my3sons
One of us had better learn to read as there is nothing ambiguous about
what is said it talks about the strong deal and how that alone has proven
the Hillcrest acquistion as a good deal. Read carefully everything IDCC
says about Internet of things and the Hillcrest acquisition.
From every measure 2016 was the best year the Company ever had. Financially our revenue and profit were the strongest ever as was our cash flow. Our stock obviously performed well.
So how did that happen? The answer is straightforward, we executed on a few simple goals we set for ourselves in 2016. Goals that because of our experience in operating our business we knew would drive substantial value. Those were one, to drive greater revenue but more importantly drive greater certainty and stability around our cash flows.
Two seize the massive 5G innovation opportunity to allow us to grow our core business. Three, drive the IoT opportunity as an additional growth factor. And four, begin acquiring businesses that would make our core business even stronger.
Let me address each of these. On the revenue side became into 2016 with a good revenue level a great opportunity for growth. What was missing was better long-term revenue stability and predictability.
Yes we had Samsung, the number one player in the market under a long-term license, but Huawei was not yet paying and revenue derived from the sale of Apple products was through a supplier arrangement that had some level of risk for us. By the end of the year this had all changed.
We signed Huawei to a license agreement that included a cooperation component. We love agreements that have a cooperation component because experience has shown that these are the easiest to renew and because we're confident in our InterDigital Labs teams ability to drive or deliver great value.
We also signed Apple to a comprehensive agreement. That gives us the top three vendors in the world under agreements that provide us with superb revenue stability and visibility. In fact the recurring revenue from those agreements combined with the past sales collection and contribution from our other licensees resulted in our finest financial year ever. It is from that incredibly solid foundation that we believe we can grow the business even further.
Part of that growth is 5G. As we have mentioned on numerous calls and in many interviews with mainstream and trade publications, 5G is a massive innovation opportunity. Our engineers along with others are being challenged to design a network that will take your mobile phone experience to new heights, but also enable the IoT dream and drive incredible new services like self driving vehicles. In my 21 years with the Company and even comparing it to the first deployment of wireless systems, we have never been faced with such an innovation challenge.
I liken it to in when John F. Kennedy instructed NASA to get us to the moon before the end of the decade. The challenge seemed insurmountable, but when undertaken by the finest engineers, that dream became a reality. The same is true for 5G as I am confident that the wireless engineers around the world, InterDigital is among them, are similarly rising to the challenge and creating a wireless system that will be able to do all of these things and more. And like the original Internet, that system will revolutionize so many things and create extraordinary opportunity for us not only to drive our core licensing business, but also create and grow a new licensing business in the IoT realm.
Which brings me to the third thing we focused on in 2016, the IoT opportunity for the Company. In 2016 we focused the opportunity in two distinct areas. First we joined the Avanci IoT licensing platform as a means of pursuing the connection level IoT opportunity. In other words the licensing of technologies in our existing licensing program to connect things like sensors, meters and other devices, IoT devices, to the network.
Cooperating with Avanci partners like Qualcomm, Ericsson and others represented the most effective and efficient means of pursuing the licensing of what will be a vast and diverse market. So far we are very happy with the progress being made by Avanci.
Second we consolidated all of our upper layer software and patent licensing opportunity into a single group at the Company. As those of you who follow us closely, that opportunity is a based on the interoperability standards development we did and continue to do and our resulting standard space software solution. Interoperability is key in IoT once devices are connected to the network they need to connect to each other in order for businesses to build meaningful capabilities.
Our IoT solutions group had a very good year in terms of building out our solution, getting it into hands of customers for trial and building an echo system of channel partners. That includes the partnership announcement with CA Technologies just two days ago, which layers on to other great partnerships with HARMAN and [Arope].
Our value proposition is very straightforward. With our cloud-based operating environment powered by our standard space connection platform, we offer the most rapidly scalable system for deploying a comprehensive IoT solution in basically any market vertical whether it is industrial, smart city, automotive, or commercial.
