S-1 1 ds1.htm FORM S-1 Form S-1
Table of Contents

As filed with the Securities and Exchange Commission on September 2, 2011

Registration No. 333-            

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form S-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 

 

RPX Corporation

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   6794   26-2990113
(State or other jurisdiction of
incorporation or organization)
  (Primary standard industrial
classification code number)
 

(I.R.S. employer

identification no.)

One Market Plaza

Suite 700

San Francisco, CA 94105

(866) 779-7641

(Address, including zip code, and telephone number, including area code, of Registrant’s principal executive offices)

 

 

John A. Amster

Chief Executive Officer

RPX Corporation

One Market Plaza

Suite 700

San Francisco, CA 94105

(866) 779-7641

(Name, address, including zip code, and telephone number, including area code, of agent for service)

 

 

Copies to:

 

Robert V. Gunderson, Jr., Esq.

Bennett L. Yee, Esq.

Gunderson Dettmer Stough Villeneuve

Franklin & Hachigian, LLP

1200 Seaport Boulevard

Redwood City, CA 94063

(650) 321-2400

 

Martin E. Roberts, Esq.

RPX Corporation

One Market Plaza

Suite 700

San Francisco, CA 94105

(866) 779-7641

 

Douglas D. Smith, Esq.

Stewart L. McDowell, Esq.

Gibson, Dunn & Crutcher LLP

555 Mission Street

San Francisco, CA 94105

(415) 393-8200

 

 

Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of this Registration Statement.

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.  ¨

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act of 1933, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act of 1933, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act of 1933, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer  ¨

   Accelerated filer   ¨    Non-accelerated filer  þ      Smaller reporting company  ¨   
   (Do not check if a smaller reporting company)   

 

 

CALCULATION OF REGISTRATION FEE

 

 

Title of Each Class of

Securities to be Registered

 

Amount to

be

Registered (1)

 

Proposed

Maximum

Offering Price

Per Share (2)

 

Proposed

Maximum

Aggregate

Offering Price (2)

 

Amount of

Registration

Fee

Common Stock, $0.0001 par value per share

  6,900,000   $24.62   $169,878,000   $19,723

 

 

 

(1) Includes shares that the underwriters have the option to purchase.
(2) Estimated solely for the purpose of calculating the amount of the registration fee in accordance with Rule 457(c) of the Securities Act, and is based on the average of the high and low trading prices for the Registrant’s common stock as reported by the Nasdaq Global Market on August 26, 2011.

 

 

The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment that specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine.

 

 

 


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The information in this preliminary prospectus is not complete and may be changed. These securities may not be sold until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell nor does it seek an offer to buy these securities in any jurisdiction where the offer or sale is not permitted.

 

Subject to Completion. Dated September 2, 2011.

            Shares

LOGO

Common Stock

 

 

RPX is offering             shares of its common stock and the selling stockholders, which include our Chief Executive Officer, Chief Operating Officer, President and Chief Financial Officer, are offering             shares of common stock. RPX will not receive any of the proceeds from the sale of shares by the selling stockholders.

Our common stock is listed on The Nasdaq Global Market under the symbol “RPXC.” The last reported sale price of our common stock on September 1, 2011 was $26.93 per share.

 

 

See “Risk Factors” on page 10 to read about factors you should consider before buying shares of the common stock.

 

 

Neither the Securities and Exchange Commission nor any other regulatory body has approved or disapproved of these securities or passed upon the accuracy or adequacy of this prospectus. Any representation to the contrary is a criminal offense.

 

 

 

     Per Share      Total  

Public offering price

   $                    $                        

Underwriting discounts and commissions

   $         $     

Proceeds, before expenses, to RPX

   $         $     

Proceeds, before expenses, to the selling stockholders

   $         $     

To the extent that the underwriters sell more than             shares of common stock, the underwriters have the option to purchase up to an additional             shares from the selling stockholders at the public offering price less the underwriting discount. RPX will not receive any proceeds from any shares sold by the selling stockholders.

The underwriters expect to deliver the shares against payment in New York, New York on                     , 2011.

 

Goldman, Sachs & Co.   Barclays Capital   BofA Merrill Lynch
  Allen & Company LLC  
Baird   Cowen and Company   Lazard Capital Markets

 

 

Prospectus dated                 , 2011.


Table of Contents

TABLE OF CONTENTS

 

     Page  

PROSPECTUS SUMMARY

     1   

RISK FACTORS

     10   

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

     28   

USE OF PROCEEDS

     29   

PRICE RANGE OF OUR COMMON STOCK

     29   

DIVIDEND POLICY

     29   

CAPITALIZATION

     30   

SELECTED CONSOLIDATED FINANCIAL DATA

     31   

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     33   

BUSINESS

     57   

MANAGEMENT

     69   

EXECUTIVE COMPENSATION

     76   

RELATED PARTY TRANSACTIONS

     94   

PRINCIPAL AND SELLING STOCKHOLDERS

     97   

DESCRIPTION OF CAPITAL STOCK

     100   

SHARES ELIGIBLE FOR FUTURE SALE

     105   

MATERIAL UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS

     108   

UNDERWRITING

     113   

LEGAL MATTERS

     118   

EXPERTS

     118   

WHERE YOU CAN FIND ADDITIONAL INFORMATION

     118   

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

     F-1   

No dealer, salesperson or other person is authorized to give any information or to represent anything not contained in this prospectus.

You should rely only on the information contained in this prospectus and any free writing prospectus prepared by or on behalf of us. This prospectus is an offer to sell only the shares offered hereby but only under circumstances and in jurisdictions where it is lawful to do so. The information contained in this prospectus is current only as of its date.


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PROSPECTUS SUMMARY

This summary highlights selected information contained elsewhere in this prospectus. Because this is only a summary, it does not contain all of the information you should consider before investing in our common stock. You should carefully read the entire prospectus, especially the risks set forth under the heading “Risk Factors” and our consolidated financial statements and related notes included elsewhere in this prospectus, before making an investment decision. References in this prospectus to “RPX,” “our company,” “we,” “us” and “our” refer to RPX Corporation and its consolidated subsidiaries during the periods presented unless the context requires otherwise.

RPX Corporation

Overview

RPX helps companies reduce patent-related risk and expense. We provide a subscription-based patent risk management solution that facilitates more efficient exchanges of value between owners and users of patents compared to transactions driven by actual or threatened litigation. As of June 30, 2011, we had a client network of 96 members.

The core of our solution is defensive patent aggregation, in which we acquire patents or licenses to patents, which we refer to collectively as “patent assets,” that are being or may be asserted against our current and prospective clients. We then license these patent assets to our clients to protect them from potential patent infringement assertions. We also provide our clients access to our proprietary patent market intelligence and data. As of June 30, 2011, we had deployed over $300 million to acquire patent assets.

Our business model aligns our interests with those of our clients. We have not asserted and will not assert our patents, which enables us to develop strong and trusted relationships with our clients. Our clients include companies that design, make or sell technology-based products and services as well as companies that use technology in their businesses. We refer to these companies as “operating companies.” Our client network consists of companies of all sizes, including some of the world’s most prominent companies, such as Cisco Systems, Inc., Google Inc., Nokia Corporation, Panasonic Corporation, Samsung Electronics Co., Ltd., SAP AG, Sharp Corporation, Sony Corporation and Verizon Communications Inc.

Since our inception in July 2008, our revenue has grown rapidly, from $0.8 million in 2008 to $32.8 million in 2009, $94.9 million in 2010 and $73.2 million for the six months ended June 30, 2011. We attained profitability in 2009, our first full fiscal year of operations. Our net income increased from a net loss of $5.2 million in 2008 to net income of $1.9 million in 2009, $13.9 million in 2010 and $14.4 million for the six months ended June 30, 2011.

The Market

We refer to the market in which participants exchange value related to patents as the “patent market.” Today, patent litigation is a significant part of the patent market and is a multi-billion dollar industry. Based on our own analysis and data from independent third parties, we estimate that there were patent claims filed against more than 40,000 defendants, including companies that were sued more than one time, in the United States from 2005 through 2010. The costs to defend and resolve a patent litigation claim can vary widely. The costs can range from modest, such as $50,000 for nuisance suits, to substantial, such as tens of millions of dollars or more in the most complex cases. Based on these metrics, we estimate that litigation-related expenses in the patent market totaled tens of billions of dollars in the United States from 2005 to 2010.

 

 

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Patent litigation risk plagues operating companies of all sizes and has the potential to significantly disrupt business activities and distract from normal business operations. Both large and small companies can be affected by major verdicts or high settlement costs. Smaller companies may also find that the expense associated with defending against a patent assertion can have a significant adverse financial impact. We believe the extensive use of litigation and the threat of litigation prevents efficient transactions between the principal participants in the market: patent owners and operating companies.

Several developments have led to an attractive environment for patent assertions. These developments include (i) the searchability of the entire United States patent database on the Internet, (ii) the ability to use the Internet to quickly identify products and services that potentially relate to patents, (iii) a proliferation and overlap of technology patents, (iv) the use of multiple technology components in a single product or service, (v) an increase in the number of businesses that make, use or sell products or services that utilize technology and (vi) the creation of a specialized appellate court for patent cases, providing for a more uniform application of patent law.

These developments have caused significant capital to flow to entities specifically formed to acquire and monetize patent assets. Entities that do not create or sell products or services and exist to monetize patents through licensing and litigation are often referred to as non-practicing entities, or NPEs. NPEs have become a major factor in the patent market and an important source of liquidity for patent owners.

We believe the annual costs incurred by operating companies to defend and resolve patent infringement cases initiated by NPEs are currently in the billions of dollars. Based on our internal analysis, we believe there were over 600 patent infringement cases filed by NPEs in 2010 against more than 4,000 defendants, which comprised over 2,000 unique companies, some of which were sued more than once. Most cases are resolved prior to trial but still result in significant defense and settlement costs. For cases that reached summary judgment or trial, a study of over 1,500 final decisions found that damages awarded to NPEs had a median value of $12.9 million during 2002-2009.

NPE activity has heightened the need for operating companies to manage patent risk and expenses proactively. Currently, we believe operating companies have limited options to mitigate patent risk and expenses. The most common approaches include (i) acquiring licenses to relevant patents directly from patent owners, (ii) developing an internal patent-buying program or (iii) organizing a patent acquisition consortium. We believe that the approaches generally employed by operating companies are expensive, time consuming and difficult to implement effectively. As a result, we believe a significant market opportunity exists for a patent risk management solution that enables operating companies to effectively reduce their patent risks and expenses.

Our Solution

We have pioneered an approach to help operating companies mitigate and manage patent risk by serving as an intermediary through which they can participate more efficiently in the patent market. Operating companies that join our client network pay an annual subscription fee and gain access to the following benefits:

 

  Ÿ  

Reduced Risk of Patent Litigation – Clients reduce their exposure to patent litigation because we continuously assess patent assets available for sale and acquire many that are being or may be asserted against our clients or potential clients. Our clients have no litigation risk related to the patent assets that we own.

 

 

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  Ÿ  

Cost-Effective Licenses – Our annual subscription fee is based on a client’s historical financial results and is subject to a cap. Accordingly, our subscription fee is predictable for our clients. We believe our approach to pricing is different from the pricing strategies of traditional patent licensing businesses, which generally negotiate license fees based on the perceived relevance of their various patent portfolios to each licensee. Our approach to pricing also provides clients with non-exclusive license rights to our large and growing portfolio of patent assets at a cost that we believe is lower than they would have paid if these patent assets were owned by other entities.

 

  Ÿ  

Reduced Patent Risk Management Costs – Clients can reduce their ongoing patent risk management costs by supplementing their internal resources with our database of information and extensive transaction experience relating to the patent market. We actively monitor the patent market to understand the availability of patent assets for sale or license, the identity of the owners and licensors of these assets, the terms by which they may be available and the technologies to which these assets apply. We also track relevant litigation activity and identify key participants and trends in the patent market. As part of their subscription, our clients have access to this information through our proprietary web portal and through discussions with our client relations team.

We believe our business has significant competitive strengths as compared to the offerings of other patent risk management alternatives in the market today. These strengths include:

 

  Ÿ  

Alignment of Interests With Our Clients – Our business model aligns our interests with those of our clients. We have not asserted and will not assert our patents. We generate revenue from subscription fees that are based on our published fee schedule rather than the value of the patent assets we acquire or the potential costs associated with defending against assertions related to our patent assets. As a result, we have relationships with our clients that are based on trust, enabling them to communicate with us without concern that the information shared will be used against them.

 

  Ÿ  

Network Effect – As we add new clients, we generate new subscription fees that can be used to fund additional acquisitions of patent assets. These acquisitions enable us to further add new clients and deliver greater value to our existing clients.

 

  Ÿ  

More Transparent Valuation Discussions – Most participants in the patent market either assert patents or face patent assertions. Because we do not assert patents and are not likely to have patents asserted against us, we are able to have more open and transparent discussions about the value of patent assets than other market participants whose discussions are directly affected by litigation or the threat of litigation.

 

  Ÿ  

Patent Market Expertise – Since our inception, we have been refining our processes for identifying potentially valuable patent assets, analyzing and evaluating those assets and executing transactions to acquire rights to those assets. We have developed an extensive set of skills, relationships, historical transaction data and methodologies for valuing patent assets.

Our Strategy

Our mission is to transform the patent market by establishing RPX as the essential intermediary between patent owners and operating companies. Our strategy is to take advantage of the network effect of our business model by pursuing the following:

 

  Ÿ  

Growing Our Client Network – We intend to grow our client network by continuing to develop relationships with companies that have experienced NPE-initiated patent litigation and by continuing to demonstrate the value of our patent risk management solution.

 

 

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  Ÿ  

Acquiring Additional Relevant Patent Assets – We intend to continue to acquire patent assets that are being or may be asserted against current and prospective clients and to increase our role and expertise in the patent market. We believe our disciplined approach to valuing and acquiring patent assets will allow us to continue to deploy our capital in an efficient and effective manner to maximize the patent risk management benefits to our clients.

 

  Ÿ  

Enhancing Client Relations – We intend to continue to expand our client relations team to ensure we deliver the highest levels of service and support to our clients, which we expect will drive client satisfaction and assist in our efforts to retain clients as their subscription agreements come up for renewal. In addition, we intend to enhance our proprietary web portal to provide our clients with the most current intelligence and data on patent acquisition opportunities, relevant litigation activity and key participants and trends in the patent market.

 

  Ÿ  

Providing Additional Solutions – We believe we can generate additional sources of revenue by offering complementary solutions that further mitigate patent risks and expenses for operating companies. We intend to develop new solutions that will increase the value we provide for our current and prospective clients. For example, we are taking steps to establish a risk retention group that will offer insurance to our clients to help manage their exposure to patent infringement claims brought by NPEs. We also intend to facilitate joint defense agreements and cross-licensing arrangements among our clients.

 

  Ÿ  

Enhancing Our Capabilities Through Acquisitions – We intend to evaluate the acquisition of businesses and technologies that can enhance our capabilities and our patent risk management solution.

Concentration of Ownership by Our Major Stockholders and Executive Officers

Upon completion of this offering and assuming no exercise of the underwriters’ option to purchase additional shares, affiliates of Index Ventures, affiliates of Charles River Ventures and KPCB Holdings, Inc., which are our three largest stockholders, together with our executive officers and their affiliates, in the aggregate, will beneficially own approximately     % of our outstanding common stock. Each of these stockholders will be able to exercise substantial control over all matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions, such as a merger or other sale of our company or its assets. In addition, each of Index Ventures, Charles River Ventures and KPCB Holdings, Inc. currently have and will continue to have, upon the closing of this offering, a representative on our board of directors.

Risks Related to Our Business

Our business is subject to numerous risks and uncertainties, including those highlighted in the section titled “Risk Factors” immediately following this prospectus summary. We have a limited operating history, which makes it difficult to evaluate our current business and predict our future operating results. We expect a number of factors to cause our operating results to fluctuate on a quarterly basis, which may make it difficult to predict our future performance. These factors include potential increases in the prices we need to pay for patent assets, increases in our operating expenses, decisions by clients not to renew their memberships, our unpredictable membership sales cycle and changes in the accounting treatment related to our patent assets or subscription agreements. In addition, we generate substantially all of our revenue from subscription fees from our clients, and if our efforts to attract new clients and retain existing clients are not successful, our operating results could be adversely affected.

 

 

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Corporate Information

We were incorporated in Delaware in July 2008. Our principal executive offices are located at One Market Plaza, Suite 700, San Francisco, California 94105. Our telephone number is (866) 779-7641. Our website address is www.rpxcorp.com. The information on, or that can be accessed through, our website is not part of this prospectus.

RPX® and Rational Patent® are our registered trademarks. Any other trademarks appearing in this prospectus are the property of their respective holders.

 

 

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THE OFFERING

 

Common stock offered by RPX Corporation

             shares

 

Common stock offered by the selling stockholders

             shares

 

Common stock to be outstanding after this offering

             shares

 

Option to purchase additional shares offered by the selling stockholders

             shares

 

Use of Proceeds

We intend to use the net proceeds from this offering for working capital and other general corporate purposes. We will not receive any proceeds from any shares sold by the selling stockholders. See “Use of Proceeds.”

 

Dividend Policy

We do not currently intend to declare dividends on shares of our common stock. See “Dividend Policy.”

 

Risk Factors

You should carefully read the “Risk Factors” section of this prospectus for a discussion of factors that you should consider carefully before deciding to invest in shares of our common stock.

 

Nasdaq Global Market symbol

“RPXC”

The number of shares of common stock to be outstanding after this offering is based on 47,121,856 shares outstanding as of June 30, 2011, and excludes:

 

  Ÿ  

7,755,828 shares issuable upon the exercise of stock options outstanding as of June 30, 2011 with a weighted average exercise price of $5.88 per share;

 

  Ÿ  

84,467 shares of our common stock issuable upon the vesting of restricted stock units, or RSUs, outstanding as of June 30, 2011 under our 2011 Equity Incentive Plan; and

 

  Ÿ  

1,469,234 shares of common stock reserved for future issuance under our 2011 Equity Incentive Plan, subject to automatic annual adjustment in accordance with the terms of the plan.

From July 1, 2011 through September     , 2011, we granted options to purchase 78,500 shares of common stock at a weighted average exercise price of $28.59 per share and RSUs covering 57,632 shares of common stock.

Except as otherwise indicated, all information in this prospectus assumes no exercise by the underwriters of their option to purchase from the selling stockholders up to an additional             shares of our common stock in this offering.

 

 

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SUMMARY CONSOLIDATED FINANCIAL DATA

The following tables summarize the consolidated historical financial and operating data for the periods indicated. We have derived the consolidated statement of operations data for the period ended December 31, 2008 and the years ended December 31, 2009 and 2010 from our audited consolidated financial statements included elsewhere in this prospectus. We have derived the summary consolidated statement of operations data for the six months ended June 30, 2010 and 2011 and the summary consolidated balance sheet data as of June 30, 2011 from our unaudited consolidated financial statements included elsewhere in this prospectus. Our historical results are not necessarily indicative of the results that may be expected in the future. You should read the summary data presented below in conjunction with our consolidated financial statements, the notes to our consolidated financial statements and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus.

 

    Period from
Inception to
December 31,
2008
    Year Ended
December 31,
    Six Months Ended
June 30,
 
      2009     2010     2010     2011  
    (in thousands, except per share data)  

Consolidated Statement of Operations Data

         

Revenue

  $ 792      $ 32,822      $ 94,874      $ 40,047      $ 73,240   

Cost of revenue

    2,551        17,710        43,602        17,949        28,193   

Selling, general and administrative expenses

    2,595        10,250        23,917        9,459        19,396   

Loss on sale of patent assets, net

                  536                 
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating income (loss)

    (4,354     4,862        26,819        12,639        25,651   

Interest expense, net

    (796     (4,369     (2,776     (1,554     (566

Other income (expense), net

           (72     12                 
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before provision for (benefit from) income taxes

    (5,150     421        24,055        11,085        25,085   

Provision for (benefit from) income taxes

           (1,513     10,184        4,644        10,724   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

  $ (5,150   $ 1,934      $ 13,871      $ 6,441      $ 14,361   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Less: allocation of net income to participating stockholders

           1,934        12,479        5,879        8,754   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) available to common stockholders-basic

  $ (5,150   $      $ 1,392      $ 562      $ 5,607   

Undistributed earnings re-allocated to common stockholders

                  279        108        484   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) available to common stockholders-diluted

  $ (5,150   $      $ 1,671      $ 670      $ 6,091   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) per common share-basic

  $ (8.94   $      $ 0.24      $ 0.11      $ 0.31   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) per common share-diluted

  $ (8.94   $      $ 0.23      $ 0.11      $ 0.29   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Weighted-average shares used in computing net income (loss) per common share-basic

    576        2,148        5,747        5,153        18,141   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Weighted-average shares used in computing net income (loss) per common share-diluted

    576        2,169        7,164        6,340        21,187   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Pro forma net income per share-basic (1)

      $ 0.37        $ 0.35   
     

 

 

     

 

 

 

Pro forma net income per share-diluted (1)

      $ 0.36        $ 0.33   
     

 

 

     

 

 

 

Pro forma weighted-average common shares outstanding-basic

        37,086          40,576   
     

 

 

     

 

 

 

Pro forma weighted-average common shares outstanding-diluted

        38,503          43,622   
     

 

 

     

 

 

 

 

(1) See Note 3 to our consolidated financial statements for an explanation of the method used to calculate pro forma basic and diluted net income per share of common stock.

 

 

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     As of or for
Period from
Inception
(July 15, 2008)
to
December 31,
2008
    As of or for Year
Ended December 31,
     As of or for Six Months
Ended June 30,
 
       2009      2010      2010      2011  
     (in thousands, except number of clients)  

Other Financial Data

             

Subscription revenue

   $ 792      $ 32,822       $ 94,102       $ 39,597       $ 69,940   

Deferred revenue

     16,895        24,691         82,440         67,399         87,574   

Non-GAAP selling, general and administrative expenses (1)

     2,569        10,023         22,671         9,110         16,460   

Non-GAAP net income (loss) (2)

     (5,124     2,161         15,117         6,783         16,815   

Other Data

             

Number of clients (end of period)

     6        23         72         51         96   

Gross acquisition spend (during the period) (3)

   $ 58,573      $ 62,921       $ 146,405       $ 103,242       $ 41,151   

 

(1) We monitor our non-GAAP selling, general and administrative expenses because the amount of those expenses affects our profitability. We define non-GAAP selling, general and administrative expenses as GAAP selling, general and administrative expenses excluding stock-based compensation expense. We review our selling, general and administrative expenses on a non-GAAP basis because stock-based compensation expense is based on non-cash equity grants made at a certain price and point in time and does not reflect how our business is performing at any particular time. This measure is not a substitute for selling, general and administrative expenses measured in accordance with GAAP, and investors should review this number in conjunction with our consolidated financial statements and related notes included elsewhere in this prospectus.
(2) We monitor our non-GAAP net income because we believe it is an indicator of our profitability. We define non-GAAP net income (loss) as GAAP net income (loss) less the after tax impact of stock-based compensation. We review our net income (loss) on a non-GAAP basis because stock-based compensation expense is based on non-cash equity grants made at a certain price and point in time and does not reflect how our business is performing at any particular time. This measure is not a substitute for net income measured in accordance with GAAP, and investors should review this number in conjunction with our consolidated financial statements and related notes included elsewhere in the prospectus.
(3) Gross acquisition spend is the amount we have deployed in the period to acquire patent assets, including both amounts contributed by us and amounts contributed by our clients in excess of their subscription fees.

 

 

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The following table reconciles selling, general and administrative expenses determined on a GAAP basis with selling, general and administrative expenses determined on a non-GAAP basis:

 

     Period from
Inception
(July 15, 2008)
to
December  31,
2008
    Year Ended
December 31,
    Six Months Ended
June 30,
 
       2009     2010     2010     2011  
     (in thousands)  

Selling, general and administrative expenses

   $ 2,595      $ 10,250      $ 23,917      $ 9,459      $ 19,396   

Stock-based compensation

     (26     (227     (1,246     (349     (2,936
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Non-GAAP selling, general and administrative expenses

   $ 2,569      $ 10,023      $ 22,671      $ 9,110      $ 16,460   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The following table reconciles net income (loss) determined on a GAAP basis with non-GAAP net income (loss):

 

     Period from
Inception
(July 15, 2008)
to
December  31,
2008
    Year Ended
December 31,
     Six Months Ended
June 30,
 
       2009      2010      2010      2011  
     (in thousands)  

Net income (loss)

   $ (5,150   $ 1,934       $ 13,871       $ 6,441       $ 14,361   

Stock-based compensation (net of tax)

     26        227         1,137         342         2,454   
  

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

Non-GAAP net income (loss)

   $ (5,124   $ 2,161       $ 15,008       $ 6,783       $ 16,815   
  

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

The balance sheet data as of June 30, 2011 are presented below:

 

  Ÿ  

on an actual basis; and

 

  Ÿ  

on an as adjusted basis to reflect the sale by us of the             shares of common stock offered by this prospectus at an assumed public offering price of $             per share, after deducting the underwriting discounts and commissions and estimated offering costs.

 

     June 30, 2011  
     Actual      As Adjusted  
     (in thousands)  

Consolidated Balance Sheet Data

     

Cash and cash equivalents

   $ 159,393       $     

Patent assets, net

     139,844      

Deferred revenue, including current portion

     87,574      

Notes payable and other obligations, including current portion

     7,616      

Total liabilities

     108,013      

Total stockholders’ equity

   $ 250,180       $                

 

 

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RISK FACTORS

Investing in our common stock involves a high degree of risk. You should consider carefully the risks and uncertainties described below before making a decision to buy our common stock. If any of the following risks actually occur, our business, financial condition, results of operations or growth prospects could be harmed. In that case, the trading price of our common stock could decline and you could lose all or part of your investment in our common stock. When making your investment decision, you should also refer to the other information set forth in this prospectus, including our consolidated financial statements and the related notes.

Risks Related to Our Business and Industry

Our limited operating history makes it difficult to evaluate our current business and future prospects, and potential clients may have concerns regarding the effectiveness in the future of our business model. If companies do not continue to subscribe to our solution, our business and operating results will be adversely affected.

We were incorporated in July 2008. We acquired our first patent assets in September 2008 and sold our first membership in October 2008. Therefore, we have not only a very limited operating history, but also a very limited track record in executing our business model. Our future success depends on acceptance of our solution by companies we target to become clients. Our efforts to sell our solution to new companies may not continue to be successful. In particular, because we are a relatively new company with a limited operating history, companies may have concerns regarding our viability. Our limited operating history may also make it difficult to evaluate our current business and future prospects. We have encountered and will continue to encounter risks and difficulties frequently experienced by companies in rapidly changing industries. If we do not manage these risks successfully, our business and operating results will be adversely affected.

We may experience significant quarterly fluctuations in our operating results due to a number of factors, which makes our future operating results difficult to predict and could cause our operating results to fall below expectations.

Due to our limited operating history, our evolving business model and the unpredictability of our emerging industry, certain of our operating results have fluctuated significantly in the past and may fluctuate significantly in the future. Many of the factors that cause these fluctuations are outside of our control. The amount we spend to acquire patent assets and the timing of those acquisitions may result in significant quarterly fluctuations in our capital expenditures, and the amount and timing of our membership sales may result in significant fluctuations in our cash flow on a quarterly basis. As a result, comparing our operating results on a period-to-period basis may not be meaningful. You should not rely on our past results as an indication of our future performance.

