Earnings Call Transcript - IDCC Q1 2020

Operator, Operator

Good day, and welcome to the InterDigital, Inc. First Quarter 2020 Earnings Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Patrick Van de Wille. Please go ahead, sir.

Patrick Van de Wille, Host

Thanks very much and thanks everybody. Good morning and welcome to InterDigital's first quarter 2020 earnings conference call. With me this morning are Bill Merritt, our President and CEO; Kai Öistämö, our COO; and Rich Brezski, our CFO. Consistent with last quarter's call, we'll 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 first quarter 2020 financial metrics tracker, which can be accessed on our homepage, interdigital.com, by clicking on the link on the left side of the homepage that says Financial Metrics Tracker for Q1 2020. Finally, we are doing this call remotely. If for any reason, there are issues, I ask you to be patient, we will make sure we reconnect. And with that taken care of, I'll turn the call over to Bill.

Bill Merritt, President and CEO

Thanks, Patrick, and good morning, everyone, and thank you for joining us on the call this morning. I appreciate this crazy time and I hope you and your families are well and find your way through this difficult period. When we last spoke, I talked about how 2019 represented the culmination of a long and productive strategic period for the company, one that landed in an exciting new strategic position with a single powerful long-term R&D engine during a strong and growing mobile device licensing business and new consumer electronics licensing business; also driving additional licensing opportunity in IoT and infrastructure. Equally exciting is the fact that we can do all of that. So I have a business with revenue potential beyond $700 million while keeping our costs at 2017 levels, the cost level before we began this journey. This created incredible operating leverage for us, as all added revenue was dropped to the bottom-line net of taxes in some cases with a modest level of revenue sharing. With all that done, 2020 represents our opportunity to execute and deliver that amazing value to shareholders. And that's what we're doing. We started the year completing some smaller deals around our mobile business and our new CE business. We also secured enough market information and negotiating history on the CE side to put a mark around revenue for that business—$150 million in 3 to 5 years. We then secured our strong license renewal with Huawei last week, managing to navigate the choppy waters of the trade wars, the COVID crisis and the particular challenges facing Huawei. To deal with all the open publication of our royalty rates, which we posted on our website as part of the transparency project. We started with those rates and applied our typical discounts for factors such as term, volume, and special market considerations. It also reflected the challenges in Huawei's business that includes both the COVID-19 pandemic and the specific governmental challenges. When we posted our rates, we expressed cautious optimism that our effort and transparency would be held by licensing media as a new level of transparency that the industry would reduce discussions around license terms and expedite deals. We believe the Huawei deal supports that initial optimism. The Huawei deal also included minimal litigation, saving tens of millions of dollars as compared to prior agreements with Huawei. I believe this deal will work perfectly with what our strategy was intended to do: increase the net value of licensing deals through some combination of higher rates, lower litigation costs, and/or shorter timeframe to reach the final deal. It also frees the company to focus on additional opportunities, driving still more value. The deal also represented another opportunity for the company to demonstrate its fair and pragmatic approach to licenses. These are not easy times for companies including Huawei. When we found a formula that worked to have them on board again as a licensee. In fact, upon completing this license term, Huawei will have been licensed for a decade and we will join the list of licensees who have been with us for at least 10 years. This currently includes Apple, Sony, Sharp, and Samsung, in particular, has been a licensee for almost 25 years. The length and stability of our license engagements speak volumes to the continuing strength of our innovation, our fair and transparent approach to licensing, and the important role we played and continue to play across multiple generations of standards and video and wireless technology. Our job now is to continue executing on our plan with both ZTE and Huawei license; we are focused on our remaining unlicensed companies, including Lenovo, Xiaomi, Oppo, Vivo, and TCL. Together these represent approximately one-third of the global handset volumes with many of those sales outside China. Combined, we're confident that they will bring us from our current revenue platform of approximately $340 million to our goal of $500 million. We will also focus on our upcoming renewal with LG. Additionally, we're diligently at work leading with our new CE customers looking to drive even further success this year. In some ways, when we executed the Technicolor acquisition, we had two intertwined goals. One was to drive revenue that described our progress there. The second goal was on the expense side, and as Rich will describe later, our hard work has resulted in the achievement of that goal. So we are off to a very fine start this year, and we've done so in what is, as we all know, a very difficult environment. Luckily, our business is relatively immune to the adverse economic effects of the virus. As Rich will discuss in more detail, our revenue is almost entirely based on fixed-price agreements. So we expect only a minor revenue decline based upon the lower smartphone shipments that are expected over the next two years. Of course, those lower expected volumes did impact the Huawei license, but that impact was tempered by the fact that the deal was longer-term and the global volumes are expected to recover over the five-year period of the deal. The crisis has also not materially impacted the ability of the company to function. We are continuing regular dialogue with our licensees as many agents have been on lockdown for an extended period and have become accustomed to working over video and audio conference calls. We also preemptively tested our remote work environment prior to the crisis, taking the entire company remote in three days to verify our ability to work effectively in a fully virtual environment. That's when we shut our offices in mid-March, seeking to protect our workforce and also to prevent the spread of the virus; we were ready to operate in that environment. Additionally, many of our engineering projects already occurred across sites. For example, our Montreal team is collaborating with our engineers. The engineers' familiarity with remote collaboration made the work to transition to work from home largely fundamental. To summarize, we have created the company we set out to create at the beginning of our strategic journey. We have integrated the assets successfully and quickly and are now executing on plan despite the current crisis. With that, let me turn it over to Kai for more information on licensing and R&D.

