Adeia Inc. Q3 FY2022 Earnings Call

Good day, everyone. Thank you for standing by, and welcome to Adeia's Third Quarter 2022 Earnings Conference Call. As a reminder, this conference is being recorded. I would now like to turn the call over to Jill Koval of Adeia. Jill, please go ahead.

Good afternoon, and thank you for joining us as Adeia reports its third quarter 2022 financial results. With me on the call today are Paul Davis, Chief Executive Officer; and Keith Jones, Chief Financial Officer. In addition to today's earnings release, there is an earnings presentation, which you can access along with the webcast on Adeia's Investor Relations website. Before we begin, I would like to provide a few reminders. First, today's discussion contains forward-looking statements that are predictions, projections or other statements about future events, which are based on management's current expectations and beliefs, and therefore, subject to risks, uncertainties and changes in circumstances. For more information on the risks and uncertainties that could cause our actual results to differ materially from what we discuss today, please refer to our Risk Factors section in our SEC filings, including our annual report on Form 10-K and our quarterly report on Form 10-Q. Please note that the company does not intend to update or alter these forward-looking statements to reflect events or circumstances arising after the call. Second, we refer to certain non-GAAP financial measures, which exclude one-time or ongoing non-cash acquired intangibles amortization charges, costs related to actual or planned business combinations, including transaction fees, integration costs, severance, facility closures and retention bonuses. Separation costs, stock-based compensation, loss on debt extinguishment, expensed debt refinancing costs, impairment of intangible assets, and related tax effects. We have provided reconciliations of these non-GAAP measures to the most directly comparable GAAP measures in the earnings release and on the Investor Relations section of our website. The recording of this conference call will be available on the IR website at www.adeia.com. I will now turn the call over to Adeia's CEO, Paul Davis.

