InterDigital, Inc. (NASDAQ:IDCC)
Q1 2016 Earnings Conference Call
April 28, 2016 10:00 AM ET
Patrick Van de Wille - IR
Bill Merritt - President and CEO
Rich Brezski - CFO
Eric Wold - B. Reily
Charlie Anderson - Dougherty & Company
Matthew Galinko - Sidoti & Company
James Berkley - Barclays
Good day, and welcome to the InterDigital First Quarter 2016 Earnings Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Mr. Patrick Van de Wille. Please go ahead, sir.
Patrick Van de Wille
Good morning, everyone, and welcome InterDigital’s first quarter 2016 earnings conference call. With me this morning are Bill Merritt, our President and CEO; and Rich Brezski, our CFO. Consistent with last quarter's call, we will offer some highlights about the quarter and the company and then open the call up for questions.
Before we begin our remarks, I need to remind you that in this call, we will make 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 our earnings release published this morning, as well as those detailed in our Annual Report on Form 10-K for the year ended December 31, 2015 and from time-to-time in our other filings with the Securities and Exchange Commission. These forward-looking statements are made only as of the date hereof, and 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.
In addition, today's presentation may contain references to non-GAAP financial measures, such as free cash flow, pro forma operating expenses and non-GAAP net income. Reconciliations of these non-GAAP financial measures to the most directly comparable GAAP financial measures are including our first quarter 2016 financial metrics tracker, which can be accessed on our homepage, www.interdigital.com, by clicking on the link on the left side of the homepage that says, Financial Metrics Tracker for Q1 2016.
With that taken care of, I will turn the call over to Bill.
Thank you, Patrick, and good morning to everyone. As you saw in this morning’s release, we delivered another very strong quarter. In fact, it was our fifth consecutive quarter with revenue over $100 million reflecting the continued strength of our research-based licensing business.
You also saw us continue to manage our expenses well taking advantage of the operating leverage in our business model. A couple of points to note for the quarter. On Tuesday, you no doubt read about our joint agreement with Huawei pursuant to which they will begin making royalty payments under our license agreement with them. While they have reserved the right to appeal the recent French decision that denied their request to involve the arbitration award and we are confident that we would prevail again in any such appeal. We believe getting them on a paying basis is a major step forward in bringing the licensing matter with them to a close for now. We will continue to work with and are open to a broader resolution with Huawei that would settle all of our disputes and establish a long-term co-operative relationship. We will continue to pursue this, but again are very happy they have agreed to begin paying the royalties out.
We think Huawei paying royalties will be helpful on our other discussions with Chinese manufacturers as well as LG and the other remaining unlicensed partners. Our flexible approach to licensing will also continue to be the hallmark of our success. If we can reach amicable terms on a strict patent license with a company, we will do so. If the company wants a broader relationship that includes R&D, patent transfers or access to some of our commercial platforms, we are happy to do that as well. If the company wants to arbitrate the terms of a license, we are open to that method of resolution. Only when a company refuses to meaningfully engage on the many options we can present [indiscernible] litigation. We think this is how licensing should be done and we think it is the reason we have succeeded with so many others have failed. That’s not to say that licensing will be easy. It remains a business model that requires a great amount of patience. It also requires that we continue to innovate to make sure that our offering to our customers is as attractive as we can make it, and in a way we continue to do.
You saw us in the first quarter continue to move our research forward. That research covered a number of important areas. First on 5G, we continue to work with a standards community to move that standard forward. At a significant 5G meeting in South Korea two weeks ago, we made a good number of contributions, including building blocks of the new air interface that were accepted among others for consideration as part of the 5G design.
As in 3G and 4G, we will look forward to demonstrate the value of our innovation and believe we will have significant success in getting our ideas adopted into the 5G standard. That success will drive the future of our core licensing programs.
Our work around IoT also continues. In addition to our work with Sony and then the IoT standards process, we entered into a commercial relationship with HARMAN to be a channel partner to push our IoT platforms into the market. We are looking to engage other partners to give us the broadest reach into a very diverse market. We are also pleased to be awarded a competitive strategy and innovation leadership award by the research firm Frost & Sullivan for our wot.io platform.
Finally, we continue to work with our partners to grow the UK-based oneTRANSPORT smart city initiative, which we think gives us a strong platform for several initiatives elsewhere. To provide our investors with a better understanding of the IoT opportunity, we tend to have an Investors Day in September of this year at which we will lay out our IoT plans.
