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RPXC > SEC Filings for RPXC > Form 10-Q on 7-Aug-2014All Recent SEC Filings

Show all filings for RPX CORP

Form 10-Q for RPX CORP


7-Aug-2014

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 ("SEC") on March 10, 2014.

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 that is 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 SEC on March 10, 2014. 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 six months ended June 30, 2014, our revenue grew to $126.2 million from $118.7 million for the six months ended June 30, 2013. Our client count increased by 16 clients during the six months ended June 30, 2014, bringing our total client network to 184 as of June 30, 2014. At June 30, 2014, we had deferred revenue of $131.2 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 acquisitions above and beyond their subscription fees and the "net spend" represents only the net incremental investment of our own capital. During the six months ended June 30, 2014, we completed 29 acquisitions of patent assets and our gross and net acquisition spend totaled $77.4 million and $73.4 million, respectively. From our inception through June 30, 2014, we have completed 196 acquisitions of patent assets with gross and net acquisition spend of $833.2 million and $606.3 million, respectively.

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, whom we historically have required to be members of our client network, to better manage and mitigate the risk of NPE patent litigation. As of June 30, 2014, we had a total of 33 active insurance policies. The effect of the insurance policies that have been issued was not material to our results of operations or financial condition for the six months ended June 30, 2014 or 2013. In connection with an evolution of the way that we will sell insurance policies, during March 2014 we formed a reinsurance company to assume some portion of the underwriting risk on insurance policies that the we issue on behalf of a Lloyd's of London underwriting syndicate. We began issuing new policies under the


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reinsurance model in May 2014. As of, and for the three and six months ended June 30, 2014, the effect of the insurance policies issued under the reinsurance model 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 started to recognize revenue from insurance premiums. We had been recognizing insurance premiums as revenue, however, under the new reinsurance model we only recognize the portion ceded to us. In addition, we receive management fees for marketing, underwriting, and claims management services. Although we expect this revenue to increase as we sell more policies in the future, for the three and six months ended June 30, 2014 and 2013, revenue from insurance premiums was not material to our results of operations. We also recognize revenue from the sale of licenses and advisory fee income in connection with syndicated acquisitions, which we collectively refer to as fee-related revenue. Although we expect to continue to generate fee-related revenue, these transactions are unpredictable and vary quarter to quarter. 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 expense related to acquired patent assets. Acquired patent assets are capitalized and amortized ratably over their estimated useful lives which are typically derived based on the anticipated cash flows from clients and prospects that may benefit from the transaction. 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 began to issue new policies under the reinsurance model in May 2014 and as a result we will no longer be ceding premiums. 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. From time to time, we may acquire patent assets that we believe are valuable to our clients and prospects 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. Estimating the economic useful lives of our patent assets depends on various factors including the remaining statutory life of the underlying patents, which could result in shorter amortization periods. Recent trends suggest that amortization periods on patent assets acquired in future periods may be amortized over shorter periods than the historical weighted-average of 46 months.

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 continue to increase.

Other Income, Net
Other income, net primarily consists of interest income earned on our cash, cash equivalents and short-term investments.

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.


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There have been no material changes to our critical accounting policies and estimates during the six months ended June 30, 2014, as compared to the critical accounting policies and estimates presented under the heading "Critical Accounting Policies and Estimates" in Part II, Item 7 of the Company's Annual Report on Form 10-K filed with the SEC on March 10, 2014.

Recently Issued Accounting Standards
In June 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2014-12, Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period ("ASU 2014-12"), which amends Compensation - Stock Compensation (Topic 718) in the Accounting Standards Codification ("ASC"). ASU 2014-12 requires that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. A reporting entity should apply existing guidance in Compensation - Stock Compensation (Topic 718) as it relates to awards with performance conditions that affect vesting to account for such awards. The amendments in ASU 2014-12 will be effective for annual and interim periods beginning after December 15, 2015 and early adoption is permitted. The adoption of ASU 2014-12 is not expected to have a material impact on our consolidated financial statements.

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606) ("ASU 2014-09"), which will supersede most existing revenue recognition guidance in U.S. generally accepted accounting principles ("U.S. GAAP") once it becomes effective. ASU 2014-09 requires an entity to recognize revenues when promised goods or services are transferred to customers in an amount that reflects the consideration that is expected to be received for those goods or services. ASU 2014-09 defines a five-step process to achieve this core principle and, in doing so, it is possible more judgment and estimates may be required within the revenue recognition process than required under existing U.S. GAAP including identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. ASU 2014-09 will be effective for annual and interim periods beginning after December 15, 2016 and early adoption is not permitted. We are currently evaluating the impact of the adoption of ASU 2014-12 to our consolidated financial statements.

