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VRINGO INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations.(Edgar Glimpses Via Acquire Media NewsEdge) This Quarterly Report on Form 10-Q contains "forward-looking statements" that involve risks and uncertainties, as well as assumptions that, if they never materialize or prove incorrect, could cause our results to differ materially from those expressed or implied by such forward-looking statements. The statements contained herein that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements are often identified by the use of words such as, but not limited to, "anticipates," "believes," "can," "continues," "could," "estimates," "expects," "intends," "may," "will be," "plans," "projects," "seeks," "should," "targets," "will," "would," and similar expressions or variations intended to identify forward-looking statements. These statements are based on the beliefs and assumptions of our management based on information currently available to management. Such forward-looking statements are subject to risks, uncertainties and other important factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified below, and those discussed in the section titled "Risk Factors" included in our Annual Report on Form 10-K filed on March 10, 2014 and any future reports we file with the Securities and Exchange Commission ("SEC"). The forward-looking statements set forth herein speak only as of the date of this report. Except as required by law, we undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements, except as required by law. All references in this Quarterly Report on Form 10-Q to "we," "us" and "our" refer to Vringo, Inc., a Delaware corporation, and its consolidated subsidiaries. Overview Vringo, Inc. ("Vringo") strives to develop, acquire, license and protect innovation worldwide. We are currently focused on identifying, generating, acquiring, and deriving economic benefits from intellectual property assets. We plan to continue to expand our portfolio of intellectual property assets through acquiring and internally developing new technologies. We intend to monetize our technology portfolio through a variety of value enhancing initiatives, including, but not limited to: • licensing, • strategic partnerships, and • litigation. The accompanying interim consolidated financial statements are presented in accordance with generally accepted accounting principles in the United States of America ("U.S. GAAP"). All significant intercompany balances and transactions have been eliminated in consolidation. Our Strategy We manage an intellectual property portfolio consisting of over 600 patents and patent applications, covering telecom infrastructure, internet search and mobile technologies. These patents and patent applications have been developed internally or acquired from third parties. We innovate, acquire, license and protect technology and intellectual property rights worldwide. We seek to expand our portfolio of intellectual property through acquisition and development both internally and with the assistance of third parties. Our goal is to partner with innovators of compelling technologies. In potential acquisitions, we seek to purchase all of, or interests in, technology and intellectual property in exchange for cash, our securities and/or interests in the monetization of those assets. Our revenue from this aspect of our business can be generated through licensing and litigation efforts. We engage in robust due diligence and a principled risk underwriting process to evaluate the merits and potential value of any acquisition or partnership. We seek to structure the terms of our acquisitions and partnerships in a manner that will achieve the highest risk-adjusted returns possible. We believe that our capital resources and potential access to capital, together with the experience of our management team and board of directors, will allow us to assemble a portfolio of quality assets with short and long-term revenue opportunities. 17 Intellectual Property Search Patents In June 2011, I/P Engine acquired eight patents from Lycos, Inc. ("Lycos") through its wholly-owned subsidiary, I/P Engine. On September 15, 2011, I/P Engine initiated litigation in the United States District Court, Eastern District of Virginia, against Google Inc., and certain of its customers ("Defendants") for infringement of two of the patents acquired from Lycos. On November 6, 2012, a jury in Norfolk, Virginia unanimously returned a verdict in favor of I/P Engine. The jury verdict is available at http://bit.ly/QBRt5S. On November 20, 2012, the District Court issued a ruling that asserted patents were not invalid as obvious, and the Court entered final judgment which can be found at http://bit.ly/1hqlUpD. On January 3, 2014, the District Court ordered that I/P Engine recover an additional sum from the Defendants for supplemental damages and prejudgment interest. This ruling can be found at http://bit.ly/1iRY5rc. On January 21, 2014, the District Court ruled that the Defendants' alleged design-around was "nothing more than a colorable variation of the system adjudged to infringe," and accordingly I/P Engine "is entitled to ongoing royalties as long as [the] Defendants continue to use the modified system." This ruling can be found at http://bit.ly/1rpVeZp. On January 28, 2014, the District Court ruled that the appropriate ongoing royalty rate for Defendants' continued infringement of the patents-in-suit that "would reasonably compensate [I/P Engine] for giving up [its] right to exclude yet allow an ongoing willful infringer to make a reasonable profit" is a rate of 6.5% of the 20.9% royalty base previously set by the District Court. Both I/P Engine and the Defendants have appealed the case to the U.S. Court of Appeals for the Federal Circuit. The case number for the District Court case is 2:11 CV 512-RAJ. The case numbers for the cases in the Court of Appeals for the Federal Circuit are 13-1307, 13-1313, 14-1233 and 14-1289. On May 6, 2014, the United States Court of Appeals for the Federal Circuit heard oral argument in I/P Engine, Inc., Plaintiff-Cross Appellant v. AOL Inc., Google Inc., IAC Search & Media, Inc., Gannett Company, Inc. and Target Corporation, Defendants-Appellants, Appeal Nos. 13-1307 and 13-1313. The Court's decision in the case is pending as of the filing date of this Form 10-Q. Requests for reexamination are a standard tactic used by defendants in patent litigation cases. Google has previously filed four separate requests for reexamination of the two asserted patents at the USPTO, with the two requests on one of the patents being merged. On July 2, 2014, the USPTO mailed a notice that it will issue a certificate that all of the claims of U.S. Patent No. 6,314,420 remain valid and unchanged. This is the second time the USPTO has confirmed the validity of the '420 patent. The USPTO has also previously confirmed the validity of U.S. Patent No. 6,775,664, the other patent asserted in litigation with Google. At this time, there are no other pending reexaminations for the patents asserted in the litigation. On January 31, 2013, I/P Engine initiated litigation in the United States District Court, Southern District of New York, against Microsoft Corporation ("Microsoft"). On May 30, 2013, I/P Engine entered into a settlement and license agreement with Microsoft to resolve the litigation. According to the agreement, Microsoft paid I/P Engine $1,000,000 and agreed to pay 5% of any future amount Google pays for its use of the patents acquired from Lycos. The parties also agreed to a limitation on Microsoft's total liability, which would not impact us unless the amounts received from Google substantially exceed the judgment previously awarded. In addition, the parties entered into a patent assignment agreement, pursuant to which Microsoft assigned six patents to I/P Engine. The assigned patents relate to telecommunications, data management, and other technology areas. The case number was 1:13 CV 00688. 