PRZM Prism Technologies Group Inc (CE)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

1. Business of Prism Technologies Group, Inc.

Prism Technologies Group, Inc. (referred to herein as “PTG”, “we”, “our” or “us”) was originally incorporated in California in February  1995 and re-incorporated in Delaware in October 1996.The mailing address of our headquarters is 101 Parkshore Drive, Suite 100, Folsom, CA 95630, and the telephone number at that location is (916) 932-2860. Our principal website is www.przmgroup.com.

Since December 21, 2011, PTG ’s business has consisted of intellectual property management and licensing and enforcing a portfolio of patents. On March 26, 2015, we completed our acquisition of Prism Technologies, LLC (“Prism LLC”), with Prism LLC becoming our wholly-owned subsidiary (the “Merger”). Prism LLC is a Nebraska limited liability company headquartered in Omaha, Nebraska. Prism LLC has two primary operating subsidiaries: Secure Axcess, LLC, a Texas limited liability company and Millenium Biologix, LLC, a Nebraska limited liability company. Prism LLC and its subsidiaries own a portfolio of patents with over 50 issued patents in the areas of computer and network security, semiconductors and medical technology. In September 2015, we changed our name to Prism LLC Technologies Group, Inc. to better reflect the operations of the combined companies.

2. Basis of Presentation and Liquidity

The condensed consolidated financial statements include the accounts of PTG and its wholly-owned subsidiaries, Goldrush Insurance Services, Inc. and Prism Technologies LLC. All significant inter-company accounts and transactions have been eliminated in the condensed consolidated financial statements.

The accompanying unaudited interim condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) for interim financial information and with the instructions to Form  10-Q and Rule 8-03 of Regulation S-X. Accordingly, they do not contain all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, the accompanying unaudited interim condensed consolidated financial statements reflect all adjustments, which include only normal recurring adjustments, necessary to present fairly our financial position as of September 30, 2017 and the results of operations for the three and nine months ended September 30, 2017 and 2016 and of cash flows for the nine months ended September 30, 2017 and 2016. The financial data and other information disclosed in these notes to the condensed consolidated financial statements related to these periods are unaudited. The results for the three and nine months ended September 30, 2017 are not necessarily indicative of the results to be expected for any future period.

The accompanying financial statements have been prepared under the assumption that PTG will continue to operate as a going concern, which contemplates the realization of assets and the settlement of liabilities in the normal course of business. The condensed consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts of liabilities that may result from uncertainty related to PTG’s ability to continue as a going concern.

As of September 30, 2017, our cash and cash equivalents totaled $0.2 million. In addition to the expenses associated with the patent licensing business, such as salaries and overhead, we have notes payable of $3.5 million, which represent installment payments due in 2017. With the consent of the note holder, these installment payments have not been paid as of the date of this report. We have implemented certain initiatives to preserve cash and we have discussed restructuring one of our notes payable with the note holder, but there can be no assurance that the discussions will be successful. We cannot estimate when or if we will receive revenues from our operations due to the uncertainty associated with the patent licensing business. In late 2016, we entered into a revenue sharing arrangement with an unrelated party from which we received $500,000 and we have also received a capital contribution from a related party of $250,000. We have implemented significant expense reduction initiatives, including a moratorium on salaries for most employees. Unless we are able to defer or restructure our liabilities, substantially reduce our operating expenses, or receive revenues, we anticipate that our cash will be insufficient to fund our operations beyond the fourth quarter of 2017. As described in Footnote No. 17 (“ Subsequent Events ”), on October 20, 2017 we announced the entry into an Asset Purchase Transaction by which we will acquire intellectual property assets and further develop our technology licensing business. Obtaining a minimum of $500,000 in capital is a condition to closing the Asset Purchase Transaction. However, if these efforts are unsuccessful, we may need to cease operations and investors could lose their investment. These factors raise substantial doubt about PTG's ability to continue as a going concern within twelve months following the date of the filing of this Form 10-Q. If our business does not generate revenues before our cash is exhausted and we are unable to raise capital on acceptable terms, we may need to cease operations and, as a result, investors could lose their investment. 

PRISM TECHNOLOGIES GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

2. Basis of Presentation (continued)

These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in our Annual Report on Form  10-K and other information as filed with the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted pursuant to such rules and regulations. The December 31, 2016 condensed consolidated balance sheet was derived from audited financial statements, but does not include all disclosures required by U.S. GAAP. We believe the disclosures in its notes to the condensed consolidated financial statements are adequate to make the information presented not misleading. We have evaluated subsequent events through the time of filing these financial statements. Based upon the evaluation, there was no material impact on the accompanying condensed consolidated financial statements.  

Summary of Significant Accounting Policies    

Revenue recognition

PTG recognizes revenue when persuasive evidence of an arrangement exists, delivery of the product or service has occurred, all obligations have been performed pursuant to the terms of the agreement, the sales price is fixed or determinable, and collectabi lity is reasonably assured.

Revenue results from grants of certain intellectual property rights for patented technologies owned or controlled by PTG  and settlements reached from legal enforcement of PTG’s patent rights. Revenue is recognized when the arrangement with the licensee has been signed and the license has been delivered and made effective, provided license fees are fixed or determinable and collectability is reasonably assured. The fair value of licenses achieved is recognized as revenue.

