Earnings Call Transcript - IDCC Q4 2020

Tiziana Figliolia, Vice President of Finance and Investor Relations

Good morning and welcome to InterDigital's Earnings Conference Call for Fourth Quarter and Full Year 2020. I am Tiziana Figliolia, Vice President of Finance and Investor Relations. And with me in today's meeting 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 and our annual report on Form 10-K for the year ended December 31, 2019, 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. Reconciliations of these non-GAAP financial measures to the most directly comparable GAAP financial measures are included in our third quarter 2020 financial metrics tracker, which can be accessed on our home page, www.interdigital.com, by going to the investor section of the website and clicking the link that says, Financial Metrics Tracker for Q4, 2020. Finally, with the pandemic still a concern, the participants on this call are all in separate locations. If there is a technical issue during the call, I'll just ask everyone to be patient while we exercise a callback option. With that taken care of, I will turn the call over to Bill.

Bill Merritt, President and CEO

Thank you, Tiziana and good morning to everyone. And thank you for joining us on the call this morning. Similar to past calls in these difficult times, I hope all of you are standing well. As you saw on the press release issued this morning, the company delivered both an excellent quarter and frankly a fantastic year while managing our way through the COVID crisis. I'm also pleased to announce that we have signed in the first quarter of 2021 a license agreement with Humax, a South Korean manufacturer of set-top boxes, DVRs and other consumer electronics. So our consumer electronics business continues to progress nicely. This is our Q4 earnings call. So let me recap the year 2020 and then talk about our objectives for 2021. And you'll get to read about more specifically about the goals we set for ourselves in 2020 in our proxy, but in a nutshell, they were to drive revenue, get other deals down the playing field and get them closer to completion, continue to innovate, and continue the positive evolution of the company in terms of talent and processes. And then COVID hit, in a reflection of the strength of the organization, the company was nonetheless able to deliver on and in some instances exceed our goals while also managing our way through the pandemic. On revenue generation, we delivered our best revenue year since 2017 signing 60 deals including the renewal of Huawei. We also renewed a number of deals down the field positioning us in 2021 with negotiations that are significantly mature and are positioned to close. We also commenced litigation against other companies where negotiations had not matured and where we believe litigation was appropriate. In addition, we continue to be a thought leader in the licensing industry, as demonstrated by the company's industry-leading efforts to provide transparency into our rate structure and patents. I mean, in some cases, we drove regulatory and legal change that dramatically improved the licensing environment. On innovation, we had another standout year despite our engineers and scientists working remotely and the standards organizations, we contribute our innovation to themselves working remotely. Oddly enough, because our research team is already collaborating across our R&D sites, the transition to a remote work environment was pretty seamless as the teams were already well equipped and versed in engaging via BlueJeans, Zoom and other platforms. And the result was great innovation, great contributions to standards and more of the advanced thinking the company is known for. On the people and process side, we've got some fantastic talent into the organization demonstrating to ourselves and to the world how attractive we are as a company, how much people believe in the opportunity we have and how enjoyable and intellectually challenging the work at InterDigital can be. And these for a relatively small company we have an outsized opportunity to drive groundbreaking innovation, be a thought leader on licensing, driving the legislation and invent new ways of working. We captured much of that when we learned about the updated mission for the company, which is inventing the technologies that make life boundless. In the combination of our innovation and the key space of wireless and video and our unique business model of making that technology available to all. We have helped to untangle the world from wires, remove the constraints of geography and bring the world's joys of friendship, knowledge, music and beauty to anyone anywhere. We're really proud of what we do. We are also very proud of having responded as a team to the pandemic, and we roll in 2021 even stronger and ready to focus on several key goals for the year. The first will be continued revenue growth. As I mentioned earlier, we need to drive deals down the field in 2020. Now it's time to push them over the goal line led by a neatly qualified licensing team. And while it's always difficult to state when and what kind, our objective is to drive leads into deals on both wireless and the consumer electronics side, as we just did with Humax. For those of us who do not follow the set-top box market, Humax is about the number five or six set-top box manufacturer in the world in terms of worldwide sales. Completing a deal with them is notable in its own right, along with the completion of this agreement. With the completion of this agreement, we now have signed benchmark agreements in three key areas of our consumer electronics licensing plan. Those would be digital TVs, set-top boxes for non-HEVC patents with the latest Humax deal representing. And then the third deal specifically around HEVC only. These three deals along with another one we have concluded since we acquired the business in Technicolor, we continue to be confident in reaching the revenue goals we have set for the consumer electronics program. Moving on to our other 2021 objectives, we will continue to drive wireless and video innovation to be measured by our contribution to worldwide standards, patent filings, publications, and other thought leadership. Of importance to our research team will be 6G. 5G will certainly do its job in creating a flexible network that can handle a wide variety of use cases from talking to web browsing to protecting billions of machines to supporting self-driving cars. Part of 6G's mission will be to make all that happens faster, using less power in a less reactive and more predictive way. This will mean inventing and adapting solutions that push more processing to the edge, drive higher and dramatically faster compute power, and lead in artificial intelligence and machine learning. Those are the types of innovations at which we excel. 2021 will also be a year of higher focus on sustainability. The company has historically been recognized for many good things on the environmental, social, and governance front. We just didn't really speak of them. That said, the rude awakening of the trifecta of the pandemic and the Black Lives Matter protests in the Capitol made clear that it is really important not only to lead by example, and be more vocal about what we do but also to do more to drive a more vibrant and sustainable world. So that is what we intend to do. In terms of technology, that means creating innovation that helps reduce the carbon footprint of wireless technology, or that helps drive the adoption of wired technologies into industries where that technology can reduce the need for travel and other energy-intensive activities. In terms of our companies, it means driving greater diversity from the top to the bottom of the organization, giving back to our communities, and rethinking the future of work to better balance people who need to live, thrive, and connect. It helps when you can do all of that from a position of strength. Thanks to the team in 2020. That is where we are. And it's the same team that is poised to deliver great things in 2021 and beyond. With that let me turn it over to Rich.

