Marathon Digital Holdings, Inc. (MARA) Q3 2014 Earnings Report, Transcript and Summary

Hello and thank you for standing by. Welcome to Marathon Patent Group's third quarter financial results conference call. As a reminder, all participants are in listen-only mode and the conference is being recorded. [Operator Instructions] At this time I would like to turn the conference over to Lasse Glassen, Investor Relations with Addo Communications. Please go ahead.

Thank you, operator. Good afternoon and welcome to Marathon Patent Group's 2014 third quarter results conference call. With us today are Marathon's Founder and Chief Executive Officer, Doug Croxall, and Chief Financial Officer, Frank Knuettel. Before I turn the call over to management, please remember that our prepared remarks and responses to questions may contain forward-looking statements. Words such as may, will, expect, intend, plan, believe, seek, could, estimate, judgment, targeting, should, anticipate, goal and variations of these words and similar expressions are intended to identify forward-looking statements. Actual results could differ materially from those implied by such forward-looking statements due to a variety of factors including but not limited to, the effect of the global economic downturn on technology companies, the ability to successfully develop licensing programs and attract new business, rapid technological change in relative markets, changes in demand for current and future intellectual property rights, and legislative, regulatory and competitive developments addressing licensing and enforcement of patents and/or intellectual property in general and general economic conditions. Our Annual Report on Form 10-K, recent and fourth coming quarterly reports on Form 10-Q, recent current reports on forms 8-K and 8-K amended and other SEC filings discuss some of the potential risk factors that may affect our business, results of operations and financial conditions. We undertake no obligation to revise or update publicly any forward-looking statements for any reason. Although the company believes the expectations reflected in such forward-looking statements are based upon reasonable assumptions, they can give no assurance that its expectations will be attained. The company undertakes no obligation to update any forward-looking statement whether as a result of new information, future events or otherwise. In addition, certain of the financial information presented in this call references non-GAAP financial measures. The company's earnings release which was issued this afternoon and is available on the company's Web site presents reconciliations to the appropriate GAAP measure and an explanation of why the company believes such non-GAAP financial measures are useful to investors. Finally, this conference call is being webcast. The webcast link is available in the investor relations section of our Web site at www.marathonpg.com. With that, it's now my pleasure to turn the call over to Marathon's Founder and CEO, Doug Croxall. Doug?

