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RPX Corporation (NASDAQ:RPXC)

Q2 2014 Earnings Conference Call

July 29, 2014 5:00 pm ET

Executives

JoAnn Horne - IR, Market Street Partners

John A. Amster - CEO and Co-founder

Ned Segal - CFO

Analysts

Jeffrey Meuler - Robert W. Baird & Co.

Tim Quillin - Stephens

Timothy Arcuri - Cowen and Company

Matthew Galinko - Sidoti & Company

Operator

Good day and welcome to the RPX Corporation's Second Quarter 2014 Earnings Conference Call. Today’s conference is being recorded. At this time, I'd like to turn the conference over to JoAnn Horne, Investor Relations for RPX. Please go ahead.

JoAnn Horne

Thank you, operator, and good afternoon everyone, and welcome to RPX Corporation's second 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 includes commentary from John, followed by a discussion of the financial results from Ned, and then Q&A.

This afternoon RPX issued a press release announcing its second quarter 2014 financial results which is available on the Company's Web-site 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 Web-site. Also please note that there are slides corresponding to the information on today's call available on the IR Web-site.

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 not limited to, expectations regarding the growth of the Company's business and the development and acceptance of new products and initiatives. RPX 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 and on the Web-site.

Now I will turn the call over to John. John?

John A. Amster

Thanks JoAnn and thanks everyone for joining us today. Ned will provide the details as always and I'm going to provide the overview of what was a solid Q2. We grew the network, continued building the insurance business and made good progress rolling out initiatives such as expanding our data capabilities, IPRs and prior art searches that reinforce our value proposition to clients and prospects.

Subscription revenues were $64.3 million, up 6% sequentially and 17% year-to-year. Non-GAAP net income was $12.9 million or $0.24 per pro forma diluted share. We added six net new clients and our renewal rate remained above 90%. Interestingly, one of the larger adds is a client that had previously left the network.

Also in Q2, we brought two more clients to a new subscription fee above their old cap in the rate card. We've talked about this effort in previous calls. There are a number of clients in our network that have a consistently high amount of NPE litigation and we can deliver an even greater reduction in their NPE costs by deploying more capital to clear relevant patents. We're very pleased to have moved three clients to this kind of premium pricing so far and we're in discussions with other members with similar risk profiles.

We also made good progress building the insurance infrastructure in Q2. As you know, we became a Lloyd's coverholder during the quarter and also entered into a relationship with the wholesale insurance broker CRC to build a more traditional insurance distribution channel.

It was only our first quarter selling A rated paper but we are seeing some of the benefits of having a more mainstream offering. We are now focused on fine-tuning our understandings of the pipeline and the variations we need in our products to fully leverage our sales channels. We have a lot to do over the next few quarters. Those of you who were at our Investor Day in May know that we continue to see insurance as a key driver for the long-term expansion of the RPX network.

Our core defensive acquisition service makes economic sense for the hundreds of companies not yet in the network that are feeling the steady pressure of NPE assertion and litigation. So we still have plenty of running room for the core service. As you all know, the sales cycle can be long and unpredictable and is often event-driven. There are thousands of other companies that are also experiencing NPE pain, just not to a degree that would make our rate card pencil out yet. For those companies, we can efficiently reduce NPE risk through insurance.

In other words, we can make RPX affordable to them by assuming their risk. It's a slightly different financial calculus for us but the end result is the same. We can use the leverage of the network to clear relevant patents cost-effectively, use our data to do it profitably and ultimately expand the network to where it becomes a true patent clearinghouse.

We ended Q2 with 33 insurance clients and a fully growing pipeline. The second quarter also saw us push forward with our IPR and prior art initiatives. IPRs are formal challenges to the validity of patents and are another way we can apply RPX resources to deliver savings to our client network. In both programs and pretty much everything else RPX does, our data and analytical capabilities are a real competitive advantage. The more we know the more we can help our clients save money.

And with our six-year head-start and the $800 million we've spent in patent transactions over that period, RPX has data about the patent market and patent litigation costs that no one else has or is even close to having. The critical element in this information advantage and why it's almost impossible to replicate, is the actual economic data underlying a large number of transactions and litigations. RPX has multiple sources of this data and none would be easy for another company to reproduce.

We are one of the few companies spending more than $100 million every year to acquire patents, we're the only player in the market regularly resolving litigations on behalf of almost 200 companies, we're the only insurer collecting in-depth litigation cost and behavior data from applicants and insurers. All of this information is proprietary and non-public and RPX alone is able to use it to acquire assets and negotiate dismissals cost effectively, price insurance policies accurately and demonstrate cost savings to current and potential clients clearly.

