04/28/2010 Meeting - Contract Compliance

Maximizing Revenue through Contract Compliance and Licensing Reviews April 28, 2010

Kim Wiatrak – Director

Chris Ruhl – Director

PricewaterhouseCoopersPwC

Contents

• What is a License Compliance Program?• Keys to Designing and Implementing an Effective Program• Contract Language and How It Impacts Revenue• Risk Assessment, Targeting & Compliance Policy• Contract Compliance - the Licensee’s Perspective• Contract Compliance - the Licensee s Perspective• Closing Comments• Questions & Comments

PricewaterhouseCoopers Slide 2PricewaterhouseCoopers

What is a License Compliance Program?


Licensing Compliance Programs

License Compliance Programs aim to:p g

• Maximize and protect the economic impact of intellectual property and intangible assets

S• Send a message to the channel about taking IP seriously

• Ensure compliance with company’s controls & business processes (i.e. SOX)

• Address widespread issue of under reported licensing revenues

• Drive incremental revenue – bottom line impact− Compliance programs pay for themselves with a 8-12x ROI of audit fees

• Enhance ability to forecast future revenue streams

• Flush out contractual and use issues

PricewaterhouseCoopers

• Flush out contractual and use issues

Slide 4

Contract Compliance OpportunitiesMaximizing revenue and/or reducing costs

• General contract compliance

• Most favoured nation / customer

• Joint venture agreements

• Research and development• Research and development agreements

• Pricing agreementsPricing agreements

• Franchise agreements

PricewaterhouseCoopers Slide 5

Contract Compliance Analysis - Objectives

Refund Recovery Issues

• Over deployment of software licenses• Cost sharing - FTE’s

Process Review Issues

• Safety guidelines / requirements• Insurance / bonding requirementsg

• Advances / Burn-down• Sales tax application - VAT• Returns and restocking charges• Discounts / Price protection

g q• Subcontractor policies• Financial statement screening• Employee monitoring• Contract structurep

• Freight and transportation• Miscellaneous discounts• Entertainment allowances• Marketing & Development Funds

• Purchasing/procurement review• Contractor credentials

g p• Fixed price and progress billings• Samples • Rebates• Most Favored Nation/Customer terms


Contract Compliance - StatisticsWhat have we found?

8 out of 10 licensors do not have a consistent process to monitor their royalty8 out of 10 licensors do not have a consistent process to monitor their royalty arrangements. Unchecked “revenue leakage” can amount to millions of dollars.

Mis-reported royalties are identified in over 90% of our royalty inspections, due to:• Accounting mistakes (i e inaccurate system-generated royalty reports)• Accounting mistakes (i.e. inaccurate system-generated royalty reports)

• Clerical errors (i.e. new products incorrectly excluded from royalty reports)

• Contract interpretation differences (i.e. standard discount)

• Lack of defined calculation and reporting process

• Staff turnover (i.e. has anyone read the contract? “I wasn’t here then”)

F d T t b t V if !


• Fraud – Trust but Verify!

Slide 7

Why Have a License Compliance Program?

Tessera Technologies, Inc.esse a ec o og es, c

Tessera Technologies, Inc. announced that its semiconductor packaging subsidiary, Tessera, Inc., has signed an updated technology licensing y, , , g p gy gagreement with United Test and Assembly Center Ltd (UTAC)… under the terms of the agreement UTAC will pay $15.0 million in cash to address past royalties owed under the initial license… As a result of this initial payment, Tessera is raising its first quarter 2010 total revenue guidance range to be between $63.0 million and $64.0 million. This compares to previous first quarter 2010 total revenue guidance given on January 28, 2010 f b t $58 0 illi d $61 0 illi Th d t d li2010, of between $58.0 million and $61.0 million... The updated license agreement and payment for past royalties resolves all outstanding litigation between the companies.


