UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM
For the quarterly period ended:
OR
For the transition period from ________ to ________
Commission File Number
(Exact name of registrant as specified in its charter)
| (State or other jurisdiction of incorporation or organization) | (IRS Employer Identification No.) |
| | ||
| (Address of principal executive offices) | (Zip code) |
| (Registrant’s telephone number, including area code) |
Securities registered pursuant to Section 12(b) of
the Act:
Securities registered pursuant to Section 12(g) of the Act: None
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.
Indicate
by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule
405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or such shorter period that the registrant was
required to submit such files).
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act:
| Large accelerated filer | ☐ | Accelerated filer | ☐ | |
| ☒ | Smaller reporting company | | ||
| Emerging growth company | ||||
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
Securities registered pursuant to Section 12(b) of the Act: None
Indicate the number of shares
outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
TABLE OF CONTENTS
i
FORWARD-LOOKING STATEMENTS
This report contains forward-looking statements regarding our business, financial condition, results of operations and prospects. Words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates” and similar expressions or variations of such words are intended to identify forward-looking statements, but are not deemed to represent an all-inclusive means of identifying forward-looking statements as denoted in this report. Additionally, statements concerning future matters are forward-looking statements.
Although forward-looking statements in this report reflect the good faith judgment of our management, such statements can only be based on facts and factors currently known by us. Consequently, forward-looking statements are inherently subject to risks and uncertainties and actual results and outcomes may differ materially from the results and outcomes discussed in or anticipated by the forward-looking statements. Factors that could cause or contribute to such differences in results and outcomes include, without limitation, those specifically addressed under the headings “Risks Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our report on Form 10-K for the year ended December 31, 2023, in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Form 10-Q and in other reports that we file with the SEC. You are urged not to place undue reliance on these forward-looking statements, which speak only as of the date of this report.
We file reports with the SEC. The SEC maintains a website (www.sec.gov) that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC, including us. You can also read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. You can obtain additional information about the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330.
We undertake no obligation to revise or update any forward-looking statements in order to reflect any event or circumstance that may arise after the date of this report, except as required by law. Readers are urged to carefully review and consider the various disclosures made throughout the entirety of this quarterly report, which are designed to advise interested parties of the risks and factors that may affect our business, financial condition, results of operations and prospects.
ii
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
QUEST PATENT RESEARCH CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
| March 31, 2024 | December 31, 2023 | |||||||
| (unaudited) | ||||||||
| ASSETS | ||||||||
| Current assets | ||||||||
| Cash and cash equivalents | $ | $ | ||||||
| Accounts receivable, net of allowance for credit losses of $ | ||||||||
| Other current assets | ||||||||
| Total current assets | ||||||||
| Patents, net of accumulated amortization of $ | ||||||||
| Total assets | $ | $ | ||||||
| LIABILITIES AND STOCKHOLDERS’ DEFICIT | ||||||||
| Current liabilities | ||||||||
| Accounts payable and accrued liabilities ($ | $ | $ | ||||||
| Loans payable | ||||||||
| Funding liability | ||||||||
| Loan payable - related party | ||||||||
| Warrant liability | ||||||||
| Accrued interest | ||||||||
| Total current liabilities | ||||||||
| Non-current liabilities | ||||||||
| Loan payable – SBA | ||||||||
| Purchase price of patents | ||||||||
| Total liabilities | $ | $ | ||||||
| Commitments and contingencies (Note 9) | ||||||||
| Stockholders’ deficit: | ||||||||
| Preferred stock, par value $ | ||||||||
| Common stock, par value $ | ||||||||
| Additional paid-in capital | ||||||||
| Accumulated deficit | ( | ) | ( | ) | ||||
| Total Quest Patent Research Corporation stockholders’ deficit | ( | ) | ( | ) | ||||
| Non-controlling interest in subsidiary | ||||||||
| Total stockholders’ deficit | ( | ) | ( | ) | ||||
| Total liabilities and stockholders’ deficit | $ | $ | ||||||
See the accompanying notes to the unaudited condensed consolidated financial statements.
1
QUEST PATENT RESEARCH CORPORATION AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
| Three Months Ended March 31, | ||||||||
| 2024 | 2023 | |||||||
| Revenues | ||||||||
| Patent licensing fees | $ | $ | ||||||
| Cost of revenue | ||||||||
| Litigation and licensing expenses | ||||||||
| Gross profit | ||||||||
| Operating expenses | ||||||||
| Selling, general and administrative expenses | ||||||||
| Total operating expenses | ||||||||
| Income (loss) from operations | ( | ) | ( | ) | ||||
| Other expenses | ||||||||
| Change in fair market value of warrant liability | ( | ) | ( | ) | ||||
| Interest expense | ( | ) | ( | ) | ||||
| Total other expenses | ( | ) | ( | ) | ||||
| Loss before income tax | ( | ) | ( | ) | ||||
| Income tax expense | ( | ) | ||||||
| Net loss | $ | ( | ) | $ | ( | ) | ||
| $ | ( | ) | $ | ( | ) | |||
See the accompanying notes to the unaudited condensed consolidated financial statements.
2
QUEST PATENT RESEARCH CORPORATION AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ DEFICIT
| Common Stock | Additional Paid-In | Accumulated | Non-controlling Interest in | Total Stockholders’ | ||||||||||||||||||||
| Shares | Amount | Capital | Deficit | Subsidiaries | Deficit | |||||||||||||||||||
| Balances as of January 1, 2023 | $ | $ | $ | ( | ) | $ | | $ | ( | ) | ||||||||||||||
| Stock-based compensation | — | |||||||||||||||||||||||
| Net loss | — | ( | ) | ( | ) | |||||||||||||||||||
| Balances as of March 31, 2023 | $ | $ | $ | ( | ) | $ | $ | ( | ) | |||||||||||||||
| Common Stock | Additional Paid-In | Accumulated | Non-controlling Interest in | Total Stockholders’ | ||||||||||||||||||||
| Shares | Amount | Capital | Deficit | Subsidiaries | Deficit | |||||||||||||||||||
| Balances as of December 31, 2023 (Restated) | $ | $ | $ | ( | ) | $ | $ | ( | ) | |||||||||||||||
| Stock-based compensation | — | |||||||||||||||||||||||
| Net loss | — | ( | ) | ( | ) | |||||||||||||||||||
| Balances as of March 31, 2024 | $ | $ | $ | ( | ) | $ | $ | ( | ) | |||||||||||||||
See the accompanying notes to the unaudited condensed consolidated financial statements.