Beyond using this advantage in our own buying, we think this data is the key to transforming this market and putting RPX in the position to create a clearinghouse that can address a much bigger piece of the $13 billion the industry spends dealing with NPEs today annually. Take our client portal on RPX Search as an example.

Before RPX Search, if you received an assertion letter or if you just want to get up to speed on a particular litigation or NPE, you would likely hire a lawyer to research the patent or plaintiff. Now you can do it yourself for free with RPX Search. Next time you're doing some research for a report on the patent space or an NPE, instead of calling the company or a lawyer, try to get answers from RPX Search. Hopefully, you will start to get a sense of how demystifying the space in this way is the first step to having patents transact in the market instead of in court.

So we firmly believe that data is a major competitive advantage and we will continue to expand and deepen our information resources to strengthen that advantage. A clear illustration of that in Q2 was our acquisition of PatentFreedom which has long been a leading source of information about NPEs.

In addition to strengthening our insights into NPE behavior and strategy, the acquisition also means that Dan McCurdy, the founder of PatentFreedom has come onboard at RPX where he will help lead the effort to drive adoption of our research and analysis tools for members of the network. We're delighted to have him join our team.

I've gotten into the habit of closing my remarks with a quick look at some market statistics that illustrate the need we are addressing. Consider that in the second quarter and only in the sectors where RPX is currently active, more than 600 unique companies were named in NPE suits, more than 500 of which are not yet RPX clients. 101 companies were sued more than once by NPEs during the quarter. Of these more than half are not yet RPX clients. Nearly 200 non-client companies were sued by NPEs for the first time, and at quarter end there were 3,800 active NPE defendants in our sectors. NPE risk is an expensive problem, it's not going away and neither is the need for solutions like the RPX network.

So that will do it for me. It was another quarter of solid operating results for RPX and the drivers of the business remain strong. Here's Ned with the details. Ned?

Ned Segal

Thanks John. As always you'll see a slide deck on the IR site that tracks today's call. I'm 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. A 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 Web-site.

Let's start with the P&L. As John mentioned, for the second quarter revenue totaled $64.3 million, a 12% increase over last year's Q2 revenue of $57.5 million. Subscription revenue increased 17% compared to $55 million in the prior year. We added six net clients to the RPX network this quarter ending the quarter with 184 clients.

In insurance, we are up to a total of 33 policyholders at the end of the quarter from 31 at the end of Q1 and we remain comfortable with our goal of doubling our insurance client base to 50 by year-end.

As expected, there was no fee related revenue in the second quarter versus $2.5 million in Q2 of 2013 and $1.1 million in Q1 of 2014. As we've mentioned in the past, our ability to perform the services that generate these fees is an important element of our business model, but the fees associated with these services do not consistently correspond to a quarterly reporting period. So, we'll continue guiding to an annual range and when appropriate to quarterly revenues when we have line of sight. In Q3, we expect to recognize about $800,000 in fee related revenue and activity levels remain robust.

We ended the quarter with our renewal rate remaining above 90%. As a reminder, we started 2014 with a similar number of clients up for renewal at last year, so a few dollars in play. We have made good progress against that group to date and as a result the remainder of the year will really be focused more on new clients than on renewing existing clients.

Despite these positive developments, you'll notice in our guidance for the third quarter our first down sequential quarter for subscription revenues. We've talked often about the things that can lead to quarterly variability in our model. Much of the variability in our Q3 outlook can be attributed to a secular trend in corporate activity and a single vertical with some large clients that played out in a relatively compressed period and at the low end of the scenarios that we anticipated.

Unfortunately, we did not have sufficient new business to offset that impact in that similar timeframe, although we believe these events have largely played out for us. This variability is just one of the realities of our business, even in the context of a year where we've guided to 7% to 13% revenue growth.

Moving down the P&L, the non-GAAP cost of revenue, which is primarily the amortization expense from our patent assets, was $31.5 million in Q2 of 2014 compared to $24.6 million in the second quarter of 2013. Again, this number can bounce around from quarter to quarter based on the amortization periods for assets acquired. The patent assets acquired during the second quarter will be amortized over a period of about 37 months, slightly below our historic average of 46 months and more in line with recent trends.

As always, our focus continues to be on completing transactions that are best for our clients and near-term prospects rather than managing to an amortization period for acquired patent assets. We're just executing more opportunities to acquire assets that amortize over shorter periods, and we continue to be disciplined about focusing on cash outlay and client savings rather than amortization. As a result, it's prudent to think about going forward amortization periods on assets acquired around a 40 month level.

