Earnings Call Transcript - IDCC Q2 2022

Richard Lloyd, Communications Director

Good morning, and thank you for standing by. Welcome to the Second Quarter 2022 Earnings Call. At this time, all participants are in a listen-only mode. After the speakers' 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 first speaker today, Richard Lloyd. Please go ahead. Good morning to everyone and welcome to InterDigital's second quarter 2022 earnings conference call. I am Richard Lloyd, Communications Director, and with me in today's call are Liren Chen, 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 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 sections of our 2021 Annual Report on Form 10-K, our second quarter 2022 quarterly report on Form 10-Q, 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 measures 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, Richard, and good morning, everyone. In the second quarter, we continued to make excellent progress across all parts of the business. And I'm particularly pleased that the strong momentum we built in 2021 has continued into the first half of this year. In Q2, we significantly increased revenue and net income on both a sequential and year-over-year basis. We entered into a multi-year, worldwide, non-exclusive, fee-bearing license with Amazon covering our technology in Amazon's consumer electronic devices and our InterDigital's patents. We made a major addition to our leadership team. We strengthened our balance sheet and we saw significant growth in revenue outside of the core smartphone market. In the second quarter, our total revenue increased 42% year-over-year to $125 million. We also delivered a substantial improvement to our profitability, more than doubling our adjusted EBITDA to $78 million, and we drove a 14-fold increase in earnings per share to $0.69 per share. I will let Rich talk you through our financial performance in more detail while I cover some other notable highlights from the quarter. Starting with the recent announcement that Dr. Rajesh Pankaj has joined InterDigital as our new CTO. Rajesh was previously a Senior Vice President and the Head of Corporate R&D at Qualcomm, where he spent 25 years in research and senior leadership roles. His background in cellular wireless, including both 4G and 5G, and the application of AI to connectivity, makes him a perfect fit with our technology footprint and with the long-term direction of our innovation. He's named as inventor in 230 patents worldwide and has a strong track record of translating technical breakthroughs into patented innovation. I'm delighted that Rajesh has joined us, and I'm confident that he will lead our R&I team to even greater heights and build upon the leadership of his predecessor, Dr. Henry Tirri. Along with our ability to attract world-class talent, one of the keys to our recent success has been the value that we continue to drive as a leading innovator across a range of critical technologies. Our research on additional horizontal technologies, like cellular, Wi-Fi, Video, and AI and machine learning allows us to license the IP that covers this horizontal technology across many verticals that utilize them. Smartphones use all of these technologies and continue to be our core market. Meanwhile, consumer electronic devices, as well as the growing array of IoT products, also use multiple technologies such as Wi-Fi and Video. In short, we are in an excellent position to drive growth from both existing relationships and new opportunities. In recent years, our strength in Video has become even more valuable, and we have built a formidable innovation pipeline, exploring opportunities to build more immersive consumer experiences and continue as a leading contributor to both the HEVC and VVC video standards. We have also achieved impressive growth in our video portfolio, which now numbers approximately 7,000 patents and applications. In wireless, our portfolio of cellular SEPs for 5G multi-mode devices continues to grow in the second quarter and now stands at more than 10,000 patents and applications, giving us an incredibly strong base in generational mobile that will define connectivity for the rest of this decade. This foundation has been enabled by our team of superb engineers. In the second quarter, the Institute of Electrical and Electronic Engineers, IEEE, recognized one of our senior wireless engineers for his work in 5G, awarding him the prestigious Benjamin Franklin Key Award. Specifically, he was recognized for his groundbreaking contribution to millimeter wave, which is a foundational technology that enables both 5G's incredible speed and its ultra-low latency. Staying on the IEEE, another InterDigital engineer was recently appointed as the Chairperson of the Topic Interest Group, which is responsible for identifying and exploring use cases for artificial intelligence and machine learning in Wi-Fi. While we continue to reap the rewards from innovation being implemented in today's devices, many of our research efforts are firmly focused on the technology that will shape connectivity and content consumption in the years to come. I'm especially excited by the new partnership we announced in June with Inria, France's leading institute for research in digital science and technology. This new initiative will not only support innovations across France but also enable engineers to conduct cutting-edge scientific research and to explore technologies that will define media experiences in the future, in areas such as AR and the Metaverse. On the licensing front, we believe that the strength of our innovation, the increasing value of our patent portfolio, and our licensing track record position us well to renew key agreements and sign new ones. In the second quarter, in addition to the Amazon deal I mentioned earlier, we also closed an additional agreement with Zebra Technologies covering our 4G, 5G, and Wi-Fi technology. Zebra's devices are used in retail, healthcare, banking, manufacturing, transportation, and other industries. This license agreement demonstrates the broad applicability of InterDigital's foundational innovation and our patent portfolio beyond smartphones. We also enjoy significant progress in licensing our innovation to the auto sector with new deals signed with GM and Ford. Through our licensing platform partner, almost half of the connected cars on the market are now licensed to our 3G and 4G standard essential patents. In summary, our licensing platform performance this quarter underscores the opportunity that we see in our core markets and in newer areas, where our innovation is helping to create considerable added value. This is an exciting time to be an innovator in connected technologies, and I'm pleased with how our strong foundational innovation translates into new licensing agreements. In terms of the integration activity, we continue to look forward to the upcoming decision from the UK High Court in our FRAND trial against Lenovo. I will reiterate my message from our last earnings call that we remain confident in the strength of our technology, the quality of our IP portfolio, and the merits of our case. On the policy front, I want to highlight that the DOJ and USPTO's recent withdrawal of our 2019 policy statement on SEP licensing and FRAND remedy is a positive development. We will not get into all the details here, but the announcement has moved the SEP policy in the U.S. in a more balanced and predictable direction and confirmed our belief that while disputes over SEP licenses may arise, factors such as the value of the innovation should guide the court's decision-making. The second quarter also saw progress in our ESG program, with the release of our second annual corporate sustainability report. At InterDigital, we passionately believe that our technology contributes to building a better and more sustainable world, and this year's report details not only how we mitigate our environmental footprint but also how we maximize our social impact, ensure our governance meets best practices, and how we strive to help our employees excel. I'd encourage you all to read the report, which can be found on our website. With that, I will turn it over to Rich.

