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VRINGO INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations.
(Edgar Glimpses Via Acquire Media NewsEdge) This Quarterly Report on Form 10-Q contains forward-looking statements that
involve risks and uncertainties, as well as assumptions that, if they never
materialize or prove incorrect, could cause our results to differ materially
from those expressed or implied by such forward-looking statements. The
statements contained herein that are not purely historical are forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the
"Exchange Act"). Forward-looking statements are often identified by the use of
words such as, but not limited to, "anticipate," "believe," "can," "continue,"
"could," "estimate," "expect," "intend," "may," "will," "plan," "project,"
"seek," "should," "target," "will," "would," and similar expressions or
variations intended to identify forward-looking statements. These statements are
based on the beliefs and assumptions of our management based on information
currently available to management. Such forward-looking statements are subject
to risks, uncertainties and other important factors that could cause actual
results and the timing of certain events to differ materially from future
results expressed or implied by such forward-looking statements. Factors that
could cause or contribute to such differences include, but are not limited to,
those identified below, and those discussed in the section titled "Risk Factors"
included in our Annual Report on Form 10-K for the year ended December 31, 2011
as updated in our Quarterly Report on Form 10-Q for the period ended June 30,
2012 filed on August 14, 2012 and other public reports we filed with the
Securities and Exchange Commissions, or the SEC. The forward-looking statements
set forth herein speak only as of the date of this report. Except as required by
law, we undertake no obligation to update any forward-looking statements to
reflect events or circumstances after the date of such statements. In this
report, "Vringo," the "Company," "we," "us," and "our" refer to Vringo, Inc.
Overview
We were incorporated in Delaware on January 9, 2006 and commenced operations
during the first quarter of 2006. In March 2006, we formed a wholly-owned
subsidiary, Vringo (Israel) Ltd., primarily for the purpose of providing
research and development services, as detailed in the intercompany service
agreement. On July 19, 2012, Innovate/Protect, Inc. ("I/P") merged with us
through an exchange of equity instruments of I/P for those of Vringo (the
"Merger"). I/P is a holding company, incorporated under the laws of Delaware on
June 8, 2011, as Labrador Search Corporation, which holds two wholly-owned
subsidiaries: I/P Engine Inc., formed under the laws of Virginia on June 14,
2011, originally as Smart Search Labs Inc., which operates for the purpose of
realizing economic benefits, and I/P Labs, Inc., incorporated in Delaware on
June 8, 2011 originally as Scottish Terrier Capital Inc., which operated to
acquire and develop other patented technologies or intellectual property. On
August 31, 2012, we formed two wholly-owned subsidiaries, incorporated in
Delaware: Vringo Labs, Inc. which operates to acquire and develop new patented
technologies or intellectual property and Vringo Infrastructure, Inc., which
operates for the purpose of realizing economic benefits from patent portfolio
acquired from Nokia Corporation ("Nokia"), as further described below. In
addition, on October 18, 2012, we formed a wholly-owned subsidiary in Germany,
Vringo Germany GmbH, for the purpose of innovating, developing, and monetizing
mobile technology and intellectual property in Germany.
As a combined company, our attempts are focused on maximizing the economic
benefits from our growing intellectual property portfolio. We plan to add
significant talent in technological innovation, and continue to enhance our
technology capabilities to create, build and deliver mobile applications and
services to our handset and mobile operator partners, as well as directly to
consumers.
The combined company has two key areas of operation:
• maximization of the economic benefits from developed and acquired intellectual
property, and
• delivery and monetization of mobile social applications.
We are a development stage company. The Merger has been accounted for as a
reverse acquisition under which I/P was considered the acquirer of Vringo. As
such, the financial statements of I/P are treated as the historical financial
statements of the combined company, with the results of Vringo being included
from July 19, 2012.
From inception of I/P (June 8, 2011) to date, we have raised approximately
$84,862,000. These amounts have been used to finance our operations, as until
now, we have not yet generated any significant revenues. From inception of I/P
through September 30, 2012, we recorded losses of approximately $9,590,000 and
net cash outflow from operations of approximately $7,491,000. Our average
monthly cash burn rate from operations for the three and nine month period ended
September 30, 2012 was approximately $1,110,000 and $662,000, respectively.
As of November 14, 2012, we had approximately $60,500,000 in cash and cash
equivalents. Based on current operating plans, we expect to have sufficient
funds for at least the next twelve months. In addition, we may choose to raise
additional funds in connection with potential acquisitions of patent portfolios
or other intellectual property assets that we may pursue. There can be no
assurance, however, that any such opportunities will materialize.
As of September 30, 2012, we had 26 full time employees and two part-time
employees.
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Intellectual Property
As a combined company, we focus on the economic benefits of intellectual
property assets through acquiring or internally developing patents or other
intellectual property assets (or interests therein) and then monetize such
assets through a variety of value enhancing initiatives, including, but not
limited to:
• licensing,
• customized technology solutions,
• strategic partnerships, and
• litigation.
Upon formation in June 2011, I/P acquired its initial patent assets from Lycos
through its wholly-owned subsidiary, I/P Engine. Such assets were comprised of
eight patents relating to information filtering and search technologies. As part
of our strategy to monetize the patents acquired from Lycos, I/P Engine
commenced litigation against AOL, Inc., Google, Inc., IAC Search & Media, Inc.,
Gannett Company, Inc. and Target Corporation (collectively, "Defendants").
Trial commenced on October 16, 2012, and the case was submitted to the jury on
November 1, 2012. On November 6, 2012, the jury unanimously returned a verdict
as follows: (i) I/P Engine had proven by a preponderance of the evidence that
the Defendants infringed the asserted claims of the patents; and (ii) Defendants
had not proven by clear and convincing evidence that the asserted claims of the
patents are invalid by anticipation. The jury also found certain specific facts
related to the ultimate question of whether the patents are invalid as obvious.
Based on such facts , the Court will issue a ruling on obviousness. We believe
that the jury's factual findings will support a finding that the patents are not
invalid as obvious. After finding that the asserted claims of the Patents were
both valid and infringed by Google, the jury found that reasonable royalty
damages should be based on a "running royalty", and that the running royalty
rate should be 3.5%.