We demonstrated that capability in the UK where we were part of a team that deployed the framework for a traffic management system in a matter of months. That capability has led to great recognition. Our IoT solutions have now won or been short-listed for nine prestigious global awards a phenomenal achievement. All in it was a great year for IoT business.
Our fourth objective in 2016 was to begin to make acquisitions that would drive our core business even further. We completed such an acquisition in December when we acquired Hillcrest Laboratories a recognized leader in sensors and sensor fusion. Hillcrest fit perfectly into our M&A strategy where our goal was to acquire additional areas of deep competence to complement a very strong position in wireless allowing us to deliver more technology to our current customer base. Such an acquisition leverages our business model, our customer position and our historic strength in licensing. There is no better way to build value at the Company.
In the case of Hillcrest that new area of competence is made up not only of a strong technology offering associated patent portfolio, but also the R&D capability to allow those elements to grow. Indeed that is the bedrock of our successful R&D backed licensing business. It is not that we just have patents it is that we have recognized core strength in an area of importance to mobile devices. A strength that is embodied in the extreme competence of our engineering teams, the accuracy of our forward vision, our leadership positions in standards [bodies], the size and quality of the patent portfolio, and how often people reference InterDigital as a thought leader in our space.
For wireless, I cannot tell you how many interviews and calls we've had about 5G, with people reaching out to us as a recognized thought leader. Hillcrest has a similar position in the growing space of sensors and sensor fusion. We intend to build on that position and further develop that area of competence.
Which brings me to 2017 with our goals being largely the same as 2016. First, for our core licensing business we continue to work towards new license agreements that drive additional revenue. We will deploy all of the tools at our disposal including our portfolio of patents, our ability to partner on R&D, our IoT assets, and our newly acquired capability with Hillcrest.
We will continue to drive innovation in 5G. 2017 will be a huge year in terms of the opportunity to influence the standards and we intend to bring our best innovation to the process. As an example of our leadership next week at the Mobile World Congress in Barcelona, the GSMA, our industries most important trade association has asked us to join Qualcomm, Ericsson and Intel in showcasing our 5G technology on the main stage.
Further we will drive the IoT opportunity. We should expect to begin to see revenue from Avanci and also revenue from the deployment of our software. While the amount of revenue may initially be small, what we will be looking for is a quality of customer to related revenues such that we can demonstrate the ability of the IoT business to grow quickly.
Next in addition to leveraging the strength of Hillcrest into our core licensing business we will also seize the opportunities that Hillcrest has created in new markets of robotics and ARVR. We believe these are important future markets where the combined technologies of Hillcrest and InterDigital can create value for shareholders.
Lastly we will continue to look for the right type of acquisitions. I think the Company will benefit from greater scale. That said the idea is not to change the fundamental nature of our business. As mentioned before, our goal is to build more technology strengths giving us significant depth in a number of different pervasive technologies related to current and future mobile devices.
Our ability to effectively and efficiently deliver these new technologies to our customers will enhance our royalty platform and drive even greater profitability, all the while keeping true to a business model that has served us very well. In sum we had a great year and we start 2017 in an incredibly strong position. We have the opportunity to drive even more success and we fully intend to do so. With that, let me turn the call over to Rich.
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Rich Brezski, InterDigital Inc - CFO [4]
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Thanks, Bill. There any number of strong adjectives I could use to describe our fourth quarter and full-year 2016 results. But the numbers really do speak for themselves. In 2016 we generated record full-year free cash flow of close to $400 million in addition to record full-year revenue of $665.9 million and EPS of $8.78 per share.
What is most important is the significant progress reflected by our 2016 results. During the year we entered into a patent license agreements with the second and third largest handset vendors in the world, which together with Samsung, accounted for approximately 40% of all 3G and 4G handsets sold in 2016. Having these top handset manufacturers under license to our portfolio of technology is the latest validation of our long-standing and continuing innovation within the wireless industry.
