RPX Corporation (NASDAQ:RPXC)
Q1 2014 Earnings Conference Call
April 29, 2014 05:00 p.m. ET
JoAnn Horne – IR, Market Street Partners
John Amster – CEO
Ned Segal – CFO
Nick Nikitas – Robert W. Baird
Timothy Arcuri – Cowen and Company
Ladies and gentlemen, thank you for standing by. Welcome to the RPX Corporation's First Quarter 2014 Earnings Call. During today's presentation, all parties will be in a listen only mode. Following the presentation, the conference will be opened for questions. (Operator Instructions) Today’s conference is being recorded today April 29, 2014.
I would now like to turn the conference over to JoAnn Horne, Investor Relations. Please go ahead.
Thank you, operator, and good afternoon everyone. And welcome to RPX Corporation first quarter 2014 financial results conference call. Joining the call today are John Amster, Chief Executive Officer, and Ned Segal, Chief Financial Officer. The agenda for today's call include commentary from John, followed by discussion of the financial results from Ned and then Q&A.
This afternoon RPX issued a press release announcing its first quarter 2014 financial results which is available on the company website at www.rpxcorp.com. This call is being broadcast over the internet and the audio of the call will be available on the Investor Relations page of the company's website. Also, please note that there are slides corresponding to the information on today's call available on the IR website.
I'd like to remind everyone that the conference call will contain forward-looking statements that are not historical facts but are rather based on the company's current expectations and belief. The forward-looking statements include, but are limited to, expectation regarding the growth of the company's business and the development acceptance of the products and initiatives. RPX's actual results may differ materially from those forward-looking statements. Please refer to the company's SEC filings for detailed information.
In addition, non-GAAP financial measures may be discussed during the call. Reconciliations to the most directly comparable GAAP financial measures are included in the table attached to the earnings release on the website.
Now I'll turn the call over to John.
Thank you JoAnn. We will follow our usual approach in today's call. I'll give a quick overview of the quarter and Ned will go into more detail on our financial results.
Overall we had a strong star to 2014. We continued to expand the network, with new clients and saw renewals and continued to make acquisitions that demonstrably reduced the cost of NPE litigation for our clients. We continue to roll out new services that augment RPX’s core defensive acquisition service and that further reduced NPE risk across our network, and we delivered solid operating growth in line with our expectations for the year.
Q1 revenues were $61.9 million, up 3% sequentially and 1% year-over-year. Subscription revenues in the first quarter this year were $60.8 million, up 13% year-over-year.
Non-GAAP net income was $12.7 million or $0.23 per pro forma diluted share. We added 10 net new clients. In addition to the adds, we had one core network member convert to insurance during Q1 for a total of 5 net new insurance clients.
We continue to build our presence in the financial services sector adding Citibank to our client base and we ended the quarter with a total of 178 companies in the RPX network, up from 146 [Ph] a year ago. Our renewal rate in Q1 remained above 90%.
RPX also continued to be an active patent buyer, spending $58.7 million in the quarter on a gross basis. It’s further evidence that as the network has grown, our capacity for acquisitions has grown with it, bolstering our position as one of the largest buyers in the patent market and certainly the largest buyer not asserting the acquired paths.
Though it was another productive quarter, before I hand it over to Ned, I just want to call out a few areas of interest. I will just touch on these briefly as we will be hosting our annual investor day in New York on May 29 and we will have time to dig a little deeper there.
I will start with a quick snapshot of NPE activity in the quarter. As usual, I will just focus on all the market sectors we currently serve. In those sectors during Q1, more than 450 unique companies were named in NPE suits, nearly 400 of which are not yet RPX clients. 85 companies were sued more than once by NPEs during the quarter, of these more than 40 are not yet RPX clients. More than 150 non-client companies were sued by NPEs for the first time.
At quarter end, there were 4000 active NPE defendants and again these numbers are just in the sectors where RPX is active. In short, the need for our solution remains very compelling for operating companies.