The a mount of consideration received upon any settlement or judgment is allocated to each element of the settlement based on the fair value of each element. Elements related to licensing agreements and royalty revenues, is recognized as revenue in the Consolidated Statement of Operations. Elements that are not related to license agreements and royalty revenue in nature will be reflected as a separate line item within the Other Income section of the Condensed Consolidated Statements of Operations. Elements provided in either settlement agreements or judgments include the value of a license, legal release, and interest. When settlements or judgments are achieved at discounts to the fair value of a license, PTG allocates the full settlement or judgment, excluding specifically named elements as mentioned above, to the value of the license agreement or royalty revenue under the residual method relative to full license fair value prior to the discount. Legal release as part of a settlement agreement is recognized as a separate line item in the Consolidated Statements of Operations when value can be allocated to the legal release. When PTG reaches a settlement with a defendant, no value is allocated to the legal release since the existence of a settlement removes legal standing to bring a claim of infringement, and without a legal claim, the legal release has no economic value. The element that is applicable to interest income will be recorded as a separate line item in Other Income of the Condensed Consolidated Statements of Operations.

Cost of Revenues

Cost of revenues include the costs and expenses incurred in connection with PTG's patent licensing and enforcement activities, including contingent fee based legal expenses, other patent-related legal expenses paid to external patent counsel, licensing and enforcement related research, consulting expenses and  revenue share payments paid to third-parties. These costs are included under the caption "Cost of revenues" in the accompanying Condensed Consolidated Statements of Operations. 

Intangible Assets

The fair value amount assigned to each acquired patent asset was being amortized on a straight-line basis over a period ranging from 1.5 to 6.5 years, depending on the patent. The amortization period of the entire acquired patent portfolio used  a weighted average of 4.8 years and was determined using the estimated life of each patent, which is represented by the period over which 100% of the expected discounted cash flows from licensing activities was expected to be received, and then used a weighted average approach based on the value of the patent and the estimated life. PTG recorded amortization expense of $0 and $2.6 million in the Condensed Consolidated Statement of Operations for the three and nine months ended September 30, 2017 and $1.9 million and $6.3 million for the comparable periods in 2016.

As part of the Merger, PTG acquired covenants not to compete agreements with Prism LLC ’s officers. The amortization period of the covenants not to compete was three years; the expected term of the agreements.

PRISM TECHNOLOGIES GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

Intangible Assets (continued)

PTG evaluates the recoverability of its long-lived assets, including intangible assets subject to amortization in accordance with Financial Accounting Standards Board  ("FASB") Accounting Standards Codification ("ASC") Topic 360, Property, Plant and Equipment . ASC 360 requires the recognition of impairment losses related to long-lived assets in the event the net carrying value of such assets exceeds fair value. PTG assesses the impairment of its long-lived assets when events or changes in circumstances indicate that the carrying amount of the intangible asset or asset group may not be recoverable. Significant judgment is required in determining whether a potential indicator of impairment of the assets exists and in estimating future cash flows from licensing activities for any necessary impairment tests. Recoverability of the intangible assets to be held and used is measured by the comparison of the carrying amount of the asset to future undiscounted net cash flows expected to be generated by the asset. If such an asset is considered to be impaired, the impairment to be recognized is measured as the amount by which the carrying amount of the asset exceeds the fair value of the asset.

The fair value of the acquired intangible assets were based on estimated future cash flows to be generated from the patent portfolio discounted using a rate commensurate with the risk involved. PTG determined that the carrying value of certain of its intangible assets were in excess of fair value because the receipt of the forecasted cash flows would likely not be realized. PTG recorded impairment charges, net of $0 and $1.0 million in the Condensed Consolidated Statement of Operations for the three and nine months ended September 30, 2017 and $0 million and $0.2 million for the comparable periods in 2016. This included impairment of intangible assets of $0 and $12.7 million, net of reductions in the fair value of contingent consideration liabilities of $0 and $11.7 million for the three and nine months ended September 30, 2017, respectively. PTG recorded impairment of intangible assets of $0 and $2.2 million, net of reductions in the fair value of contingent consideration liabilities of $0 and $2.0 million respectively, for the comparable periods in 2016.

Goodwill

Goodwill represents the excess of:   (a) the aggregate of the fair value of consideration transferred, the fair value of any noncontrolling interest in the acquiree (if any) and the acquisition date fair value of PTG’s previously held equity interest in the acquiree (if any), over (b) the fair value of assets acquired and liabilities assumed. Goodwill, deemed to have an indefinite life is subject to periodic impairment testing as described below. 

Goodwill  is tested for impairment on a periodic basis, and at least annually in the fourth quarter of the year. In the first step of testing for goodwill and intangible assets impairment, we will estimate the fair value of the net assets associated with the goodwill. If the fair value of these net assets is greater than the carrying value of the net assets, including goodwill, then there will be no impairment. If the fair value is less than the carrying value, then we would perform a second step and determine the fair value of the goodwill. In this second step, the fair value of goodwill is determined by deducting the fair value of the identifiable assets and liabilities from the fair value of the reporting unit as a whole, as if that reporting unit had just been acquired and the purchase price were being initially allocated. If the fair value of the goodwill is less than its carrying value for a reporting unit, an impairment charge would be recorded to earnings in PTG’s condensed consolidated statements of operations. 