Richard Brezski, CFO

Thanks, Liren. As Liren noted, we delivered another strong quarter with significant increases in revenue and profitability on both a sequential and year-over-year basis. We grew total revenue 42% over the second quarter of 2021 to $125 million, including $100 million of recurring revenue. While mobile agreements, such as those with Xiaomi, have driven a large part of our growth, we have also begun to see meaningful growth in the CE, auto, and IoT markets. In the second quarter of 2022, we had over $35 million in combined revenue from the CE, auto, and IoT markets, including almost $12 million on a recurring basis. Both the total and recurring revenue from these markets represent record levels. For the first half of 2022, we recognized about $23 million of recurring revenue from these markets, representing a 70% increase from the comparable period in 2021. While we are pleased to report such strong revenue from these markets, we remain committed to driving continued growth. Moving on to expenses, you can see the benefits from the cost management actions we initiated a year ago, in our first half 2022 results. On an annualized basis, excluding litigation and stock-based compensation, we have reduced our operating expenses by almost $35 million. This savings is net of the reinvestments we have already made, and we believe that we have improved our capabilities while lowering our cost base. Moving on to capital allocation, we made the decision to refinance our convertible debt during the second quarter as it became clear we were heading into a volatile period marked by inflation and rising interest rates. Similar to our prior financings, we entered into an option structure that increases the per-share price at which we experience dilution from our new debt to $106. The net proceeds from our new debt were primarily used for two purposes: first, to buy back approximately two-thirds of our old debt, and second, to concurrently buy back $75 million of our common stock. Looking forward to the third quarter, we currently expect revenue to come in between $96 million and $100 million. At this point, our revenue guidance is based only on existing contracts, so the entire range is comprised of recurring revenue. On the expense side, we expect additional investments in research and development and an uptick in litigation costs related to ongoing proceedings will drive operating expenses to the range of $76 million to $80 million. Finally, we expect non-operating expenses, comprised of interest and other expenses, to be in the range of $6 million to $8 million, and an effective tax rate in the range of 25% to 27%. With that, I'll turn it back over to Richard.