18 Infrastructure Patents On August 9, 2012, we entered into a patent purchase agreement with Nokia Corporation ("Nokia"), comprising of 124 patent families with counterparts world-wide. The total consideration paid for the portfolio was $22,000,000. Under the terms of the purchase agreement, to the extent that the gross revenue generated by such portfolio exceeds $22,000,000, we are obligated to pay a royalty of 35% of such excess. The portfolio encompasses technologies relating to telecom infrastructure, including communication management, data and signal transmission, mobility management, radio resources management and services. Declarations were filed by Nokia indicating that 31 of the 124 patent families acquired may be essential to wireless communications standards. Copies of the declarations are available on our website at http://www.vringoip.com/documents/FG/vringo/ip/99208_Nokia_ETSI_Declarations.pdf. As one of the means of realizing the value of the patents on telecom infrastructure, our wholly-owned subsidiaries, Vringo Infrastructure, Inc. ("Vringo Infrastructure"), Vringo, Inc. and Vringo Germany GmbH ("Vringo Germany") have filed a number of suits against ZTE Corporation ("ZTE"), ASUSTeK Computer Inc. ("ASUS"), and Tyco Integrated Security, LLC ("Tyco") and certain of their subsidiaries, affiliates and other companies in the United States, European jurisdictions, India, Australia, Brazil, and Malaysia alleging infringement of certain U.S., European, Indian, Australian, Brazilian, and Malaysian patents. ZTE United Kingdom On October 5, 2012, Vringo Infrastructure, filed a suit in the UK High Court of Justice, Chancery Division, Patents Court, alleging infringement of certain European patents. Subsequently, ZTE responded to the complaint on December 19, 2012 with a counterclaim for invalidity of the patents in suit. Vringo Infrastructure filed a further UK suit on December 3, 2012, alleging infringement of additional European patents. In the first UK suit, trial is scheduled for October 2014 and in the second UK suit, trial is scheduled for June 2015. Germany On November 15, 2012, Vringo Germany filed a suit in the Mannheim Regional Court in Germany, alleging infringement of a European patent. The litigation was expanded to include a second European patent on February 21, 2013. On November 4, 2013, we filed a further brief with respect to the proceedings of the first European patent suit, asserting infringement by ZTE eNode B infrastructure equipment used in 4G networks. The hearing for the first European patent case has been postponed by mutual agreement with ZTE; no date has been set for reinstatement. On December 17, 2013, the Court issued its judgment in the second European patent case, finding that ZTE infringed that patent and ordered an accounting and an injunction upon payment of the appropriate bonds. On February 19, 2014, Vringo Germany filed suit in the Mannheim Regional Court seeking enforcement of the accounting ordered and a further order that non-compliance be subject to civil and criminal penalties. On May 5, 2014, we paid a bond of approximately $1,400,000 to the Court in order to enforce the injunction against ZTE. Trial in the suit to enforce the accounting is scheduled for September 2014. On December 27, 2013, ZTE filed a notice of appeal of the Mannheim Regional Court's judgment in the second European patent case, and on January 24, 2014, ZTE filed an emergency motion with the Court of Appeals seeking a stay of the judge's order pending appeal. On February 24, 2014, ZTE's motion was denied. On September 13, 2013 and January 28, 2014, Vringo Germany filed two suits in the Regional Court of Düsseldorf, alleging infringement of two additional European patents. Both cases are scheduled to be heard in November 2014. On April 23, 2014, Google commenced the process to intervene in the fourth filed suit as an interested third party. As a result of this process, Google is entitled to file defensive briefs in tandem with ZTE. ZTE filed nullity suits with respect to the first and second European patents in the Federal Patents Court in Munich, Germany during the second and fourth quarters, respectively, of 2013. Trials in the nullity suits have not been scheduled. ZTE filed a nullity suit with respect to the third European patent in the Federal Patents Court in Munich, Germany, in the fourth quarter of 2013. A schedule has not yet been set and the trial is not anticipated before the third quarter of 2015. In addition, ZTE filed a nullity suit with respect to the fourth European patent in the Federal Patents Court in Munich, Germany in the second quarter of 2014. A schedule has not yet been set and the trial is not anticipated before the third quarter of 2015. 19 China In November and December 2012, ZTE filed reexamination requests in China against three Chinese patents owned by Vringo before the Patent Reexamination Board of the Patent Office of the People's Republic of China. On July 3, 2013, the patent rights for one of those patents was upheld. On May 30, 2014, the patent rights for another one of those patents was upheld. The oral hearing for the remaining patent occurred on January 23, 2014, for which the ruling is still pending. Between December 20 and December 28, 2013, ZTE filed four more additional reexamination requests against four other Chinese patents owned by Vringo. Vringo filed responses for these four patents in early May 2014. The oral hearing for one of the patents occurred on June 17, 2014. Oral hearings for the remaining three patents are expected to occur later in the year. Between May and July of 2014, ZTE filed reexamination requests in China against 25 additional Chinese patents owned by Vringo before the Patent Reexamination Board of the Patent Office of the People's Republic of China. Vringo's initial responses are due in August of 2014. The remaining schedule in these 25 new re-examinations is not yet available. On February 21, 2014, ZTE filed a civil antitrust complaint against Vringo and Vringo Infrastructure in the Shenzhen Intermediate Court. Vringo received notice of the action on June 26, 2014. Vringo intends to vigorously contest all aspects of this action in the appropriate manner. A schedule for the case has not yet been set. France On March 29, 2013, Vringo Infrastructure filed a patent infringement lawsuit in France in the Tribunal de Grande Instance de Paris, alleging infringement of the French part of two