Thank you, Jill. I want to welcome everyone to Adeia's first earnings call as a leading independent publicly traded IP licensing company. On behalf of our management team and our Board, I want to extend a big thank you to all our employees and partners who have worked so diligently over the past few years to make our separation from the Xperi product business a success. I also want to wish the Xperi management team and its employees all the best as they begin their own journey as a stand-alone public company. I am very proud of what the Adeia team has accomplished. We have built an incredible licensing platform and world-class innovation engines in both our media and semiconductor businesses. Our financial profile reflects strong recurring cash flows driven by long-term license agreements with companies and a diverse cross-section of the technology and media landscape. We are also excited about the growth opportunities that are in front of us, which I will cover in more detail shortly. As a reminder, the product business spinoff closed on October 1. So our third quarter financial results are inclusive of the product business prior to separation. However, Keith and I will focus today's comments on Adeia. We would refer listeners to yesterday's replay of Xperi Inc.'s third quarter earnings call for more commentary on the product business. As we prepared for separation from the Xperi product business, we focused on positioning Adeia for continued long-term success as a stand-alone business. These efforts included assembling a new management team and Board of Directors, presenting our long-term vision for Adeia on a stand-alone basis for the first time during our Investor Day in September, and implementing new systems, processes, and corporate governance policies and practices. While work continues on these efforts, I am proud of everything the team has accomplished, and we believe we are well positioned to drive the business forward. While preparing for separation, we also successfully closed a number of key deals. Over the last 4 quarters, we executed nearly 30 license agreements, which include both new deals and renewals, once again validating the strength and continued relevance of Adeia's IP portfolios. During the third quarter, deals signed include a new multi-year deal with Philo, a leading entertainment-focused Pay TV streaming service, and a long-term renewal with Foxtel, Australia's leading Pay TV provider. The new license agreement with Philo demonstrates our continued applicability and growth in virtual MVPD and streaming services. Similarly, the Foxtel renewal demonstrates how Pay TV providers around the world use Adeia's intellectual property to reach consumers in more innovative ways. As we have mentioned before, we remain committed to getting the most beneficial deals done for Adeia, which can sometimes lead to a pushout in timing. This occurred in the third quarter with a few deals pushing out to the fourth quarter. As a result, revenue for the third quarter came in at approximately $90 million. Importantly, we remain confident in our guidance for the year, as the cadence and nature of the dialogue with multiple customers remains positive. Accordingly, we have maintained the midpoint of our full year revenue expectations and have narrowed the range to $430 million to $445 million. In addition to the normal review of the quarter, I want to spend some time today covering the market opportunity for the media business. As we have noted previously, growing our annual baseline revenue is a core objective for us. Our media business represents more than 90% of our baseline revenue, and several aspects of the media business represent important areas of growth for us. As we look at the overall media opportunity, we believe it is helpful to provide a breakdown of our current addressable markets. First, U.S. Pay TV, which in 2021 was a market in excess of $100 billion, is an area in which we have historically been and continue to be very successful. The U.S. Pay TV market represents roughly 60% of our overall baseline revenue. Pay TV will continue to be a significant contributor well into the future for us, even as the industry remains in secular decline. We anticipate offsetting those declines with growth in other markets, including adjacent markets that are still emerging for us. Moving to international Pay TV, which in 2021 was roughly $60 billion in our target international markets, outside of Canada, we view this opportunity as a modest area of growth due to the fragmentation of the international Pay TV market. Thus, we will focus our efforts on the more significant remaining unlicensed Pay TV providers, but we don't believe we will reach the same level of penetration as the U.S. Pay TV market, given this fragmentation. OTT, which in 2021 was already a $97 billion market, is an area we believe will continue to grow. While we have been successful in starting to penetrate this market with some key wins and dialogue with other potential licensees progressing well, we are still in the early stages of translating that into our financial results. As of today, much of the market remains a significant opportunity for us. Moving forward, we also anticipate that we will be able to approach the OTT market more aggressively following our recent separation from the product business. Since we are no longer restricted by the channel complexities we've discussed in the past. When we look at this market, it is important to note that we anticipate the average per subscriber rate will be less than what we have established in the U.S. Pay TV market. However, given the average number of OTT services each household subscribes to, this is a significant opportunity for us. Next is consumer electronics. First, for the purposes of this presentation, we have excluded mobile from the CE market. The total CE market in 2021 was $139 billion and continues to be an attractive licensing opportunity for us, especially for the global CE providers that ship significant volume into the United States. Consumer electronics provides strong visibility for our annual baseline revenue and represents an area of growth with further market penetration. Lastly, social media is an attractive growth market for us, which in 2021 was a $136 billion market. We have had early success in this market, and we believe the opportunity will continue to expand with the explosion of video on social media platforms. In addition to these already large and attractive markets, we are actively working to expand into ad tech, automotive, gaming, music streaming, and sports gambling. As these markets further develop, we will provide additional details on these opportunities. Supporting these growth opportunities is our world-class team of engineers, investors, and IP licensing team executives and professionals. Our headcount currently stands at approximately 110 employees, and we expect to grow that in the near term to around 125. I would like to highlight our media R&D team. This impressive team averages over 20 years of experience at top-tier companies, including Dolby, Amazon, Qualcomm, Charter, Samsung, and Snap, to name a few. Approximately 60% of the team have PhDs and Russell Masters Degrees, and they are all prolific inventors. Our strong internal team also collaborates with top R&D labs in academia around the world to enhance our patent innovation engine. Collectively, this team is now producing more innovation disclosures than we had prior to separation with the combined product business. It is these invention disclosures that will lead to organic growth in our patent portfolios. Another benefit of the separation that we expected and are now beginning to realize is that without the need to navigate the separate roadmaps and strategic priorities of the Xperi product business, there is greater focus and alignment in our R&D teams on the truly innovative and disruptive technology that will drive the value of our portfolio over the long term. Turning to our semiconductor business, we continue to focus on executing in our five core semiconductor market segments: image sensors, RF front end, DRAM, NAND, and logic. We are actively engaging in partnership and licensing discussions with the remaining major unlicensed companies in each of these sectors with an emphasis on promoting the adoption of our hybrid bonding and advanced processing node technologies. We also continue our efforts to promote our proprietary hybrid bonding technology and advancing the industry beyond Moore's Law. Our marketing, thought leadership, and promotion of hybrid bonding at industry events have increased significantly over the past year as the world began to emerge from the COVID-19 pandemic. At these events, and based on customer feedback, we are widely recognized in the industry as a leader in hybrid bonding, and we've recently seen increased interest from our customers and partners. We also significantly enhanced our internal semiconductor team with key additions, including a new senior sales executive and a new Head of Strategy. These hires add decades of experience and domain expertise and will help drive success for the next chapter of our semiconductor business. Before I turn it over to Keith, I want to provide a high-level look at 2023. As a reminder, we will provide 2023 guidance on our fourth quarter earnings call in February of next year. First, we anticipate a modest decline in revenue year-over-year. However, after accounting for the impact of our revenue recognized from Micron in the first quarter of 2022, we anticipate revenue growth in 2023. Second, in our first full year as a stand-alone IP company, we will demonstrate the benefits of leveraging our highly-profitable business model with investments in our patent portfolio growth, returning capital to our shareholders primarily through our quarterly dividend, and paying down our debt through accelerated payments. Third, we will continue to progress our efforts to expand into adjacent markets that will help accelerate our revenue growth. We anticipate initial progress in music streaming, as our IP portfolio already has significant applicability, and we have begun the customer engagement process. The entire management team is excited about sharing our progress in 2023 and beyond. With that, I'll turn the call over to Keith to discuss our financials.

