WiLAN's (WILN) CEO Jim Skippen on Q2 2016 Results - Earnings Call Transcript

| About: Wi-Lan Inc. (WILN)

WiLAN, Inc. (NASDAQ:WILN)

Q2 2016 Results Earnings Conference Call

July 28, 2016, 10:00 AM ET

Executives

Jim Skippen - President & CEO

Shaun McEwan - CFO

Analysts

Doug Taylor - Canaccord Genuity

Daniel Kim - Paradigm Capital

Todd Coupland - CIBC

Operator

Good morning. And welcome to WiLAN's Second Quarter Fiscal 2016 Financial Results Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions]

Earlier this morning, WiLAN issued a news release announcing its fiscal financial results for the second quarter which ended on June 30, 2016. This news release is available on WiLAN’s website and will be filed on SEDAR and EDGAR.

On this morning's call, we have Jim Skippen, WiLAN's President and Chief Executive Officer and Shaun McEwan, WiLAN's Chief Financial Officer. Following prepared remarks by Mr. Skippen and Mr. McEwan, analysts will have an opportunity to ask questions.

Certain matters discussed in today's conference call or answers that maybe given to questions could constitute forward-looking statements. Actual results could differ materially from those anticipated. Risk factors that could affect 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, WiLAN will refer to EBITDA. EBITDA does not have any standardized meaning prescribed by U.S GAAP. EBITDA is defined in the company's quarterly and annual filings that are made available on SEDAR and EDGAR. Please note that all financial information provided is in U.S dollars, unless otherwise specified.

I would now like to turn the meeting over to President and CEO, Jim Skippen. Please go ahead sir.

Jim Skippen

Good morning, everyone. And thank you for joining us on our Q2, 2016 conference call. I will also in the call we will look at operational highlights for the quarter and then pass it over to Shaun to closely look at the numbers.

Starting with highlights. Revenues in Q2 were $16 million, EBITDA was $7.1 million and cash from operations was $8.3 million. Our cash balance stood at $103.7 million at quarter end, up $1.8 million from the end of Q1 and up $9.1 million since the beginning of the year.

The Board also declared a dividend of CAD$0.125 per share. The most existing business closing this quarter concerns to policy business development opportunities. First, we acquired an important portfolio from the Stanford Research Institute.

These patents cover advances and technology that became the popular SIRI voice-activated assistance program used in Apple devices. Apple is already licensed for this portfolio but many other players in the market are not licensed for similar products, this creates what we believe is a significant market opportunity. This is the second important portfolio we have acquired from Stanford Research Institute.

A second key development was the status and partnerships with both the University of Waterloo and the University of Saskatchewan. The two candidates top the universities as SIRI assistance to help license and promote these technologies, speaks to our high stature in the licensing world and also speaks to our potential to develop new and existing markets in the future.

Now some further thoughts on our revenues this quarter. There is no question that our business performance can be lumpy and we experienced that dynamic this quarter. Both Q4 and Q1 were positive surprises with revenues exceeded our expectations. Revenues were lower this quarter but as we said in the past, this lumpiness is just business as usual for us. It reflects the fact that timing on license agreements can vary from quarter-to-quarter. That’s how it’s been in the past and this is how we expect it to be in the future.

We continue to have a high volume of licensing activity going on and although the average value of licenses was lower this quarter, we do have a number of multimillion dollar discussions ongoing. I should add that we will continue to resist the temptation to take a deal that is less than it should be simply to have a better quarter.

Also it is worth noting that even with revenues being down, we still generated a healthy EBITDA margin and grew the cash in our balance sheet. Our ability to do so was in large part due to the cost saving measures we’ve taken in the past year or so.

Taking a look at some of the license highlights. We had success in Q2 as well as Q1 with our Building Controls portfolio which we purchased from HP. This portfolio includes patents for technology associated with home automation or smart homes. A number of licenses in the quarter were signed for the Variable Lighting portfolio which covers technology used in some types of holiday and event lighting. We also had two signs with our Advanced Microscopy portfolio which covers invasive medical photography techniques.

