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WiLAN, Inc. (NASDAQ:WILN)

Q1 2014 Earnings Conference Call

April 30, 2014 10:00 AM ET

Executives

Tyler Burns - Director of IR

Jim Skippen - President and CEO

Shaun McEwan - CFO

Michael Vladescu - COO

Analysts

Blair Abernethy - Cantor Fitzgerald Canada

Eyal Ofir - Clarus Securities

Todd Coupland - CIBC World Markets

Operator

Good morning, ladies and gentlemen, and welcome to WiLAN’s First Quarter of Fiscal 2014 Financial Results Conference Call. At this time, all participants are in a listen-only mode. Following management’s presentation we will conduct the question-and-answer session, during which analysts are invited to ask questions. (Operator Instructions) I will now like to turn the meeting over to Tyler Burns, Director of Investor Relations. Please go ahead.

Tyler Burns

Thank you, operator, and good morning, everyone. Earlier this morning, WiLAN issued a news release announcing its financial results for the first quarter ended March 31, 2013. This news release is available on WiLAN’s Web site and will be filed on SEDAR and EDGAR. On this morning's call, we have Jim Skippen, WiLAN’s President and Chief Executive Officer; Shaun McEwan, WiLAN’s Chief Financial Officer; and Michael Vladescu, WiLAN’s Chief Operating Officer. Following prepared remarks by Mr. Skippen and Mr. McEwan, analysts will have the opportunity to ask questions.

Certain matters discussed in today's conference call or answers that may be given to questions could constitute forward-looking statements. Actual results could differ materially from those anticipated. Risk factors that could affect our results are detailed in the Company's annual information form and other public filings that are made available on SEDAR and EDGAR.

During this conference call, we will refer to adjusted earnings. Adjusted earnings do not have any standardized meaning prescribed by U.S. GAAP. Adjusted earnings are defined in our quarterly and annual filings that are made available on SEDAR and EDGAR.

Now I would like to turn the call over to Jim Skippen. Jim, please go ahead.

Jim Skippen

Thanks, Tyler, and good morning to everyone. I'll now speak to the highlights of the first quarter. During the quarter, WiLAN generated revenues of $26.0 million, exceeding our guidance by $3.4 million. WiLAN generated adjusted earnings of $16.8 million during the quarter, exceeding the top-end of our guidance by $4.2 million or 33%. WiLAN had GAAP earnings of $4 million. During the quarter WiLAN generated $21.4 million in cash from operations. We returned $4.5 million to shareholders in dividend payments. We also signed agreements with Toshiba and Hon Hai that resolved multiple disputes.

Our efforts in the first quarter led to the signing of a license agreement very early in the second quarter with a U.S. wireless carrier for technology related to network management. Subsequent to the end of quarter we continued to diversify our business with licensing partnerships in the automotive and irrigation markets. Finally the Board of Directors has declared a quarterly dividend of CAD0.04 per share for the first quarter of 2014. This dividend will be paid on July 3, 2014 to shareholders of record on June 13, 2014.

Next I would like to discuss our licensing programs. In the quarter we signed a license agreement with Toshiba which ended litigation. The license agreement with Toshiba is the 7th in the last six months or so that have ended litigation and in some cases multiple litigations. The license agreements reached over this timeframe have added many tens of millions of dollar for our backlog. Very early in the second quarter a WiLAN subsidiary signed a license agreement with a U.S. wireless carrier for technology related to network management. This license was reached without litigation. The patents license in this case were acquired from Siemens in the second half of 2012, the technology which is patented in multiple jurisdictions, relates to network reliability and security for carriers generating tens of billions of dollars in annual revenue from the services that we believe relate to these patented techniques.

Next I would like to touch on some of the higher profile litigations we have underway. The signing of agreements with various defendants in the second half of 2013 and the first quarter of 2014 resulted in the outright dismissal of eight patent infringement litigations and reduced the number of defendants and two others. Our overall level of litigation activity has been reduced significantly as a result. We have two ongoing disputes with Apple and our case involving the 802 patent which went to trial against Apple in October 2013 in a partial victory for WiLAN Judge Gilstrap overruled the jury's verdict and declared that the patent was valid. We have filed our request for appeal with the U.S. Court of Appeals concerning the finding of non-infringement in this case. We expect the appeal process to take about a year.