-March 1, 2010 Press Release-Slide 8

Common Observations Licensor’s Compliance Environment

L k f t l d li i t dd hi h i k f l k• Lack of controls and policies to address high risk area of revenue leakage

• No mechanism or process to capture and analyze license and reporting data

• No process to analyze reporting variances from historical or anticipatedNo process to analyze reporting variances from historical or anticipated royalties

• Historical license agreements vary significantly

• Compliance reviews are nonexistent or infrequent

• Sales/Company culture impacts compliance attitude


Common ObservationsLicensee’s Compliance Environment

• Lack of internal controls over outbound royalties

• High degree of internal miscommunication

• Staff turnover high – no consistency• Staff turnover high – no consistency

• Contract misinterpretation within the accounting / finance / sales department

• Lawyers agree to terms which are hard to implementy g p

• Compliance with T’s & C’s low priority

• Trying to do the right thing, but…


Life Prior to the Program

• Revenue leakage what revenue leakage?• Revenue leakage – what revenue leakage?• How many license agreements do we have?• Do we have visibility/transparency into reporting or specific use of our IP?• How do we measure risk or expected variances?


Life Prior to the Program (cont.)

• Can we stratify by region licensee or type of IP?• Can we stratify by region, licensee or type of IP?• Do we have consistent terms and conditions?• Who is the owner of these issues inside the Company?• Do we ever exercise the audits rights clause?• A compliance program will have a negative customer impact, right?


Benefits of a License Compliance Program

• Identification of potential revenue leakage / incremental revenue• Identification of potential revenue leakage / incremental revenue

• Enhanced client relationships / trust and increased communication

• Improves predictability of future payments / enhanced reporting controlsy y g

• Improves the drafting of future license / agreements

• SOX – enhanced control procedure over revenue cycle


Benefits of a License Compliance Program (cont.)

• Corporate governance regarding IP protection• Corporate governance regarding IP protection

• Customers / Partners / Channel knows you take IP seriously

• Flushes out contract language misinterpretations, side letters, etc.g g p , ,

• Potentially identifies improper sales practices

• Provides better understanding of the customer base usage and licompliance


Keys to Designing and Implementing an Effective Program


Defining a Successful Program

M b i i i i l• Management buy-in is critical• Designating ownership with responsibility and authority• Taking stock of the existing situationg g• Internal control processes• Qualitative and quantitative analysis

Customer relationships are a top priority• Customer relationships are a top priority• Incremental revenues identified• New and/or better license agreements• Compliance team is NOT a cost center


Keys to Designing and Implementing an Effective Program

• "Buy in" from the top• Buy in from the top

− Consistent message throughout organization

− Compliance / Internal Auditp

− Legal

− Accounting / Finance

− Sales

• Strong corporate desire / culture to protect IP rights


Keys to Designing and Implementing an Effective Program (cont.)

• Understand the current licensing situation and key information about• Understand the current licensing situation and key information about agreements

− Gather and Validate data

− Reconcile to the licensee data

− Consider legal / contract language

U d t d l ti hi ith t d lt l i− Understand relationships with customers and cultural issues

− Legacy agreements



• Develop processes and controls over possible revenue leakage• Develop processes and controls over possible revenue leakage

− Ensure all licensees who should be reporting are reporting and doing so timely

− Compare royalty reports to historical/anticipated reporting for trends or errors

• Benchmarking / “Desk” auditsBenchmarking / Desk audits

• Risk assessment using quantitative/qualitative factors

• Follow up, follow up, follow up



• Systematic and regular enforcement through compliance reviews• Systematic and regular enforcement through compliance reviews

− Majority under-report resulting in incremental revenue

− Licensees often report underpayments upon notification a compliance p p y p pprogram is in place or in preparing for a compliance review

− Determine appropriate “level” of a program

N tifi ti l tt / G l l tt− Notification letters / General letter

• Trust, but independent verification

• Escalation path• Escalation path



• Types of findings• Types of findings

− Hard - Very little or no dispute and fact based• Unreported royalty bearing products / licenses• Royalty calculation errors• Over deployed software

− Soft - Gray area possibly due to contract interpretationSoft - Gray area possibly due to contract interpretation• Replacement or warranty units• Trial units / Free units

U l d fi i i f d d i f N S l• Unclear definition of deductions for Net Sales



• Settlement Process• Settlement Process

− Systematic process for immediate follow-up

− Late fees or interest as leverage

− Opportunity to renegotiate license agreement or resolve problems with agreement language

M st ha e an internal o ner• Must have an internal owner

• Good programs often enhance the customer relationship

• Good programs should return a reasonable ROIGood programs should return a reasonable ROI


Contract Compliance Overview – Leading Practices

Compliance Program Continuum:

