Janet Point - Senior Communications & IR Officer
Bill Merritt - President & CEO
Scott McQuilkin - CFO
Charlie Anderson - Dougherty & Company
Jonathon Skeels - Davenport
InterDigital, Inc (IDCC) Investor Update Conference Call January 23, 2012 5:30 PM ET
Good day ladies and gentlemen and welcome to the InterDigital update conference call. Today's conference is being recorded. At this time I would like to turn the conference over to Janet Point. Please go ahead.
Thank you very much and good evening everyone and welcome to InterDigital's investor update conference call. With me, this evening, are Bill Merritt, our President and CEO, and Scott McQuilkin, our Chief Financial Officer. During this call Bill will provide some insight about the process and the board’s decision to move forward with the company's business plans. He will also provide some insights into that plan and our views on the wireless environment generally. In addition, Scott will briefly cover our preliminary financial results for fourth quarter 2011. We will then open up the call for questions.
Before we begin our remarks, I need to remind you that during this call we will be making forward-looking statements regarding our current beliefs, plans and expectations, which are not guarantees of future performance and are subject to risks and uncertainties that could cause actual results and events to differ materially from results and events contemplated by such forward-looking statements.
These risks and uncertainties include those set forth in the press release as published earlier today and those detailed from time to time in our filings with the Securities and Exchange Commission. These forward-looking statements are made only as of the date hereof and as except as required by law, we undertake no obligation to update or revise any of them, whether as a result of new information, future events or otherwise.
With that I will turn the call over to Bill.
Thanks, Janet and good evening to everyone. As you saw on our release, the board has decided to conclude its previously announced exploration of strategic alternatives and focus on the execution of the company's business plans. This evening I will provide a summary of the process including some of what we learned and how we will incorporate that information into the business going forward. I will also provide a summary of our go forward plan and our financial objectives.
Along the way I will provide a summary of certain events in the wireless industry over the last six months and how those events affect our go forward strategy. So let me start with the process. As you may recall in July 2011, the company announced the board’s decision to explore strategic alternatives. The rationale is simple. While the board was optimistic about the prospects of company under its business plan, we also had seen numerous developments in the market that has caused the value of patents to increase substantially. Given these factors, the Board believes it was the appropriate time to explore potential strategic alternatives and to determine if such alternatives would enhance shareholder value.
During the last six months, the board with the assistance of independent financial advisors undertook a comprehensive review of our business and potential strategic alternatives. Together we conducted a very thorough analysis, meeting and talking with many parties about the company and its assets. Interested parties conducted their due diligence, accessing a fulsome data room established by the company.
The feedback we received from the interested parties was positive. We are told that the patent portfolio was viewed as deep and of high quality. We were told that the licensing team was considered very strong and the R&D teams were viewed as having a strong track record of identifying future needs of the wireless industry and inventing solution that build those needs. All of this confirmed our view in the value of InterDigital.
While we saw a significant interest in portions of our assets, no bid for the entire company was made by either a single company or a consortium of companies. The interest in smaller patent portfolios is consistent with what we observed outside the process where many recent transactions were smaller, patent portfolios were many, but larger deals were fewer and farther between.
For example HTC acquired 82 issue patents of ADC communications for approximately $75 million. Acacia technologies acquired approximately 250 LTE related patents and patent applications of ADAPTIX for a $160 million. And Google on top of its Motorola purchase continued to acquire smaller patent portfolio from, IBM, Golden Bridge Technology and others.
While not necessarily indicative of all situations, these examples suggest that while patents are certainly carrying high values and for good reason, more pure patent-related transactions are occurring in the hundreds of millions of dollars instead of the billion. Given all this, the board determined that it is in the best interest of the company and its shareholders to conclude its review of strategic alternatives and to execute on a strategic plan with two key components.
The first is a continuation of our strong licensing program. Here we plan to drive to our goal of licensing a substantial portion of the terminal unit market by yearend 2014 with an average 3G royalty rate consistent with current agreement and incrementally higher LTE rate.
Importantly, the board intends to tie long-term compensation to the achievement of these targets and to achieving sustainable annual revenues of at least $800 million which if realized will drive substantial growth and free cash flow. Second we plan to add targeted patent sales and licensing partnerships to our strategy as this is the demand we had seen during the strategic options process.
