RPX Corporation (NASDAQ:RPXC) Q3 2016 Earnings Conference Call November 3, 2016 5:00 PM ET
JoAnn Horne - Head, IR
John Amster - CEO and Co-founder
Bob Heath - CFO
Nick Nikitas - Baird
Nikhil Dixit - Barclays Capital
Theanne Joan - Cowen & Company
Matthew Galinko - Sidoti & Company
Good day, and welcome to the RPX Q3 2016 Earnings Conference Call. Today’s conference is being recorded.
At this time, I would like to turn the conference over to JoAnn Horne, Investor Relations for RPX. Please go ahead, ma’am.
Thank you. And thank you for joining us to review RPX Corporation’s third quarter 2016 earnings. Leading the call today to discuss the results are John Amster, Chief Executive Officer of RPX; and Bob Heath, Chief Financial Officer.
The agenda for today’s call includes commentary from John, followed by a detailed review of the third quarter financial results and updating of 2016 guidance by Bob. And then, we’ll open the call up to take your questions. Trevor Campion, CEO of Inventus, will join the call to answer questions.
This afternoon, RPX issued a press release announcing its third quarter 2016 financial results, which is available on the Company’s website at www.rpxcorp.com. This call is being broadcast over the internet and the audio of the call will be available on the Investor Relations page of the Company’s website. Also, please note that there are slides corresponding to the information discussed today available on the IR site.
I’d like to remind everyone that today’s discussion will include forward looking statements that are not historical facts but are based on the Company’s current expectations and beliefs. These forward looking statements include but are not limited to expectations regarding the growth of the Company’s business and the business outlook for the year. The Company’s actual results may differ materially from these forward looking statements. Please refer to the Company’s SEC filings for detailed information.
In addition, non GAAP financial measures will be discussed during the call. Reconciliations are included in the table attached to the earnings release and on the website.
With that, I’ll turn the call over to John Amster.
Thanks, JoAnn. RPX reported solid results in the third quarter. Total revenue grew 30% year to year with steady performance on both sides of the business. Earnings growth and cash generation were in line with our expectations. In the patent business, we ended Q3 with 328 total clients, a net addition of 11 and our renewal rate in the quarter was as usual, right around 90%.
So as we said on our last call, we’re holding our own in what has been a challenging operating environment. We are guardedly optimistic that M&A activity in our client sectors is stabilizing. We also believe that our clients and prospects are starting to recognize that the patent problem is not going away, and the positive impact of IPRs and Alice is largely limited to the lower quality, lower risk patents in the ecosystem.
In other words, we continue to see catalysts where our clients need us, and they’re giving us opportunities to deliver value. Beyond this catalyst driven engagement, we’re also encouraged that the general tenor of our sales and renewal meetings is increasingly built around the more comprehensive solution we deliver. A large part of this trend is insurance. All of our sales people are licensed to sell insurance, and insurance is part of virtually every prospect dialogue.
The actuarial and forward looking assessment we can provide in these meetings drives the conversation toward not just, the various kinds of patent risks the prospect has, but also the various ways we can help mitigate it. We think that has definitely contributed to our ability to add clients, both network members and policyholders, even with all of the negative patent headlines.
Operationally, we’re pleased with how we’ve integrated Inventus’ discovery services business and encouraged by their successes and their pipeline in Europe and the US. We also continue to explore cross selling opportunities within both operating units and are pleased that we’re now seeing client referrals from each business into the other.
Let me give you a quick recent example that we think we’ll be seeing more of. An insurance policyholder gets drawn into a patent litigation, we immediately work closely with them on their defense strategy, and this gives us the opportunity to cross sell discovery services. Our goal is to develop a growing pool of shared clients that use us for both patent and discovery work going forward.
As our roster of shared clients continues to grow, we will be actively exploring ways to maximize the value for existing clients who trust and rely on both business units. So our discovery thesis is playing out for the organic growth of our overall business. And it’s also tracking as expected in terms of building a larger presence in the discovery market. That sector is consolidating, and we remain convinced that Inventus is a strong platform for creating operating synergies. We continue to monitor opportunities that will deliver a strong return on invested capital, while also growing and diversifying our business and client base.