Turning to acquisitions. This quarter we acquired a portfolio of patents from PhysioKinematics LLC an affiliate of Barron Associates. Barron is a research and development company specializing in aerospace and healthcare solutions. They do work for NASA helping to develop wearable technology that is used to monitor the motion and health of astronauts in space. The acquired patents relates to technology that allows wearable devices to track the movement of the human body during different activities. This is a key component in today’s fitness tracking devices and wearables.

Turning now to ligation, we currently have more than 60 ongoing litigations. As mentioned on our last call we continue to look at other geographies in the U.S. namely Canada, China and Germany for possible opportunities. For instance, this quarter we commenced a litigation in Germany against Deutsche Telecom for infringement of network management patents. These patents were originally acquired from Siemens.

This quarter the amount paid out in dividends was $1.2 million while the amount returned to shareholders to buybacks was just under $1 million. So far this year we have paid out $2.2 million in dividends and $3.1 million in share buybacks. Looking forward, the Board has declared a dividend of $0.125 per share Canadian payable on October 5.

In closing, we've made some exciting partnerships and acquisitions in Q2 that will drive future revenues. We reiterate that Q2's revenue reflects the short-term fluctuations that impacts every business in the patent industry is important to keep in mind that when viewed historically over a longer term WiLAN had delivered steady levels of revenue and EBITDA. Given our patents, license pipeline, financial resources and team we still believe we should be able to maintain a long term positive revenue trend although occasionally we will have slower quarters.

Over to you Shaun.

Shaun McEwan

Thanks Jim and good morning everyone. I’ll start things out for the look at revenue. Revenue in Q2 was $16 million compared to $35 million last year. Of note revenue in Q2 last year included a large license agreement with Samsung related to the Qimonda portfolio which we acquired at the same time.

Year-to-date our revenue is $46.1 million compared to $55.4 million for the same period last year. The narrow difference between the six months revenue totals reflects the strong Q1 we had this year with revenue above $30 million. Cost of revenue expenses were $16.1 million in Q2 about equal with Q2 last year and about $2 million lower than Q1.

Year-to-date cost of revenue expenses are $34.1 million down from $35.6 million in the same period last year. Lower expenses were due to the decrease in litigation expense offset in part by increases to patent maintenance fees, contingent litigation and amortization. These trends reflect the shift towards more contingency based ligation, the expansion of our partner program and the overall growth of our patent portfolio.

Litigation expense was approximately $600,000 in Q2 down from $3.1 million in Q2 last year. Our Q2 litigation expense compares favorably with our guidance which was in the range of $1.6 million to $2.1 million. Lower litigation expense reflects our goals to reach settlement without litigation and to form contingency fee arrangement with our legal partners.

In 2016 we expect litigation expense to be lower than the 2015 level as a result of these efforts excluding the impacts of any contingent litigation expenses. Patent maintenance, prosecution and evaluation expense was $2.4 million in Q2 compared to $1.4 million last year. This expense is proportional to the size of our overall portfolio which increased significantly year-over-year. As a result we’re working to control the portfolio with certain non-core patents and we still expect the expense to be higher overall in 2016.

Finally contingent partner payments and legal fees were $800,000 in Q2 up from $121,000 last year. Increasingly more revenues are derived from our licensing program that contains contingent payment obligations. Therefore we would expect this expense to more or less track our revenues as it has so far this year.

Marketing, general and administration expenses were $2.8 million compared to $2.2 million last year. These costs are variation from the quarter-to-quarter depending on the activities and initiatives undertaken during the quarter.

EBITDA in Q2 was $7.1 million or $0.06 per share compared to $25.2 million or $0.21 per share last year. Again I’ll remind you Q2 of last year benefiting particular from one large license contract I already mentioned.

On a year-to-date basis we have generated $27 million in EBITDA representing approximately 58% of revenues, while at the same time last year we had generated $29.8 million or only 54% of revenues. So basically at the mid-point here in 2016 we’re tracking very close to last year’s comparative EBITDA totals.

Looking at the bottom line through the first six months of the year we have GAAP net income of $1.8 million, or $0.01 per share $6.2 million or $0.05 last year. The change in net income reflects lower revenue year-to-date offset in part by lower operating expenses.

