Marathon Digital Holdings, Inc. (MARA) Q1 2017 Earnings Report, Transcript and Summary

Welcome to Marathon Patent Group's First Quarter 2017 Financial Results Conference Call. [Operator Instructions]. And this conference is being recorded. At this time, I would like to turn the conference over to Jason Assad, Investor Relations with Marathon Patent Group. Please go ahead, sir.

Thank you, Jen. Good afternoon and welcome to Marathon Patent Group's 2017 First 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 certain statements contained in the release are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements contained in this release relate to, among other things, 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 relevant markets; changes in demand for current and future intellectual property rights; legislative, regulatory and competitive developments addressing licensing and enforcement of patents and/or intellectual property in general; and general economic conditions. They're generally identified by words such as believes, may, expects, anticipates, should and similar expressions. Readers should not place undue reliance on such forward-looking statements which are based upon the company's beliefs and assumptions as of the date of this release. The company's actual results could differ materially due to risk factors and other items described in more detail in the Risk Factors section of the company's annual report filed with the SEC, copies of which may be obtained at sec.gov. Subsequent events and developments may cause these forward-looking statements to change. The company specifically disclaims any obligation or intention to update or revise these forward-looking statements as a result of changed events or circumstances that occur after the date of this release, except as required by applicable law. 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 website, 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 website at www.marathonpg.com. With that, I'd like to now turn the call over to Marathon's founder and CEO, Doug Croxall. Doug?