Rich Brezski, CFO

Thanks Bill. As Bill said, we delivered tremendous results in 2020 with an increase of nearly $40 million in recurring revenue. I would like to take a moment to emphasize once again the importance of operating leverage in our business model, since it is exemplified by our 2020 results. While our top line increased $40 million or 13%, our operating expenses increased just 8%. Better still, when you adjust for litigation expenses and a full year from our expanded research, the year-over-year increase in operating expense was less than 3%. As a result, our 13% increase in the top line drove a 46% increase in operating income. This is a great result for 2020. But more importantly, it is a clear demonstration of how valuable our operating leverage is during periods of growth. Of course, we recognize that we need to continue to drive top line growth to fully take advantage of this leverage. As Bill noted, in addition to enforcing our intellectual property rights against Xiaomi and Lenovo, we made progress in 2020 for license agreements with both additional mobile handset and consumer electronics manufacturers. We believe we have made fair offers across the board. And we are pleased to see growing worldwide recognition that manufacturers have a responsibility to pay fair royalties. We believe this sets us up to drive resolutions to new and meaningful license agreements in 2021. Moreover, we continue to believe that between just mobile and consumer electronics, in the long term, we can deliver roughly $300 million of additional recurring revenue on top of our 2021 rate. Better yet, we believe we can achieve this top line while targeting inflationary level growth in operating expenses. That is outside of sharing roughly one-third of our $150 million consumer electronics revenue target with partners. We believe our 2020 results support our ability to deliver on this target. Moving on, we've delivered over $120 million of free cash flow in 2020, an increase of $70 million, which more than doubles 2019 levels. As is typically the case, our interim period cash flow was a bit choppy, with use of cash in the first quarter, and strong free cash flow over the balance of the year, in particular, the second and third quarters. Also typical for our business, a portion of the 2020 receipts related to future periods. We ended the year with a total cash and short-term investment balance of $926 million. This represented a small increase over the prior year end, despite $138 million in debt repayment and dividend payments. Looking forward, we believe our sizable cash balance puts us in a strong position to continue enforcement of our patents and to make organic investments, all while considering inorganic investments and share repurchases in 2021. To remove any chance of misunderstanding, such considerations are normal course, and will be made with the same careful focus we have employed in the past. Finally, we will provide our expectations for Q1 revenue in a few weeks after we have received our final Q4 quarterly reports.