Of note, year-to-date our tax provision is about equal at $5.3 million versus $5.7 million last year despite lower operating income in 2016. The level of the tax provision is mainly due to withholding taxes in certain jurisdictions where our revenues are derived from and non-cash deferred tax expense related to geography where our profits are regenerated.

Looking at cash flow and balance sheet for a moment. In Q2 we generated $8.3 million in cash from operations. We spent $4.5 million on patent acquisitions mostly related acquisitions completed in previous years and as Jim as already outlined we returned $2 million to shareholders through dividends and share buybacks.

We ended Q2 with cash, cash equivalents and short-term investments on our balance sheet of $103.7 million representing an increase of $1.8 million from Q1 2016 and an increase of $9.1 million from the end of last year.

Finally let’s look at guidance for our third quarter of 2016. Cash operating expenses are expected to be in the range of $9.7 million to $11 million of which $2.7 million to $3.1 million is expected to be litigation expense. This guidance does not include any contingent payment that may arise as a result of incremental revenues booked in the quarter.

This concludes my review of the financial results. I’ll now turn the call back to the operator for questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Doug Taylor from Canaccord Genuity. Please go ahead.

Doug Taylor

Thanks. Good morning. Obviously a bit of a - an air pocket in the revenue in this quarter. I was just wondering you litigation expense was pretty far below what you had guided to. What changed relative to the guidance that you gave at the beginning of the quarter, I mean, was there a low level of activity relatively to what you expected. Help me reconcile that and how that relates to the revenue in the quarter as opposed to the contingent partner payments?

Shaun McEwan

Doug, it's Shaun here. The simple fact is at the beginning of the quarter we expected a couple of cases either come out in the appeal process or otherwise move further through the court process and these expenses relate to the sort of fixed fee arrangements or the partial fix fee arrangements that we have with litigation council. So that the extent that the activity was lower in the quarter than we had expected we have lower expense.

Doug Taylor

Okay. So you are expecting those couple cases to slip into Q3 and that’s why you expect a rebound in that line item.

Shaun McEwan

That's why we guided as up in Q3 because we’ve expected that kind of activity to move into Q3 and Q4.

Doug Taylor

And so is there the potential for revenue related to that to fall into Q3 as well?

Shaun McEwan

I suppose there is always a potential.

Doug Taylor

All right. The compensation related expense ticked up in the quarter in both cost revenue and marketing G&A lines, anything one time in nature related to that we should model going away here in Q3 or can you help us - help explain what the uptick was related to?

Jim Skippen

Yes, sure. Every employee in the company has something called reserve stock units as part of their compensation effectively they’re tied with the share price. So if their share price goes down, they're punished. But if the share price goes up, they're rewarded and they're paid periodically. So we had a dramatic increase in our share price over the quarter and that the uptick in compensation expense is solely attributable to that.

Doug Taylor

Okay. Fair enough. I thought that might have shown up in the stock-based comp line as opposed to your overall competition. That's helpful. Jim another question for you, I'm not asking to wait into the U.S. political landscape here, but I would love your view on some of the patent reform changes proposed, Hillary Clinton's made some discussion about in her platform. How you think that might change the environment vis-à-vis some of the other piece of the legislation that are still being debated?

Jim Skippen

Well, there have been some comments made but it’s very hard to read very much into it. The two issues that I serve here occasionally come up from the anti-patent side are that have to do with the venue of lawsuits in the U.S. It would have to sue in the jurisdiction that the defendant resides in and at [the start of it] [ph] I occasionally hear about is what we call re-shifting or cause shifting where basically if either side loses a patent case that the other side can be required to pay the fees.

Now there are some voices in the Congress that occasionally come out and talk about these issues. I don’t know that I read that much into what Hillary well, I managed to what Hilary Clinton or just people associated with the campaign said about it.

So there are a number of voices are arguing caution and study up these types of issues. There are some issues that I occasionally hear about that are less -- less of an issue. So exhaustive demand letters from someone that doesn’t really explain the basis for the case or maybe they send out a thousand demand letters saying pay me or I am going to sue you and they don’t really give a basis for the claim and someone basically that has a difficult position of either paying them some amount let’s say $5,000 or going on hiring a lawyer and finding a case and it’s just a lot cheaper to pay the $5,000 and not fight the case.