I want to try to provide a break down of the fourth quarter revenue related to Apple. Because we recognize revenue from Pegatron in the quarter that follows their shipments, our fourth quarter results include three components of revenue from the Apple ecosystem. First, royalties Pegatron paid associated with their third quarter 2016 shipments of Apple products. Second, amortization of fourth quarter 2016 revenue associated with our new license agreement directly with Apple and third, revenue associated with past sales of Apple products that were not covered by another agreement.
Of these amounts, we recorded only the amortization of fourth quarter 2016 revenue from Apple within recurring revenue. The other two components of revenue were recorded within past sales, accounting for the vast majority of our fourth quarter past sales of $180 million.
Moving back to our overall results, we were able to achieve this record level of revenue with our lowest level of operating expense in the last five years. Over that time period our pro forma operating expense, which we believe provides a better metric for period to period comparisons, has a compound annual growth rate of 2% and that includes the slight increase in expense since 2012 associated with our participation in the Convida joint venture.
As you have heard me say before, expense management is a key area of focus with us. That doesn't mean we want to keep our expenses at the lowest possible level, but rather that we want to invest at the optimal level. Our recent acquisition of Hillcrest Laboratories illustrates that point.
As things currently stand we expect Hillcrest to contribute roughly $18 million to $20 million of annual operating expenses and costs with roughly one-third of that offset in 2017 by expected revenue contributions. The operating expenses include approximately $4 million of amortization expense associated with acquired intangibles related to Hillcrest very strong intellectual property portfolio.
We believe the resulting near-term increase in net operating expense is a very worthwhile investment to add both Hillcrest fundamental position -- investment to add both Hillcrest fundamental position and sensor fusion technologies and the team that built that position. Over the long-term we see great opportunities to capitalize on the revenue potential from Hillcrest existing business, as well as to further enhance the value proposition we offer to customers of our wireless technologies.
We finished 2016 with an effective tax rate of 27.7% in large part due to the amended tax returns we filed in second quarter 2016 to take a domestic production activities [deduction]. Excluding the impact of this deduction related to prior years, our effective tax rate would have been about 33.4%, which represents a 2.3 percentage point reduction from the prior year.
I'll close with an update on capital allocation. We have not repurchase any shares of our common stock since third quarter 2016. In fourth quarter we paid $10 million in dividends following our third quarter increase to our quarterly dividend to $0.30 per share. We also invested $48 million in the acquisition of Hillcrest.
We continue to consider share buyback and dividends along with both organic and inorganic investment opportunities. Deployment of cash is always a matter of particular attention at InterDigital, as is always a case of primary criterion for balancing the mix of these options is value to our shareholders. With that I will turn it back over to Patrick.
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Patrick Van de Wille, InterDigital Inc - Chief Communications Officer [5]
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Thank you very much, Rich. Chris, if we could open the call for questions.
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Questions and Answers
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Operator [1]
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Thank you.
(Operator Instructions)
We will take our first question from Darrin Peller of Barclays.
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Nekheal Dixon, Barclays Capital - Analyst [2]
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Hey guys this is actually [Nekheal] Dixon on for Darrin. Congrats on the strong quarter.
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Bill Merritt, InterDigital Inc - President & CEO [3]
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Thank you.
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Nekheal Dixon, Barclays Capital - Analyst [4]
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So when you think about the transition towards newer generations if we could take a step back for a moment, how do we think about the timeline for some of the earlier 2G, 3G contracts potentially winding down? And do you have any concerns about consolidation of those 2G and 3G legacy industry players? I mean are you seeing any signs of that in the market and if we could get a sense of how your exposure to 2G and 3G compares to 4G? Thanks.
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Bill Merritt, InterDigital Inc - President & CEO [5]
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This is Bill. I don't really see the windup or roll down of 2G networks affecting us it all. We don't have any revenue that comes in purely associated with 2G. The fact that the devices are multi-layer in terms of they have all the layers is what really protects us against the expiration of any either technology because operators turn it off or because patents in that particular area may eventually roll off. If you think about our 3G portfolio it actually still has a tremendous amount of life left to it.