3
QUEST PATENT RESEARCH CORPORATION AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
| Three Months Ended March 31, | ||||||||
| 2024 | 2023 | |||||||
| Cash flows from operating activities: | ||||||||
| Net loss | $ | ( | ) | $ | ( | ) | ||
| Adjustments to reconcile net loss to cash used in operating activities: | ||||||||
| Change in fair market value of warrant liability | ||||||||
| Stock-based compensation | ||||||||
| Amortization of intangible assets | ||||||||
| Change in operating assets and liabilities: | ||||||||
| Accounts receivable | ( | ) | ||||||
| Accrued interest | ||||||||
| Other current assets | ( | ) | ( | ) | ||||
| Accounts payable and accrued liabilities | ||||||||
| Net cash used in operating activities | ( | ) | ( | ) | ||||
| Cash flows from investing activities: | ||||||||
| Purchase of patents | ( | ) | ||||||
| Net cash provided by (used in) investing activities | ( | ) | ||||||
| Cash flows from financing activities: | ||||||||
| Proceeds from funding liability | ||||||||
| Payment of funding liability | — | ( | ) | |||||
| Net cash provided by financing activities | ||||||||
| Net increase in cash and cash equivalents | ||||||||
| Cash and cash equivalents at beginning of period | ||||||||
| Cash and cash equivalents at end of period | $ | $ | ||||||
| Non-cash investing and financing activities: | ||||||||
| Interest added to principal | $ | $ | ||||||
| Supplemental disclosure of cash flow information: | ||||||||
| Cash paid during the period for: | ||||||||
| Income taxes | $ | $ | ||||||
| Interest | $ | $ | ||||||
See the accompanying notes to the unaudited condensed consolidated financial statements.
4
QUEST PATENT RESEARCH CORPORATION AND SUBSIDIARIES
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS
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, “we”, “us”, “our”, the “Company” refer 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 condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the U.S. (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 restated consolidated financial statements and accompanying notes included in amendment no.1 to the Company’s annual report on Form 10-K/A for the year ended December 31, 2023. 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.
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 March 31, 2024.
The consolidated financial statements include the accounts and operations of:
Quest Patent Research Corporation (“The Company”)
Digital IP Advisors Inc. (“DIPA”) (wholly owned) (formerly Quest Licensing Corporation (NY))
Quest Licensing Corporation (DE) (“QLC”) (wholly owned)
Quest Packaging Solutions Corporation
(
Quest Nettech Corporation (“NetTech”)
(
Semcon IP, Inc. (“Semcon”) (wholly owned)
Mariner IC, Inc. (“Mariner”) (wholly owned)
IC Kinetics, Inc. (“IC”) (wholly owned)
CXT Systems, Inc. (“CXT”) (wholly owned)
Photonic Imaging Solutions Inc. (“PIS”) (wholly owned)
M-Red Inc. (“M-Red”) (wholly owned)
Audio Messaging Inc. (“AMI”) (wholly owned)
Peregrin Licensing LLC (“PLL”) (wholly owned)
Taasera Licensing LLC (“TLL”) (wholly owned)
Soundstreak Texas LLC (“STX”) (wholly owned)
Multimodal Media LLC (“MML”) (wholly owned)
LS Cloud Storage Technologies, LLC (“LSC”) (wholly owned)
Tyche Licensing LLC (“Tyche”) (wholly owned)
Deepwell IP LLC (“DIP”) (wholly owned)
EDI Licensing LLC (“EDI”) (wholly owned)
Koyo Licensing LLC (“Koyo”) (wholly owned)
Harbor Island Dynamic LLC (“HID”) (wholly owned)
Flash Uplink LLC (“FUL”) (wholly owned)
Significant intercompany transactions and balances have been eliminated in consolidation.
5
The non-controlling interests are presented in the unaudited condensed consolidated balance sheets, separately from equity attributable to the stockholders of the Company. During the three months ended March 31, 2024 and 2023, none of the Company’s net loss was attributable to non-controlling interests.
Use of Estimates
In preparing financial statements in conformity with accounting principles generally accepted in the United States of America, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and revenue and expenses during the reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents
The Company considers all highly liquid investments with original maturity dates of three months or less when purchased, to be cash equivalents. The Company had no cash equivalents as of March 31, 2024 and December 31, 2023.
Accounts Receivable
Accounts receivable, which generally relate to licensed sales, are presented on the balance sheet net of estimated uncollectible amounts. The Company records an allowance for estimated uncollectible accounts in an amount approximating anticipated losses. Individual uncollectible accounts are written off against the allowance when collection of the individual accounts appears doubtful. The Company did not record an allowance for credit losses at March 31, 2024 and December 31, 2023.
The accounts receivable balance at March 31,
2024 and December 31, 2023 of approximately $
Intangible Assets
Intangible assets consist of patents which are amortized using the straight-line method over their estimated useful lives or statutory lives, whichever is shorter, and are reviewed for impairment upon any triggering event that may impact the assets’ ultimate recoverability as prescribed under the guidance related to impairment of long-lived assets. Costs incurred to acquire patents, including legal costs, are also capitalized as long-lived assets and amortized on a straight-line basis with the associated patent.
Patents include the cost of patents or patent rights
(collectively “patents”) acquired from third-parties or acquired in connection with business combinations. Patent acquisition
costs are allocated equally across the patents in force at the time of acquisition. Patent acquisition costs are amortized utilizing the
straight-line method over their remaining economic useful lives, ranging from
Impairment of Long-Lived Assets
Long-lived assets, including intangible assets with a finite life, are reviewed for impairment in accordance with Accounting Standards Codification (“ASC”) 360, “Property, Plant, and Equipment” whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable through the estimated undiscounted cash flows expected to result from the use and eventual disposition of the assets. Whenever any such impairment exists, an impairment loss will be recognized for the amount by which the carrying value exceeds the fair value. In the event that management decides to no longer allocate resources to a patent portfolio, an impairment loss equal to the remaining carrying value of the asset is recorded.
There were no impairments of long-lived assets for the three months ended March 31, 2024 and 2023.
6
Warrant Liability
The Company records a warrant liability with respect to warrants for which the number of shares underlying the warrants is not fixed until the date of the initial exercise. The amount of the liability is determined at the end of each fiscal period and the period-to-period change in the amount of warrant liability is reflected as a change in fair market value of warrant liability and is included under other income (expense) in the accompanying consolidated statements of operations.
Fair Value of Financial Instruments
Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. A fair value hierarchy is used which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. See Note 5 for information about our warrant liability.
The fair value hierarchy based on the three levels of inputs that may be used to measure fair value are as follows:
Level 1 – Quoted prices in active markets for identical assets or liabilities.
Level 2 – Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3 – Unobservable inputs that are supported by little or no market activity and that are financial instruments whose values are determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant judgment or estimation.
The carrying value reflected in the consolidated balance sheets for cash and cash equivalents, accounts receivable, accounts payable and accrued expenses and short-term borrowings approximate fair value due to the short-term nature of these items. The carrying value of long-term debt approximates fair value since the related rates of interest approximate current market rates. The fair value of warrant liabilities are classified as Level 3 in the fair value hierarchy.