Thank you, Jason and thank you, everyone, for joining us this afternoon to discuss Marathon Patent Group's first quarter 2017 operating results. While 2016 was a record year for the company, generating revenues of $36.6 million and non-GAAP earnings of $7.5 million or $0.50 per weighted average basic share, our first quarter of 2017 revenues were lower as expected than our first quarter 2016 revenues. It's for this very reason I've long suggested the nature of our business lends itself to being evaluated on an annual basis as opposed to focusing quarter-to quarter. I'd like to address the 8-K filing that was made this past Friday with the SEC. The filing described step #1 in our debt restructuring efforts. We entered into an agreement with DBD Credit Funding, a subsidiary of Fortress Investment Group, under which we can pay them the principal load of approximately $15.8 million plus accrued interest on or before August 15, 2017. Additionally, upon payment of the note principal and interest obligation, DBD's ongoing entitlement to additional payments based upon revenues of the company will be reduced to 5% of the gross revenues received from only the patent portfolios which the company currently owns or license. These revenue-based payments will terminate 1-year following the payoff date. In addition, under the payoff letter, Marathon has agreed that the company will not enter into any further disposition of its patents until the note obligations are paid in full and not to use its current liquidity to make expenditures in excess of the specified amount or for the purposes other than is outlined in a budget prepared by the company and already approved by DBD. This will not negatively affect our normal course of operations and is already in line with our operating plan. The company may seek to repay the borrowing through any one or a combination of financing, including debt, equity, sale of assets or mergers and acquisitions of additional companies with cash balances, although no definitive agreement with respect to any of the foregoing has been reached. Our desired outcome is to put a new credit facility in place and we have been in discussions with potential funding sources and hope to have more to announce in the very near future on a replacement line of credit. In the event that we do not pay the note obligations in full on or prior to August 15, 2017, the payoff letter will terminate and the company will remain obligated under the current agreements with DBD. I'd now like to address something that I know is very important to both you and me and I want to address this head-on. I want you to know that I am keenly aware of our recent equity financing was a surprise to many of you. I regret that I did not adequately anticipate how quickly certain circumstances could change when our senior lender declined to fund our request which had been pending which put us in a position where raising additional equity capital became a viable alternative. I take full responsibility and deeply regret the surprise many of you experienced. We were put into a situation that required us to act quickly to raise capital and we were presented with market conditions conducive to a small financing and we chose to take advantage of it. As the CEO of this company, it is my job to make these quick decisions to ensure the financial well-being and long term strength of the company. It is my hope that while sometimes painful in the short term, that these tough decisions will ultimately be better in the long term for the company and its shareholders. We also remain aware of a desire to see more transparency in our strategy. Although we try to continually provide current investor communications, much of what happens at Marathon can unfortunately not be communicated until an outcome has been reached in a litigation which typically involves the settlement of the execution of a license. The entire litigation process itself and settlement negotiations are governed by strict confidentiality. However, investors need to be able to assess the state of our business and prospects. I assure you that we're doing our very best to afford you a level of transparency while not impeding our ability to generate licensing revenues. As I had previously commented and many analysts agree, the patent monetization arena has changed significantly since we embarked upon this journey. However, despite the much more difficult environment to license patents, I still feel optimistic about Marathon's future. In light of our recently announced debt replacement strategy, we're moving away from giving annual guidance and believe that any prior annual guidance should not be relied upon. As previously discussed, we've taken measures within Marathon to reduce our operational spend and to operate more efficiently. Additionally, I'll be in discussions with the Board of Directors and specifically with the Compensation Committee to ensure that any bonuses or additional compensation is in line with industry standards. I am also researching how insiders at Marathon can effectively purchase shares in the open market. I understand that the timing of certain compensation events was unfortunate and I will take extra steps, along with my board, to assure that all interests are aligned appropriately. We're researching potential steps to limit, return and in some cases, eliminate any bonuses until Marathon is back on stronger financial footing. Additionally, I have personally decided to return a substantial portion of my equity-based compensation. I want to be clear that I want to bring Marathon back to the equity levels that it once was a mere 2.5 years ago. I am dedicated to achieving these milestones, not just for me personally, but more importantly, for the shareholders of Marathon. I'd now like to talk about a letter received from the NASDAQ on April 17, 2017. NASDAQ requires a $2.5 million minimum stockholders' equity for continued listing. At the end of the year, the company reported stockholders' equity below the minimum stockholders' equity required. This was principally the result of noncash write-off at year's end. On or before June 1, 2017, we intend to submit a plan to regain compliance with the minimum stockholders' equity. We anticipate NASDAQ will grant an extension of up to 180 calendar days from the date of the notification letter to evidence compliance. There are numerous ways in which we can retain compliance, including reduction of debt. Please know that we're very aware of the value of maintaining our listing on NASDAQ and are actively evaluating various courses of action to regain compliance. However, there can be no assurance that the company's plan will be accepted or if it is, the company will be able to regain compliance. Lastly, in aggregate, our wholly-owned subsidiaries continue to manage approximately 12,000 worldwide patent assets. We also continue to explore opportunities for our 3D Nano subsidiary and have received several proposals, but have suspended internal development as we seek an appropriate partner for a spin-out. That concludes my prepared remarks. With that, I would now like to turn the call over to Frank, our CFO, for a detailed outlook at our 2017 first quarter results. Frank?