After finding that the asserted claims of the Patents were both valid and
infringed by the Defendants, the jury found that the following sums of money, if
paid now in cash, would reasonably compensate I/P Engine for the Defendants past
infringement as follows: Google: $15,800,000, AOL: $7,943,000, IAC: $6,650,000,
Gannett: $4,322, Target: $98,833. I/P Engine and Defendants are allowed to file
post-trial motions with the court, the schedule for which has yet been
determined.
On August 9, 2012, we entered into a patent purchase agreement with Nokia,
pursuant to which, Nokia agreed to sell us a portfolio consisting of over 500
patents and patent applications worldwide, including 109 issued United States
patents. We agreed to compensate Nokia with a cash payment and certain ongoing
rights in revenues generated from the patent portfolio. The portfolio
encompasses a broad range of technologies relating to telecom infrastructure,
including communication management, data and signal transmission, mobility
management, radio resources management and services. Thirty-one of the 124
patent families acquired have been declared essential by Nokia to wireless
communications standards. Standards represented in the portfolio are commonly
known as 2G, 2.5G, 3G and 4G and related technologies and include GSM, WCDMA,
T63, T64, DECT, IETF, LTE, SAE, and OMA. The purchase price for the portfolio
was $22,000,000, plus capitalized acquisition costs of $578,000. To the extent
that the gross revenue (as defined in the purchase agreement) generated by such
portfolio exceeds $22,000,000, a royalty of 35% of such excess is due to be paid
to Nokia. The $22,000,000 cash payment was made to Nokia on August 10, 2012. The
purchase agreement provides that Nokia and its affiliates will retain a
non-exclusive, worldwide and fully paid-up license (without the right to grant
sublicenses) to the portfolio for the sole purpose of supplying (as defined in
the purchase agreement) Nokia's products. The purchase agreement also provides
that if we bring a proceeding against Nokia or its affiliates within seven
years, Nokia shall have the right to re-acquire the patent portfolio for a
nominal amount. Further, if we either sell to a third party any assigned
essential cellular patent, or more than a certain portion of the other assigned
patents (other than in connection with a change of control of our company), or
file an action against a telecom provider to enforce any of the assigned patents
(other than in response to any specified action filed by a telecom provider
against us or our affiliate) which action is not withdrawn after notice from
Nokia, then we will be obligated to pay to Nokia a substantial impairment
payment. Because all of the foregoing actions are within our sole control, we do
not expect to be obligated to pay any such impairment payment.
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As one of the means of realizing the value of the patents acquired from Nokia,
on October 5, 2012, our wholly-owned subsidiary, Vringo Infrastructure, Inc.,
filed suit in the UK High Court of Justice, Chancery Division, Patents Court,
alleging infringement of European Patents (UK) 1,212,919; 1,166,589; and
1,808,029. Declarations have been filed at the European Telecommunications and
Standards Institute (ETSI) that cover the patents. The complaint alleges that
ZTE's cellular network elements fall within the scope of all three patents, and
ZTE's GSM/UMTS multi-mode wireless handsets also fall within the scope of the
'029 patent. On October 23, 2012, counsel for ZTE acknowledged service. ZTE (UK)
formal response to the complaint is anticipated by November 22, 2012. A case
management conference where among other matters, the schedule for the suit will
be set, is anticipated in January 2013.
We continue to grow our technology portfolio. From September 4 through October
12, 2012, as part of our efforts to develop new technology assets in the mobile
and social media space, inventors working for Vringo filed 9 provisional patent
applications covering a wide range of technologies including: Determining
content relevance based on a user's relationships; Using mobile technologies as
sleep aids; Combining social media and on-line videos; Improving mobile security
using facial recognition technology; Monitoring usage patterns of mobile devices
and computers to make recommendations; Technology that allows to post call
information to social media; Technology to assist in prioritizing electronic
communications; Technology that rewards a user's specific wireless device
activity. Additionally, Vringo's existing mobile portfolio continues to mature;
including the grant on August 1, 2012 of EP 1,982,549 and on October 23, 2012 of
USP 8,295,205.
As part of our efforts to develop new technology in the telecom infrastructure
space, we filed 12 continuation applications in the US. In addition, we filed a
continuation-in-part application that combines internally developed innovation
in the DRM space with telecom infrastructure. Further, through our wholly owned
subsidiary, Vringo Labs, Inc., we filed a patent application relating to
wireless energy charging.
On October 10, 2012, I/P Engine entered into a patent purchase agreement,
pursuant to which we issued seller 160,600 unregistered shares of Vringo common
stock, as well as a 20% royalty from collected future revenue. The portfolio
comprises U.S. Patent numbers 7,831,512 and 8,315,949, and US application number
13/653,894. This intellectual property relates to the placement of
advertisements on web pages when there is a vacancy for an advertisement, and
such advertisement is placed via a bidding process.
Mobile Social Applications
We have developed a platform for the distribution of mobile applications. We
believe that our technology and business relationships will allow us to
distribute new applications and services through:
• mobile operators,
• handset makers, and
• application storefronts.
Our video ringtone platform has been operating since 2008 and remains the
primary source of subscription revenues among our mobile products and we
continue to develop business for this product with mobile operators and content
providers. Our solution, which encompasses a suite of mobile and PC-based tools,
enables users to create, download and share video ringtones and provides our
business partners with a consumer-friendly and easy-to-integrate monetization
platform.
The revenue model for our video ringtone service offered through the carriers is
a subscription-based model where users pay a monthly fee for access to our
service and additional fees for premium content.
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Our Vringo video ringtone mobile app also functions as a standalone
direct-to-consumer offering. Our free version has been released as an
ad-supported application on the Google Play marketplace and is still available
in markets where we have not entered into commercial arrangements with carriers
or other partners.
As of November 14, 2012, we have commercial video ringtone services with nine
carriers and partners. We are currently in discussions with several other mobile
carriers and we will be pursuing additional agreements with mobile carriers over
the next 12, with a focus on Android-based apps as the cornerstone for future
subscriber services. Separately, we continue to expand the distribution of our
free to the user ad-supported mobile application.