Mature • Consistent company culture with

compliance tone at the top

Developing• No consistent message from the top

- Minimum executive level commitment compliance tone at the top• Systematic and sophisticated approach

to business intelligence• Zero tolerance for IP non-compliance • Integrated team approach

- Minimum executive level commitment• Sales Team is not supportive• Mixed message to the channel• Perceived tolerance of non-compliance• Disparate team interest and approach Integrated team approach

• Significant resource allocation and budget

• ROI 8-12+ times program costs• Leverages insights of external Business

Disparate team interest and approach• Piecemeal approach• Resource/budget constrained• Greater exposure and inconsistent ROI


Leverages insights of external Business Partner

Contract Language and How It Impacts Revenue


Contract Language and How it Impacts Revenue Leading Practices

• Get the license agreement language right from the start

• Convert license agreements into a single standard format to simplify managing the license review process is simplerg g p p

• Include "right to audit" and 5% clauses in every agreement

• Send licensees a letter of introduction notifying them a compliance program i i l th d t f l i l d tis in place so they do not feel singled out

• Default or late payment penalties should be included in every agreement

• Exercise your audit rights so your customers / partners know your companyExercise your audit rights so your customers / partners know your company is serious about IP compliance


Contract Language and How it Impacts Revenue

A dit Cl• Audit Clause

• Term Definition

• Royalty Calculations

• Reporting Requirements p g q

• Compliance Requirements

• Sample Contractual Language


Contract Language and How it Impacts Revenue Audit Clause

• Right to audit / review / examine

• Audit period

• WHO will be performing the compliance reviews?• WHO will be performing the compliance reviews?

• WHAT will they be examining?

• WHEN will the review take place?p

• HOW OFTEN can reviews take place?

• WHICH party will bear the costs?


Contract Language and How it Impacts Revenue Term Definition

• Are the key terms of the contract defined?

− Products: Defined as what it is and what it is not

License Metrics: Defined unit of measure− License Metrics: Defined unit of measure• Example: Software Terms: CPU, Processor, Processor Value Unit,

User, Named User, Concurrent User, Device, Seat, Instance, etc!!

− Usage: Defines what the IP can be used for and what it can not• Example: Internal use, sublicensed, resell, embedded, etc.

− Others− Others


Contract Language and How it Impacts Revenue Royalty Calculations

Potential Considerations:

• Initial licensing fees / annual minimums

• Per unit fixed fee vs percent of revenue• Per unit fixed fee vs. percent of revenue

• Sample units and other deductions

• Average selling price vs. net revenueg g p

• When a product becomes royalty-bearing

− e.g., put to use, transferred, shipped, first use by a third party, i i d l d h di linvoiced, leased, or other disposal

− Other licensees, affiliates, suppliers vs. manufacturers


Contract Language and How it Impacts Revenue Royalty Calculations

Other Considerations:

• Rates tiered by quantity or time

• Full compliance vs non compliance rates• Full compliance vs. non-compliance rates

• Local and international IP laws


Contract Language and How it Impacts Revenue Reporting Requirements

• Report format and content

• Frequency of reporting and payment

• Currency• Currency

• Interest and late fees

• Taxes, levies and other duties,


Contract Language and How it Impacts Revenue Compliance Requirements

• Trademarks

• Patents

• Logos• Logos

• Watermarks


Contract Language and How it Impacts Revenue Sample Contractual Language

Audit ClauseAudit Clause

Limited Language

… Auditors will only report to [Licensor] whether the [royalties] paid were correct, and if incorrect, the correct amount. In the event that Auditors Languagedetermine that the [royalties] paid were incorrect, Auditors will deliver to [Licensee] a report of such conclusion. …



Audit Clause

Sample Contractual Language

Audit ClauseBroad Language

Licensee shall keep complete and accurate books and records of all sales, leases, uses, returns or other disposals of licensed products for a period of [X] years following the manufacture, sale, or other disposal. Licensor [ ] y g , , pshall have the right, through a public certified auditor appointed by Licensor, to inspect, examine and make abstracts of the said books and records no more than once per calendar year. … The inspection shall be conducted at Licensor’s own expense, unless the Licensee has failed to submit proyalty statements during the period to which the inspection relates or the inspection establishes a discrepancy or error exceeding [X]% of the monies actually due, in which case the cost of the inspection shall be borne by Licensee. …y



