Earnings Call Transcript - IDCC Q1 2021

Operator, Operator

Good day, and welcome to the InterDigital First Quarter 2021 Earnings Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Ms. Tiziana Figliolia. Please go ahead.

Tiziana Figliolia, Vice President of Finance and Investor Relations

Good morning to everyone, and welcome to InterDigital’s first quarter 2021 earnings conference call. I’m Tiziana Figliolia, Vice President of Finance and Investor Relations. And with me today’s meeting 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 risk and uncertainties include those described in the Risk Factors section of our 2020 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

Thanks, Tiziana. Good morning, everyone, and thank you for joining us today. I hope everyone is doing well despite the pandemic. This is my first earnings call as InterDigital CEO and I’m very excited to be here. I have had the pleasure to meet some investors and analysts, and I look forward to meeting as many of you as possible in the coming months. Before I get into a company update, I want to take a moment to acknowledge the contributions of my predecessor Bill Merritt, who drove incredible value creation during his 25 years with InterDigital. Bill continues to be very helpful during my transition. I owe him a debt of gratitude for his leadership over the years, as well as the smoothness of the CEO transition. I want to thank Bill for his contribution and wish him the best of luck for a well-deserved retirement. I have been with the company now for one month and the onboarding has been proceeding very well. My focus for the past month has been getting up to speed, reviewing our organization’s capabilities and beginning to work with our executive teams on the company’s top priorities. Prior to joining InterDigital, I was impressed by the company’s ability to conduct fundamental research in critical areas of wireless communications, multimedia, and AI machine learning. First, as I came up to speed with the various working streams, I’m even more impressed with the dedication of the employees, the breadth and depth of our patent portfolio for 3G, 4G, 5G, multimedia and AI machine learning space, and our position as a thought leader in the licensing industry. Our efforts to provide transparency into our rate structure and patent portfolio are industry-leading. Our ability to influence regulatory and legal changes could significantly improve the licensing environment. It’s quite remarkable. Let me begin with R&D. R&D is the foundation of everything at InterDigital. More than 60% of InterDigital’s employees are engineers, and more than 90% of our engineers are inventors, which is truly amazing. Our performance over the past year, despite COVID, has been very strong. To give you just one example, in 2020, a year where we moved through remote working as early as March, our inventors created about 25% more inventions related to the 3GPP wireless standard compared to the year before. In the past quarter, we have demonstrated a 100 gigabit per second encoder, decoder technology, which is a huge achievement that we believe will open the door to 6G as part of the epic consortium. We were also selected by ETSI to launch and continue to improve their multi-access edge computing sandbox, which is a great validation for our R&D capability and the tremendous relationship we have built with that very important organization. On the video side, our success with standard-focused R&D is increasing with each new generation of standards and provides a great platform for value creation in smartphones, consumer electronics, and other assortments of our technologies. That includes the completion of the VVC standard in December of 2020, which was ratified by ISO in January of this year. InterDigital has played a pivotal role in the VVC standardization project since its inception and has held leadership positions in multiple working groups. VVC improved over the current generation codec performance by 50% and supports the highest features to enable 8K video in TVs, smartphones, and new applications like cloud gaming, immersive, and 360-degree video content distribution. In summary, we have a strong trajectory in the R&D area. Now let me turn to licensing and litigation. We concluded three new license agreements since the end of Q4, including our recently announced renewal with Sharp, a company that had been a licensee for more than 20 years. We continue to make progress with other current unlicensed companies. I’m impressed with the performance and tenacity of our licensing team as they engage with these customers. I believe the combination of our strong IP position, our dedicated licensing team, business relationships, and, where needed, litigation will drive our licensing success over time. On the litigation front, we have provided detailed updates in our 10-Q filing. So I would refer you to that document for any specifics. I want to briefly draw your attention to our cases in India and Germany. Both courts are emerging as programmatic and logical defenders of IP rights. In India, the Delhi High Court recently mitigated an interim anti-anti-suit injunction against Xiaomi. In doing so, it ordered Xiaomi to deposit with the court, for our benefit, any fines that may be levied by the Wuhan Court related to the anti-suit injunction. In Germany, the Munich Court recently also affirmed its anti-anti-suit injunction against Xiaomi. It included positive statements that Xiaomi has acted as an unwilling licensee. Following that decision, we filed three patent infringement cases in Germany against Xiaomi related to 3G and 4G cellular handsets. It is important to note that even where we have resorted to litigation to help conclude a license, we remain committed to maintaining a continued dialogue with our potential licensees. Finally, I’m happy to report that we have taken enormous strides with our ESG program. Three weeks ago, we published our first sustainability report, which documents our aspirations and our commitment to all our stakeholders to continue to progress over time. We are conscious of our responsibility to create value for the shareholders and to act in the best interest of our employees, communities, and customers. As a company, we have a proven track record of acting to stay current with good governance practices. And with our technology, we strive to solve complex challenges that will help build a more equitable and sustainable world. With that, let me turn it to Rich.