Our 4G portfolio obviously is very strong and will continue to be strong for a long time and we're building our 5G position. We really don't have exposure with respect to any one layer of the stack. We really just benefit with the thing that happens is when a new layer gets launched what we benefit from is customer excitement around that new technology that drive sales of these things. Again, we don't really have exposure to legacy equipment as it rolls off.
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Rich Brezski, InterDigital Inc - CFO [6]
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I'm sorry. I was just going to add that every year-end in our 10-K we disclose in the MD&A section expiration of patent license agreements. Including the pending expiration of any agreement that absent renewal or so forth would terminate during the next year. Which in this case is 2017. Of which there is two agreements scheduled to expire in whole or in part.
I'm not saying they will or will not be renewed. But we noted that collectively those agreements accounted for $17.7 million or about 3% of our total revenue in 2016. So really not all that significant an issue. Again as we've disclosed all along Samsung has the ability to terminate certain rates and obligations for the period after 2017, but we view and count that as a 10-year agreement.
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Nekheal Dixon, Barclays Capital - Analyst [7]
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Great thanks that's encouraging. And then with regards to the potential incremental partnerships or opportunities for IoT outside of the Avanci platform, obviously the publicity has been great. Do you have any visibility into any other revenue guidance you can provide their besides the $75 million to $100 million opportunity? Or any color with regards to how you intend on monetizing the IoT opportunity in 2017 and beyond on the strategy there would be helpful. Thanks.
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Bill Merritt, InterDigital Inc - President & CEO [8]
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Sure. So as we mentioned there's two components of revenue, high level right. There's the connection level revenue which we will give to Avanci and then separately there is the upper layer revenue that will come from the software and patent licensing with respective to those upper layers. When we put out the goal on IoT revenue we did say that we were also going to help people along the way because that was a 5-year goal and we would need to give you milestones along the way to show that we are marching towards that objective.
During the course of the year that things that we will do our best to give visibility into will be things like customer wins on the software side and related revenue there, related to those wins. And as I mentioned in my script particularly how we see that is opportunity scaling.
So we do have customer opportunities for example in the UK. We have opportunities to our partners HARMAN for example we will provide color around those opportunities as appropriate to show that we are marching towards that goal.
I think the same would be true for how we will look at the Avanci revenue as it starts to come in at the appropriate time giving color as to what is coming in and how we can see that growing. Again our intention is to give you as much granularity here as we can so that you can see that we are achieving the goals that we laid out.
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Operator [9]
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And our next question comes from Eric Wold, B. Riley.
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Eric Wold, B. Riley & Co. - Analyst [10]
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Thank you. Good morning. As you think about I guess now that you have the direct royalty agreements with Apple, Samsung and Huawei in hand, out of the revenue platform guidance that you just updated in December after the Apple agreement what portion of that revenue would now be considered fixed versus per unit? And as you think about it going forward in the future, if those three companies continue to gain share away from other manufacturers that are on per unit deals with InterDigital, how do you think about insulating yourself from that risk?
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Rich Brezski, InterDigital Inc - CFO [11]
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Yes, so I guess the first thing I'd direct you to Eric is we disclosed in our MD&A the breakout as well as in our financial metrics the breakout between fixed and per-unit and that is the recurring components of that, because the past sales is broken out separately. And so you will see the shift that occurred in the fourth quarter as compared to the prior quarter and even more so as compared to earlier in the year and the mix going more heavily weighted towards fixed. So I think that would address the first part of your question.
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Eric Wold, B. Riley & Co. - Analyst [12]
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Real quick -- I understand that because I can see in the breakdown I understand that last year there were some shifts that happened in Q4 obviously you had some different things with just if you are looking at the guidance I think the $360 million to $380 million number might be wrong of your platform revenue guidance can you just quickly give us what percentage of that would be fixed versus per-unit?
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Rich Brezski, InterDigital Inc - CFO [13]
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Yes I think rather than give you the percentage I think you can pretty much get there by looking at the breakout on our financial metrics because we will have within the fourth quarter those components broken out because they are the recurring components. They are the levels from existing agreements more or less carry forward into the next year.