Kai Öistämö, COO

Thank you, Bill. It's been a very successful start to the year in both licensing and our R&D efforts. Let me touch on both. Obviously, the headline is our successful renewal with Huawei. The fact that the deal was able to get done despite trade issues, travel restrictions, and COVID-19 speaks volumes to the strength of our portfolio and our diligent licensing efforts, but also highlights Huawei's willingness to license. We feel that with the publication of our fair rates and transparency around portfolio and licensing practices as well as our outstanding arbitration to resolve differences, we offer a perfect counterparty to a company that is willing to take a license. Hopefully, other Chinese companies will recognize that and follow the leader Huawei and ZTE in concluding agreements. The renewal with Huawei is now the sixth license agreement that we've been able to conclude in the past six months. We've often spoken of our commitment to deliver on our revenue goals, and we are diligently doing that. On the wireless side, those deals have included major brands like ZTE, Huawei, and Google. These are all important companies and the licensees help to grow the revenue while also serving as validation of our important contributions from the leading technology players. On the consumer electronic side, the goal was to proceed with smaller agreements that would serve to validate our rates before moving to larger negotiations. And that's what we are doing. So I'm pleased to say we are executing on all fronts. On the research and development side, I can say that while COVID-19 has had a limited effect on our teams as Bill described, the health crisis has nonetheless slowed the environment in which we operate. The international travel to standards meetings is obviously halted. Standard meetings are taking place by conference call, a painstaking process that slows progress. It's not all bad; in fact, typically, the companies that want the standards development to proceed at a breakneck pace are those that have limited resources. Many of our colleagues at standards have been advocating a slowdown, especially after the accelerated work to deliver the first release of 5G. Some of our video technology development work involves larger studio-style setups. So we refocused on other development work that doesn't require that capability. So there has been some impact, not all negative, but largely our work is able to continue very effectively. I appreciate some of the video work we are doing is very new to some of our investors. We've posted links to some excellent feature articles produced by leading video technology trade media on our website homepage. I encourage you to read them. They describe our groundbreaking work in digital doubles, augmented and diminished reality, visual technology science, and other areas. So to summarize, we've been through a period of tremendous progress on the licensing side and remain focused on continued execution there, and our research activities, while slightly affected by the Coronavirus issue, are nonetheless progressing well. With that, I'll turn it over to Rich.