Our case in California involving Apple and LTE related technology we filed a motion recently requesting that the court clarifies certain claim constructions. We are very pleased with the court granted all WiLAN’s requests in this motion a decision that we believe further strengthens our case. We are proceeding with preparations for trial which is scheduled to begin in November 2014. We are currently involved in a couple of active litigation matters with Ericsson. The first dispute which is being arbitrated in Ontario concerns the interpretation of license agreement signed by a company BelAir Networks, which Ericsson acquired. The second dispute involving Ericsson concerns the effect of a prior agreement with Ericsson that’s been complicated by conflicting decisions by courts in Florida and Texas. We have asked the Federal Appeals Court to resolve the conflict between the court decisions.

With the lower level of litigation activity over the last couple of quarters and the reduction of legal fees due to the new shared risk fee model that we are adopting with our counsel our legal expenses declined and our margins have increased significantly.

Next I would like to talk about the ongoing diversification and growth of our business. Our team is active in the initial stages of the development and execution of our new semiconductor technology licensing program. Our semiconductor portfolio includes patents that we acquired last year from Cypress Semiconductor Corporation and Isis. The portfolio also includes 900 issued and pending patents that came from Panasonic by way of a partnership signed in December 2013. This program which we will hope will begin generating revenue later this year is focused on semiconductor technology that we believe is used in CMOS image sensors, memory technology and circuit packaging techniques.

We’re excited about the licensing potential for a portfolio we acquired from British Telecom. This technology applies to delivery of online content including still pictures and streaming video to global market that generates many billions of dollars in service revenue annually. We’re in licensing discussions with a number of companies concerning this technology and have already filed suit against Netflix. Early in the second quarter two WiLAN subsidiaries entered into licensing partnerships in the automotive market. One of the partnerships involves technology related to headlights. The second relates to diagnostic technology. We believe the global automotive market represents the large and new opportunity for WiLAN and we anticipate being able to secure additional partnerships in this market.

More recently subsidiaries have entered into partnerships to license technology related to irrigation control and networking capabilities with non-standard devices. The agreement concerning irrigation was particularly noteworthy because even through it didn’t require us to make any upfront payment it comes with an ongoing revenues stream from existing licensees. As demonstrated by the many licensing partnerships signed in the recent months we’re focusing more on these types of deals to increase the number of portfolios that we can effectively license which will help drive the future growth and diversification of our business.

This partnership focus is intended to reduce the capital that we invest in acquiring patents. More importantly we believe the partnership will generate a greater return from the financial and human resources we invest and enable us to leverage our reserves more efficiently to executive a larger number of licensing programs. With programs, licensing patents that we own in the wireless access digital TV and network the management markets in several key licensing partnerships and other sectors some of which I descried on this call. We’re making significant progress in growing our business.

Next I will touch briefly on our strategic review. The strategic review has made significant progress in the evaluation of the various strategic alternatives that could be available for the Company. Completing this strategic review is a priority for WiLAN Board, management and our advisors, all of whom are working diligently to improve the process. WiLAN will comment further regarding the review process when a specific transaction or other alternative is approved by the Board of Directors and the review process is concluded or is otherwise determined that further discloser is appropriate or required by law. Until such time, we do not intend to make further any comments because we do not leave them to be in the best interest of the Company related to our strategic review at this time.

With that, I will now turn things over to Shaun to discuss our financial results in more detail. Shaun?

Shaun McEwan

Thank you, Jim, and good morning. Revenues for the first quarter ended March 31, 2014, were $26 million which exceeded our guidance of $22.6 million. This represents an increase of slightly more than 41% over the same period last year. As we indicated on our last conference call, this year we accelerated our annual and quarterly reporting cycle such that we could issue our results at times that are comparable to our peers. As a result, we don’t necessarily have all of our royalty reports submitted when we provide our guidance. As many of our licensees report on or shortly after the last day of the first month after a particular quarter ends and as we’ve stated in the past our guidance that we provide includes only those revenues booked to the date of that guidance and therefore would include any of these royalty reports I just mentioned.

For our first quarter of 2014, three licensees individually accounted for 25%, 12% and 10% respectively of revenues whereas for the comparable period last year, three licensees individually accounted for 17%, 11%, and 11%. In the first quarter of both 2014 and 2013 the top-10 licensees accounted for 81% of revenues.

Now covering our operating expenses briefly, please note that our definition of cost of revenue has changed with this first quarter report. We now include patent management expenses which includes patent maintenance, prosecution, and a valuation expense in cost of revenue and we have adjusted the comparison periods to reflect this reclassification. Previously we had considered patent management expenses as a component of research and development.

