InterDigital, Inc. (NASDAQ:IDCC)
Barclays Global Technology, Media and Telecommunications Conference Call
May 22, 2012 10:15 am ET
William J. Merritt – President and Chief Executive Officer
Luke J. Labella – Barclays Capital, Inc.
Luke J. Labella – Barclays Capital, Inc.
I think we’re good. Good morning, everyone. My name is Luke Labella. I’m part of the Comm Equipment team here at Barclays. And we’re delighted to have InterDigital with us today.
We have the CEO, Bill Merritt, here, who’s going to speak for about 25 minutes, and then we will move to a bit of a Q&A. And I believe, we have a breakout in Liberty Room 4. We’ll confirm that at the end.
But without further ado…
William J. Merritt
Thank you, and good morning, everyone. I’m Bill Merritt; I’m the President and CEO of InterDigital. I appreciate you all coming out to hear our story today. As you’d expect, the presentation today will include some forward-looking statements. So with regard to those statements, I would point you to our most recent filings with the SEC with regard to the statements on any risks and uncertainties associated therewith.
So let me give you first a high-level view of the company for those of you who don’t know us, right. We are a technology development and licensing company. We’ve been around for just about 40 years. Very much focused on the cellular industry and our inventions today are used in every cellular device that ships.
A little bit about our technology development is that, we don’t look at technologies that we’ll deploy in a year or two. Ever since the company was formed, we’ve always looked at what that next generation of technology would do. So back in the early – actually late 1970s, early 1980s, when the world was really an analog world, we predicted that the world would go digital in terms of cellular technology. And we made that investment and we made it right. We’ve bet on TDMA technology, and ultimately that technology got embedded in both the U.S. standards and the European standards.
And in developing the technology, we not only make those bets, but we actually build the solution. Because sometimes it’s only in building the complete solution that you identify the problems that need to be solved. And that drives a wealth of invention and wealth of knowledge for the company.
That’s what we’ve done. In the mid-1990s, we’ve made a second bet in terms of that the world would move from voice-based communications to data-based communications or from narrow-band to wide-band. Back in 1996, when I joined the company, we were actually delivering video over the air, using what we called a broadband CDMA system. Today that’s known as Wideband CDMA. We’re making similar bets today in terms of what the next network will look like, and I’ll talk about that a little later on.
As a result of that approach to technology development, we end up with a very, very strong – we have a very, very strong patent portfolio, almost 20,000 patents and patent applications. It’s a very deep portfolio of patents. They relate to all the major cellular standards in place today. So, whether it’s GSM, cdma2000, WCDMA, LTE or the generations and technology beyond that which are currently in development.
Approximately 50% of that portfolio has been disclosed as essential or potentially essential to wireless standards. That's a very, very high percentage in terms of our portfolio if you compare that to other portfolios on the market. And the reason for that is, again, the nature of the R&D that we do. We look out into the future. We figure out what we think that next system needs to do. We develop those inventions. And then like many other companies, we participate in the worldwide standards bodies and have those inventions adopted into the standard, which sets up the next part of the business model which is licensing. We’ve had a good level of success in licensing.
Over 50% of the 3G market is under license with us today. We've collected nearly $3 billion in royalties over the last 20 years or so with the company. We offer license agreements on flexible terms either its running royalties or fixed price agreements, but we have license agreements in place with many of the large manufacturers in the business today. So a very, very strong licensing program, which, at the end of the day drives very strong financial results for the company.
We've been a consistently profitable company, a company that has produced very consistent high cash flow. We've taken that cash, reinvested some of it in the business, but we also had a strong track record of returning capital to shareholders both in terms of a strong stock buyback program. Approximately about $600 million to-date in repurchases and we also have a continuing dividend for the company. So a very actually straightforward, very successful business model in terms of technology licensing and development licensing in the cellular space.
So, a little bit more in terms of our opportunity going forward, right. So we have about 50% of the market under license today for 3G handsets. As we all know the 3G market is growing substantially. So if you look at the market today, there will be about 700 million 3G handsets this year, growing to about 1.3 billion 3G and 3G or LTE handsets in the next four years for us. So it's a very strong opportunity for us, because our inventions will be used in all of those phones, are used in all 3G phones, they are used in all LTE phones, therefore, we have a licensing opportunity with respect to all of those units.
In addition to handset volumes, which obviously are growing significantly for 3G and LTE, there are other markets where our technologies are also used. So you may have heard a lot recently about machine-to-machine. This is the connection of non-handset devices on its networks, whether they're smart meters, whether they're bank machines or whatever. Ericsson, and a couple of publications, has predicted a 50 billion unit attach rate out there with respect to machine-to-machine.
