Earnings Call Transcript - IDCC Q2 2023

Operator, Operator

Good morning and thank you for standing by. Welcome to InterDigital Second Quarter 2023 Earnings Call. At this time, all participants are in a listen-only mode. After the speaker’s presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Raiford Garrabrant, Head of Investor Relations. Please go ahead.

Raiford Garrabrant, Head of Investor Relations

Good morning to everyone, and welcome to InterDigital's Second Quarter 2023 Earnings Conference Call. I am Raiford Garrabrant, Head of Investor Relations for InterDigital. With me on today's call are Liren Chen, our President and CEO; and Richard 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 made only as of the date hereof. Forward-looking statements 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 described in the Risk Factors section of our 2022 Annual Report on Form 10-K and in our other SEC filings. 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 financial metrics tracker, which is available on the Investor Relations section of our website. With that taken care of, I will turn the call over to Liren.

Liren Chen, President and CEO

Thank you, Raiford. Good morning, everyone. Thanks for joining us today. This was another strong quarter for the business. We added to our recent momentum, once again demonstrating our ability to deliver stable recurring revenue and strong profitability, and we continued our excellent track record of returning capital to shareholders. Let me start with the status update on licensing. We continue to make solid progress in the smartphone space where we added a new licensee in Q2. In addition, we closed a new licensing agreement with Alps Alpine, a specialist system, and technology provider in the IoT and auto sector. In the first half of the year, our recurring revenue from the consumer electronics and IoT, including auto, increased by almost 20% year-over-year, once again highlighting how we are capitalizing on the opportunities in multiple verticals. In addition, early in the third quarter, we added another new licensee from the consumer electronics sector. We also continue to advance our case arbitration with Samsung; the three arbitrators who will hear the case have now been confirmed, and the case management conference is being held today. As a reminder, Samsung has already agreed to take a license to our portfolio effective January 1, 2023, where the arbitration process will decide the monetary terms. We remain confident that our new license with Samsung will reflect the value of our portfolio and continue our long-term relationship with Samsung, which started more than 25 years ago. Next, I want to give you an update on our litigation with Lenovo. Recently, we received another good decision from the U.K. High Court, which increased the amount Lenovo must pay us for the license to our 3G, 4G, and 5G patents to just under $185 million, which we have already received from Lenovo. Rich will explain the revenue recognition topic in his remarks. This is a very positive development for us. As to the court's previous ruling, Lenovo must pay us in full for the past sales going back to 2007. As the court noted, this is intended to be a powerful way of discouraging licensors from holding out on taking up-front licenses. I want to remind you that the $185 million judgment is for the license to only our cellular patents until the end of 2023. It does not include our valuable portfolio of video, WiFi, and implementation patents. We remain committed to receiving a full and fair return for the technology that Lenovo uses in its devices each day. One aspect of our dispute, which I'm particularly pleased with, is that when we asserted our patents in three separate technical trials against Lenovo, each patent was found to be valid, essential, and infringed. Because they are all standard essential patents, this not only places us in a strong position in our Lenovo case, but also in our future negotiations and litigation with other prospective licensees. We are, at our core, a research innovation business. The technology we create and the patents that we file each year are, in many ways, the products that we bring to market. The high quality of our portfolio is directly connected to our ability to remain at the cutting edge of foundational research in wireless, video, and increasingly in AI. This year has already included many examples of how we excel as an innovation business. Our engineers produced a record number of new invention filings in the first half across both 5G and video spaces. As we continue our work in 5G, including what will be the first release of 5G advanced, we are also deepening our research for 6G. In Q2, we announced a new research partnership with the University of Surrey in the U.K. to focus on specific technologies that we think will become a part of the 6G standard. Our ongoing wireless work, including the use of AI to improve the efficiency and reliability of mobile networks, is an excellent example of how central AI has become to much of our innovation. Our CTO, Rajesh Pankaj, is a well-known leading expert in AI and has been working in the space for years. Many of our other engineers are becoming noted experts, and like Rajesh, several have emerged as leaders in the field. For example, in Q2, one of our senior engineers was appointed head of our industry group within the standard body, ATSC, which focuses on creating standards to preserve and improve the security of AI. Regarding our innovation success, we were recently named by LexisNexis as one of the world’s top 100 companies in innovation that advances sustainability. We strongly believe that our innovation has only become more valuable in an increasingly connected world, and I'm delighted that we are also playing our part in steering us toward a more sustainable future. Before I hand it over to Rich, I want to thank all our employees for their hard work in putting us in a strong position and delivering superb value to our shareholders. Our financial strength, combined with our innovation leadership and the growing importance of our technology for different use cases, means that we remain ideally placed to build on our recent success. And with that, I hand it over to Rich.