We completed 13 acquisitions of patent assets during the quarter. Our gross patent acquisition spend in Q2 was $18.8 million and our net acquisition spend was $17.8 million. Just as in past years, our spend will be lumpy on a quarterly basis.

Our non-GAAP SG&A expenses, which exclude stock-based compensation and the amortization of acquired intangibles, were $13.2 million in Q2 of 2014 compared to $10.8 million in the year ago period. Operating expenses continue to ramp steadily as we increase our full-time employee headcount. Total headcount at the end of Q2 was 138. We expect hiring to continue over the course of the year from these levels and still have the goal of finishing the year in the 150s. In fact, we may approach that number by the end of Q3.

During the quarter, we also sold patent assets with proceeds of approximately $900,000 from two separate transactions. We recorded a gain on sale of patent assets of $700,000 which appears as a separate line item in our income statement. On transactions like this, it's worth pointing out that the pre-tax cash benefit to RPX is about $900,000 but we pull forward the remaining amortization, thus the lower gain on the income statement. As you know, we've done these opportunistic sales in the past a handful of times and we will likely do it again in the future, although they are not a significant part of our business model.

Non-GAAP net income in Q2 was $12.9 million compared to $14 million in the year ago quarter. Looking at pro forma earnings per share, non-GAAP net income per pro forma diluted share was $0.24 for the second quarter, down from $0.26 in a year ago period. For the quarter, non-GAAP effective tax rate was 36%. We continue to expect a 37% tax rate for the third quarter and for the full year.

Turning to the balance sheet, we had another strong cash generation quarter, ending Q2 with $317.6 million in cash, cash equivalents and short-term investments. That's up just about $15 million this quarter and about $26.8 million from the end of fiscal year 2014.

Our deferred revenue balance at the end of the quarter was $131.2 million compared to $117.6 million a year ago and $140.5 million in Q1. This is a good example of how our deferred revenue balance can bounce around from one quarter to the next after increasing sequentially for the past two quarters. As we said, the activity in any one period can and often is overwhelmed by the cumulative effect of adding clients over six years with no particular cadence during the year.

Looking ahead to the third quarter of 2014, our current expectations are as follows; subscription revenue in the range of $62.3 million to $63 million; fee related revenue up $800,000; total revenue in the range of $63.1 million to $63.8 million; non-GAAP net income in the range of $12 million to $12.6 million; and 55 million diluted shares outstanding on a pro forma weighted average basis. For 2014 overall, there are no changes to our previous guidance.

To sum up, we're pleased with our results for the first half of 2014. We continue to execute and make strong progress on all fronts. We look forward to building on our momentum as we enter the second half of the year. And with that, we'd like to open it up for your questions.

JoAnn Horne

Operator, we'll take questions now.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question will be from Jeff Meuler with Baird.

Jeffrey Meuler - Robert W. Baird & Co.

So you always have this carefully worded script and I still need help decoding what you were saying about the subscription revenue outlook. Was there a catalyst portfolio acquisition or patent acquisition that drove catalyst sales of one or a few clients in a given industry, and as those came up for renewal, they didn't renew, is that what's happening?

John A. Amster

No, I don' think so, Jeff. That's not what I would attribute to it. I'd point you back onto the prepared remarks where we talked about some of the secular trends and corporate activity in a particular industry. And when you have a business like ours with a bunch of renewal activity and client adds that happen at random points during a year that are hard to predict and end up being variable in nature as much as you might get tired of hearing us say that, you end up with the possibility of a non-linear growth over the course of the year. And I think I'd just point to that, it's a lot like last year where in the context of a 20% growth year we had a quarter that was about flat. This year in the context of 7% to 13% growth, we'll end up with a down sequential quarter.

Jeffrey Meuler - Robert W. Baird & Co.

But you had a lot of clients coming up for renewal from the same sector in this quarter and last quarter. Is that what…?

John A. Amster

Yes, in a relatively compressed period of time which can happen, you can overlap, it can happen within one period. We just had a handful of events that happened really around one sector that drove a lot of this.

Ned Segal

Jeff, to answer your question, it's not as if that this is three years later we had a bunch of clients come in on a particular deal and three years later they are all dropping at the same time. It's quite the opposite actually. It's more a result of people who might have renewed early, they might have renewed at different times, it just so happens that fast forward six years in a particular sector we had a couple of these negative events, again that we certainly modelled and predicted came out at the low end in a compressed period of time but it wasn't because we had clients roll-off because of some acquisition that was no longer going to keep them in.

