InterDigital's CEO Discusses Q1 2014 Results - Earnings Call Transcript
May. 1, 2014 5:23 PM ET
Executives
Patrick Van de Wille – Vice President, Communications & Investor Relations
William J. Merritt – President and Chief Executive Officer
Richard J. Brezski – Chief Financial Officer
Analysts
Timothy J. Quillin – Stephens Investments
Charlie Anderson – Dougherty & Co
Eugene Fox – Cardinal Capital Management LLC.
InterDigital, Inc.(IDCC) Q1 2014 Earnings Conference Call May 1, 2014 10:00 AM ET
Operator
Good day, and welcome to the InterDigital First Quarter 2014 Earnings Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Mr. Patrick Van de Wille. You may begin, sir.
Patrick Van de Wille - Vice President, Communications & Investor Relations
Thank you, Steve. Good morning, everyone, and welcome to InterDigital’s first quarter 2014 earnings conference call. With me this morning are Bill Merritt, our President and CEO and Rich Brezski, our CFO. Consistent with last quarter’s call, we’ll offer some highlights about the quarter and our outlook, and then we will open the call up for questions.
Before we begin our remarks, I need to remind you that in this call, we will make forward-looking statements regarding our current beliefs, plans and expectations, which are not guarantees of future performance and are subject to risks and uncertainties that could cause actual results and events to differ materially from results and events contemplated by such forward-looking statements.
These risks and uncertainties include those set forth in our earnings release published this morning, and those detailed in our Annual Report on Form 10-K for the year ended December 31, 2013, and from time-to-time in our other filings with the Securities and Exchange Commission. These forward-looking statements are made only as of the date hereof, and except as required by law, we undertake no obligation to update or revise any of them, whether as a result of new information, future events or otherwise.
And with that, let me turn the call over to Bill.
William J. Merritt - President and Chief Executive Officer
Thanks, Patrick, and good morning everyone. It was a busy quarter from many perspectives with a good number of very positive developments. Let me highlight a few of the more important ones. First, as to the overall financial performance, we had a very, very solid revenue growth year-over-year, driven by our relationship with Pegatron, which we’ll get into the details on that, but it does bode very well for the business between that and our existing licensees, we entered the year with a very solid licensee base with good upward growth potential.
The bottom line was obviously affected by the continued high litigation spend at more traditional levels would have been comfortably profitable and delivered positive cash flow. By taking to account and opportunities, how do we leverage our history of innovation, our long history of licensing and our well-established lead structure into a more certain long-term revenue stream delivered at a much lower cost. We’ll take a few things, some of which we control, some of which we can influence that are all which are achievable. Let me go through them.
The first one, of course, is to demonstrate the value of our technology. I think our invented history speaks for itself, but recent court decisions to validate that as well. Specifically on the power ramp-up patent, which cover a critical invention in WCDMA systems. We are now seeing a consistent pattern of successful litigation despite an adverse decision in the 800 investigation in December, which we appealed.
We’ve had success in the Federal Circuit. Then earlier this year, we saw a success with the ITC in the remand case against Nokia. There the ITC confirmed it would follow the Federal Circuit decision on two of the power ramp-up patents, positioning us well against Nokia in that case.
We also saw Judge Andrews in the Delaware District Court confirmed our claim’s instructions on those same patents in the infringement case we had against the ZTE in Delaware. These developments are also pertinent to the 868 investigation where those patents are asserted against both Samsung and ZTE, and which is slated for an initial determination in mid June.
So on infringement and validity, we believe we have built a very strong case. Of course, litigation is never certain; particularly in a politically charged environment, but I think we’ve done all we can do. And if the ITC can just call balls and strikes, we think we should prevail.
The second factor is easy. We need to be objectively reasonable and we are. It’s always been our approach to negotiate in good faith and at fair value. We offer flexible licensing terms, partnering arrangements, and even arbitration. In fact the vast majority of our licenses come without litigation is testimony to our reasonable ones.
So, all being reasonable and flexible is not the problem. Instead, historically and to some extent even more recently, we have not seen the same reasonable and flexible behavior uniformly from potential license fees. In fact, the legal systems team cannot even require it, that maybe changing.
Over the past few months, arbitration has begun to pop up more frequently as a means of resolving these disputes. It did so between us and Huawei, and between Samsung and Nokia. In a recent European investigation, Samsung has agreed to arbitrate disputes involving in standard-essential patents prior to seeking an injunction.
Nokia also made a similar commitment in China with the sale – in connection with the sale of its handset business. We have also agreed to offer arbitration in China. Those commitments certainly apply only to the patent holder. There is no requirement that the other party agreed or arbitrate. However, these commitments start to create a set of standard practices or code of conduct. If a party is willing to arbitrate a license under its standard essential patents, shouldn’t agree to do the same when it needs your license.
A consistent code of conduct becomes very important within the larger framework with standard essential patents are being analyzed. Almost uniformly in the U.S. and abroad, the holders of SEPs are being seen as entitled to the full set of remedies as any other patent holders so long as we. One, they have been willing to license the patents on fair, reasonable and non-discriminatory terms. And two, the other party has not been willing to license the patent for such terms.
Indeed, in a recent federal circuit case, the court acknowledged that standard essential patents do not require any special framework in determining whether injunction is available, the standard Supreme Court eBay test would apply. And further acknowledged that an unwilling licensee could be the subject of an injunction. So what that all means? It’s simple and its rationale.
So patent holders and potential licensees should now be heavily incentive to act reasonably. What is a reasonable? Well, that can be highly fact dependent, it should meet at a high level that has a license or has made a reasonable proposal consistent with all its other license agreements, refusing a license on those terms is evidence of a potential licensees unreasonableness.