Commitments and Contingencies
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 with funding sources that provide 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 and are included in cost of revenues as litigation and licensing expenses. 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.
7
Revenue Recognition
Patent Licensing Fees
The Company recognizes revenue in accordance with ASC Topic 606, “Revenue from Contracts with Customers”. Revenue is recognized when control of the promised goods or services is transferred to customers at an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods or services. Under Topic 606, revenue is recognized when there is a contract which has commercial substance which is approved by both parties and identifies the rights of the parties and the payment terms.
For the periods presented, revenue contracts executed by the Company primarily provided for the payment of contractually determined, one-time, paid-up license fees in consideration for the grant of certain intellectual property rights for patented technologies owned or controlled by the Company’s operating subsidiaries as part of the settlement of litigation commenced by the Company’s subsidiaries. Intellectual property rights granted included the following, as applicable: (i) the grant of a non-exclusive, retroactive and future license to manufacture and/or sell products covered by patented technologies, (ii) a covenant-not-to-sue, (iii) the release of the licensee from certain claims, and (iv) the dismissal of any pending litigation. The intellectual property rights granted were perpetual in nature, extending until the legal expiration date of the related patents. The individual intellectual property rights are not accounted for as separate performance obligations, as (a) the nature of the promise, within the context of the contract, is to transfer combined items to which the promised intellectual property rights are inputs and (b) the Company’s promise to transfer each individual intellectual property right described above to the customer is not separately identifiable from other promises to transfer intellectual property rights in the contract.
Since the promised intellectual property rights are not individually distinct, the Company combined each individual IP right in the contract into a bundle of IP rights that is distinct and accounted for all of the intellectual property rights promised in the contract as a single performance obligation. The intellectual property rights granted were “functional IP rights” that have significant standalone functionality. The Company’s subsequent activities do not substantively change that functionality and do not significantly affect the utility of the IP to which the licensee has rights. The Company’s subsidiaries have no further obligation with respect to the grant of intellectual property rights, including no express or implied obligation to maintain or upgrade the technology, or provide future support or services. The contracts provide for the grant (i.e., transfer of control) of the licenses, covenants-not-to-sue, releases, and other significant deliverables upon execution of the contract. Licensees legally obtain control of the intellectual property rights upon execution of the contract. As such, the earnings process is complete and revenue is recognized upon the execution of the contract, when collectability is probable and all other revenue recognition criteria have been met. Revenue contracts generally provide for payment of contractual amounts within 30 to 90 days of execution of the contract. Contractual payments made by licensees are generally non-refundable. The Company does not have any significant payment terms, as payment is received shortly after goods are delivered or services are provided, therefore there is no significant financing component or consideration payable to the customer in these transactions.
The Company’s revenue for the three months ended March 31, 2024 was generated from licenses pursuant to the settlement of patent infringement lawsuits in the TLL portfolio. Revenue for the three months ending March 31, 2023 was generated from licenses pursuant to the settlement of patent infringement lawsuits in the Tyche and STX portfolios.
Cost of Revenues
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. During the three months ended March 31, 2024, the Company received
a reimbursement for costs expensed in prior periods in the amount of approximately $
Inventor Royalties, Litigation Funding Fees and Contingent Legal Expenses.
In connection with the investment in or acquisition of certain patents and patent rights, certain of the Company’s operating subsidiaries may grant 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.
8
The Company’s 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 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.
Income Taxes
The Company did not incur any foreign income tax expense
for the three months ended March 31, 2024. The Company incurred $
Stock-Based Compensation
The Company recognizes stock-based compensation for employees and non-employees pursuant to ASC 718, “Compensation — Stock Compensation,” which prescribes accounting and reporting standards for all stock-based payment transactions. Transactions include incurring liabilities, or issuing or offering to issue shares, options and other equity instruments. Stock-based payments to employees, including grants of employee stock options, are recognized as compensation expense in the financial statements based on their fair values estimated using a Black-Scholes option pricing model. That expense is recognized over the period during which an employee is required to provide services in exchange for the award, known as the requisite service period (usually the vesting period).
Concentration of Credit Risk
The Company maintains its cash in bank deposit accounts, which at times, may exceed federally insured limits. The Company has not experienced any such losses in these accounts.
Net Income (Loss) Per Share
The Company calculates net income (loss) per
share by dividing income or losses allocated to the Company’s stockholders by the weighted average number of shares of common
stock outstanding for the period. Diluted weighted average shares is computed using basic weighted average shares plus any
potentially dilutive securities outstanding during the period using the treasury-stock-type method and the if-converted method,
except when their effect is anti-dilutive. Because the Company incurred losses for the three months ended March 31, 2024 and 2023,
potentially dilutive securities would be anti-dilutive, and therefore, the diluted net loss per share is the same as the basic net
loss per share. The Company’s potentially dilutive securities include
Recent Accounting Pronouncements
Management does not believe that there are any recently issued, but not effective, accounting standards which, if currently adopted, would have a material effect on our financial statements.
9
Going Concern
The Company has an accumulated deficit of approximately $
3. INTANGIBLE ASSETS
| March 31, | December 31, | |||||||
| 2024 | 2023 | |||||||
| Patents | $ | $ | ||||||
| Disposal | ||||||||
| Subtotal | ||||||||
| Less: accumulated amortization | ( | ) | ( | ) | ||||
| Net value of intangible assets | $ | $ | ||||||
| Weighted Average Amortization Period (Years) | ||||||||
Intangible assets are comprised of patents with estimated useful lives. The intangible assets at March 31, 2024 represent:
| ● | patents (which were fully amortized at the date of acquisition) acquired in January 2018 pursuant to an
agreement with Intellectual Ventures Assets 62 LLC and Intellectual Ventures Assets 71 LLC “(IV 62/71”), pursuant to which
CXT has an obligation to distribute |
| ● | patents (which were fully amortized at the date of acquisition) acquired in January 2018 by Photonic Imaging
Solutions Inc. (“PIS”) from Intellectual Ventures Assets 64 LLC (“IV 64”) pursuant to which PIS is to pay IV 64
(a) |
| ● | patents (which were fully amortized at the date of acquisition) acquired in May 2020 for a purchase price
of $ |
| ● | patents (which were fully amortized at the date of acquisition) acquired in February 2021 pursuant to
an agreement with PKT for a purchase price of $ |
10
| ● | patents (which were fully amortized at the date of acquisition) acquired in May 2021 for a purchase price
of $ |
| ● | patents acquired in October 2021 from AI for a purchase price of $ |
| ● | patents acquired in January 2022 for a purchase price of $ |
| ● | patents acquired in July 2022 via assignment from AI for a purchase price of $ |
| ● | patents acquired July 2022 pursuant to an agreement with Hewlett Packard Enterprise Development LP and
Hewlett Packard Enterprise Company for a purchase price of $ |
| ● | patents acquired March 2023 from Tower for a purchase price of $ |
| ● | patents acquired in August 2023 pursuant to an agreement with Koji Yoden for a purchase price of $ |
The Company amortizes the costs of intangible assets over their estimated useful lives on a straight-line basis. Costs incurred to acquire patents, including legal costs, are also capitalized as long-lived assets and amortized on a straight-line basis with the associated patent.