European patents. Vringo Infrastructure filed the lawsuit based on particular information uncovered during a seizure to obtain evidence of infringement, known as a saisie-contrefaçon, which was executed at two of ZTE's facilities in France. The oral hearing in relation to these patents has been scheduled for December 2014 before the 3rd division of the 3rdchamber of the Tribunal de Grande Instance de Paris (specializing in IP matters). Australia On June 11, 2013, Vringo Infrastructure filed a patent infringement lawsuit in the Federal Court of Australia in the New South Wales registry, alleging infringement by ZTE of two Australian patents. We currently anticipate that the Court will set a trial date in 2015. Spain On September 6, 2013, Vringo Infrastructure filed a preliminary inquiry order against ZTE in the Commercial Court of Madrid, Spain, requiring ZTE to provide discovery relating to alleged infringement of a patent which is the Spanish counter-part of the second European patent filed in Germany. In light of ZTE's non-responsiveness to the order, on March 24, 2014 the Court granted our request to seek discovery of four of ZTE's Spanish customers. We have received responses from all four customers. India On November 7, 2013, we, along with our subsidiary, Vringo Infrastructure, filed a patent infringement lawsuit in the High Court of Delhi at New Delhi, India, alleging infringement of an Indian patent related to CDMA. On November 8, 2013, the Court granted an ex-parte preliminary injunction and appointed commissioners to inspect ZTE's facilities and collect evidence. ZTE appealed the preliminary injunction and, on December 12, 2013, the appellate panel instituted an interim arrangement, requiring ZTE to file an accounting affidavit disclosing the number of CDMA devices sold by its entities in India, revenue derived therefrom, and other supporting documentation. The Court also required ZTE to pay a bond approximately $800,000, directed Indian customs authorities to notify us when all relevant ZTE goods are imported into India, and required ZTE to give us the opportunity to inspect those goods. ZTE filed its accounting affidavit on January 13, 2014. On February 3, 2014, we filed a motion for contempt for ZTE's failure to comply with the Court's order, and requested that the Court order ZTE to pay an increased bond. 20 On January 31, 2014, we and our subsidiary, Vringo Infrastructure, filed a patent infringement lawsuit in the High Court of Delhi at New Delhi, alleging infringement of a second Indian patent related to GSM Infrastructure. The Court, finding a prima facie case of infringement, granted an ex-parte preliminary injunction, restraining ZTE and its officers, directors, agents, distributors and customers from importing, selling, offering for sale, advertising, installing, or operating any infringing products, and giving us the right to inspect any infringing goods arriving in India, which are to be detained by customs authorities. The judge granted the injunction after ruling that we would suffer an irreparable loss if such an injunction were not put into place. ZTE subsequently appealed the injunction. On August 5, 2014, ZTE's appeal was heard by the Court. A ruling is pending. Brazil On April 14, 2014, Vringo Infrastructure filed a patent infringement lawsuit in the 5th Trial Court of Rio de Janeiro State Court in Brazil, alleging infringement of a Brazilian patent related to 3G/4G/LTE infrastructure. On April 15, 2014, the court granted an ex-parte preliminary injunction restraining ZTE from manufacturing, using, offering for sale, selling, installing, testing, or importing such infrastructure equipment, subject to a fine. To enforce the injunction, the Company posted a bond of approximately $904,000 with the court on April 17, 2014. On May 9, 2014, ZTE filed an interlocutory appeal against the injunction. This appeal was denied by the Court on June 16, 2014. On July 17, 2014, ZTE filed a nullity suit in the Federal district court in Rio de Janiero, Brazil, against both Vringo and the Brazilian patent office, seeking to invalidate Vringo's Brazilian patent. Malaysia On June 23, 2014, Vringo Infrastructure filed a patent infringement lawsuit against ZTE in the High Court of Malaya at Kuala Lumpur. A schedule has not yet been set in this matter. Romania On June 23, 2014, Vringo Infrastructure filed a patent infringement lawsuit against ZTE in the Bucharest Tribunal Civil Section. On July 1, 2014, the court granted an ex-parte preliminary injunction, ordering ZTE to cease any importation, exportation, introduction on the market, offer for sale, storage, sale, trade, distribution, promotion, or any other business activity regarding the infringing product. The remaining schedule has not yet been set in this matter. Netherlands On May 28, 2014, Vringo Infrastructure commenced legal proceedings, pursuant to European Anti-Piracy Regulations, Number 1383/2003, Article 11 against ZTE in the District Court of The Hague. A schedule has not yet been set in this matter. On June 4, 2014, ZTE filed suit in the District Court of Rotterdam against Vringo and Vringo Infrastructure for the alleged wrongful detention of goods under the relevant anti-piracy regulations. A schedule has not yet been set in this matter. On July 24, 2014, ZTE filed an action for a preliminary injunction in District Court of The Hague against Vringo Infrastructure for the release of allegedly wrongfully detained goods. This matter will be heard on September 16, 2014. United States On July 2, 2014, Vringo filed suit in the United States District Court for the Southern District of New York seeking a temporary restraining order and preliminary and permanent injunctions against ZTE, enjoining ZTE's use of prohibited materials captured under NDA, including but not limited to ZTE's use of such materials in its antitrust lawsuit in China against Vringo and Vringo Infrastructure. On July 7, 2014, the court granted a temporary restraining order against ZTE's use of such material. On July 23, 2014, ZTE filed a counterclaim against Vringo. 21 European Commission On April 10, 2014, ZTE filed a complaint with the European Commission. We believe that the accusations are not accurate. The European Commission has not yet set the schedule for this matter. ASUS Germany On October 4, 2013 and January 29, 2014, Vringo Germany filed two patent infringement lawsuits against ASUS in the Düsseldorf Regional Court, alleging infringement of two European patents. The cases are scheduled to be heard in November 2014. ASUS filed nullity suits with respect to the first and second European patents in the Federal Patents Court in Munich, Germany, during the second quarter of 2014. Trials in the nullity suits have not been scheduled but are not anticipated before the second quarter of 2016 for the first patent and the second quarter of 2015 for the second patent. Spain On February 7, 2014, Vringo Infrastructure filed suit in the Commercial Court of Barcelona alleging infringement of a patent which is the Spanish counter-part of the first European patent filed in Germany. The oral hearing for this case is scheduled to be heard before the Commercial Court of Barcelona in November 2014. India On April 15, 