Jeffrey Meuler - Robert W. Baird & Co.

And it was non-renewal at client discretion, not M&A?

John A. Amster

I think it's probably getting a little too specific. We talked about in the prepared remarks that the secular trends in corporate activity in the space, and if you think about the things that can affect our renewal rate, M&A would certainly be one of them. People leaving at their own discretion or their moving up or down the rate card based on them getting invoiced off of their new levels of profitability, those would be a few of the factors.

Jeffrey Meuler - Robert W. Baird & Co.

Okay. And then can you just comment on the full year fee related revenue outlook just looking at – I mean it looks like your guidance kind of up and down is maintained for the full year but that would imply even at the low end a pretty big number for Q4 fee related revenue, and I know you said that activity levels remained robust, but any additional color you could give there?

Ned Segal

Sure. So the only thing that has changed in the last 90 days around our fee business are that we've got $800,000 more that we can point to and we've got 90 days fewer with which to hit that guidance number by the end of the year. It continues to be the guidance number that we internally have the least visibility into and have the least ability to hang our hats on, but although it doesn't have a quarterly cadence to it, it feels like that fee business does have an annual cadence to it. And so the activity levels remaining robust cause us to leave that guidance where it was.

Jeffrey Meuler - Robert W. Baird & Co.

Okay. And then just one last one for me and I'll jump back in queue. Have there been any IPRs filed against you, especially on any of your patents that are raw material?

John A. Amster

I'm not aware of any IPRs that have been filed against any patents that we own. Probably there are IPRs filed against patents that we've taken licenses to in the context of litigation but I'm actually not aware of any of those either but that would not be far-fetched. We've done a transaction with respect to a patent that was in litigation, the litigation is ongoing and somebody filed an IPR on it.

Jeffrey Meuler - Robert W. Baird & Co.

Okay, thank you.

Operator

Our next question will come from Tim Quillin from Stephens.

Tim Quillin - Stephens

I want to understand the rationale for using the coded language around what appears to be customer departures. Why not say what the reason was?

Ned Segal

I think that you might be reading too much into the language if you think that it's coded because there can be lots of reasons that our renewal activity could result in a down sequential quarter and doesn't all have to be people leaving, right. People can get invoiced at lower levels than they were before, they could leave because they were acquired, they could leave on their own, they could renew at lower rates for one reason or another. So those are all things that, one, they are embedded in the 90% renewal rate that we disclosed, and two, those are all potential negative detractors to the business when you look at it on a quarterly basis.

Obviously they can all play out in the other direction as well and in the non-linear growth that we might show over the course of the year, you also have people renewing above the rate card. People, when you're selling the technology clients, the general bias on the rate card is upwards not downwards. And so you just end up seeing at random points in a year and this quarter ended up where there were more negative data points than we were able to offset with new business.

Tim Quillin - Stephens

And then maybe as a poor choice of word in terms of coded, but I guess what I don't understand is what a secular trend within a certain sector around some type of corporate activity means.

Ned Segal

So, Tim, we're trying to focus you towards a certain area of the industry and a smaller group of clients than we service more broadly to just give you the sense that this isn't something – it's something that we look at and at the beginning of the year when we were laying out all the potential outcomes, this was one of them, but it certainly wasn't one of the more optimistic ones that we laid out and it was because we are able to see the corporate activity coming and we are able to see the secular trends and how they might impact how we invoice and renew people, and it just ended up playing out towards one of the more disappointing ends of the spectrum that we would lay out when we're modeling and guiding.

John A. Amster

Tim, just I think to read into a little bit what you're asking, if to the extent that there was code in what we were trying to say with the comment about secular and particular vertical and a handful of big clients, is that there's not a change in the way companies are viewing us, there's not a change in the way we feel about our renewal rate in general that this was really isolated to a handful of companies, we expected it to happen throughout the course of the year and it happened to happen in a concentrated period, and again as Ned mentioned, it happened, played out kind of in the worst possible scenario, but it's isolated to a particular area, that's really what we were trying to get across.

Ned Segal

And it feels like it's largely played out in the way that it's going to impact us too.

Tim Quillin - Stephens

So hypothetically, is there a scenario where it just wasn't right for value creation where you were not able to find enough patent acquisitions in that area to save those clients in that sector money?

Ned Segal

No, it really has more to do with just the changing competitive landscape and results of the companies in it and quite the contrary nothing to do with what we're doing.