The Company assesses intangible assets for any impairment to the carrying values. As of March 31, 2024, management concluded that there was no impairment to the intangible assets.
Amortization expense for patents was approximately
$
| Year Ended December 31, | ||||
| Remainder of 2024 | $ | |||
| 2025 | ||||
| 2026 | ||||
| 2027 | ||||
| 2028 | ||||
| Thereafter | ||||
| Total | $ | |||
11
4. SHORT-TERM DEBT AND LONG-TERM LIABILITIES
Short-Term Debt
Loans Payable
The loans payable represents demand loans made by
former officers and directors, who are third parties and stockholders, whose holdings were insignificant, at March 31, 2024 and December 31,
2023, in the amount of $
Funding Liabilities
| March 31, 2024 | December 31, 2023 | |||||||
| Funding liability – QFL | $ | $ | ||||||
| Funding liability – QF3 | ||||||||
| Funding liabilities | $ | $ | ||||||
Funding Liabilities - QFL
The QFL funding liabilities at March 31, 2024
and December 31, 2023 of $
The Company did not request an operating capital advance
during the three months ended March 31, 2024. The Company requested and received an operating capital advance in the amount of $
Funding Liabilities - QF3
The QF3 funding liabilities at March 31, 2024
and December 31, 2023 of $
12
On March 12, 2023, the Company and HID, entered into a series of agreements, all dated March 12, 2023, with QF3, a non-affiliated party, including a prepaid forward purchase agreement (the “Purchase Agreement QF3”), a security agreement (the “QF3 Security Agreement”), a patent security agreement (the “QF3 Patent Security Agreement” together with the QF3 Security Agreement, the QF3 Patent Security Agreement, and the QF3 Purchase Agreement, the “QF3 Investment Documents”) pursuant to which, at the closing held contemporaneously with the execution of the agreements on March 12, 2023:
(i) Pursuant to the QF3 Purchase Agreement, QF3 agreed to make available
to the Company a financing facility of: (a) up to $
(ii) On March 17, 2023, the Company used
$
(iii) Pursuant to the QF3 Security Agreement and QF3 Patent Security Agreement, payment of the Company’s obligations under the QF3 Purchase Agreement with QF3 are secured by (a) the value of anything received from the monetization of the intellectual property rights covered by the Security Agreement; (b) the patents (as defined in the Security Agreement); (c) all general intangibles now or hereafter arising from or related to the foregoing (a) and (b); and (d) proceeds (including, without limitation, cash proceeds and insurance proceeds) and products of the foregoing (a)-(c).
In connection with the agreements with QF3, the Company, HID and the Subsidiary Guarantors entered into an intercreditor agreement with QF3 and Intelligent Partners which sets forth the priority of QF3 in the collateral under the Investment Documents.
Loan Payable Related Party
The loan payable – related party at March 31,
2024 and December 31, 2023 represents the current amount of a non-interest bearing total monetization proceeds obligation (the “TMPO”)
due to Intelligent Partners, LLC (“Intelligent Partners”) of $
On or prior to the date of the Restructure Agreement,
Intelligent Partners transferred to Andrew Fitton (“Fitton”) and Michael Carper (“Carper”) $
13
Because of the beneficial ownership percentage of its principals, Intelligent Partners is treated as a related party.
Long-Term Liabilities
Loan Payable – SBA
The loans payable – SBA balance at March 31,
2024 and December 31, 2023 of $
Purchase Price of Patents
The purchase price of patents balance at March 31,
2024 and December 31, 2023 of $
The non-current portion of our obligations under the
unsecured non-recourse funding agreement with a third-party funder entered into in May 2020 whereby the third-party agreed to provide
acquisition funding in the amount of $
5. WARRANT LIABILITY
On February 22, 2021, the Company issued warrants
to purchase
As of March 31, 2024 and December 31, 2023,
the aggregate fair value of the outstanding warrant liability was approximately $
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| As of | ||||||||
| March 31, | December 31, | |||||||
| 2024 | 2023 | |||||||
| Volatility | % | % | ||||||
| Exercise price | $ | $ | ||||||
| Risk-free interest rate | % | % | ||||||
| Expected dividends | % | % | ||||||
| Expected term | ||||||||
| Fair Value Measurements as of | ||||||||||||||||||||||||
| March 31, 2024 | December 31, 2023 | |||||||||||||||||||||||
| Level 1 | Level 2 | Level 3 | Level 1 | Level 2 | Level 3 | |||||||||||||||||||
| Liabilities | ||||||||||||||||||||||||
| Warrant liability | $ | $ | ||||||||||||||||||||||
| Total liabilities | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
| Fair Value | ||||
| Balance at December 31, 2023 | $ | |||
| Loss on subsequent measurement | ||||
| Balance at March 31, 2024 | $ | |||
See Notes 4 and 6 for information on the warrant issuance.
6. STOCKHOLDERS’ EQUITY
Issuance of Options
| Number of Options (#) | Weighted Average Exercise Price ($) | Weighted Average Grant Date Fair Value ($) | Weighted Average Remaining Contractual Life (Years) | |||||||||||||
| Balance - December 31, 2023 | ||||||||||||||||
| Granted | — | |||||||||||||||
| Exercised | — | |||||||||||||||
| Expired | — | |||||||||||||||
| Cancelled | — | |||||||||||||||
| Balance - March 31, 2024 | ||||||||||||||||
| Options exercisable at end of period | ||||||||||||||||
The outstanding options do not have an intrinsic value as of March 31, 2024 or December 31, 2023.
As of March 31, 2024, there was approximately
$
15
Issuance of Warrants
| Number of Warrants (#) | Weighted Average Exercise Price ($) | Weighted Average Remaining Contractual Life (Years) | ||||||||||
| Balance - December 31, 2023 | ||||||||||||
| Granted | — | |||||||||||
| Exercised | — | |||||||||||
| Expired | — | |||||||||||
| Cancelled | — | |||||||||||
| Balance - March 31, 2024 | ||||||||||||
The warrants contain certain minimum ownership percentage
antidilution rights pursuant to which the aggregate number of shares of common stock purchasable upon the initial exercise of the warrant
shall not be less than
7. NON-CONTROLLING INTEREST
| March 31, | December 31, | |||||||
| 2024 | 2023 | |||||||
| Balance, beginning of year | $ | $ | ||||||
| Net loss attributable to non-controlling interest | ||||||||
| Balance, end of year | $ | $ | ||||||
8. RELATED PARTY TRANSACTIONS
The Company has at various times entered into transactions with related parties, including officers, directors and major stockholders, wherein these parties have provided services, advanced or loaned money, or both, to the Company which was needed to support its daily operations. The Company discloses all related party transactions.