It is also consistent with the overall trend we’ve seen in the industry. As explained below, given the depth of patent assets we have, we believe that patents sales can be an effective, value-adding complement to our business. We are confident we can deliver on both aspects of this expanded plan.
Our licensing program is well positioned to move forward with potential licensees. During the strategic options process, we remained in regular discussions with current and prospective licensees. However, due to the process, certain discussions did not move at a typical pace as a number of companies told us they were waiting to see how the process played out.
We believe that today’s announcement clarifies that issue and we believe we’re on a good position to deliver new agreements this year. As always we are prepared to resolve any licensing issues on fair and amicable terms. As we’ve done in the past, we will of course protect the value of our contribution for the evolution and growth of the wireless industry. We’ve not often resorted to litigation, but the patent landscape has evolved, with litigation becoming far more common in the wireless industry. We do not believe this is the right dynamic, but we are very well prepared to deal with it.
We’re also confident that there are opportunities to drive added cash flows through strategic patents sales and licensing partnership and look forward to executing on this added component of the business.
Let me elaborate on these opportunities, how they balance with our core licensing program and how they square with our strategy of opportunistically pursuing patent acquisition. As I discussed earlier, the strategic options process highlighted the significant depths of the company’s cellular patent assets. Today we have more than 19,500 patents and patent applications of which approximately 50% have been disclosed to ETSI based on our belief as of the date of disclosure that they are or maybe essential or may become essential to wireless standards.
That portfolio is also growing at a rapid pace. Just last year, we were granted more than 170 new US patents and over a 1000 patents worldwide. We also filed a significant number of new patent applications. Based on our historical success rate at the various patent offices, we project that our patent portfolio will reach over 24,000 patents and patent applications in the next three years.
At this time, the InterDigital patent portfolio ranks among the largest in the cellular industry. A number of parties inquired into purchasing portions of the portfolio during the strategic options process, which supports our belief that the portfolio is also very high quality and well managed.
We intend to pursue those opportunities which I would divide into three different categories. First, we will seek opportunities to monetize those portions of the portfolio that are not related to our core terminal unit licensing program. A good example of this is our 3G and LTE cellular infrastructure patent. While we have had licensing discussions regarding this portfolio, we have found that the portfolio sometimes gets overshadowed particularly when you are dealing with a company that has large terminal unit operations but smaller infrastructure operations.
One way to deal with that negotiating dynamic would be to sell all or a portion of our infrastructure portfolio to a third party and allow them to license the portfolio in a manner in which it dominates the discussion. We would benefit from that sale through guaranteed payments, contingent payments or both.
The second category of patents, we would seek the opportunities to monetize would be where we are building a licensing position, but are not yet at a point where we believe we have sufficient critical mass to support a long-term high value licensing program. For this category of patents, we may decide that in lieu of continuing to make the investment to grow the portfolio, we are better off selling the portfolio today to someone else who may be able to add sufficient additional assets to bring the portfolio to a solid licensing state. This essentially accelerates the time to money for both parties and improves value.
The third category of patents we would seek opportunities to monetize will be those related to our core terminal unit business where the incremental value to the company of the patents of these are nominal in value to our licensing discussions, over the value through sales expected to [recede] the incremental value we would see through the licensing program.
Given the vast size of the company’s portfolio and its expected growth trajectory, we believe we have a substantial number of patents and patent applications that we could offer into the market without affecting our core terminal unit licensing programs.
Moreover the fact that we may seek to sell patent assets does not signal any change in our patent acquisition strategy. Given the shift in the market from feature phones to smartphones, we believe that our core terminal unit licensing program will be best served by a multitude of patents covering a diversity of invention and capabilities in today's smartphones that are beyond the core cellular inventions. So like any good portfolio manager our goal is to sell off some assets that are not providing a significant incremental value and purchase others that would optimize the value of our portfolio.
The fact that we are both a potential buyer and seller can also create interesting negotiating opportunities. In the end, our goal is to optimize the mix and inventions we had in order to support our core licensing program in the terminal unit space, which is by far the biggest space in wireless and then complement that program with partner driven licensing programs in that same space as well as project driven and internal programs in the adjacent space.