Tim Quillin - Stephens

Okay. Okay, so could it be hypothetically within a sector where they have declining operating income, and so you're on your rate card that's going to end up…?

Ned Segal

[Inaudible] profitability shifts over a decade from one set of accompanies to another set of accompanies, and just because of the variable nature of our business that sometimes that means that events happen very far apart and sometimes it means that it happens very close together. In this particular situation they happened closer together. Just taking a step back for a second, Tim, I think when we look at the business, nothing has changed relative to where we were at the Investor Day 60 days ago or where we were on our earnings call 90 days ago.

Tim Quillin - Stephens

Okay. And then I missed the first few minutes of your compared remarks but did you comment about the acquisition of PatentFreedom, the financial details, how much you paid and does your guidance include any impact from PatentFreedom?

Ned Segal

The financial impact was really not material, Tim. We didn't talk about purchase price, we didn't talk about the impact of the financial statements, but John did mention that Dan, and I'll just offer that one other person joined the RPX team and we're really excited to have them onboard and helping us further our data capabilities and getting more people to embrace the RPX data.

Tim Quillin - Stephens

Okay. And I guess we'll see it in the cash flow statement next quarter, but it's not going to be some big amount that we see in terms of capital outlay?

Ned Segal

No, it's not.

Tim Quillin - Stephens

And then how about cross-selling opportunities, does it present opportunities for you to sell the RPX service into PatentFreedom customers that were not already RPX clients?

John A. Amster

There's a decent amount of overlap but not complete overlap in the customer bases. People have been paying them really exclusively for data and they are obviously paying us for more money and for a broader set of services. So there's always that hope and possibility but that wasn't the key driver of acquiring PatentFreedom.

Tim Quillin - Stephens

Okay. And then just one more question and I'll hop back in the queue, but John, I'd like to give you the opportunity to geek out on patent reform but if you can comment about some of what we've seen over the past couple of months including the Alice-CLS ruling and whether there is anything that might – with it that you've seen that might impact the level of NPE activity?

John A. Amster

Sure Tim. So, we really just stick with the same mantra which is, the more things change the more they stay the same and then be wary of the unintended consequences. I think it's actually interesting for somebody to read, if you're not a lawyer, to read the Alice decision. If you're curious about it, read it and you tell me what it means. I think at the end of the day courts now are going to be trying to figure out what it means and lawyers are going to have lots of interesting new arguments. And so I think there's going to be a lot more litigation about what are patentable subject matter and what are the standards for invalidating patents.

So we don't expect any meaningful shift. We're certainly not seeing any meaningful shift in the activity today with NPEs. I think the general trend – but it's been the case for a couple of years now with most NPEs that have money to invest and are investing and are making money, they are more focused on validity than they have been and they'll continue to be.

So, we think this patent reform idea and topic both in the courts and in the legislature is going to be on their – it's going to be on the agenda for the foreseeable future and we don't expect any major changes and we're certainly not seeing any major shifts in NPE activities as a result of it.

Operator

Up next, we'll take Timothy Arcuri with Cowen and Company.

Timothy Arcuri - Cowen and Company

So just as it relates to the guidance again, if I hear you correctly about the events in September coming in a little below what your expectation was even when you guided back in April, does that imply that December, since you didn't change full-year, does that imply that you're actually a little more optimistic about December and about the pace of client adds?

John A. Amster

Tim, I think the comments about – if you think about the Q3 guidance, embedded in that is the activity that we see around the business in Q2, when we signed up new clients or when they agreed to pay us above the rate card, when they did or didn't renew or at what levels, and the impact that we've seen so far and what we anticipate in Q3. So it's really much less about Q4 than it is about Q3. And we take a step back and we look at the business more broadly, we continue to be as optimistic about the opportunities around this really big market, the $13 billion that our clients and prospects spend, the 480 prospects who have been sued two or more times in each of the last three years, but whether it plays out in one quarter or the next is something that's harder for us to predict.

Timothy Arcuri - Cowen and Company

Yes, I guess the point I'm making is that people are focused on the events in this one particular sector that are driving Q3 a little lower but you didn't change your full-year which would argue that something is actually better than you thought headed into Q4, otherwise you would have cut the full year too. So I guess that's the point I'm making.

John A. Amster

I'll just point to you, you've got three of the four data points between the actuals and our guidance to get to the full-year. And so I think you can come up with the range of outcomes and what we need to accomplish between now and then in order to make them happen, and so I'd just leave that to you to do.