See Note 4 in connection with the Restructure Agreement dated February 22, 2021 with Intelligent Partners. Because of its ownership percentage, Intelligent Partners is treated as a related party.
See Note 9 with respect to the employment agreement with the Company’s president and chief executive officer.
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During three months ended March 31, 2024 and 2023, the Company contracted
with a law firm more than
During the three months ended March 31, 2024 and
2023, the Company contracted with a law firm more than
9. COMMITMENTS AND CONTINGENCIES
Employment Agreements
Pursuant to a restated employment agreement, dated
November 30, 2014, with the Company’s president and chief executive officer, the Company agreed to employ him as president and chief
executive officer for a term of three years, commencing January 1, 2014, and continuing on a year-to-year basis unless terminated by either
party on not less than 90 days’ notice prior to the expiration of the initial term or any one-year extension. The agreement provides
for an initial annual salary of $
SEP IRA Plan
Pursuant to the SEP IRA plan adopted by the Company
in March 2020, the Company deposited into a SEP IRA account of each of its participating employees a percentage of the employee’s
compensation, subject to statutory limitations on the amount of the contribution all as set forth in the IRS Form 5305-SEP. For the year
ending December 31, 2024, the percentage was set at
Inventor Royalties, Contingent Litigation Funding Fees and Contingent Legal Expenses
In connection with the investment in certain patents and patent rights, certain of the Company’s operating subsidiaries executed agreements which grant to the former owners of the respective patents or patent rights, the right to receive inventor royalties based on future net revenues (as defined in the respective agreements) generated as a result of licensing and otherwise enforcing the respective patents or patent portfolios.
17
The Company’s operating subsidiaries may engage third-party funding sources to provide funding for patent licensing and enforcement. The agreements with the third-party funding sources may provide that the funding source receive a portion of any negotiated fees, settlements or judgments. In certain instances, these third-party funding sources are entitled to receive a significant percentage of any proceeds realized until the third-party funder has recouped agreed upon amounts based on formulas set forth in the underlying funding agreement, which may reduce or delay and proceeds due to the Company.
The Company’s operating subsidiaries may retain the services of law firms in connection with their licensing and enforcement activities. These law firms may be retained on a contingent fee basis whereby the law firms are paid on a scaled percentage of any negotiated fees, settlements or judgments awarded based on how and when the fees, settlements or judgments are obtained.
Depending on the amount of any recovery, it is possible that all the proceeds from a specific settlement may be paid to the funding source and legal counsel.
The economic terms of the inventor agreements, funding agreements and contingent legal fee arrangements associated with the patent portfolios owned or controlled by the Company’s operating subsidiaries, if any, including royalty rates, proceeds sharing rates, contingent fee rates and other terms, vary across the patent portfolios owned or controlled by the operating subsidiaries. Inventor royalties, payments to noncontrolling interests, payments to third-party funding providers and contingent legal fees 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 royalties, payments to third-party funding sources and contingent legal fees expenses will continue to fluctuate and may continue to vary significantly period to period, based primarily on these factors.
Patent Enforcement and Other Litigation
Certain of the Company’s operating subsidiaries are engaged in litigation to enforce their patents and patent rights. In connection with these patent enforcement actions, it is possible that a defendant may request and/or a court may rule that an operating subsidiary has violated statutory authority, regulatory authority, federal rules, local court rules, or governing standards relating to the substantive or procedural aspects of such enforcement actions. In such event, a court may issue monetary sanctions against the Company or its operating subsidiaries or award attorney’s fees and/or expenses to a defendant(s), which could be material, and if required to be paid by the Company or its operating subsidiaries, could materially impair the Company’s operating results and financial position and could result in a default under the Company’s obligations to QFL and QF3. Since the operating subsidiaries do not have any assets other than the patents, and the Company does not have any available financial resources to pay any judgment which a defendant may obtain against a subsidiary, such a judgment may result in the bankruptcy of the subsidiary and/or the loss of the patents, which are the subsidiaries’ only assets.
10. SUBSEQUENT EVENTS
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of financial condition and results of operations should be read in conjunction with our consolidated unaudited financial statements and related notes included elsewhere in this report. This discussion contains forward-looking statements that involve risks, uncertainties and assumptions. See “Forward-Looking Statements.” Our actual results could differ materially from those anticipated in the forward-looking statements.
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 twenty-two intellectual property portfolios, of which we are currently seeking or may seek monetization with respect to twelve, 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. We anticipate that our primary source of revenue will come from the grant of licenses to use our intellectual property, including licenses granted as part of the settlement of patent infringement lawsuits.
Market and Economic Conditions
In recent years, the United States and other markets have experienced cyclical or episodic downturns, and worldwide economic conditions remain uncertain, including, as a result of the COVID-19 pandemic, supply chain disruptions, the Russian invasion of Ukraine, recent attacks by Hamas on Israel from the Gaza Strip and the resultant action by Israel against Hamas in the Gaza Strip and the potential for broader conflict in the Middle East, instability in the U.S. and global banking systems, rising fuel prices, increasing interest rates or foreign exchange rates and increased inflation and the possibility of a recession. We cannot predict the timing, strength, or duration of any future economic slowdown or any subsequent recovery generally, or in any industry. A significant downturn in economic conditions may adversely affect the intellectual property licensing market including the financial condition of financing sources and the willingness of potential financing sources to provide funding for our litigation; a law firms’ ability and willingness to provide us with legal services on acceptable contingent fee terms; and the financial condition and prospects of defendants and potential defendants, which could make it less likely that they would be willing to settle our claim.
Further, to the extent that holders of intellectual property rights see these and other macroeconomic factors, they may be reluctant to sell intellectual property to us on terms which are acceptable to us, if at all.
We seek to generate revenue from 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. All of the revenue for the three months ended March 31, 2024 and 2023 was from patent licensing fees, of which approximately 100% was paid or is payable to the patent seller, funding sources and legal counsel pursuant to our agreements with patent sellers, funding sources and legal counsel.
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 do not anticipate 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 and the net income we generated during the year ended December 31, 2023 may prove to be an aberration. Our gross profit from license fees reflects the payment of any royalties due in connection with our license.
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It is generally necessary to commence litigation in order to obtain a recovery for past infringement of, or to license the use of, our intellectual property rights. Intellectual property litigation is very expensive, with no certainty of any recovery. To the extent possible we seek to engage counsel on a contingent fee or partial contingent fee basis, which significantly reduces our litigation cost, but which also reduces the value of the recovery to us. We do not have the resources to enable us to fund the cost of litigation. Because we cannot fund litigation ourselves, we need to enter into an agreement with a third-party funding source. Our agreements with the funding sources typically provide that the funding source pays the litigation costs and that the funding source receives a percentage of the recovery, thus reducing our recovery in connection with any settlement of the litigation. In view of our limited cash and our working capital deficiency, we are not able to institute any monetization program that may require litigation unless we engage counsel on a fully contingent basis or we obtain funding from third party funding sources. In these cases, counsel may be afforded a greater participation in the recovery and the third party that funds the litigation would be entitled to participate in any recovery. 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.
