InterDigital, Inc.
Q4 2014 Earnings Call Transcript

Published: 19 Feb 2015

[Operator:]

Good day and welcome to the InterDigital Fourth Quarter 2014 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.

[Patrick Van de Wille:]

Thank you very much, Lexie. Good morning, everyone, and welcome to InterDigital's fourth quarter and full year 2014 earnings conference call. With me this morning are Bill Merritt, our President and CEO; and Rich Brezski, our CFO. We'll offer some highlights about the quarter and year and our outlook, and then we'll 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 and detailed in our Annual Report on Form 10-K for the year ended December 31, 2014 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 free cash flow and pro forma operating expenses, which are non-GAAP financial measures. Reconciliations of free cash flow to net cash used in operating activities and pro forma operating expenses to operating expenses, the most directly comparable GAAP financial measures, are included in our fourth quarter financial metrics tracker, which can be accessed on our homepage, www.interdigital.com, by clicking the link on the left side of the homepage that says, "view our financial metrics tracker." With that, let me turn the call over to Bill.

[William J. Merritt:]

Thank you, Patrick, and good morning, everyone. As you saw in this morning's release, we delivered another strong quarter, topping off an excellent year. We also guided towards a very strong Q1 2015 with over $100 million in revenue, which will be the strongest quarter in the company's history from a recurring revenue perspective. All in, our business continues to run extremely well with a platform for even greater growth. Let me start with the licensing business, which obviously drove our success in 2014 and provides us with a strong tailwind going into 2015. 2014 was a remarkable year in terms of demonstrating the strength and resilience of that business. We started the year with some challenges. We had an unfortunate loss at the ITC in late 2013, and our overall licensing market penetration rate at that time was sitting at a low 25%. Proving our point that the business is strong, that we're resilient, and that no litigation is ever a referendum on the company's deep and valuable patent portfolio, we secured an agreement with Huawei to arbitrate the terms of a fran license with us. We then followed that with the signing of the largest patent license agreement ever by the company, our June 2014 deal with Samsung. With the roll-off of the fixed-fee Apple license in June, we also began to see more robust contributions from those companies in Apple's supply-chain with whom we have per unit licenses. Those relationships drove revenue substantially higher in 2014 and are expected to contribute strongly to 2015 revenue. Later in 2014, we secured a patent infringement jury verdict and resulting District Court liability judgment against DTE. We also moved forward in our ITC case 613 against Microsoft. In January 2015, we had the evidentiary hearing in that case where the ITC's Office of Unfair Import Investigations staff supported us on all issues and stated that no public interest consideration should block the issuance of an exclusion order against Microsoft 3G WCDMA enabled products. We believe the ALJ should do the same. While we saw a setback this week in the Court of Appeals' decision affirming the ITC's determination of no violation in the ITC 800 case, we believe that decision should not be controlling either as to the 613 investigation involving Microsoft or our active ongoing District Court actions involving ZTE and Microsoft. We continue to feel confident in our litigation efforts and we believe we should be able to drive meaningful license discussions towards fair compensations. Overall, our licensing efforts in 2014 drove over $400 million in revenue, nearly double what the market consensus was for us at the beginning of the year. It also built a platform for the generation of over $300 million in recurring revenue for 2015, a 50% increase in that important metric from the beginning of 2014. Based on fourth quarter 2014 results, our annualized recurring revenue run rate was almost $350 million and we have further to go. The Huawei arbitration has proceeded well, and we're hopeful for a positive result. With success there, we should have a nice incremental add to our recurring revenue and a solid benchmark for licensing other companies in China and elsewhere. Also, as I noted earlier, we had a strong showing at the ITC in our case against Microsoft, and are doing whatever we can to work with Microsoft in a positive way to resolve the licensing matters between us. We also continue to have the discussions with other prospective licensees. Moreover, we are doing all of this in a continuously active industry and regulatory environment. For example, the IEEE recently adopted a new set of adverse rules relating to how patents related to their standards should be treated. We, Qualcomm, Ericsson, Nokia and others have all objected to the rules, which appear to have been driven by a small group of companies within the IEEE. Qualcomm has taken the further step to indicate that it may not submit assurances to the IEEE regarding the availability of licenses for Qualcomm-related intellectual property pursuant to such rules. While we focus much of our resources and standards other than the IEEE, we do have a meaningful footprint there. As a result, much like Qualcomm, we will also be taking steps to protect our IP from the objectionable rules just passed, while still maintaining our participation. Eventually, we believe the IEEE should learn the error of its decision to follow lead of a few companies who have little regard for innovation and a single-minded regard for short-term profit. Evidence that the IEEE is operating outside licensing norms was evidenced by what we believe to be, on balance, a positive development from China's NDRC in terms of the reports of its resolution of its investigation of Qualcomm. In that matter, the NDRC appears to have embraced one of the royalty setting concepts that we and others in the industry have used for many years, mainly that patent royalties are appropriately set at a percentage royalty rate applied to the handset. This resolution by the NDRC is directly at odds with the IEEE policy change, which indicates that royalties should be determined in relation to the price of the chips inside wireless devices. We hope this aspect of the NDRC resolution sets an important precedent for that market. There are other patent initiatives occurring as well within Congress, at the FTC, the European Commission, and other jurisdictions. The bottom line of these actions as well as other periodic actions that we may see, which may pose challenges to our licensing practices, is that in the long run, we tend to work our way through these issues in a reasonable way. We do so for a simple reason