Thanks, Lasse and thank you everyone for joining us this afternoon to discuss Marathon Patent Group's financial and operational results for the third quarter of 2014. I will begin today's call with an overview of the company's performance and a review of our operational highlights for the third quarter. Frank, our Chief Financial Officer, will follow by providing additional details on the company's financial results. We will then open up the call to your questions. We set a new record for revenues in the third quarter. Revenues for Q3 totaled $13.5 million, up 255% sequentially and more than 18 times higher on a year-over-year basis. More importantly, we achieved GAAP profitability for the first time with GAAP net income of $3.5 million or $0.61 per basic share compared to a GAAP net loss of $0.9 million or a loss of $0.21 per basic share in the year ago period. These results are indicative of our ability to execute our business plan. The third quarter was extremely productive for Marathon. Some key highlights include, we generated revenue from a total of five license agreements across 21 licensees. Since inception in November 2012, we have now generated revenue from eight of our 16 subsidiaries. Our subsidiaries added an additional 15 defendants across two subsidiaries. We acquired two portfolios comprising 71 patents and subsequent to the quarter end, we completed the acquisition of one additional company with the portfolio of 123 patents. We announced the commercial launch of the Opus Patent Analysis Platform, subsequent to the quarter end we successfully completed a $5.5 million convertible debt financing. And finally, our German subsidiary, MedTech Development Deutschland GmbH recently received very encouraging news which I will discuss in more detail in a moment. We continue to focus on expanding Marathon's patent portfolio and in particular diversifying our portfolio across a wide range of industries. Covering patents across multiple technology areas and varying stages of maturity. In August, we acquired the Clouding IP portfolio which comprises 70 U.S. and international patents along with 47 patent applications. The portfolio provides coverage in ecommerce, software networking, mobile communications, consumer electronics and the PC market. These technologies covered by the portfolio include file synchronization and transfer, remote content management, cloud based infrastructure, virtualized service provisioning, pay-per-use provisioning, redundancy storage and virtual private network protocols. Consideration for the acquisition included $1.4 million in cash. $1 million in the form of a promissory note that we subsequently paid in full, 25,000 shares of common stock and 50% of the net recovery in excess of $4 million in net recoveries that Marathon makes with respect to the patents purchased from Clouding IP. Please note that we define net recoveries as revenue net of direct cost and enforcement of [litigates] [ph]. In September, Marathon acquired TLI Communications LLC, owner of a single U.S. patent [reading] [ph] on apparatus and methods for recording, communicating and administering digital images. The patent is currently being asserted against 21 defendants in the Eastern District of Virginia, including, but not limited to, Facebook, Google, Twitter, Yahoo, Pinterest and Apple, among others. Consideration for the acquisition including 60,000 shares of Marathon common stock and $350,000 of cash. Additionally, Marathon will pay to the previous patent owners 50% of the net recovery once Marathon has recouped any out of pocket cost of enforcement including the $350,000 cash consideration paid pursuant to the acquisition of TLI Communications. In mid-September, the Patent Trial and Appeal Board of the U.S. Patent and Trademark Office denied application for IPR filed by Facebook against TLI Communications. We are pleased with this ruling and hope that the denial will encourage the parties in suites to reach reasonable licensing arrangements. In addition, this past month it was announced that the claim construction hearings for all member cases in the CLI Communications patent litigation will be held on January 20, 2015 at the University of Virginia, School of Law. Subsequent to the end of the quarter, in October we acquired OrthoPhoenix LLC, TLIF LLC and MedTech Development Deutschland GmbH, collectively referred to as MedTech. The purchase price for the MedTech subsidiary was $10 million in cash with $1 million paid on closing and the remaining consideration paid in equal monthly installments over a nine months period. The MedTech patent portfolios cover inventions in technologies related to kyphoplasty, intervertebral inserts and heart valve technology. Cases are currently pending in the United States and Germany and on Thursday, October 30, we received a ruling from the German court in Dusseldorf that MedTech Development Deutschland GmbH had won its infringement trial against Stryker GmbH. As a result of this ruling, we expect to pursue an injunction within the borders of Germany. With the conclusion of the MedTech acquisition Marathon now has a total of 378 patent assets, of which approximately 51% are U.S. [based] [ph]. Currently we have 7 Markman hearings scheduled in 2015 that includes 61 defendants. Additionally, we have two trials scheduled and expect that at least one other subsidiary will have its trial scheduled for 2015. A list of known Markman hearings and trial dates are now available on our Web site. Before concluding my prepared remarks, I want to quickly update you on Opus Patent Analysis Platform, our proprietary IP analysis offering. During the quarter we announced the commercial launch of Opus. We are excited about the opportunity to bring this valuable resource to the broader intellectual property and investment community which will also generate a source of fast paced recurring revenue for Marathon. We are confident that the Opus platform would deliver a feature set and price point that IP professionals and others including finance professionals, will find highly attractive relative to the other offerings currently in the market. We will continue to update you on the progress on Opus in future calls. During September and then most recently in November, we made three additions to our management team. In September, Daniel Gelbtuch joined Marathon as our Chief Marketing Officer. Daniel is a talented executive with more than 15 years of experience in the semiconductor, technology license and IT monetization sectors. Additionally, just this week, we welcomed IPNav veteran Umesh Jani and Rick Sanchez to our management. Before joining Marathon, both Umesh and Rick were integral in supporting the [three] [ph] acquisitions, [three] [ph] suite due diligence as well as the licensing of several portfolios Marathon had acquired and begun [indiscernible]. We are extremely fortunate to have added all three executives to our team. In summary, I am very pleased with Marathon's third quarter results. We believe that have built a robust highly scalable, proprietary patent monetization platform that give us the capability to manage multiple, concurrent licensing campaigns without substantial additions to our overhead. We believe that we have not only developed a foundation upon which we can continue to grow for the remainder of 2014 and beyond, but also the wherewithal to become one of the most successful patent acquisition monetization companies in the world. That concludes my prepared remarks. With that, I would now like to turn the call over to Frank, our CFO, for a detailed look at our third quarter financial results.