We believe that discovery complements not only our patent business but also the Company’s larger objective of rationalizing corporate legal spending. The same tools that we have developed through patent and licensing in discovery, including proprietary cost data, analytics and market expertise, can be applied to a variety of legal activities. These tools have never really existed in corporate legal operations. And as a result, there’s been a lot of unnecessary wasting of time and money and we’re changing that.
We recently held our annual event where we bring together the head of legal IP from a few dozen companies. We talk them through some of the tech tools and enhancements we’ve developed and we ask for their input on our product roadmap. Clients clearly value knowing more about the frequency particulars and costs of legal activity. And we know that our efforts in these areas are an important element of our value proposition for both acquiring and renewing network members and policyholders.
So even with the cost controls we’ve put in place, we are making enhancements to RPX Search and other tools to deliver more comprehensive information. Our emphasis is on leveraging the tools we’ve built for internal purposes in ways that can both make our subscription businesses stickier and possibly extend our service offering to new clients, such as legal departments in companies outside our established client sectors and to law firms.
As usual, I’ll wind up with a quick assessment of the patent market. Probably the key takeaway from these numbers is that there continues to be a growing number of companies facing both new patent risk and repeated patent risk. And RPX has a product or policy to serve them wherever they are on the spectrum of that risk.
For example, during the third quarter in the sectors where RPX is currently active, more than 450 unique companies were named in MPE suits and more than 400 of these are not yet in the RPX network. 60 companies were sued more than once by MPEs during the quarter of these nearly half were not yet RPX members. More than 170 non-client companies were sued by MPEs for the first time.
That will do it for me. Here’s Bob with the details.
Thanks, John. As JoAnn noted, please refer to the slide deck on our Investor Relations site which corresponds to today’s third quarter, 2016 financial discussion. I encourage you to review this deck and today’s press release for the full details of our financial results.
As usual, our discussion will focus on non GAAP metrics, which include stock based compensation, amortization of acquired intangibles other than patents, certain non-cash items described in the press release and the tax effect of each adjustment. Complete reconciliations from our non GAAP metrics to the associated GAAP metrics can be found in our press release and investor presentation.
Total revenue for Q3 was $88.5 million, an increase of 30% from Q3, 2015 due primarily to the inclusion of the Inventus discovery services business. Subscription revenue for the quarter was $62.4 million, down slightly from $63.2 million in Q2 and down $5.8 million from the prior year period.
Total revenue in the patent risk management business, including $8.1 million of fee related revenue was $70.5 million as compared to $68.2 million in the year ago period. Discovery services revenue was $18 million, down from $19.3 million sequentially, due primarily to the impact of summer holidays on activity based services and to a lesser extent, the decline of the British pound versus the US Dollar.
Discovery services revenue was up 30% from $13.8 million in the third quarter of 2015, primarily due to increased review revenue. As we cautioned last quarter, discovery revenue will fluctuate based on the ramp up and down of various projects. Within the patent risk management business, we finished the quarter with 328 clients and net additions for the quarter of 11, primarily new insurance policyholders. Our renewal rate remains approximately 90%, and we expect the same for the balance of the year.
Non-GAAP cost of revenue was $50.3 million in Q3, of which $40.4 million was patent amortization. Non-GAAP SG&A was $17.4 million. In the second quarter, we took steps to reduce our cost structure and Q3 benefitted from these reductions. Q3 SG&A also benefitted from lower seasonal expenses and lower than expected one-time integration costs.
Non-GAAP net income for the third quarter was $12.7 million or $0.25 per diluted share. This compares to $10.6 million or $0.19 per diluted share in the third quarter of 2015. For the quarter, consolidated non-GAAP adjusted EBITDA was $62.1 million of which $56.8 million and $5.3 million came from the patent and discovery services segments respectively.
Non-GAAP adjusted EBITDA minus net patent spend, our preferred measure of pre-tax cash flow was $27.3 million in the third quarter. And net patent spend was $34.8 million this quarter and $71.9 million year-to-date. Average amortization on patents acquired in Q3 was approximately 28 months.
Turning to the balance sheet, we ended Q3 with $182.7 million in cash, equivalents and short-term investments. During Q3, we repurchased 1.1 million shares of RPX stock for $11.7 million at an average price of $10.18 per share. Since the first quarter of last year, through the just ended third quarter, we’ve repurchased a cumulative 7.0 million shares of our stock for $76.9 million, so an average price of $10.97 per share.