We also continue to see success with XCellAir, our commercial initiative focused on improving the efficiency and operation of WiFi and LTE small cell deployments. XCellAir is working with partners to offer their commercial platform to operators worldwide. XCellAir also continue to trial its solution with cable operators who have become increasingly interested and being able to manage WiFi deployments and enhance quality for customers.
Like any startup, the company has good ways to go to begin to drive revenue and profit and building market position, but we are pleased with their progress to-date. We also continue to see very good progress from our investment activities in external startup companies. We began a more systematic method of investment about a year ago, bringing in a seasoned fund manager to manage our investment activities.
The purpose of our investments is pretty straightforward. We generally restrict the investment activities to areas of strategic interest for the company, mainly next-generation networks, IoT and content delivery. By doing so, we get the strategic value of a richer and broader understanding of the full range of innovation happening in the areas where we are also innovating. This allows us to redirect our activity when appropriate and also gives us the opportunity to acquire small start-ups and they have begun innovating in a space we see as valuable, leaping us forward in a cost efficient way.
While the investments are strategic because of their focus, we also compensate the investment managers on how well the investments perform financially. We believe this is a great balanced approach to investing and we're seeing excellent results both in terms of the opportunities to invest and the knowledge gained through the exercise.
All in, we have evolved the company to be a very different animal than it was just three years ago. We have a very solid and continuing royalty platform. We’re making reasonable inroad to patent licensing in China, which will be important in terms of long-term value of our company. While our internal adds remain focused in our areas of expertise, we are balancing our internal activities which [indiscernible] from the outside. This includes adding a dramatically different Board of Directors that we had two years ago. I think our Board today has a great balance of expertise needed to guide our business.
For those reasons, I continue to see great opportunity for the company and I’m pleased with how we are driving the business. As always, we have hard work to do, but we certainly have the car pointed in the right direction, the engine is tuned and the tank is full.
With that, let me turn the call over to Rich.
Thanks, Bill. It’s a pleasure to once again have an opportunity to discuss financial results from another strong quarter. Our financial results for the first quarter 2016 were driven by over $100 million of recurring revenue and total revenue of nearly $108 million. As was the case in first quarter 2015, our per unit royalties benefited from strong fourth quarter sales related to late 2015 product launches. This year, we expect to see similar, perhaps more pronounced sequential decline from our current per unit licenses as we move from first to the second quarter. Our first-quarter results did not include any revenue from Huawei as we had continued to defer revenue recognition from our related patent license agreement. I still mentioned Huawei has recently agreed to make payments of outstanding amounts under our patent license agreement. We look forward to the scheduled collection of those first payments and possibly the related revenue recognition as early as second quarter 2016. In first quarter we updated our compensation accrual rates consistent with our expectation that we will recognize revenue from Huawei this year. That resulted in a non-recurring charge of $3 million in the quarter. Taken together with the severance charge, our first-quarter operating expenses of $59.4 million included nearly $5 million of non-recurring charges. Our pro forma operating expenses which adjust the lead and other items is essentially flat with the prior year quarter and down $1.2 million from the fourth quarter. There are a couple of noteworthy balance-sheet updates. We paid off our $230 million of convertible debt upon its maturity this March. As you may remember, this majority was pre-funded with $ 316 million convert that we issued last year. We also repurchased approximately $40 million of our common stock during the quarter at an average price of $46.49. After factoring in the just over $5 million we repurchased so far this month, we have a balance of approximately $105 million remaining on our $400 million stock repurchase authorization. As is always the case we will continue to evaluate our cash balance and our plans for capital allocation.
With that, I will turn it back over to Patrick.
Patrick Van de Wille
Thank you, Rich and if you could open the call for questions.
[Operator Instructions] And we will go first to the line of Eric Wold with B. Reily.
I just to make sure I understood kind of clarify the comments around Huawei. So you mentioned that they will start making payments you expect in the second quarter and then you’ll figure out I guess if you can recognize revenue on that. What’s kind of the determination of whether or not the payments can be recognized as revenue or not and then is this, are these payments based on the arbitration panels figure that they gave out in terms of what the numbers should be or that they saw something else?
