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RPXC > SEC Filings for RPXC > Form 10-Q on 6-Nov-2013All Recent SEC Filings

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Form 10-Q for RPX CORP


6-Nov-2013

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 11, 2013.

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. Forward-looking statements include statements regarding our business strategies and business model, products, benefits to our clients, future financial results and expenses and patent acquisition spending. 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 11, 2013. 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.

The core of our solution is defensive patent aggregation, in which we acquire patent assets that are being or may be asserted against our current or prospective clients. We then provide our clients with licenses to our patent assets to protect them from potential patent infringement assertions. We also provide our clients access to our proprietary patent market intelligence and data.

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.

During the nine months ended September 30, 2013, our revenue grew to $177.2 million from $146.1 million for the nine months ended September 30, 2012. Our client count increased by 20 clients bringing our total client network to 160 as of September 30, 2013. At September 30, 2013, we had deferred revenue of $105.2 million.

We believe that our acquisitions of patent assets are 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 nine months ended September 30, 2013, we completed 28 acquisitions of patent assets and our gross and net acquisition spend totaled $91.1 million and $86.1 million, respectively. From our inception through September 30, 2013, we have completed 148 acquisitions of patent assets with gross and net acquisition spend of $714.6 million and $492.5 million, respectively.

During the nine months ended September 30, 2013, we completed a divestiture of a patent asset portfolio in the open market. This divestiture had an immaterial impact to our results of operations and financial condition. We expect to divest patent portfolios as a normal part of our business, and these divestitures will result in a gain or loss in the period in which the transaction occurs. The gain or loss is based on the sale price relative to the carrying value of the patent assets divested.

Insuring against the costs of non-practicing entity ("NPE") litigation is a natural extension of our core defensive patent acquisition service. In August 2012, we started to offer NPE patent infringement liability insurance, which is a liability insurance policy for operating companies that covers certain costs associated with patent infringement lawsuits by NPEs. The insurance product complements our core defensive patent acquisition service, enabling policyholders, who must be members of our client network, to


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better manage and mitigate the risk of NPE patent litigation. As of and for the three and nine months ended September 30, 2013, the effect of the insurance policies that have been issued was not material to our results of operations or financial condition.

Key Components of Results of Operations
Revenue
Subscription revenue includes membership subscription services and premiums earned from insurance policies. Historically, the majority of our revenue has consisted of fees paid by our clients under subscription agreements. Subscription revenue will be positively or negatively impacted by the financial performance of our clients since their subscription fees typically reset annually based upon their most recently reported annual financial results. In August 2012, we launched our insurance product and we started to recognize revenue from insurance premiums. Although we expect this revenue to increase as we sell more policies in the future, for the three and nine months ended September 30, 2013, revenue from insurance premiums was not material to the Company's results of operations. We also recognize revenue from the sale of licenses and advisory fee income in connection with structured acquisitions, which we collectively refer to as fee-related revenue. 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 on an annual basis, 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. Also included in the cost of revenue are expenses incurred to maintain our patents and prosecute our patent applications and amortization expense for acquired intangible assets and internally developed software. With the launch of our insurance offering in August 2012, cost of revenue also includes premiums ceded to reinsurers and loss reserves. 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 and as our insurance business grows. Our cost of revenue is primarily driven by the amortization of previously acquired patent assets, which are typically amortized over an estimated useful life of 24 to 60 months. However, from time to time, we may acquire patent assets with an estimated useful life that is significantly less than the historical weighted-average of patent assets previously acquired, resulting in increased patent asset amortization expense in immediate periods following acquisition.

Selling, General and Administrative Expenses Selling, general and administrative expenses consist of salaries and related expenses, including stock-based compensation expense, cost 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 condensed consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these condensed 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.

There have been no material changes to our critical accounting policies and estimates during the three and nine months ended September 30, 2013, as compared to those described in our Annual Report on Form 10-K filed with the SEC on March 11, 2013.


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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). Our historical results
are not necessarily indicative of our results of operations to be expected for
any future period.
                                      Three Months Ended September 30,     Nine Months Ended September 30,
                                            2013               2012              2013              2012
Revenue                              $          58,554     $   47,044     $        177,229     $  146,131
Cost of revenue                                 29,766         21,980               78,130         60,508
Selling, general and administrative
expenses                                        15,584         13,147               45,793         39,903
(Gain) loss on sale of patent
assets, net                                          -              -                  126           (177 )
Operating income                                13,204         11,917               53,180         45,897
Other income, net                                   56             65                  170             92
Income before provision for income
taxes                                           13,260         11,982               53,350         45,989
Provision for income taxes                       4,863          4,392               19,561         17,130
Net income                           $           8,397     $    7,590     $         33,789     $   28,859