Thanks, Doug. First quarter revenues totaled approximately $78,000. Revenue was derived from recurring royalties from the company's MedTech portfolios which accounted for all the company's revenue in the quarter. Direct cost of revenue in the first quarter of 2017 was approximately $450,000 compared to direct cost of revenue in the first quarter of 2016 of approximately $2.6 million, a year-over-year decrease of 83%. Direct cost of revenue includes both contingent and noncontingent payments to patent enforcement counsel and patent enforcement advisers and inventors. The decline in the direct cost of revenues resulted from no contingent counsel expenses and lower trial preparation, expert expenses for the first quarter of 2017 relative to the first quarter of 2016 when 2 of the company's subsidiaries, Dynamic Advances and Signal, were preparing for trial. The company reported other operating expenses in the first quarter of 2017 of approximately $2.4 million, a 44% decrease as compared to other operating expenses of $4.3 million in the first quarter of 2016. These expenses primarily consisted of amortization of patents, general expenses, compensation to our officers, directors and employees, professional fees and consulting fees incurred in connection with the day-to-day operation of our business. Total other operating expenses declined for the first quarter of 2017 relative to the same period in the prior year, primarily as a result of declines in expenses associated with patent amortization and consulting costs and a patent impairment charge in the amount of $400,000 for the first quarter of 2016 compared to no impairment charge for the first quarter of 2017. Noncash other operating expenses for the first quarter of 2017 and the first quarter of 2016 include noncash operating expenses totaling approximately $750,000 and $3 million, respectively. For the first quarter of 2017, we reported a net loss of $3.6 million. And for the first quarter of 2016, we reported a net loss of $3.9 million. For the first quarter of 2017, this represents a reduction in the net loss in the approximate amount of $300,000. On a non-GAAP basis, the company recorded a non-GAAP loss of approximately $2.4 million for the first quarter of 2017, roughly comparable to the non-GAAP loss reported for the first quarter of 2016. The full reconciliation of GAAP to non-GAAP financials can be found in the financial tables at the end of our first quarter results press release issued today as well as in the quarterly report filed today on Form 10-Q with the SEC. We ended the first quarter of 2017 with cash totaling approximately $0.5 million as compared to approximately $1.4 million as of March 31, 2016. As of March 31, 2017, we had approximately 19.1 million weighted average basic and diluted shares outstanding versus approximately 15 million weighted average basic and diluted shares outstanding as of March 31, 2016. Thank you for all your attention. Operator, you may now open the call for questions.

[Operator Instructions]. Our first question comes from the line of David Hoff, Private Investor.

Just a couple of questions. The nature of the business or the patent portfolio life cycle has a bunch of peak and valleys. Can you go over maybe some of the new portfolios, Traverse, Motheye, Magnus and Munitech? I know that usually the first step is to try to do some soft licensing and enter into some NDAs. Can you maybe talk about how many opportunities are out there in some of those portfolios? And also as well with GE, how many companies might have been engaged? Don't need an exact number, a dozen, 2 dozen. Just trying to get some clarity on some of those issues.

Sure. So we have not filed cases on Traverse or Motheye, although those are imminent. And they are, I would estimate, about anywhere from a half dozen to a dozen between those 2 portfolios. Magnus, we have 2 suits on file in Germany. We have about 3 or 4 on file on Munitech in Germany. We've got assets that cover jurisdictions in both of those portfolios other than just Germany and we're looking at filing in those jurisdictions as well, mostly European. I can't get into specifics on the oil and gas portfolio, but we've definitely been in conversations with some of the larger players in the market and continue to have those soft licensing discussions. So you'll see, hopefully, over the next 30 days, you'll see some new cases get filed probably some in the U.S. as well which is the first time we've done that for a couple of years. And we'll continue to file in Europe and hopefully, Asia. And we have trial on Signal coming up June 12 in Eastern District of Michigan. It's actually in Detroit in Signal IP versus Fiat Chrysler.

Okay. I'll be sure to monitor that. With the company's success in Europe, I know that's been the venue of choice, has there been additional opportunities presented? Is this more of a capital issue? Once the capital issue is cleared up with Fortress, we could see additional portfolios being onboarded? Maybe not the size of GE, but maybe 1/4 of that. Are there opportunities coming in or people looking at you?

Yes. So we do have a lot of opportunities, not just in the United States, but also in Europe, as you mentioned. And a lot of the portfolios that we look at have foreign counterparts associated with them. And what's happening in Europe with regard to the Unified Patent Court which really allows you to file a suit in one country and cover all of the European Union jurisdictions, is obviously very exciting. It's not talked about very much in the United States because it's not really U.S.-specific. In a lot of respects, Europe is moving into a different direction than what the U.S. has been moving recently. Europe is really embracing patent rights and trying to make it easier for patent owners to defend their patent rights against infringers. Whereas, as you know, in the United States, it's been somewhat of an opposite effect. But yes, we definitely have opportunities in Europe. And a lot of the opportunities now or the capital required to acquire the asset isn't really as great as it used to be, say, 3, 4 years ago. I think that's a function of companies realizing that there's fewer and fewer buyers. And I think it's a function of companies really having price expectations kind of level set over the last 12 to 24 months.