Accordingly the cost of revenue expenses for the first quarter of fiscal 2014 totaled $14.630 million or approximately 56% of revenues. Competition costs, patent management and external litigation expenses cash cost in this category were $2.4 million, $1.3 million and $1.7 million respectively. Cost of revenue expenses in the quarter also included approximately $8.8 million in non-cash expenses which is principally the amortization of our patent portfolio.

Comparatively in the first quarter of fiscal 2013 cost of revenue expenses totaled $21.3 million and included compensation costs of $1.6 million, patent management expense of $1.1 million and litigation expenses of $11.7 million along with non-cash expenses totaling $6.7 million. In the first quarter litigation expenses at $1.7 million were better than our guidance and were down significantly from the third and fourth quarters of 2013. This decrease is largely attributable to the decrease in the level of litigation activities in comparison of the same period last year as Jim outlined in his speech.

We continue to expect litigation expenses to remain low for the remainder of fiscal 2014 as compared to 2013 given the level of activity that we expect through the balance of the year. Further, the newly implemented shared risk fee arrangements as Jim highlighted with external counsel will also assist in keeping litigation expenses low relative to last year. That being said, litigation expenses are expected to vary from period-to-period due to the variability of litigation activities.

Our marketing, general and administration expenses in the first quarter of 2014 totaled $2.9 million or approximately 11% of revenue and included $2.4 million in overhead expenses which are cash oriented and $576,000 in non-cash charges for depreciation and stock-based compensation. Comparatively in the same period last year MD&A expense totaled $2.8 million which was comprised of $2 million in overhead expenses and 800,000 in non-cash charges.

In the first quarter, the Company incurred a foreign exchange loss of $1.4 million of which $800,000 was in unrealized foreign exchange loss which is a non-cash expense. The unrealized foreign exchange loss recognized in the first quarter results from the translation of monetary accounts denominated in Canadian dollars to U.S. dollars at quarter-end as well as the revaluation of foreign exchange contracts held at that time. At March 31, we did hold foreign exchange forward contracts totaling approximately $29 million and they mature at various dates through to January 2015.

We reported a net income tax expense of $2.6 million in the first quarter as compared to an income tax recovery of $876,000 in the previous year. The current income tax expense of $1.4 million relates to taxes withheld on royalties received from foreign jurisdictions for which there is no treaty relief. The increase in current income tax expense year-over-year in absolute dollar amount is attributable to a higher proportion of revenues earned in these foreign jurisdictions.

During the quarter we also reported a deferred income tax expense of $1.1 million which results from the utilization of some of our Canadian loss carry-forwards partially offset by an increase in evaluation allowance incurred. This allowance at approximately $11.7 million at quarter-end released to a portion of our Canadian deferred tax assets and all of our U.S. deferred tax assets. In total as at March 31, 2014 we have net tax assets of approximately $125 million.

WiLAN’s GAAP net earnings for the first quarter were $3.969 million or $0.03 per share on both the basic and fully diluted levels. In comparison to the fourth quarter of 2013 GAAP earnings have increased sequentially by 63%. We believe that adjusted earnings a non-GAAP measure assists in evaluating performance of our business by eliminating non-cash, non-recurring and certain other non-operating expenses.

For the first quarter ended March 31, adjusted earnings were $16.8 million or $0.14 per share on a basic level. To put this in perspective, adjusted earnings basically cash earnings for the quarter were nearly 65% of revenues in this quarter. This compares favorably to the roughly 59% adjusted earnings margin reported in our fourth quarter last year and vary favorably to the 7% margin reported for the same period last year.

Now quickly turning our attention to the balance sheet for a moment, we ended the first quarter with $142 million in cash, cash equivalents and short-term investments. This represents an increase of $10.5 million from our closing cash position at December 31, 2013. During the quarter, we generated $21.4 million from operations. Out of that we returned $4.5 million to shareholders through dividend payments. Further, we used approximately $5.7 million to pay for the patents that we had previously acquired amounts that were either in accounts payable at year-end or otherwise included in our patent finance obligation. We expect to continue this patent -- to retire this patent finance obligation at a rate of approximately 4 million per quarter for the balance of this year.

Lastly, I will discuss our guidance for the second quarter of this year ending June 30, 2014. For this quarter, we expect revenues to be at least $19.4 million. And as we have said before, this revenue guidance does not include the potential impact of any additional reports yet to be received or new agreements that maybe signed during the balance of this second quarter. Operating expenses for the second quarter of 2014 are expected to be in the range of $9 million to $10.2 million of which $1.4 million to $2.5 million is expected to be litigation expense. For the second quarter of 2014, and assuming no additional agreements are signed, adjusted earnings are expected to be in the range of $9.4 million to $10.5 million.