Agreements with QF3, QFL and Intelligent Partners
On March 12, 2023, we entered into a funding agreement with QF3.
Pursuant to the QF3 Purchase Agreement, QF3 agreed to make available to us a financing facility of: (a) up to $25,000,000 for the acquisition of mutually agreed patent rights that we intend to monetize, of which no amounts have been received as of March 31, 2024; (b) up to $4,000,000 for operating expenses, of which the we have requested and received $3,334,381 as of March 31, 2024; and (iii) $3,300,000 to fund the cash payment portion of the purchase price of a patent portfolio acquired from Tower. In return we transferred to QF3 a right to receive a portion of net proceeds generated from the monetization of those patents. We used $3,300,000 proceeds from the QF3 financing as the cash payment portion of the purchase price of a portfolio acquired from Tower. Our obligations to QF3 are secured by the proceeds from the patents acquired with their funding, the patents and all general intangibles now or hereafter arising from or related to the foregoing and the proceeds and products of the foregoing.
On February 22, 2021, we entered into a funding agreement with QFL and a restructure agreement with Intelligent Partners.
Pursuant to the Purchase Agreement with QFL, QFL agreed to make available to us a financing facility of: (a) up to $25,000,000 for the acquisition of mutually agreed patent rights that we intend to monetize, of which $2,653,000 has been advanced as of March 31, 2024; (b) up to $2,000,000 for operating expenses, of which the we have requested and received $2,000,000 as of March 31, 2024; and (iii) $1,750,000 to fund the cash payment portion of the restructure of our obligations to Intelligent Partners. In return we transferred to QFL a right to receive a portion of net proceeds generated from the monetization of those patents. We used $1,750,000 of proceeds from the QFL financing as the cash payment portion of the restructure of our obligations to Intelligent Partners. Our obligations to QFL are secured by the proceeds from the patents acquired with their funding, the patents and all general intangibles now or hereafter arising from or related to the foregoing and the proceeds and products of the foregoing. We also granted QFL a ten-year warrant to purchase a total of up to 962,463 shares of our common stock, with an exercise price of $0.54 per share which may be exercised through February 18, 2031 on a cash or cashless basis, subject to certain limitations on exercisability. The warrant also contains certain minimum ownership percentage antidilution rights pursuant to which the aggregate number of shares of common stock purchasable upon the initial exercise of the Warrant shall not be less than 10% of the aggregate number of outstanding shares of our capital stock (determined on a fully diluted basis). A portion of any gain from sale of the shares, net of taxes and costs of exercise, realized prior to the completion of all monetization activities shall be credited against the total return due to QFL pursuant to the Purchase Agreement. We also agreed to take all commercially reasonable steps necessary to regain compliance with the OTCQB eligibility standards as soon as practicable, but in no event later than 12 months from the closing date, and regained compliance on May 7, 2021 and we granted QFL registration rights with respect to the common stock issuable upon exercise of the warrants. We also granted QFL certain board observation rights. Pursuant to the Purchase Agreement, all of the net proceeds from the monetization of the intellectual property acquired with funds from QFL are paid directly to QFL. After QFL has received a negotiated rate of return, we and QFL share net proceeds equally until QFL achieves its investment return, as defined in the agreement. Thereafter, we retain 100% of all net proceeds. Except in an Event of Default, as defined therein, all payments by us to QFL pursuant to the Purchase Agreement are non-recourse and shall be paid only if and after net proceeds from monetization of the patent rights owned or acquire by us are received, or to be received.
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Contemporaneously with the execution of the agreements with QFL, we entered into a restructure agreement with Intelligent Partners to eliminate any obligations we had with respect to the outstanding notes and the securities purchase agreement. As part of the restructure of our agreements with Intelligent Partners, we amended the existing MPAs and granted Intelligent Partners certain rights in the monetization proceeds from any new intellectual property we acquire. Under these MPAs, Intelligent Partners receives a 60% interest in the proceeds from our intellectual property owned by the eight Subsidiary Guarantors. Intelligent Partners also participates in the monetization proceeds from new intellectual property that we acquire until the total payments under all the monetization participation agreements equal $2,805,000, as follows: for net proceeds between $0 and $1,000,000, Intelligent Partners receives 10% of the net proceeds realized from new patents, except that if, in any calendar quarter, net proceeds realized by us exceed $1,000,000, Intelligent Partners’ entitlement for that quarter only shall increase to 30% on the portion of net proceeds in excess of $1,000,000 but less than $3,000,000. If in the same calendar quarter, net proceeds exceed $3,000,000, Intelligent Partners’ entitlement for that quarter only shall increase to 50% on the portion of net proceeds in excess of $3,000,000. The payments with respect to the new patents terminate once total payments to Intelligent Partners under all monetization participation agreements reach $2,805,000. The payments to Intellectual Partners with respect new patents are payable from the proceeds which are allocated to us under the QFL agreements, which start after QFL has received a negotiated rate of return.
Portfolios
In October 2022, TLL brought patent infringement suits in the U.S. District for the Eastern District of Texas against Fortinet, Inc., and Musarubra US, LLC. The actions against Fortinet, Inc. and Musarubra US LLC have been resolved and revenue for the three months ended March 31, 2024 includes revenue from the related settlements.
In February 2024, Harbor Island Dynamic brought a patent infringement suit in the U.S. District for the Eastern District of Texas against Samsung Electronics Co., Ltd. et al. This action is pending.