In April 2014, the FASB issued ASU 2014-08, Presentation of Financial Statements (Topic 205) and Property, Plant and Equipment (Topic 360), ("ASU 2014-08") which amends the requirements for reporting discontinued operations and enhances disclosure requirements. The amendments in ASU 2014-08 will be effective for all disposals (or classifications as held for sale) of components of an entity beginning on or after December 15, 2014 and early adoption is permitted. The adoption of ASU 2014-08 is not expected to have a material impact on our consolidated financial statements.
Results of Operations
The following table sets forth our condensed consolidated 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 June 30,            Six Months Ended June 30,
                                            2014                 2013               2014              2013
Revenue                               $       64,293       $       57,481     $     126,181       $   118,675
Cost of revenue                               31,542               24,694            60,462            48,364
Selling, general and administrative
expenses                                      18,579               15,736            35,834            30,209
(Gain) loss on sale of patent
assets, net                                     (699 )                126              (699 )             126
Operating income                              14,871               16,925            30,584            39,976
Other income, net                                 94                   63               193               114
Income before provision for income
taxes                                         14,965               16,988            30,777            40,090
Provision for income taxes                     5,566                6,291            11,518            14,698
Net income                            $        9,399       $       10,697     $      19,259       $    25,392


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The following table sets forth our condensed consolidated operations data as a percentage of revenue.

                                        Three Months Ended June 30,         Six Months Ended June 30,
                                            2014              2013            2014              2013
Revenue                                     100  %               100 %         100  %              100 %
Cost of revenue                              49                   43            48                  41
Selling, general and administrative
expenses                                     29                   27            28                  25
(Gain) loss on sale of patent
assets, net                                  (1 )                  -            (1 )                 -
Operating income                             23                   30            25                  34
Other income, net                             -                    -             -                   -
Income before provision for income
taxes                                        23                   30            25                  34
Provision for income taxes                    9                   11             9                  12
Net income                                   14  %                19 %          16  %               22 %

Revenue
Our revenue for the three months ended June 30, 2014 was $64.3 million compared to $57.5 million during the same period a year ago, an increase of $6.8 million, or 12%. Subscription revenue, which includes membership subscription services and premiums earned from insurance policies, for the three months ended June 30, 2014 was $64.3 million compared to $55.0 million for the three months ended June 30, 2013. The increase in subscription revenue was primarily attributable to an increase in membership fees and insurance premiums of $7.7 million from new clients who joined our network subsequent to June 30, 2013 and $1.6 million from clients who joined our network prior to June 30, 2013. This will increase or decrease over time as clients leave the network or we adjust their membership fees from the prior period. As of June 30, 2014, we had a total client network of 184 companies as compared to 157 as of June 30, 2013. Revenue for the three months ended June 30, 2013 also included fee-related revenue of $2.5 million. There was no fee-related revenue recorded during the three months ended June 30, 2014.

Our revenue for the six months ended June 30, 2014 was $126.2 million compared to $118.7 million during the same period a year ago, an increase of $7.5 million, or 6%. Subscription revenue, which includes membership subscription services and premiums earned from insurance policies, for the six months ended June 30, 2014 was $125.1 million compared to $109.0 million for the six months ended June 30, 2013. The increase in subscription revenue was primarily attributable to an increase in membership fees and insurance premiums of $12.9 million from new clients who joined our network subsequent to June 30, 2013 and $3.2 million from clients who joined our network prior to June 30, 2013. Revenue for the six months ended June 30, 2014 also included $1.1 million of fee-related revenue compared to $9.7 million in the same period in 2013.

Cost of Revenue
Our cost of revenue for the three months ended June 30, 2014 was $31.5 million compared to $24.7 million during the same period a year ago, an increase of $6.8 million, or 28%. The increase was primarily attributable to a $6.4 million increase in patent amortization expense as a result of an increase in our patent assets and shorter than historical amortization periods for certain patent assets acquired subsequent to June 30, 2013. Patent assets acquired during the three months ended June 30, 2014 had a weighted-average amortization period of 37 months compared with the historical weighted-average since our inception of 46 months. We also had a $0.3 million increase in expenses incurred to maintain and prosecute patents and patent applications included in our portfolio.