So now, onto guidance. For fiscal year 2016, we are providing the following update to our guidance. Notwithstanding some of the challenges we faced this year, we are pleased to see the year finishing up pretty much inside the ranges we provided back in February.
So our current outlook on revenue is subscription revenue of $255 million to $257 million, discovery services revenue of $67 million to $69 million. And on fee related revenue, our guidance is $11 million, reflecting revenue booked through the nine months in only those Q4 transactions for which we currently have high confidence. Consequently, total revenue guidance for the year is $333 million to $337 million.
We expect non-GAAP cost of revenue to come in between $194 million and $196 million, of which we expect patent amortization to be in the range of $157 million to $159 million. Non-GAAP SG&A expense is expected to be in the range of $75 million to $77 million, and non-GAAP net income of $37 million to $40 million for the year. Non-GAAP adjusted EBITDA in the patent business is expected to be $203 million to $205 million. And for the discovery services segment, we expect $19 million to $21 million. So on a consolidated basis, we expect $222 million to $226 million for full year 2016. And net patent spend for the full year remains at $115 million to $120 million. Consequently, non-GAAP adjusted EBITDA minus net patent spend for 2016 is expected to be $102 million to $110 million.
Finally, we estimate 51 million diluted shares outstanding on a weighted average basis for the full year. In this estimate, we make no assumptions about share repurchase activity through the remainder of this quarter.
As for quarterly guidance for Q4, we expect combined subscription and discovery services revenue of $81 million to $85 million. Fee related revenue guidance for the fourth quarter is $1 million, so we expect total revenue for Q4 of $82 million to $86 million.
Fourth quarter non-GAAP net income is expected to be $7 million and $10 million, with 50 million diluted shares outstanding on a weighted basis. And for Q4, we expect non-GAAP adjusted EBITDA of approximately $51 million to $55 million.
And with that, we’d like to open it up for your questions.
Operator, we’ll take questions now, please.
[Operator Instructions] we’ll go ahead and take our first question from Jeff Meuler with Baird. Please go ahead your line is open.
Nick Nikitas on for Jeff. Just looking at the full year guidance for the subs revenue, I think, the low end implies basically flat subscription revenue in Q4. So just given the declines year-to-date, could you just kind of talk about what gives you confidence in that stabilization or potentially having some sequential ramp in revenue in Q4?
Sure, this is Bob. We’re obviously five weeks into the quarter already and we recognize revenue ratably. So by the time we get to the fourth quarter, we typically have a pretty narrow range of what the outcomes can be. As you know from earlier in the year, we had some headwinds that we’ve talked about in past calls related to M&A activity in the macro economy, which impacted us earlier on in the year. You can infer from the guidance that we’re giving that some of that has stabilized as we’ve gotten to the second half of the year.
Okay. That’s helpful, thanks. From an expense saving standpoint that continues to be pretty solid, with good profitabilities. As you’ve kind of gone through that process, have there been any other areas where you think you could maybe find additional offsets if revenue remains weak into 2017 or just additional opportunities to kind of cost save?
We’re always looking at cost savings and with Inventus as part of the organization, there are probably more opportunities for synergistic cost savings than there were this time last year, when RPX was on a standalone basis, so that’s part of our everyday job to find those savings. We did lower patent spend last quarter, so patent spend is obviously the lever that moves most, highly correlated with the subscription revenue. So we continue to look at that and as we go through the budget season, which is happening in real time, that’s a key focus for the management team across the entire organization.
I do want to reiterate what I said about Q3, we’re very proud of the cost savings that we were able to implement. But there is some seasonality that we benefitted from in our SG&A in Q3. I just want to bring that to your attention.
Okay. And then, just one last one from me looking at the net client additions in Q3, I’m assuming most, if not all, the variance versus the first half is just kind of insurance being a little slower. But from a network member perspective, can you talk about any maybe verticals or additions there? Any signs of certain industries that you’ve had kind of ongoing conversations that could be potential for growth going forward?
No, I think it’s more of the - what I’ll call more of the same, reasonable cadence of new client adds, largely catalyst driven, especially if they’re on the higher end, if they’re higher end clients, with a couple of decent insurance clients mixed in there as well.
Yes. But looking farther out, there’s a lot of discussion in the market about the Internet of Things and what that might mean for patent monetization. So while there’s nothing new to report right now, somewhat glibly, I hope that the things [ph] sector will become a big sector for us going forward.