Richard Lloyd, Communications Director

Thank you, Rich. Thank you, Liren. Operator, we can now open the call for questions.

Operator, Operator

Thank you. At this time, we'll conduct a question-and-answer session. Thank you. Anja Soderstrom, Sidoti. Please go ahead. Your line is open.

Anja Soderstrom, Analyst

Thank you for taking my questions, and congrats on good progress.

Liren Chen, President and CEO

Thanks, Anja.

Anja Soderstrom, Analyst

Can you discuss whether the sentiments among your counterparts have shifted in light of the current economic and geopolitical situations? Is that impacting your discussions in any way?

Liren Chen, President and CEO

Yeah. Hi, Anja, this is Liren. I understand the geopolitical situation in part of Eastern, in particular, it's fairly sensitive. And then the economic conditions have been in turmoil in the last couple of years, partially due to COVID. However, our current revenues are primarily supported by our fixed revenue contracts. We are largely very shielded from the near-term turmoil, and some of the downturns may play a role in our renewal discussions. But the major contracts we are currently negotiating have not been greatly impacted by some of these issues, so we are well positioned. On the geopolitical side, being a global player, we have been watching the global environment very carefully. So far, we have been demonstrating a strong track record, still striking fair deals across multiple windows in many different continents. So we will continue to watch carefully.

Anja Soderstrom, Analyst

Okay. Thank you. And Rich, as you mentioned, the operating expenses were reduced by $75 million net of reinvestments already made. What kind of remaining reinvestments do you have?

Richard Brezski, CFO

Yeah. So we've been reinvesting primarily in R&D and we expect that to continue. For the moment, I'll stick to the guidance I provided for the next quarter, where we mentioned an uptick led by R&D reinvestments but also a little bit from the litigation associated with ongoing matters.

Anja Soderstrom, Analyst

So that uptick is isolated to the third quarter?

Richard Brezski, CFO

Yeah. That relates to the third quarter guidance and that uptick is on a sequential basis versus Q2.

Anja Soderstrom, Analyst

Okay. Thank you. That was all from me. Thank you.

Richard Brezski, CFO

Thanks, Anja.

Operator, Operator

Our next question comes from Jonathan Eisenson from Bank of America. Your line is open. Go ahead.

Jonathan Eisenson, Analyst

Hey, guys. Thanks for taking my questions. The first thing I want to touch on is if you have any visibility for your operating expense guidance, given that the implied operating margins seem to decline sequentially. So would appreciate any color there? And then I also just wanted to ask if you have any updates on the Apple and Samsung deals? Thanks.

Richard Brezski, CFO

Sure, Jonathan. I'll take the first part. There is not a close association between our revenue in a given period and our operating expense in that same period. The R&D that I was just referring to related to the last question is to drive revenue that we would see years down the road because we make long-term investments in fundamental research. So it's not so much that we really have effectively 100% gross margin on new business, as there aren't variable costs associated with it. When we license, we grant permission to use technology that we've already invented in the past. So the uptick in R&D is really to drive future growth, and that's not related to the upcoming third quarter. Hopefully, that answers part of your question. I'll let Liren answer the second part.