We're very much involved in machine-to-machine doing what InterDigital has done over the years. In fact here, we are driving the architecture that we hope to be used in future machine-to-machine deployments. Obviously, there’s other form factors beyond handsets as well. There’s tablets, there’s PCs and a number of other things. So it’s a huge licensing opportunity and it’s a licensing opportunity that’s already set for us, in terms of the use of our technology.
In terms of how we size up the opportunity for ourselves, we’ve talked about recently for the company, the opportunity to get to – and our goal to get to $800 million in sustainable annual revenue, as a goal set by the board earlier this year. It’s also a goal that is set for compensation for all the senior executives within the company. So it’s a goal with actually – with teeth to it.
It’s a pretty straightforward path. If you look at where we were at the end of 2011, we had about $300 million in revenue last year. And if you look at the market, the market is expected, in terms of handset size, to double, or at least double, over that period of time. And our penetration into the market was about 50% at the end of 2011. So that will double with licensing success as well, which actually puts us well above the $800 million target and that is just handset sales. Add to that machine-to-machine and other connected devices, and then take into account some price compression in the industry, we believe the $800 million goal is achievable.
Obviously, there’s a bit of work to do to get there, but certainly management is – their compensation is tied to the achievement of that goal and certainly it’s a pretty straightforward path, we think, to get there.
In terms of the specifics of how we get there today, on your right side, you see the folks that are under license with us. So these are the major players. Obviously, there’s a number of other players. We probably have 40 or 50 license agreements in the market. The right side represents the folks under license, so Apple, Samsung, HTC, RIM, most of Japan, a lot of Taiwan, are all under license on the right side.
On the left side, the opportunities and to some extent, some near-term opportunities for us. We have four parties with whom we are in litigation. It’s not often that we go to litigation, but at times we do. And that represents about 30% of the market and that’s a trial that’s scheduled to go to – have its hearing at the ITC in October, November of this year. So with the folks under license and with success in that trial, which we believe is a very strong case for us, we would be at 80% of the market under license.
And then there’s opportunities with the upper block. Yeah, Motorola Mobility, I guess today now would be Google, the licensing opportunity there. And – but there’s a number of other folks in that block and those are folks we continue to have discussions with in terms of getting onboard with licensing. So, again pretty solid set of licensees. With us today, a group that we think we can get onboard through some efforts in the fall and then there’s an additional part of the market to get onboard after that.
In terms of the licensing opportunity for us, the charts I showed before showed great growth in the market. And also in that, we saw some very significant growth for LTE. We’ve shown – we have 50% of the market today for 3G under license. LTE now is a new opportunity for us, new products in the market and actually we think will represent one of the strongest licensing programs we’ve had to-date. It drives first off of what is considered one of the leading patent portfolios in the industry for LTE. This portfolio is a result of probably seven or eight years of investment, probably over $200 million in investment in technologies for LTE.
On your left side, you see a chart of the patents that we’ve declared in those various years that has potentially or essential – potentially essential for LTE. And on the right side, you see how that, the set of LTE patents that we have, compares to the WCDMA patents which have been very successful to-date in licensing folks.
And as you see, well, the WCDMA portfolio is somewhat larger than the LTE portfolio today. The LTE portfolio is growing at a very rapid pace. And therefore, that sets up a very strong licensing opportunity because, one, on its own, the LTE portfolio will be strong. But the other thing is that we all know that these devices will be multimode. And therefore, in licensing discussions with parties on LTE devices, we will not only bringing our LTE portfolio to those discussions but our 3G portfolio as well.
So a very, very strong opportunity based on many years of investment, many years of successful standards participation and the growth of a very strong portfolio, which then gets deployed into a very, very strong market. If we’ve – for those folks who have been in this industry for a while, you’ve seen various take-up rates for new technology.
Probably one of the better comparisons, if you go back and look at when 3G was first launched, it actually took 3G some time to actually begin to grow in substantial volumes. Really for one main reason, there was probably some challenges in terms of getting the technology to actually work in terms of battery life and other things. But it was really market need at the time 3G came out. There wasn't a significant demand for that type of technology. And so as a result, 3G rolled out at a fairly modest pace over time and now it's picking up as the need as a resident in terms of delivering video and other things.
LTE is on a very, very different trajectory because the market need was there when it was launched. And that's – and you can see that's the yellow line there in terms of – it's that hockey stick that's actually happening. Those hockey sticks move to the right. This one actually is happening. And for us, that's a great opportunity because LTE, again, will be a very, very strong licensing program for the company. So the faster the take up there, actually the happier we are. And actually, we’ve seen already in our negotiations on LTE, we have approximately six or seven agreements in place for LTE that for LTE devices as we expected we are getting higher royalty rates than we had gotten on 3G so, a very strong LTE licensing opportunity.