Our Facetones® social ringtone platform generates social visual ringtone content
automatically by aggregating and displaying a user's friends' pictures from
social networks and then displaying as a video ringtone, as well as a video
ringback tone. These ringtones do not replace, but rather enhance, standard
ringtone and ringback tones with relevant, current social content that is
visually displayed. The product is available to consumers on several operating
systems, most notably is Android and is delivered in various configurations,
with a variety of monetization methods. As of August 31, 2012, the Facetones®
free ad-supported version had more than 1,500,000 downloads and is generating
more than 2,500,000 advertising impressions on a weekly basis. Facetones® is
offered directly to consumers via leading mobile application stores and download
sites where both for purchase versions, as well as ad-supported free versions
are available. Our revenue model is based on proceeds received from advertisers,
as well as from related development projects and potential payment of royalties,
as described below.
We also continue to pursue business for Facetones® together with handset
manufacturers. We have developed five separate versions of Facetones in
partnership with Nokia. In January 2012, we launched Facetones® for iPhone which
generates, as of the end of February 2012, close to a 1,000 daily downloads
without any promotion. In November 2011, we announced an agreement with ZTE
Corporation, the largest handset maker in China and fourth-largest globally, to
preload the Facetones® application on Android handsets manufactured by ZTE. ZTE
is to pay a royalty for each preloaded device, the first of which launched with
the release of ZTE's GrandX handsets in the United Kingdom in August 2012.
Our Fan Loyalty platform was launched in mid-2011 by co-branding our Fan-Loyalty
application with Star Academy 8, the largest music competition in the Middle
East and Nokia, the world's largest handset maker. The Fan Loyalty application
for Star Academy was made available exclusively for download on the Ovi Store,
and had more than 200,000 downloads during the season. In the first quarter of
2012, we entered into an agreement with Endemol, a producer of entertainment and
reality TV programming, to collaborate on additional sponsored versions ofthis
application.
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Recent Financing Activity
On October 4, 2012, we entered into subscription agreements with several
investors with respect to the registered direct offer and sale by us of an
aggregate of 10,344,998 shares of our common stock, par value $0.01 per share,
at a purchase price of $4.35 per share in a privately negotiated transaction in
which no party acted as an underwriter or placement agent. The net proceeds were
approximately $44,900,000, after deducting estimated offering expenses payable
by us. We intend to use the net proceeds from this offering for general
corporate working capital purposes.
In October 2012, we entered into an agreement with certain of our warrant
holders, pursuant to which such warrant holders exercised in cash 3,721,062 of
their outstanding warrants, with an exercise price of $1.76 per share, and we
issued such warrant holders unregistered warrants to purchase an aggregate of
3,000,000 of our shares of common stock, par value $0.01 per share, at an
exercise price of $5.06 per share. The newly issued warrants do not bear down
round protection clauses. We are still evaluating the accounting impact of this
transaction; nevertheless, we expect such impact on our financial statements to
be material.
In addition, in October and November 2012, warrants to purchase an aggregate of
790,903 shares of our common stock, at an exercise price of $1.76 per share,
were exercised by our warrant holders, pursuant to which we received an
additional $1,391,989.
Merger
On July 19, 2012, we consummated the Merger with I/P. I/P merged with and into
VIP Merger Sub, Inc., a wholly owned subsidiary of Vringo ("Merger Sub"), with
Merger Sub being the surviving corporation through an exchange of capital stock
of I/P for our capital stock. Upon completion of the Merger, (i) all of the
6,169,661 outstanding shares of common stock of I/P, par value $0.0001 per share
were converted into 18,617,569 shares of our common stock, par value $0.01; and
(ii) all share outstanding of Series A Convertible Preferred Stock of I/P, par
value $0.0001 per share, were converted into 20,136,445 shares of our Series A
Convertible Preferred Stock. The preferred stock issued, has the powers,
designations, preferences and other rights as set forth in a Certificate of
Designations, Preferences and Rights of Series A Convertible Preferred Stock
filed by us prior to closing. In addition, we issued to the holders of I/P
capital stock (on a pro rata as-converted basis) an aggregate of 15,959,838
warrants to purchase an aggregate of 15,959,838 shares of our common stock with
an exercise price of $1.76 per share.
Immediately following the completion of the Merger, the former stockholders of
I/P owned approximately 55.04% of the outstanding common stock of the combined
company, and our current stockholders owned approximately 44.96% of the
outstanding common stock of the combined company. On a fully diluted basis, the
former stockholders of I/P owned approximately 67.61% of the outstanding common
stock of the combined company, and our current stockholders owned approximately
32.39% of the outstanding common stock of the combined company.
For accounting purposes, I/P was identified as the accounting "acquirer", as it
is defined in FASB Topic ASC 805. As a result, in the post-combination
consolidated financial statements, as of the third quarter 2012, I/P's assets
and liabilities are presented at its pre-combination amounts, and our assets and
liabilities are recognized and measured in accordance with the guidance for
business combinations in ASC 805. See also Notes 4 and 8 to the accompanying
financial statements.
Hudson Bay Note
On June 22, 2011, I/P issued a senior secured note payable, in the total amount
of $3,200,000, to one of its principal stockholders, Hudson Bay Master Fund Ltd.
("Hudson Bay") (the "Note"). The Note accrued interest at 0.46% per annum. After
the Merger was consummated, on July 19, 2012, the Note was amended and restated
and the holder was able to exercise any and all rights and remedies pursuant to
such amended and restated Note, including with respect to any optional
redemption provisions contained therein. The amended and restated Note was to
mature on June 22, 2013 and I/P had granted Hudson Bay a security interest in
all of its tangible and intangible assets, in order to secure I/P's obligations
under the senior secured note. After the consummation of the Merger, the Note
became our obligation, as it is to guarantee I/P's obligations after the Merger.
On August 15, 2012, we repaid the outstanding balance in full.