Liren Chen, President and CEO

Yeah. Hey, Jonathan. For the Apple and Samsung negotiation, obviously, our relationship with Apple and Samsung is incredibly important to us, and we have been focused on renewing their contracts for quite a while. I think everyone is aware that the Apple contract expires at the end of Q3 this year, and the Samsung contract expires at the end of Q4 this year. It's always worth reminding that those licensing agreements with us represent very long-term relationships. Apple has been our licensee since 2007, before the launch of the very first iPhone. And Samsung has been our licensee for even longer, over 25 years, before they shipped the first Galaxy phone. Such a long-term relationship has led to multiple renewals happening. We feel confident about the current negotiation based on how much our technology has advanced and frankly, it has become even more important with the connected world, with a lot of market video content being consumed on the devices. Also, the 5G adoption will be a major driver in our negotiations. It's worth noting that both Apple and Samsung have a much higher concentration of premium devices in their worldwide sales. These devices will make more and better use of our high-end technology. So, to that degree, it's worthwhile for us to remind them how much they have benefited from everything we have developed.

Jonathan Eisenson, Analyst

Got it. Thank you.

Liren Chen, President and CEO

Yeah.

Operator, Operator

Okay. Thank you, Jonathan. Our next question comes from Tal Liani from Bank of America. Your line is open. Go ahead.

Tal Liani, Analyst

I'm sorry, I was on mute and I was talking to myself. So, can you hear me now?

Operator, Operator

That's fine. Thank you.

Tal Liani, Analyst

I have a question for you. Last year, you experienced a sequential growth of 63% in Q3. This year, however, you're expecting a decline both sequentially and year-over-year. Could you discuss the seasonality factors involved? If I'm correct, you're projecting $98 million, which represents a decline from both last year and the previous quarter. Can you explain what drives these growth fluctuations? Additionally, any insights into what we might expect in the future, even without explicit guidance, would be appreciated. Thank you.

Richard Brezski, CFO

Yeah. No, it's a good question, Tal. I’m happy to address it. A couple of things I'd point to. First, regarding seasonality. There is not a lot of seasonality in our revenue because if you look at the financial metrics that we publish on our website, we show the percentage of revenue that comes from variable agreements per unit, where customers are reporting the volume they shipped and the associated revenue or royalties they pay us for the quarter. Then also fixed fee revenue, where there is a fixed price over the term of the agreement that we typically amortize over the term on a straight-line basis, with maybe sometimes exceptions. 92% of our revenue in the quarter and year-to-date is coming from fixed-price agreements. Therefore, that's a really stable base quarter-to-quarter. There is only a small amount that's coming from variable less than 10% that's maybe subject to any seasonality that does exist. The majority of that fixed fee, the majority of the total revenue, is on the mobile side, which definitely means towards the fixed fee. On the consumer electronics side, that's where it tends to be more variable, and maybe there is a little more seasonality, but overall it's a small component. So what's driving some of these changes? On a sequential basis, I mentioned recurring revenue, which includes past sales, and with some of the new agreements that we signed this quarter, think about Amazon and through our licensing partner GM and Ford, as well as others, there is some past sales where they essentially catch up for the usage of our technology before entering these agreements. We recognize that past amount, and we try to delineate so it's clear to everyone what that impact on the quarter was. In the current quarter, it's roughly $25 million. The recurring number of $100 million is, therefore, what to think about going from quarter to quarter. At the midpoint, we're down about 2%, which is a relatively small number. Again, that can be driven by expectations around the variable side. Finally, regarding meaningful changes, a year-over-year basis, we had some licenses that expired last year and renewed many of them but not all, some customers left the business. Growth has step function changes from adding significant new agreements. A great example is that in the third quarter of last year, we signed Xiaomi. As I said, third quarter last year, we signed Xiaomi, where there has been a lot of past sales there. On a year-to-year basis, that drives some of that decline.

Tal Liani, Analyst

Got it. Now the industry is weakening if you look at Qorvo and what they reported and Qualcomm, what they reported. Everyone is talking about a slowdown of devices; devices still make the vast majority of your revenues. I know you have a different business model with a lot of it being fixed revenue rather than per-device revenue. The question is what happens when the industry is weakening? What's the history? Do you have customers coming back to you and saying, 'hey, we want to renegotiate our historical agreement because now we're selling 15% less or not,' what's the variable portion of your revenues that is tied to the weakening smartphone market?