I also want to note that while we firmly believe our market-based collaborative solution represents the best response to this huge source of patent risk, we also recognize that our clients are pursuing legislative reforms to create some relief from patent assertions. We continue to support those efforts and provide data and analysis to both our client and to policy makers. The more they know, the more effectively they can craft new laws and regulations.
As for specific things we're focusing on internally to drive growth, one area of continued activity is our effort to move some larger clients to an annual fee above the rate card cap [Ph]. You’ll remember we announced at the end of 2013 that the first such client had committed to this kind of premium pricing model. We’ve continued these conversations with other clients and they’re very receptive.
The reason is simple we've shown that our defensive buying can save them millions of dollars every year and avoided legal costs in settlements. If we had more capital to deploy, we can deliver even greater savings to our client network. We're pleased with the tenor of these conversations and hope to have more to report on this effort in the next 3 to 6 months.
The second area I want to highlight is the shift of our insurance offering to a product backed by “A” rated paper. I talked about this on the last call and we made it official just a couple of weeks ago, when we announced that RPX has been approved as a Lloyd’s coverholder. We will now provide marketing, underwriting and claims management services on behalf of a syndicate at Lloyd’s which carries an A rating from AM Best and A+ ratings from Fitch and S&P.
RPX no longer owns the insurance company that writes these new policies. Instead we are paid HDE [Ph] by the carrier and will share in the premiums through a newly formed reinsurance company that will receive a portion of the unwritten risk.
Ned will give some color on the financial implications. For now I'll just say this is an important and logical step forward in the crawl, walk run evolution I have often described for our insurance products. Actually we take a crawl, walk, run approach with all of our initiatives at RPX and we’ve done so with other new services being developed. These would include our programs to conduct prior art searches and IPRs on behalf of the network and some new ideas to increase transparency between patent sellers and potential buyers. The idea behind these new initiatives is to enhance RPX’s mission to reduce the risk and costs associated with patents.
Our progress so far has been very good. We filed 8 petitions challenging a total of five patents that are owned by two different entities. We've also initiated 15 prior art searches, 11 of which are completed and have finalized two reports that are now available to members of the network. We’re crawling nicely and our clients like what they have seen so far. We should start walking soon and we will share details as we do so.
I’ve also talked in previous calls about how we're using the portal to complement RPX’s core defensive buying and insurance services. In addition to constantly adding functionality to the full client portal, we're launching a public version that will have a selection of data and analytic tools, including an assertion letter management tool that we’ve developed to help the small companies that are often targeted in large-scale assertion letter campaigns.
With that, I will wind up my remarks and provide any additional details if you have questions at the end of the call. Right now, here's Ned to review the Q1 financial results in detail.
Thanks, John. As always, you will see a slide deck on the IR site to track today’s call. I am going to focus the financial discussion on non-GAAP metrics which exclude stock-based compensation and amortization of acquired intangibles. In each case, these items are net of their respective tax effects. The complete reconciliation from our non-GAAP metrics to our associated GAAP metrics can be found in our press release and on the slides on the website.
Let’s start with the P&L. As John mentioned for the first quarter revenue totaled $61.9 million compared to $61.2 million in the year ago period. The 1% year-over-year growth represents the anniversary of $7.2 million in fees in Q1 of 2013.
Subscription revenue for the quarter was $60.8 million, up 13% over the year ago period. We added 10 net clients to the RPX network this quarter ending the quarter with 178 clients. Client additions were generally consistent with our history. We added four core clients at or above the average and the ASP for insurance clients increased but remains within the $150,000 to $250,000 range we have discussed previously.
In insurance, we’re up to a total of 31 policyholders on pace for the end of year goal we discussed in February of doubling our insurance clients. As expected, fee related revenue contributed $1.1 million in the first quarter versus $7.2 million in Q1 of 2013. These transactions are an important element of the RPX value proposition and while the size and timing of fees will vary, we continue to focus on fee related business to deliver value to the network and put high margin revenues on the income statement.
