William Merritt - President and Chief Executive Officer
InterDigital, Inc. (IDCC) NASDAQ OMX 29th Investor Program in London December 4, 2012 6:45 AM ET
Now we are moving to InterDigital, and InterDigital develops fundamental wireless technologies that are at the core of mobile devices, networks and services worldwide. Speaking today for InterDigital is their President and Chief Executive Officer, William Merritt. Bill?
Thank you very much and good morning to everyone. It's great to be here again at the NASDAQ conference in the midst of what is a record year for the company, so great to be here with you folks.
As typical with these presentations, we'll have a number of forward looking statements that I'll make during the course of the presentation, so I would refer you to our securities filings with respect to those statements.
So, I'll start with sort of the obvious, which you've probably have heard a couple speakers today speak about the wireless market and how huge it is. The one thing I think we can all be assured is, though it's huge now, it's small in comparison to where it will go. Devices continue to proliferate. The capability of the devices continues to grow at and expediential rate creating a great opportunity for companies like InterDigital.
We've been an innovator in this space for almost four decades and this is a space that continues to crave innovation as vendors out there continue to need to get their devices into the hands of the consumers. And the way they do that is by making their device so much better than the devices that their consumer had before or hasn't at the time. So, it's an unbelievable market for us and unbelievable market for a large number of folks out there.
And for InterDigital, we kind of characterize ourselves as a pure play in mobile, because what we have done over the years is develop the core technology that drives all of good portion of mobile. Doing that today with proliferation of devices and services, new opportunities to innovate, so everyone has heard about the data crunches and the opportunities with machine-to-machine technologies and a bunch of other things we are very focused on solving all of those or good portion of those technical issues for folks, very similar to what we've done through our history.
So, if you go back in time a little bit with the company, back in the early or mid-1980s, well before handheld devices were common among all, we drove that conversion from analog to digital. We were small U.S. company at that time, but we were the U.S. company that demonstrated digital cellular telephone in the U.S. that led to a very strong technology position for us both in the U.S. and on a worldwide basis and really was the start of the company.
From there, we built on that success and the mid-1990s, when I joined the company, while most people at that point in time were still getting their first phones on which to make phone calls, we were beginning the process of developing those systems that would deliver not just voice, but data over those devices. And in 1996, we actually five systems around the world that delivered high speed data to people over wireless networks delivering video and a bunch of other capabilities.
We called it broadband, CDMA, eventually working within the standards bodies that came out as wideband CDMA, incorporating a number of very key inventions from the company in terms of power control, how you construct the high capacity channels, how you manage power while the user is online. Building off of that success and we'll talk a little bit about the licensing success we've had in those areas. We began the next step for the company which to take these devices from what were data highways at that point in time to data superhighways and that's all about LTE and LTE advance which gives us tremendous capability in terms of data delivery and service delivery down to the devices and InterDigital today is positioned as probably one of the top patent holders on LTE, and this 40 years of development has done just that in terms of the asset it has built for the company.
We are one of the largest patent holder companies in wireless, 20,000 patents and patent applications held by the company. About half of those patents dealing with fundamental inventions that are embedded in either 2G, 3G or LTE technologies and we continue to have very strong pipeline of innovation that comes to the company by 1,000 new patents are issued to the company.
Each year all of this driving off a very, very strong internal development team that has been in place for quite some time and has had great success in predicting each of these major sort of fundamental shifts in wireless, whether that shift was from analog to digital, whether it was from voice to data or whether it was from a data highway to a data superhighway, InterDigital has been at the forefront of driving the technology. And, as a result, our technology today is used in every device that ships in the market, so great opportunity for the company. And, we're going to leverage that great opportunity by doing things. Continuing to source and create high quality innovative technology into the company and it will come in three ways into the company.
At the center of this slide you see innovation labs. This is the main stay of our innovation. This is 200 plus engineers in the company. Many of whom have with us for a very long time. The majority of which have masters or doctorate degrees. These were the folks that drive that next generation of technology and I'll talk a little bit about the things that we are working on today that actually we began work on these projects a number of years ago. Three or four years ago I was at NASDAQ conference talking about couple of these things. We were well ahead of our time. I could tell you now that we were spot on in terms of our vision for wireless and we'll talk about that in a second.
We've added this year a new component into our innovation sourcing strategy. As we all know, mobile devices today are very complex where as four, five, ten years ago you did voice, or few years ago you had data. Today, they are very complex computing devices that you hold in your hand. The result is there is a huge opportunity for innovation within those devices. There is a certain amount of that innovation that we drive out of our internal R&D teams very much focused on core wireless technology whether that's cellular Wi-Fi, other radio access networks.