In addition, PTG would evaluate goodwill for impairment if events or circumstances change between annual tests indicating a possible impairment.   Examples of such events or circumstances include the following:

PTG determined that the carrying value of  goodwill was in excess of fair value because the receipt of the forecasted cash flows would likely not be realized. PTG recorded impairment charges of $0 and $0.1 million in the Condensed Consolidated Statement of Operations for the three and nine months ended September 30, 2017 and no impairment charges were recorded for the comparable periods in 2016. As a result of the recorded impairment charge, the carrying value of goodwill was reduced to zero as of September 30, 2017.

P RISM TECHNOLOGIES GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

Derivative instruments

We  assess whether activities which provide capital to fund our operations include embedded features that are derivatives instruments. If a derivative instrument is embedded, the instrument is accounted for separately from the host contract. Changes in fair value are recognized in other income or loss, consistent with the underlying derivative instrument. As a result, any change in the value of our derivative instrument would be substantially offset by an opposite change in the value of the underlying derivative item. We do not use derivative instruments for trading or speculative purposes.

Share-Based Payments

We account for share-based compensation in accordance with ASC 718 “Compensation – Stock Compensation.” Under the provisions of ASC 718, share-based compensation cost is generally estimated at the grant date based on the award’s fair value as calculated by the Black-Scholes-Merton (BSM) option-pricing model. The BSM option-pricing model requires various highly judgmental assumptions including expected option life, volatility, and forfeiture rates. If any of the assumptions used in the BSM option-pricing model change significantly, share-based compensation expense may differ materially in the future from that recorded in the current period. Generally, compensation cost is recognized over the requisite service period. However, to the extent performance conditions affect the vesting of an award, compensation cost will be recognized only if the performance condition is satisfied. Compensation cost will not be recognized, and any previously recognized compensation cost will be reversed, if the performance condition is not satisfied.

Recent Accounting Standards

In May 2014, the Financial Accounting Standards Board (“ FASB”) FASB issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The ASU will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. The new standard is effective for annual reporting periods beginning after December 15, 2017. The standard permits the use of either the retrospective or cumulative effect transition method. We have not yet selected a transition method. 

We are continuing to assess the impact of the new guidance on our accounting policies and procedures and are evaluating the new requirements as applied to existing revenue contracts. The new guidance may result in an acceleration of revenue as under the new standard, we may no longer be required to defer revenues when the consideration associated with the contract can be calculated using either the expected value or the most likely amount. This change may also impact our balance sheet presentation with an expected increase in accounts or unbilled receivables. We are reviewing our revenue contracts and working on its plan for implementation of the new guidance which it will adopt beginning in the first quarter of 2018. The adoption of this standard is not expected to have a material impact on the Company’s condensed consolidated financial position and results of operations

There have been four new ASUs issued amending certain aspects of ASU 2014-09, ASU 2016-08, “ Principal versus Agent Considerations (Reporting Revenue Gross Versus Net), ” was issued in March, 2016 to clarify certain aspects of the principal versus agent guidance in ASU 2014-09. In addition, ASU 2016-10, “ Identifying Performance Obligations and Licensing,” issued in April 2016, amends other sections of ASU 2014-09 including clarifying guidance related to identifying performance obligations and licensing implementation. ASU 2016-12, “Revenue from Contracts with Customers — Narrow Scope Improvements and Practical Expedients” provides amendments and practical expedients to the guidance in ASU 2014-09 in the areas of assessing collectability, presentation of sales taxes received from customers, noncash consideration, contract modification and clarification of using the full retrospective approach to adopt ASU 2014-09. Finally, ASU 2016-20, “ Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers,” was issued in December 2016, and provides elections regarding the disclosures required for remaining performance obligations in certain cases and also makes other technical corrections and improvements to the standard. With its evaluation of the impact of ASU 2014-09, the Company will also consider the impact on its condensed consolidated financial statements related to the updated guidance provided by these four new ASUs.

PRISM TECHNOLOGIES GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

Recent Accounting Standards  (continued)

In November 2015, the FASB issued ASU No.  2015-17, Balance Sheet Classification of Deferred Taxes (“ASU 2015-17”), which amends the current requirement for organizations to present deferred tax assets and liabilities as current and noncurrent in a classified balance sheet. Organizations will now be required to classify all deferred tax assets and liabilities as noncurrent. ASU 2015-17 is effective for public companies for financial statements issued for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. Early adoption is permitted. The amendments may be applied prospectively to all deferred tax liabilities and assets or retrospectively to all periods presented. The Company adopted ASU 2015-17 effective January 1, 2017. Adoption of this standard did not have a material impact on the Company’s condensed consolidated financial position, results of operations or cash flows.

In February 2016, FASB issued ASU No. 2016-02 “ Leases” that requires a lessee to recognize the assets and liabilities that arise from operating leases. A lessee should recognize in the statement of financial position a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term. For leases with a term of 12 months or less, a lessee is permitted to make an accounting policy election by class of underlying asset not to recognize lease assets and lease liabilities. The new guidance is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted. The Company is currently evaluating the effect of the standard on its condensed consolidated financial statements and related disclosures.