In Q2, we do not expect to recognize fee related revenue. This is a good example of the lumpiness and unpredictability we expect and often talk about from our fee related. Deals just don't correspond well to quarterly reporting. We will continue guiding only to revenues where we have line of sight to what we will close that quarter and we’re still guiding to $8 million to $10 million for the year.
As you move down the P&L, the non-GAAP cost of revenue which is primarily the amortization expense from our patent assets, was $28.9 million in Q1 of 2014 compared to $23.6 million in the first quarter of 2013. Expressed as a percentage of total revenue, non-GAAP cost of revenue was 47% in Q1 compared to 39% a year ago.
As we’ve discussed many times, this number can bounce around from quarter to quarter based on the amortization period for assets acquired. The patent assets acquired during the first quarter will be amortized over a period of about 40 months, and thus longer than recent period as we didn't acquire patent assets with very short-lives as we did in Q3 and Q4 of 2013. Our focus continues to be on completing transactions that are best for our clients and near-term prospects.
Moving on to patent acquisition activity. We completed 16 acquisitions of patent assets during the quarter. Our gross patent acquisition spend in Q1 was $58.7 million and our net acquisition spend was $55.7 million. Just as in past years, spend will continue to be lumpy on a quarterly basis.
We continue to be comfortable with the full year guidance we gave on patent spend in February of $135 million. We ended the quarter with our renewal rate remaining above 90%. We mentioned on the last call that we had far fewer dollars up for renewal this year than last year with a similar number of clients up for renewal in the core business, around 30 as of February.
We made good progress against that group and we like where we sit from a renewal perspective. RPX is improving every year of delivering value to the network and getting more early renewals and many long-term commitments from our clients.
Turn to insurance, our new insurance customers included a one cross-sell through an existing RPX core member and renewal activity suggests our insurance fee value in our core service and the insurance. We think this is solid progress. John mentioned our recent announcement that RPX will now provide marketing underwriting and claims management services on behalf of the syndicate at Lloyd’s. Our approval as a coverholder at Lloyd’s is real validation of our unique approach, and paves the way for RPX to offer a mainstream insurance product that could become as widely accepted as D&O or cyber liability coverage.
We formed the insurance company that will share a portion of the underwritten risk. So we sit in a different place but continue to sell policies, service claims and bear risk. Since we are now a reinsurer, we will no longer recognize the entire policy premium as revenue. Instead, we will recognize revenue to reflect the risk we will bear and the selling underwriting and claims services that we will provide. I can imagine there are lots of questions and we look forward to answering them at our investor day.
Our non-GAAP SG&A expenses which exclude stock-based compensation and amortization of acquired intangibles were $13.1 million in Q1 of 2014 compared to $10.4 million in the year ago period. Operating expenses continued a steady ramp as we increased our headcount and full-time employees.
Total headcount at the end of Q1 was 133. We continue to expect hiring to ramp over the course of the year from these levels and still have the goal of finishing the year in 150. It’s worth pointing a trend that we probably should have shared in the past that isn’t apparent when you see headcount not moving a whole lot against our goals.
In addition to these full-time employees, there has been a gradual evolution of our technology team, and we now have the Google contractors mostly in systems development that effectively brings the broader RPX team into the mid 150s.
Non-GAAP net income in Q1 was $12.7 million compared to $17.5 million in the year ago quarter. Looking at pro forma earnings per share, non-GAAP net income per pro forma diluted share was $0.23 for the first quarter, down from $0.33 in the year ago period. Again the year-over-years are impacted by that $7.2 million in fees in Q1 of 2013.
For the quarter, non-GAAP effective tax rate was 37%. We expect the 37% tax rate for the second quarter and for the full-year.