[Richard J. Brezski:]

Thanks, Bill. As Bill noted, we had a great year, and we are very happy to see our efforts reflected in the strong financial performance for the company in 2014 as well as the momentum we see going into 2015. Over the last few quarters, you've heard me referring to recurring revenues on a more frequent basis. Recently, I have also begun to highlight pro forma operating expenses. I'd like to focus for a moment on these two metrics and the relationship between them. Recurring revenue is comprised of current patent licensing royalties and current technology solutions revenue, in other words, revenue that relates to the current quarter. For fixed-fee royalties, recurring revenue means the accounting allocation of fixed-fee payments to that particular quarter. For per unit royalties, it means the royalties reported to us in that quarter, which drive our guidance and are typically related to product sales by our licensees from the immediately preceding quarter. Recurring revenue does not include past sales where what we referred to as past sales, which is revenue related to prior periods. Two of the most prominent examples of past sales are when we received compensation for past infringement from a new licensee during a quarter or when we favorably resolve a licensee audit or benefit from some other type of reward during the quarter. The bottom line is that recurring revenue enables us to gauge the size and success of our licensing program as a whole and provides the platform from which we can build future revenue growth by adding new licensing agreements. We started 2014 with $56 million of recurring revenue in Q1. After we signed new agreements in the second quarter, including Samsung, our recurring revenue increased to $75 million. At that time, I began to discuss $300 million as a reasonable annualized recurring run rate to think about on a go-forward basis. Today, we reported that our recurring revenue grew to $85 million in the fourth quarter, a $340 million yearly run rate, driving $288 million of recurring revenue in 2014. More importantly, we expect that growth to continue in Q1 with expected recurring revenue of $107 million to $110 million. The expected sequential quarterly increase is based on the same set of licensees we had in fourth quarter 2014 and results in part from second half 2014 product introductions. While we acknowledge that product introductions can have a cyclical effect on results, we take both the fourth quarter results and first quarter expectations as a strong signal that our recurring base of revenue has increased. We look forward to providing more details when we report our final results for first quarter of 2015. Pro forma operating expense is a non-GAAP financial metric that we track, and you can see the details and reconciliation for that metric on our financial metrics tracker, which you can access on our website. This metric enables us to analyze our expenditures on a more meaningful quarter-to-quarter basis. Pro forma operating expenses were relatively flat in the fourth quarter as compared to the third. For the year, our pro forma operating expenses were $137 million, up about 7% from the prior year. Of this increase, about $4.5 million related to commercial initiatives and our Signal Trust, which proved to be strong investments. Bill mentioned the success wot.io is seeing and we completed two license agreements earlier in 2014 encompassing rights under the patents transferred to the trust. Of greatest interest to me is the change in the relationship between our pro forma operating expenses and recurring revenue over the last year. In 2013, our pro forma operating expenses represented 65% of recurring revenue. In 2014, we reduced that ratio to 48% of recurring revenue. Our business has outstanding leverage, and with very little variable cost, we believe we can continue to drive down this ratio through future revenue growth while maintaining our strong commitment to research and development. As a final point, I'd like to acknowledge that activity under our repurchase authorization has slowed after repurchasing over $150 million or half the June authorization by the end of 2014. As I've said before, we generally take a longer-term view towards share repurchases, and we don't get too hung up on activity in any one period. As our first quarter guidance indicates, we believe there is great potential to grow the business, and we remain confident in our ability to execute on that goal. With that, let me turn the call over to Patrick.