Results of Operations
Three Months Ended March 31, 2024 and 2023
| Three Months Ended March 31, | ||||||||
| 2024 | 2023 | |||||||
| Revenues (patent licensing fees) | $ | 1,045,000 | $ | 202,500 | ||||
| Cost of revenue (litigation and licensing expenses) | 561,552 | 187,973 | ||||||
| Selling, general and administrative expenses | 577,279 | 777,857 | ||||||
| Income (loss) from operations | (93,831 | ) | (763,330 | ) | ||||
| Other expenses | ||||||||
| Change in fair market value of warrant liability | (199,422 | ) | (8,566 | ) | ||||
| Interest expense | (138,189 | ) | (137,469 | ) | ||||
| Total other expenses | (337,611 | ) | (146,035 | ) | ||||
| Loss before income tax | (431,442 | ) | (909,365 | ) | ||||
| Income tax expense | — | (30,000 | ) | |||||
| Net loss | $ | (431,442 | ) | $ | (939,365 | ) | ||
We generated revenues of approximately $1,045,000 for the three months ended March 31, 2024 as compared to approximately $203,000 for the three months ended March 31, 2023. Our revenue for the three months ended March 31, 2024 was generated from licenses pursuant to the settlement of patent infringement lawsuits in the TLL portfolio. Our revenue for the three months ended March 31, 2023 was generated from licenses pursuant to the settlement of patent infringement lawsuits in the Tyche and STX portfolios. The total settlement recovery is included in revenue and the associated costs are deducted as cost of revenue. Cost of revenue for the three months ended March 31, 2024 and 2023 relating to patent service costs was approximately $562,000 and $188,000, respectively. During the three months ended March 31, 2024, the Company received a reimbursement for costs expensed in prior periods in the amount of approximately $334,000, resulting in a reduction of litigation and licensing expenses. The timing and amount of our revenue is dependent upon the results of litigation seeking to enforce our intellectual property rights, and we cannot predict when or whether we will have a recovery and how much of the recovery will be received by us after payments to legal counsel, to our funding sources, to inventors/former patent owners and to Intelligent Partners, all of whom or may have an interest in our share of the recovery from certain patent portfolios after deducting payments due to counsel and the litigation funding source.
Selling, general, and administrative expenses for the three months ended March 31, 2024 decreased by approximately $201,000, or approximately 26%, compared to the three months ended March 31, 2023, primarily due to compensation expense. Our principal operating expenses for the three months ended March 31, 2024 were amortization of intangible assets of approximately $167,000 and compensation expenses of approximately $165,000. Our principal operating expenses for the three months ended March 31, 2023 were amortization of intangible assets of approximately $159,000 and compensation expenses of approximately $450,000. We had stock-based compensation costs of approximately $6,000 and $19,000 for the three months ended March 31, 2024 and 2023, respectively. We anticipate increased administrative expenses in the second quarter of 2024 as a result of the restatement of our financial statements for the year ended December 31, 2023 and the filing of an amendment to our 10-K annual report.
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Other income and expense for the three months ended March 31, 2024 included a loss on change in fair value of warrant liability of approximately $199,000. We realized a loss on change in fair value of warrant liability of approximately $9,000 for the three months ended March 31, 2023. The fair value of the warrant liability is affected by the price of our common stock, so the liability increases as the stock price goes up, resulting in an expense, and decreases as the stock price goes down resulting in income from change in warrant liability. Other expense also reflects interest expense of approximately $138,000 for the three months ended March 31, 2024 and approximately $137,000 for the three months ended March 31, 2023.
We incurred income tax expense of approximately $0 and $30,000 for foreign income taxes for the three months ended March 31, 2024 and 2023, respectively.
As a result of the foregoing, we realized a net loss of approximately $431,000, or $0.08 per share (basic and diluted) and net loss of approximately $939,000, or $0.17 per share (basic and diluted), for the three months ended March 31, 2024 and 2023, respectively.
Liquidity and Capital Resources
At March 31, 2024, we had current assets of approximately $4,844,000 and current liabilities of approximately $14,809,000. Our current liabilities include funding liabilities of approximately $8,161,000 payable to QFL and QF3, a non-interest bearing total monetization proceeds obligation (the “TMPO”) to Intelligent Partners in the amount of approximately $2,797,000 under the Restructure Agreement, both of which are only payable from money generated from the monetization of intellectual property, loans payable of approximately $138,000, a warrant liability of approximately $481,000, accounts payable and accrued liabilities of approximately $1,999,000, and accrued interest of approximately $1,233,000. As of March 31, 2024, we have an accumulated deficit of approximately $24,342,000 and a negative working capital of approximately $9,965,000. Other than salary and pension benefits to our chief executive officer, we do not contemplate any other material operating expense requiring cash in the near future other than normal general and administrative expenses and legal fees, including expenses relating to our status as a public company filing reports with the SEC.
The following table shows the summary cash flows for the three months ended March 31, 2024 and 2023:
| Three Months Ended March 31, | ||||||||
| 2024 | 2023 | |||||||
| Cash flows used in operating activities | $ | (628,437 | ) | $ | (607,835 | ) | ||
| Cash flows used in investing activities | — | (3,300,000 | ) | |||||
| Cash flows from financing activities | 835,649 | 3,944,140 | ||||||
| Net increase in cash | 207,212 | 36,305 | ||||||
| Cash at beginning of year | 563,484 | 90,601 | ||||||
| Cash at end of year | $ | 770,696 | $ | 126,906 | ||||
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 or that we will receive any of the proceeds of any litigation settlements after making all required payments to counsel and funding sources and payments to Intelligent Partners. We have no credit facilities. Although our agreement provides for QFL and QF3 to provide us with funding to acquire intellectual property rights, subject to QFL’s and QF3’s approval, it does not provide for financing the litigation necessary for the monetization of the intellectual property rights. We do not have any credit facilities or any arrangements for us to finance the litigation necessary to monetize our intellectual property rights other than contingent fee arrangements with counsel with respect to our pending litigation. If we do not secure contingent representation or obtain litigation financing, we may be unable to monetize our intellectual property.
We cannot predict the success of any pending or future litigation. Typically, 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.
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As noted below, there is a substantial doubt about our ability to continue as a going concern.
Critical Accounting 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. 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 our financial statements.
Intangible Assets
Intangible assets consist of patents which are amortized using the straight-line method over their estimated useful lives or statutory lives whichever is shorter and are reviewed for impairment upon any triggering event that may give rise to the assets ultimate recoverability as prescribed under the guidance related to impairment of long-lived assets. Costs incurred to acquire patents, including legal costs, are also capitalized as long-lived assets and amortized on a straight-line basis with the associated patent.
Patents include the cost of patents or patent rights (collectively “patents”) acquired from third-parties or acquired in connection with business combinations. Patent acquisition costs are allocated equally across the patents in force at the time of acquisition. Patent acquisition costs are amortized utilizing the straight-line method over their remaining economic useful lives, ranging from one to ten years. Certain patent application and prosecution costs incurred to secure additional patent claims that, based on management’s estimates, are deemed to be recoverable, are capitalized and amortized over the remaining estimated economic useful life of the related patent portfolio.
Warrant Liability
We reflect a warrant liability with respect to warrants for which the number of shares underlying the warrants is not fixed until the date of the initial exercise. The amount of the liability is determined at the end of each fiscal period by using a Black-Scholes option pricing model to estimate the fair value. The period to period change in the amount of warrant liability is reflected as a gain or loss in warrant liability and is included under other expenses.
Stock-Based Compensation
We account for stock-based compensation for employees and non-employees pursuant to ASC 718, “Compensation — Stock Compensation,” which prescribes accounting and reporting standards for all stock-based payment transactions. Transactions include incurring liabilities, or issuing or offering to issue shares, options and other equity instruments. Stock-based payments to employees, including grants of employee stock options, are recognized as compensation expense in the financial statements based on their fair values estimated using a Black-Scholes option pricing model. That expense is recognized over the period during which an employee is required to provide services in exchange for the award, known as the requisite service period (usually the vesting period).