Thank you, Paul. As Paul mentioned earlier, we successfully completed the separation of the IP and product businesses on October 1, thus achieving a tremendous milestone in our history. However, as of September 30th, we were still operating as a combined company. The financial statements presented in our earnings release today reflect the results for both the IP and product businesses. Additionally, on November 8th, our counterparts at Xperi Inc. provided a comprehensive review of the operating results for the product business for the quarter ending September 30. We refer you to the earnings release and earnings call replay for more color on the financial results and the future outlook of the product business. While we have provided GAAP and non-GAAP results for the combined business, our discussion today will focus on the results of Adeia on a stand-alone basis. To aid our conversation today and to provide a more historical perspective of Adeia as a stand-alone organization, we have supplementally provided historical income statements of the business within our earnings deck. The earnings deck also provides reconciliations of the GAAP to non-GAAP numbers. Now let me walk you through our operating results for the third quarter. Revenue was $89.3 million, representing a 17% decrease from the prior quarter. The decline was principally driven by the recognition of a significant catch-up license fee in the prior quarter. As Paul mentioned earlier, there were a couple of deals in our pipeline that we anticipated to close in the third quarter that have subsequently moved into our fourth quarter forecast. We remain confident we will get these deals closed this year, which is reflected in the guidance I will cover later in the call. During the third quarter, we signed several agreements covering both our media and semiconductor portfolios, including agreements with Philo and Foxtel. These multi-year agreements contribute to the stability of our $375 million baseline revenue amount. Now let's discuss our operating expenses, which I will be referring to non-GAAP numbers only. Operating expenses were $30.4 million, a 7% increase from the prior quarter. Research and development expenses increased $466,000 or 4% primarily due to spending associated with our efforts to further build out our innovation and development engine. Selling, general and administrative expenses increased $1.3 million or 8% from the prior period primarily due to higher personnel costs and administrative support functions, as we continue to put in place the infrastructure to operate as a stand-alone company. In the third quarter, interest expense related to our term loan was $12.3 million, up from $9.5 million in the prior quarter, primarily due to the impact of higher interest rates on the loan. Other income was $900,000, primarily from interest earned on our cash and investment portfolio. Our non-GAAP income tax rate was 23% for the period. Our income tax expense consists primarily of federal and state domestic taxes, as well as Korean withholding taxes. As we discussed during our Investor Day, our financial model provides significant operating leverage. Specifically, our EBITDA for the third quarter was $59.2 million, reflecting an EBITDA margin of 66%. Depreciation expense for the quarter was approximately $400,000. Now let me provide a few balance sheet details for Adeia post-separation. Following the separation, we had $89.6 million in cash, cash equivalents, and marketable securities. Additionally, we retained the outstanding term loan, which has a balance of $759.4 million. This balance reflects paying down $10.1 million during the third quarter. Also during the quarter, we paid a cash dividend of $0.05 per share of common stock. Further, our Board approved the payment of a $0.05 per share dividend on December 21st to stockholders of record as of November 30th. Now turning to our guidance. Our licensing agreements tend to be quite large and complex by their nature. As we look to ensure that we achieve the commensurate economic return relative to the value of our patented inventions, the timing and execution of our license agreements can vary, creating fluctuations in revenue from quarter to quarter. As such, we generally believe evaluating our performance on an annual basis is the most appropriate measure. Thus, we will be focused on providing guidance on a full-year perspective only. Accordingly, we will be providing stand-alone guidance for the full year 2022. However, as Q4 will be the first time we are reporting stand-alone results, on this occasion, we'd like to give more insight and will also be providing guidance for the fourth quarter of 2022. For the fourth quarter of 2022, we expect revenue to be in the range of $95 million to $110 million. We expect operating expenses to be in the range of $35 million to $39 million. We expect interest expense to be in a range of $15 million to $17 million. And we expect other income to be approximately $0.5 million. For the full year 2022, we are narrowing our prior revenue guidance range to $430 million to $445 million. We expect operating expenses to be in a range of $120 million to $124 million. We expect interest expense to be in the range of $45 million to $47 million, and we expect other income to be approximately $2 million. We expect the non-GAAP tax rate to remain consistent at roughly 23% for both the fourth quarter and the full year. Our tax rate on a stand-alone basis is higher than previously reported on a combined basis, largely due to a greater mix of domestic-based income and utilization of certain tax credits. From a CapEx perspective, our overall needs are relatively light given our operating structure and condensed operational footprint. As such, CapEx for the fourth quarter is expected to be approximately $200,000. In closing, I'm very pleased with our results. Our media and semiconductor portfolios provide exceptional opportunities in both markets that will drive our long-term growth. With the operating leverage our financial model provides, we are well-positioned to have a balanced capital allocation strategy that will help grow our business. This consists of making both organic and inorganic investments in our company to help further expand our patent portfolio and drive adoption. Additionally, we look to make accelerated payments against our term loan in order to strengthen our balance sheet. As part of our long history of returning capital to shareholders, we remain committed to continuing our dividend program. Also, I'd like to acknowledge and thank all the employees of both Adeia Inc. and Xperi Inc. for all their hard work and dedication throughout this process. We have successfully fulfilled the long-term vision that was set forth several years ago. And with that, I'd like to turn the call over to the operator for questions.