We believe that together these opportunities can deliver substantial value to shareholders by further strengthening our core terminal unit programs and through added cash flow and profits. Such opportunities would also deliver value in terms of revenue diversity. Today our cash flow and revenue drive off of our licensing efforts in a single market cellular terminal unit. While very successful we are subject to swings in both cash flow and revenue based on the performance of our licensees and the timing of license renewals. By successfully adding patent sales and licensing partnerships to the mix we can effectively create a larger base of licensees and a more diversified stream of cash producing agreement. This also allows us to stay focused on driving our core business.
Further we believe our licensing business is highly sustainable. Much of what I have spoken about so far is based on the assets we have and our licensing efforts with those assets. However, it is also very clear that our R&D teams are succeeding in driving new innovations into the market. At the CES show this month in Las Vegas, one of the strong technology themes at the show was basically, interconnected network connecting billions of devices. This has been a centerpiece in our R&D efforts in the last five years, where we have developed key hand-off aggregation and data flow segregation technologies. Those technologies are now moving through the standardization process and into devices driven by InterDigital invention.
We also saw last week the creation of a new industry-wide standards body, named the 1M2M and M2M partnership projects that will drive the standardization of machine to machine deployment. This is another area where InterDigital has led the industry with our solutions, a core part of the M2M standard developed by us and now a candidate for the world wide standard effort to be undertaken by the new 1M2M partnership project.
We believe that the patents resulting from both of these efforts will help not only to drive our core terminal unit licensing program but also our more aggressive patent outsourcing effort. And we expect to continue that R&D success with our new and exciting work on critical compression technologies, security technologies, mobility and connectivity technologies, and radio technologies. So we believe we are running the strategic options process from a position of strength and with a great deal of valuable information that is shaping our go forward strategy.
We look forward to a good year. As I mentioned before we have a strong pipeline of licensing business discussions that we work to conclude. Based on our current agreement and anticipated prepayment schedules we expect to be cash flow positive this year and we are trying to use that cash in our cash balances in a manner we believe most effective to drive the highest share holder value.
With that let me turn the call over to Scott to go over our preliminary Q4, 2011 results and I will then come back for final comment.
Thanks Bill. Given the timing of this announcement, we wanted to take the opportunity to provide a summary of the preliminary financial results for the fourth quarter 2011. While these numbers are preliminary and unaudited, we are sufficiently through the year in the closing process to provide some meaningful guidance with respect to revenue and earnings. We’ll provide a complete analysis and discussion of our fourth quarter financial results when we announce earnings later in February.
Revenue in fourth quarter 2011 is expected to be 74.2 million and consist of current royalties of 71.8 million, no past sales and 2.4 million from technology solutions. Fourth quarter 2011 operating expenses are expected to be 41.5 million, including 10.5 million of intellectual property enforcement and non-patent litigation cost, and a 4.6 million adjustment to reduce the accrual for long-term compensation.
The adjustment relates to a reduction in the accrual rate with two of our performance cycles from a 100% to 50% resulting from the impact of our strategic alternatives review process and the timing of license agreements.
Because our goals for these long-term compensation programs are based on accumulative performance over a multiple year cycle, a delay in signing a license we paid at that time can affect the level of achievement. Other expenses are expected to be 2.7 million and the tax provision is expected to be 9.1 million in fourth quarter 2011. We expect the tax provision to include the tax benefits of 1.5 million related after tax interest income associated with the tax refund.
Net income is expected to be 21.0 million or $0.46 per diluted share in fourth quarter 2011. Finally we expect the cash and short-term investment would be approximately 678 million at December 31, 2011.
Now, I’d turn the call back over to Bill.
Thanks Scott. As always we appreciate our investors’ support. We recognize the process resulted in our being less available over the last few months. We look certainly to be out on the road to speak with you about the plans we have just discussed for the business going forward. We look forward to seeing you in the coming weeks.
With that, let me open up for questions.
Right, then if you want to give the instructions for the Q&A?
Question-and Answer Session
Thank you. (Operator Instructions) We will go first with Charlie Anderson with Dougherty & Company.
Charlie Anderson - Dougherty & Company
I wonder if you could just kind of give an overall, if anything why it didn’t happen in terms of a bid for the whole company or a consortium bid, Bill. And I wonder if you could kind of comment on quality of the patent and encumbrances and how maybe those two affected the dynamics?
Sure. I’ll actually start with the second part first. And so very uniformly through the process, the feedback we got from folks that we’re doing diligences and sales are through independent third parties that they would engage with that. People are very impressed with the patent. They are considered both well written and well managed, well prosecuted and that’s consistent what we had all along with respect to the portfolio. It is a very, very strong portfolio based upon the focus of our innovation, which is a very fundamental invention related to wireless. So I think that was definitely a very positive review.
