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VRNG > SEC Filings for VRNG > Form 10-Q on 14-Nov-2012All Recent SEC Filings

Show all filings for VRINGO INC

Form 10-Q for VRINGO INC


14-Nov-2012

Quarterly Report


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

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 (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 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 for the year ended December 31, 2011 as updated in our Quarterly Report on Form 10-Q for the period ended June 30, 2012 filed on August 14, 2012 and other public reports we filed with the Securities and Exchange Commissions, or the 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. In this report, "Vringo," the "Company," "we," "us," and "our" refer to Vringo, Inc.

Overview

We were incorporated in Delaware on January 9, 2006 and commenced operations during the first quarter of 2006. In March 2006, we formed a wholly-owned subsidiary, Vringo (Israel) Ltd., primarily for the purpose of providing research and development services, as detailed in the intercompany service agreement. On July 19, 2012, Innovate/Protect, Inc. ("I/P") merged with us through an exchange of equity instruments of I/P for those of Vringo (the "Merger"). I/P is a holding company, incorporated under the laws of Delaware on June 8, 2011, as Labrador Search Corporation, which holds two wholly-owned subsidiaries: I/P Engine Inc., formed under the laws of Virginia on June 14, 2011, originally as Smart Search Labs Inc., which operates for the purpose of realizing economic benefits, and I/P Labs, Inc., incorporated in Delaware on June 8, 2011 originally as Scottish Terrier Capital Inc., which operated to acquire and develop other patented technologies or intellectual property. On August 31, 2012, we formed two wholly-owned subsidiaries, incorporated in Delaware: Vringo Labs, Inc. which operates to acquire and develop new patented technologies or intellectual property and Vringo Infrastructure, Inc., which operates for the purpose of realizing economic benefits from patent portfolio acquired from Nokia Corporation ("Nokia"), as further described below. In addition, on October 18, 2012, we formed a wholly-owned subsidiary in Germany, Vringo Germany GmbH, for the purpose of innovating, developing, and monetizing mobile technology and intellectual property in Germany.

As a combined company, our attempts are focused on maximizing the economic benefits from our growing intellectual property portfolio. We plan to add significant talent in technological innovation, and continue to enhance our technology capabilities to create, build and deliver mobile applications and services to our handset and mobile operator partners, as well as directly to consumers.

The combined company has two key areas of operation:

• maximization of the economic benefits from developed and acquired intellectual property, and

• delivery and monetization of mobile social applications.

We are a development stage company. The Merger has been accounted for as a reverse acquisition under which I/P was considered the acquirer of Vringo. As such, the financial statements of I/P are treated as the historical financial statements of the combined company, with the results of Vringo being included from July 19, 2012.

From inception of I/P (June 8, 2011) to date, we have raised approximately $84,862,000. These amounts have been used to finance our operations, as until now, we have not yet generated any significant revenues. From inception of I/P through September 30, 2012, we recorded losses of approximately $9,590,000 and net cash outflow from operations of approximately $7,491,000. Our average monthly cash burn rate from operations for the three and nine month period ended September 30, 2012 was approximately $1,110,000 and $662,000, respectively.

As of November 14, 2012, we had approximately $60,500,000 in cash and cash equivalents. Based on current operating plans, we expect to have sufficient funds for at least the next twelve months. In addition, we may choose to raise additional funds in connection with potential acquisitions of patent portfolios or other intellectual property assets that we may pursue. There can be no assurance, however, that any such opportunities will materialize.

As of September 30, 2012, we had 26 full time employees and two part-time employees.

Intellectual Property

As a combined company, we focus on the economic benefits of intellectual property assets through acquiring or internally developing patents or other intellectual property assets (or interests therein) and then monetize such assets through a variety of value enhancing initiatives, including, but not limited to:

• licensing,

• customized technology solutions,

• strategic partnerships, and

• litigation.

Upon formation in June 2011, I/P acquired its initial patent assets from Lycos through its wholly-owned subsidiary, I/P Engine. Such assets were comprised of eight patents relating to information filtering and search technologies. As part of our strategy to monetize the patents acquired from Lycos, I/P Engine commenced litigation against AOL, Inc., Google, Inc., IAC Search & Media, Inc., Gannett Company, Inc. and Target Corporation (collectively, "Defendants").

