NOTES TO UNAUDITED CONSOLIDATED FINANCIAL
STATEMENTS
JUNE 30, 2020
NOTE 1 – DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION
The Company is a Delaware corporation, incorporated on July
17, 1987 and has been engaged in the intellectual property monetization business since 2008.
As used herein, the “Company” refers to Quest Patent
Research Corporation and its wholly and majority-owned and controlled operating subsidiaries unless the context indicates otherwise.
All intellectual property acquisition, development, licensing and enforcement activities are conducted by the Company’s wholly
and majority-owned and controlled operating subsidiaries.
The accompanying unaudited consolidated financial statements
have been prepared in accordance with accounting principles generally accepted in the US (GAAP) for interim financial information
and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, these interim financial statements do not
include all of the information and notes required by GAAP for complete financial statements. All adjustments (consisting of normal
recurring items) necessary to present fairly the Company’s consolidated financial position have been included. These interim
financial statements should be read in conjunction with the consolidated financial statements and accompanying notes included in
our Annual Report on Form 10-K for the year ended December 31, 2019. 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. Reclassifications
have been made to conform with the current year presentation.
NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of consolidation and financial statement presentation
The consolidated financial statements are prepared in accordance
with U.S. generally accepted accounting principles (“US GAAP”) and present the consolidated financial statements of
the Company and its wholly owned and majority owned subsidiaries as of June 30, 2020.
The consolidated financial statements include the accounts and
operations of:
|
|
Quest Patent Research Corporation (“The Company”)
|
|
|
Quest Licensing Corporation (NY) (wholly owned)
|
|
|
Quest Licensing Corporation (DE) (wholly owned)
|
|
|
Quest Packaging Solutions Corporation (90% owned)
|
|
|
Quest Nettech Corporation (65% owned)
|
|
|
Semcon IP, Inc. (wholly owned)
|
|
|
Mariner IC, Inc. (wholly owned)
|
|
|
IC Kinetics, Inc. (wholly owned)
|
|
|
CXT Systems, Inc. (wholly owned)
|
|
|
Photonic Imaging Solutions Inc. (wholly owned)
|
|
|
M-RED Inc. (wholly owned)
|
Prior to April 2019, the operations of Wynn Technologies, Inc.
were not included in the Company’s consolidated financial statements as there were significant contingencies related to its
control of Wynn Technologies, Inc. The sole asset of Wynn Technologies, Inc. was US Patent No. RE38,137E. Wynn Technologies, Inc.
could not transfer, assign, sell, hypothecate or otherwise encumber US Patent No. RE38,137E without the express written consent
of the owner of 35% of Wynn Technologies, Inc., unless, as of the date of such transfer, assignment, sale, hypothecation or other
encumbrance, the owner had received a total of at least $250,000. US Patent No. RE38,137E expired on September 28, 2015. The Company
accounted for its 65% interest in Wynn Technologies, Inc. under the equity method whereby the investment accounts were increased
for contributions by the Company plus its 60% share of income pursuant to the contractual agreement which provides that the holder
of 35% of the stock of Wynn Technologies, Inc. retained 40% of the income, and reduced for distributions and its 60% share of losses
incurred, respectively, with the restriction whereby the account balances cannot go below zero. On April 11, 2019, Quest NetTech
Corporation merged with Wynn Technologies, Inc. with Quest NetTech Corporation being the surviving entity. Pursuant to the merger
agreement, we issued a 35% interest in Quest NetTech Corporation to the former 35% stockholder of Wynn Technologies, Inc.
Significant intercompany transaction and balances have been
eliminated in consolidation.
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.
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 (hereinafter,
collectively “patents”) acquired from third-parties or acquired in connection with business combinations. 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.
Derivative Financial Instruments
The Company evaluates the embedded conversion feature within
its convertible debt instruments under ASC 815-15 and ASC 815-40 to determine if the conversion feature meets the definition of
a liability and, if so, whether to bifurcate the conversion feature and account for it as a separate derivative liability. For
derivative financial instruments that are accounted for as liabilities, the derivative instrument is initially recorded at its
fair value and is then re-valued at each reporting date, with changes in the fair value reported in the statements of operations.