Timothy Arcuri - Cowen and Company

Yes, right. So just then around that, so the fee related revenue for December has to be $7 million to $8 million, something like that. Does this tend to be high visibility revenue? On the surface it would seem to be a little less predictable. So maybe you could argue that it's a little riskier from kind of a timing point of view or is that not correct?

Ned Segal

I think it's right that it is less predictable. The team's been doing some things they are working on, they've been working on for months or quarters or years, and the activity levels continue to be high, but of all the things that we guide to, this is the least predictable of them and the hardest for us to forecast internally or as we talk to you guys.

Timothy Arcuri - Cowen and Company

Okay, great. And then I had two questions just on IPRs. First of all, John, how do you think of this initiative in light of some of the rulings in the [indiscernible] case, there was a bunch of IPRs where the party was ruled to be a party in interest, and so how does that change how you think about IPRs if at all?

John A. Amster

It doesn't. Hopefully this won't surprise you but we have been very intentional on the IPRs that we were filing. Every one of them is fact specific and that was very intentional for us to pick different sets of – pick IPRs that would have different facts and circumstances so that we can fully flesh out how we can utilize this tool to service our clients.

Timothy Arcuri - Cowen and Company

Okay. And then just lastly, John, so you had mentioned that a customer came back into the base that had previously left. Is this in some way related to IPRs? I know that there is a situation where you're bringing IPRs on behalf of somebody and I'm wondering if the addition of this customer back into the network is related to the efforts that you're doing on the IPR front.

John A. Amster

Sure, Tim. We generally stay away from talking about client specifically, but I would think as a general trend, the addition of different services and expanding our capabilities really making clear to our clients that because of our involvement in insurance we're more on their side than we ever have been, our interests are so closely aligned, we can then step into things like patent quality initiatives, I think just in general our clients like that. I think it's helped our renewals, I think to the extent that it's – that we're adding new bookings, I think it's a factor in every conversation we're having. So I think just in general, yes, it absolutely is helping us and it's important.

Ned Segal

And just remember, as you look at any given client, their NPE risk, that can evolve as their business evolves and that can cause our ability to help them to evolve as well.

Operator

(Operator Instructions) We'll go on to Matthew Galinko from Sidoti & Company.

Matthew Galinko - Sidoti & Company

So I guess first question quickly is just kind of remind us the purpose or motivation of patent assets dealt by RPX.

Ned Segal

Sure. So there are a couple of reasons we do them. One would be to make sure that our prospects know that they cannot free-ride on the backs of their competitors who are members of RPX network. The second would be opportunistic for one reason, either somebody approaches us or we know that something might make sense for a certain party. And so we'll continue to be opportunistic in doing this. It's not something that we'll guide to and it's not something that we can always see until it stare us in the face, and so it's not going to be an ongoing and larger and larger part of our business and we'll just tell you about it as we see them coming.

Matthew Galinko - Sidoti & Company

Got you. And then can you talk a little bit more about the process you're going through in terms of building the distribution channel for insurance? I think you mentioned it would take a number of quarters but sort of where are we in the process towards approaching a run and any color around that?

John A. Amster

Sure, and again, this probably won't surprise you but I wish I could be more quantitative on when we get to run, but let me give you some of the steps that's we're going through, and it's a good reminder of why we can't have the visibility yet, it's just not practical. People have been trying to crack this not for over a decade to try to figure this out. There's never really been a mainstream A-rated insurance product that covers NPE risk in the market, and so there's a lot of education we need to do with the broker community. That's really what the relationship with CRC is about.

They are what's called a wholesaler, so they've got relationships with brokers throughout the country. We are working with them to identify geographical areas and the brokers in those areas that we really should invest time in educating and getting them up to speed and getting them excited about this product, which is a completely new product in an industry that doesn't see a lot of, ton of new products on an annual basis.

So that's the process that we're going through right now and it takes time but we've got a really – we're also focused on really understanding the pipeline and understanding the different types of, the nature of the different types of potential insurance clients out there and trying to make sure that we've got the right products for the right geographies, for the right types of companies, et cetera. So that it really is, we want this to be as frictionless as possible and we want to make sure that when we go to these brokers that we're giving them something that they think they've got a really good chance of selling, so that they are motivated to roll it out broadly. So that's what we're going through, and I wish I could say when the inflection point that we are hoping for in that business is going to come, it's just too early to tell.

Operator

Up next, we will have Jeff Meuler from Baird.

Jeffrey Meuler - Robert W. Baird & Co.

So back to the issue that we've been trying to harp on this whole call, but the subscription revenue…

John A. Amster

[Inaudible] to think about how to ask the question differently. Let's hear it.