In terms of towards the broader opportunities for the company, given the size of the patent portfolio that we have, and the strength of the R&D teams and also the strength of our balance sheet we’ve actually expanded to some degree our opportunities. Staying true to what we do best, which is technology development high tech, advanced type technology then also licensing but broadening it into other markets through on our own and through partnership. So if you look at the left side of the chart the core R&D programs for us are very, very successful over the last 20 years. We are now augmenting that in terms of adding some partnerships on the R&D side and also doing some targeted acquisitions on the, for technology as the world of mobile technology evolves.
As we all know, while the modem continues to be and the wireless part of the device continues to be extremely important there are other aspects of the device now that are becoming also very important. In terms of compression technology, battery technology, screen technology, authentication technology as people begin to do more and more on these devices.
So well our core R&D teams are handling the wireless well and also spreading into some adjacent areas. We are using acquisitions to build a larger portfolio with respect to these other technologies. That will drive or continue to drive this very large portfolio but also diversify that portfolio going forward in terms of some other technology spaces.
We then take that large and diversified portfolio and drive it in a number of ways. We will continue to drive the core licensing programs for the company that’s the terminal unit licensing program, that’s the one we’ve successfully run over the last 20 years, and that will just continue to be the anchor tenant with respect to the business. But there are other opportunities as well. So within wireless infrastructure as an example, we have not historically licensed the infrastructure although our inventions are used in infrastructure. So today we are looking at opportunities there to extend our licensing success from terminals into infrastructure, also extend our success into consumer electronics, which will be using wireless technology. But also and also extend our success to operators and over to OTT services, which will use the inventions that we are creating today.
We rely to do that on our own with our portfolio or we will do it in combination with partners. Today we have and we will drive those partnerships in a couple of ways one of the things, we are doing today is we’ve identified some portions of our patent portfolio that are not necessary to run that core terminal unit business. So we've offered those portfolios into the market and we're offering them either for sale, but we're also offering them as essentially assets that can be contributing to ventures, which would then license in those spaces. Those are good discussions that we're having with a number of folks today, and a way for us to expand the business so that we not only have our core terminal unit programs, but also have some adjacent programs ourselves, as well as partnerships that drive revenue overtime.
And on top of that, we need to always continue to evolve the portfolio that we have. And certainly, wireless is a space that continues to crave innovation. This is just a set of headlines, which speaks to a number of the issues that are in the market – wireless market today, in terms of the bandwidth crunch, the efficient use of Wi-Fi and a number of other things that are necessary to drive the services that people will need.
I was chatting with somebody yesterday and they described the evolution of wireless, I thought, in an interesting way. They said at first, it delivered voice, then it delivered content, and the next thing it's going to deliver is, it's all going to be about context and cloud. And to deliver that type of service, and to have those types of things available to folks, networks have to evolve substantially, because networks today were not designed for that purpose. They were designed to deliver voice.
And so part of our work over the last five years has been on a network topology, as that is – would be very efficient and very useful in delivering that type of service, and we call it the network of networks. And that's where you take a look at all the different networks that are available because the – in effect, the plumbing is out there. The plumbing is out there, Wi-Fi, cellular, WiMAX, sensor networks, Bluetooth, ZigBee, all of the plumbing is out there.
The problem is the plumbing is not used intelligently. It's not connected and it's not adapted for particular services in a dynamic way. And that's really been the thrust of our technology development over the last five years, is to create that experience for the user where it is given a set of network resources that is applied dynamically, intelligently and transparently to that user to deliver the service that that person wants at that point in time.
And as that person's needs change and they have another application they want to do, then that network adapts to what they want to do. Because at the end of the day, each of these networks has things that they do well. For example, cellular, wide area network systems like cellular, do voice very well. They do data, at some level, reasonably well. But they don't do other things very well. So – for example, as you get to high data rate intensive applications, the wide band network, the wide area network really doesn’t work that well. What you want to do is shrink it down to small cells, much more power efficient, much more spectrum efficient.
Sensor networks do certain things really well. Bluetooth networks do certain things really well. And the idea at the end of the day is to apply to a user that network, which is best suited for that person’s purpose at that point in time, and then dynamically change that network.
So, again, an area that we’ve been involved in for the last five to seven years, an area which is now over the last couple years, begun to standardize in terms of our inventions now getting embodied in various standards around the world that are driving this type of network topology, and the success within that R&D program then driving continued success within our licensing programs, both with respect to our current core terminal unit license programs, but as well as programs in those adjacent spaces as well.