Rich Brezski, CFO

Thanks, Kai. I'll start today by reviewing our first quarter 2020 results, then I'll discuss our high-level expectations for Q2. Our first quarter results were very strong, especially in the context of the current macroeconomic environment. Revenue came in above our expectations at $76.2 million, and we benefited from two new agreements we signed during the quarter, which included just under $1 million of past sales. Our operating expenses came in at $71.5 million, which was in line with our previously communicated expectations. However, it's worth noting that these expenses included nearly $3 million of one-time costs associated with our efforts to bring expenses in line with 2017, as described on prior calls. Excluding these one-time costs, we have now delivered two consecutive quarters with an ongoing economic cost of running the business at or below the 2017 targets. We take a lot of pride in having met our goal, especially with a much larger patent portfolio and a much longer research team. That being said, we know how important ongoing cost control is to our company and to maximizing our operating leverage. Although we've checked that off, let me emphasize that we continue to be committed to carefully managing expenses. Litigation costs, which are excluded from that 2017 metric, were roughly $5 million in the quarter. This result was impacted, as expected, by a slower ramp-up in outstanding matters due to the COVID-19 pandemic. Our Q1 results also included a one-time non-operating gain of about $5.5 million to write up the value of a long-term investment. In early Q2, we sold nearly half of that investment as part of a round of financing and the increased value related to that sale. We reported a $1.8 million tax provision on just $200,000 of pre-tax book income, as our interim rate continues to be distorted by foreign, state, and permanent impacts that are generally small and semi-fixed, but magnified in periods of breakeven earnings. Finally, it's important to note that our first quarter results do not include any benefit from the recently announced license renewal with Huawei, which was signed after March 31. Looking forward to Q2, we expect our recently completed renewal with Huawei, combined with contributions from other fixed price agreements, will help drive another strong quarter, even as global shipments of smartphones are expected to decline substantially. Collectively, our fixed-priced agreements make up more than 90% of our revenue and include substantially all of our key licensees, including Apple, Samsung, and now Huawei. Under such fixed-fee agreements, our revenue is not sensitive to our customers' underlying volume of shipments. This is a great benefit to us during periods of uncertainty, such as the economic fallout from the COVID-19 pandemic. Having said that, we do expect declines in shipments from our per-unit basis customers. That should lead to a sequential decline in the variable portion of our revenue, which contributes roughly between 5% and 10% of our overall revenue. All in, including both anticipated declines in variable per-unit revenue and our preliminary accounting estimates for the Huawei agreement, we currently expect Q2 revenue to be in the range of $97 million to $105 million, including $82 million to $86 million of recurring revenue. Putting aside any Q2 specific impacts to our variable revenue, we now see our revenue platform about $340 million, and we maintain our goal of increasing our recurring revenue platform to $500 million from wireless licensing, plus another $150 million from our CE business, with additional contributions from IoT and infrastructure coming in over time. We will provide updated revenue and expenses guidance for Q2 a bit later in the quarter. But let me speak to a couple of the implications of the Huawei agreement on operating expenses. First, in connection with the Huawei license, we and Huawei agreed to dismiss the litigation between us. This will favorably impact litigation expenses going forward, which we would have otherwise expected to increase over the balance of the year. Second, we expect to report a charge of roughly $2 million in the second quarter related to an increase in performance-based achievements that will vest under long-term compensation plans. I'll turn it back over to Patrick.

Patrick Van de Wille, Host

Thanks very much, Rich. Casey, if we could open lines of questions.

Operator, Operator

Thank you. We'll take our first question from Eric Wold with B. Riley.

Eric Wold, Analyst

Thank you. Good morning. I guess, first question is probably the last comment around the Huawei agreement. I'm obviously expecting to see a decrease in mitigation expenses for this year should be lower than last year?

Bill Merritt, President and CEO

Yes. So Eric, what I'd say is, we certainly expected it to increase as the year went along. Having said that, that's prior to the resolution with Huawei. Q1, as I noted, came in a little bit lower than we might have expected earlier in the year, and that was because of slowness in the rollout of cases with the pandemic. So there's been some activity with Lenovo; I'm not ready to say exactly where litigation is going to come out in Q2. But it's not necessarily going to go down just yet. It's just not going to increase at the rate that we might have expected.