Rich Brezski, CFO

Thanks, Liren. I’m pleased to report our first quarter results improved in almost all aspects from the first quarter of last year. In comparison to the first quarter of 2020, our revenue is up more than $6 million. Our expenses are lower by more than $1 million. And we reported diluted EPS of $0.18 per share in the first quarter of 2021, compared to breakeven performance last year. More importantly, the results continue to validate the operating leverage in our model as an 8% increase in revenue, coupled with reduced expenses, drove operating income to more than double the Q1 2020 level. We believe this general relationship can hold, even with the significant top-line growth we are working to achieve. As Liren mentioned, our progress on the licensing front included three new license agreements since the beginning of this year, including a new CE license. This new license contributed to more than $7 million of CE revenue in the quarter, including almost $4 million of recurring revenue. This again is progress, and it has pushed our total CE revenue since we acquired the Technicolor licensing business to more than $50 million. I’ll note that over the last eight quarters, we have now signed five CE licenses and another four mobile licenses that included related HEVC patents. In addition, we have included three of the acquired HEVC patents in our litigation with Xiaomi. Liren also spoke to progress in our litigations. I’ll add to his comments by noting that we’ve been able to move these cases along while maintaining litigation costs at a reasonable level. Of course, as I always say, litigation is an investment. And we remain prepared to invest what is necessary. We look forward to continued progress in these cases and currently expect some increase from our current litigation expense levels as the year progresses. We ended the quarter with a very strong balance sheet including $470 million of net cash. Let me take a moment to explain the change in this figure since year-end. As has been typical, we use cash in our first quarter operations. In addition, we paid our normal quarterly dividend and we resumed some share repurchase activity toward the end of the quarter. But the biggest sequential change in our net cash balance was the increase in debt we recognized as a result of our early adoption of a new accounting pronouncement for convertible debt. You can find the details in the 10-Q we filed this morning, but at a high level, this does not represent a new financing, but we now carry the debt at roughly par value and we no longer report a non-cash charge to accrete the debt up to par for the conversion feature. In closing, we believe our solid results in a strong balance sheet have us well-positioned to make further progress on our goals over the balance of the year. With that, I’ll turn it back to Tiziana.

Tiziana Figliolia, Vice President of Finance and Investor Relations

Thank you, Rich, and thank you, Liren. We’ll now open the call for questions.

Operator, Operator

Thank you. We’ll take our first question from Ian Zaffino with Oppenheimer.

Ian Zaffino, Analyst

Hi, great. Thank you very much. Good comments on the CE side. I just want to ask as far as the CE – what are they all part of a package renewal on the mobile side with CE or were these independent, or maybe what was the mix. I’m trying to figure out how you’re going to market on the CE side?

Rich Brezski, CFO

Yes. So Ian, I talked about two kinds of contributions from the acquired Technicolor assets. One, first I mentioned that the CE licenses where we’re licensing consumer electronics products. So that’s now we can bring some of our legacy assets to bear in those licenses as well. But that’s primarily driven by the acquired portfolio. On the mobile side, there were a couple of deals I mentioned since we – I think the number was four, over the last eight quarters where there were mobile deals, which included the video coding assets we acquired from Technicolor because that video coding is relevant to the mobile devices.

Ian Zaffino, Analyst

Okay. Got you. And then a few others here. I know there’s a rate-setting case going on in China for Xiaomi. Where are we with that? And how do we think about that vis-à-vis the case in India right now?