Thanks, Doug. As Doug mentioned earlier, we are very pleased to report a record third quarter with revenues totaling $13.5 million, up significant from $0.7 million in the prior year period and $3.8 million sequentially. The growth in revenue was driven by the issuance of larger onetime non-recurring, non-exclusive, non-assignable licenses to five different entities and their affiliates. Licenses to two of them accounted for nearly 100% of the company's revenues in the third quarter. Direct cost of revenues for the quarter, which includes contingent payments to patent enforcement counsel, licensing advisors and previous patent owners, along with non-contingent cost, principally legal fees and cost associated with technical experts, associated with enforcing our patent rights and entering into settlement and licensing agreements, totaled $5.6 million, up from roughly $0.4 million in the third quarter of 2013 and $1.8 million in the second quarter of 2014. The increase in direct costs of revenue relative to the second quarter can be attributed to contingent payouts to counsel and former owners on the significantly higher level of revenue and various non-contingent costs associated with Marathon's patent rights, but importantly exclusive of patent amortization expenses. Gross profit for the third quarter totaled $7.9 million or 58% of revenues, up from approximately $0.3 million or 43% of revenues in the year ago time period and $2.1 million or 54% of revenues in the second quarter of 2014. Total operating expenses for the third quarter including amortization of patents, compensation and related taxes, consulting and professional fees and general G&A were $3.7 million, compared with $1.3 million in the third quarter of 2013 and $2.4 million in the second quarter of 2014. Our operating expenses for the third quarter of 2014 relative to the third quarter of 2013 rose 174% which is a result of certain cash and non-cash expenses. Principal along the increase in expenses was an almost four-fold uptick in patent amortization expenses from $0.4 million in Q3 2013 to $1.5 million in Q3 2014, reflecting the significant investment Marathon has made in its patent portfolios and pipeline as well as increases in compensation, consulting and professional fees, all in support of the expansion of the company's business. Despite the significant increase in revenue, on a cash basis, cash operating expenses rose slightly from $0.9 million in the second quarter of 2014 to $1.0 million in the third quarter of 2014. Cash operating expenses were $0.6 million for the third quarter of 2013. Total non-cash operating expenses for the third quarter of 2014 were $2.7 million. For the third quarter, we reported positive GAAP net income for the first time in the company's history of $3.5 million with $0.61 per basic share compared to a GAAP net loss of $0.9 million or a loss of $0.21 per basic share in the year ago period and a GAAP net loss of $1.2 million or a loss of $0.29 per basic share in the second quarter of 2014. The transition to net income was primarily attributable to the increase in revenue and gross profits as a result of increasing revenues during the third quarter. On a fully diluted basis, GAAP net income for the third quarter was $0.44 per diluted share. On a non-GAAP basis, net income for the quarter totaled $6.9 million or $1.20 per basic share compared to a non-GAAP net loss of $0.1 million or a loss of $0.03 per basic share in the third quarter of 2013, and a non-GAAP net income of $1.2 million or $0.21 per basic share in the second quarter of 2014. Improvement in net income can be attributed to a higher level of growth in revenues than an increase in expenses. Before opening the call to your questions, I would like to take a moment to explain our cash flows for the third quarter. We ended the third quarter of 2014 with cash and cash equivalents totaling $5.6 million as compared to $3.6 million at December 31, 2013 and $6.5 million at the end of the previous quarter. Importantly, we had accounts receivable at the end of the third quarter in the amounts of $10.5 million versus $0.1 million at the end of the second quarter of $0.3 million at December 31, 2013. We subsequently received the cash in full and closed out the accounts receivable in the first half of October. In the third quarter of 2014 we generated $0.8 million in cash from operations as compared to cash used in the amount of $0.3 million in the third quarter of 2013. Cash used in investing totaled $1.8 million for the quarter compared to cash used in investing in the amount of $1.0 million in the year ago period. During the quarter, Marathon acquired patents in two entities, both of those portfolios actively being enforced. We are very pleased to continue to generate sufficient cash to fund our current and working capital requirements. As of September 30, 2014, we had $5.8 million weighted average basic shares outstanding. Thank you for all your attention. We would now like to open the call to your questions.