Eric Wold, Analyst

On the litigation, typically any major change in timing right now because of the COVID pandemic and how would you frame public filings? What are we going to dispute with Lenovo, and how do they similarly differ?

Bill Merritt, President and CEO

Yes. The courts generally are trying to move things forward; I think things slow down a bit. But, we have scheduled and so far we have dates on the calendar, and we think that those calendar dates will be here too, so that's good. In terms of how the Lenovo litigation looks versus Huawei litigation, there are a couple of differences. So, in terms of the rate setting that we've asked for in the U.K., that was the first filed case, and we asked for a worldwide rate. So that's always a good position to be the first to have filed a case because that's an important factor. Generally, what courts decide to do different than Huawei, where they had first filed in Shenzhen and then the second filed in the U.K. I think the other important factor is having Huawei done gives us another very important benchmark to bring into the Lenovo litigation in terms of demonstrating that the rates we have are fair, reasonable, and non-discriminatory. Third, what you find a lot of times with litigants is that they will ride the coattails of somebody else. It can reduce their costs because, as an example, the other company may be the one bearing the cost of patent validations and other things. With Huawei now signed as a licensee, now both parties have agreed to settle litigation, Lenovo now is going in, wanting to do the same thing that Huawei was doing; it now starts to bear the cost of all of those activities which factor into their calculus for when to enter into licensing negotiations. So at this point, we’re very comfortable with the position of that litigation, and I think it’s even stronger now with the Huawei agreement.

Eric Wold, Analyst

Terrific. And then a question on the 3D licensing with the Technicolor IP: $150 million, 3 to 5 year goal for revenues under that. How does the path from here to that $150 million look like? What are the major hurdles in getting major deals signed? Are smaller companies setting the framework, or do bigger companies not care what smaller companies do?

Kai Öistämö, COO

I think the smaller ones are very important in terms of especially when we get—not this one, but a number of them together. They verify the value of what our offering is and play an important benchmark in negotiations logically. It’s like, whoever it might be, Samsung or so. On the CE side, we do have known essential patents included as well, and our rates are, the offering is the same to whatever the license is; there are and we are comfortable with what we have now proven in the marketplace.

Eric Wold, Analyst

Okay. And then last question for me, kind of looking at the $30 million of the revenue platform you laid out in the most recent presentation. How do I figure that relative to what was recognized last year? There have been entirely new deals signed since then. Should we assume that someone will have a fairly linear progression throughout the year?

Bill Merritt, President and CEO

Yes, Eric, I mentioned in my prepared comments that we're looking at $82 million to $86 million in recurring revenue in Q2, so $340 would be like an $85 million quarterly run rate. So it reflects everything that happened since 2019 and includes new agreements, as well as any licenses that turned out at the end of '19. And, of course, the variable impact on Q2 is included in the Q2 range.

Charles Anderson, Analyst

Yes. Thanks for taking my questions, and congrats on getting the Huawei deal done. I want to start by speaking of the Huawei deal, and you mentioned your confidence level in that next year of licensees that you don't have under contract today. To what degree is the Huawei deal an example of how some of those may look?

Bill Merritt, President and CEO

It's kind of walking your way through our rate sheet, and then think about how the different companies may fit into how that will operate. It starts at the same base rate that is across the customer base. We've always had factors like volume discounts that can differ between one company or another, and we’ve talked about other discounts related to the regions where a company ships. One thing that's unique to Huawei, with their limited access to Google services, obviously, that business has really shrunk back to China to a large extent. As for forecasting, particularly in fixed-price deals, you're going to need to create a forecast for each company. But I think our rates are fairly transparent and how we handle things is also fairly transparent.

Charles Anderson, Analyst

Okay, great. And then I've got a question for Rich. Thank you, Rich, for the commentary on OpEx. I know you don't guide OpEx specifically, but I'm curious if I exclude what's happening in litigation. If I exclude the $2 million performance comp, and then some of the one-time impacts we saw in Q1. How should I think about the trajectory of OpEx otherwise?