Turning to the balance sheet, we ended Q1 with $302.7 million in cash, cash equivalents and short-term investments. That’s up $12 million this quarter. Although we’ve not guided the cash flow, we do expect our cash balance to bounce around from one quarter to the next. As we collect fees from our clients, acquire patents and complete structured transactions that do not always correspond to quarterly reporting period, but are certainly in the best long-term interest of our business.
However as we mentioned last quarter, the cash flow history suggests we can now run the core business to generate some nice excess cash on an annual basis.
Our deferred revenue balance at the end of the quarter was $140.5 million compared to $118.2 million a year ago and $137.7 million in Q4. As a reminder, our deferred revenue balance is not just the function of the timing of signing new client, in fact, and often more significantly, it's a function of the billings of existing clients in the previous five years which makes it a difficult metric to read anything into on a quarterly basis.
Looking ahead to the second quarter of 2014, our current expectations: subscription and total revenue in the range of $63.3 million to $63.9 million; non-GAAP net income in the range of $11.4 million to $12 million, and 54.6 million diluted shares outstanding on a pro forma weighted average basis.
For 2014 overall we are reiterating our guidance for the full-year. To sum up, we’re pleased with the start to 2014. The company continues to make strong progress on all fronts and we look forward to building on our momentum. There's a lot going on.
I can’t remember we told you yet but we are having an investor day May 29 in New York. We hope you all can attend.
With that, we would like to open it up to your questions.
(Operator Instructions) Our first question is from the line of Nick Nikitas with Robert W. Baird.
Nick Nikitas – Robert W. Baird
Solid Q1 client additions number, can you just about how the pipeline is currently looking and I guess any potential verticals where you have seen strength?
Nick, we haven't talked about the pipeline prospectively much in the past and probably it doesn't make sense to do so today. On the vertical side I guess I’d point out a couple things, so John mentioned that we added Citi this past quarter which is nice for us and it was the relatively new vertical for us in financial services. And as much as we are always looking at other verticals and thinking about areas of opportunity for us, we still feel like there is lot for us to do in our core markets.
Nick Nikitas – Robert W. Baird
And then congrats on the Lloyd’s announcement, that’s pretty exciting stuff. Can you just discuss, how does that change your conversation with clients going forward, potentially your view of maybe the broader insurance product market?
The hope is and I think it’s important to understand that this was a planned part of the evolution that we wanted to get to the point where we had to say ready to pay [Ph] because that’s the norm in the insurance industry. And what we are hoping is that there is slightly less friction in sales process. We’re also hoping that it’s got broader reach because having an A rated solution with someone like Lloyd’s means that it’s more accessible to the different channels that are available in the insurance market. So we’re hoping that this is an important step to being able to achieve our goal of really going out and having a product that could be applicable to the thousands of companies that we see as part of that addressable market. And we’re going to go into some more detail on how we look at that addressable market and also some of the buts and bolts of the policy in a couple weeks at the investor day.
Nick Nikitas – Robert W. Baird
And then just one last one from me, looking at the I guess somewhat outsized Q1 patent spend relative to the full-year guide, was that part of internal expectation going into the year, maybe a little more opportunistic based on the market that you (inaudible).
Nick, you are breaking up a little bit but I think we got the gist of the question.
So first, it’s worth pointing out just the history on patent spend. Remember it’s been lumpy in the past where we’ve had bigger quarters and smaller quarters over the last few years and we expect that to continue to be the case. We can’t always decide when opportunities present themselves and sometimes they first present themselves quarters or years before we actually transact because we aren’t yet there on price right, it doesn't make sense for one reason or another. So we’d expect that number to continue to bounce around from one period to the next and we still feel like that $135 million for the full-year that, that make sense unless we see an opportunity that can meaningfully impact the trajectory of the business outside of what we’ve already talked to you guys about.
Next question is from the line of Timothy Arcuri with Cowen and Company.
Timothy Arcuri – Cowen and Company
So couple things. Question for you, John, so just in light with your comments about the efforts around IPRs, things that, how do you plan to monetize your new initiatives like that particularly in light of the fact that you are guiding no few related revenue for June?