Richard Brezski, CFO

Thanks, Liren. I'm pleased to share that in Q2 we delivered diluted earnings per share and adjusted EBITDA above the high end of our guidance range. This was driven primarily by revenue in line with expectations, coupled with continued expense management. It's worth highlighting that when we received the initial Lenovo judgment in Q1, we recognized a large amount of catch-up revenue and a smaller amount of recurring revenue. In Q2, the U.K. High Court increased the value of the award, but in Q2 we recognized the same conservative level of recurring revenue from Lenovo as in Q1. Furthermore, we expect to continue to recognize revenue on that same basis throughout the balance of the year or until the related appeal process progresses. As such, we are deferring recognition for about 40% of the updated award. This is rooted in the conservatism inherent in the generally accepted accounting principles applicable to the situation since some of the award is still contingent on appeal. Even with the deferral, our revenue continued to drive strong profitability as we posted adjusted EBITDA of $54 million at a 53% adjusted EBITDA margin. Notably, we have delivered an adjusted EBITDA margin of over 50% in seven out of the last eight quarters. Our adjusted EBITDA margin shows the power of our business model as even in a quarter with only a small amount of catch-up sales, we converted over half our revenue to adjusted EBITDA. This is driven by the operating leverage inherent in our model combined with the discipline to ensure we maximize the conversion of revenue to profit and cash flow. As discussed on the last few calls, we believe adjusted EBITDA is a great metric to measure the ability of our business to generate cash over time because it adjusts for timing differences in cash collections under our fixed fee agreements. For example, this year, we utilized cash in the first half of the year, but expect customer receipts, including Lenovo, to drive well over $200 million of free cash flow in Q3, and we continue to return excess cash to shareholders. As previously discussed, in the first quarter of this year, we repurchased 2.7 million shares through a $200 million Dutch tender. Since then, we have repurchased over 700,000 additional shares for almost $60 million. That brings the year-to-date totals to over $0.25 billion of share repurchases, a reduction of 12% of the outstanding shares since the beginning of the year. Looking forward to Q3, I'll remind you that our Q3 revenue guidance is based off of contracts signed to date, since the timing of new license agreements is inherently uncertain. We expect Q3 recurring revenues will once again be around $99 million. We expect operating expenses to be similar to Q2. We anticipate an adjusted EBITDA margin of about 50%. We expect to continue to repurchase stock. And finally, we expect GAAP diluted earnings per share of $0.60 to $0.70. Since both of our converts are in the money now, the diluted share count in our guidance includes an estimated 1.2 million shares of accounting dilution. It's important to note that while the converts are dilutive from a GAAP standpoint, they are not economically dilutive below $106 due to hedges we have in place. Longer term, our goal remains to achieve and sustain a 60% adjusted EBITDA margin on $650 million of annual recurring revenue from device licenses, with additional upside from licensing new products and services. With that, I'll turn it back to Raiford.

Raiford Garrabrant, Head of Investor Relations

Thanks, Rich. At this point, Michelle, we are ready to take questions.

Operator, Operator

The first question comes from Anja Soderstrom with Sidoti. Your line is open.

Anja Soderstrom, Analyst

Hi. Thank you for taking my question and congratulations on the solid execution. I have a question regarding the Lenovo case. The $185 million resolution pertains only to the cellular license. Are you currently addressing other technologies as well? When do you expect those issues to be resolved? How is that progressing?