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Eric Wold, B. Riley & Co. - Analyst [14]
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Okay.
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Rich Brezski, InterDigital Inc - CFO [15]
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If you focus on the fourth quarter I'm saying.
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Eric Wold, B. Riley & Co. - Analyst [16]
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Okay. And then the second part of the question in terms of if there is a continued industry shift away from the smaller per unit guys to the larger fixed fee?
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Bill Merritt, InterDigital Inc - President & CEO [17]
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That's the sense the trade off you make right? There is always that risk that the high flyers in the market will continue to do so. But obviously for all of these customers, the top customers, we've locked in deals at a time when they were doing very well.
Is there a risk that they could even do better and we would lose a little money? That's possible. They could go the other way and we would benefit from that but we obviously benefit immediately from the stability and strength of the revenue streams.
I am not sure that the movement of market share as a value creator is as important as signing new agreements. And what the signing of Huawei and Apple and Samsung does is give us a lot of strength in going after the LGs, the Lenovo's, ZTE's of the world where this is far more value creating than Samsung getting an additional 1% market share on handsets. It's the balance we strike all the time we're not fortune tellers we don't know exactly where the market is going to go but the fact that we signed these agreements at times when these folks were all three are flying pretty high that is a good time to do this the more stable agreements.
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Eric Wold, B. Riley & Co. - Analyst [18]
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Okay. That makes sense. And then if you take that a step further and think about expansion in the coming years further into IoT maybe some of the areas that Hillcrest is getting you into, does that create a sense in InterDigital -- or do you want to look for more of these fixed fee agreements that provide some stability or does that always depend upon the market growth dynamics, who you're dealing with? I mean is there a preference one way or another or a lot of underlying variables beneath that?
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Bill Merritt, InterDigital Inc - President & CEO [19]
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There's not a strong preference. I think for every customer there are a number of factors that we look at and one of the factor is what does the customer want to do? And some times they only want to do a fixed price deal and we are not going to fight City Hall and try to do something different. So ultimately we just look at things on a cash flow basis and as long as they are structured right we are almost indifferent between the per-unit agreements and the fixed-price agreements. I think we are just going to take each customer as they come be it a flexible license or that we've been all along and create the value that we've been doing consistently for the last number of years.
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Eric Wold, B. Riley & Co. - Analyst [20]
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Last question if I may around Hillcrest, so you gave comments around $18 million to $20 million of OpEx with one-third of that offset by revenues, so still in a loss position. Maybe give a sense of how fast that revenue has grown combined with if you think about your ability to get additional royalty agreements from the Hillcrest IP, add that IP into your existing deals or even pump up those deals, when would you expect Hillcrest to positively benefit EBITDA or earnings?
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Bill Merritt, InterDigital Inc - President & CEO [21]
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I think the way to look at Hillcrest I mean I appreciate that you can look at the revenue that they bring to the table and the markets they participate in and the cost they apply to our income statement and there is certainly opportunity for growth in that markets that they are participating in. The more immediate near-term value of Hillcrest is its impact on our core business. Is not their independent revenue and so if you think about customers that Hillcrest has had or has, I mean they have LG as a customer, they have other vendors in China that have been customers.
It is the ability to work with those strong customer positions and drive core licensing business deals. That is the value. So I will give you as an example as a result of the relationship with Hillcrest we were to be able to drive a strong deal with the ZTE.
The Hillcrest acquisition at that point it proves itself to be the valuable transaction we believe it is. And then the incremental revenue growth they have in their own business is really gravy on top of that.
So we are going to focus in both areas as I said in my script we are going to focus on leveraging their very strong position in sensors and sensor fusion in the mobile market. Devices today, handsets today have sensor fusion in them and so we can leverage that position and at the same time drive their position in these new markets. But the first of those two is where we will get the more near-term big value from that transaction.
Now if anyone can see anything that indicates may get a strong deal I
will kiss your ass in court square and give you a hour to draw a crowd
to witness it.
JMO
Mickey