2014, Vringo Infrastructure filed suit in the High Court of Delhi, New Delhi alleging infringement of a patent related to use of dictionaries in search engines preloaded on certain ASUS devices. A schedule for the case has not yet been set. Tyco On April 28, 2014, the Company entered into a confidential agreement with Tyco that resolved all litigation pending between the parties. Sale of mobile social application business to InfoMedia Services Limited ("InfoMedia") On December 31, 2013, we entered into a definitive asset purchase agreement with InfoMedia for the sale of certain assets (mostly comprised of acquired technology) and the assignment of certain agreements related to our mobile social application business. The closing of the transaction occurred on February 18, 2014 ("Closing"). Upon Closing, as consideration for the assets and agreements related to our mobile social application business, we received 18 Class B shares of InfoMedia, which represent an 8.25% ownership interest in InfoMedia. InfoMedia is a privately owned, UK based, provider of customer relationship management and monetization technologies to mobile carriers and device manufacturers. As part of the transaction, we will have the opportunity to license certain intellectual property assets and support InfoMedia to identify and protect new intellectual property. Additionally, our Chief Executive Officer was appointed as a full voting member on InfoMedia's board of directors and we received a number of customary protective rights. June 2014 Warrants On June 19, 2014, we entered into agreements with certain of our warrant holders, pursuant to which the warrant holders exercised for cash 5,697,227 of their outstanding Series 1 and Series 2 warrants, with an exercise price of $1.76 per share. In addition, we granted such warrant holders unregistered warrants of the Company to purchase an aggregate of 5,412,366 shares of our common stock, par value $0.01 per share, at an exercise price of $5.06 per share (the "June 2014 Warrants"). The June 2014 Warrants expire on June 21, 2015 and because such warrants do not bear any down-round protection clauses, they are classified as equity instruments. As a result of these transactions, we received approximately $10 million of proceeds. 22 Results of Operations Overview Revenue Revenue from patent licensing and enforcement is recognized when collection is reasonably assured, persuasive evidence of an arrangement exists, the sales price is fixed or determinable and delivery of the service has been rendered. We use management's best estimate of selling price for individual elements in multiple-element arrangements, where vendor specific evidence or third party evidence of selling price is not available. Currently, our revenue arrangements provide for the payment of contractually determined fees in consideration for the grant of certain intellectual property rights related to our patents. These rights typically include some combination of the following: (i) the grant of a non-exclusive, retroactive and future license to manufacture and/or sell products covered by patents, (ii) the release of the licensee from certain claims, and (iii) the dismissal of any pending litigation. The intellectual property rights granted may be perpetual in nature, extending until the expiration of the related patents, or can be granted for a defined, relatively short period of time, with the licensee possessing the right to renew the agreement at the end of each contractual term for an additional minimum upfront payment. Pursuant to the terms of these agreements, we have no further obligation with respect to the grant of the non-exclusive retroactive and future licenses, covenants-not-to-sue, releases, and other deliverables, including no express or implied obligation on our part to maintain or upgrade the related technology, or provide future support or services. Generally, the agreements provide for the grant of the licenses, covenants-not-to-sue, releases, and other significant deliverables upon execution of the agreement, or upon receipt of the minimum upfront payment for term agreement renewals. As such, the earnings process is complete and revenue is recognized upon the execution of the agreement, upon receipt of the minimum upfront fee for term agreement renewals, and when all other revenue recognition criteria have been met. Operating legal costs Operating legal costs mainly include expenses incurred in connection with our patent licensing and enforcement activities, patent-related legal expenses paid to external patent counsel (including contingent legal fees), licensing and enforcement related research, consulting and other expenses paid to third parties, as well as internal payroll expenses and stock-based compensation. Amortization of intangibles Amortization of intangibles represents the amortization expense of our acquired patents which is recognized on a straight-line basis over the remaining legal life of the patents. Research and development expenses Research and development expenses consist primarily of the cost of our development personnel, as well as of the cost of outsourced development services. General and administrative expenses General and administrative expenses include management and administrative personnel, public and investor relations, overhead/office costs and various professional fees, as well as insurance, non-operational depreciation and amortization. Non-operating income (expenses) Non-operating income (expenses) includes transaction gains (losses) from foreign exchange rate differences, interest on deposits, bank charges, as well as fair value adjustments related to our derivative warrant liabilities. The value of such derivative warrant liabilities is highly influenced by assumptions used in its valuation, as well as by our stock price at the period end (revaluation date). 23 Income taxes At June 30, 2014, deferred tax assets generated from our U.S. activities were offset by a valuation allowance because realization depends on generating future taxable income, which, in our estimation, is not more likely than not to be generated before such net operating loss carryforwards expire. Prior to the sale of our mobile social application business, our subsidiary in Israel generated net taxable income from services it provided to us. The subsidiary in Israel charged us for research, development, certain management and other services provided to us, plus a profit margin on such costs, which was 8%. In the zone where the production facilities of the subsidiary in Israel were located, the statutory tax rate was 12.5% in 2013. Three month period ended June 30, 2014 compared to the three month period ended June 30, 2013 Revenue Three months ended June 30, 2014 2013 Change Revenue $ 800,000 $ 1,100,000 $ (300,000 ) During the three month period ended June 30, 2014, we recorded total revenue of $800,000, which represents a decrease of $300,000 (or 27.3%) as compared to the three month period ended June 30, 2013. The current period revenue was due to a one-time payment in connection with a license and settlement agreement for certain of our owned intellectual property. Revenue during the three month period ended June 30, 2013 of $1,100,000 mostly relates