Tiziana Figliolia, Vice President of Finance and Investor Relations

Thank you, Rich. Thank you, Bill. And we will now open the call for questions.

Operator, Operator

Our first question comes from Eric Wold with B. Riley Securities.

Eric Wold, Analyst

Thank you. Good morning, guys. A couple of questions, I guess one Bill, maybe consistency. You talked about a lot of negotiations, and you can have any kind of progress to the point where you think they're close to closing and others did not. You resorted to litigation; I guess maybe gives a sense of what is the difference between the two? And what gives you the confidence that something's close to potentially closing versus not, kind of one of those signals? And maybe kind of what's been the hit rate of negotiations that have hit that point before?

Bill Merritt, President and CEO

Yes, so look, it's obviously something that comes from years of doing this, right. Yes, I think the simplest thing is movement, right? So you can have a considerable gap between the parties. But there can be movement, like they could be inching closer to each other. And so, that's something that you're just going to allow to play out and see where it lands. So movement, I think, is very important. I think, second is if there's not movement, the question is, can you figure out why, and sometimes there could be a really legitimate business reason, where you understand what the other side is at, and it's not. They're not really positioning themselves for litigation, that they're going through a period of time in their business when movement is not something they can get. So there's a bit of patience that comes into that. Third is sometimes you'll like, the other side may actually be positioning things for litigation. And while you don't want things to be a race to the courthouse, there's some value with being first, sometimes. So you kind of sense that, oddly enough, you have customers that will actually outright invite innovation because it's how they can raise the profile of the negotiation within their company. And so think about that. It's probably other reasons, too. But those are ones that come to mind.

Eric Wold, Analyst

Okay, it's fair. And then on the CE business, you talked about the kind of the benchmark licensing deals we've done within digital TV for the marker, HEVC. Do you think that business is now at a point where it can hit an inflection in terms of getting a major deal across the line and get you closer towards that $150 million revenue target? Or are there more benchmark yields that need to be done within those spaces?

Bill Merritt, President and CEO

I don't think we need any more benchmarks, right. So it is valuable to have deals done with reasonable sized companies that have good IP teams and things like that. So if and when you need to litigate against a larger player, those agreements become very important in terms of any court-set rate. So I think we're in good shape here, we've covered I'd say, the main products and the main technologies, we've done it with really solid companies. So I think we're in a good spot with benchmarks. As I mentioned in my call, I think this is, and I've mentioned to others, as conversations we have that we really want to move the needle on consumer electronics this year. Humax is a good deal even though the set-top box market itself is not a big market; they're a really big player in that market. So I think we're very well positioned.

Eric Wold, Analyst

And just final question for me. And I know, you typically do not dive into litigation stands, but we've seen kind of the IP enforcement costs tick higher. How should we think about that trajectory this year with everything you know at this point? And when would you expect them to start trending lower?

Rich Brezski, CFO

Yes. I will take that, Eric. It's something we always say litigation is an investment for us. It's something that we prefer not to do, but if the situation calls for it, we're certainly not afraid to do it. And I'm not saying we're totally insensitive to cost. But it's an investment that time and time again has paid off for us. So while we have seen some uptick over the last couple of years, we also saw us resolve deals with ZTE and Huawei that were under litigation not more than 18 months ago. So as for the rest of the year, we'll have to see how things play out here. But what kind of more or less around the levels that we're at, they're going to ebb and flow. It's really hard to predict very far down the road, where they might go because, of course, you could resolve these things, or new fronts could open. So maybe a bit of an unsatisfying answer, but I think the real message I want to convey is if we feel like we need to make the investment, we are going to make it.

Operator, Operator

We'll take our next question from Derek Soderberg with Colliers Security.

Derek Soderberg, Analyst

Hi, everyone. Thanks for taking my questions. Bill, I wanted to start with deal renewals. I mean, it sounds like the confidence there. There's definitely some confidence there. I'm wondering, is there a lot of potential growth in the deal size as those customers renew? I guess I'm wondering if these renewals and Apple and Samsung will likely include patents related to Technicolor, and then I will follow up.