In March 2016, the FASB issued ASU 2016-09, Compensation - Stock Compensation (Topic 718) : Improvements to Employee Share-Based Payment Accounting , related to simplifications of employee share-based payment accounting. This pronouncement eliminates the APIC pool concept and requires that excess tax benefits and tax deficiencies be recorded in the statement of operations when awards are settled. The pronouncement also addresses simplifications related to statement of cash flows classification, accounting for forfeitures, and minimum statutory tax withholding requirements. The pronouncement is effective for annual periods (and for interim periods within those annual periods) beginning after December 15, 2016. The Company adopted ASU 2016-09 effective January 1, 2017. The adoption of this standard decreased the deferred tax asset by $2.4 million from $64.7 million to $62.3 million, with a corresponding decrease to the valuation allowance at September 30, 2017. The Company elected to account for forfeitures based upon an estimated forfeiture rate and on a retrospective basis.

In Augus t 2016, the FASB issued ASU No. 2016-15, “Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments”. The amendments in this update clarify how certain cash receipts and cash payments are presented and classified in the statement of cash flows. ASU No. 2016-15 will be effective for fiscal years beginning after December 15, 2017, with early adoption permitted. The Company has not elected to early adopt this guidance and is currently evaluating ASU 2016-15 to determine the impact to its condensed consolidated financial statements.

On January 5, 2017, the FASB issued ASU 2017-01 “Business Combinations (Topic 805): Clarifying the Definition of a Business”, which clarifies the definition of a business to assist entities with evaluating whether transactions should be accounted for as acquisitions or disposals of assets or businesses. The standard introduces a screen for determining when assets acquired are not a business and clarifies that a business must include, at a minimum, an input and a substantive process that contribute to an output to be considered a business. This standard is effective for fiscal years beginning after December 15, 2017, including interim periods within that reporting period. The adoption of this standard is not expected to have a material impact on the Company’s condensed consolidated financial position and results of operations.

In January 2017, the FASB issued ASU 2017-04: “ Intangibles — Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment” (“ASU 017-04”), which removes Step 2 from the goodwill impairment test. It is effective for annual and interim periods beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment test performed with a measurement date after January 1, 2017. The adoption of this standard is not expected to have a material impact on the Company’s condensed consolidated financial position and results of operations.

 In May 2017, the FASB issued (ASU 2017-09: Compensation – Stock Compensation (Topic 718): Scope of Modification Accounting which clarifies which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting. The standard is effective beginning after December 15, 2017; early adoption is permitted. The Company has adopted this standard and its impact on its condensed consolidated financial statements and related disclosures was immaterial.

PRISM TECHNOLOGIES GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

Recent Accounting Standards (continued)

In July 2017, FASB issued ASU No.  2017-11, Earnings per Share (Topic 260), Distinguishing Liabilities from Equity (Topic 480), Derivatives and Hedging (Topic 815). ASU 2017-11 consists of two parts. The amendments in Part I of this Update change the classification analysis of certain equity-linked financial instruments (or embedded features) with down round features. When determining whether certain financial instruments should be classified as liabilities or equity instruments, a down round feature no longer precludes equity classification when assessing whether the instrument is indexed to an entity’s own stock. The amendments also clarify existing disclosure requirements for equity-classified instruments. As a result, a freestanding equity-linked financial instrument (or embedded conversion option) no longer would be accounted for as a derivative liability at fair value as a result of the existence of a down round feature. For freestanding equity classified financial instruments, the amendments require entities that present earnings per share (EPS) in accordance with Topic 260 to recognize the effect of the down round feature when it is triggered. That effect is treated as a dividend and as a reduction of income available to common shareholders in basic EPS. Convertible instruments with embedded conversion options that have down round features are now subject to the specialized guidance for contingent beneficial conversion features (in Subtopic 470-20, Debt—Debt with Conversion and Other Options), including related EPS guidance (in Topic 260). The amendments in Part II of this Update re-characterize the indefinite deferral of certain provisions of Topic 480 that now are presented as pending content in the Codification, to a scope exception. Those amendments do not have an accounting effect. For public business entities, the amendments in Part I of this Update are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. For all other entities, the amendments in Part I of this Update are effective for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020. Early adoption is permitted for all entities, including adoption in an interim period. If an entity early adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. The amendments in Part II of this Update do not require any transition guidance because those amendments do not have an accounting effect. The Company is in the process of evaluating this ASU and adoption of this ASU is not expected to have a material impact on the Company’s condensed consolidated financial position and results of operations.

3. Contingent Consideration

As part of the Merger, Prism LLC was acquired for a purchase price of $58.3 million, paid in a combination of cash, stock and potential contingent earn-out payments. The contingent consideration payable to Prism LLC’s former members consists of a share of future revenues related to lawsuits filed by Prism LLC prior to the Closing Date (“Open Suits”). Under the terms of the Merger Agreement, we will retain the first $16.5 million in litigation or settlement proceeds received from Open Suits after closing (the “Sharing Threshold”), less any cash remaining in Prism LLC at the time of closing. Prism LLC former members will receive 70% of the litigation and settlement proceeds related to Open Suits in excess of the Sharing Threshold, up to $49.5 million. The contingent consideration is calculated quarterly and payable in the quarter following the period in which it is earned. Payments due for the quarters ended March 31, September 30 and December 31, are subject to 20% retention. The retention payments are due in conjunction with the earn-out payment for December 31. See Note 4 for fair value of the consideration.