For stock-based derivative financial instruments, the Company uses a Black Scholes model, in accordance with ASC 815-15 “Derivative
and Hedging” to value the derivative instruments at inception and on subsequent valuation dates. The classification of derivative
instruments, including whether such instruments should be recorded as liabilities or as equity, is evaluated at the end of each
reporting period. Derivative instrument liabilities are classified in the balance sheet as current or non-current based on whether
net-cash settlement of the derivative instrument could be required within 12 months after the balance sheet date.
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 4 for information about derivative liabilities.
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.
Income Tax
The Company records revenues on a gross basis, before deduction
for income taxes. The Company incurred foreign income tax expenses of approximately $65,000 and $65,000 for the three and six months
ended June 30, 2020, respectively, and approximately $0 and approximately $225 for the three and six months ended June 30, 2019,
respectively.
Inventor/Former Owner Royalties and Contingent Legal/Litigation
Finance Expenses
In connection with the investment in certain patents and patent
rights, certain of the Company’s operating subsidiaries may execute related agreements which grant to the inventors and/or
former owners of the respective patents or patent rights, the right to receive a percentage of future net revenues (as defined
in the respective agreements) generated as a result of licensing and otherwise enforcing the respective patents or patent portfolios.
The Company’s operating subsidiaries may retain the services
of law firms that specialize in patent licensing and enforcement and patent law in connection with their licensing and enforcement
activities. These law firms may be retained on a contingent fee basis whereby such law firms are paid a percentage of any
negotiated fees, settlements or judgments awarded.
The Company’s operating subsidiaries may engage 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. 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.
Revenue Recognition
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. The Company adopted Topic 606 as of
January 1, 2018 using the modified retrospective transition method, with no impact on the consolidated financial position or results
of operations.
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 the Company’s financial
statements.
Going Concern
As shown in the accompanying financial statements, the Company
has an accumulated deficit of approximately $21,023,000 and negative working capital of approximately $8,061,000 as of June 30,
2020. Because of the Company’s continuing losses, its working capital deficiency, the uncertainty of future revenue, the
Company’s obligations to Intellectual Ventures and Intelligent Partners, as transferee of United Wireless, the Company’s
low stock price and the absence of a trading market in its common stock, the ability of the Company to raise funds in equity market
or from lenders is severely impaired. These conditions, together with the effect s of the COVID-19 pandemic and the steps taken
by the states to slow the spread of the virus and its effect on its business raise substantial doubt as to the Company’s
ability to continue as a going concern. Although the Company may seek to raise funds and to obtain third party funding for litigation
to enforce its intellectual property rights, the availability of such funds, particularly in view of the COVID-19 pandemic, is
uncertain. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
NOTE 3 – SHORT-TERM DEBT AND LONG-TERM LIABILITIES
The following table shows the Company’s short-term and
long-term debt at June 30, 2020 and December 31, 2019.
|
|
|
June 30,
|
|
|
December 31,
|
|
|
|
|
2020
|
|
|
2019
|
|
|
Short-term debt:
|
|
|
|
|
|
|
|
Loans payable – third party
|
|
$
|
147,000
|
|
|
$
|
147,000
|
|
|
Purchase price of patents – current portion
|
|
|
975,000
|
|
|
|
569,386
|
|
|
Unamortized discount
|
|
|
(9,467
|
)
|
|
|
-
|
|
|
Net short-term debt
|
|
|
1,112,533
|
|
|
|
716,386
|
|
|
|
|
|
|
|
|
|
|
|
|
Loan payable – related party
|
|
|
|
|
|
|
|
|
|
Gross
|
|
|
4,672,810
|
|
|
|
4,672,810
|
|
|
Accrued Interest
|
|
|
116,500
|
|
|
|
117,780
|
|
|
Unamortized discount
|
|
|
(68,940
|
)
|
|
|
(189,705
|
)
|
|
Net loans payable – related party
|
|
$
|
4,720,370
|
|
|
$
|
4,600,885
|
|
|
Long-term liabilities:
|
|
|
|
|
|
|
|
|
|
Loan payable - SBA
|
|
|
|
|
|
|
|
|
|
Gross
|
|
$
|
170,832
|
|
|
|
-
|
|
|
Accrued Interest
|
|
|
900
|
|
|
|
-
|
|
|
Net loans payable SBA
|
|
|
171,732
|
|
|
|
-
|
|
|
Purchase price of patents
|
|
|
|
|
|
|
|
|
|
Gross
|
|
|
1,315,000
|
|
|
|
1,725,000
|
|
|
Unamortized discount
|
|
|
(186,114
|
)
|
|
|
(282,503
|
)
|
|
Net purchase price of patents – long-term
|
|
$
|
1,128,886
|
|
|
$
|
1,442,497
|
|
|
Contingent funding liabilities:
|
|
|
|
|
|
|
|
|
|
Gross
|
|
|
20,378
|
|
|
|
20,378
|
|
|
Net contingent funding liabilities
|
|
$
|
20,378
|
|
|
$
|
20,378
|
|
Loan payables:
The loan payable – third party represents unsecured demand
loans made by former officers and directors, who are unrelated third parties at June 30, 2020, and December 31, 2019, in the amount
of $147,000. The loans are payable on demand plus accrued interest at 10% per annum. These third parties are also stockholders,
but their stockholdings are not significant.