Okay. Thanks for taking the questions.
Thank you. And we’ll go ahead and take our next question from Darrin Peller with Barclays. Please go ahead your line is open.
This is actually Nikhil Dixit on for Darrin Peller. One question on the MPE environment, a couple of MPEs have been mentioning changes in the courts, claiming that either enhanced images are now easier to prove and/or that some are seeing an increase in soft licensing resolutions without litigation. Does this align with kind of you’ve been seeing the patent space? And how does that affect your strategy?
That’s a good question. I think the wilfulness enhanced damages question I would say, what we always say about things related to what goes on in the courts and what goes on in legislation is the more things change, the more they stay the same. Things are going to move back and forth. And yes, there was a recent opinion which changes the standard slightly. And there’s been a couple of recent cases where there’ve been some publicized enhanced damages.
From our perspective, those changes don’t really impact the way we do business and how things go from a transaction perspective when we get involved. Because we’re trying to get an outcome that’s bringing cost savings. Generally, if somebody really thinks that they’re going to get enhanced damages, they go the litigation route. And those types of cases and those types of owners really should go the litigation route, because that’s the only way they’re going to get what they’re asking for.
We have been seeing I mean, if you think about what we do on the pre-litigation buying, those are another way to describe those transactions, which is a large number of the transactions that we do, is that is pre-litigation licensing and that’s the goal of our business, is to have a clearing house that’s able to clear patent risk at a fraction of the cost that it would incur on the industry, if it went to litigation and we’re doing that, I think, very effectively avoiding potentially billions of dollars of litigation with the buying that we’ve done historically. And we’re also resolving litigation as well.
And so I think I’m not sure which MPE’s you’re talking about. But it would be hard to imagine that those MPEs that you may’ve spoken to, it’d be hard to imagine just statistically that somewhere in the 20% to 30% range of everything that they’re doing is actually flowing through us. So I think we’re part of that trend of more things settling. And that’s absolutely been our goal in this space, is to drive prices down by eliminating waste out of the market and make things more efficient.
Okay, great, that’s really helpful. And then, jumping back to the additions for a second, it seems like the majority of new member additions have been in insurance, but that decelerated this quarter. Moving forward, how do you think about the sustainability there of incremental insurance additions? And what are some of the drivers to maintain that run rate?
I think we mentioned on our last call or two that we have these portfolio transactions that we’re working on for emerging companies. And those are going to lead to some big numbers, they’re very small policies. We again think it’s a very important strategy for us, especially as we grow the number of services we can sell into those companies. But we didn’t have any of those large numbers this quarter. We have a really good pipeline of those.
So I think in terms of numbers, you can expect, hopefully, that the insurance business is going to continue to grow in terms of number of logos in a similar fashion than it has over the course of four quarter periods over the last couple of years. So we still feel good about the pipeline, both the direct sales that we’re doing, hoping to get more sales out of the traditional insurance broker channel, and then more portfolio sales, as we’ve seen in the past.
Great, that’s encouraging. I’ll turn it back to the queue now, thanks.
Thank you and we’ll go ahead and take our next question from Timothy Arcuri with Cowen & Company. Please go ahead your line is open.
This is Theanne Joan for Tim Arcuri. So I have a follow-up on the last question. So how many of your insurance adds were from the portfolio transactions last quarter?
We haven’t given a specific number. But assume similar cadence of that this is a more typical cadence of new client adds. And things in excess of this type of levels are probably going to be more the portfolio stuff.
Okay. Then, so this quarter, you had more than 150 insurance clients. And you said majority of that, 11 new adds, were on the insurance side. And so at the end of the quarter, has your insurance climbed over 160?
That’s the approximate number, yes.
Yes. Okay. And then, I have a question on the discovery revenue side. Last quarter, you said that you were strong Europe and then US was solid, too. And you expect US to contribute meaningfully into this quarter. How did that play out?
I’m sorry, can I ask you to repeat the question?
Yes. So last quarter, you said that discovery revenue was strong in Europe, and US was solid as well. And you expect US to contribute meaningfully into this quarter for the discovery revenue. So how did that play out in this quarter?