Liren Chen, President and CEO

Ian, hey, this is Liren. So you are correct. There’s a case in Wuhan, China, where Xiaomi has requested the court for global FRAND rate determination. That case is still in its early stages. And so we don’t want to speculate on what the court may or may not do in what timeframe, but it is important to know that we have a very comprehensive global strategy. So if you look at the case in India, as I covered, and I was also summarizing in our 10-Q filing, so it’s proceeding really, really well. And we also have a case in Germany, actually multiple cases in Germany where the court has found Xiaomi to be an unwilling licensee. And we have followed that up by filing three individual patent cases after that. So it’s important to look at everything in the global context. And if we have more updates from the case in China, we will obviously provide timely updates.

Ian Zaffino, Analyst

Okay. Thank you. And then the final question would be on buybacks. You don’t have to get like $70 million or something at least at the beginning of the quarter, you bought back some stock; take it maybe a little bit more aggressive, but was that just because the stock started to move up, and is that why you kind of didn’t really put the pedal to the metal on buybacks, or is there something else going on?

Rich Brezski, CFO

Yes. I think Ian, we’re always looking to balance the strategic benefit of a strong balance sheet, and the optionality that provides. We’ve been disciplined in responsible return of cash to shareholders. So that’s always been the case and remains the case. We picked up some activity towards the end of the quarter there. But beyond that, I’ll let our history on this topic speak for itself rather than get into specific details about the programs.

Ian Zaffino, Analyst

Okay. Thank you very much, guys. Appreciate the color.

Operator, Operator

We’ll take our next question from Scott Searle with ROTH Capital.

Scott Searle, Analyst

Hey, good morning. Thanks for taking my questions. Liren, congratulations and welcome to your first conference call. Hey Rich, I’m not sure if I heard the number, but did you give a CE number or a Technicolor number for a first quarter contribution?

Rich Brezski, CFO

Yes. I said total CE revenue was about $7 million with about four of that being recurring.

Scott Searle, Analyst

Got you. Okay. So we had some catch-up licenses in there in terms of some of the new licensees.

Rich Brezski, CFO

Yeah. If you look at our financial metrics, you’ll see that we had some past sales. I think that’s discussed in the Q as well.

Scott Searle, Analyst

Got you. And Rich in terms of OpEx, I know it varies from quarter to quarter given the patent administration costs, but how should we be thinking about that over the course of this year? I know you’ve been looking at tightening things up and maybe coupling that, Liren, you’re having been in now for a relatively short period of time, but how are you thinking about the current expense structure? Are there things that you’re looking at in terms of optimizing that as we go forward?

Rich Brezski, CFO

Yes. So I’ll start and then allow Liren to comment afterward. So on the first part of your question, I mentioned on the call or in my script that we saw some pretty reasonable expense levels in litigation in the first quarter. But with the cases that Liren already referenced, we do expect that to go up a bit as the year progresses. Don’t have any more specific comments at this point, but certainly we’ll provide some updates there as we move along. And we have been working for a long time, as you know, to bring expenses and the portfolio cost down following the Technicolor acquisition. We think that we got through most of that work last year. And really now it’s just the ongoing process to make sure that the portfolio and our operations in general are operating efficiently.

Scott Searle, Analyst

Okay.

Liren Chen, President and CEO

Yes. Scott, this is Liren. So regarding the overall strategy as well as the cost structure goes, I want to underscore this is my first month at InterDigital. I have done a lot of internal reviews as well as looked at various different aspects of the high priority issues, organizational capabilities. I’m overall very impressed by what we are doing on the R&D side, as well as in the licensing area and the breadth of our patent portfolio is quite impressive. So at this moment, I think we are in very good shape strategy-wise and execution-wise. But in the meantime, though, I do want to point out I’m a strong believer in continuous improvement. So as I learn more about the company and its different aspects, I’m sure we’ll find ways to do better in probably a number of different areas. And I’ll work very closely with our executive team to improve and to add value where it’s appropriate.

Scott Searle, Analyst

Okay, great. And Liren, if I could I know you had some comments as it related to Xiaomi both in India and Germany, but I’ve not gone through the full filing online. Could you take us through the highlights and timelines we should be expecting in the near to intermediate term, in terms of how those cases progress and kind of what the ultimate timeline here is to get some of this because it sounds like from an India standpoint, there’s an injunction potentially on the table in the not-too-distant future. What are the milestones really to get to that and enforce that, and then the timeline as it relates to the German proceedings?