Trial commenced on October 16, 2012, and the case was submitted to the jury on November 1, 2012. On November 6, 2012, the jury unanimously returned a verdict as follows: (i) I/P Engine had proven by a preponderance of the evidence that the Defendants infringed the asserted claims of the patents; and (ii) Defendants had not proven by clear and convincing evidence that the asserted claims of the patents are invalid by anticipation. The jury also found certain specific facts related to the ultimate question of whether the patents are invalid as obvious. Based on such facts , the Court will issue a ruling on obviousness. We believe that the jury's factual findings will support a finding that the patents are not invalid as obvious. After finding that the asserted claims of the Patents were both valid and infringed by Google, the jury found that reasonable royalty damages should be based on a "running royalty", and that the running royalty rate should be 3.5%.

After finding that the asserted claims of the Patents were both valid and infringed by the Defendants, the jury found that the following sums of money, if paid now in cash, would reasonably compensate I/P Engine for the Defendants past infringement as follows: Google: $15,800,000, AOL: $7,943,000, IAC: $6,650,000, Gannett: $4,322, Target: $98,833. I/P Engine and Defendants are allowed to file post-trial motions with the court, the schedule for which has yet been determined.

On August 9, 2012, we entered into a patent purchase agreement with Nokia, pursuant to which, Nokia agreed to sell us a portfolio consisting of over 500 patents and patent applications worldwide, including 109 issued United States patents. We agreed to compensate Nokia with a cash payment and certain ongoing rights in revenues generated from the patent portfolio. The portfolio encompasses a broad range of technologies relating to telecom infrastructure, including communication management, data and signal transmission, mobility management, radio resources management and services. Thirty-one of the 124 patent families acquired have been declared essential by Nokia to wireless communications standards. Standards represented in the portfolio are commonly known as 2G, 2.5G, 3G and 4G and related technologies and include GSM, WCDMA, T63, T64, DECT, IETF, LTE, SAE, and OMA. The purchase price for the portfolio was $22,000,000, plus capitalized acquisition costs of $578,000. To the extent that the gross revenue (as defined in the purchase agreement) generated by such portfolio exceeds $22,000,000, a royalty of 35% of such excess is due to be paid to Nokia. The $22,000,000 cash payment was made to Nokia on August 10, 2012. The purchase agreement provides that Nokia and its affiliates will retain a non-exclusive, worldwide and fully paid-up license (without the right to grant sublicenses) to the portfolio for the sole purpose of supplying (as defined in the purchase agreement) Nokia's products. The purchase agreement also provides that if we bring a proceeding against Nokia or its affiliates within seven years, Nokia shall have the right to re-acquire the patent portfolio for a nominal amount. Further, if we either sell to a third party any assigned essential cellular patent, or more than a certain portion of the other assigned patents (other than in connection with a change of control of our company), or file an action against a telecom provider to enforce any of the assigned patents (other than in response to any specified action filed by a telecom provider against us or our affiliate) which action is not withdrawn after notice from Nokia, then we will be obligated to pay to Nokia a substantial impairment payment. Because all of the foregoing actions are within our sole control, we do not expect to be obligated to pay any such impairment payment.

As one of the means of realizing the value of the patents acquired from Nokia, on October 5, 2012, our wholly-owned subsidiary, Vringo Infrastructure, Inc., filed suit in the UK High Court of Justice, Chancery Division, Patents Court, alleging infringement of European Patents (UK) 1,212,919; 1,166,589; and 1,808,029. Declarations have been filed at the European Telecommunications and Standards Institute (ETSI) that cover the patents. The complaint alleges that ZTE's cellular network elements fall within the scope of all three patents, and ZTE's GSM/UMTS multi-mode wireless handsets also fall within the scope of the '029 patent. On October 23, 2012, counsel for ZTE acknowledged service. ZTE (UK) formal response to the complaint is anticipated by November 22, 2012. A case management conference where among other matters, the schedule for the suit will be set, is anticipated in January 2013.