(Operator Instructions) First question is from Amit Dayal of H.C. Wainwright. Please go ahead.

Just on the AR, Frank, the accounts receivable. You said you have recognized that in the fourth quarter already?

We actually received in the fourth quarter. The revenue was recognized in the third quarter.

Okay. So the revenue was recognized in the third quarter.

Yes. But the outstanding accounts receivable was closed in the first two weeks of October.

Understood. Thank you. Doug, how many total patents in the portfolio now, if you provide us with an update on that?

Approximately 370.

370. And what percentage of these are we in the process of enforcing? If you have any idea on that?

Probably 10% to 15%.

Okay. So there is a lot of upside in terms of just going out and enforcing the remaining 80% to 90% of them?

You know, just because you own a patent, you are not necessarily going to enforce it. But we were asserting the patents that we think have the strongest reads and the best damages. So we could very well own patents and never assert them. But currently we have got about 10% to 15% that we have in different assertions.

Okay. Got it. And then just lastly, on the Stryker case. What are the next steps on this? You received lot of a favorable decision, where do we go from here?

Yes. We received -- obviously we won the infringement trial in Germany. We are working with German counsel right now to get our bond funded and the injunction in place. And we hope to have an update to the shareholders within the imminent future.

This is something that could happen in the fourth quarter?

Is the bond is being posted and an injunction being put in place, if that’s the question, yes, that can happen in the fourth quarter.

The next question is from Jon Hickman of Ladenburg Thalmann. Please go ahead.

Could you help us think about -- I mean obviously your licensing efforts are going to be lumpy due to the timing of events. But because you obviously scored big in the second and third quarter, can you help us think about maybe the next few quarters. What do you see on the horizon?

You know we don’t give guidance, Jon, on revenues or frankly anything. So it's kind of tough to point you to what we think we are going to do in Q4 or Q1 next year. But the one thing that I would point to is that we have got I think seven Markman hearings in the first ten months of 2015. 60 some defendants are involved in those different Markman hearings. So that typically is a natural point which a license will get done. So all I can really do is kind of point you to some of the milestones that we think will be meaningful for both revenue generation and settlement. But obviously I can't give you what that number is because, frankly, it's too difficult to give and I wouldn’t do it anyway.

Could you give us any idea of how many -- let's see, how do I phrase this. How many discussions you are in that are far enough along to result in licensing efforts or licensing outcome in maybe over the next six months?

We are always open to discussions with defendants on a number of different topics. Oftentimes defendants will want to know what a settlement is at a particular point in time. So we are constantly in those discussions. I couldn’t even tell you how many would potentially settle in the next six months. It's just not something that we can -- it's not something we can provide guidance on.

Okay. So let me try one more thing. Obviously, the third quarter, the $30 million was obviously the result of one particular -- can you elaborate on anything on the settlement then generated this much revenues in one quarter.

All I can tell you is that oftentimes when you are in discussions with multiple defendants within the same subsidiary that you will have what I would call like a group license. So that’s the best way to kind of think of it is that we had a lot of parties who wanted to settle at the same time.

Are there more parties who settled in that particular enforcement?

Yes, yes.

Okay. So this one settlement kind of encouraged the others to follow?

Sometimes. I mean it depends on the defendant. Some don’t care and some want to see what kind of "the market is willing to pay for a license". And so often times it can help for additional settlements and sometimes it just doesn’t matter because of the attitude of a particular defendant.

And then one last question. You were at that IP Deal Makers Conference in New York just last week and it seemed to me that one of the messages was that this is very buyer oriented market right now. That if you have the resources, patents can be had for maybe a more attractive price than say a year ago. Could you comment on that?