Liren Chen, President and CEO

Yes. So, hey Scott, basically what I was pointing out to you in our earlier discussion as well as in our 10-Q filing here, we had pretty major good outcomes from the India case that was really good verbally two to three days ago. So where the judge has determined the interim anti-anti-suit injunction that was awarded to us earlier, is now turning into a preliminary injunction against the permanent anti-anti-suit injunction against Xiaomi while the case is pending for the court to review in India. In addition, Xiaomi is also ordered to restrain from reinforcing that ASI in Wuhan, and if the Wuhan Court finds InterDigital, then Xiaomi is required to deposit whatever fine amount the Wuhan court issued against us into the India court, where we will essentially be able to access the same fine transferred to InterDigital. So that’s the essence of the caseload in a nutshell. So regarding the timeline here, it’s very difficult to predict the precise timeline. And in China, India, or in Germany and the German case, let me touch on a little bit more here. Essentially, the court has determined Xiaomi to be an unwilling licensee in the prior decision. And then we followed that up by filing three new patent cases. Those cases, we’ll go through their patent trials. If they are found to be valid and infringed, then we expect the court to issue its decision regarding an injunction among other things. But it’s really difficult to predict the exact precise timing for those cases.

Scott Searle, Analyst

Hey, very helpful. If I could just a quick follow-up on the India proceeding then, given so if you’re moving to a permanent injunction and they’re requiring them to basically, I guess, sounds like place fines in escrow. What are they basing that fine amount on? I’m kind of curious in terms of how they set that rate. And do you know how many units Xiaomi shipped into India in 2020?

Liren Chen, President and CEO

Okay. Scott, I want to make it very clear. Maybe there’s a little bit of confusion on this. So when we say make it permanent, we mean the anti-suit injunction order. While the case is pending, the previous decision was making an interim, now the court has made that anti-suit injunction against Xiaomi to be permanent, while our case is pending review at the India court. So that’s why I want to make sure it’s clear. The second thing this discussion about deposit funds into the account, it’s also specific really to the Wuhan Court’s earlier decision against InterDigital, where the court has threatened a certain amount of fine to us. But that Wuhan Court really has not enforced that fine. And in this context, the Indian court basically decided if the court in Wuhan is enforcing a fine against InterDigital regarding its anti-suit injunction decision, then Xiaomi is required to deposit fine into the India court, so we will be able to use the funds to make InterDigital whole. I hope that’s clear.

Scott Searle, Analyst

That is, thank you. And lastly, if I could, I’d be curious as to your thoughts in terms of the strategy on the IoT front. There are currently a couple of joint ventures where the company is pursuing certain markets like metering and auto. I was wondering your thoughts from a high level in terms of the opportunity for IoT and how you approach that market going forward. Thanks.

Liren Chen, President and CEO

Yes. Hey, as you pointed out, InterDigital has a couple of participations in various different platforms for IoT plays. That covers automobile and smart meters. And we are still going through the internal onboarding process here. I currently do not have any updates on the strategy; everything is going well with our current platform. But for me, as I learn more, if there are any updates, I will provide updates you in future discussions.

Matthew Galinko, Analyst

Good morning, everybody. I’m on for Anja this morning.

Liren Chen, President and CEO

Hey, Matt. Good to hear from you.

Matthew Galinko, Analyst

Yes, nice to talk to you. I think you called out for wireless renewals that included Technicolor assets today. How did the economics play out in general relative to the uplift you had anticipated when you acquired Technicolor?

Rich Brezski, CFO

Yes. So a number of those deals were fixed price agreements. So at the end of the day, you’re negotiating for a sum. What I would tell you is that all the deals were consistent with our rates schedule. So that includes all aspects of technology that we bring to the deal. So unpacking it and saying, this much for that or it’s not called out that way, it’s essentially a negotiation for a total fixed amount.

Matthew Galinko, Analyst

Got it, all right. And I guess, an accounting question here, I guess I’m thinking through it on the fly, but in terms of the new accounting policy around the convertible debt. Was there a material impact to the P&L quarter-to-quarter on the interest line?

Rich Brezski, CFO

Yes. So the way that you booked the convertible debt beforehand was, you try to estimate the value of the conversion feature that’s embedded within the instrument. That’s what enables you to pay a lower coupon. So that is treated as a no ID, and then you accrete it up to par over the life of the debt. So under the new rules, which we early adopted on January 1, you no longer do that. So you’re basically carrying the debt at par. So you’ll see the beginning of the year adjustment to retained earnings to bring that up. And you’ll see that, as I mentioned, the value of the debt on the balance sheet is obviously higher as well. So that non-cash accretion – in effect of non-cash interest expense goes away, which was somewhere in the neighborhood of $3.5 million to $4 million impact on the quarter. But those details you can see in the footnote.