We continue to grow our technology portfolio. From September 4 through October 12, 2012, as part of our efforts to develop new technology assets in the mobile and social media space, inventors working for Vringo filed 9 provisional patent applications covering a wide range of technologies including: Determining content relevance based on a user's relationships; Using mobile technologies as sleep aids; Combining social media and on-line videos; Improving mobile security using facial recognition technology; Monitoring usage patterns of mobile devices and computers to make recommendations; Technology that allows to post call information to social media; Technology to assist in prioritizing electronic communications; Technology that rewards a user's specific wireless device activity. Additionally, Vringo's existing mobile portfolio continues to mature; including the grant on August 1, 2012 of EP 1,982,549 and on October 23, 2012 of USP 8,295,205.

As part of our efforts to develop new technology in the telecom infrastructure space, we filed 12 continuation applications in the US. In addition, we filed a continuation-in-part application that combines internally developed innovation in the DRM space with telecom infrastructure. Further, through our wholly owned subsidiary, Vringo Labs, Inc., we filed a patent application relating to wireless energy charging.

On October 10, 2012, I/P Engine entered into a patent purchase agreement, pursuant to which we issued seller 160,600 unregistered shares of Vringo common stock, as well as a 20% royalty from collected future revenue. The portfolio comprises U.S. Patent numbers 7,831,512 and 8,315,949, and US application number 13/653,894. This intellectual property relates to the placement of advertisements on web pages when there is a vacancy for an advertisement, and such advertisement is placed via a bidding process.

Mobile Social Applications

We have developed a platform for the distribution of mobile applications. We believe that our technology and business relationships will allow us to distribute new applications and services through:

• mobile operators,

• handset makers, and

• application storefronts.

Our video ringtone platform has been operating since 2008 and remains the primary source of subscription revenues among our mobile products and we continue to develop business for this product with mobile operators and content providers. Our solution, which encompasses a suite of mobile and PC-based tools, enables users to create, download and share video ringtones and provides our business partners with a consumer-friendly and easy-to-integrate monetization platform.

The revenue model for our video ringtone service offered through the carriers is a subscription-based model where users pay a monthly fee for access to our service and additional fees for premium content.

Our Vringo video ringtone mobile app also functions as a standalone direct-to-consumer offering. Our free version has been released as an ad-supported application on the Google Play marketplace and is still available in markets where we have not entered into commercial arrangements with carriers or other partners.

As of November 14, 2012, we have commercial video ringtone services with nine carriers and partners. We are currently in discussions with several other mobile carriers and we will be pursuing additional agreements with mobile carriers over the next 12, with a focus on Android-based apps as the cornerstone for future subscriber services. Separately, we continue to expand the distribution of our free to the user ad-supported mobile application.

Our Facetones® social ringtone platform generates social visual ringtone content automatically by aggregating and displaying a user's friends' pictures from social networks and then displaying as a video ringtone, as well as a video ringback tone. These ringtones do not replace, but rather enhance, standard ringtone and ringback tones with relevant, current social content that is visually displayed. The product is available to consumers on several operating systems, most notably is Android and is delivered in various configurations, with a variety of monetization methods. As of August 31, 2012, the Facetones® free ad-supported version had more than 1,500,000 downloads and is generating more than 2,500,000 advertising impressions on a weekly basis. Facetones® is offered directly to consumers via leading mobile application stores and download sites where both for purchase versions, as well as ad-supported free versions are available. Our revenue model is based on proceeds received from advertisers, as well as from related development projects and potential payment of royalties, as described below.

We also continue to pursue business for Facetones® together with handset manufacturers. We have developed five separate versions of Facetones in partnership with Nokia. In January 2012, we launched Facetones® for iPhone which generates, as of the end of February 2012, close to a 1,000 daily downloads without any promotion. In November 2011, we announced an agreement with ZTE Corporation, the largest handset maker in China and fourth-largest globally, to preload the Facetones® application on Android handsets manufactured by ZTE. ZTE is to pay a royalty for each preloaded device, the first of which launched with the release of ZTE's GrandX handsets in the United Kingdom in August 2012.

Our Fan Loyalty platform was launched in mid-2011 by co-branding our Fan-Loyalty application with Star Academy 8, the largest music competition in the Middle East and Nokia, the world's largest handset maker. The Fan Loyalty application for Star Academy was made available exclusively for download on the Ovi Store, and had more than 200,000 downloads during the season. In the first quarter of 2012, we entered into an agreement with Endemol, a producer of entertainment and reality TV programming, to collaborate on additional sponsored versions of this application.