Jeffrey Meuler - Robert W. Baird & Co.

Exactly. No, I'm more interested in how much of a one-off you view this as, meaning what percentage of your book, and I'm not looking for a number, I'm just looking for a qualitative kind of assessment of risk, in terms of generally how much of your book is in sectors that may be facing similar secular structural challenges developments, whatever?

John A. Amster

I think here's a way to think about it. So think about all the words that we used on the call talk. We talked about corporate activity, we talked about secular trends and we talked about the randomness of the client additions and renewals aligning around a compressed timeframe and then playing out towards the lower end of the ways that we contemplated it potentially playing out. That is a combination of factors that certainly could happen again, either in a sector where we see secular trends happening or one that we don't yet see it but where it can end up happening. But when we look at our clients, when we look at when their renewal dates are coming and we look at the secular trends of corporate activity, I think it's fair to say that it's not something that you would see a lot of – it's not something that you can see a lot of examples of the way it could play out. I'd just point out, but this is one sector and our sense is that we have seen it play out, that is we've seen the set of circumstances around this sector, we have a pretty good sense for how they're going to hit our P&L.

Jeffrey Meuler - Robert W. Baird & Co.

And then I guess you reiterated that you guys remain excited about the market opportunity, and I know your pipeline isn't necessarily concrete, that it can be fluid, but just your view of the pipeline, is that also similar to what it's been the last 60 days or last 90 days?

John A. Amster

Yes, absolutely, and the way we think about it is, and the reason we're excited about it is, we see data, we see evidence every day that the theories about our business are right, we see our ability to take transaction costs, we see our ability – out of the transaction we see our ability to get better pricing because we're negotiating on behalf of large companies. We see really, really good evidence that we just absolutely didn't have six years ago that there is a direct link that we are getting better a proving between patents that we buy and litigations that are avoided, because we can now look at a six-year history of things that we passed on and see the thousands of litigations that have been led to by things that we passed on. We can see a consistent pattern of our ability to be able to with just over $100 million of buying take care of about 20% of our clients dismissals on an annual basis from NPE cases, yet they're spending $12 billion, right.

So when we look at this stuff, we get super, super excited about it. Now I have to be, and I've said this before, it is frustrating that we don't convert more of those couple of hundred companies that face multiple litigations in a year. We wish we could convert more of them more quickly, and that can be a little bit frustrating, but as long as we focus on what we're doing, getting our adjusting clients to pay us more, continue to buy really good stuff that people care about to be able to demonstrate what we're doing, we're going to continue to add new clients, and if we developed these other new products and services and focus on things like patent quality and if we develop insurance, we think we're going to take a big chunk of those $12 billion out of the market and have that be part of what is our revenue line.

Ned Segal

By the way, we'd love it if we could do it in a linear fashion too, but that's not something that we've historically been able to do even when we've been able to give a very solid guidance looking out four quarters at a time, it just ends up not playing out in a linear fashion and we'd expect that to continue to be the case.

Jeffrey Meuler - Robert W. Baird & Co.

I'd be okay if you did it all at once.

Ned Segal

Alright, we'll get going on that.

Jeffrey Meuler - Robert W. Baird & Co.

Then my last question, just I thought in the past you guys talked about kind of patent amortization averages of 45 months or something along those lines, and I know the recent history has been buying patents to get amortised over shorter periods. But just in terms of the comment about expect 40 months going forward versus what I will recall as being more mid-40s in the past, are you just incorporating kind of what the recent trends have been into the longer-term average or is there something structurally different about the types of patents that you're buying today versus what you were buying a couple of years ago?

John A. Amster

Sure. So I think there's a couple of things to say there. One is, so the historical average is 46 months but it definitely has been skewing lower over the last year and a half or so, and we used to leave it to you guys to come up with an amortization period to just put in your models as you're trying to figure out how things hit the P&L, and as it's become more and more clear to us that 40 is the new 50, we wanted to give you as much clarity as we could so that although this is a number that we don't manage to, that you've got the benefit of the same data that we do to put in your models. We don't think it's going back to fit, although it certainly could, we think that 40 is a better number to use. So that's number one.

Number two, has something structurally changed? I don't think anything structurally changed. This isn't about pricing, it's not about the types of things that we're seeing. I do think that we've opened our aperture as it relates to our willingness or ability to buy shorter life patents if we can save our clients more money by doing those than we can by doing other things, just as I think that you'd want us to do.