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Grants of Stock Options and RSUs
Immediately following the Merger, the vesting of shares of common stock granted
prior to the Merger to I/P's officers and directors was fully accelerated. As a
result, an additional 2,702,037 shares previously issued became vested. In
addition, our board of directors approved the granting of 265,000 shares to
certain consultants, as well as the acceleration of vesting of 908,854 options
granted to certain officers and directors of Vringo. Finally, according to
resolution made by our board of directors in January 2012, upon Merger, the
vesting of all Vringo pre-Merger outstanding options was accelerated by one
year.
On July 26, 2012, our board of directors approved the granting of 4,975,000
options to management, directors and employees at an exercise price of $3.72 per
share. These options will vest quarterly over a three year period. In addition,
the board also approved the granting of 15,000 options at an exercise price of
$3.72 per share to one of our consultants. These options will vest over a one
year period. Certain options granted to officers, directors and certain key
employees are subject to acceleration of vesting of 75% - 100% (according to the
agreement signed with each grantee), upon subsequent change of control.
Moreover, on July 26, 2012, the board of directors approved the granting of
3,105,000 RSUs to management, directors and key employees. These RSUs will vest
quarterly over a three and year periods (dependent on the agreement made with
each grantee). In addition, we approved the granting of 25,000 RSUs to two of
our consultants. These RSUs will vest over a 6-12 month period (according to the
agreement signed with each grantee).
On August 8, 2012, the board of directors approved the granting of 500,000
options to a member of our management, at an exercise price of $3.44 per share.
These options will vest quarterly over a three year period.
As of November 6, 2012, the vesting of all of Vringo's pre-Merger granted
options outstanding (except for separation grants) was accelerated by 50%, as
our market capitalization reached $250,000,000 for twenty of thirty consecutive
trading days.
Revenue
We recognize revenue when all the conditions for revenue recognition are met:
(i) persuasive evidence of an arrangement exists, (ii) collection of the fee is
probable, (iii) the sales price is fixed and determinable and (iv) delivery has
occurred or services have been rendered. Intellectual property rights for
patented technologies may include some combination of the following: (i) the
grant of a non-exclusive, retroactive and future license to manufacture and/or
sell products covered by patented technologies owned or controlled by operating
subsidiaries, (ii) a covenant-not-to-sue, (iii) the release of the licensee from
certain claims, and (iv) dismissal of any pending litigation. Our subscription
service arrangements are evidenced by a written document signed by both parties.
Our revenues from monthly subscription fees, content purchases and advertisement
revenues are recognized when we have received confirmation that the amount is
due to us, which provides proof that the services have been rendered, and making
collection probable. We recognize revenue from non-refundable up-front fees
relating to set-up and billing integration across the period of the contract for
the subscription service as these fees are part of hosting solution that we
provide to the carrier. The hosting is provided on our servers for the entire
period of the arrangement with this carrier, and the revenues relating to the
monthly subscription, set-up fees and billing integration have been recognized
over the period in the agreement. We also recognize revenue from development
projects, based on percentage of completion, if the required criteria are met,
or when the project is completed.
Cost of revenue
Cost of revenues mainly include the costs and expenses incurred in connection
with our patent licensing and enforcement activities, contingent legal fees paid
to external patent counsels, other patent-related legal expenses paid to
external patent counsel, licensing and enforcement related research, consulting
and other expenses paid to third parties, the amortization of patent-related
acquisition costs and of the acquired technology. Cost of revenue also includes
third party expenses directly related to providing our service in launched
markets. In addition, these costs include royalty fees for content sales and
amortization of prepaid content licenses. Cost of revenue does not include
expenses related to product development, integration, and support. These costs
are included in research and development and marketing expenses.
Research and development expenses
Research and development expenses consist primarily of salary expenses of our
development and quality assurance engineers in our research and development
facility in Israel, outsourcing of certain development activities, preparation
of patent filings, server and support functions for our development environment.
Marketing, general and administrative expenses
Marketing, general and administrative expenses include the cost of management,
administrative and marketing personnel, public relations, advertising,
overhead/office cost and various professional fees, as well as insurance,
depreciation and amortization.
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Non-operating income (expenses)
Non-operating income (expenses) includes transaction gains (losses) from foreign
exchange rate differences, interest on deposits, bank charges, as well as fair
value adjustments of derivative liabilities on account of the Preferential
Reload Warrants, Special Bridge Warrants, Series 1 Warrants and the Conversion
Warrants, which are highly influenced by our stock price at the period end(revaluation date).
Income taxes
Our effective tax rate differs from the statutory federal rate primarily due to
differences between income and expense recognition prescribed by income tax
regulations and generally accepted accounting principles. We utilize different
methods and useful lives for depreciating and amortizing property and equipment
and different methods and timing for certain expenses. Furthermore, permanent
differences arise from certain income and expense items recorded for financial
reporting purposes but not recognizable for income tax purposes. In addition,
our income tax expense has been adjusted for the effect of foreign income from
our wholly owned subsidiary in Israel. At September 30, 2012, deferred tax
assets generated from our U.S. activities were offset by a valuation allowance
because realization depends on generating future taxable income, which, in our
estimation, is not more likely than not to be generated. The deferred tax assets
and liabilities generated from our subsidiary in Israel's operations are not
offset by an allowance, as in our estimation, they are more likely than notto
be realized.
Our subsidiary in Israel generates net taxable income from services it provides
to us. The subsidiary in Israel charges us for research, development, certain
management and other services provided to us, plus a profit margin on such
costs, which is currently 8%. In the zone where the production facilities of the
subsidiary in Israel are located the statutory tax rate is 15% in 2011 and 2012
and expected to be 12.5% in 2013 and 2014, and 12% in 2015 and thereafter.
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Results of Operations
Three and nine month periods ended September 30, 2012 compared to three month
period ended September 30, 2012 and period from June 8, 2011 (inception of I/P)
through September 30, 2011 and the development stage period, cumulative from
inception of I/P through September 30, 2012
Revenue
Period from
inception of I/P (June Cumulative
Nine months 8, 2011) through from inception
Three months ended September 30, ended September 30, September 30, to September 30,
2012 2011 Change 2012 2011 Change 2012
Revenue 266,000 - 266,000 266,000 - 266,000 266,000
In the third quarter of 2012, following the consummation of the Merger, for the
first time since inception of I/P, we recorded total revenues of $266,000. The
recognized revenue consisted of: (i) subscription and content sales based
revenue of $76,000, which represents legacy Vringo revenue from July 19, 2012,
the date of the Merger, through September 30, 2012, (ii) revenue from a
development project with Nokia of $90,000 and (iii) proceeds from partial
settlement with AOL in the total amount of $100,000.