In addition to the factors described above, other factors that may affect our operating results include:

 

  Ÿ  

increases in the prices we need to pay to acquire patent assets;

 

  Ÿ  

increases in operating expenses, including those attributable to additional headcount and the costs of new business initiatives;

 

  Ÿ  

non-renewals from existing clients for any reason;

 

  Ÿ  

loss of clients, including through acquisitions or consolidations;

 

  Ÿ  

changes in our subscription fee rates or the pricing policies of our competitors;

 

  Ÿ  

our inability to acquire patent assets that are being asserted or may be asserted against our clients due to lack of availability, unfavorable pricing terms or otherwise;

 

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  Ÿ  

changes in patent law and regulations and other legislation, as well as United States Patent and Trademark Office procedures or court rulings, that reduce the value of our solution to our existing and potential clients;

 

  Ÿ  

our lengthy and unpredictable membership sales cycle, including delays in potential clients’ decisions whether to subscribe to our solution;

 

  Ÿ  

changes in the accounting treatment associated with our acquisitions of patent assets, how we amortize those patent assets and how we recognize revenue under subscription agreements;

 

  Ÿ  

lower subscription fees from clients where the annual subscription fee decreases due to declining operating income or revenue of such clients;

 

  Ÿ  

our inability to develop and implement new solutions that meet client requirements in a timely manner;

 

  Ÿ  

decreases in our clients’ and prospective clients’ costs of litigating patent infringement claims;

 

  Ÿ  

our inability to retain key personnel;

 

  Ÿ  

any significant changes in the competitive dynamics of our market, including new competitors or substantial discounting of services that are viewed by our target market as competitive to ours;

 

  Ÿ  

gains or losses realized as a result of our selling patents, including upon the exercise by any of our clients of their limited right to purchase certain of our patent assets for defensive purposes in the event of a patent infringement suit brought against such client by a third party; and

 

  Ÿ  

adverse economic conditions in the industries that we serve, particularly as they affect the intellectual property risk management and/or litigation budgets of our existing or potential clients.

While we have not experienced seasonality trends to date, we anticipate that we may experience lower new client additions in the third quarter of the year due to vacation schedules of the executive management of many of our prospective clients. If our operating results in a particular quarter do not meet the expectations of securities analysts or investors, our stock price could be substantially affected. In particular, if our operating results fall below expectations, our stock price could decline substantially.

The market for our patent risk management solution is immature, and if our solution is not widely accepted or is accepted more slowly than we expect, our operating results will be adversely affected.

We have derived substantially all of our revenue from the sale of memberships to our patent risk management solution and we expect this will continue for the foreseeable future. As a result, widespread acceptance of this solution is critical to our future success. The market for patent risk management solutions is new and it is uncertain whether these solutions will achieve and sustain high levels of demand and market acceptance. Our success will depend, to a substantial extent, on the willingness of companies of all sizes to purchase and renew memberships as a way to reduce their patent litigation costs. If companies do not perceive the cost-savings benefits of patent risk management solutions, then wide market adoption of our solution will not develop, or it may develop more slowly than we expect. Either scenario would adversely affect our operating results in a significant way. Factors that may negatively affect wide market acceptance of our solution, as well as our ability to obtain new clients and renew existing clients, include:

 

  Ÿ  

uncertainty about our ability to significantly reduce patent litigation costs for a particular company;

 

  Ÿ  

reduced assertions from NPEs or decreased patent licensing fees owed to NPEs;

 

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  Ÿ  

limitations on the ability of NPEs to bring patent claims or limitations on the potential damages recoverable from such claims;

 

  Ÿ  

reduced cost to our clients of defending patent assertion claims;

 

  Ÿ  

lack of perceived relevance and value in our existing patent asset portfolio by existing or potential clients;

 

  Ÿ  

concerns by existing or potential clients about our future ability to obtain rights to patent assets that are being or may be asserted against them;

 

  Ÿ  

reduced incentives to renew memberships if clients have vested in perpetual licenses in all patent assets that they believe are materially relevant to their businesses;

 

  Ÿ  

lack of sufficient interest by mid- and small-sized companies in our solution;

 

  Ÿ  

reduced incentive for companies to become clients because we do not assert our patent assets in litigation;

 

  Ÿ  

concerns that we might change our current business model and assert our patent assets in litigation;

 

  Ÿ  

budgetary limitations for existing or potential clients; and

 

  Ÿ  

the belief that adequate coverage for the risks and expenses we attempt to reduce is available from alternative products or services.

We have limited experience with respect to our subscription pricing model, and if the prices we charge for memberships are unacceptable to our existing or potential clients, our revenue and operating results could experience volatility or decline.

We have limited experience with respect to determining the appropriate metrics for establishing the annual subscription fees for our patent risk management solution. If the market for our solution fails to develop or develops more slowly than we anticipate, or if competitors introduce new solutions that compete with ours, we may be unable to renew our memberships or attract new clients at favorable prices based on the same pricing model we have historically used. In the future, it is possible that competitive dynamics in our market may require us to change our pricing model or reduce our subscription fee rates, which could harm our operating results. If we introduce a higher fee schedule in the future, it may be more difficult for us to attract new clients. In order to attract clients, in certain cases we have previously offered, and may in the future offer, discounts or other contractual incentives to clients who execute multi-year subscription agreements or who make client referrals.

We have very limited flexibility to change the pricing of our solution for existing clients and may not be able to respond effectively to changes in our market. This limited flexibility could have an adverse effect on our operating results.

Under our subscription agreements, our annual subscription fee is based on a published fee schedule applicable to all of our clients that join our network while that fee schedule is in effect. Clients are able to renew their memberships perpetually under the fee schedule in effect at the time that they joined our network with periodic adjustments by us only based on changes in the Consumer Price Index. This means that any increases to our fee schedule apply only to clients that join after such increase. Accordingly, we have limited ability to change the economics of our business model with respect to existing clients in response to changes in the market in which we operate. This limited flexibility could have an adverse effect on our operating results. For example, if we increase our operating expenses as a result of changes in our market, we would have very limited ability to increase the subscription fees we charge to our existing clients as an offset to the increased operating expenses, and our operating results could be adversely affected.

 

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Our membership sales cycles can be long and unpredictable, and our membership sales efforts require considerable time and expense. As a result, our membership sales are difficult to predict and will vary substantially from quarter to quarter, which may cause our cash flow to fluctuate significantly.

Because we operate in a relatively new and unproven market, our membership sales efforts involve educating potential clients about the benefit of our solution, including potential cost savings to a company. Potential clients typically undergo a lengthy decision-making process that has, in the past, generally resulted in a lengthy and unpredictable sales cycle. We spend substantial time, effort and resources in our membership sales efforts without any assurance that our efforts will produce any membership sales. In addition, subscriptions are frequently subject to budget constraints, multiple approvals, and unplanned administrative, processing and other delays. As a result of these factors, our membership sales in any period are difficult to predict and will likely vary substantially between periods, which may cause our cash flow to fluctuate significantly between periods.

The success of our business will increasingly depend on clients renewing their subscription agreements, but we do not have an adequate operating history to predict the rate of membership renewals. Any significant decline in our membership renewals could harm our operating results.

Our clients have no obligation to renew their subscriptions after the expiration of their initial membership period. We have limited historical data with respect to rates of subscription renewals, so we cannot accurately predict renewal rates. The weighted average term of our subscription agreements in effect as of June 30, 2011 was 2.8 years. As our overall membership base grows, we expect our renewal rate to decline compared to our historical rate. Our clients may choose not to renew their memberships or, if they do renew, may choose to do so for shorter terms or seek a reduced subscription fee. Many of our subscription agreements provide for automatic one-year renewal periods. As a result, as more of our clients are in renewal periods, the weighted average term of our subscription agreements may decrease. If our clients do not renew their subscriptions or renew for shorter terms or if we allow them to renew at reduced subscription fees, our revenue may decline and our business may be adversely affected.

Upon initial subscription, our clients receive a term license for the period of their membership to the patent assets in our portfolio at the time of subscription. In addition, clients receive term licenses to substantially all of the patent assets we acquire during the period of their membership. Our subscription agreements also include a vesting provision that converts a client’s term licenses into perpetual licenses on a delayed, rolling basis as long as the company remains a client. Accordingly, clients who continue to subscribe to our solution receive perpetual licenses to an increasing number of our patent assets over time. If we are unable to adequately show clients that we are continuing to obtain additional patent assets that are being or may be asserted against them, clients may choose not to renew their subscriptions once they have vested into a perpetual license in all patent assets they believe are materially relevant to their businesses.

Our subscription agreements generally provide our clients with a right to terminate their membership if we fail to meet certain conditions. If we fail to meet those conditions and clients elect to terminate their subscription agreements, our operating results will be harmed.

Until recently, our form of subscription agreement provided that we will use commercially reasonable efforts to spend at least a specified minimum amount each year to acquire patent assets related broadly to information technology. If we fail to meet this standard, the clients whose agreements contain this standard have the right to terminate their memberships. In addition, a select number of our subscription agreements also provide that if we fail in any year to acquire patent assets broadly related to information technology worth at least a specified amount that is lower than the

 

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minimum amount generally included in our subscription agreements, then those clients have the right to terminate their memberships. If we fail to meet these standards and clients elect to terminate their membership, our operating results will be harmed.

Because we generally recognize revenue from membership subscriptions over the term of the membership, upturns or downturns in membership sales may not be immediately reflected in our operating results. As a result, our future operating results may be difficult to predict.

We generally recognize subscription fees received from clients ratably over the period of time to which those fees apply. Most of our clients are invoiced annually, and thus their fees are recognized as revenue over the course of 12 months. Consequently, a decline in new or renewed subscriptions in any one quarter will not be fully reflected in that quarter’s revenue and will negatively affect our revenue in future quarters. In addition, we may be unable to adjust our cost structure quickly to reflect this reduced revenue. Accordingly, the effect of either significant downturns in membership sales or rapid market acceptance of our solution may not be fully reflected in our results of operations in the period in which such events occur. Our membership subscription model also makes it difficult for us to rapidly increase our revenue through additional sales in any period, as subscription fees from new clients must generally be recognized over the applicable membership term.

Our subscription fees from clients may decrease due to factors outside of our control. Any reduction in subscription fees could harm our business and operating results.

Each client’s subscription fee is reset yearly based on its reported revenue and operating income measured as of the end of its last fiscal year. If a client who is not already paying the minimum due under our fee schedule experiences reduced operating results, its subscription fee for the next year will decline. As a result, our revenue stream is affected by conditions outside of our control that impact the operating results of our clients.

Our fee schedule is capped for each of our clients. As a result, if one of our clients acquires another client, our future revenue would be reduced as a result of our fee schedule being applied to the combined entity rather than to each entity separately. Any reduction in subscription fees could harm our business and operating results.

New legislation, regulations or court rulings related to enforcing patents could reduce the value of our solution to clients or potential clients and harm our business and operating results.

If Congress, the United States Patent and Trademark Office or courts implement new legislation, regulations or rulings that impact the patent enforcement process or the rights of patent holders, these changes could negatively affect the operating results and business model for NPEs. This, in turn, could reduce the value of our solution to our current and potential clients. For example, limitations on the ability to bring patent enforcement claims, limitations on potential liability for patent infringement, lower evidentiary standards for invalidating patents, increased difficulty for parties making patent assertions to obtain injunctions, reductions in the cost to resolve patent disputes and other similar developments could negatively affect an NPE’s ability to assert its patent rights successfully, decrease the revenue associated with asserting or licensing an NPE’s patent rights and increase the cost of bringing patent enforcement actions. As a result, assertions and the threat of assertions by NPEs may decrease. If this occurs, companies may seek to resolve patent claims on an individual basis and be less willing to subscribe to our solution or renew their memberships. Furthermore, even if companies are interested in subscribing to our solution or maintaining their memberships, companies may be unwilling to pay the subscription fees that we propose. Any of these events could result in a material adverse effect to our business and operating results.

 

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If we are unable either to identify patent assets that are being asserted or that could be asserted against existing and potential clients or to obtain such assets at prices that are economically supportable within our business model, we may not be able to attract or retain sufficient clients and our operating results would be harmed.

Our ability to attract new clients and renew the subscription agreements of existing clients depends on our ability to identify patent assets that are being asserted or that could be asserted against our existing or potential clients. There is no guarantee that we will be able to adequately identify those types of patent assets on an ongoing basis and, even if identified, that we will be able to acquire rights to those patent assets on terms that are favorable to us, or at all. As new technological advances occur, some or all of the patent assets we have acquired may become less valuable or obsolete before we have had the opportunity to obtain significant value from those assets.

Our approach to acquiring patent assets generally involves acquiring ownership or a license at a fixed price. Other companies, such as NPEs, often offer contingent payments to sellers of patents that may provide the seller the opportunity to receive greater amounts in the future for the sale of its patents as compared to the fixed price we generally pay. As a result, we may not be able to compete effectively for the acquisition of certain patent assets.

If clients do not perceive that the patent assets we acquire are relevant to their businesses, we will have difficulty attracting new clients and renewing existing clients, and our operating results will be harmed. Similarly, if clients are not satisfied with the amount we deploy to acquire patent assets, they may choose not to renew their subscriptions. These risks are greater if we elect to invest a significant amount of our capital on one or more acquisitions of patent assets.

We may not be able to compete effectively against others to attract new clients or acquire patent assets. Any failure to compete effectively could harm our business and results of operations.

In our efforts to attract new clients and retain existing clients, we compete primarily against established patent risk management strategies employed by those companies. Companies can choose from a variety of other strategies to attempt to manage their patent risk, including internal buying or licensing programs, cross-licensing arrangements, patent-buying consortiums or other patent-buying pools and engaging legal counsel to defend against patent assertions. As a result, we spend considerable resources educating our existing and prospective clients on the potential benefits of our solution and the value and cost savings it may provide.

In addition to competing for new clients, we also compete to acquire patent assets. Our primary competitors in the market for patent assets include other entities that seek to accumulate patent assets, including NPEs such as Acacia Research, Altitude Capital Partners, Coller IP, Intellectual Ventures, Millennium Partners and Rembrandt IP Management, along with patent-buying consortiums such as Allied Security Trust. Many of our current or potential competitors have longer operating histories, greater name recognition and significantly greater financial resources than we have. In addition, many NPEs that compete with us to acquire patent assets have complicated corporate structures that include a large number of subsidiaries, so it is difficult for us to know who the ultimate parent entity is and how much capital the related entities have available to acquire patent assets. We also face competition for patent assets from operating companies, including operating companies that are current or prospective clients.

We expect to face more direct competition in the future from other established and emerging companies. In addition, as a relatively new company in the patent risk management market, we have limited insight into trends that may develop and affect our business. As a result, we may make errors in predicting and reacting to relevant business trends, making us unable to compete effectively against others.

 

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Our current or potential competitors vary widely in size and in the scope and breadth of the products and services they offer. Many of our competitors have greater financial resources and a larger customer base and sales and marketing teams. The competition we face now and in the future could result in increased pricing pressure, reduced margins, increased sales and marketing expenses and a failure to increase, or the loss of, market share. We may not be able to maintain or improve our competitive position against our current or future competitors, and our failure to do so could seriously harm our business.

Our acquisitions of patent assets are time consuming, complex and costly, which could adversely affect our operating results.

Our acquisitions of patent assets are time consuming, complex and costly to consummate. We utilize many different transaction structures in our acquisitions and the terms of the acquisition agreements tend to be very heavily negotiated. As a result, we incur significant operating expenses during the negotiations even where the acquisition is ultimately not consummated. Even if we successfully acquire particular patent assets, there is no guarantee that we will generate sufficient revenue related to those patent assets to offset the acquisition costs. While we conduct confirmatory due diligence on the patent assets we are considering for acquisition, we may acquire patent assets from a seller who does not have proper title to those assets. In those cases, we may be required to spend significant resources to defend our interest in the patent assets and, if we are not successful, our acquisition may be invalid, in which case we could lose part or all of our investment in the assets.

We occasionally identify patent assets that cost more than we are prepared to spend with our own capital resources or that may be relevant only to a very small number of clients. In these circumstances, we may structure and coordinate a transaction in which certain of our clients contribute funds that are in addition to their subscription fees in order to acquire those patent assets. These structured acquisitions are complex and can be large and high profile. We may incur significant costs to organize and negotiate a structured acquisition that does not ultimately result in an acquisition of any patent assets. These higher costs could adversely affect our operating results. If we are successful in the acquisition of patent assets, our role in managing the acquisition entity may also expose us to financial and reputational risks.

Our business model is new and complex, requiring estimates and judgments by our management. Our estimates and judgments are subject to changes that could adversely affect our operating results.

Our patent risk management business model is new and therefore our accounting and tax treatment has limited precedent. The determination of patent asset amortization expense for financial and income tax reporting requires estimates and judgments on the part of management. Some of our patent asset acquisitions are complex, requiring additional estimates and judgments on the part of our management. From time to time, we evaluate our estimates and judgment. However, such estimates and judgment are, by their nature, subject to risks, uncertainties and assumptions, and factors may arise that lead us to change our estimates or judgments. If this or any other changes occur, our operating results may be adversely affected. Furthermore, if the accounting or tax treatment is challenged, we may have to spend considerable time and expense defending our position and we may be unable to successfully defend our accounting or tax treatment, any of which could adversely affect our business and operating results.

We plan to substantially increase our operating expenses to expand our operations, and those increased expenses may negatively impact our profitability.

We expect to significantly increase future expenditures to develop and expand our business, including making substantial expenditures to acquire patent assets and develop new solutions. Our

 

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efforts to develop new solutions will result in an increase in our operating expenses with no assurance that such solutions will result in additional revenue that is sufficient to offset the additional expenses we incur.

We also plan to incur additional operating expenses as we hire new personnel, including employees for client relations, patent research and analysis, development of reporting systems and general and administrative functions. From January 1 through June 30, 2011, our headcount grew from 66 to 81 employees. Because we intend to continue to hire aggressively, we expect our operating expenses to increase substantially. In addition, as a public company, we incur significant legal, accounting and other expenses that we did not incur as a private company. If we are not successful in generating additional revenue that is sufficient to offset these operating expense increases, our operating results may be harmed.

If we are unable to successfully expand our membership base to include mid- and small-size companies, we may not be able to maintain our growth and our business and results of operations may be harmed.

Many of our current clients are very large companies. The number of companies of that size is limited, so in order for us to continue our growth, we need to expand our membership base to include mid- and small-size companies. There is no guarantee that we will be successful in those efforts. Those companies often have more limited budgets available for solutions of the type we offer compared to larger companies. Those companies may also request solutions that we do not currently offer. They may also have concerns that we will focus our patent acquisition efforts on patent assets that are of more benefit to our larger clients who pay us higher subscription fees. If we are unable to successfully expand our membership base to include more mid- and small-size companies, our growth may slow, and our business may be harmed.

We receive a significant amount of our revenue from a limited number of clients, and if we are not able to obtain membership renewals from these clients, our revenue may decrease substantially.

We receive a significant amount of our revenue from a limited number of clients. For example, during the six months ended June 30, 2011, our 10 highest revenue generating clients accounted for approximately 34% of our total revenue. We expect that a significant portion of our revenue will continue to come from a relatively small number of clients for the foreseeable future. If any of these clients choose not to renew their memberships, or if our subscription fees from them decline, our revenue may correspondingly decrease and our operating results may be adversely affected.

If we are unable to enhance our current solution or to develop or acquire new solutions to provide additional value to our clients and potential clients, we may not be able to maintain our growth, and our business may be harmed.

In order to attract new clients and retain existing clients, we need to enhance and improve our existing solution and introduce new solutions that meet the needs of our clients. We have in the past, and may in the future, seek to acquire or invest in businesses, products or technologies that we believe could complement or expand our service offerings, enhance our technical capabilities or otherwise offer growth opportunities. We are currently taking steps to establish a risk retention group that will offer insurance to our clients to help manage their exposure to patent infringement claims brought by NPEs. We are also currently developing programs to facilitate joint defense agreements and cross-licensing arrangements among clients that pay us additional fees to participate in those arrangements.

The development and implementation of new solutions will continue to require substantial time and resources, as well as require us to operate businesses that would be new to our organization.

 

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These or any other new solutions may not be introduced in a timely manner or at all. If we do introduce these or any other solutions, we may be unable to implement such solutions in a cost-effective manner, achieve wide market acceptance, meet client expectations or generate revenue sufficient to recoup the cost of developing such solutions. Any new solutions we introduce may expose us to additional laws, regulations and risks. If we are unable to develop these or other solutions successfully and enhance our existing solution to meet client requirements or expectations, we may not be able to attract or retain clients, and our business may be harmed.

We are investing significant management time and resources into developing products that will provide insurance against NPE patent claims. We do not have prior experience in providing insurance products. If we are not successful in launching and selling these insurance products, we will not realize the anticipated benefit of these investments, which could have an adverse effect on our growth prospects and our business may be harmed.

We expect to invest a significant amount of management time and financial resources in the development of our products that provide insurance against NPE patent claims. We expect to provide some or all of the capital necessary to develop and operate this business. We do not have prior experience in forming or operating an insurance business, attracting policyholders or establishing the pricing or terms of insurance policies. We cannot assure you that our patent insurance products will appeal to a significant number of our existing clients or attract new clients. If we are unsuccessful in implementing this business, we may not realize the anticipated benefits of our investments of capital and management attention, which could have an adverse effect on our financial performance and growth prospects and our business may be harmed.

If we are successful in launching insurance products for NPE patent claims, we will face the risks associated with operating an insurance business. If we fail to manage these risks, our results of operations and financial condition may be adversely affected.

If we are successful in launching our insurance products for NPE patent claims, we will face new risks associated with the operation of an insurance business. We have no prior experience in operating an insurance business, which includes assuming underwriting risk and setting premiums. There are many estimates and forecasts involved in predicting underwriting risk and setting premiums, many of which are subject to substantial uncertainty. If we do not estimate our underwriting risks and set our premiums successfully, we may incur larger losses on our policies than we expect, which could have an adverse effect on our results of operations and financial condition. Furthermore, the insurance market is highly regulated, so operation of an insurance business will expose us to additional laws and regulations. Compliance with such laws and regulations may be costly, which could affect our results of operations.

We have experienced rapid growth in recent periods, and we plan to continue to grow our operations to support our current solution and the development of new solutions. If we fail to manage our growth effectively, we may be unable to execute our business plan, maintain high levels of service or address competitive challenges adequately.

We have substantially expanded our overall business, headcount and operations in recent periods. We plan to aggressively expand our operations and headcount in the future in order to support our efforts to increase our membership base, continue to acquire valuable patent assets and develop additional solutions. Further, increases in our membership base could create challenges in our ability to provide our solutions and support our clients. In addition, we will be required to continue to improve our operational, financial and management controls and our reporting procedures. As a result, we may be unable to manage our business effectively in the future, which may negatively impact our operating results.

 

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If we are not perceived as a trusted defensive patent aggregator, our ability to gain wide market acceptance will be harmed, and our operating results could be adversely affected.

Our reputation, which depends on earning and maintaining the trust of existing and potential clients, is critical to our business. Our reputation is vulnerable to many threats that can be difficult or impossible to control and costly or impossible to remediate. For our business to be successful, we must continue to educate potential clients about our role as a trusted intermediary in the patent market. If our reputation is harmed, we may have more difficulty attracting new clients and retaining existing clients, and our operating results could be adversely affected.

We may become involved in patent litigation proceedings related to our clients. Our involvement could cause us to expend significant resources and could require us to disclose information related to our clients, which could cause such clients not to renew their subscriptions with us.

The patent market is heavily impacted by litigation. As a result, we may be required, by subpoena or otherwise, to participate in patent litigation proceedings related to our clients. Our participation in any such proceedings could require us to expend significant resources and could also be perceived as adverse to the interests of our clients or potential clients if we are required to disclose any information about our clients that we have gathered in the course of their memberships. These additional expenditures and potential disclosures could make it more difficult for us to attract new clients and retain existing clients and our results of operations could be harmed.

Interpretations of current laws and the passage of future laws could harm our business and operating results.

Because of our limited operating history and our presence in an emerging industry, the application to us of existing United States and foreign laws is unclear. Many laws do not contemplate or address the specific issues associated with our patent risk management solution or other products and services we may provide in the future. It is possible that courts or other governmental authorities will interpret existing laws regulating risk management and insurance, competition and antitrust practices, taxation, the practice of law and patent usage and transfers in a manner that is inconsistent with our business practices. Our business, prospects, financial condition and results of operations may be harmed if our operations are found to be in violation of any existing laws or any other governmental regulations that may apply to us. Additionally, existing laws may restrict our ability to deliver services to our clients, limit our ability to grow and cause us to incur significant expenses in order to comply with such laws and regulations. Even if our business practices are ultimately not affected, we may incur significant cost to defend our actions, incur negative publicity and suffer substantial diversion of management time and effort. This could have a material adverse effect on our business, prospects, financial condition and results of operations.

Additionally, we face risks from laws that could be passed in the future. It is impossible to determine the extent of the impact of any new laws, regulations or initiatives that may be proposed, or whether any of the proposals will become law. Compliance with any new or existing laws or regulations could be difficult and expensive, affect the manner in which we conduct our business and negatively impact our business, prospects, financial condition and results of operations.

Any failure to maintain or protect our patent assets or other intellectual property rights could impair our ability to attract or retain clients and maintain our brand and could harm our business and operating results.

Our business is dependent on our ability to acquire patent assets that are valuable to our existing and potential clients. Following the acquisition of patent assets, we spend significant time and resources to maintain the effectiveness of those assets by paying maintenance fees and making filings

 

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with the United States Patent and Trademark Office. In some cases, the patent assets we acquire include patent applications which require us to spend resources to prosecute the applications with the United States Patent and Trademark Office. If we fail to maintain or prosecute our patent assets properly, the value of those assets to our clients would be reduced or eliminated, and our business would be harmed.

We might require additional capital to support our business growth and future patent asset acquisitions, and this capital might not be available on acceptable terms, or at all. If we are unable to obtain adequate financing or financing on terms satisfactory to us when we require it, our ability to continue to support our business growth and to respond to business challenges could be significantly limited.

We intend to continue to make investments to support our business growth and may require additional funds to respond to business challenges, including the need to acquire patent assets, satisfy debt payment obligations related to patent asset acquisitions, develop new solutions or enhance our existing solution, enhance our operating infrastructure and acquire complementary businesses and technologies. Accordingly, we may need to engage in equity or debt financings or enter into credit agreements to secure additional funds. If we raise additional funds through further issuances of equity or convertible debt securities, our existing stockholders could suffer significant dilution, and any new equity securities we issue could have rights, preferences and privileges superior to those of holders of our common stock. Any debt financing secured by us in the future could involve restrictive covenants relating to our capital-raising activities and other financial and operational matters, which may make it more difficult for us to obtain additional capital and to pursue business opportunities, including potential acquisitions. In addition, we may not be able to obtain additional financing on terms favorable to us, or at all. If we are unable to obtain adequate financing or financing on terms satisfactory to us when we require it, our ability to continue to support our business growth and to respond to business challenges could be significantly limited.

If we fail to develop widespread brand awareness cost-effectively, we may not attract new clients and our business and operating results may suffer.

We believe that developing and maintaining widespread awareness of our brand in a cost-effective manner is critical to achieving widespread acceptance of our solution and is an important element in attracting new clients. Furthermore, we believe that the importance of brand recognition will increase as competition in our market develops. Brand promotion activities may not generate client awareness or yield increased revenue, and even if they do, any increased revenue may not offset the expenses we incurred in building our brand. If we fail to promote and maintain our brand successfully, or if we incur substantial expenses in an unsuccessful attempt to promote and maintain our brand, we may fail to attract or retain clients to the extent necessary to realize a sufficient return on our brand-building efforts.

We are dependent on our management team, and the loss of any key member of this team may prevent us from implementing our business plan, which could harm our future growth and operating results.

Our success depends largely upon the continued services of our executive officers and other key personnel. We do not have employment agreements with any of our executive officers or other key management personnel that require them to remain our employees. Therefore, they could terminate their employment with us at any time without penalty. We do not maintain key person life insurance policies on any of our employees. The loss of one or more of our key employees could seriously harm our business.

 

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Our inability to identify, attract, train, integrate and retain highly qualified employees would harm our business.

Our future success depends on our ability to identify, attract, train, integrate and retain highly qualified technical, sales and marketing, managerial and administrative personnel. In particular, our ability to grow our revenue is dependent on our ability to hire personnel that can identify and acquire valuable patent assets and sign up new clients. Competition for highly skilled sales, business development and technical individuals is intense, and we continue to face difficulty identifying and hiring qualified personnel in some areas of our business. We may not be able to hire and retain such personnel at compensation levels consistent with our existing compensation and salary structure. Many of the companies with which we compete for hiring experienced employees have greater resources than we have. If we fail to identify, attract, train, integrate and retain highly qualified and motivated personnel, our reputation could suffer, and our business, financial condition and results of operations could be adversely affected.