to a one-time payment in connection with the license and settlement agreement entered into with Microsoft for $1,000,000. We seek to generate revenue through the monetization of our intellectual property through licensing, strategic partnerships and litigation, when required, which may be resolved through a settlement or collection. We also intend to continue to expand our planned operations through acquisitions and monetization of additional patents, other intellectual property or operating businesses. In particular, following the incorporation of our subsidiary in Germany and the acquisition of a patent portfolio from Nokia, we intend to continue to expand our intellectual property monetization efforts worldwide. We anticipate that our legal proceedings may continue for several years and may require significant expenditures for legal fees and other expenses. Disputes regarding the assertion of patents and other intellectual property rights are highly complex and technical. Operating legal costs Three months ended June 30, 2014 2013 Change Operating legal costs $ 5,982,000 $ 4,790,000 $ 1,192,000 During the three month period ended June 30, 2014, our operating legal costs were $5,982,000, which represents an increase of $1,192,000 (or 24.9%) from operating legal costs recorded for the three months ended June 30, 2013. This increase was primarily due to the timing and nature of consulting and patent litigation costs related to legal proceedings against Google and ZTE. During the three month period ended June 30, 2014, there were costs associated with the oral argument heard in the appeals court in May 2014 in connection with our legal proceedings against Google. With respect to our legal proceedings against ZTE, costs during the three month period ended June 30, 2014 were associated with our continued worldwide litigation efforts including commencement of legal actions in Brazil, Malaysia, Spain, Netherlands, and other countries. 24 It is uncertain whether our operating legal costs will increase over time. Though we aim to diversify our portfolio of products and increase our intellectual property monetization efforts, we have also increased the size of our in-house legal department staff as mentioned above. The goal is to decrease our overall legal expenses by bringing more work in-house, which we believe will cost less than outsourcing to external firms. There is no guarantee, however, that an in-house team will be less expensive or more efficient than outsourcing this work. Moreover, as we expand the scope of our monetization efforts, the amount of legal work will increase leading to a concomitant increase in our operating legal costs, regardless of whether such work is performed in-house or outsourced. Amortization of intangibles Three months ended June 30, 2014 2013 Change Amortization of intangibles $ 968,000 $ 839,000 $ 129,000 During the three month period ended June 30, 2014, amortization expense related to our intangibles was $968,000 which represents an increase of $129,000 (or 15.4%) from amortization of intangibles recorded for the three month period ended June 30, 2013. Currently, our intangible assets consist of our patent portfolios which are amortized over their remaining useful lives (i.e., through the expiration date of the patent). The increase during the current quarter was due to the additional patent portfolios that were acquired during the second half of 2013. Research and development Three months ended June 30, 2014 2013 Change Research and development $ 217,000 $ 467,000 $ (250,000 ) During the three month periods ended June 30, 2014 and 2013, our research and development expenses amounted to $217,000 and $467,000, respectively. The prior period amount excludes research and development expenses related to our mobile social application business which is presented in discontinued operations. The decrease of $250,000 (or 53.5%) is primarily due to a decrease in costs related to third party consultants who were engaged on certain projects during 2013. Such projects had ended prior to 2014 and therefore these third party consultants were no longer utilized in the current period. As mentioned above, in February 2014, we sold our mobile social application business to InfoMedia. As part of the sale agreement, the employment of our mobile products and services personnel were assumed by InfoMedia. General and administrative Three months ended June 30, 2014 2013 Change General and administrative $ 3,986,000 $ 3,759,000 $ 227,000 During the three month period ended June 30, 2014, general and administrative expenses increased by $227,000 (or 6.0%), to $3,986,000, compared to $3,759,000 that was recorded during the three month period ended June 30, 2013. The overall increase in general and administrative expenses was primarily due to increased costs in connection with our efforts to consolidate our executive management and finance functions in a centralized location. In addition, there was an increase in corporate legal and accounting fees as compared to the prior period. The overall increase is partially offset by a decrease in stock-based compensation expense of about $319,000 as compared to the prior three month period. 25 Non-operating income (expense), net Three months ended June 30, 2014 2013 ChangeNon-operating income (expense), net $ 304,000 $ (1,474,000 ) $ 1,778,000 During the three month period ended June 30, 2014, we recorded non-operating income in the amount of $304,000 compared to non-operating expense in the amount of $1,474,000 during the three month period ended June 30, 2013. During the three month period ended June 30, 2014, we recorded approximately $348,000 of income related to a decrease in the fair value of our derivative warrant liabilities. This income was partially offset by $65,000 of expense recorded in connection with the issuance of the June 2014 Warrants described above. During the three month period ended June 30, 2013, a charge of $1,574,000 was recorded related to the removal of the down-round protection clause in certain then outstanding Series 1 Warrants. This expense was partially offset by income of $77,000 related to a decrease in fair value of our then remaining derivative warrant liabilities. We expect that our non-operating income (expense) will remain highly volatile, and we may choose to fund our operations through additional financing. In particular, non-operating income (expense) will be affected by the adjustments to fair value of our derivative instruments. Fair value of these derivative instruments depends on a variety of assumptions, such as estimations regarding triggering of down-round protection and estimated future share price. An estimated increase in the price of our common stock increases the value of the warrants and thus results in a loss on our statement of operations. In addition, high estimated probability of a down-round protection increases the value of the warrants and again results in a loss on our statement of operations. Also refer to Note 8 to the accompanying unaudited consolidated financial statements. Loss from discontinued mobile social application operations Three months ended June 30, 2014 2013 Change Revenue $ - $ 61,000 $ (61,000 ) Operating expenses - (748,000 ) 748,000 Operating loss - (687,000 ) 687,000 Non-operating expense - (22,000 ) 22,000 Loss before taxes on income - (709,000 ) 709,000 Income tax expense - (2,000 ) 2,000Loss from discontinued operations $ - $ (711,000 ) $ 711,000 On February 18, 2014, we executed the sale of our mobile social application business to InfoMedia, receiving eighteen (18) Class B shares of InfoMedia as consideration, which represent an 8.25% ownership interest. Additionally, our Chief Executive Officer was appointed as a full voting member on InfoMedia's board of directors and we received a number of customary protective rights. The InfoMedia Class B shares are accounted for as a cost-method investment. During the three month period ended June 30, 2014, there were no results from discontinued operations since all related activities ceased when the sale was executed. Six month period ended June 30, 2014 compared to the six month period ended June 30, 2013 Revenue Six months ended June 30, 2014 2013 Change Revenue $ 1,050,000 $ 1,100,000 $ (50,000 ) During the six month period ended June 30, 2014, we recorded total revenue of $1,050,000, which represents a decrease of $50,000 (or 4.5%) as compared to the six month period ended June 30, 2013. The current period revenue was due to certain one-time payments in connection with license and settlement agreements for certain of our owned intellectual property. Revenue during the six month period ended June 30, 2013 of $1,100,000 mostly relates to a one-time payment in connection with the license and settlement agreement entered into with Microsoft for $1,000,000. 26 We seek to generate revenue through the monetization of our intellectual property through licensing, strategic partnerships and litigation, when required, which may be resolved through a settlement or collection. We also intend to continue to expand our planned operations through acquisitions and monetization of additional patents, other intellectual property or operating businesses. In particular, following the incorporation of our subsidiary in Germany and the acquisition of a patent portfolio from Nokia, we intend to continue to expand our intellectual property monetization efforts worldwide. We anticipate that our legal proceedings may continue for several years and may require significant expenditures for legal fees and other expenses. Disputes regarding the assertion of patents and other intellectual property rights are highly complex and technical. Operating legal costs Six months ended June 30, 2014 2013 Change Operating legal costs $ 10,857,000 $ 10,189,000 $ 668,000 During the six month period ended June 30, 2014, our operating legal costs were $10,857,000, which represents an increase of $668,000 (or 6.6%) from operating legal costs recorded for the six months ended June 30, 2013. This increase was primarily due to the timing and nature of consulting and patent litigation costs related to legal proceedings against Google and ZTE. During the six month period ended June 30, 2014, there were costs associated with the oral argument heard in the appeals court in May 2014 in connection with our legal proceedings against Google. With respect to our legal proceedings against ZTE, costs during the six month period ended June 30, 2014 were associated with our continued worldwide litigation efforts including commencement of legal actions in Brazil, Malaysia, Spain, Netherlands, and other countries. Also, there was an increase in stock-based compensation expense (approximately $133,000) due to our efforts to expand our in-house legal department staff. It is uncertain whether our operating legal costs will increase over time. Though we aim to diversify our portfolio of products and increase our intellectual property monetization efforts, we have also increased the size of our in-house legal department staff as mentioned above. The goal is to decrease our overall legal expenses by bringing more work in-house, which we believe will cost less than outsourcing to external firms. There is no guarantee, however, that an in-house team will be less expensive or more efficient than outsourcing this work. Moreover, as we expand the scope of our monetization efforts, the amount of legal work will increase leading to a concomitant increase in our operating legal costs, regardless of if such work is performed in-house or outsourced. Amortization of intangibles Six months ended June 30, 2014 2013 Change Amortization of intangibles $ 1,925,000 $ 1,678,000 $ 247,000 During the six month period ended June 30, 2014, amortization expense related to our intangibles was $1,925,000 which represents an increase of $247,000 (or 14.7%) from amortization of intangibles recorded for the six month period ended June 30, 2013. Currently, our intangible assets consist of our patent portfolios which are amortized over their remaining useful lives (i.e., through the expiration date of the patent). The increase during the current period was due to the additional patent portfolios that were acquired during the second half of 2013. Research and development Six months ended June 30, 2014 2013 Change Research and development $ 442,000 $ 737,000 $ (295,000 ) 27 During the six month periods ended June 30, 2014 and 2013, our research and development expenses amounted to $442,000 and $737,000, respectively. These amounts exclude research and development expenses related to our mobile social application business which is presented in discontinued operations. The decrease of $295,000 (or 40.0%) is primarily due to a decrease in costs related to third party consultants who were engaged on certain projects during 2013. Such projects had ended prior to 2014 and therefore these third party consultants were no longer utilized in the current period. As mentioned above, in February 2014, we sold our mobile social application business to InfoMedia. As part of the sale agreement, the employment of our mobile products and services personnel were assumed by InfoMedia. General and administrative Six months ended June 30, 2014 2013 Change General and administrative $ 8,004,000 $ 7,750,000 $ 254,000 During the six month period ended June 30, 2014, general and administrative expenses increased by $254,000 (or 3.3%), to $8,004,000, compared to $7,750,000 that was recorded during the six month period ended June 30, 2013. The overall increase in general and administrative expenses was primarily due to increased costs in connection with our efforts to consolidate our executive management and finance functions in a centralized location. In addition, there was an increase in corporate legal, insurance, and accounting costs as compared to the prior period. Non-operating income (expense), net Six months ended June 30, 2014 2013 ChangeNon-operating income (expense), net $ (771,000 ) $ (1,834,000 ) $ 1,063,000 During the six month period ended June 30, 2014, we recorded non-operating expense in the amount of $771,000 compared to non-operating expense in the amount of $1,834,000 recorded during the six month period ended June 30, 2013. During the six month period ended June 30, 2014, we recorded approximately $728,000 of expense related to an increase in the fair value of our derivative warrant liabilities and $65,000 of expense