes. We do not anticipate having a U.S. federal income tax liability in 2017. However, we recorded an income tax provision for the nine months ended September 30, 2017, in the amount of $0.6 million primarily because, as of the filing of this report, we believe we will be subject to the U.S. Personal Holding Company tax for 2017. See Note 11 – Income Taxes of the Notes to the Condensed Consolidated Financial Statements. Income tax expense of $49,000 for the three months ended September 30, 2017 related to foreign taxes withheld on revenue generated from license agreements executed with third party licensees domiciled in a foreign jurisdiction.

For the year ended December 31, 2016, we did not record a provision for U.S. federal income tax due to available tax loss carryforwards that were used to offset the Company’s income.

Liquidity and Capital Resources

Overview. As of September 30, 2017, we had cash and cash equivalents of $187.2 million. Our primary expected cash needs for the next twelve months include redemption of fractional shares if we complete the 2017 Reverse Split, ongoing operating costs associated with commercialization of our IP assets, legal expenses, expenses associated with researching new business opportunities and other general corporate purposes. We may also use our cash, and may incur debt or issue equity, to acquire or invest in other businesses or assets.

We believe our current balances of cash and cash equivalents and cash flows from operations will be adequate to meet our liquidity needs for the foreseeable future. Cash and cash equivalents in excess of our immediate needs are held in interest bearing accounts with financial institutions.  

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Cash Flows. The following table is provided to facilitate the discussion of our liquidity and capital resources for the nine months ended September 30, 2017 and 2016 (in thousands):

 

 

For the nine months ended September 30, 2017, the $27.9 million of cash provided by operating activities consisted primarily of (i) revenue generated by operations of $40.6 million, (ii) $10.2 million net change in accounts receivable and (iii) $1.1 million of interest income, partially offset by $22.3 million of operating expenses, including $3.2 million related to contract termination costs, adjusted for various non-cash items including $2.6 million of stock-based compensation expense and $1.8 million of amortization expense associated with intangibles, as well as a $6.1 million decrease in accounts payable and accrued expenses.

For the nine months ended September 30, 2016, the $12.6 million of cash provided by operating activities consisted primarily of (i) revenue generated by operations of $58.5 million, (ii) $2.0 million received from the disposition of assets associated with our former satellite business, and (iii) $0.5 million of interest income, partially offset by a $29.9 million increase in accounts receivable and operating expenses of $38.0 million adjusted for various non-cash items including (a) $7.1 million of amortization expense associated with intangibles, (b) $2.6 million of stock-based compensation expense, and (c) $0.2 million of depreciation and costs associated with abandonment of patents, as well as a $9.6 million increase in accounts payable, accrued expenses and other current/non-current liabilities.

For both the nine months ended September 30, 2017 and September 30, 2016, cash provided by investing activities was primarily due to the receipt of installment payments from the sale of the Provitro assets in 2015.

For the nine months ended September 30, 2017, the $15.9 million of cash used in financing activities was primarily due to the repurchase of all 2,432,923 shares of our Class A common stock owned by the Crusader Fund at a price per share of $6.55. For the nine months ended September 30, 2016, the $40,000 of cash used in financing activities was statutory taxes paid due to the vesting of restricted stock awards.

Contractual Obligations. We have a contractual obligation under an operating lease agreement for our main office in Kirkland, Washington.

Risks and Uncertainties

Certain risks and uncertainties that could materially affect our future results of operations or liquidity are discussed under “Part II—Other Information, Item 1A. Risk Factors” in this quarterly report.  

Inflation

The impact of inflation on our condensed consolidated financial condition and results of operations was not significant during any of the periods presented.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements.

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We have assessed our vulnerability to certain market risks, including interest rate risk associated with our accounts receivable, accounts payable, other liabilities, and cash and cash equivalents and foreign currency risk associated with our cash held in foreign currencies.

As of September 30, 2017, our cash and investment portfolio consisted of both cash and money market funds, with a fair value of $187.2 million. The primary objective of our investments in money market funds is to preserve principal, while optimizing returns and minimizing risk, and our policies require, at the time of purchase, that we make these investments in short-term, high rated securities. These securities have a current yield of approximately 1%.

 

 

Our primary foreign currency exposure relates to cash balances in foreign currencies. Due to the small balances we hold, we have determined that the risk associated with foreign currency fluctuations is not material to us.

Evaluation of Disclosure Controls and Procedures

Under the supervision and with the participation of our management, including our principal executive officer and our principal financial officer, we have evaluated our disclosure controls and procedures (as such term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended). Based on this evaluation, our principal executive officer and our principal financial officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this quarterly report.

Changes in Internal Control Over Financial Reporting

There were no changes in our internal control over financial reporting during the third quarter of 2017 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II—OTHER INFORMATION

See Note 6 – Commitments and Contingencies of the Notes to the Condensed Consolidated Financial Statements.

There have been no material changes to our risk factor disclosures included under Part I, Item 1A of our 2016 Form 10-K.  

The Class A common stock securities purchases described in the table below represent the withholding of restricted stock to satisfy tax withholding obligations upon the vesting of the related restricted stock.  

 

 

 

 

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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.

 

 

 

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