So that’s InterDigital’s story. It’s been a story of consistent success in terms of predicting that next-generation of technology. A very good success in building a portfolio among the largest wireless patent portfolios in the market, and also very good success in bringing licensees on board and driving strong profits and cash flow for the company, which again we have then either reinvested in the business, but also returned a good amount to shareholders over a period of time.
So with that, I can open it up for a few questions here before we go to the breakout room.
Luke J. Labella
Jeffrey T. Kvaal – Barclays Capital, Inc.
Bill, it’s Jeff; could you help us a little bit on what you think will bring people to the table or back to the table? I know we’ve been waiting for a very long time for Nokia to get its act together and come back. How is that process going, and do you think there will be a domino effect once that case is resolved?
William J. Merritt
Sure. I’ll start with the second question first. There is a good amount of momentum that happens in licensing. So if you’re able to get large licensees on board, others tend to follow to some degree, some continue to operate independently. But there is, I would say a little bit of a herd mentality there, which is good.
In terms of getting people to the table, obviously we’ve had good success to-date with some number of the large players. But with other folks, we’ve had to resort to litigation, which we don’t often do. Obviously, the biggest driver for this year will be success in that litigation in the fall. If we’re successful there, all four of those parties, we believe will come on board as licensees. So, and I would look at that as sort of the – what can be driven by litigation. But outside of litigation, we’re doing things today with all of those companies and to drive them, to incent them to selling licenses today
So as an example, with all of our licensees, we’re always dealing with them not only on the base of just patents, but technology as well, so access to the technologies we have. One example of the technology that we had is a fully tested modem solution, which is interesting to a number of parties in the market in terms of some desire to have an internal mode solution.
The other thing we’re doing is in terms of the patent sales that we’re doing, it’s being used as, I would say both the caret and the stick, caret in terms of folks who may want patents. and therefore, it’s incensing them to come to the table early to get accessed to those patents, before we sell them to somebody else. but other folks who may not need patents, but don’t want to see the portfolio splinter and therefore needing to deal with more than one party.
So I would say that we are using all the tools at our disposal, the discussions with all of these folks take place at senior levels in those companies. so we make sure that myself or Scott or others are involved in the discussions in the right places to drive them. we appreciate the importance of getting them onboard and again to your second point, once we get one or two additional licensees like that, we think the others are easy to bring onboard.
Just a question about the network of networks here, I’m curious about how you anticipate to monetize it, it seems like it will involve a lot more juggling than your traditional licensing agreements. so if you could just walk us through how you anticipate kind of move forward with this?
William J. Merritt
Sure, I see it doing three things for the company, right. First, a number of the inventions that we would create and have created for network of networks will be resonant on handsets. so that will just perpetuate the handset-licensing program. Second, other inventions that are created will be found on the other side of the link, which is the network side, the infrastructure side. and so, as I talk about building that infrastructure-licensing program, those inventions will feed that part of the business. and then third, a lot of the intelligents that we’re bringing into the system, we believe will be very important at the end of the day for over the top services.
If you think about the way data is handled on networks currently. all bits are treated the same. it doesn’t matter if it’s video, medical, security, electrics all the same. and what the network of networks does is say now, we’re going to treat these bits differently, if it’s video, we’re going to treat it one way, if its medical information, we’re going to treat it in a different way. and we’re going to apply networks based upon that actual uses. So we actually believe it further opens up and over the top play for us with respect to folks that want to deliver services over these networks and they are going to need to have that network at that for whether it’s a movie provider that wants to provide a high-definition video and the network of network is capable of bolting up a high-definition channel for that person or someone else who wants to deliver medical information and need to make sure it’s accurate and secured. So it opens up that third opportunity to us.
Hi Bill. So I mean, it seems like it has been – excuse me, you talk a lot about this network of network and in terms of even in this last slide, you focus a lot about on infrastructure, which is I feel like a little different there where you focus was a year ago. can you just help us understand how this maybe ties into and you know when you came back on the road and talked about your strategy, you mentioned potential patent sales and infrastructure was highlighted there. Has that thinking changed, is that more important to your portfolio now? Should we not think you know?
William J. Merritt
No, it continues to be very important and how we actually go about licensing whether we do it directly ourselves for infrastructure or do it through partnerships. It’s not going to change our technology a lot. We’re still going to feed those programs, and there is a benefit to doing it on our own, but there is a benefit to doing with partners particularly partners that can bring their own technology and patents to the equation. So it’s a very important part of our program and the idea with the network of networks is again to drive invention, which not only maintains the core programs, it drives the near-term opportunity with respect to infrastructure, but it opens up that over the top. So it’s pretty consistent with what we were talking about, when we entered the process and I think at that point, we have to.
Okay, thank you very much and then rest will be in the breakout room.