This concludes my review of the financial results for the first quarter ended March 31, 2014. I will turn the call over to you Tyler.

Tyler Burns

Thank you very much, Shaun. We now move to the Q&A portion of our conference call. As we want to get to questions from as many analysts as possible, we ask that you limit yourself to one question and one follow-up. We also ask that analysts avoid long or multi part questions, should analysts have additional question and time permits, analysts are invited to rejoin the queue. Operator, may we have the first question, please?

Question-and-Answer Session

Operator

(Operator Instructions) Our first question today is coming from Blair Abernethy from Cantor Fitzgerald. Please proceed with your question.

Blair Abernethy - Cantor Fitzgerald

Thanks very much. Jim, I was just wondering if you can give us a little more of an update or a little more color around the Panasonic relationship and how that's been unfolding in the last couple of quarters?

Jim Skippen

Sure, well, as you know we signed an important deal with Panasonic where basically we took over a very large portfolio of patents and we think it’s a very, very strong and interesting portfolio. We think it has three major areas that it’s in. One is CMOS image sensing, which is basically the chips that are used in digital cameras or in cellphones, and we think it has very broad application to that market and we’ve already started licensing activities in that regard. I think Panasonic is quite pleased with the progress we’ve made and what we’ve been able to there.

And the two other areas are packaging and there is a portfolio that relates to LED lighting. And we’re still working on those. We’re active already on the CMOS image sensing. And we hope that this is the first of a series of partnerships that we have with Panasonic. We are working with them on some other areas, they’ve actually hired us to help them identify valuable patents in their portfolio and so we do see this as hopefully as an ongoing relationship. So it’s early days because as you know we just signed the partnership in December and we’re just in April not even four months or four months later but it’s exactly the kind of partnership that we’re trying to work on it faster with other companies and so far so good.

Blair Abernethy - Cantor Fitzgerald

Great, thank you.

Operator

Thank you. Our next question today is coming from Eyal Ofir from Clarus Securities. Please proceed with your question.

Eyal Ofir - Clarus Securities

Thanks. Congrats on the quarter, guys. Just a question from me, you guys are announcing a lot more partnership deals here so my question is twofold. Number one, how many more of these types of partnership deals are you seeing in your pipeline? And then number two are you going to need to add a little bit more headcount to be able to support obviously more of these partnership deals and trying to monetize more of these on different portfolios going forward?

Jim Skippen

So the question on partnerships, yes, that’s a little bit it’s a shift in the way we’re looking at the world. We think more and more that it’s better for us to basically be the licensing partner for parties with valuable patents rather than just pay them upfront and they are done with the process. So you probably will be seeing more partnerships. Now we’re adjusting off a lot. We’re quite fussy. If we take something on it’s because we think they’ve really got something. And we think that it’s going to be a successful licensing program for both WiLAN and our partners.

The second question do we have the resources, the human resources and another resources to handle these? We really think we do. We think we could take on many, many more portfolios and handle them -- part of the reason for that is that our litigation model has changed now. Where we’re really sharing a lot more of the risk of the law firm and so from the financial point of view we can afford to say handle more without it dramatically affecting our short-term financial results. But just when I look at the makeup and look at the people we’ve got and look at how much we can manage, I do believe we can manage many more. So don’t be surprised if you see more coming on-stream. Very few of these partnerships involve significant upfront payments of cash, if any upfront payments of cash.

Eyal Ofir - Clarus Securities

Okay, that sounds good. Just a question as well now on these partnerships, when we actually see you guys partner on the same domain or same type of patent portfolios, like how go about in terms of -- do you go to the market as one holistic to try and license all of the portfolio at the same time? Or are you going to market separately with your licensing discussions?

Jim Skippen

Just to clarify Eyal can you think of an example that where you…

Eyal Ofir - Clarus Securities

Well, you just announced the two automotive and the two different technologies within the automotive segment but would you go and attack the automotive segment and say okay, we have these two different portfolios but…?

Jim Skippen

This is another somebody asked the question, it’s a good question and I said, there was a little bit of a change in our approach. I think we’re going to be much more focused on licensing just the technology that our licensee or customer needs. And so it’s unlikely we would license an entire automotive portfolio unless one they need it and two they’re willing to pay for it. So those technologies other than automotive they’re quite different one really is pertaining to adaptive headlines sorry headlights and the other is pertaining to diagnostic on-board diagnostics and with different product companies we think need the patents more than us so they don’t know -- it’s not maybe the techniques aren’t necessarily employed across the entire automotive industry so we’ll be really targeting just the people who need those specific portfolios not necessarily offering the whole automotive portfolio as one.