There’s some talk about legislation to deal with that, that would not even be remotely problematic I think for us. I think the venue stuff and the cost shifting stuff, that would affect us, I don’t think it would be a profoundly negative thing that would affect us.

But at this point when I answer the legislation who knows, there are all kinds of voices all over the place. So that’s what's going on for years and years now. And it’s -- I really I’m not sure what if anything is going to happen. So that’s the legislation. You didn’t ask about this. But there are some interesting developments from the Supreme Court maybe I'll take this opportunity just to talk a little bit about that.

Two important cases went up to the U.S. Supreme Court Halo and Cuozzo is what the parliament referred to and both concern patent assertion. One Halo was about can you get the hands damages or troubled damages, how rigorous is the test to get that.

And basically Halo the decision came out and the decision was that the standard was too strict on getting those and should be made -- should be easier for patentees to get triple damages or enhance damages. So it’s pretty good for those in the patent assertion business.

The other decision had to do with inter-parties reviews by the patent trade marking a field support and what is the standard that they should apply to deciding whether to validate patents and that one came out and that was less favorable for patent holders because basically the core affirmed the standard as being used by that Board which is the broadest reasonable interpretation of the claims, which makes it easier to validate the patent.

So that was a bit disappointing but it’s a mix result with some positive and some negative. So those are many things that I think are going on in the U.S.

Doug Taylor

Okay. And you’ve now trumpeted for a couple quarters the move to increase your business in other parts of the world. Is there any of that in response to still pretty choppy overall conditions for patent assertion in the U.S.?

Jim Skippen

Yes, I think that you nailed it exactly that the environment for patent litigation in the U.S. is not as favorable I don’t think as it was a decade ago. It’s still -- we still think it is a good jurisdiction but we think it's worth looking at other jurisdictions.

And particularly the jurisdictions I talked about Germany and China and even Canada where we’ve got a fairly major litigation now going on against the service providers in Canada. So we’re expanding our horizons and we’ve seen a number of results in Germany and China that have been favorable for the patent holder.

In some cases it’s the same patent that are litigated in the U.S. and we get a positive result out of say say Germany and a negative result in the US. So I think this is a trend that has been happening for some time in the patent business and Europe is now on a path to develop a unitary patent court for all of Europe, which will make it actually a largest single jurisdiction than the U.S. alone.

So there will be advantages of filing in Europe as compared to the past and as compared even with the U.S. So I think you’re going to see more and more suits filed in Europe.

Doug Taylor

And you’ve got a large portfolio of patents but could you help us understand what percentage of your portfolio are applicable outside of the U.S. as opposed to U.S. patent specifically?

Jim Skippen

Sure. Well, just to give you a sense of it. 42% of our very large portfolio are U.S. based meaning 58% is in the rest of the world. So we have a lot of depth in the rest of the world and we want to exploit that opportunity for us.

Doug Taylor

That’s helpful. All right, thank you for the perspective. I’ll pass the line.

Operator

Your next question comes from the line of Daniel Kim from Paradigm Capital. Please go ahead.

Daniel Kim

Good morning, thank you. Jim if I look back, I believe it was one maybe two years ago at your AGM you provided a great breakdown in terms of your total addressable market.

If memory serves, I believe it was somewhere in the neighborhood of $850 million of potential addressable market in terms of all the portfolios you had at hand. Obviously a lot has changed since then. I’m wondering if you or anyone else has run the numbers have gone through the exercise to take a look at what your addressable market is now today given all the new partnerships and portfolio acquisitions?

Jim Skippen

Sure. And we do this all the time. So internally we're tracking this all the time trying to keep track of it. And I’ll tell you firstly, we have 40 partners now, we have over 50 portfolios, we have over 15,000 patents, more than 60 ongoing in litigations. And if you look at that breakdown of what is the future potential and recall this doesn’t include backlog.

In cellular wireless and infrastructure our estimate is at least 350,000 should be generated -- $350 million, sorry should be generated from licensing.