As a combined company, after the recently issued verdict in our litigation
against AOL, Inc., Google, Inc., IAC Search & Media, Inc., Gannett Company,
Inc., and Target Corporation for infringement of the Patents acquired from
Lycos, we expect to generate revenue based on the verdict, although both sides
have the right for an appeal, we also intend to continue to expand our planned
operations through acquisitions and monetization of additional patents and other
intellectual property. In particular, following the incorporation of our
subsidiary in Germany and the acquisition of a patent portfolio from Nokia, we
intend to expand our intellectual property monetization efforts in Europe. In
October 2012, we filed litigation against a UK subsidiary of ZTE, with a goal of
achieving a positive verdict or settlement, including, potentially, a licensing
arrangement on terms beneficial to us.
We also expect to continue to generate a portion of our future revenues from:
(i) Facetones® preloads, as well as from additional clients in the handset
makers, (ii) Facetones® app, and Fan Loyalty application platforms, (iii)
revenue-sharing agreements in India, Malaysia, Singapore, United Arab Emirates
and UK, (iv) new revenue-sharing agreements for subscription-based services in
new territories, (v) one-time service fees for customized production and
development of the Facetones® and Fan Loyalty application platforms, and (vi)
monetization of our intellectual property.
Cost of revenue
Period from
inception of I/P (June Cumulative
Nine months ended 8, 2011) through from inception to
Three months ended September 30, September 30, September 30, September 30,
2012 2011 Change 2012 2011 Change 2012
Cost of services provided 18,000 - 18,000 18,000 - 18,000 18,000
Amortization of intangibles 878,000 157,000 721,000 1,189,000 170,000 1,018,000 1,517,000
Operating legal 2,519,000 390,000 2,129,000 4,769,000 391,000 4,379,000 6,001,000
Total 3,415,000 547,000 2,868,000 5,976,000 561,000 5,415,000 7,536,000
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During the three month period ended September 30, 2012, our cost of revenue was
$3,415,000, which represents an increase of $2,868,000 (or 524%) compared to our
cost of revenue for the three month period ended September 30, 2011. The
increase in cost of revenue, compared to the third quarter of 2011, was mainly
related to increased amortization of patents, due to the newly acquired patents
from Nokia ($541,000, compared to $157,000 in 2011), as well as due to
amortization of technology, the value to which was allocated upon consummation
of the Merger ($338,000, compared to $0 in 2011). In addition, we incurred
significant costs in connection with the commencement of I/P Engine patent trial
on October 16, 2012 and share based compensation related costs ($318,000 in 2012
compared to $0 in 2011). Finally, the increase in cost of services, related to
legacy Vringo mobile app services, reflects the costs recorded for the first
time during the quarter, pursuant to the Merger with I/P.
During the nine month period ended September 30, 2012, our cost of revenue was
$5,976,000, which represents an increase of $5,415,000 (or 962%) compared to our
cost of revenue for the period from June 8, 2011 through September 30, 2011. The
increase in cost of revenue, compared to the parallel period in 2011, was mainly
related to increased amortization expenses related to the patents acquired from
Nokia and Lycos ($852,000, compared to $171,000 in 2011), as well as to
amortization of acquired technology ($338,000, compared to $0 in 2011). In
addition, we incurred increased costs in connection with commencement of the
Lycos patent trial on October 16, 2012 and share based compensation related
costs ($318,000 in 2012 compared to $0 in 2011). Finally, the increase in cost
of services, related to legacy Vringo mobile app services, reflects the costs
accounted for the first time, pursuant to the Merger with I/P.
From inception through September 30, 2012, cost of revenue expenses amounted to
$7,536,000. Of this amount, $18,000 was attributed to the cost of mobile
services provided to our clients, $318,000 to share based compensation expense,
$338,000 was attributed to amortization of the acquired technology, $5,682,000
was attributed to operating legal expenses, mainly related to I/P Engine patent
litigation, and $1,180,000 was attributed to patent amortization.
We expect that cost of revenue will increase over time, as we diversify the
portfolio of our products and increase our intellectual property. As most of
these costs are incurred irrespective of our revenues, we expect our gross
margin to increase as our revenues grow.
Research and development
Period from inception of Cumulative
Nine months I/P (June 8, 2011) from inception to
Three months ended September 30, ended September 30, through September 30, September 30,
2012 2011 Change 2012 2011 Change 2012
Research and development 997,000 - 997,000 997,000 - 997,000 997,000
Research and development expenses, in the total amount of $997,000, recorded
following the Merger with I/P, consist primarily of the cost of our development
team ($454,000, compared to $0 in 2011) and share based compensation ($452,000,
compared to $0 in 2011). We anticipate that our research and development costs
will increase over time, as we seek to develop additional products and
intellectual property to diversify and enhance our original core business.Marketing, general and administrative
Period from inception of Cumulative
Nine months I/P (June 8, 2011) from inception to
Three months ended September 30, ended September 30, through September 30, September 30,
2012 2011 Change 2012 2011 Change 2012
Marketing, general and administrative 6,364,000 323,000 6,041,000 7,508,000 762,000 6,746,000 8,694,000
During the three month period ended September 30, 2012, marketing, general and
administrative expenses increased by $6,041,000 (or 1,870%), to $6,364,000, from
$323,000 during the three month period ended September 30, 2011. Marketing
general and administrative expenses increased mostly due to the increase in
payroll expense ($941,000, compared to $81,000 in 2011), as well as due to an
increase in non-cash share based compensation expense ($4,592,000, compared to
$50,000 in 2011), increased merger and acquisition expense ($90,000, compared to
$0 in 2011) and increased corporate legal expenses ($240,000, compared to
$73,000).