Ned Segal

But also, there is no trend in what's going on in the patent market for sure because there are a lot of factors that go into how we determine the amortization and a lot of it has to do with just internal things related to our business and expectations of new clients with respect to different things and renewals and there's lots of factors that go into it, Jeff. And so, they had nothing to do with the patent market, I want to make sure that you guys understand that.

Operator

Up next, we have Tim Quillin with Stephens.

Tim Quillin - Stephens

Why is your 3Q revenue guidance down? I'm kidding. Yes, that's stupid question, bingo, I asked one. So I want to get your views on different emerging business models in the patent world. So I think there has been some creativity, PatentFreedom I guess being kind of one example, RPX being an example, but one that we've heard of recently is this license on transfer network, the Latin network or whatever Google and Company is calling that, but do you view those type of business models as competition for your clients' dollars or is it just validation that there is different approaches to the market that might help you as clients evaluate different ways to approach the NPE problem?

John A. Amster

So in order of those questions, I think it's no and yes. So they are complementary in the sense that – we'll take license on transfer for example, they are complementary in the sense that they are targeting the same age-specific area of supply of patents that lead to a meaningful double-digit percentage of the NPE supply that comes from operating companies, and I think Google and other companies are really focused on trying to get companies to not sell to NPEs. And that's what I'll tell about.

The reason I said no on the dollar, it's not competing for dollars, this isn't a dollars thing, this is more of an information and a collaboration thing. We think we have a really good platform for doing that as well and we have a similar goal of trying to help alleviate the problem of transferring patents from companies to NPEs because it is a big source of the supply. Our view of that problem is, let's focus on creating transparency and only the transparency. A lot requires, some pretty big commitments of companies in terms of licenses that they're willing to grant if they do end up selling to an NPE.

So it's not necessarily for everybody because it can be restrictive in what they can do in the future but it is going at that problem in a very creative way. Our view is that we should just focus on, let's create transparency, let's let the market decide. So if a company does want to sell, it requires them to give notice so that then the market could either react and pay more than what the NPE is going to pay or not, and that's our view is creating market mechanisms that create transparency and efficiency is the way to go. And so, any efforts in these regards we think are good validation of what we've been saying for the last six years.

Tim Quillin - Stephens

And then just last question is, what the pipeline of potential premium subscriptions looks like, are you still having fruitful discussions with your top rate card clients that you think will lead to getting a greater share of their wallet over time?

John A. Amster

Yes, we still like the pipeline. I wish again, I wish like everything in our business, we could have more predictability around it but we don't, but we do have a good level of activity.

Operator

At this time we have one question remaining in the queue. (Operator Instructions) We'll take our next question from Timothy Arcuri from Cowen and Company.

Timothy Arcuri - Cowen and Company

Since everyone is asking follow-ups, I figured I should too. So, John, have you seen any – there are some companies that are talking about a model that sounds vaguely similar to yours. We've talked about this before but have you seen any – I know it's going to be difficult over time to come anywhere near replicating your pool of knowledge on the industry and your accumulated data, but have you heard of any companies trying to replicate what you're doing or models that are similar to yours?

John A. Amster

I have not heard of anything. I've heard of nothing similar to ours in the sense of charging a subscription and going out and buying patents, and there's nothing out there that's focused on the same sort of defensive patent aggregation. Look, the patent properties which Jay Walkers, the Chairman of Priceline and I don't know how many hundreds if not approaching 1,000 patents in his name, they are working on something that we think is interesting. They talk about a patent utility that's trying to create a lot more of efficiencies and transaction volume. I think that's a really interesting idea.

They're really focusing on enabling smaller companies to pay reasonable small amounts of money to get licenses and stuff that they think is relevant to them, and there's a number of things that they're doing that I think are interesting, they are focused on using a software tool to do it which I think is interesting and they're also just focused on trying to take patents outside of the litigation context. But it's a very different business model and I think one thing that's different about them is they've also got a lot of active litigation which really separates them from what we're doing.

Ned Segal

There are lots of folks, Tim, who do something similar to a component of our business but we don't hear about anybody who's either doing it at the scale that we are, who that combine the different pieces the way that we have.

Timothy Arcuri - Cowen and Company

Awesome, guys. Thanks so much.

Operator

It appears there are no further questions at this time. Mr. Amster, I'd like to turn the conference back to you for any additional or closing remarks.

John A. Amster

Nothing other than thank you all for joining and we look forward to talking to you next quarter. Thanks.

Operator

This does conclude today's conference. Thank you for your participation.

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Source: RPX's (RPXC) CEO John Amster on Q2 2014 Results - Earnings Call Transcript
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