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,
                                           2013                  2012              2013                   2012
Revenue                                      100 %                 100 %             100 %                100  %
Cost of revenue                               51                    47                44                   41
Selling, general and administrative
expenses                                      27                    28                26                   27
(Gain) loss on sale of patent
assets, net                                    -                     -                 -                    -
Operating income                              22                    25                30                   32
Other income, net                              -                     -                 -                    -
Income before provision for income
taxes                                         22                    25                30                   32
Provision for income taxes                     8                     9                11                   12
Net income                                    14 %                  16 %              19 %                 20  %

Revenue
Our revenue for the three months ended September 30, 2013 was $58.6 million compared to $47.0 million during the same period a year ago, an increase of $11.5 million, or 24%. Subscription revenue, which includes membership subscription services and premiums earned from insurance policies, for the three months ended September 30, 2013 was $57.8 million compared to $47.0 million for the three months ended September 30, 2012, an increase of $10.8 million, or 23%. The increase in subscription revenue was attributable to an increase in membership fees, which was composed of $8.8 million from new clients who joined our network subsequent to September 30, 2012 and $2.0 million from clients who joined our network prior to September 30, 2012. As of September 30, 2013 we had a total client network of 160 companies as compared to 128 as of September 30, 2012. Revenue for the three months ended September 30, 2013 also included $0.7 million of fee-related revenue, as compared to nil in the same period in 2012.

Our revenue for the nine months ended September 30, 2013 was $177.2 million compared to $146.1 million during the same period a year ago, an increase of $31.1 million, or 21%. Subscription revenue for the nine months ended September 30, 2013 was $166.8 million compared to $136.7 million for the nine months ended September 30, 2012, an increase of $30.1 million, or 22%. The increase in subscription revenue was attributable to an increase in membership fees, which was composed of $17.6 million from new clients who joined our network subsequent to September 30, 2012 and $12.5 million from clients who joined our network prior to September 30, 2012. Revenue for the nine months ended September 30, 2013 also included $10.4 million of fee-related revenue, as compared to $9.4 million in the same period in 2012.

Cost of Revenue
Our cost of revenue for the three months ended September 30, 2013 was $29.8 million compared to $22.0 million during the same period a year ago, an increase of $7.8 million, or 35%. The increase was primarily attributable to a $6.7 million increase in


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patent amortization expense and a $0.7 million increase in the provision for known and incurred but not reported claims from our liability insurance policy business. The increase in patent amortization expense was a result of an increase in our patent assets and a shorter amortization period for certain patent assets acquired during the three months ended September 30, 2013. The weighted-average estimated economic useful life at the time of acquisition of the patent assets acquired during the three months ended September 30, 2013 was 30 months compared to the 44 months weighted-average estimated economic useful life of the patent assets acquired since inception, excluding fully amortized patent assets.

Our cost of revenue for the nine months ended September 30, 2013 was $78.1 million compared to $60.5 million during the same period a year ago, an increase of $17.6 million, or 29%. The increase was primarily attributable to a $15.3 million increase in patent amortization expense and a $0.5 million increase in patent maintenance and prosecution expenses, as a result of an increase in our patent assets and a $1.1 million increase in the provision for known and incurred but not reported claims from our liability insurance policy business. Cost of revenue for the nine months ended September 30, 2013 also included $0.5 million of fees paid to a third-party service provider in connection with our performance of advisory services.

Selling, General and Administrative Expenses Our selling, general and administrative expenses for the three months ended September 30, 2013 were $15.6 million compared to $13.1 million during the same period a year ago, an increase of $2.4 million, or 19%. The increase was primarily due to a $1.4 million increase in stock-based compensation expense and a $0.5 million increase in rent expense.

Our selling, general and administrative expenses for the nine months ended September 30, 2013 were $45.8 million compared to $39.9 million during the same period a year ago, an increase of $5.9 million, or 15%. The increase was primarily due to a $5.6 million increase in personnel-related costs, including $4.6 million of stock-based compensation expense, attributable to increasing our headcount to 136 as of September 30, 2013 compared to 126 as of September 30, 2012, and a $0.7 million increase in rent expense.

We expect that in the foreseeable future, selling, general and administrative expenses will increase as we seek to serve more clients, develop new products and services, and support our operations.

Provision for Income Taxes
Our provision for income taxes was $4.9 million and $4.4 million for the three months ended September 30, 2013 and 2012, respectively, and $19.6 million and $17.1 million for the nine months ended September 30, 2013 and 2012, respectively. Our effective tax rate, including the impact of discrete benefit items, was 37% for both the three and nine months ended September 30, 2013 and 2012.