32
During the nine month period ended September 30, 2012, marketing, general and
administrative expenses increased by $6,746,000 (or 885%), to $7,508,000, from
$762,000 during the period from inception of I/P through September 30, 2011.
Marketing, general and administrative expenses increased mostly due to the
increase in payroll expense ($1,274,000, compared to $88,000 in 2011), as well
as due to increase in non-cash share based compensation expense ($4,762,000,
compared to $373,000 in 2011), increased merger and acquisition expense
($267,000, compared to $0 in 2011) and increased corporate legal expenses
($310,000, compared to $178,000 in 2011).
From inception through September 30, 2012, general and administrative expenses
totaled approximately $8,694,000. $1,493,000 was attributed to salaries and
related expenses, $5,236,000 were attributed to share based payments, $267,000
was attributed to merger and acquisition activity, and $1,109,000 was attributed
to various professional fees.
We expect that our general and administrative expenses will increase, as our
expenses will incorporate full costs of the new management, on a post-Merger
basis (accounted for from July 19, 2012). In addition, increased costs include
increased administration, rent, office, accounting, legal and insurance costs.
Non-operating income (expense), Net
Period from inception of Cumulative
Nine months I/P (June 8, 2011) through from inception to
Three months ended September 30, ended September 30, September 30, September 30,
2012 2011 Change 2012 2011 Change 2012
Non-operating Income, Net 7,310,000 (4,000 ) 7,314,000 7,303,000 (4,000 ) 7,307,000 7,295,000
Following the Merger, our non-operating income, net, included mainly the impact
of changes in fair value of derivative warrants, the fair value of which is
highly affected by our share price at the measurement date. Consequently, as of
September 30, 2012, we recorded an income of $7,240,000 due to the decrease of
our share price at quarter end, compared to the price on the date of the Merger.
In 2011, and prior to the Merger, our non-operating expense consisted of bank
charges, as well as of interest expense related to the note payable (see also
Note 5 to the accompanying financial statements). Finally, our non-operating
income/expense includes the impact of dollar/shekel fluctuations, in connection
with which we recorded income of approximately $75,000 in the three and nine
months of 2012.
Income tax benefit
Period from inception of Cumulative
Nine months ended I/P (June 8, 2011) from inception to
Three months ended September 30, September 30, through September 30, September 30,
2012 2011 Change 2012 2011 Change 2012
Income tax benefit 76,000 - 76,000 76,000 - 76,000 76,000
During the three and nine month period ended September 30, 2012, we recorded an
income tax benefit in the total amount of $76,000, compared to $0 in all
previous periods. In general, taxes on income are mainly due to taxable profits
generated by our subsidiary in Israel, as a result of the intercompany cost plus
agreement between us and the subsidiary in Israel, whereby the subsidiary in
Israel performs development and other services for us and is reimbursed for its
expenses plus 8%. For financial statements purposes, these profits are
eliminated upon consolidation. In addition, income tax benefit included $118,000
due to a decrease in deferred tax liability in respect of the acquired
technology (see also Note 4 of the accompanying financial statements). In all
periods since inception, we have fully offset our U.S. net deferred tax asset
with a valuation allowance. Our lack of earning history and the uncertainty
surrounding our ability to generate U.S. taxable income prior to the expiration
of such deferred tax assets were the primary factors considered by management in
establishing the valuation allowance.
We expect taxable income in our subsidiary in Israel, in 2012, under the terms
of the intercompany agreement. We also expect our income tax expense will be
offset by a tax benefit derived from the decrease in deferred tax liability
related to the acquired technology, as discussed above.
33
Off-Balance Sheet Arrangements
We have no obligations, assets or liabilities which would be considered
off-balance sheet arrangements. We do not participate in transactions that
create relationships with unconsolidated entities or financial partnerships,
often referred to as variable interest entities, which would have been
established for the purpose of facilitating off-balance sheet arrangements.
Liquidity and Capital Resources
As of September 30, 2012, we had a cash balance of $9,549,000 and approximately
$5,842,000 in net working capital. The increase of $4,337,000 in our cash
balance from December 31, 2011 was mainly due to $31,200,000 received in a
private registered direct financing round and $1,769,000 from exercise of
options and warrants, offset by net cash used by us in our business operations,
in the total amount of approximately $5,962,000, $22,548,000 used to acquire
Nokia patents, as well as $3,200,000 used to repay outstanding notes to Hudson
Bay, as also described in Note 5 to the accompanying financial statements. As of
September 30, 2012, our total stockholders' equity was $90,111,000, mainly
increased by the net assets of Vringo recorded upon consummation of the Merger,
offset by continued operating deficits from inception to date.
On October 4, 2012, we entered into subscription agreements with several
investors with respect to the registered direct offer and sale by us of an
aggregate of 10,344,998 shares of our common stock, par value $0.01 per share,
at a purchase price of $4.35 per share in a privately negotiated transaction in
which no party acted as an underwriter or placement agent. The net proceeds to
us were approximately $44,900,000 after deducting estimated offering expenses
payable by us. We intend to use the net proceeds from this offering for general
corporate working capital purposes.
In October 2012, we entered into an agreement with certain of our warrant
holders, pursuant to which such warrant holders exercised in cash 3,721,062 of
their outstanding warrants, with an exercise price of $1.76 per share, and we
issued such warrant holders unregistered warrants to purchase an aggregate of
3,000,000 of our shares of common stock, par value $0.01 per share, at an
exercise price of $5.06 per share. The newly issued warrants do not bear down
round protection clauses. We are still evaluating the accounting impact of this
transaction; nevertheless, we expect such impact on our financial statements to
be material.
In addition, in October and November 2012, 790,903 warrants at an exercise price
of $1.76 were exercised by our warrant holders, pursuant to which we received an
additional $1,391,989.
The accompanying financial statements have been prepared on a basis which
assumes that we will continue as a "going concern", which contemplates the
realization of assets and the satisfaction of liabilities and commitments in the
normal course of business. As of November 14, 2012, we had approximately
$60,500,000 in cash and cash equivalents. Based on current operating plans, we
expect to have sufficient funds for at least the next twelve months. In
addition, we may choose to raise additional funds in connection with potential
acquisitions of patent portfolios or other intellectual property assets that we
may pursue. There can be no assurance, however, that any such opportunitieswill
materialize.