We reassessed the contingent consideration liability in connection with this transaction by comparing the estimated future undiscounted cash flows expected to be generated relating to this liability to its carrying amount. For the three and nine months ended September 30, 2017, the reductions in the fair value of the contingent consideration liabilities were recorded as impairment, net in the Condensed Consolidated Statement of Operations of $0 and $1.0 million respectively, and $0 and $0.2 million for the comparable periods in 2016. This included impairment of intangible assets of $0 and $12.7 million, net of reductions in the fair value of contingent consideration liabilities of $0 and $11.7 million for the three and nine months ended September 30, 2017, respectively. PTG recorded impairment of intangible assets of $0 and $2.2 million, net of reductions in the fair value of contingent consideration liabilities of $0 and $2.0 million respectively, for the comparable periods in 2016.

PRISM TECHNOLOGIES GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

4.   Fair Value Measurements

The following table presents the assets measured at fair value on a recurring basis as of September 30, 2017 (in thousands):

The following table presents the financial assets measured at fair value on a recurring basis as of December  31, 2016 (in thousands):

Cash equivalents and restricted cash equivalents include certificates of deposit, money market deposit accounts and money market funds. The carrying value of these cash equivalents and restricted cash equivalents approximates fair value. For these securities, we use quoted prices in active markets for identical assets to determine their fair value that are considered to be Level 1 inputs.

The contingent consideration payable to Prism LLC's former members consists of a share of future revenues related to lawsuits filed by Prism LLC prior to the Closing Date ("Open Suits"). See Note 3 for further discussion. For this liability, we use valuation techniques based on management's assumptions and expectations that require inputs that are both unobservable and significant to the overall fair value measurement and are considered to be Level 3 inputs.  

PRISM TECHNOLOGIES GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

4.   Fair Value Measurements (continued)

As discussed in Note 10, on December 21, 2016 we entered into a non-recourse future revenue sharing arrangement by which Bentham Capital, LLC provided PTG with $500,000 in cash. Under ASU 815, the repayment of the premium portion was bifurcated from the repayment of the principal and recorded as an embedded derivative. For this liability, we use valuation techniques based on management's assumptions and expectations that require inputs that are both unobservable and significant to the overall fair value measurement and are considered to be Level 3 inputs.

Impairment

PTG estimates the expected undiscounted future cash flows generated from its intangible assets and compares such amounts to the carrying amount of the intangible assets to determine if the carrying amount is recoverable. If the carrying amount exceeds the estimated undiscounted future cash flows, PTG will adjust the carrying amount of such assets to fair value. The factors used to determine fair value are subject to management’s judgment and expertise and include, but are not limited to the present value of future cash flows and various discount rates commensurate with the risk and current market conditions associated with realizing the expected cash flows projected. These assumptions represent Level 3 inputs.

As a result of adverse litigation events in t he second quarter of 2017, which led to a significant reduction in expected cash flows, contingent consideration and the derivative liability were revalued to zero as of June 30, 2017. The reduction to contingent consideration and derivative liability were recorded as other income in the Condensed Consolidated Statement of Operations. PTG recorded an impairment, net during the three and nine months ended September 30, 2017 of $0 $1.0 million respectively. Impairment, net for the three and nine months ended September 30, 2016 was approximately $0 and $0.2 million, respectively.

5. Restricted Cash Equivalents

As of September 30, 2017 and December 31, 2016, restricted cash equivalents consisted of $0 and $0.4 million respectively. A portion of the cash equivalents was used as collateral for a letter of credit of the same amount that secured our rent obligations under the office space lease for our former corporate headquarters. On February 28, 2017, the office lease for our former headquarters expired. On March 15, 2017, the landlord released the letter of credit covering the office space and the Company is no longer required to maintain $0.4 million in restricted cash equivalents.

6. Other Assets

Prism LLC owns several life insurance policies (also referred to as “life settlement contracts”). These life settlement contracts were part of the assets we acquired in the Merger. A life settlement contract is the payment of cash to an insured in return for an assignment of ownership or beneficial interest in, and the right to receive the value of, a life insurance policy upon the death of the insured. In 2016, PTG ’s premiums on these life settlement contracts were $40,000 and PTG anticipates paying $33,000 for each of the five succeeding fiscal years to keep the life settlement contracts in force. 

Life settlement contracts are preliminarily  recorded at cash surrender value, with premium payments expensed as incurred. The policies are not subject to amortization; however, we analyze the carrying value for the impairment annually. Based upon our analysis, no impairment was noted for the three and nine months ended September 30, 2017. For the three and nine months ended for September 30, 2017, one life insurance policy was sold with net proceeds of $6,000. During the year ended December 31, 2016, PTG sold two life insurance policies with net proceeds of $37,000. The net proceeds from these life insurance policies were recognized in other income. The basis of $40,000 for these life insurance policies was recorded as a decrease in other assets in operating activities on the condensed consolidated statements of cash flows for the year ended, December 31, 2016.

Life settlement contracts consist of the following  (in thousands):

PRISM TECHNOLOGIES GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

7. Intangible Assets

Intangible assets, net, include the following amounts (in thousands):

 Goodwill, the excess of the purchase price paid to former members of Prism LLC  over the fair market value of the net assets acquired, in the amount of $0.1 million was recorded as of the Closing Date. We did not have goodwill prior to the acquisition of Prism LLC. As a result of adverse litigation events in the second quarter of 2017, which led to a significant reduction of expected cash flows, the carrying value of goodwill and other intangible assets were reduced to zero as of June 30, 2017.  

Acquisition-related intangible assets are amortized using the straight-line method over their estimated economic lives from 3 to 6.5 years. As of June 30, 2017, the  acquisition-related intangible assets no longer have an estimated useful life.