The loan payable – related party at June 30, 2020 represents
the principal amount of the Company’s 10% secured convertible note to Intelligent Partners, LLC (“Intelligent Partners”)
as transferee of the secured convertible notes issued to United Wireless Holdings, Inc. (“United Wireless”), in the
amount of $4,672,810 pursuant to securities purchase agreement dated October 22, 2015 between the Company and United Wireless,
as more fully described in the Company’s financial statements for the year ended December 31, 2019. The notes payable to
Intelligent Partners, as transferee of United Wireless, are classified as a current liability as of June 30, 2020 and December
31, 2019.
Interest on all notes issued pursuant to the securities purchase
agreement, accrued through September 30, 2018, with accrued interest being added to principal on September 30, 2016, 2017 and 2018.
On September 30, 2018, approximately $395,459 of accrued interest was added to principal. Since September 30, 2018, the Company
has been required to pay interest quarterly. For the three and six months ended June 30, 2020, the Company paid approximately $115,000
and 233,000 in interest, respectively, on these loans.
Because of its right to elect a director of the Company, United
Wireless is treated as a related party. Prior to the securities purchase agreement with United Wireless, the Company had no relationship
with United Wireless.
Long term liabilities
The loan payable-SBA at June 30, 2020 represents:
|
|
●
|
An unsecured loan from JPMorgan Chase Bank, N.A. in the aggregate amount of $20,832, pursuant to the Paycheck Protection Program (the “PPP”) under Division A, Title I of the Coronavirus Aid, Relief, and Economic Security Act, also knows as the CARES Act, which was enacted March 27, 2020. The loan, which was taken down on April 23, 2020, matures on April 23, 2022 and bears interest at a rate of 0.98% per annum, payable monthly commencing on November 23, 2020. The loan may be prepaid by the Company at any time prior to maturity with no prepayment penalties. Funds from the loan may only be used for payroll costs, costs used to continue group health care benefits, mortgage payments, rent, utilities, and interest on other debt obligations incurred before February 15, 2020. The Company intends to use the entire loan amount for qualifying expenses. Under the terms of the PPP, certain amounts of the loan may be forgiven if they are used for qualifying expenses as described in the CARES Act.
|
|
|
●
|
A secured Economic Injury Disaster Loan from the U.S. Small Business Association (“SBA”) in the aggregate amount of $150,000, pursuant to Section 7(b) of the Small Business Act as part of the COVID-19 relief effort, as amended. The Company’s obligations on the loan are set forth in the Company’s note dated May 14, 2020 which matures on May 14, 2050 and bears interest at a rate of 3.75% per annum, payable monthly commencing on May 14, 2021. The Note may be prepaid by the Company at any time prior to maturity with no prepayment penalties. Funds from the Loan may be used solely as working capital to alleviate economic injury caused by disaster occurring in the month of January 31, 2020 and continuing thereafter and to pay Uniform Commercial Code (UCC) lien filing fees and a third-party UCC handling charge of $100 which were deducted from the Loan amount stated above. In addition to the Loan, as part of the COVID-19 relief effort, the Company obtained an Emergency EIDL Grant from the SBA in the amount of $1,000. The Company is not required to repay the grant.