Our cost of revenue for the six months ended June 30, 2014 was $60.5 million compared to $48.4 million during the same period a year ago, an increase of $12.1 million, or 25%. The increase was primarily attributable to a $11.4 million increase in patent amortization expense as a result of an increase in our patent assets, and shorter than historical amortization periods for certain patent assets acquired subsequent to June 30, 2013. We also had a $0.7 million increase in expenses incurred to maintain and prosecute patents and patent applications included in our portfolio.

Selling, General and Administrative Expenses Our selling, general and administrative expenses for the three months ended June 30, 2014 were $18.6 million compared to $15.7 million during the same period a year ago, an increase of $2.8 million, or 18%. The increase was primarily due to a $2.2 million increase in personnel-related costs, including a $0.6 million increase in stock-based compensation expense, primarily attributable to increasing our headcount to 138 employees as of June 30, 2014.

Our selling, general and administrative expenses for the six months ended June 30, 2014 were $35.8 million compared to $30.2 million during the same period a year ago, an increase of $5.6 million, or 19%. The increase was primarily due to a $4.0 million increase in personnel-related costs, including a $0.7 million increase in stock-based compensation expense, primarily attributable to


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increasing our headcount to 138 employees as of June 30, 2014, a $0.5 million increase in legal and other professional services due to the growth of our business and a $0.4 million increase in rent expense for leasing additional office space at our San Francisco headquarters.

Provision for Income Taxes
Our provision for income taxes was $5.6 million and $6.3 million for the three months ended June 30, 2014 and 2013, respectively, and $11.5 million and $14.7 million for the six months ended June 30, 2014 and 2013, respectively. Our effective tax rate, including the impact of discrete benefit items, was 37% for each of the three and six months ended June 30, 2014 and 2013, respectively. Liquidity and Capital Resources
We have financed substantially all of our operations and patent asset acquisitions through the sale of equity securities and subscription and other fees collected from our clients. As of June 30, 2014, we had $118.6 million of cash and cash equivalents and $199.0 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):

                                             Six Months Ended June 30,
                                                2014             2013
Net cash provided by operating activities $     100,305       $ 123,379
Net cash used in investing activities           (83,601 )      (102,475 )
Net cash provided by financing activities         1,730           4,736
Net increase in cash and cash equivalents $      18,434       $  25,640

Cash Flows from Operating Activities
Cash provided by operating activities for the six months ended June 30, 2014 was $100.3 million, consisting of adjustments for non-cash items of $67.4 million, changes in working capital and non-current assets and liabilities of $13.7 million and net income of $19.3 million. Non-cash adjustments to net income primarily consisted of $59.3 million of depreciation and amortization, $8.9 million of stock-based compensation, $3.4 million of amortization of premium on investments, a reduction of $2.0 million due to excess tax benefit from stock-based compensation and a $1.0 million net decrease in our deferred tax liabilities. The change in working capital and non-current assets and liabilities resulted primarily from a $26.4 million decrease in accounts receivable, partially offset by a $6.6 million decrease in deferred revenue, a $5.3 million increase in prepaid expenses and other assets and a $0.8 million decrease in our accrued and other liabilities. The decrease in accounts receivable was due to $145.1 million in cash collections, partially offset by billings to new and existing clients of $118.7 million. The decrease in deferred revenue was due to revenue and other adjustments recognized during the period of $125.3 million, partially offset by $118.7 million in billings to new and existing clients. 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 six months ended June 30, 2013 was $123.4 million, consisting of adjustments for non-cash items totaling $55.2 million, changes in working capital and non-current assets and liabilities of $42.8 million and net income of $25.4 million. Non-cash adjustments to net income primarily consisted of $47.8 million of depreciation and amortization, $8.2 million of stock-based compensation, $3.0 million of amortization of premium on investments, a reduction of $2.0 million due to excess tax benefit from stock-based compensation and a $1.9 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 $13.2 million increase in deferred revenue. The increase in deferred revenue was due to $122.2 million in revenue billings to new and existing clients, partially offset by revenue recognized during the period of $109.0 million.

Cash Flows from Investing Activities
Cash used in investing activities for the six months ended June 30, 2014 was $83.6 million, of which $73.9 million was used to acquire patent assets, $7.7 million represented net purchases of short-term marketable securities, $2.2 million was used in the acquisition of DCML Services Corporation, and $0.8 million was used to acquire property and equipment. This decrease was partially


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offset by $0.9 million in proceeds from the sale of patent assets. We expect our cash used in investing activities to increase in the future as we acquire additional patent assets.

Cash used in investing activities for the six months ended June 30, 2013 was $102.5 million, of which $69.6 million was used to acquire patent assets, $32.1 million represented net purchases of short-term marketable . . .

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