Recent Financing Activity

On October 4, 2012, we entered into subscription agreements with several investors with respect to the registered direct offer and sale by us of an aggregate of 10,344,998 shares of our common stock, par value $0.01 per share, at a purchase price of $4.35 per share in a privately negotiated transaction in which no party acted as an underwriter or placement agent. The net proceeds were approximately $44,900,000, after deducting estimated offering expenses payable by us. We intend to use the net proceeds from this offering for general corporate working capital purposes.

In October 2012, we entered into an agreement with certain of our warrant holders, pursuant to which such warrant holders exercised in cash 3,721,062 of their outstanding warrants, with an exercise price of $1.76 per share, and we issued such warrant holders unregistered warrants to purchase an aggregate of 3,000,000 of our shares of common stock, par value $0.01 per share, at an exercise price of $5.06 per share. The newly issued warrants do not bear down round protection clauses. We are still evaluating the accounting impact of this transaction; nevertheless, we expect such impact on our financial statements to be material.

In addition, in October and November 2012, warrants to purchase an aggregate of 790,903 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 an additional $1,391,989.

Merger

On July 19, 2012, we consummated the Merger with I/P. I/P merged with and into VIP Merger Sub, Inc., a wholly owned subsidiary of Vringo ("Merger Sub"), with Merger Sub being the surviving corporation through an exchange of capital stock of I/P for our capital stock. Upon completion of the Merger, (i) all of the 6,169,661 outstanding shares of common stock of I/P, par value $0.0001 per share were converted into 18,617,569 shares of our common stock, par value $0.01; and
(ii) all share outstanding of Series A Convertible Preferred Stock of I/P, par value $0.0001 per share, were converted into 20,136,445 shares of our Series A Convertible Preferred Stock. The preferred stock issued, has the powers, designations, preferences and other rights as set forth in a Certificate of Designations, Preferences and Rights of Series A Convertible Preferred Stock filed by us prior to closing. In addition, we issued to the holders of I/P capital stock (on a pro rata as-converted basis) an aggregate of 15,959,838 warrants to purchase an aggregate of 15,959,838 shares of our common stock with an exercise price of $1.76 per share.

Immediately following the completion of the Merger, the former stockholders of I/P owned approximately 55.04% of the outstanding common stock of the combined company, and our current stockholders owned approximately 44.96% of the outstanding common stock of the combined company. On a fully diluted basis, the former stockholders of I/P owned approximately 67.61% of the outstanding common stock of the combined company, and our current stockholders owned approximately 32.39% of the outstanding common stock of the combined company.

For accounting purposes, I/P was identified as the accounting "acquirer", as it is defined in FASB Topic ASC 805. As a result, in the post-combination consolidated financial statements, as of the third quarter 2012, I/P's assets and liabilities are presented at its pre-combination amounts, and our assets and liabilities are recognized and measured in accordance with the guidance for business combinations in ASC 805. See also Notes 4 and 8 to the accompanying financial statements.

Hudson Bay Note

On June 22, 2011, I/P issued a senior secured note payable, in the total amount of $3,200,000, to one of its principal stockholders, Hudson Bay Master Fund Ltd. ("Hudson Bay") (the "Note"). The Note accrued interest at 0.46% per annum. After the Merger was consummated, on July 19, 2012, the Note was amended and restated and the holder was able to exercise any and all rights and remedies pursuant to such amended and restated Note, including with respect to any optional redemption provisions contained therein. The amended and restated Note was to mature on June 22, 2013 and I/P had granted Hudson Bay a security interest in all of its tangible and intangible assets, in order to secure I/P's obligations under the senior secured note. After the consummation of the Merger, the Note became our obligation, as it is to guarantee I/P's obligations after the Merger. On August 15, 2012, we repaid the outstanding balance in full.

Grants of Stock Options and RSUs

Immediately following the Merger, the vesting of shares of common stock granted prior to the Merger to I/P's officers and directors was fully accelerated. As a result, an additional 2,702,037 shares previously issued became vested. In addition, our board of directors approved the granting of 265,000 shares to certain consultants, as well as the acceleration of vesting of 908,854 options granted to certain officers and directors of Vringo. Finally, according to resolution made by our board of directors in January 2012, upon Merger, the vesting of all Vringo pre-Merger outstanding options was accelerated by one year.