Rich Brezski, CFO

At least from a GAAP perspective, the gain has been recognized, right? The realization of that doesn't hit the P&L in Q2. From an OpEx perspective, at this stage without being overly precise, I'd think about the levels that we're at. As we review things and get a better view on Q2, particularly where litigation stands, we’ll include some commentary when we provide the revenue guidance. But at this point, I’d say we are still a kind of in range that we're at with the $2 million charge.

Charles Anderson, Analyst

Okay. Fair enough. And then lastly, I know in the past you had given some commentary as to future expected cash inflows from all of your deals.

Rich Brezski, CFO

I'm not providing an update today, but we'll look to provide an update at some point in the not too distant future.

Scott Searle, Analyst

Hey, good morning. Good afternoon. Thanks for taking my questions, and congratulations on the Huawei deal. To get a little more clarity on Technicolor, could you give us an idea of what video was in the March quarter? And in terms of your expectations of that recurring component of $82 million to $86 million in the June quarter? What are you thinking about from a video perspective?

Rich Brezski, CFO

The $82 million to $86 million is the recurring number. The delta would be related to past. On the CE business, it’s in the neighborhood of $4 million on the quarter, and there was a little bit of favorable true-up in there. The annualized rate is probably a little bit south of that. All-in, it's not dramatically different from a year ago despite Chinese new deals. As Kai noted, those deals are smaller, but they’re still very important.

Scott Searle, Analyst

To dig in a little bit on that target of $700 million in revenue. It seems like there's a $50 million-ish component related to IoT and infrastructure. Could you do more color on that? Is all of the IoT then related to Avanti? When would you expect to see some of that start to accelerate?

Bill Merritt, President and CEO

I'd say that's a rough order of magnitude, the $50 million number. There’s still a lot of uncertainty in the IoT market in terms of penetration, cellular, and how the various middleware gets deployed. Until that sorts itself out a little bit, we're not comfortable providing a more specific number around that opportunity. We think it's meaningful, which is why I say that $50 million is just a placeholder for the time being.

Scott Searle, Analyst

Got you. And lastly, if I could just dig in a little bit more on some of the parameters around Huawei. I know without getting too specific, there are a lot of moving elements there where there's a strong domestic presence, but their export presence has been marginalized.

Bill Merritt, President and CEO

As I mentioned to Charlie, the things that you wanted to ask about are definitely the factors that we would look at. The beauty of actually having a settled rate sheet in a very transparent regime is that we can look at things like current volume forecasts, regions of sale, price points of devices, risk, and forecasts. The collective group of potential licensees will give us a good marker of what we can anticipate.

Anja Soderstrom, Analyst

Hi, everyone, and congratulations on a good quarter and getting the Huawei deal done. If you can just give us some color on how the current environment has impacted discussions with other Chinese OEMs, if at all?

Kai Öistämö, COO

The current environment has not really impacted our capability to execute. It’s actually much easier to set meetings in this environment where it's all virtual than agreeing to travel logistics, and we’re experiencing significant increases in interactions with all of our customers. While predicting any deals in the future is difficult, we’d rather take the right deal than rush into the wrong deals now.

Anja Soderstrom, Analyst

On the consumer electronics side, you’ve said that you’re proceeding with smaller agreements to validate before moving into larger agreements. Do you have any sort of timeframe for when you’re going to approach the larger deals in this segment?

Kai Öistämö, COO

Giving you a specific timing on any of the larger deals would be premature. Our approach has been to make the right deal regardless of timing, and it takes the time that it takes.

Patrick Van de Wille, Host

Thanks very much, Casey. And thanks to everybody for joining us today. As Bill and Kai mentioned, we are taking steps to ensure the safety and security of our company. Please stay safe, and accept our best wishes. We're proud to be with you again next quarter. Thank you. Have a good day.

Operator, Operator

Thank you for today's presentation. Thank you for your participation. You may now disconnect.