Liquidity and Capital Resources
We have financed substantially all of our operations and patent asset acquisitions through the sale of equity securities, subscription fees collected from our clients and patent-seller financing. As of September 30, 2013, we had $132.6 million of cash and cash equivalents and $145.0 million in short-term investments. 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, growth of our insurance business 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 financing. Additional funds may not be available on terms favorable to us or at all.

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

                                                               Nine Months Ended September 30,
                                                                  2013                 2012
Net cash provided by operating activities                  $       156,526       $        80,665
Net cash used in investing activities                             (104,476 )            (107,959 )
Net cash provided by financing activities                            6,926                 3,985
Increase (decrease) in cash and cash equivalents           $        58,976       $       (23,309 )

Cash Flows from Operating Activities
Cash provided by operating activities for the nine months ended September 30, 2013 was $156.5 million, consisting of adjustments for non-cash items totaling $88.0 million, changes in working capital and non-current assets and liabilities of $34.8 million, and net income of $33.8 million. Non-cash adjustments to net income primarily consisted of $76.8 million of depreciation and amortization, $12.1 million of stock-based compensation, $4.5 million of amortization of premium on investments, partially offset by


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a reduction of $2.8 million due to excess tax benefit from stock-based compensation and a $2.8 million net decrease in our deferred tax liabilities. The change in working capital resulted primarily from a $33.8 million decrease in other receivables representing the collection of client contributions outstanding as a result of the completion of a syndicated patent acquisition and licensing transaction and a $0.9 million increase in deferred revenue. The increase in deferred revenue was due to $167.7 million in billings to new and existing clients and was partially offset by revenue recognized during the period of $166.8 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 cumulative impact of the timing of invoicing existing clients that have joined our network at various points since our inception.

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 billings to new and existing clients of $127.4 million.

Cash Flows from Investing Activities
Cash used in investing activities for the nine months ended September 30, 2013 was $104.5 million, of which $82.8 million represented our acquisitions of patent assets, $17.9 million represented net purchases of short-term marketable securities, $2.1 million represented our acquisitions of property and equipment and $1.8 million represented our increase in restricted cash. We expect our cash used in investing activities to increase in the future as we acquire additional patents.

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

Cash Flows from Financing Activities
Cash provided by financing activities for the nine months ended September 30, 2013 was $6.9 million, the result of proceeds from exercise of stock options of $4.2 million and excess tax benefit from stock-based compensation of $2.8 million.

Cash provided by financing activities for the nine months ended September 30, 2012 was $4.0 million, of which $5.8 million was due to excess tax benefit from stock-based compensation and $2.8 million represented proceeds from exercise of stock options. The increase was partially offset by $5.2 million of principal payments for our deferred payment obligations.

Contractual Obligations and Commitments
Operating Lease Commitments
We generally do not enter into long-term minimum purchase commitments. Our principal long-term commitments consist of obligations under operating leases for office space. There were no substantial changes to our contractual obligations or commitments during the nine months ended September 30, 2013 as presented under the heading "Contractual Obligations and Commitments" in Part II, Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" or the heading "Commitments and Contingencies" in Note 14 of the Notes to Consolidated Financial Statements in Part II, Item 8 "Consolidated Financial Statements and Supplementary Data" included in our Annual Report on Form 10-K for our fiscal year ended December 31, 2012.

Patent Asset Purchase Commitments
During the three months ended September 30, 2013, we entered into various agreements to acquire patent assets for an aggregate purchase price of $7.1 million. Pursuant to these agreements, we paid the applicable purchase price and acquired the patent assets in October 2013.

Off Balance Sheet Arrangements
At September 30, 2013, we did not have any relationships with unconsolidated entities or financial partnerships, such as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance-sheet arrangements or other contractually narrow or limited purposes.


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Recent Accounting Pronouncements
Recently Adopted Accounting Standards
In February 2013, the FASB issued Accounting Standards Update ("ASU") 2013-02, Reporting of Amounts of Reclassified Out of Accumulated Other Comprehensive Income ("ASU 2013-02"), which amends Comprehensive Income (Topic 220) in the Accounting Standards Codification ("ASC"). These amendments require an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component. In addition, an entity is required to present significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income. The amendments in ASU 2013-02 are effective for our interim and annual fiscal periods beginning January 1, 2013. The adoption of ASU 2013-02 did not have a material impact on our consolidated financial statements.

In October 2012, the FASB issued ASU 2012-04, Technical Corrections and Improvements ("ASU 2012-04"), which amends a wide range of topics in the ASC. These amendments include technical corrections and improvements to the ASC and conforming amendments related to fair value measurements. The amendments in ASU 2012-04 are effective for our interim and annual fiscal periods beginning January 1, 2013. The adoption of ASU 2012-04 did not have a material impact on our consolidated financial statements.

In July 2012, the FASB issued ASU 2012-02, Intangibles - Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment ("ASU . . .

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