On July 26, 2012, our board of directors approved the granting of 4,975,000 options to management, directors and employees at an exercise price of $3.72 per share. These options will vest quarterly over a three year period. In addition, the board also approved the granting of 15,000 options at an exercise price of $3.72 per share to one of our consultants. These options will vest over a one year period. Certain options granted to officers, directors and certain key employees are subject to acceleration of vesting of 75% - 100% (according to the agreement signed with each grantee), upon subsequent change of control. Moreover, on July 26, 2012, the board of directors approved the granting of 3,105,000 RSUs to management, directors and key employees. These RSUs will vest quarterly over a three and year periods (dependent on the agreement made with each grantee). In addition, we approved the granting of 25,000 RSUs to two of our consultants. These RSUs will vest over a 6-12 month period (according to the agreement signed with each grantee).

On August 8, 2012, the board of directors approved the granting of 500,000 options to a member of our management, at an exercise price of $3.44 per share. These options will vest quarterly over a three year period.

As of November 6, 2012, the vesting of all of Vringo's pre-Merger granted options outstanding (except for separation grants) was accelerated by 50%, as our market capitalization reached $250,000,000 for twenty of thirty consecutive trading days.

Revenue

We recognize revenue when all the conditions for revenue recognition are met:
(i) persuasive evidence of an arrangement exists, (ii) collection of the fee is probable, (iii) the sales price is fixed and determinable and (iv) delivery has occurred or services have been rendered. Intellectual property rights for patented technologies may 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 patented technologies owned or controlled by operating subsidiaries, (ii) a covenant-not-to-sue, (iii) the release of the licensee from certain claims, and (iv) dismissal of any pending litigation. Our subscription service arrangements are evidenced by a written document signed by both parties. Our revenues from monthly subscription fees, content purchases and advertisement revenues are recognized when we have received confirmation that the amount is due to us, which provides proof that the services have been rendered, and making collection probable. We recognize revenue from non-refundable up-front fees relating to set-up and billing integration across the period of the contract for the subscription service as these fees are part of hosting solution that we provide to the carrier. The hosting is provided on our servers for the entire period of the arrangement with this carrier, and the revenues relating to the monthly subscription, set-up fees and billing integration have been recognized over the period in the agreement. We also recognize revenue from development projects, based on percentage of completion, if the required criteria are met, or when the project is completed.

Cost of revenue

Cost of revenues mainly include the costs and expenses incurred in connection with our patent licensing and enforcement activities, contingent legal fees paid to external patent counsels, other patent-related legal expenses paid to external patent counsel, licensing and enforcement related research, consulting and other expenses paid to third parties, the amortization of patent-related acquisition costs and of the acquired technology. Cost of revenue also includes third party expenses directly related to providing our service in launched markets. In addition, these costs include royalty fees for content sales and amortization of prepaid content licenses. Cost of revenue does not include expenses related to product development, integration, and support. These costs are included in research and development and marketing expenses.

Research and development expenses

Research and development expenses consist primarily of salary expenses of our development and quality assurance engineers in our research and development facility in Israel, outsourcing of certain development activities, preparation of patent filings, server and support functions for our development environment.

Marketing, general and administrative expenses

Marketing, general and administrative expenses include the cost of management, administrative and marketing personnel, public relations, advertising, overhead/office cost and various professional fees, as well as insurance, 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 of derivative liabilities on account of the Preferential Reload Warrants, Special Bridge Warrants, Series 1 Warrants and the Conversion Warrants, which are highly influenced by our stock price at the period end (revaluation date).

Income taxes

Our effective tax rate differs from the statutory federal rate primarily due to differences between income and expense recognition prescribed by income tax regulations and generally accepted accounting principles. We utilize different methods and useful lives for depreciating and amortizing property and equipment and different methods and timing for certain expenses. Furthermore, permanent differences arise from certain income and expense items recorded for financial reporting purposes but not recognizable for income tax purposes. In addition, our income tax expense has been adjusted for the effect of foreign income from our wholly owned subsidiary in Israel. At September 30, 2012, deferred tax assets generated from our U.S. activities were offset by a valuation allowance . . .

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