recorded in connection with the issuance of the June 2014 Warrants described above. During the six month period ended June 30, 2013, a charge of $1,574,000 was recorded related to the removal of the down-round protection clause in certain then outstanding Series 1 Warrants. In addition, expense of $292,000 was recorded related to an increase in fair value of our then remaining derivative warrant liabilities. We expect that our non-operating income (expense) will remain highly volatile, and we may choose to fund our operations through additional financing. In particular, non-operating income (expense) will be affected by the adjustments to fair value of our derivative instruments. Fair value of these derivative instruments depends on a variety of assumptions, such as estimations regarding triggering of down-round protection and estimated future share price. An estimated increase in the price of our common stock increases the value of the warrants and thus results in a loss on our statement of operations. In addition, high estimated probability of a down-round protection increases the value of the warrants and again results in a loss on our statement of operations. Also refer to Note 8 to the accompanying unaudited consolidated financial statements. 28 Loss from discontinued mobile social application operations Six months ended June 30, 2014 2013 Change Revenue $ 37,000 $ 126,000 $ (89,000 ) Operating expenses (266,000 ) (1,893,000 ) 1,627,000 Operating loss (229,000 ) (1,767,000 ) 1,538,000 Non-operating income (expense) 20,000 (31,000 ) 51,000 Loss before taxes on income (209,000 ) (1,798,000 ) 1,589,000 Income tax expense - (18,000 ) 18,000Loss from discontinued operations $ (209,000 ) $ (1,816,000 ) $ 1,607,000 On February 18, 2014, we executed the sale of our mobile social application business to InfoMedia, receiving eighteen (18) Class B shares of InfoMedia as consideration, which represent an 8.25% ownership interest. Additionally, our Chief Executive Officer was appointed as a full voting member on InfoMedia's board of directors and we received a number of customary protective rights. The InfoMedia Class B shares are accounted for as a cost-method investment. Cash requirements for termination of mobile operations included mainly post-employment obligations, were incurred during the six month period ended June, 2014, and are considered to be immaterial. During the six month period ended June 30, 2014, operating expenses decreased by $1,627,000 (or 85.9%), to $266,000, from $1,893,000 recorded during the six month period ended June 30, 2013. This decrease is primarily due to the fact that there were no substantial operating expenses and no amortization related to acquired technology during the current year as the related asset was classified as held for sale as of December 31, 2013 and was subsequently sold to InfoMedia in February 2014. Taxes on Income As of June 30, 2014, our estimated aggregate total net tax loss carryforwards ("NOL") was approximately $96 million for U.S. federal, state and local purposes expiring 20 years from the respective tax years to which they relate. The Tax Reform Act of 1986 imposed substantial restrictions on the utilization of NOL and tax credits in the event of an ownership change of a corporation. Thus, our ability to utilize all such NOL and credit carryforwards may be limited. A valuation allowance has been recorded against the net deferred tax asset in the U.S., as it is in the opinion of our management that it is more likely than not that the operating loss carryforwards will not be utilized in the foreseeable future. We file our tax returns in the U.S. federal jurisdiction, as well as in various state and local jurisdictions. Vringo, Inc. has open tax years for 2010 through 2013. As of June 30, 2014, all tax years for Innovate/Protect are still open. The Israeli subsidiary files its income tax returns in Israel. As of June 30, 2014, the Israeli subsidiary has open tax years for 2010 through 2013. We did not have any material unrecognized tax benefits as of June 30, 2014. We do not expect to record any additional material provisions for unrecognized tax benefits within the next year. Liquidity and Capital Resources As of June 30, 2014, we had a cash balance of $31,654,000. This represents a decrease of $1,932,000 from our cash balance on December 31, 2013, which is mainly due to net cash used by us in our business operations of approximately $12,955,000 during the six month period ended June 30, 2014. The majority of these expenditures consisted of costs related to our four litigation campaigns. In our case against Google et al., we incurred costs related to the preparation for the oral argument, which was heard before the United States Court of Appeals for the Federal Circuit on May 6, 2014, in addition to other related costs. In our cases against ZTE and ASUS, we incurred costs related to the preparation and filing of briefs and other court documents, as well as case preparation and management. A large percentage of these costs were incurred in the United Kingdom, Australia, Germany, Brazil, and France. In civil law jurisdictions, such as Germany, France, Spain, and others, the majority of costs are incurred in the early stages of litigation and we anticipate that the costs in these jurisdictions will be lower in future periods. In our case against Tyco, we incurred costs related to the preparation and filing of briefs and other court documents, case preparation and management, and the worldwide resolution of litigation between the parties. In addition, we paid approximately $2,304,000 in deposits with courts related to proceedings in Germany and Brazil. 29 The overall decrease in our cash balance from expenditures related to our litigation campaigns was partially offset by approximately $13,500,000 that was received in connection with the exercises of warrants and stock options that occurred during the six month period ended June 30, 2014, as described below. As of June 30, 2014, our total stockholders' equity was $114,166,000 which is consistent with the balance as of December 31, 2013. During the six month period ended June 30, 2014, a total of 6,415,992 warrants to purchase an aggregate of 6,415,992 shares of our common stock, at an exercise price of $1.76 per share, were exercised by our warrant holders, pursuant to which we received $11,292,000. These proceeds are most significantly attributable to the execution of the agreements with certain of our warrant holders described above in connection with the June 2014 Warrants. In addition, 1,126,815 options to purchase 1,126,815 shares of our common stock were exercised during the six month period ended June 30, 2014. As a result, we received $2,160,000 through June 2014. Based on current operating plans, we expect to have sufficient funds for our operations for at least the next twelve months. In addition, until we generate sufficient revenue, we may need to raise additional funds, which can be achieved through the exercise of our outstanding warrants and options, the issuance of additional equity or through loans from financial institutions. There can be no assurance, however, that any such opportunities will materialize. We anticipate that we will