Liren Chen, President and CEO

Yeah. Hey, Tal. This is Liren. So as Rich mentioned earlier, a vast majority of our smartphone license agreements are fixed fee agreements. What that means is that, under contract, those vendors pay us the same dollar amount year-after-year during the term of the contract. All our customers own their contracts. So we do get paid regardless of whether the market goes up or down. That dynamic does come into play when we have to renegotiate for the next contract, right? If they have lost significant market share, those factors will be factored in, but it's worth noting that for the next contract we are trying to negotiate. It's also a long-term contract. We typically look at third-party projections that make certain forward-looking expectations for the next five years or longer to see how much the volume will be. Some of the shorter-term ups and downs will be factored in but will not drive the long-term numbers. More importantly for us, Tal, it's worth noting that we currently have roughly 55% coverage of the market, with 50% coverage of the smartphone market. We see that over a relatively short period of time, after resolving a handful of vendor relationships, we should be able to grow to about 80% to 85% market penetration. Gaining more vendors and coverage will actually be, in my opinion, a much bigger driver than the short-term losses of certain vendors' market share.

Tal Liani, Analyst

And these missing vendors are mostly Chinese vendors as much as I understand? In the current environment where the Chinese market is weakening, does it help you to get the contracts? Could it inject delays in the contract signing? What’s the timing aspect of getting these extra vendors that are currently not paying?

Liren Chen, President and CEO

Yeah. So we have identified three major vendors that we are in discussions with: Oppo, Vivo, and Lenovo. Among them, Oppo, which includes the three brands, Oppo, Realme, and OnePlus, ships over 200 million devices per year. Vivo is slightly smaller than Oppo, but still a considerable player. The third one is Lenovo, who is a major player in various markets, including the U.S. We're currently in litigation with Lenovo, and our Lenovo litigation has been ongoing for three years now. As I mentioned earlier, we are waiting for a major court decision out of the UK, where the court will decide on a global basis how much our worldwide patent portfolio is worth in what is called a brand rate determination case, which also involves damages for the infringement of our patents on a worldwide scope. On Oppo, we are also in litigation, having filed a series of lawsuits last December across multiple jurisdictions against them. We do not yet have progress to report as those cases are relatively new. Regarding how the Chinese market's weakening impacts these negotiations, I would say it has some impact but not significant. The reason being, all three vendors we are discussing are global vendors. For example, a vast majority of Lenovo's phones are sold outside China. So, the negotiations are determined on a global basis.

Tal Liani, Analyst

The last question, my education is in finance, but I became almost a lawyer covering Qualcomm with the history. In the Qualcomm case, it always goes to court, but in the last second, there is an agreement. Once someone loses, the court rarely decides; I've been following Qualcomm since the '90s, and it always settles out of court eventually. What's the history of your negotiations? Is it based on court decisions or do you typically negotiate once you win a major milestone or you lose a major milestone in court?

Liren Chen, President and CEO

Yeah. Hey, Tal. You're correct that a vast majority of the cases are negotiated or settled before trial; that has been InterDigital's experience as well. Like Qualcomm, we prefer bilateral negotiations, and most deals get done this way. To give you a data point, since the beginning of last year, we have signed 16 new agreements up to the end of Q2. That's a large number, and our last year was record-breaking, signing 30 new agreements. A vast majority of these agreements were signed through bilateral negotiation, without lawsuits. Occasionally, we do have to file lawsuits, usually after lengthy negotiations where the other side simply refuses to pay a fair term that many other vendors pay. When we file those lawsuits, sometimes cases settle before going to trial, and sometimes we go to trial and get a court decision; it's hard to generalize, as it's truly case by case. It's worth noting that throughout InterDigital's history, whenever we have filed a lawsuit to enforce our patent rights, we have always ended up with a licensing agreement under the FRAND terms. Our track record in this area is quite strong.