Our next question comes from the line of Mike Latimore with Northland Capital Markets.

This is Nick Altmann on for Mike. I know you guys said that you're no longer giving out guidance. But just from a modeling perspective, how should we be thinking about operating expenses going forward here?

So the actions we took during the first quarter fairly significantly reduced the company's overhead on 2 parts. One is both with respect to the core Marathon component, where we optimized the operations and reduced the headcount in some regards. And as Doug also mentioned, we suspended, with respect to the second part, the new development at the 3D Nano subsidiary and reduced the cost there as well. So we anticipate that the overall cost of the -- of operating the overall business will decline considerably, maybe 50% or more.

Okay. All right. And then can you guys just talk about any events that you maybe have more visibility compared to others?

I'm not sure I followed...

What type of event...

What type of visibility? I'm not sure I followed the question.

Yes, just any revenue-generating events in the future. Are there any more in particular that you guys have a bit more visibility into or...

Well, none that we can really talk about openly or publicly without jeopardizing those exact events. I mean, it's just -- it's difficult to go into any detail because it would be difficult to have that conversation right now without giving away talks that are frankly confidential and can't be disclosed. I mean, look, we have a trial coming up in a month. Typically, that's a good indicator of a potential revenue event. Again, it takes 2 parties to settle. So Fiat Chrysler could decide to go to trial which clearly is a position that we're both taking at this point. But it's very difficult to answer that question without tripping up any sort of NDA or confidentiality issues.

No, that's fair. I guess kind of going off that. Maybe are there any specific portfolios that are showing more promise than others right now? Or any more that you guys are maybe a little bit more excited about than others?

Well, the cases in Germany obviously have already started. So from just a licensing perspective, you tend to get more activity when you have cases on file or when you've got history with a particular portfolio, like we do at Dynamic Advances. So I think I would look at kind of those -- the portfolios where we posted results before and the portfolios where we have active cases, Signal, Magnus, Munitech, as the more likely revenue generators in the short term, if that helps answer your question.

Our next question comes from the line of Matt Rockman [ph], Private Investor.

I want to focus a bit on Dynamic Advances. I believe it's been now a little bit over a year since the big Apple settlement. And I do recall with at least several quarters ago on the call, you said that new filings would be imminent if there weren't settlements announced. And there's been no filings to date. Can you give us a little more color on what's happening in that portfolio?

Yes, I don't recall my specific words, Matt, but I think I said if the talks weren't going in the direction that we thought were productive, there would be filings. And since you haven't seen any, I would assume that the conclusion you could draw is that talks are generally going at the right course, the right pace and in the right direction. So we're going to let those talks continue to play out in the interim.

And can you give us an approximate number of how many parties you're engaged with there? It seems like that technology is continuing to extend. I know the -- I believe the patents are valid until 2022 or so. So are you engaging in a number of different potential licensing partners there? Or is it limited to a few right now? Or what can you tell us?

It's the kind of the, what we would call kind of the major players in the natural language processing, the AI space. But you're right, I mean, if you look at all the announcements coming out of CES this year, it's like every other announcement was AI-related. So a lot of the interfaces are moving to voice-activated interfaces which we think is great because it starts to expand the market with which we believe licensees exist. But at this point, until those companies really grow and get a meaningful revenue base, we're just going to focus on kind of the half dozen that we think are the prime targets and the prime licensees right now.

Got it. Do you anticipate any revenue in 2017 from that portfolio?

I definitely anticipate revenue from that portfolio and we sure hope it's going to be in 2017. But as we stated earlier on the call, we're not -- we just can't give guidance at this point.

Now can we talk a little bit more about that because I know on the prior call, the previous guidance was investors would expect revenue for 2017 to exceed 2016. And my understanding in what you're saying now is because of the current debt situation, you're withdrawing that guidance. But I'm not quite sure why, to be honest.

Well, just because we're in flux with our credit facility.

Is there anything more that you can kind of...