Matthew Galinko, Analyst

Perfect. All right, thanks. And then last question, just around the CE licensing strategy. I think you called out about $50 million generated since the Technicolor deal closed. Where do you think we are – what inning are we in there? And do you see that accelerating as we move through 2021 into 2022 or kind of one of the factors that are influencing that pace?

Rich Brezski, CFO

Yes. So I think the encouraging thing is that we’re signing deals that further validate the rates that we charge within that market. And maybe Liren has other comments on that, but in terms of what inning we’re in, I mentioned there’s about $4 million of recurring revenue in the quarter. Now mind you, the CE business is a little bit more volatile quarter-to-quarter, but that implied $60 million annualized, which is a little more than 10% of the overall goal there. So it’s still early innings. Most of the larger vendors are unlicensed at this point. So the important thing is to transition from getting the smaller deals done to getting the medium and larger deals done. That’s what’s really going to move the needle there.

Liren Chen, President and CEO

Yes. So this is Liren. The only thing I would add is so the Technicolor acquisition, we have acquired very valuable assets related to HEVC, as well as the next generation VVC. We believe those assets will be really valuable, not just for the CE market but also for smartphone mobile use cases. So we believe those assets will come into play for the car license inside as well.

Derek Soderberg, Analyst

Hi, guys. Thanks for taking my questions. I’m sort of piggybacking off an earlier question on pricing, but maybe a bit more high-level. Is there anything having an impact on the rates you’re charging today for new agreements? Just given some of the price increases we’re seeing broadly. Do you have any plans to change the royalty rates generally that might be abnormal compared to years in the past? Any thoughts on the pricing environment would be helpful?

Rich Brezski, CFO

Yes, Derek. So what I want to go back to is, as Liren mentioned in his remarks, we have among, if not the most transparent rate structure in the industry and we came out with that and published that a little more than a year ago. And there really hasn’t been any change to it. We feel good about that. And that’s what we’re going to market with.

Derek Soderberg, Analyst

Got it. And Liren congrats on the new role. I’m just sort of curious, if you could share some of your top priorities; I know it’s still kind of early in the game for you. Just anything you’re targeting this year, if that differs at all from your predecessor, maybe as it relates to targeting various handset OEMs, fixed versus variable agreements. And then if you could just share any of your – some of the key opportunities that you’re targeting this year, that’d be great.

Liren Chen, President and CEO

Yes. Hey, Derek, this is Liren. Thank you. So as I mentioned earlier, we’re executing exceptionally well despite also a very difficult environment for R&D, and we have very, very valuable patents covering super important technology related to 5G video and AI machine learning. And those technologies have become increasingly more important with the pandemic and potentially post-pandemic, remote working, remote learning, and remote education opportunities here. So we feel very good about what we have and we also have a very, very capable licensing team who are driving really hard. We obviously still have some pretty major opportunities in our unlicensed accounts. So it’s obviously a priority for us to approach those accounts and through business negotiations or whenever we have to sort of engage in ongoing dedication to drive closure to those accounts. So those are some of the top priorities. As I’m going through my review for the company-level priorities, I’m sure there will be new opportunities and new areas for improvement, and those will also be important for us to keep on driving the operational efficiencies in all these different areas.

Operator, Operator

That concludes today’s question-and-answer session, Ms. Tiziana, at this time, I will turn the conference back to you for any additional or closing remarks.

Tiziana Figliolia, Vice President of Finance and Investor Relations

Thank you, Victoria. Liren, would you like to make any final remarks?

Liren Chen, President and CEO

Yes. Hey, I just want to say thank you to all the employees for their dedication, and also for keeping on executing during a very, very difficult time. I’m honored, excited, and definitely humbled by the opportunity to lead the company into the next chapter. Thank you.

Tiziana Figliolia, Vice President of Finance and Investor Relations

Thank you, Liren, and thanks to everybody for joining us today. We look forward to giving you an update next quarter.

Operator, Operator

This concludes today’s call. Thank you for your participation. You may now disconnect.