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RPXC > SEC Filings for RPXC > Form 10-Q on 2-Nov-2012All Recent SEC Filings

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Form 10-Q for RPX CORP


2-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 26, 2012.

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 in this Quarterly Report on Form 10-Q 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 (the "Exchange Act"). Forward-looking statements are often identified by the use of words such as, but not limited to, "anticipate," "believe," "can," "continue," "could," "estimate," "expect," "intend," "may," "will," "plan," "project," "seek," "should," "target," "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. 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 Part II, Item 1A of this Quarterly Report on Form 10-Q and elsewhere in this filing and our Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 26, 2012. Furthermore, such forward-looking statements 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.

Overview

We help companies reduce patent-related risk and expense by providing a subscription-based patent risk management solution that facilitates more efficient exchanges of value between owners and users of patents compared to transactions driven by actual or threatened litigation. As of September 30, 2012, we had a client network of 128 companies.

Our business model aligns our interests with those of our clients. We have not asserted and will not assert our patents, which enables us to develop strong and trusted relationships with our clients. Our clients include companies that design, make or sell technology-based products and services as well as companies that use technology in their businesses.

The core of our solution is defensive patent aggregation, in which we acquire patents or licenses to patents that are being or may be asserted against our current or prospective clients. We also may occasionally enter into agreements to acquire covenants not to sue in order to further mitigate our client's litigation risk. The acquired patents, licenses to patents and agreements for covenants not to sue are collectively referred as "patent assets." We then provide our clients with licenses to substantially all of these patent assets to protect them from potential patent infringement assertions. We also provide our clients access to our proprietary patent market intelligence and data.


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During the three months ended September 30, 2012, we also began underwriting patent infringement liability insurance policies. For the three and nine months ended September 30, 2012, the effect of the insurance policies that have been issued have not been material to our results of operations or financial condition.

In May 2011, we completed our initial public offering, in which we sold and issued 9,065,000 shares of common stock, including 634,565 shares issued pursuant to an over-allotment option granted to the underwriters. The shares were sold by the underwriters at a price of $19.00 per share and we received proceeds of $160.2 million after deducting underwriting discounts and commissions. We incurred offering costs of $2.9 million. In September 2011, we completed a follow-on offering in which we sold and issued 1,400,000 shares of common stock. The shares were sold by the underwriters at a price of $20.49 per share and we received proceeds of $27.4 million after deducting underwriting discounts and commissions. We incurred offering costs of $0.5 million.

Revenue grew to $146.1 million for the nine months ended September 30, 2012 as our total client network increased to 128 clients, up from 112 as of December 31, 2011. We ended the quarter with deferred revenue of $98.7 million.

We believe that the amount that we spend to acquire patent assets is a key driver of the value that we create for our clients. We measure patent asset acquisition spend on both a "gross" and a "net" basis, whereby the "gross spend" represents the aggregate amount spent including amounts contributed by our clients in syndicated and structured acquisitions above and beyond their subscription fees and the "net spend" represents only the net incremental investment of our own capital. During the three and nine months ended September 30, 2012, we completed 8 and 23 acquisitions of patent assets, respectively. For the three months ended September 30, 2012, our gross and net acquisition spend totaled $26.4 million. For the nine months ended September 30, 2012, our gross and net acquisition spend totaled $147.4 million and $93.2 million, respectively. Over the trailing four quarters ended September 30, 2012, our gross and net acquisition spend totaled $176.2 million and $121.9 million, respectively. From our inception through September 30, 2012, we have completed 113 acquisitions of patent assets with gross and net acquisition spend of $519.1 million and $383.2 million, respectively.

On March 30, 2012, we entered into a number of agreements with Digitude Innovations, LLC ("Digitude"), Preservation Technologies LLC ("Preservation"), and Robert and Susan Kramer (collectively, the "Agreements"). The Agreements were subject to closing conditions that were satisfied on April 19, 2012. Pursuant to the Agreements, we paid $45.8 million and acquired among other things (i) certain patents, patent rights and covenant not to sue and (ii) all of the issued and outstanding membership interests in Altitude Capital Management LLC ("ACM"). Eleven of our clients participated in the transaction, making it our largest syndicated transaction to date. We entered into the Agreements to significantly increase our portfolio of patent assets and remove the potential exposure that Digitude, Preservation and ACM, present to our clients. We acquired ownership of or rights to more than 500 U.S. (and more than 50 non-U.S.) patents that were held by Digitude and certain sub-license rights to patents licensed exclusively by Preservation. The portfolios acquired cover a broad range of technologies including mobile handsets, TVs, cameras, PCs, media players, content delivery, video-on-demand, internet streaming, and enterprise networks and have increased the Company's total portfolio of patent assets by more than 30%. In addition, we obtained proprietary data and models related to patent analysis and valuation methodologies. We believe this transaction will enhance our market intelligence and patent risk management capabilities. We also obtained certain restrictive covenants pursuant to which Robert Kramer agreed to refrain from competing against any of our lines of business for an extended period of time.