Yeah Eric, it’s Rich. So, the reason we deferred payment up until now is we haven’t at this point met all the criteria for revenue recognition, most notably collectability is reasonably assured and the terms are fixed and determinable. So we’ll continue to evaluate that in the second quarter as we look forward to collecting that payment but as Bill mentioned there is also opportunities to continue to work with Huawei to expand beyond what we’ve even agreed to so far.
And then on Q2, you may not give an official guidance and you noted that you should see a pronounced decline sequentially for the per units agreements, any kind of more I guess directional idea kind of how pronounced that decline could be and is that kind of where you're seeing that?
I would rate it more that I would have at this point Eric, I think it's something that we typically will wait and issue guidance once we receive our reports. We’re going continue to do that but we have observed in the marketplace based on earnings reports of companies that you may be familiar with indications that perhaps that will lead to lower levels of per unit royalties for us in the next quarter.
And we’ll go next to the line of Charlie Anderson. Please go ahead, your line is open.
I wonder Rich is there anything on the balance sheet that relates to Huawei at this point or is that something that shows up more next quarter’s balance-sheet?
Nothing on the balance sheet at this point.
And then, Bill for you, now that Huawei is effectively at some sort of a closing point here where you’ll able to collect, talk to me about sort of the conversations with the other counterparties who may have been waiting and watching that, do you feel like you are in the 7th and 8th inning and they were just waiting for a data point here or did this, do you have to sort of restart with people in terms of how other licensees counterparties will read through about Huawei as in terms of a rate for you guys.
So, we felt we don’t have to restart it, I think it's a continuation of a dialog that's been going on for a number of years with some of these folks. I think it's exactly what you said it becomes a very important data point for them, so there has been a couple of data points on the way one fact that Huawei was willing to arbitrate, I think it was actually that we would be willing to arbitrate with the other parties as well. The second is that they are agreeing to begin paying which is another data point we can point our perspective licensees to. And then once payment comes in and to the extend there is visibility around that and the contribution to revenue then that will be another data point that we can point people to in terms of their competitive positioning, so I think it’s all going to be very helpful with respect to those perspective licensees and hopefully we can move those discussions along.
Then I noticed in the queue there was a new disclosure on the arbitration which Sharp, I wanted what prompted that disclosure now and your general thoughts around that situation?
So, I mean the disclosure it just follows what the disclosure rules are from accounting prospective, so we have gotten some as the case move forward we’ve gotten some additional information from them that caused the disclosure. Sharp has a long-term licensee of ours in the case data asked for, the modification to the royalties to an agreement that they had in 2001, it was modified a couple of times along the way, so if that's what a party looks at then the natural result of that is going to be a bigger number. So there is a panel that will take a look at the claims this year, I guess in July this year. Typical of these cases, we belief we have strong defenses. And so any case we can’t predict the outcome and we have strong defenses here. So that's where it is, we have we've had a number of arbitrations around our license agreement without pointing to this agreement in terms of predicting an outcome we’ve generally been very, very successful in supporting our agreement, our licensing practices and things like that.
And then a quick housekeeping one from me, Rich you mentioned retiring the bill convert. What should we be thinking in terms of the ongoing quarterly interest expense now?
I believe Charlie we disclosed the interest expense in our 10-K related to the different instruments or certainly you can look at when we added the interest for the new convert I think second quarter of last year would have been the first full quarter. So you can kind of gauge off of that.
[Operator Instructions] And we will go to Matthew Galinko. Please go ahead.
Hey, thanks for taking my question. I guess in light of your commentary about pressure on per unit royalties sequentially, I guess could you give your bigger picture view of the end market as we look out over the next few quarters and even a year or two?
So I will give you some color and Rich can add. Certainly we have within our per unit population we have exposure to certain manufacturers who have talked about pressure in terms of their sales. So I think that’s certainly one factor that we have there. I think generally their comments reflect I think a general comment around the smartphone environment which seems to be flattening at the moment and that’s also not that unusual if you think about 4G has been in place for a certain period of time and the replacement cycle has drove really good sales for a while and it’s not surprising that it’s kind of flattened out for a bit. So I think for that cycle I think changes once we get to 5G. Once again components of 5G that will come out in couple of years, so I think you then can drive another refresh cycle which is good.