Innovation partners is an opportunity for our company to take our knowledge of the industry roadmaps, take our knowledge of the standards process which mobile. Take our knowledge of the patent systems, which we've used very effectively to protect our inventions and to monetize them and bring that capacity to prolific inventors out there, small companies, universities, we've done some of that over last few years and last month we've announced a broadening of our strategy to focus more attention on that opportunity to source not taking away from innovation labs. Innovation labs will continue to be, again, the main stay of the company's innovation, but innovation partners will provide a new avenue for acquiring technology that we can then further develop into our own labs. It will create opportunities to bring innovative technologies developed by small companies into standards and we can hugely benefit from the mass proliferation of that technology, so we are very excited about that new component of our strategy, because we think it will greatly broaden the types of innovation that we can bring into the company and then monetize.
We are also going to complement our innovation labs with a new business unit called InterDigital Solutions. Over the years, InterDigital actually has been very successful in working in two different venues I'll call them. One is the standards bodies themselves. As we all know mobile devices are driven off of standards and the reason for standards is that you have a multi-vendor environment, where each vendor can produce a product that can talk to the other person's product, right? And, that's what the operators want. That's what the consumers want. InterDigital has been very, very active in driving its technology into the standards and successful in that way in getting our technology used across the entire market.
InterDigital Solutions will bring another component of customer interaction. Over the years, we've also been involved directly with a number of large companies and delivering them technology. So, as an example, we worked with Infineon in developing now part of Intel, in developing their protocol stack for their 3G solutions. We worked with Siemens and Samsung and other companies over the years, Nokia as well, in developing technology for them.
InterDigital solutions is going to take the fruits of labors coming out of innovation labs and brining that technology to market are a complete modem solutions that we've already licensed to a number of parties, but we believe that there is more opportunities both, in terms of with semiconductor companies as well as with handset companies that are looking to control the modem roadmaps.
We have machine-to-machine technology. You've probably heard a fair amount over the last couple of days in terms of the proliferation of machine-to-machine in terms of connected devices out there and we have a platform that we've driven and a standard that we have driven for machine-to-machine.
Smart Access technology. This is technology that allows your device on an intelligent basis to access different network for their network or cellular networks. Historically the off load to a Wi-Fi has been sort of a, we call a dumb connection. If the Wi-Fi network was there you got moved onto it. As the world moves forward, those connections are going to obviously more policy based, quality or service based and we've driven that innovation as well.
So, going forward there will be a much greater diversity in technology coming into the company augment it's already and very valuable patent portfolio and we'll take that technology to market in three ways. Licensing has been the major source of revenue for the company. We'll talk a little bit about the financial performance of the company, but it has been very, very strong over the last 10 years and that will continue to be the case, and this is licensing of handsets, licensing of infrastructure and other components in the ecosystem.
Second, we added this year the component of patent sales with a portfolio of 20,000 assets. We found that we could get more money with those, we call them incremental patent assets that we had by selling them versus just simply them to the licensing program. This year so far, we've generated about $385 million, $384 million in patent sales. And, given the volume of patents and new innovation that we crate every year, we can expect patent sales to be a continuing contributor to the business going forward.
And the third component of monetizing both, our patents as well as our R&D capabilities, the Solutions group again, so Solutions group will not only create technology, but will also through working with partners create a revenue opportunity for the company in terms of giving those companies access to technology, getting access to our patents and also working those companies in terms of providing them with patents that may come out of some joint development that the parties do. So, if you've observed InterDigital last few years, you've probably watched making number of incremental changes in our strategy which has led to I think a much stronger company today. We have been very strong over last few years, we but we are in a particularly strong position today.
That evolution came as follows. As we started to go back three or four years, basically 100% of the technology that we licensed was developed internal to the company. It was very much targeted at handsets through standards processes and all of our money and all of our revenue was derived from licensing.
Over time, we began to broaden our internal development to give us access to not just handsets, but of course other devices as they came onto the market and had other capability and other services being delivered over wireless systems well. Again, driven by our internal teams.
As our patent portfolio grew, it created the opportunity as I mentioned before, to expand our revenue opportunities beyond simply licensings to patent sales. Patent sales opening up a whole different or broader segment of possible customers to folks that are in the market, folks that are coming into the market, folks that produce handsets, folks that produce semiconductor products, folks that produce infrastructure, a broad array of customers that were looking for patents either for defense or other purposes.
And then, we also have other opportunities with respect to patents. The patents as a business, as folks who have watched that area of the market has evolved, patents have evolved into an asset class. Many business models now have developed around patents and with 20,000 patents and patent applications gives us the opportunity to work with a number of different companies in terms of how you make money off of patents.