Weak global economic conditions may adversely affect demand for our solution or fees payable under our subscription agreements, which could adversely affect our financial condition and operating results.

Our operations and performance depend significantly on worldwide economic conditions, and the United States and world economies have recently experienced weak economic conditions. Uncertainty about global economic conditions poses a risk as businesses may postpone spending in response to tighter credit, negative financial news and declines in income or asset values. This response could have a material negative effect on the demand for our solution. Furthermore, if our clients experience reduced operating income or revenues as a result of economic conditions or otherwise, it would reduce their subscription fees because those fees are generally reset annually based on the clients’ then-current operating income or revenue. If the subscription fees payable under our subscription agreement are reduced substantially, it would have an adverse effect on our business and results of operations.

We may acquire other companies or technologies, which could divert our management’s attention, result in additional dilution to our stockholders and otherwise disrupt our operations and harm our operating results.

We have in the past and may in the future seek to acquire or invest in businesses, products or technologies that we believe could complement or expand our client offerings, enhance our technical capabilities or otherwise offer growth opportunities. The pursuit of potential acquisitions may divert the attention of management and cause us to incur various expenses in identifying, investigating and pursuing suitable acquisitions, whether or not they are consummated.

We may not be able to integrate the acquired personnel, operations and technologies successfully or effectively manage the combined business following the completion of the acquisition. We may also not achieve the anticipated benefits from the acquired business due to a number of factors, including:

 

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difficulties in integrating operations, technologies, services and personnel;

 

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unanticipated costs or liabilities associated with the acquisition;

 

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incurrence of acquisition-related costs;

 

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diversion of management’s attention from other business concerns;

 

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potential loss of key employees;

 

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additional legal, financial and accounting challenges and complexities in areas such as tax planning, cash management and financial reporting;

 

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  Ÿ  

use of resources that are needed in other parts of our business; and

 

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use of substantial portions of our available cash to consummate the acquisition.

Future acquisitions could also result in dilutive issuances of equity securities or the incurrence of debt, which could adversely affect our operating results. In addition, if an acquired business fails to meet our expectations, our operating results, business and financial condition may suffer.

We have incurred significant increased costs as a result of operating as a public company, and our management will be required to devote substantial time to compliance efforts.

As a public company, we have incurred significant legal, accounting, investor relations and other expenses that we did not incur as a private company, including costs associated public company reporting requirements. The Sarbanes-Oxley Act, the Dodd-Frank Wall Street Reform and Consumer Protection Act, as well as rules subsequently implemented by the SEC and The Nasdaq Stock Market, impose additional requirements on public companies, including enhanced corporate governance practices. For example, the listing requirements for The Nasdaq Stock Market provide that listed companies satisfy, among other things, certain corporate governance requirements relating to independent directors, audit committees, distribution of annual and interim reports, stockholder meetings, stockholder approvals, solicitation of proxies, conflicts of interest, stockholder voting rights and codes of business conduct. Our management and other personnel devote a substantial amount of time to satisfy these requirements. Moreover, these rules and regulations have increased our legal and financial compliance costs and have made some activities more time consuming and costly.

If we fail to maintain proper and effective internal controls, our ability to produce accurate financial statements could be impaired, which could adversely affect our operating results, our ability to operate our business and investors’ views of us.

Ensuring that we have internal financial and accounting controls and procedures adequate to produce accurate financial statements on a timely basis is a costly and time-consuming effort that needs to be re-evaluated frequently. We have in the past discovered, and may in the future discover, areas of our internal financial and accounting controls and procedures that need improvement. The Sarbanes-Oxley Act requires, among other things, that we maintain effective internal control over financial reporting and disclosure controls and procedures. In particular, we must perform system and process evaluation and testing of our internal control over financial reporting to allow management and our independent registered public accounting firm to report on the effectiveness of our internal control over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act. Our testing, or the subsequent testing by our independent registered public accounting firm, may reveal deficiencies in our internal control over financial reporting that are deemed to be material weaknesses. Our compliance with Section 404 will require that we incur substantial accounting expense and expend significant management time on compliance-related issues. We need to hire additional accounting and financial staff, improve our existing controls and implement new processes. We cannot be certain that our actions to improve our internal controls over financial reporting will be sufficient, or that we will be able to implement our planned processes and procedures in a timely manner. Moreover, if we are not able to comply with the requirements of Section 404 in a timely manner, or if we or our independent registered public accounting firm identify deficiencies in our internal control over financial reporting that are deemed to be material weaknesses, investors could lose confidence in the reliability of our financial statements, which could cause the market price of our common stock to decline. In addition, a delay in compliance with Section 404 could subject us to sanctions or investigations by The Nasdaq Stock Market, the SEC or other regulatory authorities, make us ineligible for short form resale registrations or result in the inability of registered broker-dealers to make a market in our common stock, any of which could further reduce our stock price and could harm our business.

 

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Furthermore, implementing any appropriate changes to our internal control over financial reporting may entail substantial costs in order to modify our existing accounting systems, may take a significant period of time to complete and may distract our officers, directors and employees from the operation of our business. These changes, however, may not be effective in maintaining the adequacy of our internal control over financial reporting, and any failure to maintain that adequacy, or consequent inability to produce accurate financial statements on a timely basis, could increase our operating costs and could materially impair our ability to operate our business. In addition, investors’ perceptions that our internal control over financial reporting is inadequate or that we are unable to produce accurate financial statements may adversely affect our stock price. While neither we nor our independent registered public accounting firm have identified deficiencies in our internal control over financial reporting that are deemed to be material weaknesses, there can be no assurance that material weaknesses will not be subsequently identified.

Changes in financial accounting standards or practices may cause adverse, unexpected financial reporting fluctuations and may have an effect on our reported results of operations.

A change in accounting standards or practices could have a significant effect on our reported results and may affect our reporting of transactions completed before the change is effective. New accounting pronouncements and varying interpretations of accounting pronouncements have occurred and may occur in the future. Changes to existing rules or the questioning of current practices may adversely affect our reported financial results or the way we conduct our business.

Our results of operations could vary as a result of the methods, estimates and judgments we use in applying our accounting policies.

The methods, estimates and judgments we use in applying our accounting policies have a significant impact on our results of operations, including the reported amounts of assets, liabilities, revenue and expenses and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to revenue recognition, patent assets, other investments, income taxes, litigation and other intangibles, and other contingencies. Such methods, estimates and judgments are, by their nature, subject to substantial risks, uncertainties and assumptions, and factors may arise over time that lead us to change our methods, estimates and judgments. In addition, actual results may differ from these estimates under different assumptions or conditions. Changes in those methods, estimates and judgments could significantly affect our results of operations.

Our operations are subject to risks of natural disasters, acts of war, terrorism or widespread illness at our domestic and international locations, any one of which could result in a business stoppage and negatively affect our operating results.

Our business operations depend on our ability to maintain and protect our facility, computer systems and personnel, which are primarily located in the San Francisco Bay Area. The San Francisco Bay Area is in close proximity to known earthquake fault zones. Our facility and transportation for our employees are susceptible to damage from earthquakes and other natural disasters such as fires, floods and similar events. Should earthquakes or other catastrophes, such as fires, floods, power outages, communication failures or similar events disable our facilities, we do not have readily available alternative facilities from which we could conduct our business, which stoppage could have a negative effect on our operating results. Acts of terrorism, widespread illness and war could also have a negative effect at our international and domestic facilities.

 

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Risks Related to This Offering and Ownership of Our Common Stock

The trading price of our common stock has been volatile and is likely to be volatile in the future, and you might not be able to sell your shares at or above the public offering price.

Since our initial public offering in May 2011, our stock price has traded as high as $31.41 per share and as low as $20.49 per share. Further, our common stock has a limited trading history and an active trading market for our common stock may not be sustained following this offering. The market price of our common stock could be subject to wide fluctuations in response to various factors, some of which are beyond our control. These factors include those discussed in this “Risk Factors” section of this prospectus and others such as:

 

  Ÿ  

variations in our financial condition and operating results;

 

  Ÿ  

adoption or modification of laws, regulations, policies, procedures or programs applicable to our business, including those related to the enforcement of patent claims;

 

  Ÿ  

announcements of technological innovations, new products and services, acquisitions, strategic alliances or significant agreements by us or by our competitors;

 

  Ÿ  

addition or loss of significant clients;

 

  Ÿ  

recruitment or departure of members of our board of directors, management team or other key personnel;

 

  Ÿ  

the financial projections we may provide to the public, any changes in these projections or our failure to meet these projections;

 

  Ÿ  

changes in the estimates of our operating results or changes in recommendations by any securities analysts that follow our common stock;

 

  Ÿ  

market conditions in our industry and the economy as a whole;

 

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price and volume fluctuations in the overall stock market or resulting from inconsistent trading volume levels of our shares;

 

  Ÿ  

lawsuits threatened or filed against us;

 

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sales of our common stock by us or our stockholders; and

 

  Ÿ  

the expiration of market standoff or contractual lock-up agreements.

In recent years, the stock market has experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the changes in the operating performance of the companies whose stock is experiencing those price and volume fluctuations. Broad market and industry factors may seriously affect the market price of our common stock, regardless of our actual operating performance. These fluctuations may be even more pronounced in the trading market for our stock shortly following this offering.

Our three largest stockholders and our directors and executive officers will, in the aggregate, own approximately     % of our outstanding common stock and will be able to exercise substantial control over all matters requiring stockholder approval. This concentration of ownership limits your ability to influence corporate matters.

Upon completion of this offering and assuming no exercise of the underwriters’ option to purchase additional shares, affiliates of Index Ventures, affiliates of Charles River Ventures and KPCB Holdings, Inc. will each beneficially own approximately     % of our outstanding common stock, and our directors and executive officers and their affiliates, in the aggregate, will beneficially own approximately     % of our outstanding common stock. As a result, these stockholders will be able to exercise

 

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substantial control over all matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions, such as a merger or other sale of our company or its assets. This concentration of ownership will limit your ability to influence corporate matters and may have the effect of delaying or preventing a third party from acquiring control over us. In addition, each of Index Ventures, Charles River Ventures and KPCB Holdings, Inc. currently have and will continue to have, upon the closing of this offering, a representative on our board of directors. For information regarding the ownership of our outstanding stock by our executive officers and directors and their affiliates, see “Principal and Selling Stockholders.”

If securities analysts do not continue to publish research or publish unfavorable research about our business, our stock price and trading volume could decline.

The trading market for our common stock depends in part on the research and reports that securities analysts publish about us or our business. A limited number of securities analysts currently publish research reports on us. If one or more of the analysts who covers us downgrades our stock or publishes unfavorable research about our business, our stock price would likely decline. If one or more of these analysts ceases coverage of our company or fails to publish reports on us regularly, demand for our stock could decrease, which could cause our stock price and trading volume to decline.

Substantial future sales of shares by existing stockholders, or the perception that such sales may occur, could cause our stock price to decline, even if our business is doing well.

If our existing stockholders, particularly our directors and executive officers and the venture capital funds affiliated with our current and former directors, sell substantial amounts of our common stock in the public market, or are perceived by the public market as intending to sell substantial amounts of our common stock, the trading price of our common stock could decline. Based on shares outstanding as of June 30, 2011, upon completion of this offering, we will have                  outstanding shares of common stock. Of these shares, the shares of common stock sold in this offering and the 9,695,000 shares of common stock sold in our initial public offering will be freely tradable, without restriction, in the public market. Our officers, directors and the holders of substantially all of our common stock have entered into contractual lock-up agreements with the underwriters pursuant to which they have agreed not to sell or otherwise transfer any of their common stock or securities convertible into or exchangeable for shares of common stock for a period through the date 180 days after the date of the final prospectus for our initial public offering. Furthermore, our directors and certain of our security holders, including all of the selling stockholders, have entered into contractual lock-up agreements with the underwriters pursuant to which they have agreed not to sell or otherwise transfer any of their common stock or securities convertible into or exchangeable for shares of common stock for a period through the date 90 days after the date of the final prospectus for this offering. However, the lead underwriters in this offering may permit these holders to sell shares prior to the expiration of the lock-up agreements with the underwriters.

The 180-day restricted period and the 90-day restricted period under the lock-up agreements with the underwriters will be automatically extended if: (1) during the last 17 days of the 180-day or 90-day, as applicable, restricted period we issue an earnings release or announce material news or a material event; or (2) prior to the expiration of the 180-day or 90-day, as applicable, restricted period, we announce that we will release earnings results during the 15-day period following the last day of the 180-day or 90-day, as applicable, period, in which case the restrictions described in the preceding paragraph will continue to apply until the expiration of the 18-day period beginning on the date of release of the earnings results or the announcement of the material news or material event. In addition, MHV Partners LLC, an entity affiliated with Shelby Bonnie, and Sanford Robertson, both of whom purchased shares of our common stock in April 2011, have agreed with us to a one-year restricted period with respect to such shares. See “Shares Eligible for Future Sale” for a discussion of these and other transfer restrictions.

 

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Based on shares outstanding as of June 30, 2011, after the contractual lock-up agreements pertaining to this offering expire, or such longer periods described above, up to an additional                  shares will be eligible for sale in the public market,                  of which are held by directors, executive officers and other affiliates and will be subject to volume limitations under Rule 144 under the Securities Act. In addition, some of these                  shares are limited by restrictions on sales related to our right of repurchase on unvested shares.

Some of our existing stockholders have demand and piggyback rights to require us to register with the SEC up to                  shares of our common stock that they will beneficially own after the completion of this offering, subject to expiration of the contractual lock-up agreements. If we register these shares of common stock, the stockholders would be able to sell those shares freely in the public market.

In addition, shares that are subject to outstanding options or that may be granted in the future under our equity plans will be eligible for sale in the public market to the extent permitted by the provisions of various vesting agreements, the contractual lock-up agreements and Rules 144 and 701 under the Securities Act.

If any of these additional shares described are sold, or if it is perceived that they will be sold, in the public market, the trading price of our common stock could decline. For additional information, see “Shares Eligible for Future Sale.”

As a newly public company, our stock price may be volatile, and securities class action litigation has often been instituted against companies following periods of volatility of their stock price. Any such litigation, if instituted against us, could result in substantial costs and a diversion of our management’s attention and resources.

In the past, following periods of volatility in the overall market and the market price of a particular company’s securities, securities class action litigation has often been instituted against these companies. This litigation, if instituted against us, could result in substantial costs and a diversion of our management’s attention and resources.

Our management will have broad discretion over the use of the proceeds we receive in this offering and might not apply the proceeds in ways that enhance our operating results or increase the value of your investment.

We expect to use the net proceeds from this offering for general corporate purposes. Our management will have broad discretion to use the net proceeds from this offering, and you will be relying on the judgment of our management regarding the application of these proceeds. Our management might not apply the net proceeds of this offering in ways that enhance our operating results or increase the value of your investment. Additionally, until the net proceeds we receive are used, they may be placed in investments that do not produce income or that lose value.

Anti-takeover provisions in our charter documents and Delaware law could discourage, delay or prevent a change in control of our company and may affect the trading price of our common stock.

We are a Delaware corporation and the anti-takeover provisions of the Delaware General Corporation Law may discourage, delay or prevent a change in control by prohibiting us from engaging in a business combination with an interested stockholder for a period of three years after the person becomes an interested stockholder, even if a change in control would be beneficial to our existing stockholders. In addition, our amended and restated certificate of incorporation and amended and restated bylaws may discourage, delay or prevent a change in our management or control over us that

 

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stockholders may consider favorable. Our amended and restated certificate of incorporation and amended and restated bylaws

 

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authorize the issuance of “blank check” preferred stock that could be issued by our board of directors to thwart a takeover attempt;

 

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establish a classified board of directors, as a result of which the successors to the directors whose terms have expired will be elected to serve from the time of election and qualification until the third annual meeting following their election;

 

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require that directors only be removed from office for cause and only upon a majority stockholder vote;

 

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provide that vacancies on our board of directors, including newly created directorships, may be filled only by a majority vote of directors then in office;

 

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limit who may call special meetings of stockholders;

 

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prohibit stockholder action by written consent, requiring all actions to be taken at a meeting of the stockholders;

 

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do not provide stockholders with the ability to cumulate their votes;

 

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require supermajority stockholder voting to effect certain amendments to our amended and restated certificate of incorporation and amended and restated bylaws; and

 

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require advance notification of stockholder nominations and proposals.

For more information regarding these and other provisions, see “Description of Capital Stock—Anti-Takeover Provisions.”

We do not currently intend to pay dividends on our common stock in the foreseeable future, and consequently, your ability to achieve a return on your investment will depend on appreciation in the price of our common stock.

We have never declared or paid cash dividends on our common stock and do not anticipate paying any cash dividends to holders of our common stock in the foreseeable future. Consequently, investors must rely on sales of their common stock after price appreciation, which may never occur, as the only way to realize any future gains on their investments. There is no guarantee that shares of our common stock will appreciate in value or even maintain the price at which our stockholders have purchased their shares.

 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This prospectus contains forward-looking statements that involve risks and uncertainties. The forward-looking statements are contained principally in “Prospectus Summary,” “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business.” In some cases, you can identify forward-looking statements by terms such as “may,” “might,” “will,” “objective,” “intend,” “should,” “could,” “can,” “would,” “expect,” “believe,” “design,” “estimate,” “predict,” “potential,” “plan” or the negative of these terms, and similar expressions intended to identify forward-looking statements. These statements reflect our current views with respect to future events and are based on assumptions and subject to risks and uncertainties. Given these uncertainties, you should not place undue reliance on these forward-looking statements. Forward-looking statements include, but are not limited to, statements about:

 

  Ÿ  

anticipated trends and challenges in our business and the markets in which we operate;

 

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the capabilities, benefits and effectiveness of our solution;

 

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intellectual property;

 

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our plans for future solutions and enhancements of our existing solution;

 

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our expectations regarding our expenses and revenue;

 

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our anticipated growth strategies;

 

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our ability to retain and attract clients;

 

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the regulatory environment related to our business;

 

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our expectations regarding competition; and

 

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use of proceeds.

These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performances or achievements expressed or implied by the forward-looking statements.

We discuss many of these risks in this prospectus in greater detail under the heading “Risk Factors.” Also, these forward-looking statements represent our estimates and assumptions only as of the date of this prospectus. Unless required by United States federal securities laws, we do not intend to update any of these forward-looking statements to reflect circumstances or events that occur after the statement is made.

The market data and certain other statistical information used throughout this prospectus are based on independent industry publications, governmental publications, reports by market research firms or other independent sources. Some data are also based on our good faith estimates. Although we believe these third-party sources are reliable, we have not independently verified the information attributed to these third-party sources and cannot guarantee its accuracy and completeness. Similarly, our estimates have not been verified by any independent source.

You should read this prospectus and the documents that we reference in this prospectus and have filed as exhibits to the registration statement, of which this prospectus is a part, completely and with the understanding that our actual future results may be materially different from what we expect. We qualify all of our forward-looking statements by these cautionary statements.

 

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USE OF PROCEEDS

We estimate that we will receive net proceeds from the sale of this offering of approximately $            million, based on an assumed public offering price of $            per share, after deducting the underwriting discounts and commissions and estimated offering costs payable by us. We will not receive any proceeds from any shares sold by the selling stockholders.

The principal purposes of this offering are to obtain additional capital and to expand the public market for our common stock. We expect to use the net proceeds of this offering for working capital and general corporate purposes, including:

 

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acquiring additional patent assets;

 

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hiring additional personnel; and

 

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developing new products and services.

We may also use a portion of the net proceeds for the acquisition of, or investment in, companies, technologies, products or assets that complement our business.

As of the date of this prospectus, we have not yet determined our anticipated expenditures, and therefore cannot estimate the amounts to be used for any particular expenditure. The amounts and timing of any expenditures will vary depending on the amount of cash generated by our operations, competitive and technological developments and the rate of growth, if any, of our business. Accordingly, our management will have significant flexibility in applying the net proceeds from this offering to the uses specified above, and investors will be relying on the judgment of our management regarding the application of these net proceeds. Pending the uses described above, we intend to invest the net proceeds from this offering in short-term, interest-bearing, investment-grade securities. The goal with respect to the investment of these net proceeds will be capital preservation and liquidity so that these funds are readily available to fund our operations.

PRICE RANGE OF OUR COMMON STOCK

Our common stock commenced trading on the Nasdaq Global Market under the symbol “RPXC” on May 4, 2011. The following table sets forth, for the periods indicated, the high and low reported sales prices of our common stock as reported on the Nasdaq Global Market:

 

2011

   High      Low  

Second quarter (from May 4, 2011)

   $ 31.41       $ 23.00   

Third quarter (through September     , 2011)

   $                    $                

As of August 31, 2011, there were approximately 50 holders of record of our common stock. The last reported sale price of our common stock on the Nasdaq Global Market on September 1, 2011 was $26.93 per share.

DIVIDEND POLICY

We have never declared or paid any cash dividends on our capital stock, and we do not currently intend to pay any cash dividends on our common stock for the foreseeable future. We expect to retain future earnings, if any, to fund the development and growth of our business. Any future determination to pay dividends on our common stock will be at the discretion of our board of directors and will depend upon, among other factors, our financial condition, operating results, current and anticipated cash needs, plans for expansion and other factors that our board of directors may deem relevant.

 

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CAPITALIZATION

The following table sets forth our capitalization as of June 30, 2011:

 

  Ÿ  

on an actual basis; and

 

  Ÿ  

on an as adjusted basis to reflect the sale by us of the         shares of common stock offered by us in this offering at an assumed public offering price of $             per share, after deducting the underwriting discounts and commissions and estimated offering costs.

You should read this table together with our consolidated financial statements and related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus.

 

     June 30, 2010  
         Actual          As
Adjusted
 
     (in thousands, except share data)  

Current portion of long-term debt

   $ 6,517       $     

Long-term debt, less current portion

     1,099      

Stockholders’ equity:

     

Common stock, $0.0001 par value per share; 60,000,000 shares authorized, 11,432,434 shares issued and 10,944,001 shares outstanding, actual; 200,000,000 shares authorized,             shares issued and                      outstanding, as adjusted

     5      

Additional paid-in capital

     225,159      

Retained earnings

     25,016      
  

 

 

    

 

 

 

Total stockholders’ equity

     250,180      
  

 

 

    

 

 

 

Total capitalization

   $ 257,796       $                
  

 

 

    

 

 

 

In the table above, the number of shares outstanding as of June 30, 2011 does not include:

 

  Ÿ  

7,755,828 shares issuable upon the exercise of stock options outstanding as of June 30, 2011 with a weighted average exercise price of $5.88 per share;

 

  Ÿ  

84,467 shares of our common stock issuable upon the vesting of RSUs outstanding as of June 30, 2011 under our 2011 Equity Incentive Plan; and

 

  Ÿ  

1,469,234 shares of common stock reserved for future issuance under our 2011 Equity Incentive Plan, subject to automatic annual adjustment in accordance with the terms of the plan.

From July 1, 2011 through September     , 2011, we granted options to purchase 78,500 shares of common stock at a weighted average exercise price of $28.59 per share and RSUs covering 57,632 shares of common stock.

 

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SELECTED CONSOLIDATED FINANCIAL DATA

The tables on the following pages set forth the consolidated financial and operating data as of and for the periods indicated. We have derived the selected consolidated statement of operations data for the period ended December 31, 2008 and the years ended December 31, 2009 and 2010 and the selected consolidated balance sheet data as of December 31, 2009 and 2010 from our audited consolidated financial statements and related notes included elsewhere in this prospectus. We have derived the consolidated balance sheet data as of December 31, 2008 from our audited consolidated financial statements that are not included in this prospectus. We have derived the summary consolidated statement of operations data for the six months ended June 30, 2010 and 2011 and the summary consolidated balance sheet data as of June 30, 2011 from our unaudited consolidated financial statements included elsewhere in this prospectus. Our historical results are not necessarily indicative of the results to be expected for any future period. The following selected consolidated financial data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes included elsewhere in this prospectus.

 

    Period from
Inception to
December 31,
2008
    Year Ended
December 31,
    Six Months Ended
June 30,
 
    2009     2010     2010     2011  
    (in thousands, except per share data)  

Revenue

  $ 792      $ 32,822      $ 94,874      $ 40,047      $ 73,240   

Cost of revenue

    2,551        17,710        43,602        17,949        28,193   

Selling, general and administrative expenses

    2,595        10,250        23,917        9,459        19,396   

Loss on sale of patent assets, net

                  536                 
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating income (loss)

    (4,354     4,862        26,819        12,639        25,651   

Interest expense, net

    (796     (4,369     (2,776     (1,554     (566

Other income (expense), net

           (72     12                 
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before provision for (benefit from) income taxes

    (5,150     421        24,055        11,085        25,085   

Provision for (benefit from) income taxes

           (1,513     10,184        4,644        10,724   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

  $ (5,150   $ 1,934      $ 13,871      $ 6,441      $ 14,361   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Less: allocation of net income to participating stockholders

           1,934        12,479        5,879        8,754   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) available to common stockholders-basic

  $ (5,150   $      $ 1,392      $ 562      $ 5,607   

Undistributed earnings re-allocated to common stockholders

                  279        108        484   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) available to common stockholders-diluted

  $ (5,150   $      $ 1,671      $ 670      $ 6,091   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) per common share-basic

  $ (8.94   $      $ 0.24      $ 0.11      $ 0.31   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) per common share-diluted

  $ (8.94   $      $ 0.23      $ 0.11      $ 0.29   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Weighted-average shares used in computing net income (loss) per common share-basic

    576        2,148        5,747        5,153        18,141   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Weighted-average shares used in computing net income (loss) per common share-diluted

    576        2,169        7,164        6,340        21,187   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Pro forma net income per share-basic (1)

      $ 0.37        $ 0.35   
     

 

 

     

 

 

 

Pro forma net income per share-diluted (1)

      $ 0.36        $ 0.33   
     

 

 

     

 

 

 

Pro forma weighted-average common shares outstanding-basic

        37,086          40,576   
     

 

 

     

 

 

 

Pro forma weighted-average common shares outstanding-diluted

        38,503          43,622   
     

 

 

     

 

 

 

 

(1) See Note 3 to our consolidated financial statements for an explanation of the method used to calculate pro forma basic and diluted net income per share of common stock.

 

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     December 31,      June 30,  
     2009     2010      2011  
     (in thousands)  

Consolidated Balance Sheet Data

       

Cash and cash equivalents

   $ 28,928      $ 46,656       $ 159,393   

Patent assets, net

     82,759        126,508         139,844   

Deferred revenue, including current portion

     24,691        82,440         87,574   

Notes payable and other obligations, including current portion

     38,750        23,583         7,616   

Total liabilities

     66,161        123,522         108,013   

Redeemable convertible preferred stock

     59,012        62,793           

Total stockholders’ equity (deficit)

     (1,249     10,707         250,180   

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations should be read together with “Selected Consolidated Financial Data” and our consolidated financial statements and related notes appearing elsewhere in this prospectus. In addition to historical information, this discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of a variety of factors, including but not limited to, those set forth under “Risk Factors” and elsewhere in this prospectus.

Overview

We have pioneered an approach to help operating companies manage patent risk by serving as an intermediary through which they can participate more efficiently in the patent market. Operating companies that join our client network pay an annual subscription fee and receive a license to the patent assets that we have acquired as well as access to our extensive patent market intelligence. The majority of our clients have entered into multi-year subscription agreements. As of June 30, 2011, the weighted average term of our existing subscription agreements was 2.8 years.

The core of our solution is defensive patent aggregation, in which we acquire patent assets that are being or may be asserted against our current and prospective clients. We then license these patent assets to our clients to protect them from potential patent infringement assertions. From our inception through June 30, 2011, we have deployed over $300 million to acquire patent assets in over 65 separate transactions. We refer to the amount deployed in each period to acquire patent assets as our gross acquisition spend.