As a result of adverse litigation events in the second quarter of 2017, which led to a significant reduction in expected cash flows, the carrying value of intangible assets were reduced to zero as of June 30, 2017 and PTG  will no longer record acquisition-related amortization expense in future periods.

8. Impairment, net

When indicators are present, PTG evaluates the recoverability of the patent assets based on comparison to estimated undiscounted cash flows to the carrying value of the patent assets.  

  As a result of adverse litigation events in the first and second quarters of 2017, which led to a significant reduction in expected cash flows, PTG recorded impairment charges, net of ($2.1) million and $3.1 million respectively. This included impairment of intangible assets of $0.2 million and $12.4 million, net of reductions in the fair value of contingent consideration liabilities of $2.3 million and $9.3 million for the second quarter and first quarter of 2017, respectively. The impairment charges resulted in a reduction to the carrying values of the patent portfolio by $0.2 million and $12.4 million respectively. The carrying value of patent portfolio was reduced to zero as of June 30, 2017.

The events resulting in the reassessment of the patent assets described above also required a reassessment of the contingent consideration liability. Adjustments to the contingent consideration liability were made representing the difference between the contingent consideration as of the acquisition date and accrued imputed interest compared to the contingent consideration expected to be paid, based upon the estimated future undiscounted cash flows expected to be generated. The fair values of the contingent consideration liabilities were reduced by $2.3 million and $9.3 million in the first quarter and second quarters of 2017 respectively.

9. Accrued Expenses

Accrued expenses and other current liabilities consist of the following (in thousands ):

PRISM TECHNOLOGIES GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

9. Accrued Expenses (continued)

The decrease to the incentive compensation accrual and payroll accruals above were attributable to adverse litigation events in the second quarter of 2017, which led to a significant reduction in expected cash flows from licensing activities, and was reco rded in the current period. These expenses were recorded as part of incentive compensation pursuant to a plan adopted by our board of directors on September 1, 2016.

10. Notes Payable

As part of the Merger, PTG assumed $3.6 million in two discounted non-interest bearing notes payable due in four semi-annual installments of $1,000,000 from June 2015 to December 2016. The notes include imputed interest of 12% based on management's assumptions about the risk associated with satisfying the payment obligations, including the fact that certain patents serve as security for the notes.

The balances of the notes payable consist of the following (in thousands):

The installment payments due on December 31, 2015, June 30, 2016 and December 2016 have not been paid as of the date of this report. PTG has postponed payments of the notes payable upon permission from the note holder.  

11. Future Revenue Sharing Arrangement

On December 15, 2016, we entered into a non-recourse future revenue sharing arrangement by which Bentham Capital, LLC provided PTG with $500,000 in cash in exchange for a portion of the proceeds we expect to receive in connection with the patent infringement litigation with Sprint Spectrum, L.P., ( Prism LLC Technologies LLC v Sprint Spectrum L.P. D/B/A/ Sprint PCS; Case Nos. 16-1456 and 16-1457), and any related appeals or remands (collectively, the Sprint Litigation). After payment of any fees to PTG's litigation counsel, the financing party is entitled to receive:

To the extent not recovered from the proceeds associated with the Sprint Litigation, however, the financing party is only entitled to recover its principal ($500,000) from the proceeds of patent litigation and  licensing activities instituted by PTG's subsidiaries, prior to December 15, 2016. In addition, PTG agreed to reimburse the financing company for certain costs totaling $59,000.

As a result of adverse litigation events in the second quarter of 2017, which led to a significant reduction in expected cash flows, there was a change in estimate of the expected payout to the non-recourse future revenue sharing arrangement. Therefore, the non-recourse future revenue sharing arrangement was reduced to zero as of June 30, 2017.

PRISM TECHNOLOGIES GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

11. Future Revenue Sharing Arrangement (continued)

Derivative instruments

Accounting Standards Update ("ASU") No. 2016-06, Derivatives and Hedging, (Topic 815) requires that in certain circumstances embedded derivatives be bifurcated from the host contract and accounted for separately. We determined that the premium portion of the revenue sharing arrangement was an embedded derivative under ASU 815; therefore, the payment of the premium was bifurcated from the repayment of the principal.

As a result of adverse litigation events in the second quarter of 2017, which led to a significant reduction in expected cash flows, the derivative liability was revalued to zero as of June 30, 2017.

12. Due to Related Party

On December 29, 2016, the Board of Directors of PTG approved a transaction by which Mr. Enan, Chairman and CEO of PTG,  provided PTG with $250,000 in cash. In exchange, Mr. Enan is entitled to receive $625,000 when PTG's cumulative Net Cash Flow ("NCF") exceeds $7.5 million. The agreement with Mr. Enan was amended on November 13, 2017 to clarify that NCF is defined as the cumulative cash received from patent license activities less all cumulative cash operating expenses incurred, for the period beginning January 1, 2017. The cash contribution is unsecured and non-convertible to equity.

As a result of adverse litigation events in the second quarter of 2017, which led to a significant reduction in expected cash flows, there was a change in estimate of the expected payout due to the related party. Therefore, the amount due to the related party was reduced to zero as of June 30, 2017.

13. Net  Loss Per Share

Basic net loss per share is computed using the weighted-average number of shares of common stock outstanding. Diluted income per share is a measure of the potential dilution that would occur if stock options had been exercised.