From our perspective, the bigger value driver for us in the near term is not so much market growth or even market movement around our existing licensees, but it's getting the other licensees onboard. That’s the big thing for us, because even though the step functions in revenue that will drive. We will be up and down with the market and if the market is flat, all else being equal, our licensees may be flat, but again our focus is going to be on – as we’ve done with Huawei, get them on paying basis, get them contributing to revenue, leverage that into opportunities with the rest of the folks in China and get those contributing to revenue. Those movements for us are far greater than any market movement in terms of unit sales.
I completely agree with everything Bill said and I will just add that there is a seasonal nature in the decline from Q1 to Q2. So that’s something we experienced last year and as I indicated we would expect to experience again. If you look at our financial metrics tracker which has been updated, we do disclose the contribution to revenue for those licenses that have a greater than 10% contribution. And if you look at the first quarter of this year, for purposes of this discussion, revenue was close to flat, it was down maybe a little bit from last year and yet Pegatron’s contribution was 46% this year compared to 39% last year. So there is a little bit of timing in terms of when sales volume throughout the year occurs. And that kind of sets you up for a potentially bigger drop from Q1 to Q2.
Great. Thanks. And then one more maybe around your efforts to get after the unlicensed segment of the market here. I appreciate you going over the ways you can purse that. Is there any elevated interest that you're seeing at this point in kind of the R&D method or brining your commercial initiatives into ultimate license agreements or contracts or is it still primarily pat license or is there anything kind of shifting in one direction or the other?
So I think that generally if you look at the things that we have to offer, so we’ve always had research as a component of our offerings, [indiscernible] research continues to be something of interest to folks, I think because they equate it to a very strong point for the company, right. The commercial initiatives are gaining some traction. I’d say still early because the initiatives in sales are still somewhat early. Certainly having Sony acquire one of the platform, I think a licensees in the platforms is very helpful in terms of getting one customer onboard and I think the other things that we've been doing inside to sort of mature platforms in an effective way and even work we're doing through our spins, our commercial startups is helping to create a more attractive asset.
And so we’ve had some middles around those things and I would hope it’s really mature than the conversations around the more mature. The third component of consideration that we can look at is patent. So the patients can flow in either direction, right, so patents can flow from up to a customer to the extent their customer needs defense. And that's always something that is on the table with folks. They can flow in the other direction as well. Then can flow into us and that can be - they can come in two different ways. One is just in sort of in time considerations. The other is as an opportunity for that the other company to have some sort of joint licensing activity with us in a particular space.
I think that last one is also an area where we see more interest. I think that’s because [indiscernible] how people look at the company and what our core competence is. So certainly research is a core competence in that area of interest. Licensing is also viewed as a core competency, so people would be comfortable about managing intellectual property for them. So we are looking at those opportunities as well. So again I think it's a nice list of things and it gives us a lot of options for talking about something other than just the straight patent license with folks.
And maybe if I could just get you on one more on that latter point, I mean clearly there has been some shifts on how companies bring their or sort of assert their IP at least in terms of NPEs. Is that favor you at all as part of that market kind of implodes or are you getting – are you seeing more interest from companies that maybe previously they saw market where they could asset their patents through and now it shifts a little bit so do you have a little bit more weight there today?
I think we do. I think we have it for a couple of reasons. One, I think the company has got a very good reputation as a licensing company both in terms of fairness and the fact that we tend to put research behind things and so it's not just a depleting asset that you are licensing but it’s one that's growing. And so I think that makes us – in the new environment that we're living in today where various patent licensing and practices come under scrutiny. That kind of licensing program tends to be less – tend to be more favored, right, because it’s a really research based program with a company that has had a long history of doing it right. So it's a company that patents – worried about its reputation in terms of how it monetizes its patents, we are a more attractive partner than someone who doesn't have the same reputation as we do.
Second, a lot of the non-practicing entities, they run this pure partnership models with no cash upfront and everything is going to come. We don't have to go down that path. I mean we can provide sort of more certain compensation either by some cash payment upfront or some revenue share off of their assets, but perhaps their assets in combination with other things that we have. So I think we were a more attractive partner from a financial perspective as well.
We will take our next question from the line of Darrin Peller. Please go ahead.
Thanks, guys. This is James Berkley for Darrin. Just real quick on Huawei with the appeal, obviously it sounds like you guys think you’re well positioned there and new payments are going to start coming in, so there probably is not much of a concern, but just the odds on just how you see that playing out, the potential timing there and just a little more detail on your positioning, that would be great.