Since our inception in July 2008, we have experienced rapid growth, and as of June 30, 2011, our client network consisted of 96 operating companies. In 2008, 2009 and 2010, we added six, 17 and 49 clients, respectively, and in the first six months of 2011, we added 24 clients. Our increased membership has resulted in strong growth in our revenue. We had revenue of $0.8 million in 2008, $32.8 million in 2009, $94.9 million in 2010 and $73.2 million for the six months ended June 30, 2011. We attained profitability in 2009, our first full fiscal year of operations. Our net income increased from a net loss of $5.2 million in 2008 to net income of $1.9 million in 2009, $13.9 million in 2010 and $14.4 million for the six months ended June 30, 2011. For the six months ended June 30, 2011, subscription fees from our 10 highest revenue generating clients accounted for approximately 34% of our revenue, and approximately 38% of our revenue was generated from clients who are based outside of the United States.

We believe there is a significant market opportunity for our solution, and our future revenue growth is dependent on our success in developing this opportunity. Based on our internal analysis, we believe there were over 500 patent infringement cases filed by NPEs in 2009 against more than 1,400 unique defendants, and more than 600 patent infringement cases filed by NPEs in 2010 against more than 2,000 unique defendants, some of which were sued more than once. The current focus of our membership sales team is developing opportunities within the over 250 companies in our sales pipeline that were sued by NPEs twice or more from January 1, 2010 through June 30, 2011. We believe that our new clients in the next year will be a subset of this group.

Our ability to grow our future revenue will also be dependent on our clients’ renewal of their subscriptions. We count each client’s decision to extend its subscription agreement as a renewal, whether the extension is due to the waiver of a right of termination or an affirmative exercise of a right of extension.

 

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We benefit from a network effect. A primary driver of our membership growth is our ability to acquire patent assets that are being or may be asserted against our current and prospective clients. As we add new clients, we generate new subscription fees that can be used to fund additional acquisitions of patent assets. These acquisitions enable us to further add new clients and deliver greater value to our existing clients.

We expect our revenue growth to continue if we are successful in our efforts to add new clients, retain existing clients and acquire patent assets that have been or may be asserted against current and prospective clients. However, we also expect to increase our future expenditures significantly to develop and expand our business, including making substantial expenditures to acquire patent assets and develop new products and services that complement our current patent risk management solution. Our efforts to develop new products and services will result in an increase in our operating expenses and any additional revenue we generate from those new products and services may not be sufficient to offset the additional expenses we incur.

Our Agreements with Our Clients

To gain access to our solution, our clients enter into subscription agreements that provide for payments to us of annual subscription fees in exchange for our membership offering. Each client’s annual subscription fee is based on our fee schedule in effect at the time of the client’s initial agreement with us. This same fee schedule is in effect for the client during all renewal terms, subject to our limited ability to make adjustments based on the Consumer Price Index. We calculate each client’s subscription fee using its fee schedule and its normalized operating income, or NOI, which we define as the greater of (i) the average of the three most recently reported fiscal years’ operating income and (ii) 5% of the most recently reported fiscal year’s revenue. Our fee schedule as of June 30, 2011 had a subscription fee ceiling of $6.6 million and a floor of $60,000. We intend to evaluate our fee schedule from time to time in the future.

Generally, each client’s annual subscription fee is reset yearly on the anniversary of its membership, based on its then-current NOI. If a client experiences improved results of operations and is not already paying subscription fees at the cap for its fee schedule, its subscription fee for the next membership year will rise. On the other hand, if a client that is not already paying the minimum for its fee schedule experiences reduced operating results, its subscription fee for the next membership year will decline. As a result, our revenue is affected by the operating results of our clients.

Our subscription agreements are non-cancelable and state that fees paid are non-refundable. We recognize revenue from our subscription agreements ratably over the term of the agreement. We invoice the majority of our clients annually, with the first payment due shortly after the execution of the subscription agreement and each future payment due upon the yearly anniversary date of the subscription agreement. Clients are generally invoiced 45 days prior to a scheduled payment date. We record the amount of subscription fees billed as deferred revenue once the related contract period has begun, and recognize those amounts as revenue ratably over the period of time for which the billed fees apply.

In addition to subscription fees, we have assessed additional fees to clients joining after April 2009. These fees effectively increase our fee schedule for later-joining clients. We recognize these fee payments as revenue ratably over the period in which the client’s subscription revenue is recognized. The current fee schedule has these additional fees built into it, creating a higher blended rate for clients joining under the new fee schedule. In November 2008, we agreed with three of our early clients that we would charge these additional fees and that we would share with them a portion of our additional fee collections in the form of a rebate. We account for these rebates as a reduction of these three clients’ subscription fee revenue. In early 2011, we agreed to reduce the ongoing subscription fees of these early clients in exchange for eliminating this rebate.

 

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Acquisitions of Patent Assets

Amortization expense associated with our patent assets represents the most significant portion of our expenses and is included in our cost of revenue. We acquire patent assets from multiple parties, including operating companies, individual inventors, NPEs and bankruptcy trustees. We also acquire patent assets in different contexts, including when they are made available for sale or license by their owners or to resolve threatened or pending litigation against our clients or prospective clients. When we acquire licenses to patents, we generally acquire licenses for all of our clients at the time of the acquisition. In the same transaction, we may also acquire the right to provide sublicenses to future clients, either as part of the initial purchase price or in exchange for an agreed-upon option price.

We capitalize the cost of acquired patent assets, including certain third-party transaction costs such as legal fees, and amortize these costs ratably over the shorter of (i) our best estimate of the useful lives of the patent assets and (ii) the remaining statutory life of the patent assets. We estimate the useful life of our patent assets based on the period of time over which we expect to directly or indirectly realize economic benefits associated with them, which ranges from 24 months to 60 months. The statutory (legal) life of an acquired patent asset generally exceeds our estimate of its useful life. Determining the estimated economic useful life of patent assets requires significant management judgment.

The substantial majority of our over 65 acquisitions through June 30, 2011 involved patent assets that we believed were relevant to multiple clients and/or prospective clients and were funded with our own capital resources, which consist of equity financing, subscription fee collections and seller financing.

When we obtain seller financing, we typically agree to make an initial payment to the seller when we execute the acquisition agreement and to make payments in the future. In such cases, the deferred payments represent a liability. If the deferred payments are without a stated interest rate, or the stated rate is below our estimated borrowing rate, we impute interest expense at our estimated borrowing rate (thereby discounting the future payments to present value) to account for the time-value-of-money component of the patent asset acquisition. The difference between the contractual amounts due and the present value is recognized as interest expense over the period the payments are due. Deferred payments due within approximately one year of the date of the acquisition are capitalized at face value. As of June 30, 2011, we had outstanding seller-financing obligations of $7.6 million.

Patent assets that cost more than we are prepared to spend with our own capital resources or that may be relevant only to a very small number of clients do not generally fit within our self-financed acquisition model. When such patent assets are available for sale, we may work to acquire them with financial assistance from the particular clients against whom the assets are being or may be asserted. Such clients either pay amounts separate from their subscription fee or, less frequently, lend us funds to be used in the transaction. We call these types of transactions structured acquisitions. In structured acquisitions where we have acquired only licenses to patents, we have acquired the right to sublicense our other clients and have paid for such right with our own capital. As a result, in our structured acquisitions to date, we have provided licenses to all of our other clients on the same terms as such clients are granted licenses to our other patent assets. Through June 30, 2011, we have completed 11 structured acquisitions. To date, we have completed all but one of our structured acquisitions as a service to our clients and have not charged fees, although we may elect to charge fees on a more frequent basis in the future.

The accounting for structured acquisitions is complex and often requires judgments on the part of management. In some structured acquisitions, we may acquire a patent asset and immediately grant a perpetual license to one or more clients in exchange for a cash payment that is separate from their

 

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subscription fee. While this license grant may generate licensing revenue that is recognized immediately, the expense from the related patent asset may be amortized over the asset’s useful life.

In certain structured acquisitions, we may negotiate with the patent owner to obtain a release from past damages and a license on behalf of our clients. One or more clients may contribute to us the cost of the license we obtain for them, and we contribute the cost of any licenses we obtain in the same transaction for our other clients. In those instances, consistent with our revenue recognition policies, we may treat the contributions from the clients on a net basis and capitalize only the acquired asset that relates to our non-contributing clients. In such case, there is generally minimal or no revenue recognized, and the cost basis of the acquired patent asset excludes the amounts paid by the contributing client or clients. Determining whether to account for contributions on a gross or net basis requires significant management judgment.

On two occasions, we have acquired patent assets in a barter transaction in which we provided membership rights to our solution for a specified period in exchange for patent assets. In these non-monetary transactions, we were able to determine the fair value of the membership agreement based on our fee schedule and thus recognized the acquired assets at such fair value. We may occasionally complete barter transactions in the future.

We have, in limited instances, sold and likely will, from time to time, sell patents to increase our available capital that can be used for future acquisitions or other business expenses. The sale of patents has not been and is not expected to be a material part of our business. When we sell a patent and give up all future rights to license that patent, all of our clients at the time of sale receive an immediate non-exclusive, perpetual license to the patent. We may recognize a gain or a loss as a result of the sale of patent assets.

Key Financial and Operating Metrics

In addition to reviewing our financial statements, we regularly review a number of key financial and operating metrics to manage and assess our business. The following table provides certain key metrics from our inception through December 31, 2008, the years ended December 31, 2009 and 2010 and the six months ended June 30, 2010 and 2011.

 

    As of or for
Period from Inception
(July 15, 2008) to
December 31,

2008
    As of or for Year Ended
December 31,
    As of or Six Months Ended
June 30,
 
            2009                 2010                 2010                 2011        
    (in thousands, except number of clients)  

Financial Metrics

         

Subscription revenue

  $ 792      $ 32,822      $ 94,102      $ 39,597      $ 69,940   

Deferred revenue

    16,895        24,691        82,440        67,399        87,574   

Non-GAAP selling, general and administrative expenses

    2,569        10,023        22,671        9,110        16,460   

Cash and cash equivalents

    14,316        28,928        46,656        40,072        159,393   

Operating Metrics

         

Number of clients (end of period)

    6        23        72        51        96   

Gross acquisition spend (during the period)

  $ 58,573      $ 62,921      $ 146,405      $ 103,242      $ 41,151   

 

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Financial Metrics

Subscription Revenue.    Subscription revenue is the revenue recognized from our clients’ subscription agreements and represents substantially all of our revenue to date.

Deferred Revenue.    We believe deferred revenue is a useful indicator of future revenue performance because it consists of amounts we have invoiced under our subscription agreements but have not yet recognized as revenue. While deferred revenue is one of the indicators of our future revenue performance, the amount of deferred revenue in any given quarter varies with the addition of new clients, the mix of payment terms that we offer and the timing of invoicing existing clients. The substantial majority of our clients today are invoiced annually. In future periods, payment terms may change, which could affect deferred revenue.

Non-GAAP Selling, General and Administrative Expenses.    We monitor our non-GAAP selling, general and administrative expenses because the amount of those expenses affects our profitability. We define non-GAAP selling, general and administrative expenses as GAAP selling, general and administrative expenses excluding stock-based compensation expense. We review our selling, general and administrative expenses on a non-GAAP basis because stock-based compensation expense is based on non-cash equity grants made at a certain price and point in time and does not reflect how our business is performing at any particular time. This measure is not a substitute for selling, general and administrative expenses measured in accordance with GAAP, and investors should review this measure in conjunction with our consolidated financial statements and related notes included elsewhere in this prospectus. As we focus on growing our business, we plan to increase our investment in our membership, client relations and patent analysis teams and in our teams that will develop and support new products and solutions. We also plan to continue to expand our finance, legal and administrative teams to support our operations and comply with the requirements of a public company. As a result, we expect our selling, general and administrative expenses will increase in future periods. The following table reconciles selling, general and administrative expenses determined on a GAAP basis with selling, general and administrative expenses determined on a non-GAAP basis.

 

    Period from Inception
(July 15, 2008) to
December 31,

2008
    Year Ended
December 31,
    Six Months Ended
June 30
 
    2009     2010     2010     2011  
    (in thousands)  

Selling, general and administrative expenses

  $ 2,595      $ 10,250      $ 23,917      $ 9,459      $ 19,396   

Stock-based compensation

    (26     (227     (1,246     (349     (2,936
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Non-GAAP selling, general and administrative expenses

  $ 2,569      $ 10,023      $ 22,671      $ 9,110      $ 16,460   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash and Cash Equivalents.    We monitor cash and cash equivalents as the key measure of our liquidity and our ability to continue to acquire patent assets and fund our selling, general and administrative expenses.

Operating Metrics

Number of Clients.    Our client count measures the total number of companies with whom we have an active subscription agreement. We monitor this metric as a measure of the scale of our business and changes in this metric as a measure of our ability to acquire new clients and to retain existing clients. Our historical quarterly membership additions have varied significantly, ranging from a low of two clients to a peak of 16 clients. We have limited visibility into client additions in any future quarter. While we have not experienced seasonality trends to date, we believe that we may experience lower new client additions in the third quarter of the year due to vacation schedules of the executive management of many of our prospective clients.

 

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Gross Acquisition Spend.    We acquire patent assets that are being or may be asserted against existing or potential clients. We believe that our level of gross acquisition spending is an important measure of the value created for our clients. We calculate this operating metric as the amount we deployed to acquire patent assets in the period, including both amounts contributed by us and amounts contributed by our clients in excess of their subscription fees through structured acquisitions. This measure may vary from quarter to quarter depending on the timing, amount and structure of patent asset acquisitions we may complete.

Key Components of Results of Operations

Revenue

Historically, substantially all of our revenue has consisted of annual subscription fees. We expect that subscription fee revenue will increase with the growth of our client network. Subscription revenue will be positively or negatively impacted by the financial performance of our clients since their subscription fees are typically reset yearly based upon their most recently reported annual financial results. We have also received license revenue from the sale of licenses and fee income in connection with structured acquisitions. In the future, we may receive other revenue and fee income from newly introduced products and services.

Cost of Revenue

Cost of revenue primarily consists of amortization expenses related to acquired patent assets. Acquired patent assets are capitalized and amortized ratably over the shorter of their estimated useful lives or the remaining statutory life. Also included in the cost of revenue are the expenses incurred to maintain and prosecute patents and patent applications. We expect our cost of revenue to increase in the future as we add additional patent assets to our existing portfolio to support our existing and future clients.

Selling, General and Administrative Expenses

Selling, general and administrative expenses consist of salaries and related expenses, including stock-based compensation expenses, cost of marketing programs, certain legal costs, professional fees, travel costs, facility costs and other corporate expenses. We expect that in the future, as we seek to serve more clients and develop new products and services, selling, general and administrative expenses will increase. Selling, general and administrative expenses will also increase in order to support our operations and compliance requirements as a public company.

Interest Expense, Net

Interest expense, net represents interest incurred on our debt obligations mainly resulting from financed patent asset acquisitions, which is partially offset by interest income earned on cash balances. We expect interest expense and interest income to fluctuate in the future with changes in our debt obligations and changes in average cash balances and market interest rates.

Provision for (Benefit from) Income Taxes

Income taxes are computed using the asset and liability method, under which deferred tax assets and liabilities are determined based on the difference between the financial statements and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. Based on available information, we believe

 

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it is more-likely-than-not that our deferred tax assets will be fully realized. Accordingly, we have not applied a valuation allowance against our net deferred tax assets for the tax years ended December 31, 2009, December 31, 2010 or the six months ended June 30, 2011.

Critical Accounting Policies and Estimates

Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses and related disclosures. On an ongoing basis, we evaluate our estimates and assumptions. Our actual results may differ from these estimates under different assumptions or conditions.

We believe that, of our significant accounting policies, which are described in Note 2 of our consolidated financial statements, the following accounting policies involve a greater degree of judgment and complexity. Accordingly, these are the policies we believe are the most critical to aid in fully understanding and evaluating our consolidated financial condition and results of operations.

Revenue Recognition

Our primary source of revenue is subscription fees paid by our clients under subscription agreements. We believe that our subscription service comprises a single deliverable and therefore we recognize revenue from such arrangements ratably over the term of the agreement. We commence revenue recognition when all of the following conditions are met:

 

  Ÿ  

there is persuasive evidence of an arrangement;

 

  Ÿ  

delivery of the subscription or services to the client has commenced;

 

  Ÿ  

the collection of related fees is reasonably assured; and

 

  Ÿ  

the amount of related fees is fixed or determinable.

If a subscription agreement contains contingent or non-standard performance criteria to be met, we defer recognizing revenue until the satisfaction of such conditions. If a subscription agreement contains a discount or other contractual incentive, we recognize revenue net of any such amounts.

Executed agreements are used as evidence of an arrangement. Our subscription agreements are non-cancelable by either party and require us to provide membership services over a specific subscription term. Given that delivery occurs with the passage of time, we recognize subscription revenue ratably over the term of the subscription agreement. Our cash collectability is reasonably assured as our clients are generally required to pay their subscription fees before we provide the service or within a very short time period thereafter. We assess whether the fee is fixed or determinable based on each client’s respective agreement.

To the extent that we are contractually able, our clients receive a term license to, and a release from all prior damages associated with, patent assets in our portfolio. The term license to each patent asset converts to a perpetual license at the end of a contractually specified vesting period provided that the client is a member at such time. We do not view the conversion of a license from term to perpetual to be a separate deliverable in our arrangements with our clients because the utility of, access to and freedom to practice the inventions covered by the patent asset are no different between a term and perpetual license. We do not view providing longer term access to the patent asset as a new deliverable separate from the term license.

 

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In structured acquisitions, we accept a payment from one or more clients to finance part or all of the acquisition. The accounting for structured acquisitions is complex and requires significant judgment on the part of our management. In structured acquisitions that result in the sale of a patent license, we may recognize revenue on a gross basis related to such sale. In circumstances where we substantively act as an agent to acquire patent assets from a seller on behalf of clients who are paying for such assets separately from their subscription agreements, we may treat the client payments on a net basis. As a result, there is no revenue recognized and the basis of the acquired patent assets excludes the amounts paid by the contributing clients based on our determination that we are not the principal in these transactions. In these situations, the contributing clients are typically defendants in an active or threatened patent infringement litigation filed by the owner of a patent. We are brought in to assist our clients to secure a dismissal from litigation and a license to the underlying patents.

Key indicators evaluated to reach the determination that we are not the principal in the transaction include:

 

  Ÿ  

the seller is generally viewed as the primary obligor in the arrangement, given that it owns and controls the underlying patent(s) and thus has the absolute authority to grant and deliver any release from past damages and dismissal from litigation, as well the general terms of the license granted;

 

  Ÿ  

we have no inventory risk as the clients generally enter into their contractual obligations with us prior to or contemporaneous with our entry into a contractual obligation with the seller;

 

  Ÿ  

we are not involved in the determination of the product or service specification and have no ability to change the product or perform any part of the service in connection with these transactions, as the seller owns the underlying patent(s); and

 

  Ÿ  

we have limited or no credit risk, as each respective client has a contractually binding obligation, and in many instances we collect the client contribution prior to making a payment to the seller.

Amortization of Patent Assets

We acquire patent assets from third parties using cash and contractual deferred payments. We capitalize the fair value of the acquired patent assets as intangible assets. Because each client receives a license to the vast majority of our patent assets, we are unable to reliably determine the pattern over which our patent assets are consumed. As a result, we amortize each patent asset on a straight-line basis. The amortization period is equal to the shorter of the asset’s estimated useful life and remaining statutory life. We estimate the useful life of these assets based upon the period of time over which we expect these assets to contribute directly or indirectly to our future cash flows, generally from 24 months to 60 months. We take into account various factors in making estimates regarding the useful life of our patent assets, including the applicability of the assets to future clients, the vesting period for current clients to obtain perpetual licenses to such patent assets and any contractual commitments by clients that are related to such patent assets. The assessment of many of these factors requires significant management judgment, and changes to these judgments could affect the amortization period of our patent assets and our results of operations. We periodically evaluate our estimates to assess any adjustments that may be required to the remaining useful life of our patent assets.

Accounting for Stock-Based Awards

We measure all stock-based payments to employees, including grants of stock options, based on the grant date fair value of the awards and recognize these amounts in our consolidated statement of operations over the period during which the employee is required to perform services in exchange for the award (generally over the vesting period of the award).

 

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The following table summarizes the awards granted from our inception (July 15, 2008) through the effective date of our initial public offering:

 

Common Stock Valuation

 

Grant Date

  Number of
Shares
Underlying
Awards
Granted
    Exercise
Price
    Common
Stock
Fair Value
per Share
for Financial
Reporting
Purposes at
Grant Date
    Intrinsic
Value
per Share
at Grant
Date
 

Received

 

As of

         

November 10, 2008

  September 30, 2008   November 19, 2008     1,782,739      $ 0.25      $ 0.24      $ 0.00   

January 23, 2009

  January 23, 2009   January 30, 2009     57,630        0.47        0.47        0.00   
    April 8, 2009     656,665        0.47        0.47        0.00   

December 8, 2009

  October 8, 2009   December 16, 2009     970,239        1.02        1.02        0.00   
    January 14, 2010     180,000        1.02        1.29        0.27   
    February 11, 2010     414,496        1.02        2.00        0.98   

May 7, 2010

  March 31, 2010   May 11, 2010     351,111        2.38        2.38        0.00   
    June 24, 2010     35,000        2.38        3.27        0.89   

September 13, 2010

  August 27, 2010   September 15, 2010     501,111        4.96        4.96        0.00   
    October 21, 2010     1,279,203        4.96        6.37        1.41   

November 15, 2010

  October 31, 2010   November 16, 2010     1,077,500        6.63        6.63        0.00   

January 20, 2011

  January 18, 2011   January 20, 2011     1,452,116        9.85        9.85        0.00   
    January 31, 2011     60,000        9.85        9.85        0.00   

April 6, 2011

  April 1, 2011   April 6, 2011     364,033        14.19        14.19        0.00   

To estimate the fair value of an award, we use the Black-Scholes pricing model. This model requires inputs such as expected term, expected volatility and risk-free interest rate. These inputs are subjective and generally require significant analysis and judgment to develop. For all options granted to date, we calculated the expected term using the SEC simplified method. We determined that it was not practicable to calculate the volatility of our share price because our securities are not publicly traded, and therefore there is no readily determinable market value for our stock. Additionally, we have limited information on our own past volatility, and we have a limited operating history. Therefore, we have estimated the volatility data based on a study of publicly traded industry peer companies. For purposes of identifying these peer companies, we considered the industry, stage of development, size and financial leverage of potential comparable companies. The estimated forfeiture rate is derived primarily from our historical data, and the risk-free interest rate is based on the yield available on United States Treasury zero-coupon issues similar in duration to the expected term of our stock options.

 

    

Period from
Inception
(July 15, 2008)
to December 31,

2008

  

Year Ended
December 31,

       

2009

  

2010

Risk-free interest rate

   3.17%    2.46%    2.00%

Expected volatility

   109%    122%    59%

Expected dividend yield

        

Expected term

   5 years    6 years    6.2 years

Prior to our initial public offering, the fair values of the common stock underlying our stock options had been determined by our board of directors with input from management, and our board of directors intended all options to be exercisable at a price per share not less than the per share fair market value of our common stock underlying those options on the date of grant. In the absence of a public trading market for our common stock, our board of directors determined the fair value of the common stock utilizing methodologies, approaches and assumptions consistent with the American Institute of Certified Public Accountants Practice Guide, Valuation of Privately-Held-Company Equity Securities

 

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Issued as Compensation, referred to herein as the AICPA Practice Guide. Pursuant to the AICPA Practice Guide, prior to our initial public offering our board of directors determined the fair value of our common stock based in part on an analysis of relevant metrics, including some or all of the following for each grant date:

 

  Ÿ  

contemporaneous valuations of our common stock;

 

  Ÿ  

prices for our convertible preferred stock that we sold to outside investors in arm’s-length transactions, and the rights, preferences and privileges of our preferred stock and our common stock;

 

  Ÿ  

our financial condition and results of operations during the relevant period;

 

  Ÿ  

developments in our business, including growth in our business operations and membership base;

 

  Ÿ  

forecasts of our financial results; and

 

  Ÿ  

the likelihood of achieving a liquidity event for the shares of common stock underlying the stock options, such as an initial public offering or sale of our company, given prevailing market conditions and our relative financial condition at the time of grant.

When determining the fair value of our common stock based on our convertible preferred stock financings with third parties, the indicated equity value of our company calculated at the valuation date was allocated to the shares of convertible preferred stock and shares of common stock and the options to purchase common stock using an option pricing methodology. The option pricing method treats common stock and preferred stock as call options on the total equity value of a company, with exercise prices based on the value thresholds at which the allocation among the various holders of a company’s securities changes. Under this method, the common stock has value only if the funds available for distribution to stockholders exceed the value of the liquidation preference at the time of a liquidity event, such as a strategic sale, merger or initial public offering, assuming the enterprise has funds available to make a liquidation preference meaningful and collectible by the holders of preferred stock. The common stock is modeled as a call option on the underlying equity value at a predetermined exercise price. In the model, the exercise price is based on a comparison with the total equity value rather than, as in the case of a regular call option, a comparison with a per share stock price. Thus, common stock is considered to be a call option with a claim on the enterprise at an exercise price equal to the remaining value immediately after the preferred stock is liquidated. The option pricing method uses the Black-Scholes option pricing model to price the call options. This model defines the securities’ fair values as functions of the current fair value of a company and uses assumptions such as the anticipated timing of a potential liquidity event and the estimated volatility of the equity securities. The anticipated timing of a liquidity event utilized in these valuations was based on then- current plans and estimates of our board of directors and management regarding a liquidity event. The aggregate value of the common stock derived from the option pricing method was then divided by the number of shares of common stock outstanding to arrive at the per share value. A discount for lack of marketability was applied to reflect the increased risk arising from the inability to readily sell the shares. This approach is consistent with the methods outlined in the AICPA Practice Guide.

Our board of directors determined the fair value of our common stock for purposes of grants of stock options from December 2009 through February 2010 primarily based on the valuation of our common stock as of October 8, 2009, pursuant to which the fair value of our common stock was estimated to be $1.02 per share. This valuation was primarily based upon the price set by the sale of shares of our Series B convertible preferred stock in July 2009 negotiated at an arm’s-length basis with a new venture capital firm leading the round, using the option pricing methodology described above, taking into account the additional rights, preferences and privileges of the Series B convertible preferred stock compared to the common stock and applying a discount for lack of control and marketability of 15%. The price per share for the Series B convertible preferred stock was $3.0019. As

 

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of September 30, 2009, we had only 16 clients and had acquired patent assets with a gross book value of $94.6 million. We experienced only modest growth in revenue in the quarter ended December 31, 2009 from the quarter ended September 30, 2009.

Our board of directors determined the fair value of our common stock for purposes of grants of stock options from May 2010 through June 2010 primarily based on the valuation of our common stock as of March 31, 2010, pursuant to which the fair value of our common stock was estimated to be $2.38 per share. This valuation relied primarily on the discounted cash flow analysis of the income approach when estimating our aggregate enterprise value at the valuation date. The income approach measures the value of a company as the present value of its future economic benefits by applying an appropriate risk-adjusted discount rate to expected cash flows, based on forecasted revenue and costs. We prepared a financial forecast for each valuation that took into account our past experience and future expectations. The risks associated with achieving these forecasts were assessed in selecting the appropriate discount rate. The comparable public company approach and the market multiples of publicly traded firms in the same or similar lines of business were utilized to derive a terminal value indication in the discounted cash flow analysis, but the comparable company approach was not used as a separate valuation methodology. The valuation applied a 20% discount for lack of marketability. Between October 9, 2009 and March 31, 2010, we added 23 new clients, for a total of 39 clients, and the gross book value of our patent assets grew to $138.2 million. This rate of growth exceeded our plan. Although we experienced substantial growth in revenue for our quarter ended March 31, 2010, the rate of our revenue growth was lower for the quarter ended June 30, 2010 and our net income was relatively flat in this quarter relative to the prior quarter.