Our first question comes from Nick Zangler of Stephens.

Yes. So I think you're talking about a modest revenue decline in 2023, obviously when you're comparing to the Micron deal. If I recall at the Analyst Day, you talked about a 6% CAGR. I think that was starting from F '21 and going through, but I believe it was F '25. So would that imply that there's an acceleration in revenue as you look past 2023 into the '24, 2025 period, if I'm getting my math right there? And if so, just curious what the driver of that acceleration might be?

Yes. Hey, Nick. This is Paul. I think that's a great question. Thanks for asking it. The CAGR was built from 2021 revenue as the baseline and went out about 5 years, so into 2026. And certainly, we see revenue growth expanding past 2023 and accelerating a bit. But from 2021 into that 2026 period, and certainly it won't be linear as our business often consists of high-dollar deals, but low volumes. And so you can see step-ups during that period of time.

Got you. Is there a way to think about the number and size of IP arrangements and agreements that come up for renewal each year? I want to gauge the risk of a non-renewal in the year, as well as the likelihood that a particular arrangement is renewed and at better rates.

Nick, that's a great question. I wish there was an easy answer. The truth is that our deals do vary in size. One thing to kind of point out is that we're a high-dollar, small-volume shop. So with that being said, all of the deals that we pursue have some impact. But really what I would point to is that if you take a look at our history, we've been incredibly successful in this. It's greater than 90%. So I think one parallel you can follow is when we talk about our baseline revenue at $375 million. It's a combination of renewals and what we currently have signed, as well as those that we have good visibility on. So from that risk profile, we adjust, but on both ends, we see that growing and we have great confidence in renewing in the future.

Got it. That’s very helpful. I have one last question. Since you're now a stand-alone company and we're adjusting to your guidance, it's clear that 85% of your revenue is recurring. However, looking at your guidance for the fourth quarter, there's a $15 million range between the peak and trough estimates. This seems to represent the 15% of your revenue quite closely. Given that a large portion of your revenue is recurring, could you explain why the difference between the peak and trough revenue estimates is so substantial? What factors do you consider when establishing the revenue range for the quarter?

Hey, that's a great question. And I like the way you tied that question back into your previous question because they're related. What that really means is that, once again, we have large deals. And what I talked about earlier, you could have some influence from month-to-month. And quite frankly, even though we manage the business and we have targets, when we think about how we score ourselves on an annual basis, the timing of those deals could shift. There could currently be a situation where we're negotiating a contract in general commercial terms that we need to close. And that might slip a month or something like that and could have a $10 million impact on revenue if they fall out of license, if you will. So that's why you're seeing that gap in the range. And that's why it's very difficult just to measure us on a quarterly basis; evaluating us on an annual basis is much more reflective because the pipeline remains strong with consistent strong numbers. There's no change in our outlook.

I understand. I'm not sure if I mentioned this last time, but this is the final inquiry. I'm not sure if you're open to discussing it again, now that you've established a new company and all. However, regarding the litigation expenses or ongoing costs for your team, could you provide an overview of everything currently pending? Specifically, I'm interested in the various potential companies you are targeting and any efforts to reach agreements. Is there a way to outline the list of where you are pursuing potential agreements?

So Nick, I guess maybe just a clarifying question first. Are you referring to outstanding litigation or in a broader sense?

I'm more referring to, I guess, outstanding litigation. I'm just trying to determine where there are opportunities where you have feet on the ground, trying to come to a resolution and therefore an agreement could be reached at any near-term time.