Q3 was very similar to Q2 in terms of mix of business both geographically and across the different services that the discovery service business offers. The main difference between the Q2 results and the Q3 results really related to a slight abatement that you normally expect during the summer months on some of the activity based services, not just review but also some of the other services; as well as minor headwind we had from the devaluation of the British pound in Q3 versus Q2.
Okay. That’s helpful. And then, you said you were seeing some improvement from M&A stabilization. So last quarter, you said four or five clients were tough in those negotiations. Is that getting better this quarter? And how should we think about that progressing into the end of the year?
Yes. The catalysts that we have right now are good. We have a good pipeline, good set of dialogs. And I think our team has done a great job of identifying things that can deliver value and get us through the renewals Q4 and Q1 renewals, which are always a heavy renewal time for us. Typically, we get through those really well and we’re optimistic that that’s going to continue to be the case. And that said, there’s always a surprise here and there. That’s the nice thing about surprises, is they happen in both directions and usually, they happen at the same time and balance them out.
The main thing is that we’ve done a good job over the last six months of really looking at the pipeline of transactions, finding things that clients care about, at the end of the day, that’s the most important thing. If we focus on delivering a good service, we’re going to get our clients through those renewal discussions.
Okay. Thanks, guys.
Thank you and we’ll go ahead and take our next question from Matthew Galinko from Sidoti & Company. Please go ahead your line is open.
One question I had was on kind of the sensitivity on your OpEx to performance and your core patent business. So only say hypothetically works into a double-digit subscriber growth next year in the core business? Would you need to add headcount to service that adequately at this point? And would OpEx follow closely behind? Or is this kind of a sustainable level, if the business jumps up a little bit?
Matt, it’s Bob here. In general, I’d say the level of OpEx is sustainable. If we just had an organic jump up because we added some new larger clients, which we’d love to see happen, I don’t know that, that would have, I don’t think that that would have much impact on our OpEx. We would be doing pretty much the same thing on the acquisition side for patent acquisitions as we do for our existing client base. Our client reps, our client service folks, are extendable.
So we would be looking to stay relatively flat. There might be some compensation related issues, related to higher revenue and associated profitability. But when we think about OpEx, we would think more about whether we’d be spending money to pursue some sort of growth initiative or adjunct service.
Got it. And then, maybe one more would be around how your discovery services are kind of being layered into your sales process, whether maybe more on trying to get new clients over the line, particularly stubborn ones that have been hanging out there for a little bit longer. Does it appear to be helping? Or is it, do you have sort of the bundle down that you’re comfortably going to market with? And then, what are you seeing in terms of prospective client reaction?
We don’t have the bundle locked down yet. But an important step was getting enough of a concept together to be able to get useful meetings with the right audiences, we’ve started that process and are having productive dialogs on the class of client that I would say is the larger client, where we can talk to them about a big piece of their overall legal spend that goes to the combination of defending against patent suits and broader discovery issues, where we could become a very big service provider for those clients. We’re really early stages of those dialogs. But we’re optimistic that we’re going to figure something out.
I think I mentioned before, you take some of our larger clients that pay us millions of dollars a year, they’re some of those clients that spend tens of millions of dollars annually on discovery services. So we think it’s a great opportunity, a great dialog for us to have. What we’ve been seeing now, I think I gave the example in the prepared remarks of the low hanging fruit that we hope to see, we’re seeing. So again, the insurance policyholder gets hit with a claim, they call us, we are helping them. They ask us who should we use on discovery, we say you should use Inventus. They tell their law firm, you should use Inventus.
So we’re seeing that play out in the market, as we had hoped. We’re seeing companies that, an increase in business on the discovery side with companies where we have a longstanding relationship with them, not necessarily based on any direct effort, but just knowing that we are a bigger service provider to them, maybe get some more comfortable using us more. And having more tentacles into our organization, if you will, makes them more comfortable. I don’t want to quite say the no one gets fired for using IBM analogy, but maybe we’re starting to get a small bit of that. And then, we have had lots of other opportunistic sales opportunities where Inventus clients have had a patent issue and then asked for an introduction into RPX, things like that.
So all of the things that we hoped would play out organically are playing out. And I’d say Trevor and I are mainly focused on that first bigger opportunity that I mentioned.
Thank you. And it appears we have no further questions at this time. I will now hand it back over to your speakers for any additional or closing remarks.
Thank you very much for joining the call. We look forward to speaking with you next time.