Our board of directors determined the fair value of our common stock for purposes of grants of stock options from September 2010 through October 2010 based primarily on the valuation of our common stock as of August 27, 2010, pursuant to which the fair value of our common stock was estimated to be $4.96 per share. This valuation relied on (i) the discounted cash flow analysis of the income approach described above, combined with (ii) the implied equity value from a contemplated Series C round based on indications of a pre-money value range and investment amount from an interested third-party investor, using the option pricing methodology described above and taking into account the anticipated additional rights, preferences and privileges of the Series C convertible preferred stock compared to the common stock. This valuation applied a 20% discount for lack of marketability and a weighting of 75% toward the discounted cash flow analysis and 25% toward the Series C financing analysis based on the uncertainty over whether this financing round would close. From April 1, 2010 to August 27, 2010, our client base grew by an additional 18 clients to a total of 57 clients. As of June 30, 2010, the gross book value of our patent assets had grown to $157.5 million. While we experienced growth in revenue in each of the quarters ended June 30, 2010 and September 30, 2010, we also experienced substantial increases in cost of revenue and operating expenses as we acquired additional patent assets and built out our infrastructure.

Our board of directors determined the fair value of our common stock for purposes of grants of stock options in November 2010 based primarily on the valuation of our common stock as of October 31, 2010, pursuant to which the fair value of our common stock was estimated to be $6.63 per share. This valuation relied on the discounted cash flow analysis of the income approach described above, combined with the equity value implied by the sale of shares of our Series C convertible preferred stock sold in November 2010 at a price of $7.78 per share to a different third-party investor than contemplated above and our venture capital firms using the option pricing methodology described above and taking into account the additional rights, preferences and privileges of the Series C convertible preferred stock compared to the common stock. The price per share for the Series C convertible preferred stock and the terms of the transactions were the result of negotiations between us and the third-party Series C investor. This valuation applied a weighting of 50% toward the discounted cash flow analysis and 50% toward the Series C financing analysis and applied a 15%

 

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discount for lack of marketability. From August 27, 2010 to October 31, 2010, we added 11 new clients such that our client network totaled 68 clients. As of September 30, 2010, the gross book value of our patent assets had grown to $179.0 million. The valuation by our board of directors also took into account the timing of a potential public offering of our common stock and reduced discount for lack of marketability. We continued to grow our personnel infrastructure, including hiring Ms. Yen as our Executive Vice President in November 2010.

Our board of directors determined the fair value of our common stock for purposes of grants of stock options in January 2011 based primarily on the valuation of our common stock as of January 18, 2011, pursuant to which the fair value of our common stock was estimated to be $9.85 per share. This valuation relied on the discounted cash flow analysis of the income approach described above to estimate our aggregate enterprise value and also relied on the comparable public company approach to estimate our fair market value by applying market multiples of publicly-traded firms in similar lines of business to our results and projected results. This valuation applied a discount for lack of marketability of 7.5% to the comparable public company approach and 15.0% to the discounted cash flow approach. The valuation weighted the comparable public company approach at 80% and the discounted cash flow analysis at 20%. From October 31, 2010 through January 18, 2011, we added seven new members bringing our client network to 75 clients. As of December 31, 2010, the gross book value of our patent assets had grown to $188.4 million. The valuation by our board of directors also took into account the timing of a potential public offering of our common stock and reduced discount for lack of marketability. We also made further development on our proprietary web portal and elected Shelby Bonnie to our board of directors in January 2011.

Our board of directors determined the fair value of our common stock for purposes of grants of stock options in April 2011 based primarily on the valuation of our common stock as of April 1, 2011, pursuant to which the fair value of our common stock was estimated to be $14.19 per share. This valuation relied primarily on the comparable public company approach and, to a lesser extent, the discounted cash flow analysis of the income approach, as each is described above. This valuation applied a 10.0% discount for lack of marketability to the results of the discounted cash flow approach and no such discount to the results of the comparable public company approach. The valuation weighted the comparable public company approach at 90% and the discounted cash flow analysis at 10%. The valuation by our board of directors took into account the anticipated timing of a potential public offering of our common stock and eliminated the discount for lack of marketability that had been used in previous valuations. The valuation also considered the continued expansion in our business. From January 18, 2011 through April 1, 2011, we added six new clients bringing our client network to 81 clients. In addition, based on our preliminary estimates for the quarter ended March 31, 2011, operating income is expected to be between $11.6 million and $12.6 million, and revenue is expected to be between $33.9 million and $34.4 million. The midpoint of the expected operating income range represents an increase of 95% as compared to operating income of $6.2 million for the quarter ended March 31, 2010 and an increase of 63% as compared to operating income of $7.4 million for the quarter ended December 31, 2010. This constitutes the largest dollar growth in our quarterly operating income since our inception. The midpoint of the expected revenue range represents an increase of 88% as compared to revenue of $18.2 million for the quarter ended March 31, 2010 and an increase of 15% as compared to revenue of $29.7 million for the quarter ended December 31, 2010. We also elected Sanford Robertson to our board of directors in May 2011.

Prior to the issuance of our financial statements for the year ended December 31, 2010 in connection with the initial filing of our registration statement on Form S-1, we decided to revise our estimates of the fair value of our common stock as of January 14, 2010, February 11, 2010, June 24, 2010 and October 21, 2010. The revised estimate of fair value for each of those dates was derived based on a linear increase of the estimated fair value of our common stock between the immediately

 

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previous valuation and the subsequent valuation. We used a linear increase method because we determined based on a review of events during each of the periods that no single factor changed or single event occurred that led to a change in the fair value of our common stock.

Accounting for Income Taxes

We account for income taxes using the asset and liability approach, which requires the recognition of deferred tax assets or liabilities for the tax-effected temporary differences between the financial reporting and tax bases of our assets and liabilities and for net operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The measurement of deferred tax assets is reduced, if necessary, by the amount of any tax benefits that, based on available evidence, are not expected to be realized.

The tax expense or benefit for extraordinary items, unusual or infrequently occurring items and items that do not represent a tax effect of current-year ordinary income are treated as discrete items and recorded in the interim period in which the events occur.

Our effective tax rate could be adversely affected by changes in federal, state or foreign tax laws, certain non-deductible expenses arising from stock-based awards and changes in accounting principles.

We are currently under examination by the IRS for the 2008 and 2009 tax years. The ultimate resolution of this examination is not expected to have a material impact on our financial statements.

Results of Operations

The following table sets forth, for the periods indicated, certain consolidated statements of operations data (in thousands). Our historical results are not necessarily indicative of our results of operations to be expected for any future period.

 

    Period from Inception
(July 15, 2008) to
December 31,

2008
    Year Ended
December 31,
    Six Months Ended
June 30
 
    2009     2010     2010     2011  
    (in thousands)  

Revenue

  $ 792      $ 32,822      $ 94,874      $ 40,047      $ 73,240   

Cost of revenue

    2,551        17,710        43,602        17,949        28,193   

Selling, general and administrative expenses

    2,595        10,250        23,917        9,459        19,396   

Loss on sale of patent assets, net

                  536                 
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating income (loss)

    (4,354     4,862        26,819        12,639        25,651   

Interest expense, net

    (796     (4,369     (2,776     (1,554     (566

Other expense, net

           (72     12                 
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before provision for (benefit from) income taxes

    (5,150     421        24,055        11,085        25,085   

Provision for (benefit from) income taxes

           (1,513     10,184        4,644        10,724   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

  $ (5,150   $ 1,934      $ 13,871      $ 6,441      $ 14,361   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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The following table sets forth, for the periods indicated, certain consolidated statements of operations data as a percentage of revenue. Our historical results are not necessarily indicative of our results of operations to be expected for any future period.

 

    Period from Inception
(July 15, 2008) to
December 31,

2008
    Year Ended
December 31,
    Six Months Ended
June 30
 
      2009         2010           2010             2011      
    (in thousands)  

Revenue

    100     100     100     100     100

Cost of revenue

    322     54     46     45     39

Selling, general and administrative expenses

    328     31     25     23     26

Loss on sale of patent assets, net

                  1              
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating income (loss)

    (550 )%      15     28     32     35

Interest expense, net

    (101 )%      (13 )%      (3 )%      (4 )%      (1 )% 

Other expense, net

                                  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before provision for (benefit from) income taxes

    (650 )%      1     25     28     34

Provision for (benefit from) income taxes

           (5 )%      11     12     15
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

    (650 )%      6     15     16     20
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Six Months Ended June 30, 2010 and 2011

Revenue.    Revenue for the six months ended June 30, 2011 increased by $33.2 million, or 83%, to $73.2 million compared to the same period a year ago. The increase was primarily due to the growth in our client network and the resulting recognition of revenue from clients that joined both during the period and prior to the start of the period. Revenue included $3.3 million from the sale of a perpetual license in the six months ended June 30, 2011 as compared to $0.5 million in the same period in 2010.

We expect our revenue growth to continue if we are successful in our efforts to add new clients and retain existing clients. However, while we expect to continue to experience revenue growth, we do not believe that our rate of growth since inception is representative of anticipated future revenue growth.

Cost of Revenue.    Our cost of revenue for the six months ended June 30, 2011 increased by $10.2 million, or 57%, to $28.2 million compared to the same period a year ago. The increase was primarily the result of additional amortization expense recorded from patent assets acquired in 2010 and during the six months ended June 30, 2011. The expenses incurred to maintain patents and prosecute patent applications included in our portfolio were approximately $0.3 million and $0.4 million for the six months ended June 30, 2011 and 2010, respectively.

Selling, General and Administrative Expenses.    Our selling, general and administrative expenses for the six months ended June 30, 2011 increased by $9.9 million, or 105%, to $19.4 million compared to the same period a year ago. The increase from the prior year was primarily due to a $6.9 million increase associated with personnel related costs and increased stock-based compensation expense when compared to the same prior year period. We had 81 employees at June 30, 2011 compared to 43 employees at June 30, 2010. Our legal fees increased by $0.7 million and professional fees increased by $0.8 million for the six months ended June 30, 2011. Our patent asset related acquisition costs for the six months ended June 30, 2011 increased by $0.7 million compared to the same period a year ago. Our facility-related costs, depreciation and other corporate expenses for the six months ended June 30, 2011 also increased by $1.1 million to support the growth of our business, including leasing of additional office space and costs associated with being a public company compared to the

 

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same period a year ago. We expect that our selling, general and administrative expenses will increase in future periods as we continue to invest in the growth of our business and incur costs associated with being a public company.

Interest Expense, net.    Our interest expense, net for the six months ended June 30, 2011 decreased by $1.0 million, or 64%, to $0.6 million compared to the same period a year ago. The decrease was primarily due to a decrease in our interest expense of $1.1 million, the result of a net reduction in outstanding principal balances caused by reduced use of acquisition-related debt and the amortization of existing debt.

Provision for Income Taxes.    The provision for income taxes for the six months ended June 30, 2011 increased by $6.1 million or 131%, to $10.7 million compared to the same period a year ago. The overall increase in income tax expenses for the six months ended June 30, 2011 was due to our higher income before taxes.

Our effective tax rate for the six months ended June 30, 2011 was 42.8% compared to 41.9% for the six months ended June 30, 2010. The higher effective tax rate for the six months ended June 30, 2011 was primarily due to an increase in stock-based compensation expense. The difference between the consolidated effective income tax rate and the U.S. federal statutory rate is primarily attributable to the effect of certain permanent differences and state income taxes.

Years Ended December 31, 2009 and 2010

Revenue.    Our revenue increased by $62.1 million, or 189%, to $94.9 million for the year ended December 31, 2010. The increase was primarily the result of growth in our client network and the resulting recognition of revenue from clients that joined both during this period and prior to the start of this period.

Cost of Revenue.    Our cost of revenue increased by $25.9 million, or 146%, to $43.6 million for the year ended December 31, 2010. The increase was primarily the result of additional amortization expense recorded from new patent acquisitions. The expenses incurred to maintain and prosecute patents and patent applications included in our portfolio were approximately $0.8 million and $0.7 million during 2009 and 2010, respectively.

Selling, General and Administrative Expenses.    Our selling, general and administrative expenses increased by $13.7 million, or 133%, to $23.9 million for the year ended December 31, 2010. The increase was primarily due to our headcount growth, which resulted in increased salaries and related expenses, including stock-based compensation expenses, of an aggregate of $9.1 million and increased travel costs by $0.6 million. Our headcount increased from 27 at December 31, 2009 to 66 at December 31, 2010. Our legal and professional fees increased by $2.3 million mainly to support the due diligence for our patent acquisitions, recruiting efforts and expansion of our business. Our facility costs and other corporate expenses also increased by $1.6 million to support the growth of our business, including leasing of additional office space. In September 2010, we opened our Tokyo office to facilitate our development and management of client relationships with companies located in Asia. In August 2010, we launched our Client Relations group, which is focused on building deep relationships throughout our clients’ organizations, both to ensure that our clients’ current needs are being met and to serve as the vehicle for marketing additional, value-added patent risk management solutions as we develop them.

Loss on Sale of Patent Assets, Net.    We incurred a loss of $0.5 million resulting from patent sale transactions during the year.

 

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Interest Expense, Net.    Our interest expense, net decreased by $1.6 million, or 36%, to $2.8 million for the year ended December 31, 2010. The decrease was primarily due to a decrease in our interest expense of $1.3 million, the result of a net reduction in outstanding principal balances caused by reduced use of acquisition-related debt and the amortization of existing debt. The decrease was also due to an increase in our interest income of $0.3 million primarily resulting from interest income earned on a note receivable.

Provision for Income Taxes.    We had a tax provision of $10.2 million for 2010, compared to a tax benefit of $1.5 million for 2009. The overall change in income taxes is the result of becoming profitable in 2010. Further, 2009 included the benefit of the release of the valuation allowance on the deferred tax asset of $1.5 million.

Period from Inception through December 31, 2008 and the Year Ended December 31, 2009

Revenue.    Our revenue was $0.8 million for the period ended December 31, 2008, which represented membership revenue earned during the year from six clients. Our revenue was $32.8 million for year ended December 31, 2009, which represented membership revenue earned during the year from 23 clients.

Cost of Revenue.    Our cost of revenue was $2.6 million for the period ended December 31, 2008, primarily representing the amortization cost for our patent asset portfolios held over this period. Our cost of revenue for the period ended December 31, 2008 also includes approximately $0.1 million of expenses incurred to maintain and prosecute patents and patent applications included in our portfolio. Our cost of revenue was $17.7 million for the year ended December 31, 2009 primarily representing the amortization cost for our patent asset portfolios held over the year. Our cost of revenue for the year ended December 31, 2009 also includes approximately $0.8 million of expenses incurred to maintain and prosecute patents and patent applications included in our portfolio.

Selling, General and Administrative Expenses.    Our selling, general and administrative expenses were $2.6 million for the period ended December 31, 2008, consisting of $1.5 million of salaries and related expenses including stock-based expenses, $0.2 million for the cost of marketing programs, $0.4 million for legal and professional fees, $0.3 million for travel costs, and $0.2 million for facility costs and other corporate expenses. Our headcount at December 31, 2008 was 15. Our selling, general and administrative expenses were $10.3 million for the year ended December 31, 2009, consisting of $6.8 million of salaries and related expenses including stock-based expenses, $0.7 million for cost of marketing programs, $1.2 million for legal and professional fees, $0.9 million of travel costs and $0.7 million for facility costs and other corporate expenses. Our headcount at December 31, 2009 was 27.

Interest Expense, Net.    Our interest expense, net was $0.8 million for the period ended December 31, 2008, primarily representing interest expense on notes payable and other deferred payment obligations related to the financing of our 2008 patent acquisitions. Our interest expense, net was $4.4 million for the year ended December 31, 2009, primarily representing interest expense on notes payable and other deferred payment obligations related to the financing of our 2008 and 2009 patent acquisitions.

Benefit from Income Taxes.    For the period ended December 31, 2008, we were in a loss position and recorded a valuation allowance against all of our deferred tax assets. For the year ended December 31, 2009, we concluded that it is more-likely-than-not that our deferred tax assets will be fully realized. We reversed the existing valuation allowance against our deferred tax assets, resulting in a benefit from income taxes.

 

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Quarterly Results of Operations

The following table presents our unaudited consolidated statements of operations and other data for each of the nine quarters up to and including the period ended June 30, 2011. The quarterly data have been prepared on a basis consistent with the audited consolidated financial statements appearing elsewhere in this prospectus and include, in the opinion of management, all normal recurring adjustments necessary for the fair statement of the financial information below. You should read this information together with our consolidated financial statements and related notes included elsewhere in this prospectus. Our historical results are not necessarily indicative of our results of operations for any future period.

 

    Three Months Ended  
    June 30,
2009
    September 30,
2009
    December 31,
2009
    March 31,
2010
    June 30,
2010
    September 30,
2010
    December 31,
2010
    March 31,
2011
    June 30,
2011
 
    ($ in thousands)        

Revenue

  $ 8,858      $ 8,963      $ 9,824      $ 18,212      $ 21,835      $ 25,131      $ 29,696      $ 34,390      $ 38,850   

Cost of revenue

    4,198        4,805        5,008        7,733        10,216        12,401        13,252        13,665        14,528   

Selling, general and administrative expenses

    2,311        2,653        3,061        4,268        5,191        5,891        8,567        8,110        11,286   

Loss on sale of patent assets, net

                                       75        461                 
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

    2,349        1,505        1,755        6,211        6,428        6,764        7,416        12,615        13,036   

Interest expense, net

    (1,145     (1,150     (1,034     (840     (714     (645     (577     (373     (193

Other expense, net

    (5            (67                          12                 
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income before provision for/(benefit from) income taxes

    1,199        355        654        5,371        5,714        6,119        6,851        12,242        12,843   

Provision for / (benefit from) income taxes

    1,096        490        (2,289     2,251        2,393        2,553        2,987        5,547        5,177   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income / (loss)

  $ 103      $ (135   $ 2,943      $ 3,120      $ 3,321      $ 3,566      $ 3,864      $ 6,695      $ 7,666   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other Data

                 

Deferred revenue, including current portion

    28,512        20,875        24,691        62,226        67,399        77,471        82,440        92,763        87,574   

Stock-based compensation

    48        48        106        157        192        282        615        1,048        1,888   

 

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The following table presents certain unaudited quarterly information as a percentage of our net revenue for each of the nine quarters up to the period ended June 30, 2011 on a historical basis. Our historical results are not necessarily indicative of our results of operations for any future period.

 

    June 30,
2009
    September 30,
2009
    December 31,
2009
    March 31,
2010
    June 30,
2010
    September 30,
2010
    December 31,
2010
    March 31,
2011
    June 30,
2011
 

Revenue

    100     100     100     100     100     100     100     100     100

Cost of revenue

    47     54     51     42     47     49     45     40     37

Selling, general and administrative expenses

    26     30     31     23     24     23     29     24     29

Loss on sale of patent assets, net

                                              2              
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

    27     17     18     34     30     27     25     37     34

Interest expense, net

    (13 )%      (13 )%      (11 )%      (5 )%      (3 )%      (3 )%      (2 )%      (1 )%      (0 )% 

Other expense, net

    (0 )%      (0 )%      (1 )%      (0 )%      (0 )%      (0 )%      (0 )%      (0 )%      (0 )% 
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income before provision for / (benefit from) income taxes

    14     4     7     29     26     24     23     36     33

Provision for / (benefit from) income taxes

    12     5     (23 )%      12     11     10     10     16     13
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income / (loss)

    1     (2 )%      30     17     15     14     13     19     20
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Comparison of Unaudited Quarterly Results

Revenue increased sequentially in each of the quarters presented, primarily due to the addition of new clients. The number of our clients grew from six at December 31, 2008 to 96 at June 30, 2011.

Our cost of revenue increased sequentially in each of the quarters presented, primarily due to increased amortization expense resulted from our acquisitions of patent assets.

Selling, general and administrative expenses increased sequentially in each of the quarters presented, primarily due to increased salaries and benefits associated with our headcount growth, increased legal and profession fees, facilities costs and other corporate expenses to support the growth of our business.

Our quarterly operating results are likely to fluctuate. Some of the important factors that could cause our quarterly revenue and operating results to fluctuate include:

 

  Ÿ  

our ability to attract new clients;

 

  Ÿ  

the timing and costs of our patent asset acquisitions;

 

  Ÿ  

client renewal rates;

 

  Ÿ  

the loss of clients, including through acquisitions or consolidations;

 

  Ÿ  

the amount and timing of operating expenses related to the maintenance and expansion of our business and infrastructure;

 

  Ÿ  

general economic, industry and market conditions; and

 

  Ÿ  

gains or losses realized as a result of selling patents.

 

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The effect of one or more of these factors might cause our operating results to vary widely. As such, we believe that our quarterly results of operations, including our revenue, cost of revenue and deferred revenue, may vary significantly in the future and that period-to-period comparisons of our operating results may not be meaningful and should not be relied upon as an indication of future performance.

Liquidity and Capital Resources

In May 2011, we completed our initial public offering of common stock in which we issued 9,065,000 shares of common stock and received cash proceeds of $160.2 million, net of underwriting discounts and commissions. We incurred offering costs of $2.9 million. Prior to the initial public offering, substantially all of our operations and patent asset acquisitions had been financed through the private sale of equity securities, subscription fees collected from our clients and patent-seller financing.

As of June 30, 2011, we had cash, cash equivalents and investments of $198.7 million. We expect to use substantial cash in the future to acquire additional patent assets and to service the obligations undertaken in connection with prior patent asset purchases.

We believe our existing cash, cash equivalents, investments and contractual payments due to us from existing members will be sufficient to meet our working capital and capital expenditure needs for at least the next 12 months. Our future capital needs will depend on many factors, including, among other things, our acquisition of patent assets, addition and renewal of clients, development of new solutions and performance of general and administrative activities. We anticipate an increased level of patent acquisition spending as our business grows. Although we are not currently a party to any agreement or letter of intent regarding potential investments in, or acquisitions of, complementary businesses, we may enter into these types of arrangements, which could require us to seek additional equity or debt financing. Additional funds may not be available on terms favorable to us or at all.

As a public company, we incur costs that we have not previously incurred including, but not limited to, costs and expenses for directors fees, increased directors and officers insurance, investor relations fees, expenses for compliance with the Sarbanes-Oxley Act of 2002 and rules implemented by the SEC and The Nasdaq Global Market, on which our common stock is listed, and various other costs. The Sarbanes-Oxley Act of 2002 requires that we maintain effective disclosure controls and procedures and internal control over financial reporting.

The following table sets forth a summary of our cash flows for the periods indicated:

 

     Period from
Inception
(July 15, 2008)
to December  31,
2008
    Year Ended
December 31,
    Six Months Ended
June 30,
 
       2009     2010     2010     2011  
     (in thousands)  

Net cash provided by operating activities

   $ 14,652      $ 17,582      $ 120,134      $ 74,669      $ 55,087   

Net cash used in investing activities

     (23,181     (23,537     (72,361     (43,158     (86,002

Net cash provided by (used in) financing activities

     22,845        20,567        (30,045     (20,367     143,652   

Cash and cash equivalents

     14,316        28,928        46,656        40,072        159,393   

 

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Cash Flows from Operating Activities

Cash provided by operating activities primarily consists of net income adjusted for certain non-cash items including depreciation, amortization, stock-based compensation and the effect of changes in working capital and other activities. Cash provided by operating activities for the six months ended June 30, 2011 was $55.1 million, consisting of net income of $14.4 million, adjustments for non-cash items of $31.6 million and changes in working capital and non-current assets and liabilities totaling $9.2 million. The change in working capital resulted primarily from a decrease in accounts receivable of $6.4 million and an increase in deferred revenue of $5.0 million. The increase in deferred revenue for the six months ended June 30, 2011 is primarily attributable to $78.2 million of subscription billings for the period offset by $73.2 million of revenue recognized during the period. The increase in deferred revenue is due to annual subscription billings and the growth in our membership to 96 clients as of June 30, 2011 from 72 clients as of December 31, 2010. The amount of deferred revenue in any given period varies with the addition of new clients, the mix of payment terms that we offer and the timing of invoicing existing clients.

Cash provided by operating activities for the year ended December 31, 2010 was $120.1 million and consisted of net income of $13.9 million, adjustments for non-cash items of $44.6 million and $61.6 million provided by changes in working capital and non-current assets and liabilities. The change in working capital resulted primarily from an increase in the deferred revenue of $57.7 million. The increase in the deferred revenue is made up of $152.6 million, net of adjustments, billed to our clients offset by revenue recognized of $94.9 million in 2010. The increase in the deferred revenue is due to the significant growth in our membership from 23 clients as of December 31, 2009 to 72 clients as of December 31, 2010.

Cash provided by operating activities for the six months ended June 30, 2010 was $74.7 million and consisted of net income of $6.4 million, adjustments for non-cash items of $19.0 million and $49.2 million provided by changes in working capital and non-current assets and liabilities. The change in working capital resulted primarily from a decrease in accounts receivable of $3.5 million and an increase in deferred revenue of $42.7 million. The increase in deferred revenue during the six months ended June 30, 2010 is attributable to $82.7 million of subscription billings for the period offset by $40.0 million of revenue recognized during the period. The increase in deferred revenue is due to the growth in our membership from 23 clients as of December 31, 2009 to 51 clients as of June 30, 2010.

Cash provided by operating activities for the year ended December 31, 2009 was $17.6 million and consisted of net income of $1.9 million, adjustments for non-cash items of $17.6 million and $1.9 million used by changes in working capital and non-current assets and liabilities. The change in working capital resulted primarily from an increase in the deferred revenue of $4.6 million offset by a decrease in other assets and liability of $6.5 million. The increase in the deferred revenue is made up of $37.4 million of billings, net of adjustments, to our clients offset by revenue recognized of $32.8 million during 2009. The increase in the deferred revenue is due to the growth in our membership from six clients as of December 31, 2008 to 23 clients as of December 31, 2009.

Cash provided by operating activities for the period ended December 31, 2008 was $14.7 million and consisted of net loss of $5.2 million, adjustments for non-cash items of $2.6 million and $17.2 million provided by changes in working capital and non-current assets and liabilities. The change in working capital resulted primarily from an increase in deferred revenue of $16.9 million. The increase in the deferred revenue is made up of $17.7 million, net of adjustments, billed to our clients offset by revenue recognized of $0.8 million during 2008. The increase in the deferred revenue is due to the initial clients signing up during the period.

 

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Cash Flows from Investing Activities

Cash used in investing activities primarily consists of acquisitions of patent assets and purchases of short-term marketable securities classified as available-for-sale. Net cash used in investing activities for the six months ended June 30, 2011 was $86.0 million, of which $43.2 million represented our acquisitions of patent assets and $39.1 million represented our net purchases of short-term marketable securities. In June 2011, we acquired substantially all of the assets of a patent research and intellectual property news provider for $3.0 million. Cash used by investing activities for the year ended December 31, 2010 was $72.4 million, the majority of which represented our acquisition of patent assets for the period. Cash used by investing activities for the six months ended June 30, 2010 was $43.2 million and primarily consisted of our acquisitions of patent assets of $43.0 million. Cash used by investing activities for the year ended December 31, 2009 was $23.5 million and consisted of our acquisition of patent assets of $38.5 million offset by proceeds from the sale of patent assets of $15.0 million for the year. Cash used by investing activities for the period ended December 31, 2008 was $23.2 million, the majority of which represented our acquisition of patent assets for the period.

Cash Flows from Financing Activities

Net cash provided by financing activities for the six months ended June 30, 2011 was $143.7 million. Net cash provided by financing activities during the six months ended June 30, 2011 was due primarily to proceeds from our initial public offering, net of issuance costs of approximately $157.8 million, offset by the repayment of $16.4 million of debt and other obligations. Cash used by financing activities for the year ended December 31, 2010 was $30.0 million, the majority of which represented repayment of our debt obligations, which consist of seller financing for our patent asset acquisitions. Net cash used in the financing activities for the six months ended June 30, 2010 was $20.4 million, the majority of which represented the repayment of debt obligations. Cash provided by financing activities for the year ended December 31, 2009 was $20.6 million, primarily the result of the net receipts of $33.8 million from the sale of Series B convertible preferred stock and the repayment of our debt obligations of $13.3 million for the year. Cash provided by financing activities for the period ended December 31, 2008 was $22.8 million, primarily the result of the net receipts of $10.1 million from the sale of Series A convertible preferred stock and the net receipts of $15.1 million from the sale of Series A-1 convertible preferred stock. These receipts were partially offset by a repayment of our debt obligations of $2.4 million for the period.