We look at monetization of these new efforts in a couple different ways, Tim. I think we look at first of all our existing client base and our view is that offering additional services is part of the reason that we have been able to break through the rate card cap at least one and is part of the reason why we think we’re going to be able to continue to do that. We look at the rest of the existing client base and we certainly see opportunities potentially being able to charge for bits and pieces of it depending on what people are looking for. We also see supporting our renewal rate through the additional services. And then when we look at the addressable market more broadly, we look at it in two different ways again which is there may be some prospects today that we are having trouble getting over the line but that these additional services make the overall composition more valuable and they become clients and then the same thing which is in the future may become of those or even pass more as a result of these things.
And so what – the key thing that we are doing right now is just focused on building out the offering based on the market demand, over time I'm sure that we're going to evolve in different ways, the way that we charge for things and I think the critical thing that we’re doing is really two fold. One, we’re constantly assessing and analyzing what our options are and two, we are trying not to do anything that close any doors going forward.
Timothy Arcuri – Cowen and Company
Second question might be, I just want to clarify so there weren’t (inaudible) above the rate – this quarter, correct?
There were no renewals above the rate we had in the first quarter, that’s right.
Timothy Arcuri – Cowen and Company
And then lastly can you give us just some update in terms of environment around legislation, can you give us a sense of where things stand from your perspective and what some development or some potential developments that we should watch over the next few quarters are?
Sure, and again to pick up on Ned’s monologue about the investor day, we’re going to go into more detail, we’re actually going to have a section on patent reform where I think we’re going [Ph] talk a bit about what’s going on. There is a lot going on, there is stuff going on in the House, or stuff going on in Senate, the Supreme Court’s got a series of decisions related to patents are going to impact the reform effort overall. And I think our view remains the same which is it’s likely that – I mean there is ongoing reform, the Supreme Court had I think two decisions in the last few days and it's very likely that Congress does something at some point in the next – it could be 3 months, it could be a year. We think that those reform efforts are mainly focused at what we would call the lower end of the market, the privileged using the stuff is definitely seems to be the area of focus. We've been involved in trying to provide whoever is interested in data and analysis around how different elements of the reform could impact things and we've been very actively talking a lot to policymakers to support our client effort in that regard.
So we don’t think that there is any meaningful impact for adjustment market or anything like that, and we think it's actually a good thing for improvement of patent quality, improvement of transparency and that’s kind of the good news of this reform efforts, seems to be very much focused on themes that I think RPX was really one of the first entities to be talking about, the themes of transparency and making this more like an efficient market, and I think it’s good to see some of those efforts coming into play in this round of reforms as well.
Timothy Arcuri – Cowen and Company
If I can just follow up quickly on that, I was talking to a company that was the leading me down the path of believing that that if you're a private equity investor in a small company that the new reform is going to make it such that your potential loss is beyond your investment. so i.e. that a company who wins the judgment can go back and they can collect more than royalties, more than just what the judgment is, and they can go back to the shareholders and basically require them to actually put in more money. Is there any truth to that?
What you are saying does not ring any bell. I mean I think the reform is talking about – the reform and the supreme court just came out with the decision on -- related to attorney fees and kind of little known fact, attorney fees, the ability for this – award attorney fees in a patent case has been the law for I don’t know if it’s 40, 50 years, something along those lines. And so there's lots of debate whether or not the Congress should enact a law that somehow codifies that in a different way and the Supreme Court just opined on what the standards are for that. I’ve never heard anything that is much broader than that, but I could be missing something, it’s entirely possible, although I don’t think it’s likely.
And at this time there are no further questions in queue. I would like to turn the call back over to Mr. Amster for closing remarks.
Thank you very much for joining us today and again I think fifth or sixth time, we look forward to seeing you in a couple weeks at the investor day in New York. Thanks.
Ladies and gentlemen this does conclude our conference for today. Thank you for your participation and you may now disconnect.
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