In semiconductor technologies we now believe that at least $400 million should be generated. In televisions, we believe at least $50 million should be generated and in the other 40 portfolios which are consumer and automotive and medical and we talked about one just now the SIRI portfolio, we believe that’s approximately $150 million.

So that gives you a breakdown of what our current thinking is and it does change all the time as we get more patents in or as we reevaluate the strength of patents or what the opportunity is. But that’s our latest estimates on what we should be able to generate.

Now if you look at what the addressable market is and you apply a royalty rate to it which is what I hear a lot of other companies do when they get these numbers they're much, much, much higher, which could basically be what you would expect to get it as you enter the quarter and people were required to pay royalty on these products but I’m giving you all the amounts that we believe we can generate through our licensing efforts.

Daniel Kim

Great, okay. So just to be clear those numbers that you highlighted, those would be the dollars that WiLAN has still not litigated against so that is addressable to you?

Jim Skippen

Well litigated against might not be the right way to put. I have several of these dollars archived to existing litigations. But they are dollars that are not yet in an agreement or represent an agreement by some of the payers that we think we should be able to get into an agreement in the future from some other payers based on our experience and same for the patents and everything else. But it's something that maybe driven by existing litigations.

Daniel Kim

Okay, great. Thank you. Second question, question about recurring revenue, I believe there was a bit of a shift in strategy not too long ago, did not recognize onetime revenue -- excuse me and didn’t recognize it over say a three or five year term or on a royalty basis or what have you.

If we look at what has happened in the recent past, looks like you’ve had a number of big wins but they're all recognized essentially in the quarter. Can you talk about how that strategy has been playing out with past deals signed and what your strategy might be going forward?

Jim Skippen

Well I’m not -- I think what you're seeing now is probably the new reality in that we used to have more onetime deals than we’ve had in the past. We expect to have a greater number of them and unfortunately that’s probably going to contribute to the more lumpiness in the quarter.

So we'll have quarters like Q1 that were positive surprises that Q1 was over $30 million and then we have quarters like this one where although we were active selling licenses that was at a lower volume and mostly we were -- our revenues for the quarter represent backlog.

So I think it’s going to continue like that. My hope is that the overall trend is upward and that we continue to grow the business. We think we can, but unfortunately the lumpiness is probably going to be more than it was in past.

I do think occasionally we will have deals that will have periodic payments. Currently our approach on that is we recognize -- so let’s say someone takes the license for $10 million and is paying us over a number of quarters every 10 quarters, we would recognize a million per quarter when they pay that. We understand and it looks like it’s going to happen until new accounting rules that we’re going to miss that very soon and we will be required to recognize all of those payments probably upfront.

So the entire amount of revenue and its get more complex from there. We’ll have to recognize the financing component if they’re paying over time it the revenue gets recognized right at the beginning.

So in recognition of that happening is we're leaning more and more towards trying to get onetime payments I think because I think in the long run it helps us more. So even though we do have some deals, we continue to sign deals that do have in some cases running royalties or other things. The bigger deals we’ve signed so far this year have mostly been onetime or one or two payments something like that.

Daniel Kim

Terrific. That’s helpful. And last question probably best suited to Shaun patent acquisition payments I believe we’re supposed to wind down pretty materially this year from past deals I believe from Insignia and Qimonda. Can you give us a sense of where that's going to tailor towards the end of this year and if you have a view for 2017 that would be great as well? Thank you.

Shaun McEwan

Yes, I think if you look at the current year run rate is in the current statements for the last two quarters. We'll happen out for basically the balance of the year and then there will be one fairly substantial payment but it’s not payable for a few years so it will be wallet for now.

Daniel Kim

And then would you anticipate 2017 to come down quite materially?

Shaun McEwan

Yes.

Daniel Kim

Any sense could give us a sense of ballpark?

Shaun McEwan

Probably approaching zero.

Daniel Kim

Okay. Great. Thanks so much.

Operator

[Operator Instructions] Your next question comes from the line of Todd Coupland from CIBC. Please go ahead.

Todd Coupland

Hi, good morning everyone. I wanted to -- I didn't take the litigation expense number down for Q3 if you could just repeat that?

Shaun McEwan

In the guidance it’s between 2.6 and 3.1.

