Royalty review uncovers inaccuracies and nets $115,000 in lost revenue
CASE STUDY |
Our client is a publicly traded company with a number of patents over computer hardware and software technologies. The company was founded in 2000, and licenses their technology for use in several products.
Our client developed a specific computer device technology, and agreed to license the technology to an unrelated third party. As part of this contract, the company received royalties. However, five years after the execution of the agreement, concerns emerged as to whether the amounts received were underreported and misaligned with the expected sales volume of the products that utilized our client’s technology. As a result, the client wanted to determine whether royalties reported and paid were accurate.
Our client’s license agreement included an audit provision clause, allowing them to retain an independent accounting firm to conduct a royalty audit to determine if the licensee was paying royalties, in accordance with the agreement. RSM was selected based on the royalty contract review team’s experience and proven track record in successfully conducting royalty audits.
An audit notice was sent to the licensee to notify them that RSM was retained to conduct the investigation. The team met with the licensor’s counsel to gain an understanding of the intricacies of the technology and the reasons why the licensor felt the royalties were underreported.
After gathering information and planning with the client, RSM visited the licensee’s location to conduct fieldwork. The team analyzed 3 1/2 years of royalty payments, and noted that royalties were not paid for multiple products that included the licensed technology. In addition, inconsistencies were prevalent in the royalty reporting for the products the licensee was paying royalties on. As part of the licensee’s organizational structure, the list of products that use the licensed technology was maintained by the marketing group. They were tasked with updating it and communicating changes to the royalty reporting group, and failed to do so in several instances.
Midway through the time period investigated, RSM discovered the licensee ceased royalty payments on three high-volume items. Through analysis and conversations with the licensee, the team learned the licensee had discontinued the original product numbers, and launched new products that utilized our client’s technology. However, the new products were not included in the royalty reports. Therefore, royalties were significantly underreported from that point forward.
The contract between the two parties included a 5 percent late payment penalty applying to any underpaid royalties. Additionally, a provision in the license agreement called for interest to accrue on late payments at 1.5 percent per month. With the team’s findings, underpayments were subject to both the late payment penalty and the interest provision, resulting in additional recoveries for the client.
Another provision in the agreement dictated that if an underreporting of royalties in excess of 3 percent was identified in any reporting quarter, any costs incurred to conduct the audit would shift to the licensee. RSM identified that deviation in every analyzed quarter, absolving the client from costs related to the royalty contract review.
RSM identified significant underpayment of royalties over a 3 1/2-year period. The team’s findings and correction of issues resulted in additional royalties recovered. In addition, the underpaid royalties allowed the licensor to receive late payment interest and penalties, while inducing future compliance.
The benefits to our client included:
- Discovery of 20 different products with underpayment of royalties, some products that were never reported and other royalty-bearing products that were reported irregularly
- Recovered $115,000 in lost revenue, in addition to late penalties and interest.
- The transfer of the cost of RSM’s work from our client to the licensee, after reaching a royalty underreporting threshold in the contract