Royalties


RoyaltiesLimited Language

Licensee shall pay [Licensor] the royalties set forth in the applicable [Appendix]. Royalties …



Royalties


RoyaltiesBroad Language

Licensee agrees to pay to [Licensor] a royalty on each [licensed product] manufactured by or for Licensee and incorporated into [licensed products] used, sold, leased, or otherwise disposed of by Licensee in which any one or more of the [licensed patents] …. This royalty shall be due irrespective of whether such [licensed patents] are used in the country of manufacture, sale or other disposal…



Reporting


ReportingLimited Language

…Licensee will provide Licensor a written list describing the shipped [licensed product] quantity and the customers receiving all such [licensed products…



Reporting


ReportingBroad Language

Within 30 days …, Licensee shall submit to Licensor a written statement in the form attached hereto as Exhibit C, …

Licensed products by type part number brand name model number and/or serialLicensed products by type, part number, brand name, model number, and/or serial number

Quantities manufactured, purchased and/or sold or otherwise disposed, …

Net revenue

Customers

Countries in which the licensed product was manufactured and sold…


Potential Issues

• Out-dated agreements in use• Out-dated agreements in use− The licensor may not have the same rights as in current agreements− All products may not be covered (i.e., royalty bearing)

• No standardized procedure to determine the completeness and accuracy of licensee reporting / collection of receipts

− Should implement quarterly reporting requirement, rather than only when amounts are determined due.

• Soft dollar reconciliations sometimes complex


Global Issues

Si ifi t i l diff• Significant regional differences• The “You Don’t Trust Me” factor• Respect for I.P. rights is a major issue• Sales into unauthorized territories – Foreign Corrupt Practices Act

(FCPA and anti-bribery/anti corruption issues)• Sales to unauthorized parties – Office of Foreign Asset ControlSales to unauthorized parties Office of Foreign Asset Control

(OFAC) issues


Leading Practices

• Consistent language in all agreements• Audit Rights clause mandatory• Compliance Program Letter of IntroductionCompliance Program Letter of Introduction• Default penalties, late fees and interest charges• The “5% clause”, mandatory

S t ti ‘ ff’ h t li• Systematic vs. ‘one-off’ approach to compliance


Risk Assessment, Targeting & Compliance Policy


Licensing Portfolio Risk Assessment – Audit Risk & gTarget (ART) Tool

• Driving value up and keeping compliance costs down

• Quantitative and qualitative analytics

Geographies

Public company vs. private

Sales representative assessment

Qualitative Index Factors

Business intelligence

Sales representative assessment Factors

Product mix

Anomalies in entitlement or support data

Reconciliation differences

Quantitative Index Factors


Type of license agreement

Risk Assessment Benefits

QuantitativeQualitative• Higher margin revenue and more predictable

revenue stream

• Lower structural cost and positive EPS impact

• Defined corporate strategy- Consistent message throughout organization- Board of Directors and C Suite leadership- Becomes part of the culture

• Shorter cycle times

• Better maximization and utilization of IP portfolio

• Greater appeal to global partners and improved

- Becomes part of the culture• Procedural and contractual compliance

- Fulfill fiduciary responsibility as a public company• Move consistency for future royalty streams• Forge consistent policies to address IP compliance

relationships

• Revenue leakage opportunity 5%-10% of revenue

• Send a message to the channel that you take IP seriously

• Establish corporate policy for non-compliance- Zero tolerance policy

• Collaboration with Business Partners to build aCollaboration with Business Partners to build a sustainable model and leverage knowledge


Risk Assessment

• Suggestions for approach:

Identify & Rate Risk Factors

• Suggestions for approach:

− Keep it simple

− Easy to implementy p

− Not an exact science

Risk Score 1 2 3Risk Group Low Moderate High


Risk AssessmentIdentify & Rate Risk Factors

1st Tier1) Geography

2) Public vs. Private

3) R ti R ili ti Diff3) Reporting Reconciliation Differences

2nd Tier4) A/R Aging) g g

5) Sales Rep Coverage

6) Past Settlements/Compliance Reviews

7) Business Intelligence7) Business Intelligence

8) Strength of Audit Clause

9) Product Mix


10) Sales Representative Assessment

11) Contacts with Licensees

Transparency International - Corruption Perception p y p pIndex (TI - CPI)