Todd Coupland

And just to be clear, this could be tied to higher revenue but not necessarily is that the way you answered that question?

Shaun McEwan

Every one of our litigations could be tied to higher revenue yes, Todd.

Todd Coupland

Okay.

Jim Skippen

But I think a bit more granular about. Some of that is tied to the fact that we think we’re going to win and appeal on what we backed into trial and so that’s part of the reason that we have higher litigation expenses. So if we don’t win an appeal that will change, but that's how we’re planning things and so those numbers reflect that.

Todd Coupland

Okay. So just my own observation from the outside I think if I counted right there were roughly 10 licensing agreements announced in the second quarter yet revenue was down so should the take away be that those were just smaller deals or should the take away be that there was mix in size of deals but now we are starting to getting into the area where the expiring licensing agreements are actually having an impact on the results and they are not being offset even though you are signing in a decent number of deals including in Q2.

Shaun McEwan

I would say that the main take away is those were smaller deals and in some cases they were deals where the payments were spread out over a longer term so the revenue impact this quarter was minimal. There is some towing and forewing I think with backlog but not that much. But really the new deals didn’t contribute very much this quarter.

Todd Coupland

Okay. You had - in Q1 you had a pretty good pace in your semi portfolio and do you still see quite a bit of activity in that larger portfolio could you see that coming back in future quarters?

Shaun McEwan

Absolutely. I think what we’ve reported last quarter was we thought we were probably in the range 25% done on the Qimonda portfolio and 5% done on the Freescale portfolio. That’s still very much our view. Like I said we have ongoing multimillion dollar discussion with companies. They are not stupid. They know that we’re under pressure. We understand the lumpiness of the business but we still strive to make every quarter better than the last to the best of our ability they know we’re under pressure to do that.

So sometimes they will sort of stick at us and say well that’s it and so sometimes we have to hold tight and hold tough and show them we’re not going to succumb just quarterly pressure for the long term sake of our business and that dynamic play out to some extent this quarter.

Todd Coupland

Okay. And I just wanted to make sure I understood the TAM opportunity that you lay out. So the $350 million which was sell - in a few other areas, that’s essentially the wireless area, is that right?

Shaun McEwan

Yes, it’s wireless but we have a lot of infrastructure stuff that’s not wireless exactly that we still include in that area so for instance the suite I told you about against Deutsche Telekom, or the suite I told you about Canada against [indiscernible] that will be included in those numbers but it’s not strictly speaking wireless.

Todd Coupland

Right, no that’s fair. It makes sense to bucket it there. And then just lastly from me, is there anything else to say on potential wireless resignings.

Shaun McEwan

Well, the discussions are definitely starting and underway with some of those licensees. I think the mix of patents is slightly different and that we speak to some of the big signers back in 2011 and later in 2010 renewals will be driven as much by new semiconductor patents maybe as wireless but that dynamic is underway.

Those agreements have some time before they expire so at this point in 2016 it would be unusual for us to be announcing renewals in one case we did, we announced a new deal with Samsung that renewed an agreement that they had early but I can assure those discussions were underway. There is no guarantees of what will happen but we remain confident and hopeful that we’ll have renewals in that things won't pull the way we’ve stuck in through.

Todd Coupland

Okay. And I guess that it’s an importance nuance that you are using semi as a hoot to bring these guys to the table to take a license as their old deals are expiring?

Shaun McEwan

Yes, I think if you look at our portfolio it's gone from a smaller portfolio that was probably strongest in WiFi, much larger portfolio with a lot more strength in cellular and wideband and a lot more strength in semiconductor.

And so we used the best weapons in our arsenal and some of the best weapons are no longer WiFi, it's other areas so that’s what we are focusing on and a lot of these companies have a lot of parts that use these technologies. So that’s the dynamic that’s unfolding.

Todd Coupland

Okay. Great, thanks gentleman. Appreciate it.

Operator

And we have no further questions at this time. I'll turn the call back over to Mr. Skippen.

Jim Skippen

Well, that concludes the call and we hope that we will have a great second half of the year and look forward to talking to investors next time. Thank you.

Operator

Thank you. This concludes today's conference call. You may now disconnect.

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