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Key Components of Results of Operations

Revenue

Historically, substantially all of our revenue has consisted of fees paid by our clients under subscription agreements. We expect that subscription fee revenue will increase with the growth of our client network. Subscription revenue will be positively or negatively impacted by the financial performance of our clients since their subscription fees are typically reset yearly based upon their most recently reported annual financial results. From time to time, we also recognize revenue from the sale of licenses and fee income in connection with structured acquisitions. In the future, we may receive other revenue and fee income from newly introduced products and services. While we expect to continue to experience revenue growth, we do not believe that our rate of growth since inception is representative of anticipated future revenue growth.

Cost of Revenue

Cost of revenue primarily consists of amortization expenses related to acquired patent assets. Acquired patent assets are capitalized and amortized ratably over their estimated useful lives or the remaining statutory life. Also included in the cost of revenue are expenses incurred to maintain and prosecute patents and patent applications and amortization expense for acquired intangible assets and internally developed software. We expect our cost of revenue to increase in the future as we add additional patent assets to our existing portfolio to support our existing and future clients.

Selling, General and Administrative Expenses

Selling, general and administrative expenses consist of salaries and related expenses, including stock-based compensation expenses, costs of marketing programs, legal costs, professional fees, travel costs, facility costs and other corporate expenses. We expect that in the foreseeable future, as we seek to serve more clients and develop new products and services, selling, general and administrative expenses will increase.

Provision for Income Taxes

Income taxes are computed using the asset and liability method, under which deferred tax assets and liabilities are determined based on the difference between the financial statements and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. Based on available information, we believe it is likely that our deferred tax assets will be fully realized. Accordingly, we have not applied a valuation allowance against our net deferred tax assets.

Critical Accounting Policies and Estimates

Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses and related disclosures.

With the exception of the paragraph below, which describes our accounting for business combinations, there have been no material changes to our critical accounting policies and estimates during the nine months ended September 30, 2012, as compared to those described in our Annual Report on Form 10-K filed with the SEC on March 26, 2012.

We apply the provisions of Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") 805, Business Combinations ("ASC 805"), in the accounting for our business acquisitions. ASC 805 requires companies to separately recognize goodwill from the assets acquired and liabilities assumed, which are at their acquisition date fair values. Goodwill as of the acquisition date represents the excess of the purchase price over the fair values of the assets acquired and the liabilities assumed.

We use significant estimates and assumptions, including fair value estimates, to determine fair value of assets acquired and liabilities assumed and when applicable the related useful lives of the acquired assets, as of the business combination date. When those estimates are provisional, we refine them as necessary during the measurement period. The measurement period is the period after the acquisition date, not to exceed one year, in which we may gather new information about facts and circumstances that existed as of the acquisition date to adjust the provisional amounts recognized. Measurement period adjustments are applied retrospectively, if material. All other adjustments are recorded to the consolidated statements of operations.


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Results of Operations

The following table sets forth selected consolidated statements of operations
data for each of the periods indicated (in thousands).

                                     Three Months Ended September 30,       Nine Months Ended September 30,
                                           2012              2011              2012                 2011
Revenue                              $        47,044     $   38,394     $       146,131       $       111,634
Cost of revenue                               21,980         16,459              60,508                44,652
Selling, general and administrative
expenses                                      13,147          9,069              39,903                28,465
(Gain) on sale of patent assets, net               -              -                (177 )                   -
Operating income                              11,917         12,866              45,897                38,517
Other income (expense), net                       65            (79 )                92                  (645 )
Income before provision for income
taxes                                         11,982         12,787              45,989                37,872
Provision for income taxes                     4,392          4,935              17,130                15,659
Net income                           $         7,590     $    7,852     $        28,859       $        22,213

The following table sets forth, for the periods indicated, consolidated statements of operations data as a percentage of revenue.