Eyal Ofir - Clarus Securities

Okay, perfect. And then just before I pass the line just a question on your comments in the press release you actually talk about how there is some of the implications from the revenues due to higher fixed payments at the beginning of license agreements. Obviously that's related to some of the agreements you signed late in the year last year, potentially even some in the early part of the this year. Can you just talk about how much of the 26 we should think about as being more of the fixed type that would be less recurring?

Jim Skippen

Well, we don’t usually break it down like that I think as we have more and more licensing programs we probably will see more and more episodic or one-time payments that for quarters so I think it’s going to become potentially a higher percentage per quarter. So we came out with guidance of 22 and some of that was one-time and this is not going apply in every case but if you sort of thought in terms of our revenues being 20% one-time at this time that’s in the ballpark of what it might well be.

The guidance breakdown is 19.4, so that is mostly the recurring stuff but there is still is an opportunity for one-time stuff to come in and we’re still waiting for some royalty reports to come in. So I’d be surprised if the actual revenues don’t end up being more than that but as you know when we give our guidance all we gave is what is actually in the bag at the time we give it.

Eyal Ofir - Clarus Securities

Yes, okay. Thanks for the clarification and I'll pass the line.

Jim Skippen

Thanks Eyal.

Operator

Thank you. (Operator Instructions) Our next question is coming from Todd Coupland from CIBC. Please proceed with your question.

Todd Coupland - CIBC World Markets

Good morning everyone.

Jim Skippen

Hi Todd.

Todd Coupland - CIBC World Markets

So since you announced your backlog you've reported revenue of 55 million and you've announced a number of licensing agreements. So I am wondering if you can give us an update on that backlog net of the revenue that's already been booked, would the backlog be higher or lower than when you last reported it in October.

Jim Skippen

I’ll offer a few comments maybe Shaun will offer a few. So, we have thought a lot about whether we should be updating backlog every quarter and I guess we’re not at that point yet because we just think that it would reveal too much information about licensees and could really in the long run or even short run be a net negative for the company. Having said that though I do understand it’s helpful for inventors to understand that I can’t tell you the backlog is somewhat reduced from what it was when we announced it and I am not sure if I can get too much more color on that. Shaun is there anything more you would like to say on that?

Shaun McEwan

I will stop there and other than to say that it’s not dollar for dollar equivalent to the revenue it’s gone down because there have been license agreements that have been signed.

Todd Coupland - CIBC World Markets

Okay. No, that's helpful. And then, Jim, just on one follow-up on the strategic review like I get what you're saying you’re going to leave it open to other things that may come along as we -- as you work through it. But it feels like from the outside based on the moves that you're making et cetera, that you're carrying forward with a strategy for growth and building out partnerships and getting back on track post some of the trials that went against you in 2013. So that's the impression I am left with. Is that right? Like something may come along but it's certainly back on track to try and jumpstart the growth again at the Company?

Jim Skippen

Well I think if you compare the last two quarters with the year ago that we’ve just -- we're not trying to jumpstart the growth there has been significant growth and I would say that when we started the strategic review with the view to analyzing all the possible alternatives with the help of outside advisors to figure out what the best thing we could do for shareholders and we have to evaluate long possibilities and it’s a time consuming process because some of the possibilities are if you just shut it down what is the company work if you sold it what could you get for the company and if you carry on with your business, what it is going to -- what the performance point of view like and where is the share price likely to do.

And going through these processes for a complicated company like ours is not a minimis task but we always believe that it was in the best interest of the company and actually the shareholders as well whether we sold the company or whether we continued as a business that need to keep working hard and keeping our nose to the grindstone and doing things and building the company. And whether that was to make it more valuable in the sale and whether that was just to make it more valuable and we carry on. That was the right thing to do. So we haven’t been sitting back in our roles. We've been working very hard and continue to make progress on many fronts.

Todd Coupland - CIBC World Markets

Okay. That’s great, thanks a lot guys.

Jim Skippen

Thanks Todd.

Tyler Burns

This concludes WiLAN’s first quarter 2014 financial results conference call. A replay of the conference call will be available until 11:59 PM on July 30, 2014. Instructions for accessing the replay of this conference call can be found on the news release that was issued earlier today and on the WiLAN Web site. Thank you very much for attending.

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