Contractual Obligations and Commitments

The following summarizes such contractual obligations and commitments as of December 31, 2010:

 

     Less Than
1 Year
     1 to 3
Years
     3 to 5
Years
     More Than
5 Years
     Total  
     (in thousands)  

Notes payable

   $ 7,579       $      $      $      $ 7,579   

Contractual interest payment on notes payable

     288                              288   

Other obligations(1)

     10,948         5,056                       16,004   

Lease commitments

     1,350         2,118                       3,468   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 20,165       $ 7,174       $      $      $ 27,339   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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The following summarizes such contractual obligations and commitments as of June 30, 2011:

 

     Less Than
1 Year
     1 to 3
Years
     3 to 5
Years
     More Than
5 Years
     Total  
     (in thousands)  

Other obligations(1)

   $ 6,517       $ 1,099       $       $       $ 7,616   

Lease commitments

     737         2,186                         2,923   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 7,254       $ 3,285       $       $       $ 10,539   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) When we obtain seller financing, we typically agree to make an initial payment to the seller when we execute the patent acquisition agreement and to make deferred contractual payments in the future.

Off Balance Sheet Arrangements

On December 12, 2008, in connection with the acquisition of certain patent assets from an unaffiliated third party in an arm’s-length transaction, we agreed to make a one-time payment of $5.0 million in the event that we earn $170.0 million of annual subscription revenues in any calendar year. No provision has been made for this contingency as of June 30, 2011.

On September 10, 2010, we entered into certain agreements with a special-purpose entity formed for the sole purpose of acquiring specific patent assets that had been made available for sale by a third party. If the entity was successful in acquiring the patent assets, we agreed to make a $5.0 million investment in the equity securities of the entity and serve as the exclusive licensing agent for the entity. As of June 30, 2011, the third party had completed the sale of the assets and the special-purpose entity was not the buyer. Therefore, no investment in such entity has been made and we have no further obligations under these agreements.

As of December 31, 2010 and June 30, 2011, we did not have any other relationships with unconsolidated entities or financial partnerships, such as structured finance or special purpose entities, that would have been established for the purpose of facilitating off-balance-sheet arrangements or other contractually narrow or limited purposes.

In the patent sale transactions that we have completed, we agreed to indemnify and hold harmless the buyer for losses resulting from a breach of representations and warranties made by us. The terms of these indemnification agreements are generally perpetual. The maximum amount of potential future indemnification is unlimited. To date, we have not paid any amounts to settle claims or defend lawsuits. We do not indemnify our clients for patent infringement.

In accordance with our amended and restated bylaws and certain contractual obligations, we also indemnify our board of directors and certain officers and employees for certain events or occurrences, subject to certain limits, while the director, officer or employee is or was serving at our request in such capacity. The term of the indemnification period is indefinite. The maximum amount of potential future indemnification is unspecified. We have no reason to believe that there is any material liability for actions, events or occurrences that have occurred to date.

Quantitative and Qualitative Disclosures about Market Risk

Market risk represents the risk of loss that may impact our financial position due to adverse changes in financial market prices and rates. Our market risk exposure is primarily a result of fluctuations in foreign currency exchange rates and interest rates. We do not hold or issue financial instruments for trading purposes.

 

 

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Foreign Currency Exchange Risk

Our subscription agreements are denominated in U.S. dollars, and therefore, our revenue is not currently subject to significant foreign currency risk. Our expenses are incurred primarily in the United States, with a small portion of expenses incurred and denominated in the currencies where our other international offices are located. Our results of operations and cash flows are therefore subject to fluctuations due to changes in foreign currency exchange rates, particularly changes in the Japanese Yen relative to the U.S. dollar. To date, we have not entered into any foreign currency hedging contracts.

Interest Rate Sensitivity

We had cash, cash equivalents and restricted cash of $160.1 million at June 30, 2011. Cash equivalents are primarily invested in bank deposits and money market funds denominated primarily in U.S. dollars. Interest rate fluctuations affect the returns in our invested funds. Our cash balances deposited in U.S. banks are non-interest bearing and insured up to the Federal Deposit Insurance Corporation limits. Cash and cash equivalents are held for working capital purposes and restricted cash amounts are held as security against credit card deposits and various lease obligations.

At June 30, 2011, we also had $39.3 million held in short-term investments, primarily invested in U.S. Government and Agency securities with maturities between 90 days and 13 months. As of June 30, 2011, our investments have been classified as available-for-sale and, consequently, are recorded at fair value in the consolidated balance sheet with unrealized gains or losses reported as a separate component of stockholders’ equity. We review our investments for impairment when events and circumstances indicate a decline in fair value of such assets below carrying value is other-than-temporary. As of June 30, 2011, we have not recorded an impairment related to our investments in the consolidated statement of operations.

If overall interest rates had changed by 10% during the year ended December 31, 2010, the fair value of our investments would not have been materially affected.

Effect of Inflation

We believe that inflation has not had a material impact on our consolidated results of operations for years ended December 31, 2009, December 31, 2010 and the six months ended June 30, 2010 and 2011. There can be no assurance that future inflation will not have an adverse impact on our consolidated results of operations or financial condition.

Fair Value of Financial Instruments

We do not have material exposure to market risk with respect to investments, as our investments consist primarily of highly liquid investments that approximate their fair values due to their short period of time to maturity. We do not use derivative financial instruments.

Recent Accounting Pronouncements

In June 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update (“ASU”) No. 2011-05, “Presentation of Comprehensive Income” (“ASU 2011-05”). ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of shareholders’ equity. Instead, we must report comprehensive income in either a single continuous statement of comprehensive income which contains two sections, net income and other comprehensive income, or in two separate but consecutive statements. ASU 2011-05 does not change

 

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the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. ASU 2011-05 is effective retrospectively for fiscal years, and interim periods within those years, beginning after December 15, 2011. Early adoption is permitted. The adoption of this guidance is not expected to have material impact on our consolidated financial position, results of operations, or cash flows.

In May 2011, the FASB issued ASU 2011-04, “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS” (“ASU 2011-04”). The amendments in ASU 2011-04 result in common fair value measurement and disclosure requirements in U.S. GAAP and IFRS. Consequently, ASU 2011-04 changes the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements. For many of the requirements, the FASB does not intend for the amendments in ASU 2011-04 to result in a change in the application of the requirements in Topic 820. ASU 2011-04 is effective prospectively for interim and annual reporting periods beginning after December 15, 2011. The adoption of this guidance is not expected to have material impact on our consolidated financial position, results of operations, or cash flows.

In December 2010, the FASB issued ASU 2010-29, “Disclosure of Supplementary Pro Forma Information for Business Combinations” (“ASU 2010-29”). ASU 2010-29 amends and clarifies the acquisition date to be used for reporting pro forma financial disclosures when comparative financial statements are presented. In addition, it requires a description of the nature of and amount of any material, non-recurring pro forma adjustments directly attributable to the business combination. ASU 2010-29 is effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. We adopted this amendment effective January 1, 2011. There was no impact on our consolidated financial position, results of operations, or cash flows.

In December 2010, the FASB issued ASU 2010-28, “When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts” (“ASU 2010-28”). ASU 2010-28 modifies Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. In detcsaermining whether it is more likely than not that a goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating that an impairment may exist. The qualitative factors are consistent with existing guidance which requires that goodwill of a reporting unit be tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. This ASU is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2010. We adopted this amendment effective January 1, 2011. There was no impact on our consolidated financial position, results of operations, or cash flows.

 

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BUSINESS

Overview

RPX helps companies reduce patent-related risk and expense. Products and services in today’s economy increasingly incorporate innovative and complex technologies that are subject to a growing number of issued patents. As a result of this technology and patent proliferation, companies of all sizes can face significant challenges managing the risks and expenses arising from claims that their products and services infringe on patents owned by others.

We believe the process by which value is transferred from users to owners of patents lacks key attributes of more developed markets, such as an open exchange to execute transactions, transparent pricing information and broadly accepted standard contract terms. Because an orderly and efficient market for the exchange of patent value has yet to develop, this transfer of value is currently driven by litigation or the threat of litigation. Patent litigation today is a multi-billion dollar industry.

Our patent risk management solution facilitates more efficient exchanges of value between owners and users of patents compared to transactions driven by actual or threatened litigation. The core of our solution is defensive patent aggregation, in which we acquire patent assets that are being or may be asserted against our current and prospective clients. We then license these patent assets to our clients to protect them from potential patent infringement assertions. We believe our solution allows clients to mitigate patent risk at a lower cost than they would be able to achieve through other approaches. We also provide our clients with access to our proprietary patent market intelligence and data. Our solution offers the following benefits to our clients:

 

  Ÿ  

Reduced Risk of Patent Litigation – Clients reduce their exposure to patent litigation because we continuously assess patent assets available for sale and acquire many that are being or may be asserted against our clients or potential clients. Our clients have no litigation risk related to the patent assets that we own.

 

  Ÿ  

Cost-Effective Licenses – Our annual subscription fee is based on a client’s historical financial results and is subject to a cap. Accordingly, our subscription fee is predictable for our clients. We believe our approach to pricing is different than the pricing strategies of traditional patent licensing businesses, which generally negotiate license fees based on the perceived relevance of their various patent portfolios to each licensee. We believe our approach to pricing also provides clients with non-exclusive license rights to our large and growing portfolio of patent assets at a lower cost than they would have paid if these patent assets were owned by other entities.

 

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Reduced Patent Risk Management Costs – Clients can reduce their ongoing patent risk management costs by supplementing their internal resources with our database of information and extensive transaction experience relating to the patent market. We actively monitor the patent market to understand the availability of patent assets for sale or license, the identity of the owners and licensors of these assets, the terms by which they may be available and the technologies to which these assets apply. We also track relevant litigation activity and identify key participants and trends in the patent market. As part of their subscription, our clients have access to this information through our proprietary web portal and through discussions with our client relations team.

Our business model aligns our interests with those of our clients. We do not and will not initiate patent litigation, which enables us to develop strong and trusted relationships with our clients. As a result, our revenue has grown rapidly, from $0.8 million in 2008 to $32.8 million in 2009, $94.9 million in 2010 and $73.2 million for the six months ended June 30, 2011, and we attained profitability in 2009, our first full fiscal year of operations. Our net income increased from a net loss of $5.2 million in 2008

 

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to net income of $1.9 million in 2009, $13.9 million in 2010 and $14.4 million for the six months ended June 30, 2011. As of June 30, 2011, we had a network of 96 clients, including some of the world’s most prominent technology companies, such as Cisco Systems, Inc., Google Inc., Nokia Corporation, Panasonic Corporation, Samsung Electronics Co., Ltd., SAP AG, Sharp Corporation, Sony Corporation and Verizon Communications Inc.

The Market

The United States Constitution empowers Congress “to promote the progress of science and the useful arts by securing for limited times to authors and inventors the exclusive right to their respective writings and discoveries” through the grant of patents. Patent rights are a key component of a knowledge-based economy and are assets that can be bought, sold or licensed. We refer to the market in which participants exchange value related to patents as the “patent market.”

Today, patent litigation is a significant part of the patent market and is a multi-billion dollar industry. Based on our own analysis and data from independent third parties, we estimate that there were patent claims filed against more than 40,000 defendants, including companies that were sued more than one time, in the United States from 2005 through 2010. The costs to defend and resolve a patent litigation claim can vary widely. The costs can range from modest, such as $50,000 for nuisance suits, to substantial, such as tens of millions of dollars or more in the most complex cases. Based on these metrics, we estimate that litigation-related expenses in the patent market totaled tens of billions of dollars in the United States from 2005 to 2010.

Patent litigation risk plagues operating companies of all sizes and has the potential to significantly disrupt business activities and distract from normal business operations. Both large and small companies can be affected by major verdicts or high settlement costs. Smaller companies may also find that the expense associated with defending against a patent assertion can have a significant adverse financial impact. We believe the extensive use of litigation and the threat of litigation prevents efficient transactions between the principal participants in the market: patent owners and operating companies.

Two recent transactions highlight the importance that operating companies place on patents. In July 2011, a consortium of operating companies that includes Apple Inc., EMC Corporation, Ericsson, Microsoft Corporation, Research in Motion and Sony Corporation purchased approximately 6,000 patent and patent applications held by Nortel Telecommunications for $4.5 billion. In August 2011, Google Inc. announced that it is purchasing Motorola Mobility, Inc. for $12.5 billion. Motorola Mobility states that it holds 14,600 patents and 6,700 pending patent applications worldwide.

Monetization of Patents

Historically, the following fundamental attributes of patents have enabled patent monetization:

 

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Patents Provide a Limited Monopoly – In exchange for public disclosure of an invention, a patent owner is granted a monopoly over the use of a patented invention for a specified period, typically 20 years. Patent rights are negative rights, meaning that they generally enable a patent owner to exclude others from commercial exploitation of a patented invention, regardless of whether the patent owner has the resources to manufacture or commercialize the invention.

 

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Patents Confer Negative Rights – As the owner of a negative right, a patent owner has recourse through litigation to prevent others from using, making or selling the patented invention. Even when the patented invention is only a component of a broader product or service, the negative right can be enforced against any product or service that incorporates the component.

 

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  Ÿ  

Patents May Be Licensed – A patent owner can authorize use of the patented invention by one or more parties, typically in exchange for licensing fees.

 

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Patents Are Assets That Can Be Transferred – A patent can be sold, in which case the negative right and monopoly associated with the patented invention are transferred to the buyer. When a patent is sold, the buyer’s negative rights are constrained by licenses granted by previous owners.

More recently, several developments have increased opportunities for patent monetization and created an environment that is more favorable to investing in patents for the purpose of generating financial returns. These developments include:

 

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Improved Search Capabilities – The entire database of United States patents is now searchable on the Internet, enabling patent investors to quickly identify patents and their owners. The Internet also makes it much easier for patent owners to identify and research products and services that may relate to their patents.

 

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Increasing Rate of Issuance of Technology Patents – From 1991 through 2000, 303,220 patents were issued with class code identifiers that we classify as technology-related patents. From 2001 through 2010, 682,086 patents were issued in the same class codes.

 

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Overlap of Technology Patents – Because inventors can patent incremental improvements to existing inventions, multiple patents can apply to single components of a product or service. Consequently, multiple patent owners may seek to extract license fees related to a single product or service. One example of this overlap of patents is semiconductor technology known as DRAM. Today, there are over 6,200 issued United States patents with “DRAM” specifically listed as a claim element. These DRAM patents span design, fabrication, testing and component technology including dies, capacitor, memory cells, transistors, integrated circuits, substrates and packaging. Each of those aspects may be covered by multiple patents that could be infringed by a DRAM semiconductor device or downstream product. Potential infringement of these patents could occur by anyone who makes, uses or sells a product using this technology.

 

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Technology Convergence – Modern products and services incorporate numerous technology components. The evolution of mobile devices provides an example. Based on our research, we believe there are more than 250,000 active patents relevant to today’s smartphones, a significant increase compared to our estimate of approximately 70,000 patents that were active and relevant to mobile phones in 2000. This growth can be attributed to the expanded set of features and functionality incorporated in today’s smartphones, including touchscreens, internet access, streaming video, media playback, application store readiness and other web-based services, and WiFi connectivity options.

 

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More Companies Employing Patented Technologies – A growing number of companies, including non-technology companies, make, use and sell products or services that utilize patented inventions. For example, consumer banks now offer online bill pay as a standard feature, which relies on complex technologies that may be subject to many patents.

 

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Specialized Appellate Court for Patent Cases – The United States Court of Appeals for the Federal Circuit was created in 1982 to serve as the central appellate venue for patent-related cases. We believe this centralization of patent-related appeals has resulted in a more uniform application of patent law. In addition, various federal district courts have adopted patent-specific rules of procedure to facilitate patent litigation. These factors have created a more attractive environment for patent assertions.

All of these developments have caused significant capital to flow to companies specifically formed to acquire and monetize patent assets.

 

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Emergence and Growth of NPEs

NPEs do not create or sell products or services, but instead exist to monetize patents through licensing and litigation. Some NPEs obtain patents through their own research and development efforts, while others accumulate patents through acquisitions. NPEs have become a major factor in the patent market and an important source of liquidity for patent owners.

Operating companies can incur significant costs to defend themselves against patent assertions by NPEs. At a minimum, companies faced with an assertion must respond to the assertion letter and evaluate the patents being asserted. If the assertion proceeds to trial, costs grow substantially. NPEs generally do not create or sell their own products or services and therefore are not susceptible to counter assertion, a common defensive strategy in patent disputes between operating companies.

We believe the annual costs incurred by operating companies to defend and resolve patent infringement cases initiated by NPEs are currently in the billions of dollars. Based on our internal analysis, we believe there were over 600 patent infringement cases filed by NPEs in 2010 against more than 4,000 defendants, which comprised over 2,000 unique companies, some of which were sued more than once. Most cases are resolved prior to trial but still result in significant defense and settlement costs. For cases that reached summary judgment or trial, a study of over 1,500 final decisions found that damages awarded to NPEs had a median value of $12.9 million during 2002-2009.

We believe that the amount of capital raised by NPEs is currently in the billions of dollars. Some of the large awards and settlements received by NPEs have resulted in extensive media coverage, contributing to a significant influx of capital into the patent market. PatentFreedom, a patent information research organization, has identified and profiled over 380 distinct NPEs as of January 1, 2011. In addition, many individual inventors and universities are also using litigation to monetize patents.

Challenges for Operating Companies

The recent developments in the patent market and the increased activity of NPEs create challenges for operating companies in managing patent risk. We believe the process by which patent value is transferred lacks key attributes of more developed markets. These missing attributes include (i) an open exchange to execute transactions, (ii) transparent pricing information and (iii) incentives that encourage outcomes driven by economic factors rather than legal considerations.

 

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No Open Exchange for Executing Transactions – There is no forum or exchange in the patent market where market participants can openly indicate interest in patent assets, observe the interests of others and engage in an efficient price discovery process. As a result, interactions between market participants are generally limited to one-on-one discussions between patent owners and potential patent users that are not visible to other participants in the market. This market structure inhibits the ability of operating companies to share resources and pool risks to mitigate their exposure to patent assertions.

 

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Difficulty of Assessing Patent Value – The relevance of a patent to the products or services of a specific operating company is subject to interpretation. This interpretation can lead to large differences in the perceived value of a patent. While pricing transparency has developed for other unique and hard-to-value assets, such as real estate and art, this development has not yet occurred in the patent market. The lack of pricing transparency in the patent market means there is very limited historical data related to patent transactions, and we believe this lack of historical transaction data contributes to the use of litigation to resolve differences regarding the applicability and value of patents.

 

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  Ÿ  

Litigation-Based Incentives – Many transactions in the patent market are based on actual or threatened litigation, particularly when the patent owner is an NPE. The adversarial context of such negotiations can create agency conflicts, as defense counsel typically earn greater fees when litigation proceedings are prolonged. The prevalence of litigation in the patent market also inhibits information sharing and adds to the inefficiencies in the market. For example, we believe operating companies often avoid expressing interest in patents because doing so may alert patent owners that the operating companies perceive risk related to those patents, which in turn may encourage the patent owner to initiate litigation.

Faced with these challenges, operating companies have employed several alternatives to mitigate their risk of patent infringement claims. The approaches employed by operating companies generally involve unilateral actions and are expensive, time consuming and difficult to implement effectively. The most common approaches include:

Proactive Approaches

 

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Acquire Licenses to Relevant Patents – Operating companies can approach patent owners before litigation and attempt to obtain a license to patents they deem relevant to their products or services. Given the large volume of patents that may need to be licensed to cover an operating company’s products or services, this approach is often not economically viable.

 

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Develop an Internal Patent-Buying Program – Operating companies can acquire relevant patents through direct negotiation with patent owners. Although this approach has the potential to reduce the risk of patent infringement assertions, it generally requires a significant investment of time and resources to identify and attempt to acquire the relevant patents. In addition, for the operating company to acquire the patent, it must pay enough to compensate the patent owner for foregoing opportunities to monetize the patent from other companies, which makes this approach expensive.

 

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Organize a Patent Acquisition Consortium – Some operating companies have tried to overcome the difficulties of acquiring patent assets individually by organizing a consortium to purchase patent assets relevant to multiple operating companies. We believe the effectiveness of this approach is limited, as operating companies are reluctant to cooperate and share information with current and potential competitors.

Reactive Approaches

 

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Settle Rapidly – When patents are asserted against operating companies, defendants may attempt to reduce their legal costs and remove the risk of a large adverse verdict by quickly reaching a settlement. However, by offering to settle, operating companies may signal that they perceive significant risk from the patent, potentially impair their litigation defense strategy and possibly establish themselves as easy targets for future assertions.

 

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Defend Vigorously – Operating companies may elect to pursue a “fight hard” strategy in which they forego early settlement and proceed through litigation or patent re-examination. Operating companies pursuing this strategy may do so in order to establish reputations as difficult targets. However, litigation may lead to large adverse verdicts and settlements that attract attention to an operating company as a potentially lucrative target. This strategy also requires spending considerable time and resources on litigation, which can be distracting to management, customers and investors.

Our Solution and Benefits to Our Clients

We have pioneered an approach to help operating companies mitigate and manage patent risk and expense by serving as an intermediary through which they can participate more efficiently in the

 

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patent market. Operating companies that join our network pay an annual subscription fee and gain access to our patent risk management solution. The subscription fee is based on a capped fee schedule that is tied to a client’s revenue or operating income and remains in place over the life of a membership, with adjustments limited to Consumer Price Index increases. By offering a fee schedule that does not change based on our patent asset acquisitions, we divorce the amount of fees charged from the value of our patent assets. We believe our pricing structure creates an alignment of interests with our clients, allowing us to be a trusted intermediary for operating companies in the patent market.

Defensive Patent Aggregation

The core of our solution is defensive patent aggregation, in which we acquire patent assets that are being or may be asserted against our current and prospective clients. We then license these assets to our clients to protect them from potential patent infringement assertions. As of June 30, 2011, we had deployed over $300 million to acquire our portfolio of patent assets. We acquire patent assets from multiple parties, including operating companies, individual inventors, NPEs and bankruptcy trustees. We also acquire patent assets in different contexts, including when they are made available for sale or license by their owners or to resolve threatened or pending litigation against our clients or prospective clients.

We have not asserted and will not assert our patents. We have never initiated patent infringement litigation, and our clients receive guarantees that we will never assert patents against them. We consider this guarantee to be of paramount importance in establishing trust with our clients. In addition, because we are not at risk from infringement claims, we are able to engage in more transparent discussions regarding the value of patent assets with patent owners. Our ability to engage in transparent discussions with both operating companies and patent owners allows us to act as an effective intermediary between participants in the patent market. As a result, we provide a conduit through which value can flow between market participants at lower transaction costs than is typically the case when patents are monetized through litigation or the threat of litigation.

As a part of our solution, we provide extensive patent market intelligence and data to our clients. Clients can access this market intelligence and data through our proprietary web portal and through discussions with our client relations team. This market intelligence and data helps our clients better understand past and potential patent acquisition transactions, relevant litigation activity and key participants and trends in the patent market.

Benefits to Our Clients

In general, operating companies join our network to reduce their risk of patent litigation and the expected costs associated with patent risk management. In exchange for an annual subscription fee, which in some instances has been less than the costs associated with a single patent assertion, our clients gain access to the following benefits:

 

  Ÿ  

Reduced Risk of Patent Litigation – Clients reduce their exposure to patent litigation because we continuously assess patent assets available for sale and acquire many that are being or may be asserted against our clients or potential clients. Our clients have no litigation risk related to the patent assets that we own.

 

  Ÿ  

Cost-Effective Licenses – Our annual subscription fee is based on a client’s historical financial results and is subject to a cap. We believe our approach is different than the pricing strategies of traditional patent licensing businesses, which generally negotiate license fees based on the perceived relevance of their various patent portfolios to each licensee. We believe our approach to pricing also provides clients with non-exclusive license rights to our large and growing portfolio of patent assets at a lower cost than they would have paid if these patent assets were owned by other entities.

 

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  Ÿ  

Reduced Patent Risk Management Costs – Clients can reduce their ongoing patent risk management costs by supplementing their internal resources with our database of information and extensive transaction experience relating to the patent market. We actively monitor the patent market to understand the availability of patent assets for sale or license, the identity of the owners and licensors of these assets, the terms by which they may be available and the technologies to which these assets apply. We also track relevant litigation activity and identify key participants and trends in the patent market. As part of their subscription, our clients have access to this information through our proprietary web portal and through discussions with our client relations team.

Our Competitive Strengths

We have pioneered a patent risk management solution focused on reducing patent-related risk and expense for operating companies. We believe we are the only for-profit company approaching patent risk management from this perspective. Our business model incorporates attributes that we believe provide us with key competitive strengths.

 

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Alignment of Interests With Our Clients – Our business model aligns our interests with those of our clients. We have not asserted and will not assert our patents. We generate revenue from subscription fees that are based on our published fee schedule rather than the value of the patent assets we acquire or the potential costs associated with defending against assertions related to our patent assets. As a result, we have relationships with our clients that are based on trust, enabling them to communicate with us without concern that the information shared will be used against them.

 

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Network Effect – As we add new clients, we generate new subscription fees that can be used to fund additional acquisitions of patent assets. These acquisitions enable us to further add new clients and to deliver greater value to our existing clients.

 

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More Transparent Valuation Discussions – Most participants in the patent market either assert patents or face patent assertions. Because we do not assert patents and are not likely to have patents asserted against us, we are able to have more open and transparent discussions about the value of patent assets than other market participants whose discussions are directly affected by litigation or the threat of litigation.

 

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Patent Market Expertise – Since our inception, we have been refining our processes for identifying potentially valuable patent assets, analyzing and evaluating those assets and executing transactions to acquire rights to those assets. We have developed an extensive set of skills, relationships, historical transaction data and methodologies for valuing patent assets.

Our Strategy

Our mission is to transform the patent market by establishing RPX as the essential intermediary between patent owners and operating companies. Our strategy is to take advantage of the network effect of our business model by pursuing the following:

 

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Growing Our Client Network – We intend to grow our client network by continuing to develop relationships with companies that have experienced NPE-initiated patent litigation and continuing to demonstrate the value of our patent risk management solution.

 

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Acquiring Additional Patent Assets – We intend to continue to acquire patent assets that are being or may be asserted against current and prospective clients and to increase our role and expertise in the patent market. We believe our disciplined approach to valuing and acquiring patent assets will allow us to continue to deploy our capital in an efficient and effective manner to maximize the patent risk management benefits to our clients.

 

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Enhancing Client Relations – We intend to continue to enhance our client relations team to ensure we deliver the highest levels of service and support to our clients, which we expect will drive client satisfaction and assist in our efforts to retain clients as their subscription agreements come up for renewal. In addition, we intend to enhance our proprietary web portal to provide our clients with the most current intelligence and data on patent acquisition opportunities, relevant litigation activity and key participants and trends in the patent market.

 

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Providing Additional Solutions – We believe we can generate additional sources of revenue by offering complementary solutions that further mitigate patent risks and expenses for operating companies. We intend to develop new solutions that will increase the value we provide for our current and prospective clients. For example, we are taking steps to establish a risk retention group that will offer insurance to our clients to help manage their exposure to patent infringement claims brought by NPEs. We also intend to facilitate joint defense agreements and cross-licensing arrangements among our clients. A joint defense agreement is an agreement among multiple defendants in a lawsuit to appoint one legal counsel or group of legal counsel to represent multiple defendants. A cross-licensing arrangement is an agreement among two or more parties to license some or all of their patent portfolios to each other.

 

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Enhancing Our Capabilities Through Acquisitions – We intend to evaluate the acquisition of businesses and technologies that can enhance our capabilities and our patent risk management solution.

Our Client Network

We have built a network of clients that includes some of the world’s most prominent technology companies, as well as many smaller and emerging companies. Our client network has grown rapidly since our inception, with six client additions in 2008, 17 in 2009, 49 in 2010 and 24 in the first six months of 2011. As of June 30, 2011, we had 96 clients.