I think, you know, encumbrance wise, actually I think people saw that there was an opportunity as someone would require the assets that the patents would roll off, like patent licenses would role off, for example with Samsung at the end of this year. So, actually while the patent portfolio is burdened by about 50% of the market today, overtime that would go down and give the people the opportunity if they wanted to manage those patents a little bit differently, to do so and I think that actually was a positive. Sometimes those there could be a negative view there too but I think in this process, I think that was viewed as positive.
So I think all that was good, I think as we described in the script, I think ultimately what you saw, what we saw in the process and it was very consistent with that folks did not have a strategic need for the full asset. What they have a strategic need for was a portion of the asset and that was consistent with what we saw outside in terms of other transactions that was going on. Along the way, we did work in trying to build some consortiums but they don’t form naturally, these are folks that tend to be competitors and so while there was an effort to do that, ultimately that did not come together again. I think because people have unique strategic interest that may not have been fully realized through a consortium either.
So, ultimately we did not see a bid for the whole company, but as we mentioned in the script today, very significant interest for a portion of the patent assets, both for people interested in defense but also for people looking at offensive licensing opportunities as well. And I think, once we got to that point, it made lot of sense for the board to make the decision to move on with the business and now like to exploit that information and use that to basically append a new piece to the strategy going forward which I think if well executed on that we've got the right asset, that can be very value creating for shareholders.
Charlie Anderson - Dougherty & Company
Was there a FRAND versus non-FRAND element to what would deem strategic or not?
No, you know there is always that dialogue that goes on you know, and frankly our portfolio is a mix of patents that to which a FRAND obligation would apply and to ones which it would not apply and I think both have got their advantages and disadvantages, right. So I don't think our portfolio by nature would have, because it has a mix it would’ve send one person, one way or the other. And I didn't really hear a lot about that during the process so I didn't think it was a big issue for us.
Charlie Anderson - Dougherty & Company
And as you walk forward, I mean are you going to be thinking about encumbrances at all given the fact that you do have a quite a bit rolling off in ’12 or are you, you know go forward you are trying to reassign everybody just like you were before the whole [dovetail] happened?
Yeah, I think we have, I think what we need to do is kind of balance it, so I think to some extent the sales opportunity is something we need to move forward on quickly because for someone who wants to use the patents for defense or offense frankly. In that situation the less encumbrance, is the better.
And so you know that said, I think we will also move forward aggressively on the licensing program just balance those two. And I think many of the buyers will understand that this is a moment in time for the individual assets because as we move forward and put more licenses in place the patents become a little bit more encumbered and perhaps were deniable to them so I think there is a natural sort of, it can drive the timing of some buyers which is good.
Charlie Anderson - Dougherty & Company
Okay, then just a real last question from me which is the cash flow positive comment; I think you guys if my math is right burned about little over $60 million of cash in calendar ’11. So we walk into ‘12 what assumptions are you making in terms of new licensee signs to be at cash flow positive in terms of the amount that you need to sign to get there? Thanks.
Really, I think those comments related to cash flow from existing licenses including prepayments; and so when we say that we think we can get there without a lot of new business and on the other side we said the existing licenses including prepayment. So you know in the past those remind that we have a fair amount of money coming from prepayments and some of those are up for additional prepayments.
We will take our next question from Jonathon Skeels of Davenport.
Jonathon Skeels - Davenport
Could you comment on the thought process behind possibly not selling some of the pieces of patent portfolio where you did have interest during the review process?
Sure. What I would say is that we saw a very good level of interest during the process, but while you are in the process it may not be the right time to negotiating and market dynamics standpoint to exploit those because those were the folks that were typically coming in first with an interest perhaps for looking at the whole portfolio and then backing down to a portion of it. We deem that the people that came in with their first interest being a portion of the portfolio because they didn’t think that that’s what we were in the market to sell at that point.
So, I think and if you were at somewhere negotiating with a company to a portion of their assets and you know at the same time they are for sale, you may be reluctant to spend a lot of time on negotiation because you can have the rug pulled out from under at some point.
So I think we needed to make it clear and to create the best time that we were out of the strategic options process and now adding individual patent sales going forward to reach back to those buyers that were interested and then see if there were additional buyers that should be interested as well. So I think we’ll have better negotiating dynamics for that outside the process than we did inside the process.