Most of this still being generated from internal programs, and most recently we then announced innovation partners as a broadening of our innovation strategy, bringing in greater diversity of innovation into the company, greater supply of innovation into the company to take advantage of the monetization opportunities that we saw. So, a very, very strong opportunity for the company going forward, going back to the market, because it is a huge market and a huge market that continues to crave innovation of all sorts.
So, how does that translate into money for the company? Well, if you look at the last ten years of performance by the company, a very, very strong financial performance by the company. This year, $630 million, 600-plus million dollars in revenue the company, a mixture now of both sales and licensing revenue, but actually prior to this all the revenue that you see on that page was licensing revenue. So, if you think about the opportunity for the company, we've had substantial success through one facet of the business that we talked about before which was developing technology for handsets and licensing their technology to handset manufacturers. This is the first year with a broadened strategy and look at the results in terms of revenue, so the company is very bullish in terms of its opportunities going forward. Again, leveraging the very, very strong portfolio invention we have inside the company, the very, very strong R&D team we have inside the company, the strong relationships we have with companies throughout the wireless market.
So, for that reason, we've set as a goal for the company, very significant increase in terms of our licensing revenue and then you would add on to this revenue from sales and other things. So, from just a licensing perspective, the company has set a goal of $800 million that we would achieve. We set the goal at the beginning of those year, then we said it was in three to five years, so at this point two to four years. We are firmly committed to that goal both, as a company, but also as individual management folks in the company, our compensation is tied to achieving that goal. And it's a very straightforward goal when you think about it. The company's inventions are already used in every devices that ships and the market itself is huge and growing.
So, the effort for the company is simply an effort of getting contracts in place with folks shipping devices. Today, we have about 50% of the handset market under license and there's two opportunities to drive that. Of course, one is, get the other half of the market under license. So, if you look at our royalty revenue at the end of last year was around $300 million in just handset licensing revenue. If we go from 50% to 100% market the doubling of that is $600 million in revenue.
If you look at the market growth over that same period of time in terms of 3G and LTE devices that market is also expected to double. So, essentially there will be two doublings off of that $300 million in revenue. Actually gets you up to about $1.2 billion, the goal of $800 million reflects the fact that you probably don't get to a full 100% of the market and there's probably some price compression and other things that go on within the business. That takes you to that number.
The exciting thing for us about that is the operating leverage in the business. If you think about what happens when we sign a major license agreement. There is no cost associated with that license agreement, so all the additional revenue that comes from that agreement drops to the bottom line. The company has been very good in terms of managing its cost pretty aggressive in terms of while we spend a lot of money on R&D, we make sure we spend that money effectively and we've done a good job managing our expenses, so that revenue growth we expect would come without any material increase in costs. Meaning that all the additional revenue that we gain from where we are today at $800 million basically drops to the bottom line net of tax, so a very, very strong opportunity for the company in terms of just licensing revenue.
And then when you layer on top of that, the opportunity for sales, the opportunity for ventures, the opportunity for InterDigital Solutions to sell technology and license technology and folks the opportunity for the company become very, very strong and that's where the future as well will be driven by our future vision of technology.
As I said, a couple of these areas are things that we began working on about five years ago. Well ahead of when the market believe that these were the issues or believe that these solutions were necessary. And as we sit here today, we find that this innovation from the company has been spot on.
So, the first is, the movement away from what we call one network to multiple networks. What that means is, networks have typically been considered as things that live in isolation, so your cellular network has lived somewhat in isolation from your Wi-Fi network, from your other networks and essentially what we've believed five years ago and continue to believe today that it's all the networks out there in the aggregate, intelligently seamlessly and brought together on a basis of policy that will deliver the services to folks that they want over the phone.
So, in fact the plumbing is out there and what we are doing is creating those upper layer solutions to drive all of that capacity together. Doing what we have done before, which is to drive the solutions into standards, develop solutions that we can license to folks and drive into the market, so very successful run in technology and this is one of the technologies basis that's been moved into our solutions group.
The next is people the things, machine-to-machine, so Ericsson and other are predicting $50 billion connections in terms of wireless connection when they get off the plane today, here is where I saw the first camera that has a phone embedded in it. That will create a different type of network topology. We've been driving that for a while, we've actually standardized the machine-to-machine network with HC moving forward with that in a larger standardization effort. So, again, looking at that next generation network, what it's going to need. How it's going to need to be designed and then building solutions for that.
The third area research for us is video. Video will be the major consumer of bandwidth out there and video today is very inefficiently delivered over wireless network. It's delivered over wireless networks, the same way it's delivered over wire line networks and the two environments are completely different, so we are developing technologies that adapt video specifically for wireless environment and very interesting exciting that we've come with and a big area of growth for the company. So, a great story in terms of our ability to predict that next generation of technology, successfully crate the inventions for that next generation technology and then make money off of that and repeat that cycle over and over again.