Potentially dilutive securities  not included in the diluted net loss calculation because we had a net loss from operations, net of tax. There were no antidilutive securities to include in the calculation above for employee stock options and non-employee directors to purchase shares of 456,459 for the three and nine months ended September 30, 2017 and 334,793 for the comparable periods in 2016.

  14. Commitments and Contingencies

Leases

We have a non-cancelable 12 month lease from October 31, 2017 until November 1, 2018 for approximately 300 square feet of office space in Folsom, California, which is currently our corporate headquarters. The monthly lease amounts are not material.

We had a non-cancelable five-year full-service lease through February 14, 2017 for approximately 16,000 square feet of office space in a building that housed our headquarters until May 2013. On April 16, 2013, we subleased this space for the remainder of our term, which also terminated in February 2017. The monthly sublease rent was less than our rent obligation to the landlord.

PRISM TECHNOLOGIES GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

15. Legal Proceedings

Litigation

In the ordinary course of business, we are the subject of, or party to, various pending or threatened legal actions, including various counterclaims in connection with our patent enforcement activities. We believe that any liability arising from these actions will not have a material adverse effect on our consolidated financial position, results of operations or cash flows.

In connection with any of our patent enforcement actions, it is possible that a defendant may request and/or a court may rule that we have 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 us or our operating subsidiaries or award attorneys' fees and/or expenses to defendant(s) in the action, which could be material and, if required to be paid by us or our operating subsidiaries, could materially harm our operating results and our financial position.

Wireless Litigation  

On June 23, 2015, Prism LLC won a jury verdict in its patent infringement lawsuit against Sprint Spectrum LP d/b/a Sprint PCS (“Sprint”).  Prism LLC was awarded trial damages of $30 million, representing a reasonable royalty for Sprint’s infringement for the period from February 2012 through December 2014. On March 7, 2017, the jury verdict in favor of Prism LLC was unanimously upheld by a three judge panel of the Court of Appeals for the Federal Circuit (“Federal Circuit”). On May 8, 2017 the Federal Circuit rejected Sprint’s petition for rehearing and issued its mandate on July 25, 2017 transferring jurisdiction of the case back to the U. S. District Court for the District of Nebraska (“District Court”). Sprint also filed a motion with the District Court seeking relief from the judgment or a stay pending the outcome of Prism LLC’s patent infringement suit against T-Mobile (described below). On August 8, 2017, the District Court granted Sprint’s motion for relief from the June 2015 judgment and set aside the $30 million jury verdict previously awarded to Prism LLC. On October 10, 2017 Prism notified the District Court that the order setting aside the jury verdict would be appealed to the Federal Circuit.

On October 30, 2015, a jury found that T-Mobile USA, Inc. did not infringe the asserted claims of U.S. Patent Nos. 8,387,155 and 8,127,345. On April 6, 2016, the District Court denied T-Mobile ’s motion for judgment as a matter of law and its motion for attorney fees; the court also denied Prism LLC’s motion for judgment as a matter of law and its motion for a new trial. Both parties appealed to the Federal Circuit. On June 23, 2017, the Federal Circuit ruled that the claims of the patents-in-suit recite patent ineligible subject matter under 35 U.S.C. § 101.2. The Federal Circuit also dismissed Prism’s request for a new trial as moot and denied T-Mobile’s request for a determination that the case was “exceptional” under 35 U.S.C. § 285, which authorizes an award of attorney fees to the prevailing party in patent litigation. On August 17, 2017, the Federal Circuit denied our request for rehearing, and issued its mandate to the District Court on August 24, 2017. On November 9, 2017, Prism LLC filed a petition for writ of certiorari with the U.S Supreme Court.

Patent infringement lawsuits against United States Cellular Corporation (8:12-cv-125-LES-SMB) and Cellco Partnership d/b/a Verizon Wireless (8:12-cv-126-LES-SMB) have been stayed pending the final resolution of the Sprint and T-Mobile appeals.

PRISM TECHNOLOGIES GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

Litigation (continued)

Glazer Patent Litigation

In multiple Inter Partes Review (“IPR”) and Covered Business Methods (“CBM”) challenges initiated in 2015 and 2016, the U.S. Patent Trial and Appeal Board (“PTAB”) invalidated the claims of U.S. Patent No. 7,631,191 B2 (the “Glazer” patent) owned by Secure Axcess, LLC.

On February 21, 2017, the U.S. Court of Appeals for the Federal Circuit (“Federal Circuit”) affirmed the PTAB ruling, without an opinion, in the IPR matter. The Federal Circuit, however, also ruled that the PTAB should not have instituted the CBM proceedings because the Glazer patent claims do not constitute a “covered business method.” Accordingly, the Federal Circuit vacated the invalidity ruling in the CBM proceedings. However, on March 23, 2017, U.S. Bancorp filed a petition seeking a rehearing of the decision vacating the CBM proceedings, but that petition was denied on June 6, 2017. On September 4, 2017 several defendants filed a petition for writ of certiorari with the U.S. Supreme Court.

The Glazer patent is the subject of patent infringement litigation in the U.S. District Court for the Eastern District of Texas (Secure Axcess, LLC v. U.S. Bank, et al. 6:13-cv-00717-KNM), which has been stayed pending the IPR and CBM proceedings..

