04/28/2010 Meeting - Contract Compliance

Maximizing Revenue through
Contract Compliance and Licensing
Reviews
April 28, 2010
Kim Wiatrak – Director
Chris Ruhl – Director
PricewaterhouseCoopers
PwC

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
• Flush out contractual and use issues
Slide 4

Contract Compliance Opportunities
Maximizing 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 - Statistics
What 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 licensingy, , , g p gy g
agreement 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 Observations
Licensee’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

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 compliancep p y p p
program 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

A dit Cl• Audit Clause
• Term Definition
• Royalty Calculations
• Reporting Requirementsp g q
• Compliance Requirements
• Sample Contractual Language

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?

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

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

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

Reporting Requirements
• Report format and content
• Frequency of reporting and payment
• Currency• Currency
• Interest and late fees
• Taxes, levies and other duties,

Compliance Requirements
• Trademarks
• Patents
• Logos• Logos
• Watermarks

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 AuditorsLanguage
determine that the [royalties] paid were incorrect, Auditors will deliver to
[Licensee] a report of such conclusion. …

Audit Clause
Audit Clause
Broad
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 , , p
shall 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 submitp
royalty 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
Royalties
Limited
Language
Licensee shall pay [Licensor] the royalties set forth in the applicable [Appendix].
Royalties …

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

Reporting
Reporting
Broad
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 &g
Target (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 assessmentFactors
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 3
Risk Group Low Moderate High

Risk Assessment
Identify & Rate Risk Factors
1st Tier
1) Geography
2) Public vs. Private
3) R ti R ili ti Diff3) Reporting Reconciliation Differences
2nd Tier
4) 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 Perceptionp y p p
Index (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) 2
Private 3
3) Reporting Reconciliation
Differences
0 – 250K 1
251K – 500K 2
e e ces
500K+ 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 2
Poor/None 3
6) Past Settlements/Compliance
Reviews
No findings 1
Successfully negotiated 2
Unable to reach the agreement / complete audit 3
7) Business Intelligence
Positive business intelligence 1
No 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 4
CP 5
CP 6
CP 7
CP 8
CP 9
40%
50%
60%
70%
80%
90%
sVolumeIndex
CP 1CP 2
CP 10
0%
10%
20%
30%
0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%
Sales
Controls Index
CP 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 Completion
Slide 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
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 Policyp y
• 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
External
Compliance
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 Policyp y
Data Analysis
Critical work stream to efficient audit process
• Agreements Analysis
• Licensee Reporting Data Analysis
• Third-party or Internal Data Collection

Technical 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 g
Compliance 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 toy g pp p p
ensure an successful delivery of the review and a thorough analysis of the
findings

(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

(cont.)
• 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

(cont.)
• 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 PROFIT
Broadcom… 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

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