Bill Merritt, President and CEO

Sure. So I'm still on growth. I think growth for us is going to come in the short term, mostly from new deals. So things like Humax today. And we are in litigation with folks like Xiaomi and Lenovo; they will all be new customers, I think that's a pretty big driver of growth. When you think about renewals, you have a little bit of a mixed bag. To answer your question with respect to Apple and Samsung, absolutely, the technologies that we've acquired and developed since the last deal with those folks will be front and center in a new negotiation with them. So that's great. On other renewals, so as an example, LG, there is, I think, as people are aware, they've signaled that they're going to add a strategic options process underway for their handset business, which has really declined over the last couple of years. So we're in conversation with them, and then we knew there would be any lower value than prior because the business is at a lower value. So but other than that, I think, as I said, the major revenue growth for the company is going to come from signing people that have never been licensees before. And then the renewals will be in some cases, if the business has declined, it'd be at a lower level, but for people whose businesses are better or even the same, we bring more to the table in that next negotiation.

Derek Soderberg, Analyst

Got it. And then, as my follow up, I think you guys have some good visibility into the Biden administration. Now that we're starting to see some more policies come out, executive actions taken such, how's your view evolved on the new administration so far? And maybe as it relates to the FTC and their views on patent trolls, or anything related to that, how might that impact new deals or, resigning existing ones? Thanks.

Bill Merritt, President and CEO

So I think there are three aspects of the administration that we would be focused on. One is their approach to China. Second would be their approach to IP generally. And I think third would be other things like tax and other stuff; I'll let Rich handle the last one. I'll do the first two. So on China, what we've seen, and I'm sure many of you have seen this too, for example, I think was the secretary of state designate when he testified, he agreed with Trump's objectives in China. I think the approach will be different. I think it's going to be more of a coordinated approach with the Europeans concerning China. But I think the ultimate objective is the same. And so that's a good thing. And as you may have seen, there was recent legislation proposed in Congress actually proposed by Republicans to provide additional tools for security royalties from Chinese companies shipping into the United States under and using standard essential patents. So hopefully that legislation moves forward. There's also the Stronger Patents Act, which we were very supportive of, and we believe the administration would be as well. And so I think that speaks generally to their support of IP. I think that we've all come to recognize that the prior narratives used by tech against patents were a false narrative and that it's really important to have a strong patent system. And I think that's generally, Biden's administration is going to be at least supportive of that. As I've mentioned before, Senator Coons from Delaware is a very, very strong supporter of the patent office and honestly, a friend of the President and the administration.

Rich Brezski, CFO

Yes. Thanks, Bill. And welcome, Derek. Glad to have you on the call. On the tax side, really nothing dramatically changed since we've most recently expressed our views there. We see a number of at least in the short term moderating factors, whether it's the composition of the senate, concerns about the impact of the pandemic on the economy, and midterms. So we're not anticipating anything in the short term, but it's obviously something that we're going to watch pretty closely to see how it develops over the longer term.

Operator, Operator

Our next question comes from Scott Searle with ROTH Capital.

Scott Searle, Analyst

Hey, good morning. Thanks for taking my questions. Nice job in a difficult operating environment guys, I hope you, your families and your teams are all healthy and safe. Maybe quickly to follow up on some of the litigation questions. Could you just give us a quick update Bill in terms of both, Xiaomi in India, and Lenovo in the UK, the next steps over the next couple of months? If we're tracking what that earlier timeline currently look like? And then I guess the follow up on Eric's earlier question, in your language in the script, you referenced players that were misbehaving to kind of push to the litigation route. So should we read anything into that in terms of players that you are - OEMs that you are not currently litigating with that they are much closer along in the process, i.e. Vivo, Oppo some of the other Chinese manufacturers or shouldn’t we read into that?