                                        Three Months Ended September 30,          Nine Months Ended September 30,
                                          2012                   2011                2012                 2011
Revenue                                     100 %                100  %              100  %               100  %
Cost of revenue                              47                   43                  41                   40
Selling, general and administrative
expenses                                     28                   24                  27                   25
(Gain) on sale of patent assets, net          -                    -                   -                    -
Operating income                             25                   33                  32                   35
Other income (expense), net                   -                    -                   -                   (1 )
Income before provision for income
taxes                                        25                   33                  32                   34
Provision for income taxes                    9                   13                  12                   14
Net income                                   16 %                 20  %               20  %                20  %

Revenue

Our revenue for the three months ended September 30, 2012 was $47.0 million compared to $38.4 million during the same period a year ago, an increase of $8.6 million, or 23%. The increase was primarily due to the growth in our client network and the resulting recognition of revenue from clients that joined both during the current period and prior to the start of the current period. Our client count increased by eight and seven clients during the three months ended September 30, 2012 and 2011, respectively. As of September 30, 2012 we had a total client network of 128 companies.

Our revenue for the nine months ended September 30, 2012 was $146.1 million compared to $111.6 million during the same period a year ago, an increase of $34.5 million, or 31%. The increase was primarily due to the growth in our client network and the resulting recognition of revenue from clients that joined both during the current period and prior to the start of the current period and an increase in revenue from the sale of perpetual licenses. Our client count increased by 16 and 31 clients, during the nine months ended September 30, 2012 and 2011, respectively. Revenue for the nine months ended September 30, 2012 also included $9.4 million from the sale of perpetual licenses as compared to $3.3 million in the same period in 2011.

Cost of Revenue

Our cost of revenue for the three months ended September 30, 2012 was $22.0 million compared to $16.5 million during the same period a year ago, an increase of $5.5 million, or 34%. The increase was primarily a result of additional amortization expense attributable to the increase in our patent assets. Amortization expense related to our patent assets was $21.5 million and $16.1 million for the three months ended September 30, 2012 and 2011, respectively. The expenses incurred to maintain patents and prosecute patent


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applications included in our portfolio were approximately $0.3 million and $0.2 million for the three months ended September 30, 2012 and 2011, respectively.

Our cost of revenue for the nine months ended September 30, 2012 was $60.5 million compared to $44.7 million during the same period a year ago, an increase of $15.8 million, or 36%. The increase was primarily a result of additional amortization expense attributable to the increase in our patent assets. Amortization expense related to our patent assets was $59.2 million and $43.9 million for the nine months ended September 30, 2012 and 2011, respectively. The expenses incurred to maintain patents and prosecute patent applications included in our portfolio were approximately $0.8 million and $0.6 million for the nine months ended September 30, 2012 and 2011, respectively. Amortization expense related to our intangible assets was $0.5 million and $0.2 million for the nine months ended September 30, 2012 and 2011, respectively.

Selling, General and Administrative Expenses

Our selling, general and administrative expenses for the three months ended September 30, 2012 were $13.1 million compared to $9.1 million during the same period a year ago, an increase of $4.0 million or 45%. The increase was primarily due to a $1.2 million increase in personnel-related costs, including stock-based compensation, attributable to increasing our headcount to 126 employees as of September 30, 2012, compared to 99 employees at September 30, 2011. Expenses for professional services for the three months ended September 30, 2011 were reduced by $2.1 million due to the recovery of professional fees associated with an incomplete syndicated acquisition that had been expensed in 2010.

Our selling, general and administrative expenses for the nine months ended September 30, 2012 were $39.9 million compared to $28.5 million during the same period a year ago, an increase of $11.4 million, or 40%. The increase was primarily due to a $5.9 million increase in personnel-related costs, including stock-based compensation, attributable to increasing our headcount to 126 employees as of September 30, 2012, compared to 99 employees at September 30, 2011, a $2.0 million increase in our facility-related costs, depreciation and other corporate expenses due to the leasing of additional office space, and higher depreciation expenses due to increases in property and equipment balances. Expenses for professional services for the nine months ended September 30, 2011 were reduced by $2.1 million due to the recovery of professional fees associated with an incomplete syndicated acquisition that had been expensed in 2010.

Other Income (Expense), Net

Other income (expense), net for the three months ended September 30, 2012 was $65,000 compared to other income (expense), net of ($79,000) during the same period a year ago, a decrease of $0.1 million. Other income (expense), net, for the nine months ended September 30, 2012 was $0.1 million compared to other income (expense), net of ($0.6 million) during the same period a year ago, a decrease of $0.7 million. The decreases for both the three and nine months ended September 30, 2012 were primarily due to a reduction in outstanding debt balances.

Provision for Income Taxes

Our effective tax rate for both the three and nine months ended September 30, 2012 was 37% including the impact of discreet benefit items, compared to 39% and 41% for the three and nine months ended September 30, 2011, respectively. The decrease in our effective tax rate was primarily attributable to the use of a single sales factor for California state income tax apportionment. The difference between the consolidated effective income tax rate and the U.S. federal statutory rate is primarily attributable to the effect of certain permanent differences and state income taxes.