|
The purchase price of patents at June 30, 2020 represents:
|
|
●
|
the
minimum payments due under the agreement between CXT Systems, Inc. (“CXT”), a wholly owned subsidiary, and IV 34/37
pursuant to which at closing CXT acquired by assignment all right, title, and interest in a portfolio of fourteen United States
patents, five foreign patents and six related applications (the “CXT Portfolio”). Under the agreement, CXT will distribute
50% of net recoveries, as defined, to IV 34/37. CXT advanced $25,000 to IV 34/37 at closing, and agreed that in the event that,
on December 31, 2018, December 31, 2019 and December 31, 2020, cumulative distributions to IV 34/37 total less than $100,000,
$375,000 and $975,000, respectively, CXT shall pay the difference necessary to achieve the applicable minimum payment amount within
ten days after the applicable date; with any advances being credited toward future distributions to IV 34/36. As of June 30, 2020,
$600,000 of the minimum future cumulative distributions were presented as short-term debt based on the payment due date. No affiliate
of CXT has guaranteed the minimum payments. CXT’s obligations under the agreement are secured by a security interest in
the proceeds (from litigation or otherwise) from the CXT Portfolio. During the six-months ended June 30, 2020, the Company paid
the $194,386 liability that was classified as a short-term liability as of December 31, 2019.
|
|
|
●
|
The non-current portion of minimum payments due under the agreement between M-RED Inc. (“M-RED”), a wholly owned subsidiary and Intellectual Ventures Assets 113 LLC and Intellectual Ventures Assets 108 LLC (“IV 113/108”) pursuant to which M-RED paid IV 113/108 $75,000 and IV 113/108 transferred to M-RED all right, title and interest in a portfolio of sixty United States patents and eight foreign patents (the “M-RED Portfolio”). Under the agreement, M-RED will distribute 50% of net proceeds, as defined, to IV 113/108, as long as the Company generates revenue from the M-RED Portfolio. The agreement with IV 113/108 provides that if, on September 30, 2020, September 30, 2021 and September 30, 2022, cumulative distributions to IV 113/108 total less than $450,000, $975,000 and $1,575,000, respectively, M-RED shall pay the difference between such cumulative amounts and the amount paid to IV 113/108 within ten days after the applicable date. The $75,000 advance is treated as an advance against the first distributions of net proceeds payable to IV 113/108. As of June 30, 2020, $1,125,000 and $375,000 of the minimum future cumulative distributions were presented as long-term and short-term debt, respectively, based on payment due dates. No affiliate of M-RED has guaranteed the minimum payments. M-RED’s obligations under the agreement with IV 113/108 are secured by a security interest in the proceeds (from litigation or otherwise) from the M-RED Portfolio.
|
|
|
|
|
|
|
●
|
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 $95,000 for the company’s acquisition of the audio messaging portfolio. Under the funding agreement,
the third party funder is entitled to a priority return of funds advanced from net proceeds. as defined, recovered until the funder
has received $190,000. The Company has no other obligation to the third party and has no liability to the funder in
the event that the Company does not generate net proceeds. Pursuant to ASC 470, the company recorded this monetization
obligation as debt and the difference between the purchase price and total obligation as a discount to the debt and fully expensed
to interest during the period.
|
The contingent funding liabilities at June 30, 2020 represents:
|
|
●
|
the non-current portion of our obligations under the unsecured
non-recourse litigation funding agreement with a third-party litigation funder entered into in December 2018 whereby the third-party
agreed to provide litigation funding in the amount of $150,000 to the Company to enable the Company to support its structured licensing
programs for the CMOS and M-RED portfolios. Under the funding agreement, the third party receives a priority interest in the proceeds
from the programs that are payable to the Company, and the Company has no other obligation to the third party.
Our relationship with the funding source meets the criteria
in ASC 470-10-25 - Sales of Future Revenues or Various Other Measures of Income (“ASC 470”), which relates to cash
received from a funding source in exchange for a specified percentage or amount of revenue or other measure of income of a particular
product line, business segment, trademark, patent, or contractual right for a defined period. Under this guidance, we recognized
the fair value of our contingent obligation to the funding source, as of the acquisition date, as long-term debt in our consolidated
balance sheet. This initial fair value measurement is based on the perspective of a market participant and includes significant
unobservable inputs which are classified as Level 3 inputs within the fair value hierarchy and are discussed further within Note
2. At each subsequent reporting period, we will measure the long-term debt at fair value based on the discounted expected future
cash flows over the life of the obligation. Our repayment obligations are contingent upon future patent licensing fee revenues
generated from the licensing programs.