Bill Merritt, President and CEO

Sure. So there's a pretty robust description of litigation in the 10-K. So I'll refer you to that for the details, but maybe just give you a sort of a high-level view of where things are at. So with respect to Lenovo, there's a series of cases involving them with the UK case, there's the US dollar base case, and then there's cases going on in China. I think that the leading case there is the UK case; I think from a timing standpoint it's the most mature. We have a trial starting in March. We call that case the way the UK system works, is there's a number of technical trials, those are basically patent infringement and validity trials, and then sort of stuck in the middle of the technical trials is the FRAND determination. And that is scheduled for early 2022. All right. So I think that those cases are pretty well developed. And we feel good about the technical cases, and we feel good about the FRAND trials, and the beauty of the UK system is that there's that opportunity to get the worldwide license and resolve the matter completely. With the Xiaomi, again, settled litigations around the world, India, China, places at both the China and India cases have moved slower than one would have anticipated because it's hard to say exactly why. There's always the uncertainty of litigation as well. So I'd say not quite as mature as the Lenovo litigation. But obviously, there's a lot going on there. And litigation also generally provides an opportunity for the parties to talk, right? And so it's an expensive way to get people to talk, but they do talk. Your question of if somebody's not in litigation, does it mean the parties are closed? Not necessarily going back to the answer again, Eric, on why we bring litigation from time to time. It could be that the parties remain far apart, but that there's movement. And so you want to let that play out without drawing a line in the sand, as long as we're seeing movement, there's no reason not to continue to engage with the customer in a positive way. So it could be that a deal is still a ways off in time because it can take a while to close the gap. But it does not make sense in that case to bring litigation. So I wouldn't necessarily read into who's been who is not in terms of who's close to the deal and who's not.

Scott Searle, Analyst

Got you. And lastly, if I could on the variable royalty front, was up a little bit this quarter. Are you starting to see them pick up as it relates to video and/or IoT? I wonder if you could give us a quick update in terms of where video came in the corner, and where Avanti is in its current time. Thanks.

Rich Brezski, CFO

Yes. I think some of that pickup is just a reflection of the pandemic in the economy and maybe even a little bit of seasonality. Again, we have comparatively fewer licensees there, but more on the variable side. So we'll gain more and more understanding of these markets and the trends as we sign more deals and move forward. Right now, you can have one or two licenses, as a report coming in unexpectedly high, that leads to a true-up and cause you to increase your estimates going forward. So I think that will probably settle down over time. But definitely part of it was a level of again, we have to in most quarters estimate the royalties for the quarter without really being involved in the supply chain. So we're not in a great position, at least compared to anybody else to make those estimates. We have to look at history and current factors, and then they get trued up when we get to reports in the following quarter. That true up will obviously influence our estimate for that work. So what we've seen in the second half of the year is things were a little bit better than maybe we would have expected during the pandemic. So there were positive true-ups. On a kind of ongoing recurring basis, we're still running roughly in the same levels that we've been talking about on the CE side, in the neighborhood of 10% of that goal. We'll look forward to some help from Humax in Q1.

Operator, Operator

Our next question comes from Ian Zaffino with Oppenheimer.

Unidentified Analyst, Analyst

Hey, good morning, guys. This is Mark on for Ian. Thanks for taking our question. So I guess just a quick follow up on the prior question on litigation. It seems like there's a new case filed in Germany with Xiaomi. Can you just provide a little bit more details there? This is something more meaningful, or how should we sort of interpret this going forward?

Bill Merritt, President and CEO

Sure. So, again, the descriptions in the K but to, not surprising in litigation, sometimes these things spread out to various jurisdictions, the reasons for that can be different, right? So it could be that you're securing certain rulings from the judge that sort of support what may be going on in China. And I think that's an area of law that we've been pushing. I've also seen Ericsson and others push that as well, that kind of take what was a very aggressive stance by the Chinese on trying to almost claim exclusive jurisdiction over these matters and having courts around the world push back on that. And it could also, there's other purposes for litigation and not getting into Xiaomi or Lenovo specifically, it could be that you want to start another front of pure patent litigation. So I wouldn't - it's a little bit of a chess game that goes on in litigation, and I'd say that this is just another chess move.

Unidentified Analyst, Analyst

Okay, that's fair. Thanks for that. And then I guess, like just another one on LG contracts. I know, like there's been news that they're looking to add to the smartphone space, how have the conversations with them gone? And have you guys engaged or towards on maybe like, anything on the CE side with LG that you guys could provide?