System on Chip Litigation

In March 2015, Secure Axcess filed lawsuits against six companies in the U.S. District Court for the Eastern District of Texas alleging infringement of patents in the System on Chip patent family. Five of these cases have been dismissed, without prejudice, pursuant to Secure Axcess ’ motion or by joint stipulations of dismissal. The defendant in the remaining case was HP Enterprise Services, LLC. On July 21, 2016, the U.S. District Court for the Eastern District of Texas held a claim construction hearing in Secure Axcess, LLC v. HP Enterprise Services, LLC. The parties participated in a mediation on November 9, 2016, and reached settlement on February 3, 2017. That settlement did not have a material impact on our cash position or results of operations.

16. Equity and Stock Options

 As of September 30, 2017, there was $40,000 in unrecognized compensation cost for all stock options outstanding under PTG’s stock option plans. A portion of the unrecognized compensation cost relates to options to purchase 500,000 shares of common stock to five executive officers of Prism LLC under employment agreements executed in connection with the Merger. The exercise price of all of the options granted to the executive officers of Prism LLC is $2.68. One-half of the options granted to each such executive officer is serviced based and vest as follows: (i) 33.33% will vest upon the first anniversary of the first date of employment, and (ii) 1/24 of the remaining 66.67% will vest at the end of each of the 24 months following such anniversary, so long as the individual remains employed pursuant to the terms of his or her employment agreement.

The remaining one-half of the options granted to the five Prism LLC  officers are performance based and vest as follows: (i) 33.33% will vest upon the first anniversary of the first date of employment based on achievements measured against financial targets for such period; (ii) 33.33% will vest upon the second anniversary of the first date of employment based on achievements measured against financial targets for the second year of employment; and (iii) 33.34% will vest upon the third anniversary of the first date of employment based on achievements measured against financial targets for the third year of employment. The employee must remain employed for the service based and performance based options to vest; however, all unvested options will immediately vest upon: (A) termination of such person’s employment without good cause; or (B) the occurrence of a change of control as defined in such person’s employment agreement.

On June 11, 2015, PTG granted 72,500 performance based stock options, 72,500 service based stock options and 70,000 stock options which vested immediately, to members of management. The service based stock options vest 33% after one year and ratably over the next two years. The performance based stock options vest annually, if financial targets are met.

PRISM TECHNOLOGIES GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

For the  performance based options noted above, in accordance with ASC 718 “Compensation – Stock Compensation.” , a performance condition must be met for the award to vest and compensation cost will be recognized only if the performance condition is satisfied. The performance based option vesting criteria uses a tiered vesting structure between 0% to 100% based upon a comparison of annual licensing and enforcement outcomes to an annual target approved by PTG’s board of directors. The 2017 financial targets have not been set by PTG’s board of directors, therefore no compensation costs are required to be recorded. When we are able to assess the probability of achieving target levels, the fair value will be calculated at that time. As of September 30, 2017, 50% of the 2015 performance-based options have been vested and none of the 2016 and 2017 performance-based options have been vested.

The 2008 Stock Option Plan provides that each non-employee director receive a fully-vested option to purchase 5,000 shares of common stock on July  1st (or the first business day thereafter) of each year in which the director remains in office. Pursuant to the Option Plan, on July 3, 2017, fully-vested options to purchase 5,000 shares of common stock were granted to each of the two non-employee directors with an exercise price of $0.38 and on July 1, 2016, fully-vested options to purchase 5,000 shares of common stock were granted to each of the three non-employee directors with an exercise price of $0.27.

PTG recognized $ 23,000 and $60,000 in stock compensation expense for the three and nine months ended September 30, 2017 and $19,000 and $57,000 for the comparable periods in 2016.

During the three and nine months ended September 30, 2017 and 2016 there were no common share issuances associated with the exercise of stock options. PTG has reserved common shares for issuance in conjunction with the issuance of options underlying PTG’s stock option plans.

The following table summarizes the Company ’s stock option activity for the nine months ended September 30, 2017: 

17. Subsequent Event

On October 19, 2017, PTG entered into an Asset Purchase Agreement (“Agreement) with Amorphous Technologies International, Inc. (“ATI”) pursuant to which PTG will acquire from ATI certain intellectual property assets related to innovative uses for amorphous metals and PTG will issue to ATI shares of newly designated Series A Convertible Preferred Stock (“Asset Purchase Transaction”). The Asset Purchase Transaction will close on or about the second Business Day after the satisfaction or waiver of the closing conditions. Following the closing of the Asset Purchase Transaction, PTG will commercialize the acquired intellectual property assets to create new amorphous metal technology offerings for the consumer electronics, automotive and other business sectors. A complete description of the transaction and a copy of the Asset Purchase Agreement is available in the Current Report on Form 8-K issued on October 20, 2017.

On November 3, 2017, the Company received a letter from an employee alleging breach of an employment contract. The employee alleges that he did not: 1) agree to participate in the Incentive Compensation Plan; or 2) agree to forego any portion of his salar y as stated in his employment agreement. The letter demanded payment of $263,846.15, constituting his wages since October 7, 2016. The Company is reviewing its alternatives and intends to vigorously defend any litigation brought by the employee.

On November 13, 2017, the Board of Directors of PTG approved a clarifying amendment to the due to related party transaction with Mr. Enan, Chairman and CEO of PTG, who provided PTG with $250,000 in cash in December 2016. The amendment further clarifies that $625,000   is payable to Mr. Enan when the cumulative cash received from patent litigation activities, less all cumulative cash operating expenses incurred by PTG during the same period, exceeds $7.5 million.