Jonathon Skeels - Davenport
And then second, on the two pieces you commented on receiving interest, the mobile infrastructure piece and I guess some of the LTE patent; can you just refresh us on who is licensed to those two pieces of portfolio at this point?
Sure. Now the mobile infrastructure very light and on you know we had done licensing on 2G infrastructure, but on 3G the only license in place is with Lucent actually for a small pieces of cdma2000 portfolio. So that is a very, we think a very attractive portfolio; one, because it’s like the rest of our portfolio contains a lot of fundamental innovation patents that we believe are may become are essential to standard and also was likely encumbered so I think that’s good for both buyers of defensive assets as well as offensive assets.
So mobile terminal portfolio for both where 3G is about 50% licensed, but absence some new licenses coming on, those will roll off overtime, so I think that’s again a good position for perspective license, perspective buyers. LTE is actually, there is less encumbrances on that, so that would be very attractive right from the get-go for folks. So again I think it’s a good time for us to be exploring those opportunities because I think the portfolio is a very high-quality, high-value and it’s also the encumbrances are in a good position.
Jonathon Skeels - Davenport
And then last one and I’ll let someone else get on, but on the partnership opportunities, can you maybe comment a little bit more on what those would potentially look like in terms of the assets you identify. I guess I am just thinking, you know, what do you think you need to bring in I guess, licensing expertise or form some partnership with a third party entity when that’s kind of a core competency of the company or this is primarily focused on may be just non-core assets?
Yeah I would say that one is focused on non-core, right, and so with assets that are not being fully utilized inside the company. And there is a couple of things you can do, so with some additional patents on the terminal unit side, if you were to go to an outside party and provide them some of those patents either for sale or an earn-out basis, you essentially get an opportunity to earn royalties from two different directions into that terminal unit market, both from our program, right and then from that outside party’s program. So I think that that’s attractive. And you could do the same thing with respect to infrastructure as well.
The other thing you can do with the patents is obviously the types of partnerships you can strike which can be both with strategic, because as you’ve seen, the strategic are very interestingly in using their patent portfolios to optimize their position in the market and we could assist in that regard. And second, there has also been a lot of activity by other technology licensing companies out there in acquiring portfolios that we could take advantage of their expertise as well.
So I think all these things we described will be done in a way that make sure that we can run that core program very well ourselves and basically we unlock the value of assets as that we have on the balance sheet right now that we have not exploited.
We will take our next question from Jeff Kvaal, Barclays Capital.
Hi guys, this is [Sara] on behalf of Jeff. I have two questions really and you commented that some of the vendors were interested and looking at a portion of your portfolio. I guess, I was wondering you know, if you could comment on what portion that was?
And then also in terms of, I guess I am thinking in terms of your LTE portfolio, once now that the process is concluded how do you begin approaching some of these vendors to sign, and to get some under contract; you’ll have to wait until some of their current contracts are over or how does that happen?
Okay. So during the process, I would say that both of the global terminal patent assets and the infrastructure asset were of interest to those probably a little bit more on the mobile terminal side, but interest on both sides.
And as I said before, pretty uniform in terms of how people got there and they should start with reviewing all the assets and then decide that the portfolio was very deep and there was an opportunity for us to do something with some smaller portions of portfolio which would serve their needs and could work very well for us. And so those are the things we intend to explore as we go forward.
On the LTE agreements, they fall into I would say two different categories and there are license agreements today that continue to run, but do not have LTE as a component to them and so what’s licensed in those agreements would be a device and it could be an LTE device.
The only thing is the LTE portion of that device would not be licensed, so we have opportunities to go back to those licensees and basically upgrade devices unlike they are paying some royalties and increased royalties to capture the LTE piece. There are other customers where it was a fixed payment for the period and in some of those instances there could be an LTE licensing opportunity and in other ones you may have to wait until the end of that term before you can look to the LTE patents for licensing.
And ladies and gentlemen, that is all the time the company has allotted today for the call. At this time, for closing remarks I would turn the conference over to Janet Point.
Alright, thanks everyone for dialing in. If you have any further questions please reach out directly and we will be seeing some of you fairly soon. Thanks very much.
Ladies and gentlemen, this does conclude today's conference. We appreciate your participation.