Under ASC 470, amounts recorded as debt shall be amortized under
the interest method. The Company made an accounting policy election to utilize the prospective method when there is a change in
the estimated future cash flows, whereby a new effective interest rate is determined based on the revised estimate of remaining
cash flows. The new rate is the discount rate that equates the present value of the revised estimate of remaining cash flows with
the carrying amount of the debt, and it will be used to recognize interest expense for the remaining periods. Under this method,
the effective interest rate is not constant, and any change in expected cash flows is recognized prospectively as an adjustment
to the effective yield. As of June 30, 2020, the total contingent funding liability was approximately $20,000, and the effective
interest rate was approximately 8.5%. This rate represents the discount rate that equates the estimated future cash flows with
the fair value of the debt and is used to compute the amount of interest to be recognized each period. Any future payments made
to the funding source will decrease the long-term debt balance accordingly. For the period ended June 30, 2020, the amortization
amount is deemed immaterial.
|
NOTE 4 – DERIVATIVE LIABILITIES
Because there is not a fixed conversion price, remaining compliant
with the authorized share requirement under the notes to Intelligent Partners is outside of the control of the Company. Because
there is no set limit on the number of shares issuable under the notes if the notes become convertible, absent an increase in the
stock price or an increase in authorized shares, there are potentially not enough authorized shares of common stock to satisfy
the exercise of the Company’s options, thus the Company determined that certain options qualify as derivative liabilities
under ASC Topic 815. On January 22, 2016, the Company reclassified all non-employee warrants and options as derivative liabilities
and revalued them at their fair values at each balance sheet date. Any change in fair value was recorded as other income (expense)
for each reporting period at each balance sheet date.
As of June 30, 2020, and December 31, 2019, the aggregate fair
value of the outstanding derivative liability was approximately $495,000 and $595,000, respectively.
The Company estimated the fair value of
the derivative liability using the Black-Scholes option pricing model using the following key assumptions during the period ended
June 30, 2020 and December 31, 2019:
|
|
|
Period Ended
|
|
|
|
|
June 30,
|
|
|
December 31,
|
|
|
|
|
2020
|
|
|
2019
|
|
|
Volatility
|
|
|
261
|
%
|
|
|
207-426
|
%
|
|
Risk-free interest rate
|
|
|
0.20
|
%
|
|
|
0.24
|
%
|
|
Expected dividends
|
|
|
-
|
|
|
|
-
|
%
|
|
Expected term
|
|
|
.25
|
|
|
|
1.75-4.70
|
|
The following schedule summarizes the valuation
of financial instruments at fair value in the balance sheets as of June 30, 2020 and December 31, 2019:
|
|
|
Fair Value Measurements as of
|
|
|
|
|
June 30, 2020
|
|
|
December 31, 2019
|
|
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
None
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Total assets
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Option derivative liability
|
|
|
-
|
|
|
|
-
|
|
|
|
495,000
|
|
|
|
-
|
|
|
|
-
|
|
|
|
595,000
|
|
|
Total liabilities
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
495,000
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
595,000
|
|
The following table sets forth a reconciliation of changes in
the fair value of derivative liabilities classified as Level 3 in the fair value hierarchy:
|
|
|
Significant Unobservable
Inputs
(Level 3)
as of
June 30,
2020
|
|
|
Beginning balance
|
|
$
|
595,000
|
|
|
Change in fair value
|
|
|
(100,000
|
)
|
|
Ending balance
|
|
$
|
495,000
|
|
NOTE 5 – STOCKHOLDERS’ EQUITY
No options were granted during six months ended June 30, 2020.