Tal Liani, Analyst

Got it. Great. Thank you. Thanks so much.

Operator, Operator

Thank you for your questions, Tal. At this time, we'll conduct our next question from Scott Searle with ROTH. Scott, go ahead. Your line is open.

Scott Searle, Analyst

Hey, good morning. Thanks for taking the questions. Liren and Rich, I apologize I got on the call late, so I won't rehash probably some of the stuff you covered in your opening remarks. But I was wondering on a couple of fronts. Samsung recently renewed with Qualcomm. I'm wondering if there is anything to be read in that in terms of read-through for you guys in their ability or willingness to negotiate before an expiration of the renewal agreement?

Liren Chen, President and CEO

Yeah. Hey, Scott. This is Liren. I read the same news about Samsung renewing that agreement; they have continued their existing agreement and added seven more years to it. I view it as a great development for Samsung as well as Qualcomm. I do not really know for sure how that will impact our negotiations, but we definitely see it as an encouraging sign that licensees and licensors continue their long-term relationships. We have a very long-term relationship with Samsung, and I think that’s an encouraging sign.

Scott Searle, Analyst

Okay, good. On the technical front, I'm not sure did you quantify CE or video contribution to the current quarter. As part of that, you've been building some momentum on that front. Now with the macroeconomic overhang, if you will, is that changing the discussion, the dialogue, and opportunity with any of the customers in the near term or are things progressing as they were before?

Richard Brezski, CFO

Yeah. Hey, Scott. I'll take the first part of that question. We mentioned we didn't break it out, but in combination, we said that CE, auto, and IoT contributed $35 million of total revenue in the quarter, and $12 million of that was recurring revenue. We're pleased by the traction across those markets, and both that total and recurring figure represent records for us.

Scott Searle, Analyst

Got you. And Liren, is there any impact in terms of the discussions going forward when you look at what's going on from a macroeconomic standpoint, particularly in some end markets and the slowdown in TVs or smartphones or other larger video display opportunities?

Liren Chen, President and CEO

Yeah. Scott, in general we do not see an impact to our existing agreements because they are fixed fee agreements. But for the new licensing agreements, it's really a case-by-case basis. As you know, our near-term focus is on Apple and Samsung, who are major players in the premium tier. Based on all the reports we see, the impact is more pronounced for those players competing in the low to mid-tier devices. Regarding TVs and others, it's hard to say generically, but we are focused on getting some of the leading brand TV vendor deals signed, and those agreements are also long-term agreements. There is a significant past sales component to it. So in the near term, the impact is relevant, but it’s not necessarily a deciding factor.

Scott Searle, Analyst

Got you. Lastly, if I could. I'm not sure Liren if you had any comments in terms of other video monetization and opportunities. I'd love to hear your thoughts on that front. If not, we can take it offline. Thanks so much.

Liren Chen, President and CEO

We didn't comment specifically, Scott. But one thing I was describing earlier is that, combined with our Technicolor acquisition, we have really positioned ourselves through the past several decades as one of the leading technology developers and patent holders in the video space. Video is increasingly becoming relevant for many devices, including smartphones and other connected devices. We have identified different layers of technology involved, and some of those services layers are also benefiting from our video technology. We are actively looking into this space and will hopefully provide more updates in the future.

Scott Searle, Analyst

Great. Thanks so much.

Richard Brezski, CFO

Thanks, Scott.

Operator, Operator

Thank you, Scott. I'd now like to turn the call back to Liren Chen for closing remarks.

Liren Chen, President and CEO

Yeah. Thanks, everyone. Before we sign off, I'd like to thank all the shareholders for their continued support and our employees for their contributions to another outstanding quarter. Thank you all for joining us today, and I hope everyone enjoys the rest of the summer.

Operator, Operator

Thank you for your participation in today's conference. This concludes the program, and you may now disconnect.