I wish I could. I can't.

Okay. Moving to GE. Same question as Dynamic Advances, do you anticipate revenue from that portfolio in 2017?

Again, it's the same answer. I mean, we sure hope, but I can't. I just can't give guidance at this point.

Got it. One more question and I guess it really relates to Erich and what he's doing has been some kind of -- there's been some confusion with the investor base in terms of his day-to-day role at Marathon and his role with Hermes Patents which I know you guys touched on it in your press release. Can you kind of give some more color on kind of what Erich is focusing on specifically with respect to Marathon and how much time he's devoting to Marathon and I guess, the relationship between Marathon and Hermes?

Yes, so Erich is devoting 12-plus, 13-plus hours a day on Marathon-related business. His position and his responsibilities have not changed from approximately 1 year ago when we announced him joining Marathon. He is running intake and licensing for Europe and Asia. And obviously, he weighs in on U.S. events as well. But he is primarily -- as busy as he's ever been. And Hermes Patents is -- look, it's a natural extension from where we're with our, for example, GE relationship, where we're managing 11,000, 11,500 patents. And so the thought is that if you have a platform that can do something more efficiently and you start to scale that platform and add other kind of patent management departments, you can really become an outsourcing play for a lot of IP departments and you can do it probably faster, better, cheaper than that the company can. And so Hermes Patents is a project that we've been working on and that we're going to continue to work on to develop what we call kind of non-IP licensing and litigation business strategies, really utilizing the core knowledge of the team, the core knowledge of the patent landscape and the systems that we've developed over the years to effectively manage assets, not just for ourselves, but for others. And hopefully, being paid on a recurring quarterly, annual basis to do that. And that's a project that, like I said, we've been working on for a while. And it's a project that Erich obviously is working on in addition to his other duties. But he's fully engaged.

Got it. Okay. I had actually one additional question and I'm reading back to my notes and it goes towards your comments on insiders buying potentially shares potentially and as well as you stated that you'd be returning a substantial portion of your equity-based compensation. Can you explain exactly what that means?

There are two different issues there. So one is the insider buying issue. And it's difficult when you have 5, 6 people in a company. We all know what's happening. It's not the same as some of the other companies in our space which we often get compared to, where they have 50 to 60 employees. And literally, there are senior executives that don't know what's happening with particular licensing and particular portfolios and so they don't have the same material nonpublic information that we all possess here. So the strategy that we're trying to put in place is one in which we put a buying plan in place for those who are able and willing to participate, of which I will be one. But there is a time -- there is an element of time that needs to be associated with what has been described to me as a cleansing of the information. So let's say, we put a plan in place during an open window, we would need to wait some period of time, 9 months, 6 months, 12 months, in order for that plan to actually take effect, for the buying to take effect so that the information that we possess at the time we put the plan in place has been cleansed. So it's not an overnight fix, but it's one that we think we can get comfortable with. But again, it's just not as easy a company in our business of our size to do what others have done in our space that are frankly much larger and don't possess the same level of information across basically the entire employee base. That's the first question. Second question, I will, within the next week, be returning a substantial number of my equity-based compensation. I'm working with Frank and the board to get that put in place. I don't know if that's an 8-K announcement. But certainly, on our next earnings call, I will let the investors know exactly what has happened.

Is that shares that you have that you received or is that your cash base or a combination of both?

It's option-based.

Ladies and gentlemen, at this time, I would like to turn the floor back to management for closing comments.

So thank you, everyone. I know it's been a difficult couple of months and I appreciate everyone's support. I appreciate the phone calls and the conversations I've had with investors. Some that have been difficult to have, but need to be had. Nonetheless, I remain very positive about where we're and where we're going. I mean, there are very few companies in our space. We have great opportunities, not just in our pipeline, but that we already own. And assuming we can find the right funding partner, we think we have a great opportunity ahead of us. And I look forward to talking to you more between now and August 15 or whenever our next earnings call is. Thank you.

Thank you. Ladies and gentlemen, this concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.