continue to search for additional sources of liquidity, when needed, until we generate positive cash flows to support our operations. We cannot give any assurance that the necessary capital will be raised or that, if funds are raised, it will be on favorable terms. Any future sales of securities to finance our operations may require stockholder approval and will dilute existing stockholders' ownership. We cannot guarantee when or if we will ever generate positive cash flows. Cash flows Six months ended June 30, 2014 2013 Change Net cash used in operating activities $ (12,955,000 ) $ (10,966,000 ) $ (1,989,000 ) Net cash used in investing activities $ (2,449,000 ) $ (3,143,000 ) $ 694,000 Cash provided by financing activities $ 13,452,000 $ 327,000 $ 13,125,000 Operating activities During the six month period ended June 30, 2014, net cash used in operating activities totaled $12,955,000. During the six months period ended June 30, 2013, net cash used in operating activities totaled $10,966,000. The $1,989,000 increase in net cash used in operating activities was mainly due to increased litigation costs described above, as well as an increase in cost of our in-house staff, which was expanded during the second half of 2013. Our net cash used in operating activities could increase if we engage in future business development activities. As we expect to move towards greater revenue generation in the future, we expect that these amounts will be offset over time by the collection of revenues. Investing activities During the six month period ended June 30, 2014, net cash used in investing activities totaled $2,449,000. During the six month period ended June 30, 2013, net cash used in investing activities totaled $3,143,000. Net cash used in investing activities during the six month period ended June 30, 2014 is mostly comprised of the $2,304,000 deposited with courts that is described above. Net cash used in investing activities during the six month period ended June 30, 2013 is related to an investment made in commercial paper during that period in the amount of $3,120,000. There was also an increase in fixed asset purchases during the six month period ended June 30, 2014 as compared to the six month period ended June 30, 2013. 30 We expect that net cash used in investing activities will increase as we intend to continue to acquire additional intellectual property assets and invest surplus cash, according to our investment policy. Financing activities During the six month period ended June 30, 2014, cash provided by financing activities totaled $13,452,000, which relates to funds that we received from the exercises of warrants and stock options in the total amount of $11,292,000 and $2,160,000, respectively. During the six month period ended June 30, 2013, cash provided by financing activities totaled $327,000, which relates to funds received from the exercises of warrants and stock options in the total amount of $174,000 and $153,000, respectively. A significant portion of our issued and outstanding warrants are currently "in the money" and the underlying shares of common stock held by non-affiliates are freely tradable, with the potential of up to $7.4 million of additional incoming funds as of June 30, 2014, should the warrant holders choose to exercise. We may choose to raise additional funds in connection with any acquisitions of patent portfolios or other intellectual property assets that we may pursue. There can be no assurance, however, that any such opportunity will materialize, and moreover, that any such financing would likely be dilutive to our current stockholders. Future operations We are constantly seeking to identify patent portfolios, other intellectual property assets and operating businesses that we may wish to acquire. In addition, we are continuing to explore further opportunities for strategic business alliances. However, there can be no assurance that any such opportunities will be consummated. Off-Balance Sheet Arrangements From October 2012 through the filing date of this Form 10-Q, our subsidiaries filed patent infringement lawsuits against the subsidiaries of ZTE Corporation in the United Kingdom, France, Germany, Australia, India, Brazil, Malaysia, and Romania. Should we be deemed the losing party in any of its applications to the court in the UK, we may be held responsible for a portion of the defendant's legal fees for the relevant application or for the litigation. Pursuant to negotiation with ZTE's UK subsidiary, in the United Kingdom, we placed two written commitments to ensure the payment of a potential liability by Vringo Infrastructure resulting for the two cases filed in the fourth quarter of 2012 and second quarter of 2013, which the defendants estimated to be approximately $2,900,000 each. In addition, we may be required to grant additional written commitments, as necessary, in connection with our commenced proceedings against ZTE Corporation in Europe, Brazil, India and Australia. It should be noted, however, that if we were successful on any court applications or the entirety of any litigation, ZTE Corporation would be responsible for a substantial portion of our legal fees. Other than the arrangements described in the preceding paragraph, we have no obligations, assets or liabilities which would be considered off-balance sheet arrangements. We do not participate in transactions that create relationships with unconsolidated entities or financial partnerships, often referred to as variable interest entities, which would have been established for the purpose of facilitating off-balance sheet arrangements. Contractual Obligations The following table summarizes our future contractual obligations beginning on July 1, 2014: Remainder of 2014 2015 2016 2017 2018 2019 TotalOperating leases $ 79,000 $ 403,000 $ 403,000 $ 407,000 $ 416,000 $ 347,000 $ 2,055,000 In July 2012, the Company signed a rental agreement for its corporate executive office in New York for an annual rental fee of approximately $137,000 (subject to certain adjustments) which was to expire in September 2015. However, in January 2014, the Company entered into an amended lease agreement with the landlord for newly renovated office within the same building. The initial annual rental fee for this new office is approximately $403,000 (subject to certain future escalations and adjustments) beginning when the renovations are completed and the new office is available. Until the new office is available, the monthly rent payments are based on the previous annual rental fee. The lease for the New York office will expire five years and three months after the new office is available. 31 Critical Accounting Estimates These consolidated financial statements should be read in conjunction with the audited consolidated financial statements included in our Annual Report on Form 10-K filed with the SEC on March 10, 2014, which includes a description of our critical accounting policies that involve subjective and complex judgments that could potentially affect reported results. While there have been no material changes to our critical accounting policies as to the methodologies or assumptions we apply under them, we continue to monitor such methodologies and assumptions. |