Other Risks to Highlight…

• Grey Market• Grey Market• FCPA• OECD• Local law violationsLocal law violations


Risk Assessment - Tier 1

Risk Factor Items to Consider Risk Rating

1) Geography ( b i k t )

Western Europe, US, Australia, Canada 1

Middle East, Central Europe, Japan 2(map by risk, sectors) Middle East, Central Europe, Japan 2

China, India, South America, Eastern Europe 3

2) Public vs. Private Public 1

Newly Public (<12 months) 2Private 3

3) Reporting Reconciliation Differences

0 – 250K 1

251K – 500K 2e e ces500K+ 3


Risk Assessment – Tier 2

Risk Factor Items to Consider Risk Rating

4) A/R Aging

0 – 90 days 1

91 – 180 days 2

180+ days 3

5) Sales Rep Relationship Excellent 1

Neutral 2Poor/None 3

6) Past Settlements/Compliance Reviews

No findings 1

Successfully negotiated 2

Unable to reach the agreement / complete audit 3

7) Business IntelligencePositive business intelligence 1No recent events 2


Recent M&A, major event 3

Risk Assessment Audit Risk Tool output

• Identify and rate risk factors• Identify and rate risk factors• Stratify the licensee/channel partner portfolio• Calculate an actual risk score for each licensee/channel partner

Channel Partner Portfolio Risk Assessment

CP 390%100%

CP 3

CP 4CP 5

CP 6CP 7

CP 8

CP 9

40%50%60%70%80%90%

sVo

lum

e In

dex

CP 1CP 2CP 10

0%10%20%30%

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Sale

s


Controls IndexCP 1 CP 2 CP 3 CP 4 CP 5 CP 6 CP 7 CP 8 CP 9 CP 10

Risk Assessment

License Compliance Reviews differ in:

Types of Reviews

License Compliance Reviews differ in:

• Scope− License Agreements: All agreements or selection of agreements

− Product Portfolio: All products or subset of products

− Geography: Global or select territories

• Review Approach• Review Approach− Self Reporting: Licensee self-reports units/revenues

− Remote Review: Licensor or the licensor’s third-party partner (i.e. independent party) requests information from licensee and verifies the completeness and accuracy of therequests information from licensee and verifies the completeness and accuracy of the provided reports without an onsite visit

− Onsite Review: Licensor or third-party partner conducts a full review that includes an onsite visit to the licensee’s premises


p

• Level of Effort and Time to CompletionSlide 52

Risk Assessment

• Identify IP compliance strategy

Critical Success Factors

Identify IP compliance strategy

• Sales buy-in and support

• Consistent execution

• Resources – internal and external

• Realistic timeline to implement and evaluate

• Change management/cultural shift

− Executive sponsorship

Communication and education− Communication and education


Establish Compliance Policy

U i th ART P d di i ith l l l d fi l t

Establish Compliance Policy Risk Assessment to Nominations to Close

• Using the ART Process and discussions with legal, sales, and finance select companies for compliance reviews

• Create escalation procedures and path

• No-surprises at close meeting

• Transparent process – lends to customer goodwill

• Thorough report with audit information & references

• Develop a seamless audit negotiation and settlement strategy


Establish Compliance Policy p yRisk Assessment to Nominations to Close

• Internal Communication Strategy• Internal Communication Strategy − Planning Meetings

• External Communication Strategy Design− Compliance Program − Audit Program Communication and Documentation

• Biweekly Status MeetingsBiweekly Status Meetings• Knowledge Transfer


Contract Compliance Communication LoopContract Compliance Communication Loop

Internal

External Compliance Strengthens Internal Compliance by:

Internal Compliance Strengthens External Compliance bInternal

Compliance• Impact future agreement language

• Enhance transparency by broadening/redefining reporting

Compliance by:

• Enhance internal/external communication lines

• Incorporate the use of portfolio risk assessment

ExternalCompliance

templates• Assessing findings from past

examinations and identifying other risk Partners which resemble those already

portfolio risk assessment • Enhance partner- specific

intelligence • Identify partner-specific “red

flags” or other risk areasresemble those already examined.