So, to sum up on InterDigital, we have been in this market for almost 40 years. It is a market that continues to explode in terms of growth, in terms of innovation and opportunity for us. We are anchored by one of the largest patent portfolios in the market. We've leveraged that into over $3 billion in cash into the company from that patent portfolio. We have an approach to licensing and patent monetization that allows us to go to multiple parts of the market and multiple customers with different styles of monetization.
We have a very strong path, very confident path, the $100 million revenue and we have the ability through reinvestment of a good portion of that money back into the business to drive more technology, drive even larger patent portfolio driving greater success for the company.
So, with that, I would open it up to questions.
How long it takes for newly developed patents to generate revenue. Could you give the idea of your revenue split by kind of age kind of vintage of patents and how that mix is shifted over time? Thanks.
It's really driven by the generations of technology. So, today the majority of our revenue I would say is associated with 3G technology and there is a portion now building with LTE technology. We don't license individual patents. We license the portfolio. I'd say the lag time between when we do our innovation and when we start to see revenue was about three to five years and that's typically the timeframe at which it takes the technology to be standardized and then products to be built according to that standard. Some can be a little bit shorter, some can be a little bit longer, but I'd say three to five is when the revenue starts to come and then in that five to ten-year period at least historically that's when they particular portion may drive a good portion of revenue for the company.
Can you just elaborate how do you move from $300 million of licensing to $800 million in three years. I just didn't understand. And, second question is, can you just touch on the renewal of your licensing with some agreements what's the status?
So, the $300 million to $800 million is pretty straightforward. $300 million was our revenue at the end of 2011. That was our licensing revenue with 50% of the market under license. Since 100% of the market uses our technology, that $300 million can go to $600 million just based up on our increase in getting people under license.
Sorry. Can you repeat that?
So, 100% of the market uses the technology. There is not a cellular phone that shipped today that does not use InterDigital's technology. We are in 100% of the phones. That comes as a result of having our technology embedded in the worldwide standards. So, it's a question of putting contracts in place, because people begin to ship the technology without the contracts, so we have 50% of the market under license today on track to get that up to much higher numbers over the next couple of years.
So, if you just assume for sake of math, a doubling $300 million goes to $600 million. The second that happens during that same three to five year period is the market size of 3G and LTE handsets more than doubles. You go from 500 million handsets up to about 1.2 billion handsets. The effect of those doublings on a $300 million revenue base actually gets you to like $1.2 billion, so $800 million reflects again some, the fact that you may not get a 100% of the market, because there are manufacturers in part of the world that you may not get to. And then second, there may be some price compression in the market as well.
Your second question in terms of Samsung and RIM, those are two license of ours, are up for renewal at the end of the year. In discussions with both of those parties on renewals, actually good opportunities with both of those folks and whether those renewals happen at the end of the year, whether they happen sometime thereafter, we're someone in [different]. We recapture any sales that happen during a gap period, they still used our technology. We'll still recover revenue for that gap period as well, but we're a very, very strong renegotiation position with both of those companies.
I understand that you have the broadest portfolio in the market of patents, but how do you compare against Qualcomm, especially in CDMA and LTE technology is first question. And, second question on the licensing. What kind of payment your licensees must make, it's a fixed rate? It's based in percentage of the smartphone product? Can you give us more color on that?
Sure. So in terms of the portfolio, we are among the largest. If you look at some of the published data, we don't know how these reports are done, so we can't endorse reports, but they are out there. So, on LTE, we tend to be among the top three, or five in terms of LTE patent position. Similar type position with respect to 3G, so in total Qualcomm as an example would have more patents than we do, but if you also look at Qualcomm's portfolio, a good portion of Qualcomm's portfolio will be product related, because they are a big product company.
We're a research company, so our patents are going to be more oriented towards research and fundamental inventions. It's one of the reasons why over half of our portfolio today is declared to actually is the standards body for 3GPP, so very, very strong portfolio in the market.
And second, in terms of how we license, it really comes in two flavors at a high level. One is a fixed price agreement, so our Samsung agreement as an example $400 million for a four-year license. It's up for renewal this year, so that's one type of license that we do. The second type of license actually running royalty type license, so RIM as an example was a running royalty type license. It's hard to come up with, you can take the company's published revenue in any quarter when we will breakout the licensing revenue and you can divide it by the number of 3G units that were shipped in that quarter under license, it gives a number in terms of what we earned that quarter in terms of revenue and may not be precise in terms of what the effective rate is, because over the way the agreements are structured, but if you did that math, you end up anywhere from $0.75 to $1 in terms of what we recognized as revenue in a quarter in terms of unit shipped.
Any other questions? Well, terrific. I appreciate again the opportunity to come out and speak with folks. And, any other question, just please follow-up with Patrick. Thank you very much.
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