I think it depends. I think that probably it cuts both ways. I think that the courts have said, look certain patents aren't going to survive whether through an IPR or whether through a 101 challenge or a 112 challenge. So the higher quality patent is going to be, it's really going to be demanding whatever price it can demand. And so if there is scarcity in the supply then it's going to be, it's going to be the sellers who are going to set the pricing. If there is a few buyers than the buyers are going to have probably the benefit. We are really picky on what we buy and how we pay for it. So I like to think that the pendulum is swinging back over to Marathon's side where the buyers are kind of studying the prices. But I am not sure I have enough data to really give you any sort of guidance on that.

The next question is from Mike Latimore of Northland Capital. Please go ahead.

Yes. Thanks a lot. Great results. Definitely it looks like the strategy is gelling here. I guess you gave a number of Markmans in [indiscernible] can you update on just like the number of trial dates you are seeing as well?

So right now we have two trial dates that are set. We expect to have another trial date that will get set hopefully before the end of the calendar year. But trial dates typically, they are not always set in advance. But if you go to our Web site, we actually have a section in our Web site under the about section with Marathon key dates and it lists all the known Markman dates and trial dates.

Great. And then on the licensing deal in this third quarter. Was that agreed to around a Markman or a trial date or was it just done via standard negotiations.

Well, there is a lot of different settlements. Some were done -- none of them were done because there was a Markman the next day. It was just kind of standard negotiation I guess is the category I would put it in.

Got it. And in the deal that you struck in the quarter, have you licensed the majority of the addressable market there, would you say?

No. The answer is no.

No. Okay. Got it. And on the Stryker situation, I thought I read in one of the releases here that you know there were some damages. Has there been fees paid or is it really more on the adjunct side of the plan?

Adjuncted side.

Okay. And just last question. Any prospect here for doing binding arbitrations as opposed to going through full litigation or they are [indiscernible] like that yet?

Not for Marathon. I mean I wish we could get this resolved without either binding arbitration or litigation but it takes two and we are willing but no one else seems to be.

The next question is from Bill Relyea of Midtown Partners. Please go ahead.

Very good results, obviously. Could you talk a bit about the introduction of Opus and what kind of a breakdown between the three levels you are seeing initially?

Hey, Bill. So Opus was launched September 15 or 16, so we are relatively new to the process. So we are not giving any sort of guidance on revenue. And it's just so nascent right now that they are just not meaningful numbers.

Okay. A sort of larger question. With the Republican victory in the Senate and the house, what do you think going forward in terms of the patent legislation which called killed before?

Well, it's a great question. And in fact I was on the phone the other day with some of our consultants in Washington DC. And so it's interesting, if you look at the [indiscernible] bill, a lot of what they were looking for in that bill has started to kind of resolve itself. You know the FTC is taking action against those who abuse, kind of letter writing campaign decision. The fee shifting provision that are being enacted. A lot of the things are kind of resolving themselves which I think is probably the best way for litigation reform. And this is not really patent reform. This is litigation reform. I think there is probably a place for that to occur. What might happen I have no idea. I mean there is a lot of people who speculate because the republicans will be in charge of the judicial committee. I think [indiscernible] will be in charge of that committee. And it's hard to say but I suspect we probably won't, if we see anything, it probably won't happen until Q1 of next year. And I frankly don’t know what they are going to want to change that hasn’t already started to change on its own. Maybe some pleading requirements, but it's going to be anybody's guess but I tend to think that if you take a more measured approach and see what the real effects of AIA and the [post-grant] [ph] review proceeding and the Supreme Court decision and how those are being implemented. I think it probably makes sense to take a step back and see what the actual effects are before we start to regulate even more. But sometimes Washington DC has a hard time to take that approach.

Next question is from Jon Hickman of Ladenburg Thalmann. Please go ahead

Real quick. The settlement in this particular quarter, the license, what subsidiary was that in?