Cash flows
Period from June 8, Cumulative
Nine month period ended 2011 to from June 8, 2011 to September 30,
September 30, 2012 September 30, 2011 Change 2012
Net cash used in operating activities (5,962,000 ) (254,000 ) (5,708,000 ) (7,491,000 )
Net cash used in investing activities (19,419,000 ) (3,400,000 ) (16,019,000 ) (22,823,000 )
Net cash provided by financing activities 29,717,000 7,360,000 22,357,000 39,862,000
Operating activities
During the nine month period ended September 30, 2012, net cash used in
operating activities totaled $5,962,000. During the period from inception
through September 30, 2011, net cash used in operating activities totaled
$254,000. The increase of $5,708,000 in cash used in operating activities was
mainly due I/P's incorporation in June 2011, the Merger with Vringo, and further
development of our business. Operating activities include merger and acquisition
related payments of $267,000 that reflect I/P's and post-merger Vringo's
non-capitalized expenses.
34
We expect our net cash used in operating activities to increase due to further
development of our business, development of our products and enhancement of our
intellectual property. As we move towards greater revenue generation, we expect
that these amounts will be offset over time by collection of funds generated by
generated revenues.
Investing activities
During the nine month period ended September 30, 2012, net cash used in
investing activities totaled $19,419,000. During the period from inception
through September 30, 2011, net cash used in investing activities totaled
$3,400,000. The increase in cash used in investing activities, in the total
amount of $16,019,000 was primarily due to the purchase of the patent portfolio
from Nokia, in the total amount of $22,548,000, compared to the cost of patents
acquired from Lycos in 2011, for $3,395,000. Fixed asset purchases in the nine
month period ended September 30, 2012 amounted to $151,000 compared to $5,000
for the period from inception of I/P through September 30, 2011, due to
post-Merger relocation of our headquarters.
We expect that net cash used in investing activities will increase as we intend
to continue to acquire additional intellectual property and upgrade our
computers and software.
Financing activities
During the nine month period ended September 30, 2012, net cash provided by
financing activities totaled $29,717,000, which relates to the August private
financing round, in which we raised approximately, $31,148,000, offset by
repayment of notes payable to Hudson Bay, and funds received from exercise of
warrants and options in the total amount of $1,769,000. During the from
inception of I/P through September 30, 2011, net cash provided by financing
activities totaled $7,360,000, which included the receipt of notes payable from
Hudson Bay and proceeds from the issuance of Series A Convertible Preferred
Stock and shares of common stock in the total amount of $4,160,000.
As mentioned above, a significant portion of our issued and outstanding warrants
are currently "in the money" and the shares of common stock underlying such
warrants held by non-affiliates are freely tradable, with the potential of up to
$21,904,382 of incoming funds. We may choose to raise additional funds in
connection with any acquisition of patent portfolios or other intellectual
property assets that we may pursue. There can be no assurance, however, that any
such opportunity will materialize, moreover, any such financing would likely be
dilutive to our current stockholders.
Future operations
We believe that through the Merger we will create a company with enhanced
technology capabilities to create, build and deliver mobile applications and
services to its handset and mobile operator partners as well as directly to
consumers. We believe that the value of each company's intellectual property
portfolio will be enhanced through the combined company's ability to license and
enforce its intellectual property rights. Together with the executive team from
I/P we anticipate the creation of additional products and services that will be
distributed through our existing operator and handset relationships. We may
choose to raise additional funds in connection with any potential acquisition of
patent portfolios or other intellectual property assets that we may pursue.
There can be no assurance, however, that any such opportunities will
materialize, moreover, any such financing would likely be dilutive to our
stockholders.
As one of the means of realizing the value of the patents on telecom
infrastructure, on October 5, 2012, our wholly-owned subsidiary, Vringo
Infrastructure, Inc., filed suit in the UK High Court of Justice, Chancery
Division, Patents Court, alleging infringement of European Patents (UK)
1,212,919; 1,166,589; and 1,808,029. Declarations have been filed at the
European Telecommunications and Standards Institute (ETSI) that cover the
patents. The complaint alleges that ZTE's cellular network elements fall within
the scope of all three patents, and ZTE's GSM/UMTS multi-mode wireless handsets
also fall within the scope of the '029 patent. On October 23, 2012, counsel for
ZTE acknowledged service. ZTE (UK) formal response to the complaint is
anticipated by November 22, 2012. A case management conference where among other
matters, the schedule for the suit will be set, is anticipated in January 2013.
On October 10, 2012, our subsidiary in the United States entered into a patent
purchase agreement, as part of which we issued to seller 160,600 unregistered
shares of our common stock, as well as a 20% royalty from collected future
revenue.
We are currently in discussions with several potential strategic partners and
mobile carriers and we will be pursuing additional agreements over the next 12
to 24 months. In addition, we are continuing to explore further opportunities
for strategic business alliances, as well as, potential acquisition of patent
portfolios or other intellectual property assets. However, there can be no
assurance that any such opportunities may arise, or that any such opportunities
will be consummated.
35
Critical Accounting Estimates
While our significant accounting policies are more fully described in the notes
to our audited consolidated financial statements for the years ended
December 31, 2011 contained in the definitive proxy statement/prospectus filed
with the SEC on July 21, 2012, we believe the following accounting policies to
be the most critical in understanding the judgments and estimates we use in
preparing our consolidated financial statements.
Goodwill and intangible Assets
We accounted for the Merger in accordance with FASB Topic ASC 805 "Business
Combinations" and for identified goodwill and technology in accordance with FASB
Topic ASC 350 "Intangibles - Goodwill and Other". Additionally, we review our
long-lived assets for recoverability in accordance with FASB Topic ASC 360
"Property, Plant and Equipment".