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Revenue Recognition
Patent Licensing Fees
We recognize revenue in accordance with ASC Topic 606, “Revenue from Contracts with Customers”. Revenue is recognized when control of the promised goods or services is transferred to customers at an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods or services. Under Topic 606, revenue is recognized when there is a contract which has commercial substance which is approved by both parties and identifies the rights of the parties and the payment terms.
For the periods presented, revenue contracts executed by us primarily provided for the payment of contractually determined, one-time, paid-up license fees in consideration for the grant of certain intellectual property rights for patented technologies owned or controlled by us or our operating subsidiaries as part of the settlement of litigation commenced by our subsidiaries. Intellectual property rights granted included the following, as applicable: (i) the grant of a non-exclusive, retroactive and future license to manufacture and/or sell products covered by patented technologies, (ii) a covenant-not-to-sue, (iii) the release of the licensee from certain claims, and (iv) the dismissal of any pending litigation. The intellectual property rights granted were perpetual in nature, extending until the legal expiration date of the related patents. The individual intellectual property rights are not accounted for as separate performance obligations, as (a) the nature of the promise, within the context of the contract, is to transfer combined items to which the promised intellectual property rights are inputs and (b) the Company’s promise to transfer each individual intellectual property right described above to the customer is not separately identifiable from other promises to transfer intellectual property rights in the contract.
Since the promised intellectual property rights are not individually distinct, we combine each individual IP right in the contract into a bundle of IP rights that is distinct, and accounted for all of the intellectual property rights promised in the contract as a single performance obligation. The intellectual property rights granted were “functional IP rights” that have significant standalone functionality. Our subsequent activities do not substantively change that functionality and do not significantly affect the utility of the IP to which the licensee has rights. Our subsidiaries have no further obligation with respect to the grant of intellectual property rights, including no express or implied obligation to maintain or upgrade the technology, or provide future support or services. The contracts provide for the grant (i.e., transfer of control) of the licenses, covenants-not-to-sue, releases, and other significant deliverables upon execution of the contract. Licensees legally obtain control of the intellectual property rights upon execution of the contract. As such, the earnings process is complete and revenue is recognized upon the execution of the contract, when collectability is probable and all other revenue recognition criteria have been met. Revenue contracts generally provide for payment of contractual amounts within 30 to 90 days of execution of the contract. Contractual payments made by licensees are generally non-refundable. We do not have any significant payment terms, as payment is received shortly after goods are delivered or services are provided, therefore there is no significant financing component or consideration payable to the customer in these transactions.
Our revenue for the three months ended March 31, 2024 was generated from licenses pursuant to the settlement of patent infringement lawsuits in the TLL portfolio. Our revenue for the three months ended March 31, 2023 was generated from licenses pursuant to the settlement of patent infringement lawsuits in the Tyche and STX portfolios.
Recent Accounting Pronouncements
Management does not believe that there are any recently issued, but not effective, accounting standards which, if currently adopted, would have a material effect on our financial statements.
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Going Concern
We have an accumulated deficit of approximately $24,342,000 and negative working capital of approximately $9,965,000 as of March 31, 2024. Although we generated income in 2023, we incurred a loss for the three months ended March 31, 2024 and we have a history of losses and can give no assurance that we will generate income in the future. Because of our history of losses, our working capital deficiency, the uncertainty of future revenue, our obligations to Intelligent Partners, QF3, and QFL, the low stock price of our common stock and the absence of an active trading market in our common stock and our failure to have effective internal controls over financial reporting, as reflected in the restatement of its financial statements for the year ended December 31, 2023, our ability to raise funds in the equity market or from lenders is severely impaired. These conditions, as well as any adverse consequences which would result from our failure to meet the continued listing requirements of the OTCQB, raise substantial doubt as to our ability to continue as a going concern. Our revenue is generated exclusively from license fees generated from litigation seeking damages for infringement of our intellectual property rights. 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 is 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.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
We are a smaller reporting company as defined by Rule 12b-2 of the Securities Exchange Act of 1934 and are not required to provide the information under this item.
Item 4. Controls and Procedures.
Management’s Conclusions Regarding Effectiveness of Disclosure Controls and Procedures
We conducted an evaluation of the effectiveness of our “disclosure controls and procedures” (“Disclosure Controls”), as defined by Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of March 31, 2024, the end of the period covered by this Quarterly Report on Form 10-Q. The Disclosure Controls evaluation was done under the supervision and with the participation of management, including our chief executive officer and acting chief financial officer, which positions are held by the same person. 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 acting chief financial officer concluded that, due to the material weaknesses in our internal control over financial reporting, our disclosure controls were not effective as of March 31, 2024, such that the information required to be disclosed by us in reports filed under the Securities Exchange Act of 1934 is (i) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and (ii) accumulated and communicated to the chief executive officer and acting chief financial officer, as appropriate to allow timely decisions regarding disclosure.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. In light of the restatement of our financial statements included in amendment no. 1 to our annual report on Form 10-K/A for the year ended December 31, 2023, which resulted from our failure to have effective internal controls over financial reporting, we plan to enhance our processes to identify and appropriately apply applicable accounting requirements to better evaluate and understand the nuances of the complex accounting standards that apply to our financial statements keeping in mind the limitation resulting from our limited resources and our not having a full-time chief financial officer with an accounting background. As previously disclosed, management has determined that our internal control over financial reporting contains material weaknesses due to the absence of segregation of duties, as well as lack of qualified accounting personnel and excessive reliance on third-party consultants for accounting, financial reporting and related activities. The lack of any separation of duties, with the same person, who is our only full time employee, serving as both chief executive officer and acting chief financial officer, and who does not have an accounting background, makes it unlikely that we will be able to implement effective internal controls over financial reporting in the near future.
During the period ended March 31, 2024, there was no change in our internal control over financial reporting (as such term is defined in Rule 13a-15(f) under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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Item 6. Exhibits.
| 31.1 | Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
| 32.1 | Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | |
| 101.INS | Inline XBRL Instance Document. | |
| 101.SCH | Inline XBRL Taxonomy Extension Schema Document. | |
| 101.CAL | Inline XBRL Taxonomy Extension Calculation Linkbase Document. | |
| 101.DEF | Inline XBRL Taxonomy Extension Definition Linkbase Document. | |
| 101.LAB | Inline XBRL Taxonomy Extension Label Linkbase Document. | |
| 101.PRE | Inline XBRL Taxonomy Extension Presentation Linkbase Document. | |
| 104 | Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101). |
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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.
Date: May 15, 2024
| QUEST PATENT RESEARCH CORPORATION | ||
| By: | /s/ Jon C. Scahill | |
| Jon C. Scahill | ||
| Chief Executive Officer and Acting Chief Financial Officer | ||
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