Sure. So what Huawei has done so far is they’ve reserved their right to it. And so whether they actually appeal or not, I mean as we described, we think about this as an appeal, of an appeal of an arbitration award and that’s not something that has a significant track record of success at all. Right. And so I think obviously they need to think through what they want to do on the legal side and on the legal side, typical with any type of thing that is, options start to -- you have less and less options and those things become harder and harder as the case goes on. And so that is the situation facing them. From our perspective, we continue to be very open to a broader solution with them.
We think that they’re obviously an important player in the market and to the extent we can do all the things I described earlier in times of research and access the platforms and other things with them over a longer period of time, that is certainly our preference. So hard to give you a timeframe on something like that, but it certainly is something that we would like to get done in the shorter term versus the longer term with them and I think that we have -- certainly, the arbitration results gets us some strength in that discussion, but I’d hope that other aspects of the company are -- would be attractive to them as well in terms of things that we can do with them. So I would say, certainly, it’s a pretty big focus of mine to try to see if we can do something broader in the longer term with them. That said, that doesn’t work out, the situation we’re in today is just fine.
Okay. Makes sense. And then just a quick follow-up here and I apologize if this is a repeat question, let me know if somebody else asked, I actually had a drop and come back on really quick because of some feedback I was getting on the phone line, but if you don’t mind providing investors with an update on some of the larger handset opportunities and where they stand especially with regards to ZTE and Lenovo just given the Huawei news, I know that there are some related components there that make those deals in particular a little bit more focused.
Yeah. So in terms of positive momentum I think that the Huawei arbitration result, decision and now their agreement to begin payment is a very strong bit of momentum. Ultimately, these companies are all going to make up their own minds on things, but having some clarity around the Huawei situation for them I think is very important, because it will define the competitive position that they will be in vis-à-vis Huawei and that’s a pretty important component in the discussion. So I think that that -- we will certainly use that to our advantage, advantage in terms of getting them the information that they need, so they can make an educated decision on their part.
I think that the item I just talked about here in terms of ways to work with companies, I think we are continuing to be, I think, better and better positioned to work with folks in part because of the decline of the NPE community and therefore we become one of the few, but also one of the better, if not the best option for folks to monetize that as that opportunity we look at. Another time driven component is 5G research, right, and so the 5G standards are sort of reaching -- it’s a very active period of time over the next year, sort of which the main development work will take place for 5G.
It’s the perfect time for companies to engage with us and I’d say Sony was, I can’t tell you what was in their mind, but certainly one of the things they could have thought about was in terms of why they engaged with us in 5G, timely to do that and it won’t be timely a year from now. And so we’re very well positioned in the 5G standards, both from a participation and leadership standard positions. So I think we can use that timeframe to drive opportunity there. And there was a similar opportunity within the 802 environment as well. So I certainly like the things that are happening in terms of drivers for licensing. That said, as I mentioned, this is not -- it’s not a business model where we can predict the timing of outcomes, but certainly, I think we’re doing things the right way and creating the right incentives for our folks.
And we’ll go next to [indiscernible]. Please go ahead.
Good morning. Could you give a little more color with Huawei as far as the Chinese ruling and did your arbitration cover that?
So the arbitration itself covered sales outside of China and so the sales inside of China will be -- or the royalties for those will be determined via the process going on inside China and that is sitting up at basically with Supreme Court within China where we have request the rehearing based upon a variety of factors among them the lack of evidence in the case that occurred below. So we’re basically at this point waiting for a ruling from the Chinese court.
At this time, we have no further questions. I’d like to turn it back over to Mr. Patrick de Wille for any closing comments.
Patrick Van de Wille
Thanks very much. Before we conclude the call, I just want to remind the folks that our 2015 annual report has been published. So you should either have received it electronically or hard copy or be receiving hard copy soon. In the proxy statement. I’ve asked shareholders to pay particular attention to the instructions for accessing our virtual annual meeting which are on pages 3 and 4 of the proxy. As indicated in the proxy, you can also point your web browser to idcc.onlineshareholdermeeting.com and there is a link that provides simplified instructions which vary slightly depending on whether you chose an electronic delivery or not. Rest assured, we will be issuing a press release closer to the event with simplified instructions as well. Thanks for joining our call today and have a great day.
I’d like to thank everybody for their participation on today’s conference call. Please feel free to disconnect your lines at any time.
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