Liquidity and Capital Resources

As of September 30, 2012, we had $83.4 million of cash and cash equivalents and $125.2 million in short-term investments. In September 2011, we completed a follow-on offering of our common stock, in which we sold and issued 1,400,000 shares of common stock. The shares were sold by the underwriters at a price of $20.49 per share, and we received proceeds of $27.4 million after deducting underwriting discounts and commissions. In connection with this offering, we incurred offering costs of $0.5 million. In May 2011, we completed our initial public offering in which we sold and issued 9,065,000 shares of common stock, including 634,565 shares issued pursuant to an over-allotment option granted to the underwriters. The shares were sold by the underwriters at a price of $19.00 per share and we received proceeds of $160.2 million after deducting underwriting discounts and commissions. We incurred offering costs of $2.9 million. Prior to the initial public offering, substantially all of our operations and patent asset acquisitions had been financed through the private sale of equity securities, subscription fees collected from our clients and patent-seller financing.

We believe our existing cash, cash equivalents and short-term investments will be sufficient to meet our working capital and capital expenditure needs for the foreseeable future. Our future capital needs will depend on many factors, including, among other things, our acquisition of patent assets, addition and renewal of client membership agreements and development of new products and services. We anticipate an increased level of patent acquisition spending as our business grows. Additionally, we may enter into potential investments in, or acquisitions of, complementary businesses which could require us to seek additional debt or equity


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financing. Additional funds may not be available on terms favorable to us or at all.

As a public company, we incur costs that we had not previously incurred prior to our initial public offering, including, but not limited to, costs and expenses increased directors and officers insurance, investor relations fees, expenses for compliance with the Sarbanes-Oxley Act of 2002 and rules implemented by the SEC and The Nasdaq Global Market, on which our common stock is listed, and various other costs. The Sarbanes-Oxley Act of 2002 requires that we maintain effective disclosure controls and procedures and internal control over financial reporting.

The following table sets forth a summary of our cash flows for the periods indicated (in thousands):

                                                               Nine Months Ended September 30,
                                                                  2012                  2011
Net cash provided by operating activities                  $         80,665       $       97,265
Net cash used in investing activities                              (107,959 )           (195,740 )
Net cash provided by financing activities                             3,985              173,503
Increase (decrease) in cash and cash equivalents           $        (23,309 )     $       75,028

Cash Flows from Operating Activities

Cash provided by operating activities for the nine months ended September 30, 2012 was $80.7 million, consisting of net income of $28.9 million; adjustments for non-cash items of $65.0 million primarily due to $61.2 million of depreciation and amortization, $7.5 million of stock-based compensation, $3.8 million of amortization of premium on investments and reduction of $5.8 million due to excess tax benefit from stock-based compensation and a $1.5 million net increase in our deferred tax assets; and a reduction in working capital and non-current assets and liabilities totaling $13.2 million primarily from a $10.0 million increase due to a refundable deposit to a third party, a $2.9 million decrease in accrued liabilities and a $9.6 million decrease in deferred revenue, which was partially offset by a $5.9 million decrease in prepaid expenses and other assets, a $3.2 million decrease in accounts receivable due to collections from our clients. The decrease in deferred revenue is due to $137.0 million of revenue and other adjustments recognized during the period and was partially offset by revenue billings to new and existing clients of $127.4 million. The amount of deferred revenue in any given period varies with the addition of new clients, the mix of payment terms that we offer and the timing of invoicing existing clients.

Cash provided by operating activities for the nine months ended September 30, 2011 was $97.3 million, consisting of net income of $22.2 million, adjustments for non-cash items of $46.5 million and changes in working capital and non-current assets and liabilities totaling $28.6 million. The change in working capital resulted primarily from a decrease in accounts receivable of $10.6 million, an increase in deferred revenue of $15.0 million and an increase in accrued liabilities of $7.5 million. The increase in deferred revenue for the nine months ended September 30, 2011 is primarily attributable to $126.4 million of subscription billings for the period offset by $111.3 million of revenue recognized during the period. The increase in deferred revenue is due to annual subscription billings and the growth in our membership to 103 clients as of September 30, 2011 from 72 clients as of December 31, 2010. The amount of deferred revenue in any given period varies with the addition of new clients, the mix of payment terms that we offer and the timing of invoicing existing clients.

Cash Flows from Investing Activities

Cash used in investing activities for the nine months ended September 30, 2012 was $108.0 million, of which $65.1 million was used to acquire patent assets, $45.8 million paid for the business acquisition of Altitude Capital and $1.6 million used to purchase property and equipment. This increase was partially offset by $3.7 million in proceeds from net maturities of short-term marketable securities. We expect our cash used in investing activities to increase in the . . .

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