A summary of the status of the Company’s stock options
and changes is set forth below:
|
|
|
Number of
Options (#)
|
|
|
Weighted
Average
Exercise
Price ($)
|
|
|
Weighted
Average
Remaining
Contractual
Life (Years)
|
|
|
Balance - December 31, 2019
|
|
|
50,000,000
|
|
|
|
0.03
|
|
|
|
0.75
|
|
|
Granted
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Expired
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Cancelled
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Balance - June 30, 2020
|
|
|
50,000,000
|
|
|
|
0.03
|
|
|
|
0.25
|
|
NOTE 6 – INTANGIBLE ASSETS
Intangible assets include patents purchased
and are recorded based at their acquisition cost. Intangible assets consisted of the following:
|
|
|
|
|
|
|
|
|
Weighted
average
|
|
|
|
|
June 30,
|
|
|
December 31,
|
|
|
amortization
period
|
|
|
|
|
2020
|
|
|
2019
|
|
|
(years)
|
|
|
Patents
|
|
$
|
5,690,000
|
|
|
$
|
5,595,000
|
|
|
|
6.50
|
|
|
Less: net monetization obligations
|
|
|
(509,811
|
)
|
|
|
(509,811
|
)
|
|
|
|
|
|
Imputed interest
|
|
|
(713,073
|
)
|
|
|
(713,073
|
)
|
|
|
|
|
|
Subtotal
|
|
|
4,467,116
|
|
|
|
4,372,116
|
|
|
|
|
|
|
Less: accumulated amortization
|
|
|
(1,989,274
|
)
|
|
|
(1,617,762
|
)
|
|
|
|
|
|
Net value of intangible assets
|
|
$
|
2,477,842
|
|
|
$
|
2,754,354
|
|
|
|
6.38
|
|
Intangible assets are comprised of
patents with estimated useful lives. The intangible assets at June 30, 2020 represent:
|
|
●
|
patents acquired in October 2015 for a purchase price of $3,000,000, the useful lives of the patents, at the date of purchase, was 6-10 years;
|
|
|
●
|
patents acquired in July 2017 pursuant to an obligation to distribute 50% of net revenues to IV 34/37, against which $25,000 was advanced at closing and provided that in the event that, on December 31, 2018, December 31, 2019 and December 31, 2020, cumulative distributions of 50% of net revenues to IV 34/37 total less than $100,000, $375,000 and $975,000, respectively, CXT shall pay the difference necessary to achieve the applicable minimum payment amount within ten days after the applicable date; with any advances being credited toward future distributions to IV 34/36; the useful lives of the patents, at the date of acquisition, was 5-6 years;
|
|
|
●
|
patents (which were fully depreciated at the date of acquisition) acquired in January 2018 pursuant to an agreement with to Intellectual Ventures Assets 62 LLC and Intellectual Ventures Assets 71 LLC “(IV 62/71”), pursuant to which CXT has an obligation to distribute 50% of net revenues to IV 62/71 against which CXT advanced $10,000 at closing;
|
|
|
●
|
patents 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) 70% of the first $1,500,000 of net revenue, (b) 30% of the next $1,500,000 of net revenue and (c) 50% of net revenue in excess of $3,000,000, against which PIS advanced $10,000 at closing; and
|
|
|
●
|
patents acquired in March 2019 by M-Red Inc. (“M-Red”) from Intellectual Ventures Assets 113 LLC and Intellectual Ventures 108 LLC (“IV 113/108”) pursuant to which M-Red is obligated to distribute 50% of net revenues to IV 113/108, against which $75,000 was advanced at closing and provided that in the event that, on September 30, 2020, September 30, 2021 and September 30, 2022, cumulative distributions of 50% of net revenues to IV 113/108 total less than $450,000, $975,000 and $1,575,000, respectively, M-Red shall pay the difference necessary to achieve the applicable minimum payment amount within ten days after the applicable date; with any advances being credited toward future distributions to IV 113/108; the useful lives of the patents, at the date of acquisition, was approximately nine years; and
|
|
|
●
|
patents (which were fully depreciated at the date of acquisition) acquired in May 2020 for a purchase price of $95,000 pursuant to an agreement with Texas Technology Ventures 2, LLP (“TTV”), pursuant to which of the Company retains the first $230,000 of net proceeds, as defined in the agreement, after which the company has an obligation to distribute 50% of net proceeds to TTV.
|
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. Amortization
of patents is included as a selling, general and administrative expense in the accompanying consolidated statements of operations.
The Company assesses intangible assets for any impairment to
the carrying values. As of June 30, 2020, and December 31, 2019, management concluded that there was no impairment to the
acquired assets. At June 30, 2020 and December 31, 2019, the book value of the Company’s intellectual property was $2,477,842
and $2,754,354, respectively.
Amortization expense for patents comprised $371,512 and $529,486
for the six months ended June 30, 2020 and the year ended December 31, 2019, respectively. Future amortization of intangible assets
is as follows:
|
Year ended December 31,
|
|
|
|
|
Remainder of 2020
|
|
$
|
273,606
|
|
|
2021
|
|
|
549,345
|
|
|
2022
|
|
|
495,742
|
|
|
2023
|
|
|
323,070
|
|
|
2024 and thereafter
|
|
|
836,079
|
|
|
Total
|
|
$
|
2,477,842
|
|
Pursuant to the securities purchase
agreement dated October 22, 2015 between the Company and United Wireless, more fully described in the Company’s Annual Report
on Form 10-K for the year ended December 31, 2019, 15% of the net monetization proceeds from the patents acquired in October 2015
will be paid to Intelligent Partners, as transferee of United Wireless. This monetization obligation was recognized as a discount
to the loan and will be amortized over the life of the loan using the effective interest method. In addition, the Company entered
into a monetization agreement with United Wireless pursuant to which the Company agreed to pay United Wireless 7.5% of the net
monetization proceeds from the patents acquired by CXT in July 2017. This obligation was recorded as an expense and is reflected
in interest expense during the third quarter of 2017.