[Patrick Van de Wille:]

Thank you, Rich. Now, we'll take some questions from the folks on the call. So, Lexie, if you could open the line for questions please.

[Operator:]

And we'll take our first question from Darrin Peller with Barclays.

[James Robert Berkley:]

Hi. Thanks, guys, for taking my question. This is James Berkley stepping in for Darrin here. I guess, I'll just start real quick on ZTE. I believe there were five patents involved in the appeal, four of which would aid cell phones using less power than they otherwise would, and one that allows a device to use various networks to transfer data. That data related patent, as I understand it, was declared invalid. Could you comment on that, and why that patent was called out specifically as well as how important it was relative to your ZTE opportunity, and how we should think about your approach to ZTE going forward?

[William J. Merritt:]

So, you're right, there was a number of patents involved in the appeal. But that said, they still represent a very, very small number of the patents that the company holds, and they were, for example, different than the patents that are being used in the Delaware litigation, the active litigation against ZTE. So, while the decision itself was disappointing and, we think, pretty flawed, as we mentioned yesterday in the release, we don't think that the decision is controlling with respect to the other active litigations we have going on against ZTE or controlling as to the Microsoft 613 investigation.

[James Robert Berkley:]

Okay, great, thanks. Turning to Pegatron real quick, is it fair to assume that the current agreement stands as is until the challenge by Pegatron reaches a resolution, or would Pegatron potentially try and withhold payment until that time? We can assume that that revenue stream is safe, correct?

[William J. Merritt:]

Yeah. So, James, what I can tell you is, typically one of the conditions for us recognizing revenue is looking at the considerations around collection. So if we generally aren't collecting the money, we'll typically defer. That's a bit of a generalization, I think that's probably valid here.

[James Robert Berkley:]

Okay, thanks. And then just lastly, when thinking about the $340 million number recurring revenue you spoke to, previously, you were at $300 million and talking about a $600 million opportunity. Given some of the licensing arrangements in there, how should we think about the $600 million number now? And then if you could just speak to, obviously, your guidance was very strong for the first quarter. How should we think about that recurring revenue number for 2015 as well?

[William J. Merritt:]

So, in terms of the target, the goal for the company in terms of its revenue off the licensing business, we talked about $500 million to $600 million. I think we're still comfortable with that range, and obviously the performance we're seeing now off the licensing business makes us even more comfortable with respect to achieving those numbers. So, we got – we still have some work to do and sign up some new folks, but as we mentioned in the script, a really strong year last year, very good positioning this year, so we're definitely on track, as far as management is concerned towards that opportunity. On terms, I think Rich mentioned in the script in terms of Q1, obviously there were some product introductions that drove that Q1 guidance. So – and I think there's a lot of information in the market and people can probably kind of figure out pretty well what those introductions were and how they could relate to our sales. So, Q1 obviously is very strong, but I wouldn't necessarily take Q1 as the baseline for the remainder of the year.

[James Robert Berkley:]

Okay, that's fair. I guess just lastly, would you potentially be able to breakout that $40 million incremental increase, and like how, just like you could provide any color on what drove that from the $300 million to $340 million?

[Richard J. Brezski:]

Yeah. I think I provided about as much color as I can. Well, the $300 million to $340 million, in that case, you're talking about Q2 to Q4. So what I can do there is refer you to the financial metrics where we track our revenue concentrations greater than 10%. And you can see, if you look at the contributions that participants made in that category, you can get a sense for it. As for comparing that to our Q1 guidance, we typically don't provide any more detail than we already have at this stage.

[James Robert Berkley:]

All right, guys. Thanks a lot. I'll turn it over.

[William J. Merritt:]

Thank you.

[Richard J. Brezski:]

Thanks.

[Patrick Van de Wille:]

Thanks very much, sir.

[Operator:]

And it appears we have no further questions at this time. I'd like to turn the conference back over to our speakers for any additional or closing remarks.

[Patrick Van de Wille:]

Well, thank you very much, Lexie, and thanks everybody for joining the call today. Not too many questions, but I'll take it as satisfaction that we've had a good quarter and a good year. Thanks for joining and we'll talk to you soon.

[Operator:]

And this concludes today's conference. We thank you for your participation.