• Identify key risk areas that can transcend partners/better prepare for future examinations

g• Retain and organize relevant

partner-specific documentation


Establish Compliance Policy p yRisk Assessment to Nominations to CloseData Analysis

Critical work stream to efficient audit process

• Agreements Analysis

• Licensee Reporting Data Analysis

• Third-party or Internal Data Collection


Establish Compliance Policy Risk Assessment to Nominations to CloseTechnical Analysis

Critical work stream to efficient audit process

• Work directly with Licensor’s engineers and technical employees to understand the technology, verification process, detection process, usage, schematic charts, etc.schematic charts, etc.

• Increase efficiencies and perform complex data analytics


Contract Compliance – The Licensee’s Perspective


Common Review Challenges Facing Licensees

Some of the common challenges faced by organizations during a License

g g

g y g gCompliance Review include:• Lack of resources − Causes delays in completing the Review in an efficient and timely manner− Causes delays in completing the Review in an efficient and timely manner

• Lack of transparency in Review scope and process− Leads to potential mis-understandings of the fact-pattern and “surprise” findings

• Communication− Undefined communication channels leading to possible disclosure of mis-information

• Collection of accurate sales records− Numerous sales/distribution channels make compiling sales records cumbersome

• Retail, Distributors, Large Account Resellers

− Over reliance on third-party records (i e Distributor Managed Service Provider etc )


Over reliance on third party records (i.e. Distributor, Managed Service Provider, etc.)

− Organizational changes resulting in changing responsibilities, data loss, and lack of access to legacy systems

Slide 60

Items to Consider to Prepare and Mitigate RisksItems to Consider to Prepare and Mitigate Risks

License Compliance Reviews can require a significant level of effort from your organization depending on the scope of the Review, but there are steps you can take to prepare and mitigate risks:

• Identify appropriate executive sponsorship − Determine who within your organization is an appropriate sponsor to y g pp p p

ensure an successful delivery of the review and a thorough analysis of the findings


Items to Consider to Prepare and Mitigate RisksItems to Consider to Prepare and Mitigate Risks (cont.)

• Assemble a project team across the licensing lifecycle (and across geographies)− Executive Sponsor: Provides executive management support for the project in assisting

the team gain the necessary resources, approvals, etc. for success

− Project Manager: Develops a project plan, coordinates team’s activities, resolves issues and drives project to a successful completion

− Contract / Vendor Management: Gathers and reviews license agreements for key terms and conditions regarding licensing and conditions of the Review

− Legal: Provides legal advice and support

• Understand scope− Organizational entities (and legacy firms and divestures) and business units

− Geographies


Geographies

− Products

Slide 62


• Develop a workplan− Include key tasks, milestones, responsibilities, assumptions and dependencies

− Hold regular status updates with project team and drive towards committed deadlines

• Review all license agreements− Gather and review all the license agreements related to the licensorGather and review all the license agreements related to the licensor

− Understand obligations regarding any Review



• Be cooperative− Ensure concerns regarding scoping, approach, analysis and others are addressed in a

cooperative (and professional) mannerp ( p )

− Past relationship history is important context to any review, but don’t recite a detailed history in front of the third-party partner

• CommunicateCommunicate− Request that the licensor/third-party to be transparent about approach and be transparent

about your process to collect and validate required data

− Establish periodic internal team and review team project status updatesEstablish periodic internal team and review team project status updates

− Express concerns, risks, issues to get resolution as soon as possible


Closing Comments


Public InformationPublic Information

BROADCOM RECORDS 2ND-QUARTER PROFITBroadcom… reported its first profit in three quarters on a royalty settlement from Qualcomm… Qualcomm agreed in April to pay Broadcom $891 million over four years to end a global dispute over technology used in mobile phones.

-San Jose Mercury News, July 24, 2009


Closing Comments

• Compliance programs are now leading practice and generally accepted by U.S. licensees

• Board of Director and Audit Committee queries• The concept of a profit center vs. cost center• Tone at the top/culture: Sales or Finance?• Why wouldn’t you have a compliance program?Why wouldn t you have a compliance program?


QuestionsQuestions&

Comments


04/28/2010 Meeting - Contract Compliance

Business

compliance reviews

implementy g p compliance

incremental revenue

revenue andor

initial license

f d t t b t v

consistent process

updated license agreement