We believe our patent risk management solution is broadly applicable to companies that design, make or sell technology-based products and services as well as to companies that use technology in their businesses. Our clients are active in a broad range of industries including consumer electronics, personal computers, e-commerce, software, media content and distribution, mobile communications and handsets, networking and semiconductors.

New Client Acquisitions

Our membership team identifies potential clients by prioritizing operating companies that have been subject to patent infringement claims initiated by NPEs. The membership team is responsible for educating potential clients on the benefits of our solution and explaining how our solution mitigates patent risk and expense. After we have communicated our business model to a prospective client, we invest considerable resources learning about the company’s business, providing information about the patent market and developing a relationship of trust with the executives responsible for patent-related matters. We also proactively monitor litigation activity related to each of our clients and certain prospective clients to help us direct our patent asset acquisition and membership sales efforts. In addition, we conduct a variety of marketing efforts to establish ourselves as a leading source of information in the patent market, including industry conferences and seminars, public relations and industry research.

Client Retention and Client Relations

After a company has become a client, the maintenance of the relationship is handled by our client relations team. One of the primary responsibilities of our client relations team is to maintain frequent

 

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dialogue with senior executives of our clients so we can better understand their patent risk profiles. Our continued success and our ability to retain clients depends on our ability to demonstrate that our patent risk management solution enables clients to avoid costs that, in aggregate, exceed their subscription fees. We refer to this concept as return on investment, or ROI.

Our client relations team also provides clients with patent market intelligence, updates on our patent asset acquisitions and assessments of the ROI delivered over the term of their memberships. We provide this information through direct discussions with our clients and also share information with them through our proprietary web portal. We believe our frequent interactions allow us to optimize our patent asset acquisition decisions, which lead to a more compelling ROI for our clients, thus supporting our client retention efforts.

Subscription Fees and Agreements

We charge our clients an annual subscription fee according to a published fee schedule that is independent of the value of our patent portfolio. We calculate each client’s subscription fee using its fee schedule and its normalized operating income, or NOI, which we define as the greater of (i) 5% of the client’s most recently reported fiscal year’s revenue and (ii) the average of the three most recently reported fiscal years’ operating income of the client. Each client’s annual subscription fee is reset yearly based on its revenue and operating income for its most recently completed fiscal years. The fee schedule is effective for the term of each client’s initial agreement and for all renewal terms, subject to our limited ability to make adjustments based on the Consumer Price Index. Our current fee schedule has a subscription fee ceiling of $6.6 million and floor of $60,000. In some circumstances, we may offer a discount to our fee schedule to encourage multi-year commitments, referrals of new clients or for other client-specific reasons. As of June 30, 2011, the terms of our subscription agreements ranged from one to five years, but were more commonly two or three years. As of June 30, 2011, the weighted-average length of our then-outstanding subscription agreements was 2.8 years.

Upon initial subscription, to the extent that we are contractually able, clients receive a term license for the period of their membership to, and a release from all prior damages associated with, patent assets in our portfolio. In addition, clients receive term licenses to substantially all of the patent assets we acquire during the period of their membership. Our subscription agreements also include a vesting provision that converts a client’s term licenses into perpetual licenses on a delayed rolling basis as long as the company remains an RPX client. Accordingly, clients who continue to subscribe to our solution receive perpetual licenses to an increasing number of our patent assets over time. For example, if a client has a vesting term of three years, on the third anniversary of becoming a client, the client will receive a perpetual license for all of the patent assets we held as of the date of such client’s original subscription. On each day thereafter, so long as the company continues to be a client, it will vest and receive a perpetual license for those patents that we held three years prior to such date. Under this example, when the company has been an RPX client for four years, the company will hold a term license on patent assets we acquired in the last three years and a perpetual license for patent assets we acquired prior to the last three years. Each client’s agreement specifies the vesting period that applies for all licenses granted to such client. Our early client agreements provided for either two or three year vesting. In 2011 we began introducing three year vesting in all new client agreements. We believe this vesting arrangement provides a compelling incentive for clients to renew their subscriptions.

Clients also receive a limited right to purchase our patents for defensive purposes in the event of a patent infringement suit brought against a client by a third party. If a client elects to exercise such right, the client may not license the patent to anyone other than the plaintiff in the patent infringement suit. After the final adjudication or settlement of the litigation, we have a right to repurchase the patent

 

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at a fixed price, as specified in the client’s subscription agreement. When a patent is acquired by a client pursuant to this defensive option, each of our other clients receives an immediate perpetual license to the patent.

Our Patent Asset Portfolio and Patent Asset Acquisition Strategy

We acquire patent assets that are being or may be asserted against current or prospective clients. As of June 30, 2011, we had deployed over $300 million to assemble a portfolio of patent assets. As of June 30, 2011, approximately one-third of our patent assets, based upon acquisition price, were acquired from brokers or other entities seeking to sell patent assets, while the balance were acquired out of litigation. The substantial majority of our over 65 acquisitions through June 30, 2011 involved patent assets that we believed were relevant to multiple clients and/or prospective clients and were funded with our own capital resources, which consist of equity financing, subscription fee collections and seller financing. For the period from inception through June 30, 2011, the Company’s patent asset acquisition efforts were broadly diversified across the following market sectors: consumer electronics and personal computers; mobile communications and devices; semiconductors; e-commerce and software; and networking.

We apply a disciplined and proprietary methodology to valuing patents that is based primarily on our judgment regarding the costs our clients might incur from potential assertions of those patents if we were not to acquire them. A number of factors are involved in our valuation methodology, including the degree to which patent claims may describe technologies incorporated in clients’ products or services, the revenues our clients generate from products or services potentially affected by the patents, the extent to which the patents would be attractive to NPEs, and the legal quality of the patents and their likely validity. As part of our approach, we also consider the degree to which we have already acquired patent assets that were being or may be asserted against each of our clients.

Because each acquisition of a patent asset may create value for more than one client, we believe our acquisitions of patent assets create a network effect: the more patent assets we acquire results in greater patent risk mitigation for our clients, which we believe leads to greater opportunities to retain and grow our membership base.

Our patent analysts, members of our acquisitions team and our acquisitions committee employ a rigorous and disciplined approach to evaluate acquisition opportunities. When considering the acquisition of patent assets outside the context of an assertion or litigation, the key steps in this process include:

 

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Initial Screen – A patent analyst reviews the basic patent information to form a general assessment of the portfolio’s alignment with current and prospective client interests.

 

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Detailed Review – If the opportunity passes through the initial screen, a patent analyst reviews, analyzes and assesses the key independent claims of each patent being considered, materials provided by the seller and the possible assertion threat to our current and prospective clients. Our acquisitions team and patent analysts meet weekly to discuss and determine which potential acquisitions will advance to the next step of the evaluation process.

 

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Valuation Analysis – For potential acquisitions that pass the detailed review, our acquisitions team employs our proprietary valuation methodology to determine the maximum value at which we can support an acquisition.

 

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Acquisitions Approval Committee Review – The acquisitions approval committee, composed of members of our senior management, meets regularly to consider the acquisition of patent assets that have passed all prior screens. The committee reviews the patent and valuation analyses and considers the effect of the potential acquisition on our operating results prior to approving the pricing terms of any potential offer.

 

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  Ÿ  

Negotiation and Closing – Following the approval of a bid amount and other acquisition terms, the acquisitions team makes an offer and negotiates to close a transaction. Once there is agreement with the seller regarding price and other terms, the acquisitions team coordinates extensive confirmatory diligence, which may include the completion of a detailed title review.

In situations where patents are already being asserted or litigated against our current or prospective clients, the evaluation process begins with the second step, our detailed review.

In some circumstances, we may consult with third-party experts to supplement our evaluation efforts, though our use of these consultants is not significant to our overall expenses and operation. Depending on the value of the transaction, the complexity of the evaluation process, the number of patent assets in the portfolio and the quality of the information provided by the seller, the patent acquisition process can range from as short as several weeks to more than six months.

We believe our position as a leading acquirer of patent assets gives us extensive access and visibility into the patent market. We closely track patent assets that become available on the market and, as of June 30, 2011, we had reviewed more than 2,500 patent portfolios since our inception. We believe our position in the market gives us direct access to a diverse group of patent sources, including brokers, individuals, companies, universities and law firms, all of which are familiar with our approach and acquisition criteria. We believe this familiarity provides us early notice of patent portfolios that are entering the market.

Competition

In our efforts to attract new clients and retain existing clients, we compete primarily against established patent risk management strategies within those companies. Companies employ a variety of other strategies to attempt to manage their patent risk, including internal buying or licensing programs, cross-licensing arrangements, patent-buying consortiums or other patent-buying pools and engaging legal counsel to defend against patent assertions. As a result, we spend considerable resources educating our existing and prospective clients on the potential benefits of our solution and the value and cost savings it may provide.

In addition to competing for new clients, we also compete to acquire patent assets. Our primary competitors in the market for patent assets are other entities that seek to accumulate patent assets, including NPEs such as Acacia Research, Altitude Capital Partners, Coller IP, Intellectual Ventures, Millennium Partners, and Rembrandt IP Management, along with patent-buying consortiums such as Allied Security Trust. We also face competition for patent assets from operating companies, including current or potential clients of RPX, that seek to acquire patents or license patent assets in connection with new or existing product offerings.

We believe we compete favorably based on a number of factors:

 

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our alignment of interest and strong relationships with our clients resulting from our pricing structure and guarantee never to assert our patent assets against our clients;

 

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our ability to reduce the costs associated with patent market transactions by engaging in more transparent discussions based on the economic value of patent assets rather than discussions involving litigation or the threat of litigation;

 

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our ability to increase efficiency and expand our role in the patent market as our client network and capital available for patent asset acquisitions grows; and

 

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our extensive patent market expertise, relationships and transaction experience.

 

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Nevertheless, many of our competitors and potential competitors have longer operating histories, greater name recognition, larger customer or membership bases and significantly greater financial, research, sales and marketing and other resources than we have. We expect to face additional competition from other established and emerging companies in the future.

Intellectual Property

We rely primarily on a combination of confidentiality, license and other contractual provisions and trademark, trade secret and copyright law to protect our proprietary intellectual property rights. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy or obtain and use our technology. We rely on a dedicated internal team as well as third party vendors and advisors to assist with the maintenance and prosecution of the patent assets and applications that we acquire.

Legal Proceedings

We are currently not party to any material legal proceedings. We may from time to time become involved in litigation relating to claims arising from our ordinary course of business. These claims, even if not meritorious, could result in the expenditure of significant financial and managerial resources.

Employees

As of June 30, 2011, we had 81 employees. Of the total employees, 22 are engaged in sales, marketing and corporate development, 22 in patent acquisition and research and 37 in finance, administration and operations. None of our employees is represented by a labor union, and we consider current employee relations to be good.

Facilities

We currently lease approximately 29,585 square feet of office space in two locations in San Francisco, California pursuant to leases that expire in April 2013. We have also signed a lease for an additional 31,887 square feet of office space in San Francisco, California that expires in April 2013. We also maintain sales offices in Japan and Finland. We believe that our current facilities are suitable and adequate to meet our current needs and we intend to add new facilities or expand existing facilities as we add employees. We believe that suitable additional or substitute space will be available as needed to accommodate expansion of our operations.

 

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MANAGEMENT

Executive Officers, Key Employees and Directors

The following table provides information regarding our executive officers, key employees and directors:

 

Name

   Age     

Position(s)

John A. Amster

     42       Chief Executive Officer; Director

Geoffrey T. Barker

     49       Chief Operating Officer; Director

Eran Zur

     43       President; Director

Adam C. Spiegel

     48       Chief Financial Officer; Senior Vice President, Finance; Treasurer

Mallun Yen

     41       Executive Vice President

Henri Linde

     53       Senior Vice President; General Manager

Paul Reidy

     50       Senior Vice President

Izhar Armony

     48       Director (1)

Shelby W. Bonnie

     47       Director (2) (3)

Randy Komisar

     57       Director (1)

Sanford R. Robertson

     80       Director (3)

Thomas O. Ryder

     67       Director (2) (3) (4)

Giuseppe Zocco

     45       Director (1) (2)

 

(1) Member of our Nominating and Corporate Governance Committee.
(2) Member of our Audit Committee.
(3) Member of our Compensation Committee.
(4) Lead independent director. Our board of directors does not have a Chairman.

John A. Amster, age 42 and a founder of our company, has served as our Chief Executive Officer since March 2010, our Co-Chief Executive Officer from our inception until March 2010 and a director since our inception. Prior to founding our company, Mr. Amster served as the General Manager of Strategic Acquisitions and Vice President of Licensing at Intellectual Ventures, a patent licensing firm, where he was responsible for strategic acquisitions of patent portfolios as well as developing the software and e-commerce licensing programs, from 2005 to 2008. From 2003 to 2004, Mr. Amster served as Managing Director and founded the M&A Advisory practice for Ocean Tomo, an intellectual property and brokerage firm. From 1998 to 2003, Mr. Amster served in various positions, most recently as Vice President and Secretary, at InterTrust Technologies, where he worked on intellectual property transactions, merger and acquisition activities and late-stage financing activities. Mr. Amster received a J.D. from Benjamin N. Cardozo School of Law and a B.A. from Middlebury College. Our board of directors determined that Mr. Amster should serve as a director based on his position as an officer of our company, his history as one of our founders and largest stockholders and his experience in the fields of intellectual property and law.

Geoffrey T. Barker, age 49 and a founder of our company, has served as our Chief Operating Officer since March 2010, our Co-Chief Executive Officer from our inception until March 2010 and a director since our inception. Prior to founding our company, Mr. Barker served as Vice President, Licensing at Intellectual Ventures, where he was responsible for the portfolio development and licensing strategy of its software patent portfolio from 2006 to 2008. From 2000 to 2006, Mr. Barker served as founder, Chairman and CEO of Vigilos, Inc., which provided a platform for controlling and

 

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managing the physical security systems of large enterprises. Prior to founding Vigilos, Mr. Barker was co-founder and co-CEO of The Cobalt Group from 1995 to 2000. Prior to that, Mr. Barker held positions in trading, research and investment banking with Kidder, Peabody & Company, Salomon Brothers Inc and Piper Jaffray Incorporated. Mr. Barker received an M.B.A. from Columbia University and a B.A. in Economics from Tufts University. Our board of directors determined that Mr. Barker should serve as a director based on his position as an officer of our company, his history as one of our founders and largest stockholders and his experience in the fields of technology, finance and intellectual property.

Eran Zur, age 43 and a founder of our company, has served as our President and a director since our inception. Prior to founding our company, from 2002 to 2008, Mr. Zur was a partner at the boutique IP firm Hoffman & Zur, which assisted patent holders in monetizing their patents, including developing and implementing licensing and enforcement programs and conducting patent sale negotiations. From 1998 to 2002, Mr. Zur joined a team that designed and implemented the licensing program of the Lemelson Medical, Education & Research Foundation, LP, a leading patent licensing program. Mr. Zur obtained his law degree, with honors, from the University of Leeds, England, and has a post-graduate degree in International Trade Law from the University of Arizona. Our board of directors determined that Mr. Zur should serve as a director based on his position as an officer of our company, his history as one of our founders and largest stockholders and his experience in the fields of intellectual property and law.

Adam C. Spiegel, age 48, has served as our Chief Financial Officer and Senior Vice President, Finance since March 2010, our Senior Vice President, Finance and Administration from February 2010 until March 2010, our Interim Chief Financial Officer from August 2009 through March 2010 and our Vice President, Corporate Development from March 2009 until August 2009. From September 2006 until December 2008, Mr. Spiegel served as Chief Financial Officer of Vectrant Technologies Inc., an early stage molecular diagnostic company. Previously, Mr. Spiegel advised a wide variety of technology, financial services and industrial companies in complex capital markets financing and advisory assignments while serving as an investment banker at Credit Suisse and Prudential Securities. Mr. Spiegel holds a B.S. in Electrical Engineering from the University of Pennsylvania and an M.B.A. from the Anderson School at UCLA.

Mallun Yen, age 41, has served as our Executive Vice President since November 2010. Prior to joining us, Ms. Yen served as Vice President of Worldwide Intellectual Property and Deputy General Counsel from 2002 to 2010, at Cisco Systems, Inc. where she was responsible for developing and implementing the company’s strategy to protect, enhance, defend and capture the value of its intellectual property. Ms. Yen received her B.S. from California Polytechnic State University, San Luis Obispo and her J.D. from UC Berkeley School of Law, Boalt Hall.

Henri Linde, age 53, has served as our Senior Vice President and General Manager since November 2010, our Vice President and General Manager, Memberships from April 2010 to October 2010 and our Vice President, Memberships from September 2008 to March 2010. Prior to joining us, Mr. Linde was President Americas at Actimagine Corp, a video software development company from 2007 until 2008. From 1994 to 2007, Mr. Linde was Vice President, Intellectual Property & Licensing at Thomson S.A., now called Technicolor SA, where Mr. Linde was responsible for licensing and business development programs. Mr. Linde received his B.B.A. from Nyenrode, the Netherlands School of Business.

Paul Reidy, age 50, has served as Senior Vice President since January 2011 and our Vice President, Memberships from March 2010 until January 2011. Prior to joining us, from April 2007 to March 2010, Mr. Reidy served as Vice President at Intellectual Ventures where he was responsible for Intellectual Ventures’ patent portfolio related to information technology hardware, including semiconductors and systems. Prior to joining Intellectual Ventures, from April 2004 to March 2007,

 

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Mr. Reidy served as Vice President of Corporate Business Development and Licensing for Freescale Semiconductor, Inc. Mr. Reidy also served as Director of Intellectual Property Licensing at Motorola, Inc. from September 2002 until April 2004. Mr. Reidy co-founded and served as CEO of Traq Wireless, Inc. from July 1999 until November 2001. Mr. Reidy holds a J.D./M.B.A. from Indiana University and a B.A. in Economics from Michigan State University.

Izhar Armony, age 48, has been a director of our company since August 2008. Mr. Armony has been a general partner at Charles River Ventures, a venture capital investment firm, since 1997. Prior to joining Charles River Ventures, Mr. Armony was with Onyx Interactive, an interactive training company based in Tel Aviv where he served as Vice President of Marketing and Business Development. Mr. Armony also served as an officer in the Israeli Army. Mr. Armony has been a director of Virtusa Corporation since 2004 and also serves as a director of a number of privately held companies. Mr. Armony received an M.B.A. from the Wharton School of Business and an M.A. in Cognitive Psychology from the University of Tel Aviv in Israel. Our board of directors determined that Mr. Armony should serve as a director based on his extensive experience in the technology industry and venture capital, as well as his relationship with Charles River Ventures, one of our largest stockholders.

Shelby W. Bonnie, age 47, has been a director of our company since January 2011. Mr. Bonnie is the CEO of Whiskey Media LLC, a position he has held since June 2007. Previously, Mr. Bonnie was a co-founder of CNET Networks, Inc. and was at CNET Networks, Inc. as both an executive and member of the board of directors from 1993 to 2006, including as Chief Executive Officer from March 2000 until October 2006. Prior to joining CNET Networks, Inc., Mr. Bonnie held positions at Tiger Management Corporation, a New York-based investment management firm, Lynx Capital, a private equity fund, and Morgan Stanley & Co. Inc. Mr. Bonnie received a B.S. in Commerce from the University of Virginia and an M.B.A. from Harvard Business School. Our board of directors determined that Mr. Bonnie should serve as a director based on his extensive experience in the technology industry, as well as his skills relating to financial statement and accounting matters.

Randy Komisar, age 57, has been a director of our company since August 2008. Mr. Komisar has been a partner at Kleiner Perkins Caufield & Byers, a venture capital investment firm, since 2005. Prior to joining Kleiner Perkins Caufield & Byers, Mr. Komisar worked with entrepreneurs creating businesses in the technology industry. Mr. Komisar was a director of TiVo Inc. from 1998 to 2010. During the past five years, Mr. Komisar has also been a director of a number of privately held companies. Mr. Komisar received a J.D. from Harvard Law School and a B.A. in Economics from Brown University. Our board of directors determined that Mr. Komisar should serve as a director based on his extensive experience in the technology industry and venture capital, as well as his relationship with KPCB Holdings, Inc., one of our largest stockholders.

Sanford R. Robertson, age 80, has been a director of our company since May 2011. Mr. Robertson has been a partner of Francisco Partners, a technology buyout fund, since 1999. Prior to founding Francisco Partners, Mr. Robertson was the founder and chairman of Robertson, Stephens & Co., a technology investment bank formed in 1978 and sold to BankBoston in 1998. Since the sale, Mr. Robertson has been a technology investor and advisor to several technology companies. Mr. Robertson was also the founder of Robertson, Colman, Siebel & Weisel, later renamed Montgomery Securities, another technology investment bank. Mr. Robertson also serves on the boards of directors of Dolby Laboratories, Inc., Pain Therapeutics, Inc., salesforce.com, inc. and the Schwab Charitable Fund. Mr. Robertson received a B.B.A. and an M.B.A. from the University of Michigan. Our board of directors determined that Mr. Robertson should serve as a director based on his extensive experience in investment banking, private equity and capital markets transactions in the technology industry, as well as his service on the boards of other publicly-held companies.

 

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Thomas O. Ryder, age 67, has been a director of our company since December 2009. Mr. Ryder has been a director of Starwood Hotels & Resorts Worldwide, Inc. since April 2001, Amazon.com, Inc. since November 2002 and Quad/Graphics, Inc. since July 2010 and was Chairman of the board of directors at Virgin Mobile USA, Inc. from October 2007 to November 2009. Mr. Ryder was Chairman of the Reader’s Digest Association, Inc. from April 1998 to December 2006 and was its Chief Executive Officer from April 1998 to December 2005. Mr. Ryder received a B.A. in Journalism from Louisiana State University. Our board of directors determined that Mr. Ryder should serve as a director based on his experience as a senior executive of a large company, including experience with intellectual property, as well as his customer experience skills and skills relating to financial statement and accounting matters.

Giuseppe Zocco, age 45, has been a director of our company since July 2009. Since 1996, Mr. Zocco has been a general partner of Index Ventures, a venture capital firm he co-founded. From 1991 to 1996, Mr. Zocco served as a consultant with McKinsey & Company, a consulting firm. Mr. Zocco also serves on the boards of directors of a number of privately held companies. Mr. Zocco holds a B.A. in Business Administration from Bocconi University in Milan, an I.E.P. from London Business School and an M.B.A. from the Stanford Graduate School of Business. Our board of directors determined that Mr. Zocco should serve as a director based on his extensive experience in the technology industry and venture capital, as well as his relationship with Index Ventures, one of our largest stockholders.

Board of Directors

Our board of directors currently consists of nine members. The authorized number of directors may be changed by resolution of our board of directors. Vacancies on our board of directors can be filled by resolution of our board of directors. Our board of directors is divided into three classes, each serving staggered, three-year terms.

Our directors are divided among the three classes as follows:

 

  Ÿ  

The Class I directors are Messrs. Armony, Komisar and Zocco, and their terms expire at the annual meeting of stockholders to be held in 2012;

 

  Ÿ  

The Class II directors are Messrs. Amster, Barker and Zur, and their terms expire at the annual meeting of stockholders to be held in 2013; and

 

  Ÿ  

The Class III directors are Messrs. Bonnie, Robertson and Ryder, and their terms expire at the annual meeting of stockholders to be held in 2014.

As a result, only one class of directors will be elected at each annual meeting of stockholders, with the other classes continuing for the remainder of their respective terms. This classification of our board of directors may delay or prevent a change in control.

Corporate Governance

We believe our corporate governance initiatives comply with the Sarbanes-Oxley Act of 2002 and the rules and regulations of the SEC adopted thereunder. In addition, we believe our corporate governance initiatives comply with the rules of The Nasdaq Stock Market. Our board of directors evaluates our corporate governance principles and policies on an ongoing basis.

Our board of directors has adopted a code of business conduct that applies to each of our directors, officers and employees. The code addresses various topics, including:

 

  Ÿ  

compliance with applicable laws, rules and regulations;

 

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  Ÿ  

conflicts of interest;

 

  Ÿ  

public disclosure of information;

 

  Ÿ  

insider trading;

 

  Ÿ  

corporate opportunities;

 

  Ÿ  

competition and fair dealing;

 

  Ÿ  

gifts;

 

  Ÿ  

discrimination, harassment and retaliation;

 

  Ÿ  

health and safety;

 

  Ÿ  

record keeping;

 

  Ÿ  

confidentiality;

 

  Ÿ  

protection and proper use of company assets;

 

  Ÿ  

payments to government personnel; and

 

  Ÿ  

reporting illegal and unethical behavior.

The code of business conduct is posted on our website. Any waiver of the code of business conduct for an executive officer or director may be granted only by our board of directors or a committee thereof and must be timely disclosed as required by applicable law. We have also implemented whistleblower procedures that establish formal protocols for receiving and handling complaints from employees. Any concerns regarding accounting or auditing matters reported under these procedures will be communicated promptly to the audit committee.

Board Committees

We have established an audit committee, a compensation committee and a nominating and corporate governance committee. We believe that the composition of these committees meets the criteria for independence under, and the functioning of these committees complies with the applicable requirements of, the Sarbanes-Oxley Act of 2002, the current rules of The Nasdaq Stock Market and SEC rules and regulations. We intend to comply with future requirements as they become applicable to us. Our board of directors has determined that Shelby W. Bonnie and Thomas O. Ryder are audit committee financial experts, as defined by the rules promulgated by the SEC. Each committee has the composition and responsibilities described below:

Audit Committee

Messrs. Bonnie, Ryder and Zocco serve on the audit committee. Mr. Ryder is chairman of this committee. The audit committee assists our board of directors in fulfilling its legal and fiduciary obligations in matters involving our accounting, auditing, financial reporting, internal control and legal compliance functions by approving the services performed by our independent registered public accounting firm and reviewing their reports regarding our accounting practices and systems of internal accounting controls. The audit committee also oversees the audit efforts of our independent registered public accounting firm and takes actions as it deems necessary to satisfy itself that such firm is independent of management. The audit committee is also responsible for monitoring the integrity of our financial statements and our compliance with legal and regulatory requirements as they relate to financial statements or accounting matters.

 

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Compensation Committee

Messrs. Bonnie, Robertson and Ryder serve on the compensation committee. Mr. Bonnie is chairman of this committee. The compensation committee assists our board of directors in meeting its responsibilities with regard to oversight and determination of executive compensation and assesses whether our compensation structure establishes appropriate incentives for officers and employees. The compensation committee reviews and makes recommendations to our board of directors with respect to our major compensation plans, policies and programs. In addition, the compensation committee reviews and approves the compensation for our executive officers, establishes and modifies the terms and conditions of employment of our executive officers and administers our equity incentive plans.

Nominating and Corporate Governance Committee

Messrs. Armony, Komisar and Zocco serve on the nominating and corporate governance committee. Mr. Armony is chairman of this committee. The nominating and corporate governance committee is responsible for making recommendations to our board of directors regarding candidates for directorships and the size and composition of our board of directors. In addition, the nominating and corporate governance committee is responsible for overseeing our corporate governance guidelines and reporting and making recommendations to our board of directors concerning corporate governance matters.

Compensation Committee Interlocks and Insider Participation

In 2010, Messrs. Armony, Komisar and Zocco served as members of the compensation committee. None of the members of our compensation committee is or has in the past served as an officer or employee of our company. None of our executive officers currently serves, or in the past year has served, as a member of the board of directors or compensation committee of any entity that has one or more executive officers serving on our board of directors or compensation committee.

Compensation of Directors

Prior to our initial public offering in May 2011, our directors did not receive any cash compensation for their service on our board of directors or committees of our board of directors. However, we had a policy of reimbursing our directors for their reasonable out-of-pocket expenses incurred in attending board and committee meetings.

In January 2011, our board of directors adopted a compensation program for our non-employee directors that became effective upon our initial public offering. Pursuant to such program, we do not compensate our non-employee directors for their service in cash, instead providing compensation in the form of stock option awards as described below. We continue, however, to reimburse our non-employee directors for their reasonable out-of-pocket expenses incurred in attending board and committee meetings.