The Company granted Intellectual Ventures
a security interest in the patents assigned to the Company as security for the payment of the balance of the purchase price. The
security interest of Intellectual Ventures is senior to the security interest of United Wireless in the proceeds derived from such
patents.
Pursuant to the funding agreement dated
May 29, 2019 between the Company and the funding source, 100% of the net monetization proceeds due to the company from the audio
messaging patents acquired in May 2020 will be paid to the funding source until the funding source receives $190,000. The monetization
obligation, net of the $95,000 provided by the funding source, was recognized as a discount to the debt, recorded as an expense
and is reflected in interest expense during the period.
The balance of the purchase price of
the patents is reflected as follows:
|
|
|
June 30,
2020
|
|
|
December 31,
2019
|
|
|
Current Liabilities:
|
|
|
|
|
|
|
|
Purchase price of patents, current portion
|
|
|
975,000
|
|
|
$
|
569,386
|
|
|
Unamortized discount
|
|
|
(9,467
|
)
|
|
|
|
|
|
Non-current liabilities:
|
|
|
|
|
|
|
|
|
|
Purchase price of patents, long term
|
|
|
1,315,000
|
|
|
$
|
1,725,000
|
|
|
Unamortized discount
|
|
|
(186,114
|
)
|
|
|
(282,503
|
)
|
|
Total current and non-current
|
|
|
2,094,419
|
|
|
|
2,011,883
|
|
|
Effective interest rate of Amortized over 2-3 years
|
|
|
9.35%-14.45
|
%
|
|
|
9.6-12.5
|
%
|
Because the non-current minimum payment
obligations of $2,100,000 are due over the next three and a quarter years, the Company imputed interest of 10% and the interest
will be accreted up to the maturity date.
NOTE 7 – NON-CONTROLLING INTEREST
The following table reconciles equity attributable to the non-controlling
interest related to Quest Packaging Solutions Corporation.
|
Balance as of December 31, 2019
|
|
$
|
239
|
|
|
Net income attributable to non-controlling interest
|
|
$
|
-
|
|
|
Balance as of June 30, 2020
|
|
$
|
239
|
|
NOTE 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 Notes 3 and 6 in connection with transactions with United
Wireless. During periods ended June 30, 2020 and 2019, the Company incurred interest expense on the Company’s 10% notes issued
to United Wireless pursuant to the securities purchase agreement dated October 22, 2015 more fully described in the Company’s
financial statements for the year ended December 31, 2019. On each of September 30, 2017 and 2018, accrued interest was added to
the principal amount of the note. Subsequent to September 30, 2018, the Company is to pay interest quarterly. During the three
and six months ended June 30, 2020 the Company paid the amounts due of approximately $116,500 and 233,000 in interest, respectively,
and the amounts due of approximately $115,000 and 233,000 for the three and six months ended June 30, 2019, respectively.
See Note 9 with respect to the employment agreement with the
Company’s president and chief executive officer.
During the three and six months ended June 30, 2020 and 2019,
the Company contracted with an entity owned by the chief technology officer for the provision of information technology services
to the Company. The cost of such services was approximately $90 and $205 for the three and six months ended June 30, 2020, respectively,
and approximately $90 and $235 for the three and six months ended June 30, 2019, respectively.
NOTE 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 $252,000, which may be increased, but not decreased, by the board or the compensation
committee. In March 2016, the Company’s board of directors increased the chief executive officer’s annual salary to
$300,000, effective January 1, 2016. The chief executive officer is entitled to a bonus if the Company meets or exceeds performance
criteria established by the compensation committee. In August 2016, the Company’s board of directors approved annual bonus
compensation equal to 30% of the amount by which our consolidated income before income taxes exceeds $500,000, but, if the Company
is subject to the limitation on deductibility of executive compensation pursuant to Section 162(m) of the Internal Revenue Code,
the bonus cannot exceed the amount which would be deductible pursuant to Section 162(m). The chief executive officer is also eligible
to participate in any executive incentive plans which the Company may adopt.