Liren Chen, President and CEO

Hi, Anja. Good morning. This is Liren. So as I mentioned in the prepared remarks, our current $185 million award from the U.K. judge only captures 3G, 4G, 5G cellular technology. But it also only captures the use of those technologies until the end of this year. Therefore, there are really three elements for additional value. One, we have other patents that relate to WiFi, HEVC, and implementation patents that their devices are using. We also have patents waiting on their non-cellular devices, including their PC and their laptop, which are not part of the judge's decision. In addition, after the end of the year going forward, they are unlicensed, even for the cellular devices. Regarding our ability to capture the value, we currently already have ongoing litigation against them, for example, in Germany, but we are asserting our HEVC patents against their laptops and their mobile devices, their cell phones, and the trial is actually coming up in the next month. So we're definitely working on those, and we are committed, as I said in the prepared remarks, to be paid fully for the technology that they are using.

Anja Soderstrom, Analyst

Okay. Thank you. And in terms of capital allocation with all this cash coming in, what are your sort of priorities?

Richard Brezski, CFO

Yes. So Anja, our priorities are to be responsible stewards of our cash. We've returned, as I noted in my comments, quite a bit of cash so far this year. But we have $142 million remaining on the authorization. And as I indicated, we certainly plan to continue to repurchase shares into Q3. So that's, as always, an ongoing discussion with us.

Anja Soderstrom, Analyst

Okay. Thank you. That was all from me.

Operator, Operator

The next question comes from Brian Chen with Jefferies. Your line is open.

Brian Chen, Analyst

Hi. Thanks for taking the question. Just on the targets that you've outlined, $500 million for wireless and the $150 million for IoT revenues. Could you please give an update on reaching those targets? How should we think about levers that you still need to pull, perhaps upside from the ongoing cases to reach that $500 million wireless target?

Liren Chen, President and CEO

Yes. Hi, Brian, this is Liren. We are making good progress towards our $500 million target for mobile. The Lenovo case is a step in that direction, but we are also focused on the three largest unlicensed players, including Oppo and Vivo, which have greater annual device sales than Lenovo. We currently have pending cases against Oppo in several jurisdictions. As I mentioned earlier, the recent decision in the U.K. regarding three patent trials is beneficial for our case against Oppo, as all our standard essential patents have been found to be valid, infringed, and essential, allowing us to expedite the case in the U.K. There is an important hearing scheduled for October this year, and we anticipate an upfront redetermination next February. So the timeline for Oppo looks promising. In terms of Vivo, we are maintaining active discussions with them and are confident in reaching our $500 million target for the mobile segment. Regarding our CE and IoT segment, we are making progress towards the $150 million target as well. In fact, our growth rate for IoT and CE is outpacing our mobile segment, with double-digit year-over-year growth in IoT for the past few years. In the first half of this year, we saw a 20% increase year-over-year, and we aim to continue building on that momentum.

Brian Chen, Analyst

Okay. Perfect. I just had one follow-up. You have started discussing the potential monetization of services. Could you provide an update on the size of the opportunity and the timing of this, as well as any insight into the processing and strategy for developing this platform?

Liren Chen, President and CEO

Yes, this is Liren. The online services are utilizing technology for video distribution, both one-way and interactively. It's clear they're benefiting significantly from our connectivity and video technology. The main question now is how we can launch a licensing program, which we've been developing for some time. The online video market is projected to reach around $500 billion by 2027, roughly the same size as the current smartphone market. We're actively working on this, but we don't yet have enough details to give a precise estimate of the licensing opportunity since we would prefer to secure at least one license before providing a specific figure. We'll keep you updated as we progress in this area.

Brian Chen, Analyst

Okay. Great. Thank you.

Operator, Operator

I’m showing no other questions in the queue at this time. I would now like to turn the call back to Raiford for closing remarks.

Raiford Garrabrant, Head of Investor Relations

Thank you, Michelle. I'll now turn it back to Liren for his closing remarks.

Liren Chen, President and CEO

Thank you, everyone, who joined today's call. We look forward to updating you on our progress next quarter.

Operator, Operator

This concludes today's conference call. Thank you for participating. You may now disconnect.