Yes. We are not giving guidance on the subsidiary. And that’s for strategic reasons Jon. We are obviously in discussions with a lot of other parties and we don’t want to harm and licensing discussions that we are having right now.

[Operator Instructions] The next question is from [Gerald Tepelmen] [ph] a private investor. Please go ahead.

I seem to recall -- I am a relatively new investor -- I seem to recall that you have provided some guidance maybe six months ago or so that you are anticipating over a five-year period from now. Revenues of around $100 million a year, five years out. Is that something that you still think is realistic or would you like to update that at all or where do you stand on that?

Yes. That guidance was provided at the end of last year. And that revenue number was attributed to what we thought we would do aggregately over a three to five year period and that number hasn’t changed. Or let me say, we have not updated that number. And if we do make any changes or update to that number it won't be until most likely next year. We are adding -- as you can tell, we have added quite a bit of assets. So on a monthly basis, I don’t know how many portfolios over the last six months, but almost one or two a month. So it tends to be tough to keep that number updated to the public but we will make a concerted effort to do that under 2015.

Now as you acquire new patents, how do you typically pay for them? Do you pay for them with cash and stock or what's the normal way you normally pay for these assets?

So we do a pretty good job disclosing what we use for consideration. And it's usually a combination of some cash. Sometimes we use equity and sometimes we use either debt or seller financing like an earn out. But I think if you look at our SEC filings, specifically if you look at our most recent, the Q that we filed 30 minutes ago, we do a pretty job in analyzing and providing transparency on what we paid for what asset. But it's a combination of both cash, a percentage of the revenue that they asset may generate and sometimes equity as well.

Okay, great. One final question, because this kind of want over my head a little bit. But you mentioned I think there was some positive and free cash flow in the third quarter and also in the current quarter in October you have collected on your accounts receivable around $10 million, if I understood correctly. So how much cash would there currently be on your balance sheet if you are able to disclose that roughly at this point in time? Because you ended the quarter at $5.6 million? Can you talk about that?

Yes. We are not able to disclose the balance sheet right now. But you are accurate, and I can let Frank speak to this as well, that accounts receivable balance at the end of Q3 was roughly $10 million and I believe that was collected within the first two weeks of October.

That’s terrific. So if I do my addition, you have maybe $5 million in change at the end of the third quarter and if I add $10 million to it, assuming you haven't spent that much money, you are probably somewhere around $15 million in change or something at this point in time. But obviously it would be disclosed at some later date?

Yes. We can't confirm that number. But just as a frame of reference, our operating cash expenses for the third quarter were approximately $1 million and that does not include the cost of revenue which is largely tied to the revenue itself. But it just shows the underlying operating expenses we burned about $1 million of cash and that’s up slightly from approximately $900,000 in the second quarter. So that I think provides a pretty good framework to analyze that question.

And also because I am an individual investor, you provided a bunch of numbers, I am a little bit confused. You provided a number of $1.20, you provided another EPS of like $0.61 and another one of $0.44. So these are three obviously widely discrepant numbers. Which is the right one to use in kind of like looking at the company or which is the most important one in your opinion?

So, Gerald, I mean it depends what kind of investor you are. I happen to be very traditional. So I look at the bottom line. So I think our GAAP EPS number is incredibly important. But I am also -- and we have to take non-cash charges for things that we buy, patents that we buy. And that number which is captured in our patent amortization expense obviously is deducted prior to getting our GAAP EPS number. It would not be unheard of to look at our non-GAAP EPS number and look at that as another measurement of being able to drive earnings for the shareholder. So I think both numbers are probably important. If we were doing some huge revenue number but still not profitable, you might want to look into why that would be. Clearly that’s not our case. But both numbers are probably important, but again, it depends on what type of investor you are.

This concludes the question-and-answer session. I will hand the call back over to management.

All right. Thank you everyone for dialing in and supporting the company and we look forward to talking to you next quarter and we look forward to updating you on some of the more recent events, specifically with MedTech as soon as we have that announced.

This concludes today's conference call. You may disconnect your lines. Thank you for participating and have a pleasant day.