On May 11, 2020, the board of directors adopted a Simplified
Employee Pension – Individual Retirement Accounts Contribution Agreement for it employees pursuant to which the Company deposits
to a SEP IRA account of its employees a percentage of the employee’s compensation, subject to statutory limitations on the
amount of the contribution. For 2020, the percentage was set at 19%. The Company has only one employee, its chief executive officer.
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.
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.
In December 2018, we entered into an unsecured non-recourse
funding agreement whereby a third party agreed to provide funds to us to enable us to support our structured licensing programs
for the CMOS and M-RED portfolios. Under the funding agreement, the third party receives an interest in the proceeds from the programs,
and we have no other obligation to the third party. As of June 30, 2020, the Company paid the third party approximately $130,000
under the agreement.
In May 2020, the Company entered into an unsecured non-recourse
funding agreement whereby a third party agreed to provide funds for the acquisition of the audio messaging portfolio. Under the
funding agreement, the third party receives a priority interest in the net proceeds, as defined in the agreement, from the program
up to $190,000 and the Company has no other obligation to the third party and has no liability to the funder in the event that
the Company does not generate net proceeds. See Note 3 for information with respect to the funding agreement.
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 harm the Company’s operating results and financial position and could result in a default under the Company’s
notes to Intelligent Partners. 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 judgement
may result in the bankruptcy of the subsidiary and/or the loss of the patents, which are the subsidiaries’ only assets.
On January 19, 2017, the court in the Mobile Data Portfolio
litigation granted the defendants’ motion for summary judgment of non-infringement, On January 31, 2017, Quest Licensing
Corporation filed a notice of appeal with the United States Court of Appeals for the Federal Circuit. Following the court’s
decision granting the defendant’s motion for summary judgment, the defendants moved for an award of attorneys’ fees
under Section 285 of the Patent Act which provides that “the court in exceptional cases may award reasonable attorney fees
to the prevailing party.” On June 29, 2017, the defendants’ motion for attorney fees in the Mobile Data litigation
was denied, without prejudice and with leave to renew their motion thirty days from the decision of the appellate court on Quest
Licensing Corporation’s appeal. On June 8, 2018 the appellate court affirmed the lower court’s decision. On June
9, 2018 Quest Licensing Corporation filed a petition for rehearing with the appellate court. On July 30, 2018 the appellate court
denied Quest Licensing Corporations petition for rehearing. On March 27, 2019 the court in the Mobile Data Portfolio litigation
denied the defendants’ motion for attorney fees under Section 285 of the Patent Act.
In May 2018 CXT brought patent infringement suits in the United
States District Court for the Eastern District of Texas against Stage Stores, Inc. In February 2020, Specialty Retailers, Inc.
(“Specialty”), the parent company of Stage Stores, Inc., failed to make the final installment payment pursuant to the
Settlement and License Agreement between Specialty and CXT. On March 31, 2020, CXT made a sealed motion with the Court to Reopen
the Action and Enforce the Settlement Agreement. On April 17, 2020, the Court set a Telephone Status Conference for April 20, 2020.
On May 1, 2020, CXT filed a sealed motion with the Court seeking Summary Judgment to Enforce the Settlement Agreement. On May 4th
the Court granted the motion. On May 10, 2020 Specialty filed voluntary petitions under Chapter 11 of the Bankruptcy Code in the
U.S. Bankruptcy Court for the Southern District of Texas, Houston Division. On May 16, 2020, CXT filed a proof of claim with the
Bankruptcy Court. On May 20, 2020, the reopened District Court action was stayed automatically pending the outcome of the bankruptcy
action.
In May 2018 CXT Systems brought patent infringement suits in
the United States District Court for the Eastern District of Texas against J.C. Penney Company, Inc. (“JCP”). On April
20, 2020 the parties entered into a settlement and license agreement and the case was dismissed. On May 15, 2020 JCP filed voluntary
petitions under Chapter 11 of the Bankruptcy Code in the U.S. Bankruptcy Court for the Southern District of Texas, Houston Division.
On June 4, 2020, the CXT notified JCP of material breach of the settlement and license agreement for failure to make payment pursuant
to the agreement. On May 16, 2020, CXT filed a proof of claim with the Bankruptcy Court.