The identification and valuation of intangible assets and the determination of
the estimated useful lives at the time of acquisition are based on various
valuation methodologies including reviews of projected future cash flows. The
use of alternative estimates and assumptions could increase or decrease the
estimated fair value of our goodwill and other intangible assets, and
potentially result in a different impact to our results of operations. Further,
changes in business strategy and/or market conditions may significantly impact
these judgments thereby impacting the fair value of these assets, which could
result in an impairment of the goodwill and acquired intangible assets.
We evaluate our long-lived tangible and intangible assets for impairment in
accordance with FASB Topic ASC 350 "Intangibles - Goodwill and Other"and FASB
Topic ASC 360 "Property, Plant and Equipment" whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. Goodwill is subject to an annual test for impairment, or for
impairment testing up on the occurrence of triggering events. If such assets are
considered to be impaired, the impairment to be recognized is measured by the
amount by which the carrying amount of the assets exceeds the fair value of the
assets. While we use available information to prepare our estimates and to
perform impairment evaluations, the completion of annual impairment tests
requires significant management judgments and estimates.
Valuation of Financial Instruments
On July 19, 2012, the date of the Merger, Vringo's outstanding warrants
included: (i) 148,390 Special Bridge Warrants, at an exercise price of $0.94,
with an expected remaining term of 2.44 years; (ii) 101,445 Conversion Warrants,
at an exercise price of $0.94, with an expected remaining term of 2.44 years;
(iii) 887,330 Preferential Reload Warrants, at an exercise price of $1.76, with
an expected remaining term of 4.55 years; and (iv) 814,408 non-Preferential
Reload Warrants, at an exercise price of $1.76, with an expected remaining term
of 4.55 years. Following the Merger and through September 30, 2012, 101,692
non-Preferential Reload Warrants were exercised.
As part of the Merger, on July 19, 2012, we issued to I/P's stockholders
8,299,116 warrants at an exercise price of $1.76 and expected term of 5 years
("Series 1 Warrant"). These warrants bear down-round protection clauses, as a
result, they were classified as a long-term derivative liability and recorded at
fair value. In addition, I/P's stockholders received another 7,660,722 warrants
at an exercise price of $1.76 and expected term of 5 years ("Series 2 Warrant").
As these warrants do not have down-round protection clauses, they were
classified as equity. Following the Merger and through September 30, 2012,
371,440 Series 1 Warrants and 342,873 Series 2 Warrants were exercised. The
following table represents the assumptions, valuation models and inputs used, as
of September 30, 2012:
Valuation Unobservable
Description Technique Inputs Range
Volatility 63.75% -
67.43%
Risk free interest 0.27% -
Special Bridge Warrants, rate 0.63%
Conversion Warrants, Black-Scholes-Merton Expected term, in 2.25 - 4.80
Preferential Reload Warrants and the Monte-Carlo years
and the Series 1 Warrants models Dividend yield 0%
Probability and 15%
timing of down-round occurrence
triggering event in December
2012
Had we made different assumptions about the risk-free interest rate, volatility,
the impact of the down-round provision, or the estimated time that the
above-mentioned warrants will be outstanding before they are ultimately
exercised, the recorded expense, our net loss and net loss per share amounts
could have been significantly different.
36
Accounting for Stock-based Compensation
We account for stock-based awards under ASC 718, "Compensation-Stock
Compensation", which requires measurement of compensation cost for stock-based
awards at fair value on the date of grant and the recognition of compensation
over the service period in which the awards are expected to vest. In addition,
for options granted to consultants, FASB ASC 505-50, "Equity-Based Payments to
Non Employees" is applied. Under this pronouncement, the measurement date of the
option occurs on the earlier of counterparty performance or performance
commitment. The grant is revalued at every reporting date until the measurement
date. The estimation of stock-based awards that will ultimately vest requires
judgment, and to the extent actual results differ from our estimates, such
amounts will be recorded as a cumulative adjustment in the period estimates are
revised. We consider various factors when estimating expected forfeitures,
including historical experience. Actual results may differ substantially from
these estimates.
We determine the fair value of stock options granted to employees, directors and
consultants using the Black-Scholes-Merton and the Monte-Carlo (for grants that
include market conditions) valuation models, those require significant
assumptions regarding the expected stock price volatility, the risk-free
interest rate and the dividend yield, and the estimated period of time option
grants will be outstanding before they are ultimately exercised. Due to
insufficient history, we estimate our expected stock volatility incorporating
historical stock volatility from comparable companies.
These option pricing models utilize various inputs and assumptions, which are
highly subjective. Had we made different assumptions about risk-free interest
rate, volatility, or the estimated time that the options will be outstanding
before they are ultimately exercised, the recorded expense, our net loss and net
loss per share amounts could have been significantly different. Had we used
different assumptions, our results may have been significantly different.
Accounting for Income Taxes
As part of the process of preparing our consolidated financial statements, we
are required to estimate our income taxes in each of the jurisdictions in which
we operate. This process involves management estimating our actual current tax
exposure together with assessing temporary differences resulting from differing
treatment of items for tax and accounting purposes. These differences result in
deferred tax assets and liabilities, which are included within our consolidated
balance sheet. We must then assess the likelihood that our deferred tax assets
will be recovered from future taxable income and, to the extent we believe that
recovery is not more likely than not, we must establish a valuation allowance.
Significant management judgment is required in determining our provision for
income taxes, our deferred tax assets and liabilities and any valuation
allowance recorded against our net deferred tax assets. At September 30, 2012
and December 31, 2011, we have offset our U.S. net deferred tax asset with a
valuation allowance. Our lack of earnings history and the uncertainty
surrounding our ability to generate U.S. taxable income prior to the expiration
of such deferred tax assets were the primary factors considered by management in
establishing the valuation allowance. Also, refer to Note 14 of Vringo
consolidated financial statements for the year ended December 31, 2011.
ASC 740, "Income Taxes", prescribes how a company should recognize, measure,
present and disclose in its financial statements uncertain tax positions that
the company has taken or expects to take on a tax return. Additionally, for tax
positions to qualify for deferred tax benefit recognition under ASC 740, the
position must have at least a "more likely than not" chance of being sustained
upon challenge by the respective taxing authorities, which criteria is a matter
of significant judgment.
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