Bill Merritt, President and CEO

So LG has been a customer of ours for quite some time. And you're correct. There are two different areas where we can have conversations with LG and do have conversations with them. One is on mobile, where they had been a customer for a long time. The new one is on the CE particularly around their televisions. On their mobile side, these are people that we've developed relationships with, and they're very straightforward. And it's, as I mentioned, I think also Eric or somebody else, earlier in the call, sometimes you just there's just practical situations that's confronting someone that you need to respect, does not mean there's not an opportunity to license; there absolutely is because if the business gets old, it needs to, we would want the buyer to have a license. If the business gets shut down, there's going to be sales during the stub period that we want covered. So there are a lot of really good reasons to continue to engage them and secure all the correct terms. But I think you just have to also respect where people are at in their life. And if they're very focused on trying to figure out what to do with the business, you need to give them a little space to do that.

Unidentified Analyst, Analyst

Okay, sure, that's helpful. And then just finally, a quick one, I know it's hard to gauge on the long term, the sort of the operating expense side, but any sort of sense of moving parts going to Q1, 2021 for the operating expenses, whether it's litigation or management, I think that will be very helpful. Thank you.

Rich Brezski, CFO

Yes, these are things that I'll highlight there is that for the last two years since we acquired Technicolor patent portfolio, we've had a robust effort to bring those costs in line. We obviously done a very good job with that had a little bit of a charge associated with some of the activities towards the end of that initial process. But patent management is an ongoing effort, we have a very large portfolio, and like any company with a large portfolio, we have to stay on top of it and make sure that we're directing our resources to the best assets. So that's an ongoing effort. We now have a full year under our belt with the full calendar year with the research team. So we see expenses being a little bit more stable than maybe they've been over the last two years. And, again, as I said, one of the things that we come back to again and again is our appreciation for the operating leverage that exists in the model. That was a theme in my prepared remarks today. When you're in periods of growth and you can drive that top line without really having meaningful movement on the operating expense line, it has a tremendous impact on bottom line results. So that's what we're focused on continuing.

Operator, Operator

We will take our next question from Anja Soderstrom with Sidoti.

Anja Soderstrom, Analyst

Hi, everyone thanks for taking my question. It's been a lot of good questions asked and good discussion already. But as you have not sort of incorporated a Technicolor fully, what do you see in terms of M&A and where you could head in that direction? And then what do you see in the market?

Bill Merritt, President and CEO

Sure. So as Rich mentioned in his script, I think we were in a good position to pursue M&A if we wanted to. In terms of what we would be interested in, I think it's a couple things that would be, I think, fairly obvious, right? So in the consumer electronics business we have today, I think is strong, includes a wide variety of patents from broadcast standards to Wi-Fi to HEVC, to product-specific implementations. And we have R&D obviously behind that creating new innovative innovation. But I think that there's opportunity to further strengthen that in a way. So I'll give an example. So Wi-Fi portfolios don't come on the market all that often, but when they do, they're interesting to us, because they would cut across all of our programs. And so that's an example of a technology that would be in portfolio that would be interesting to us. And it's also very synergistic with the R&D that we already do. Beyond that, I think additional investment in video, particularly scanner-based patents would be interesting, again, because it cuts across all of our licensing programs, so from time to time that stuff becomes available. I think we look at things that are going to be widely applicable or broadly applicable across our programs, because that's the best way of ensuring that we're going to drive the right returns from the deployment of that capital. In terms of the opportunities, it's interesting; there was a little bit of a rush at the beginning of the pandemic. And actually from our standpoint at least the things that we were interested in kind of slowed down. But now we've seen more of a pickup in variety of opportunities that come through. The opportunities kind of fall into two categories; one would be simply portfolio and those are interesting to us because, again, they can get quickly deployed into our business from time to time, it's operating companies as well if there's something interesting to kick the tires, but I think it's been a little bit of a pickup over the last quarter or so in terms of M&A opportunities.

Tiziana Figliolia, Vice President of Finance and Investor Relations

And at this time, I'm showing no further questions. Thank you, Casey. And thank you for joining us today. This concludes our call and we look forward to giving an update on next quarter.

Operator, Operator

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