Sure. If you look in our 10-Q, it lists all of our outstanding litigation. So it's really Canada and then there's an older litigation matter with NVIDIA that remains outstanding as well. We'll provide those updates on a quarterly basis in our 10-Q, and that's where you should look for them. However, I want to remind you that the vast majority of our deals are completed without litigation. It's not a significant part of our strategy. We use litigation as a last resort, but our goal is to finalize deals without it, and we're very successful at that. So I wouldn't categorize it as a driver for our success but as an occasional necessity when we need a third party to help validate the value of our portfolio.

The next question comes from Hamed Khorsand of Financial.

Could you just talk about the essence of why the pushout occurred and why you thought it would happen in Q3 and it did not?

Sure. We did get deals done in Q3. But the business, as Keith mentioned earlier, is challenging to predict on a quarterly basis because we are focusing on sizable deals, and we want to ensure we are achieving the best long-term value. The negotiations and discussions with other parties are proceeding well, but we just weren't ready to finalize them at that time. We decided that it was better to pursue longer-term value. We see this situation from time to time, but on an annual basis, and this is why Keith mentioned earlier, we'll guide on an annual basis going forward; that's how we view the value of the business rather than on a quarterly basis, as fluctuations can occur.

Is this with the existing licensee?

There are multiple discussions. There wasn't just one deal.

Okay. And then just given the fluid nature of the business with these negotiations, how do you organize them into each bucket? And what's a certain event and what's not, so this doesn't happen again, especially when you look out into '23?

Sure. Well, I would say we look at it on an annual basis, and quarterly fluctuations can happen. But what we evaluate is the stage of the deal negotiation. Are we discussing financial terms, exchanging draft agreements, or are we at an earlier stage having technical discussions on the value of the portfolio? We monitor that closely, and we're adept at gauging our projections for the year. Again, those quarterly fluctuations can happen. But as we look to close out the year, we feel very confident in our annual guidance, and that hasn't changed.

Okay. My last question is given the different end markets that you were talking about in the presentation slides, what does the funnel look like for '23? Is there a particular end market that you think you'll be capturing more of when you look out the next 12 months?

Certainly, we continue to have success in U.S. Pay-TV and also in consumer electronics. We've had considerable success in both areas. Other markets are large and attractive as well. OTT and social media have seen deals recently. So there's activity across all segments, including international Pay-TV with our announcement of Foxtel. We’ve signed 30 deals in the last 12 months, as we mentioned earlier. So there are opportunities everywhere. Not to mention, we also have developments in semi that we’re actively pursuing. We feel good about progress across all market segments highlighted today and the semi part of the business as well.

The next question comes from Matthew Galinko of Maxim Group.

I guess maybe going to the unlicensed opportunity in semi, particularly around the graphical markets or hybrid bonding, how do you think about the pace of capturing that opportunity?

Yes. We're excited about the opportunities we see. There’s obviously a lot of interest, as I mentioned on the call. These deals take time. Our average sales cycle is 18 to 24 months from the start to finish. We are at various stages with a number of those discussions. In the semi market, within memory, we've achieved significant success and continue to find unlicensed opportunities, especially in NAND. We are also witnessing an increased pull in the logic market as well. Obviously, I can't get into the details of specific customers, but we are enthusiastic about the pipeline of opportunities in semi as this business expands into its next phase.

Thanks for that information. You mentioned plans to gradually increase headcount. What can we expect in terms of the timeline for that increase between the fourth quarter and throughout 2023? Also, do the current conditions in the tech labor market affect your ability to reach the higher targets you set?

Yes, we certainly hope so. I think we're in a unique situation where we're trying to expand our team, especially in R&D. As previously discussed, we have a targeted 10% growth. We've already expanded that team significantly, as I mentioned on the call, but we do have some hires specifically in that area, and we think there’s tremendous opportunity given the current market dynamics. Regarding the timing, it will likely be spread out over the year. I don’t foresee a large influx of hiring in Q1, but we are actively looking to expand the team overall. So it might be slightly front-loaded, but I expect to see growth throughout the year.

Ladies and gentlemen, we have reached the end of our question-and-answer session. I will now turn the call over to Mr. Paul Davis for closing remarks.

Thank you, operator, and thank you, everyone, for joining today's call. Keith and I look forward to seeing many of you at the Stephens Annual Investment Conference next week in Nashville. As we close out 2022, we are excited about our path forward on a stand-alone basis and demonstrating continued growth in our highly profitable business model. Thank you again for joining us on the call. Goodbye.

Thank you. Ladies and gentlemen, this concludes today's teleconference. Thank you for your participation, and you may now disconnect your lines.