Each new non-employee director is granted an initial stock option award to purchase 60,000 shares of common stock upon such director’s election to our board of directors, which vests in equal monthly installments over 36 months of service. In addition, non-employee directors who continue to serve on our board of directors receive annual stock option grants to purchase 7,500 shares of common stock in connection with our annual meetings of stockholders, which vest in equal monthly installments over 12 months of service. The annual stock option granted to a non-employee director who joined our board of directors within 12 months prior to an annual meeting will be pro-rated based on the number of whole months of service on our board during the prior 12 month period.

 

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Both the initial and annual stock options are granted under our 2011 Equity Incentive Plan, are subject to full vesting acceleration in the event we undergo a change in control while the director is serving on our board of directors, have an exercise price equal to the fair market value of a share of our common stock on the date of grant and have a term of ten years from the date of grant, subject to earlier termination after termination of the director’s service. For further information regarding our equity compensation programs, see “Executive Compensation – Equity Benefit Plans – 2011 Equity Incentive Plan.”

As of December 31, 2010, Thomas O. Ryder held outstanding options to purchase 202,803 shares of our common stock. Mr. Ryder was the only director who held any outstanding options as of December 31, 2010. Mr. Ryder exercised an option to purchase 63,375 shares in March 2011.

In connection with Shelby Bonnie’s appointment to our board of directors on January 31, 2011, Mr. Bonnie was granted an initial stock option to purchase 60,000 shares on the terms described above. In connection with Sanford Robertson’s appointment to our board of directors effective upon the closing of our initial public offering, Mr. Robertson was also granted an initial stock option to purchase 60,000 shares on the terms described above. In addition, each of Messrs. Armony, Komisar and Zocco were granted stock options to purchase 60,000 shares on the terms described above in connection with their continued service on our board of directors following our initial public offering.

 

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EXECUTIVE COMPENSATION

Compensation Discussion and Analysis

This compensation discussion and analysis reviews and discusses our compensation programs and policies for our executive officers who are required to be named in the 2010 Summary Compensation Table under the rules of the SEC. For 2010, these “named executive officers” are John Amster, Chief Executive Officer, Adam Spiegel, Chief Financial Officer, Geoffrey Barker, Chief Operating Officer, Mallun Yen, Executive Vice President, and Henri Linde, Senior Vice President. This compensation discussion and analysis should be read together with the compensation tables and related disclosures set forth below.

General Overview and Objectives of our Executive Compensation Programs

We help companies reduce patent-related risk and expense by facilitating a more efficient exchange of value in the patent market. We recognize that the success of our company depends to a great degree on our ability to attract and retain talented employees who have relevant skills and experience to help us manage and expand our business. As such, the principal objectives of our executive compensation programs are the following:

 

  Ÿ  

to attract and retain talented and experienced executives;

 

  Ÿ  

to provide incentive to our executives to manage our business to meet our short-term and long-term business objectives;

 

  Ÿ  

to reward clear, easily measured performance goals that closely align our executive officers’ incentives with the long-term interests of stockholders; and

 

  Ÿ  

to ensure that our total compensation is fair, reasonable and competitive.

Our compensation programs are designed to be flexible and complementary and to collectively serve the principles and objectives of our executive compensation program.

Role of Our Board of Directors, Compensation Committee and Management

Historically, our compensation programs were administered by our board of directors. In 2010, we created a compensation committee to assist our board of directors by making recommendations regarding the compensation of our executive officers. Following our initial public offering, our compensation committee assumed responsibility for determining the compensation of our executive officers. For more information about our compensation committee, see “Management—Board Committees—Compensation Committee.”

Prior to our initial public offering, our Chief Executive Officer and Chief Operating Officer made recommendations to our board of directors and compensation committee with respect to the compensation of our executive officers, other than themselves. We anticipate that our Chief Executive Officer and Chief Operating Officer, as the managers of our executive team, will continue to make recommendations regarding the compensation of our other executive officers. However, while our compensation committee will consider their recommendations, it need not adopt them and may adjust them as it determines appropriate.

Compensation Process

The compensation of our founders, Messrs. Amster and Barker, was initially negotiated with our initial investors at the time of our incorporation and Series A Preferred Stock financing. The initial compensation of our other named executive officers has been determined as a result of arm’s-length

 

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negotiations with each officer and has been based on a variety of factors and the subjective judgment and experience of the members of our board of directors. Factors influencing these decisions have included the need to fill a particular position, the officer’s professional experience, an evaluation of the competitive market based on the experience of the members of our board of directors and the compensation of our other officers, each at the time of the applicable compensation decision.

Subsequent to implementing these arrangements, our board of directors and compensation committee have been responsible for overseeing our executive compensation program. Given the relatively small size and short operating history of our company, there has been no set schedule for reviewing or modifying compensation. Instead, compensation has been modified based on recommendations from Messrs. Amster and Barker and as determined appropriate by our board of directors and compensation committee, for example in connection with a promotion or as necessary to retain an officer. We currently expect that our compensation committee will review the compensation of our named executive officers annually.

Compensation Consultant

Our compensation committee has the authority to engage the services of outside consultants to assist it in making decisions regarding our compensation programs and philosophy. The compensation committee did not engage a compensation consultant in 2010.

Elements of Compensation

The compensation of our named executive officers consists of the following elements, each of which is designed to fulfill one or more of the principles and objectives described above:

 

  Ÿ  

base salary;

 

  Ÿ  

performance-based bonuses;

 

  Ÿ  

equity incentives;

 

  Ÿ  

change in control benefits;

 

  Ÿ  

broad-based employee benefits; and

 

  Ÿ  

perquisites.

Each of these elements is discussed in greater detail below. In setting compensation levels for individual named executive officers, our board of directors and compensation committee apply their judgment in determining the amount and mix of compensation elements for each named executive officer and the appropriate level of each element. The appropriate use and weight of each of these components has not to date been dictated by any particular formula. The specific mix of components has been and will continue to be within the discretion and business judgment of our board of directors and the compensation committee, which have placed greater emphasis on considerations specific to the individual holding a particular executive position than on general market data. These components of our compensation programs together provide competitive compensation packages that our board of directors believes have enabled us to successfully retain and motivate our named executive officers.

Base Salary

We provide base salary to our named executive officers and other employees to compensate them for services rendered on a day-to-day basis during the fiscal year and to provide sufficient fixed cash compensation to allow the officers to focus on their ongoing responsibilities to our company. Base salaries are reviewed and adjusted when necessary to reflect individual roles and performance as well

 

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as our board of director’s subjective assessment of market conditions. The annual base salary for each of our named executive officers in fiscal year 2010 was as follows: $300,000 for Messrs. Amster and Barker and Ms. Yen, $247,500 for Mr. Spiegel and $225,000 for Mr. Linde. Mr. Spiegel’s base salary was increased from $225,000 to his current level of $247,500 in January 2010 in connection with his promotion to Senior Vice President, Finance and Administration. In contemplation of our initial public offering, in January 2011 our board of directors increased Mr. Amster’s base salary to $500,000 per year and eliminated his quarterly bonus opportunity described below under “Performance-Based Bonuses.” The higher salary reflects the increased responsibility Mr. Amster assumed as chief executive officer of a publicly traded company. In March 2011, our compensation committee approved increases in the base salaries of Messrs. Spiegel and Linde to $260,000 per year. Mr. Spiegel received an increase in recognition of the increased responsibility he assumed as chief financial officer of a publicly traded company. Mr. Linde received an increase in recognition of the growth of our business during 2010.

Performance-Based Bonuses

Cash performance bonuses are used to reward our named executive officers for the achievement of individual and company performance goals, which we believe will in turn further our long-term business objectives. In early 2010, our board of directors agreed to establish a 2010 company-wide bonus pool for all employees based on the achievement of the target new client revenue goal set forth in our 2010 operating plan of $58.5 million. The target pool was set to 30% of base salary for all employees, with the understanding that the final pool would be determined based on our performance relative to the goal. We chose new client revenue, measured on an annualized basis, as the metric used to fund the bonus program, as we consider it a good measure of our current year success. The allocation of this pool among our employees and named executive officers was entirely discretionary, thereby giving our board of directors flexibility to award individual bonus amounts that reflected each named executive officer’s 2010 performance. The size of the pool (30% of base salary) was based on our assessment of the bonus opportunity necessary to recruit and retain our executives and employees. Because we exceeded our 2010 new client revenue goal (actual new client revenue was $76.3 million), based on the recommendation of Messrs. Amster and Barker, in December 2010, our board of directors increased the size of the company-wide bonus pool by 50% to 45% of the annual base salary of all employees. At the same time it approved the overall pool amount, our board of directors approved the following bonus payouts to our named executive officers: $135,000 for Mr. Amster, $225,000 for Mr. Spiegel, $135,000 for Mr. Barker, $25,000 for Ms. Yen and $225,000 for Mr. Linde. The bonus amounts for Messrs. Amster and Barker were based on 45% of their base salary and reflect an allocation that directly correlates to the determination of the size of the bonus pool. Mr. Spiegel’s bonus was equal to approximately 90% of his base salary in recognition of his significant work in preparing our company for an initial public offering, and Mr. Linde’s bonus was equal to 100% of his base salary in recognition of his role in executing significant subscription agreements in 2010 and also his management of the group directly responsible for generating our membership revenue. Additionally, with respect to Ms. Yen, our board of directors determined that her bonus payout would be set at 50% of her base salary earned in 2010, due to both her recent date of hire and contributions made to our company during that time.

Until 2011, Mr. Amster was also eligible for quarterly bonus payments of $50,000 as part of an arrangement he negotiated with our investors at the time of our inception and Series A Preferred Stock financing. These bonuses were awarded at the discretion of our board of directors, based on its review of Mr. Amster’s and our company’s performance. In 2010, Mr. Amster was awarded $50,000 each quarter, reflecting our strong performance, in particular, with respect to new client revenues, and Mr. Amster’s contributions and leadership in preparing for our initial public offering. Beginning in 2011, Mr. Amster no longer has a quarterly bonus opportunity.

 

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Equity Incentives

We believe that strong long-term corporate performance may be achieved by using equity-based awards to encourage long-term performance by our named executive officers. Our board of directors grants equity awards to our named executive officers and other employees in order to enable them to participate in the long-term appreciation of our stockholder value. We believe that equity grants align the interests of our named executive officers with our stockholders, provide our named executive officers with incentives linked to long-term performance and create an ownership culture. In the event we do not perform well, these awards will have less value or no value. Additionally, we believe our equity awards provide an important retention tool for our named executive officers, as they are generally subject to multi-year vesting.

The initial equity awards held by Messrs. Amster and Barker consist of restricted stock that they purchased at the time they founded our company, which is subject to our repurchase rights that lapse (which is what we mean by vesting with respect to these awards) over four years of service from August 2008. Equity-based awards to our other named executive officers have generally been granted in the form of options to purchase shares of our common stock. Typically, each named executive officer receives a grant of restricted stock or a stock option upon joining our company. These initial awards generally vest over four years of service, with 25% vesting after one year of service and the remainder vesting in equal monthly installments over the next three years. Prior to September 2010, our stock options were generally exercisable in full on the grant date but subject to a right of repurchase at the exercise price held by us that lapses in accordance with the option’s vesting schedule. Options granted after September 2010 are exercisable in accordance with the applicable option’s vesting schedule for vested (unrestricted) shares.

The size and other terms of the initial equity awards made to our named executive officers have been established through arm’s-length negotiations at the time the officer was hired. Our board of directors has considered, among other things, the prospective role and responsibility of the individual, the cash compensation received by the individual and the size of the equity awards held by our other executives. To date, there has been no set program for the award of additional stock options, and our board of directors and compensation committee retain discretion to award stock options to employees at any time, including in connection with a promotion, to reward extraordinary performance, for retention purposes or in other circumstances.

Mr. Spiegel was granted an additional option to purchase 189,496 shares of our common stock in February 2010 in connection with his promotion to Senior Vice President, Finance and Administration. The size of this award was intended to bring his total equity holdings in our company up to 1% of our fully diluted capitalization, which our board of directors believed was appropriate for a senior officer. Mr. Linde was granted an option to purchase 50,000 shares of our common stock in February 2010, in recognition of his contributions to our company during its first full fiscal year of operations, including his efforts in building our membership sales team and in procuring clients. Both of these options vest in equal monthly installments over four years of service, in the case of Mr. Spiegel, with a vesting commencement date of August 13, 2009, the date that he assumed responsibilities as Interim Chief Financial Officer.

In October 2010, our board of directors granted additional stock options to many of our employees, including Messrs. Spiegel and Linde. These options will not begin vesting until October 2012, at which point they will begin vesting in equal monthly installments over four years of service. The overlapping vesting schedules created by the employees’ existing options and the new options were intended to create additional retention incentives as we transitioned into being a company whose stock is publicly traded. Mr. Spiegel received an option to purchase 100,000 shares of our common stock, and Mr. Linde received an option to purchase 75,000 shares of our common stock. The size of

 

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these stock options was determined by our board of directors based on recommendations from Messrs. Amster and Barker and was based in part on how vested the employee was in his or her existing stock option.

In connection with joining our company in November 2010, Ms. Yen was granted an initial stock option grant covering 700,000 shares of our common stock that vests over four years of service. In addition, Ms. Yen was granted an additional option to purchase 200,000 shares of our common stock that vests based on her achievement of certain qualitative, subjective performance milestones (the submission of business plans and successful launch of at least one of the businesses described in the business plans) within 18 months of her employment commencement date, at which point they begin vesting in equal monthly installments over four years of service from the date the milestones are achieved. At the time the option was granted, it was not probable that both of the milestones would be achieved. In May 2011, the first of the two milestones was achieved. The size and other terms of Ms. Yen’s initial stock option grants were negotiated at the time she was hired. In particular, the size of Ms. Yen’s initial stock options reflect her significant experience, knowledge and skills, the relatively small pool of candidates possessing the necessary qualifications for the position she was hired to fill and the need to attract her to leave a position at another company where she received higher cash compensation. Given the substantial size of the equity awards negotiated by Ms. Yen, we thought it was appropriate that vesting of a portion of these awards be tied to achievement of specific performance milestones as well as her continued service.

In 2010, we repurchased a portion of the vested shares held by Messrs. Amster and Barker. The repurchase was effected as a means to provide Messrs. Amster and Barker with some liquidity in their shares. In conjunction with the repurchase, our investors purchased Series C Preferred Stock from us at a purchase price equal to the repurchase price. The proceeds from the investment were used to repurchase the shares. As the amount we paid for the shares of common stock repurchased from Messrs. Amster and Barker exceeded the current fair market value of our common stock at the time of the repurchase, the excess was treated as compensation to them.

In January 2011, our board of directors granted stock options to Messrs. Amster and Barker that were similar to the options granted to Messrs. Spiegel and Linde and other employees in October 2010. These options will not begin vesting until August 2012, when the shares of restricted stock held by Messrs. Amster and Barker have fully vested, at which point the options will begin vesting in equal monthly installments over four years of service. The sequential vesting schedules created by the restricted stock held by Messrs. Amster and Barker and the new options were intended to create additional retention incentives in connection with our transition to a company whose stock is publicly traded. Mr. Amster received an option to purchase 537,692 shares of our common stock, and Mr. Barker received an option to purchase 358,462 shares of our common stock. The size of these stock option grants was determined by our board of directors based on its assessment of the responsibilities and contributions of Messrs. Amster and Barker related to our business and to incentivize them to manage our business to meet our objectives.

We do not have, nor do we plan to establish, any program, plan or practice to time stock option grants in coordination with releasing material non-public information, nor do we have any established grant schedule. In addition, to date, we have not adopted stock ownership guidelines for our named executive officers.

Change in Control Benefits and Severance

The restricted stock Messrs. Amster and Barker hold and the options granted to Mr. Spiegel and Ms. Yen include a “double trigger” acceleration benefit if the officer is terminated without cause or resigns for certain reasons within 12 months after a change in control of our company. In the case of the performance option granted to Ms. Yen, this benefit only applies after the performance goals

 

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applicable to the option have been achieved. In addition, the stock options granted to Messrs. Amster and Barker in January 2011 also include this benefit in the event of a change in control after the options begin vesting in August 2012. The terms of these arrangements are described below in “2010 Potential Payments Upon Termination or Change in Control.” Our board of directors believes that it is necessary to offer senior members of our executive team the level of protection provided under these agreements to ensure that they remain focused on executing our company’s strategic plans including in the event our company is to be acquired.

None of our named executive officers have any contractual severance benefits.

Employee Benefits

We provide the following benefits to our named executive officers, generally on the same basis as provided to all of our employees:

 

  Ÿ  

health, dental and vision insurance;

 

  Ÿ  

life insurance and accidental death and dismemberment insurance;

 

  Ÿ  

a 401(k) plan;

 

  Ÿ  

employee assistance plan;

 

  Ÿ  

short- and long-term disability;

 

  Ÿ  

medical and dependent care flexible spending account; and

 

  Ÿ  

a health savings account.

We believe these benefits are consistent with those of companies with which we compete for employees.

Perquisites

Given our location in downtown San Francisco, we pay the monthly $435 parking fee incurred by certain of our officers and employees, including Mr. Amster and Ms. Yen. We also pay for an apartment in San Francisco that is used by Mr. Barker, as well as his airfare and other expenses for travel between our office in San Francisco and his residence in Washington. We generally do not provide any additional perquisites to our named executive officers.

Tax Considerations

Generally, Section 162(m) of the Internal Revenue Code disallows a deduction for any publicly held corporation for individual compensation exceeding $1 million in any taxable year payable to its Chief Executive Officer and certain other officers. However, compensation in excess of $1 million may be deducted if, among other things, it qualifies as “performance-based compensation” within the meaning of Section 162(m). Prior to our initial public offering, our board of directors did not take the deductibility limit imposed by Section 162(m) into consideration in setting compensation as we were not publicly traded. While our compensation committee has not adopted a formal policy regarding tax deductibility of compensation paid to our named executive officers, our compensation committee intends to consider the tax deductibility under Section 162(m) as a factor in future compensation decisions.

Section 280G of the Internal Revenue Code disallows a tax deduction with respect to excess parachute payments to certain executives and significant stockholders of companies that undergo a

 

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change in control. In addition, Section 4999 of the Internal Revenue Code imposes a 20% excise tax on the individual with respect to the excess parachute payment. Section 409A of the Internal Revenue Code also imposes significant additional taxes should an executive officer, director or other service provider receive “deferred compensation” that does not meet the requirements of Section 409A of the Internal Revenue Code. We have not provided any named executive officer with a gross-up or other reimbursement for tax amounts the executive might pay pursuant to Section 280G or Section 409A of the Internal Revenue Code. As a general matter, it is our intention to design and administer our compensation and benefits plans and arrangements for all of our employees and other service providers, including our named executive officers, so that they are either exempt from, or satisfy the requirements of, Section 409A of the Internal Revenue Code.

Financial Restatement

Our compensation committee has not adopted a policy on whether we will make retroactive adjustments to any cash or equity-based incentive compensation paid to the named executive officers (or others) where the payment was predicated upon the achievement of financial results that were subsequently the subject of a restatement. Our compensation committee believes that this issue is best addressed if and when a need actually arises, when all of the facts regarding the restatement are known.

2010 Summary Compensation Table

The following table provides information regarding the compensation of our “principal executive officer,” “principal financial officer” and our next three most highly compensated executive officers during the 2010 fiscal year. We refer to these individuals as our “named executive officers.”

 

Name and Principal Position

   Year      Salary
($)
     Bonus(1)
($)
     Option
Awards(2)
($)
     All Other
Compensation
($)
    Total
($)
 

John Amster

Chief Executive Officer

(Principal Executive Officer)

     2010         300,000         335,000                 236,504 (3)      871,504   

Adam Spiegel

Chief Financial Officer

(Principal Financial Officer)

     2010         247,500         225,000         681,538                1,154,038   

Geoffrey Barker

Chief Operating Officer

     2010         300,000         135,000                 180,671 (4)      615,671   

Mallun Yen

Executive Vice President

     2010         50,000         25,000         2,559,166                2,634,166   

Henri Linde

Senior Vice President

     2010         225,000         225,000         380,701                830,701   

 

(1) The amounts in this column reflect discretionary bonuses approved by our board of directors in December 2010 for our company and individual performance, which were paid on January 15, 2011. For Mr. Amster, the amount also includes quarterly discretionary bonuses in the amount of $50,000 each, approved by our board of directors and paid to Mr. Amster for each fiscal quarter of 2010.
(2)

The amounts in this column represent the aggregate grant date fair value of option awards granted to the officer in the applicable fiscal year computed in accordance with FASB ASC Topic 718. See Note 15 of the notes to our consolidated financial statements included elsewhere in this prospectus for a discussion of the assumptions made by our company in determining the grant

 

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date fair value of its equity awards. In accordance with the SEC’s rules, the grant date fair value of any award subject to a performance condition is based on the probable outcome of the performance condition. No amount is included with respect to a performance-contingent option granted to Ms. Yen on November 16, 2010, as at the time the option was granted it was not probable that the milestones applicable to the option would be achieved. The maximum grant date fair value of Ms. Yen’s performance-contingent option assuming that both of the milestones are achieved is $778,182.

(3) Represents compensation deemed received by Mr. Amster in connection with our repurchase of shares of our common stock from him in November 2010.
(4) Represents $147,815 in compensation deemed received by Mr. Barker in connection with our repurchase of shares of our common stock from him in November 2010, $22,239 in company-paid expenses related to Mr. Barker’s commute between his residence in Washington and our office in San Francisco, and $10,617 in compensation deemed received by Mr. Barker in connection with his usage of an apartment leased by our company in San Francisco. The cost of Mr. Barker’s use of the apartment was determined by multiplying the number of nights Mr. Barker stayed in the apartment in 2010 by a per night cost, determined by dividing the total cost of the apartment, composed of rent and utilities, by 730, the number of nights in the year multiplied by the number of bedrooms in the apartment.

2010 Grants of Plan-Based Awards

The following table sets forth certain information regarding each plan-based award granted to our named executive officers during our 2010 fiscal year. Only Messrs. Spiegel and Linde and Ms. Yen received plan-based awards during our 2010 fiscal year.

 

Name

   Grant Date      Estimated
Future Payouts
Under Equity
Incentive Plan
Awards
    All Other
Option Awards:
Number of
Securities
Underlying
Options(1) (#)
     Exercise or Base
Price of Option
Awards(2) ($/Sh)
     Grant Date
Fair Value of
Stock and
Option
Awards(3) ($)
 
      Target (#)          

Adam Spiegel

     2/11/2010                189,496         1.02         269,547   
     10/21/2010                100,000         4.96         411,991   

Mallun Yen

     11/16/2010                700,000         6.63         2,559,166   
     11/16/2010         200,000 (4)              6.63         (5) 

Henri Linde

     2/11/2010                50,000         1.02         71,707   
     10/21/2010                75,000         4.96         308,994   

 

(1) The vesting schedule for each of these options is described in the table entitled “Outstanding Equity Awards at 2010 Fiscal Year-End” below.
(2) The amounts in this column represent the fair market value of a share of our common stock, as determined by our board of directors on the date of grant. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies and Estimates—Accounting for Stock-Based Awards” for a discussion of how we valued our common stock.
(3) The amounts in this column represent the aggregate grant date fair value of option awards granted to the officer in the applicable fiscal year computed in accordance with FASB ASC Topic 718. See Note 15 of the notes to our consolidated financial statements included elsewhere in this prospectus for a discussion of the assumptions made by our company in determining the grant date fair value of its equity awards.
(4)

The vesting of this option is contingent upon the achievement of two milestones. Both milestones must be achieved to commence the time-based vesting of the shares subject to the option on a monthly basis over four years of continuous employment beginning as of the date our board of

 

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directors determines the milestones are achieved. The number of shares reflected in the table above as “target” assumes that both of the milestones will be achieved and that Ms. Yen will remain employed by our company for four years following the date our board of directors determines the milestones have been achieved. No threshold or maximum amount is applicable to the option grant. As of December 31, 2010, neither of the two milestones underlying the option grant had been achieved. In May 2011, the first of the two milestones was achieved.

(5) The maximum grant date fair value of the option assuming that both of the milestones are achieved is $778,182. At the time the option was granted, it was not probable that both of the milestones would be achieved, and therefore no amount attributable to the option is included in the “Grant Date Fair Value of Stock and Option Awards” column.

Narrative Disclosure to the Summary Compensation Table and Grants of Plan-Based Awards Table

Offer Letters

We have entered into offer letters with each of our named executive officers. The offer letters set forth each named executive officer’s initial base salary and other general terms of employment.

Offer Letters with John Amster and Geoffrey Barker

We entered into offer letters with each of Messrs. Amster and Barker in August 2008, setting forth the initial terms of their employment with our company. Pursuant to their offer letters, each of Messrs. Amster and Barker receive a base salary of $300,000 per year. In addition, pursuant to his offer letter Mr. Amster was eligible for an annual incentive bonus with a target amount of $200,000 per year, payable in quarterly installments. Beginning in 2011, Mr. Amster is no longer eligible for this bonus opportunity.

Offer Letter with Adam Spiegel

We entered into an offer letter with Mr. Spiegel in February 2009 that set forth the initial terms of his employment with our company, including an initial base salary of $200,000 per year. In connection with Mr. Spiegel’s promotion to Senior Vice President, Finance and Administration in February 2010, Mr. Spiegel’s offer letter was amended, and his base salary increased to $247,500, retroactive to January 1, 2010.

Offer Letter with Mallun Yen

We entered into an offer letter with Ms. Yen in October 2010 setting forth the initial terms of her employment with our company, including an initial base salary of $300,000 per year and a guaranteed 2011 bonus of $200,000 provided she remains actively employed and in good standing with our company as of December 31, 2011. Pursuant to her offer letter, Ms. Yen is also eligible to participate in our company’s annual incentive compensation plan in 2011, and to the extent the amount she becomes eligible to receive thereunder exceeds the amount of the guaranteed 2011 bonus, she will be entitled to receive an additional bonus in the amount of the difference.

Offer Letter with Henri Linde

We entered into an offer letter with Mr. Linde in September 2008 setting forth the initial terms of his employment with our company, including an initial base salary of $225,000 per year.

 

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Outstanding Equity Awards at 2010 Fiscal Year-End

The following table sets forth information regarding each unexercised option and all unvested restricted stock held by each of our named executive officers as of December 31, 2010.

The vesting schedule applicable to each outstanding award is described in the footnotes to the table below. For information regarding the vesting acceleration provisions applicable to the options and restricted stock held by our named executive officers, see “2010 Potential Payments Upon Termination or Change in Control” below.

Prior to September 2010, our stock options were generally exercisable in full on the grant date but subject to a right of repurchase at the exercise price held by us that lapses in accordance with the option’s vesting schedule (we refer to such lapse as vesting with respect to these stock options). Options granted after September 2010 are exercisable in accordance with the applicable option’s vesting schedule for vested (unrestricted) shares.

 

    Option Awards     Stock Awards  

Name

  Number
of
Securities
Underlying
Unexercised
Options
(#)
Vested
    Number of
Securities
Underlying
Unexercised
Options
(#)
Unvested
    Equity
Incentive
Plan Awards:
Number of
Securities
Underlying
Unexercised
Unearned
Options
(#)
    Option
Exercise
Price
($)
    Option
Expiration
Date
    Number of
Shares or
Units of
Stock That
Have Not
Vested
(#)
    Market Value
of Shares or
Units of
Stock That
Have Not
Vested(1)
($)
 

John Amster

                                       1,306,945 (2)      24,831,955   

Adam Spiegel

    94,548        121,563 (3)             0.47        4/7/2019                 
    63,165        126,331 (4)             1.02        2/10/2020                 
           100,000 (5)             4.96        10/20/2020                 

Geoffrey Barker

                                       1,325,695 (6)      25,188,205   

Mallun Yen

           700,000 (7)             6.63        11/15/2020                 
                  200,000 (8)      6.63        11/15/2020                 

Henri Linde

                                       91,268 (9)      1,734,092   
                                       39,584 (10)      752,096   
           75,000 (5)             4.96        10/20/2020