It should also mean that the patent holder has offered arbitration as a means of resolving the differences between the parties, refusing to arbitrate may be correctly perceived as unreasonable behavior. So between the strength of our patent position, the reasonableness of our licensing practices and willingness to arbitrary and the increasing pressure on potential latencies to act reasonably in turn, we think we’re in a strong position. If those elements come together, our goal would be to lock in a strong, more predictable revenue stream in a much lower cost than what we see today. It also makes our business less dependent on single events, like any particular ITC or court decision.
Our second priority is to move the company beyond simply patent licensing as our revenue source. You have seen some of the shifts we have made over the past few years; most notably last year’s addition of InterDigital solutions to drive commercial relationships around our technology. After a year of our solutions group exploring the market value of the technology that we have created and assessing the pipeline with new technology we are building and their market readiness, we learned a lot to ready for the next step.
So first, we’re making some adjustments with regards to our research. As you saw, we recently added Dr. B.K. Yi as Chief Technology Officer and Head of InterDigital Labs. We will also be separating InterDigital Labs from the rest of our R&D activities. InterDigital Labs and all employees responsible for standards, standards development and long-term research will be moved under leadership of Larry Shay. In effect this place is InterDigital’s entire core licensing business under Larry. That business will be fully vertically integrating, meaning it will control everything from the investment that makes in the research to the monetization of that investment; including patent licensing, patent sales, and other needs.
We will also add business development and transaction execution resources to that group to help develop more steady-like relationships with perspective licensees as well as assist in buying and selling patent. I think this is consistent with our desire to be, a reasonable creative and flexible and driving relationships around our research and patents. And BK is a terrific new hire in that regard as it is long tenure in the mobile industry particularly his leadership grow at LG heading our North American R&D activities, gives us even greater insight in connections into those customers it can help drive stickier relationships.
Secondly, we’re making some adjustments to our innovations group, which is led by Scott McQuilkin. First Jim Nolan will move it from InterDigital lab to head up InterDigital solutions, which will work alongside a nation partners in corporate development under Scott to uncover new market opportunities. We’re also redeploying some resources from InterDigital labs, where the focus is pure research on a timeline of seven to eight years ahead of the market to InterDigital solutions where the focus will be development of technologies that are more immediately relative to the market and with the timeline to product and revenue will be much shorter.
Like Larry’s business unit, Scott business unit will control all of the resources needed to grow these new businesses. Importantly, given the different focus, it will operate completely independent from our core licensing business.
We also expect that these efforts will be far less R&D intensive than our historic research activities meaning less costly. The great example of the change in focus is our InterDigital things area, as we discussed on numerous occasions InterDigital has done many years of research into core IOT technology, both on our own basis and as part of the Convida joint venture – Convida wireless joint venture with Sony.
And we think that there is intellectual property platform can be a source of a tremendous licensing opportunity going forward. However, what became apparent to us through our work with InterDigital solutions was I think it was an immediate market opportunity that would leverage the research we had already done, and that we wanted to take advantage of as quickly as possible.
I don’t want to preempt the records or eventful – eventual market loans. But this is the opportunity that Allen Proithis, this is leading InterDigital solutions to lead and we’re very excited about that. The new opportunities will operate us as a start-up essentially graduating from InterDigital solutions family and innovations group. We hope this is model, we are going to achieve going forward in other areas.
And some of those other areas will be related to the network servicing which it is strength of our company and some will be around content delivery, which is a growing area of expertise at InterDigital the moment we see some very exciting technology. In the first quarter, we had the opportunity to demo some of these technologies at the Mobile World Congress in Barcelona. On the network side, we were able to demonstrate the shared spectrum used with guaranteed quality of service, which we think is an industry first and a necessary step in making that technology operator ready.
InterDigital is without question, one of the leaders in Spectum research. In addition, we unveiled a technology, the Perceptual Pre-Filter that can reduce bandwidth consumption for 4K with video streaming by up to 40%. So overall with both the positive progress on the licensing side and the opportunities that were targeting our new structure and we very excited about the future of the company.
With that, we turn the call over to Rich.
Richard J. Brezski - Chief Financial Officer
Thanks, Bill. We reported recurring revenue of $57 million in the quarter, representing a strong increase of 22% over first quarter 2013. In addition, we also signed a worldwide patent license agreement with Fujitsu in early April. We are currently evaluating the accounting for that agreement, but we expect it will contribute to both recurring revenue and past sales in second quarter 2014.
Our first quarter 2014, operating expenses of $57.9 million were down $3 million from the prior year after excluding a $1.5 million repositioning charge in first quarter 2013. This decrease was driven by lower litigation expenses of $16.9 million in the current quarter. Although high in absolute terms, this is our lowest level of quarterly litigation spend in over a year.
Absent new matters, we expect to see further declines during the balance of the year, as we move to the post-hearing phase of our 868 case at the International Trade Commission. We will also see continued improvements in the efficiency in which we develop new technologies, including both technologies that are patentable and those that generate commercial opportunities for InterDigital.
Bill touched upon the evolution of the latter of these two. It is important to know that these projects, each represent a relatively small investment and reflects our efforts to shorten the average time to month for every dollar we invest in development. Ultimately, the quantum of our development funding is dictated by both the return we expect to achieve and the efficiency with which we can successfully pursue it.
Nonetheless while our quarter-to-quarter spending can fluctuate based on project cycles let me be perfectly clear in stating that we do not envision any significant long-term increase in development spending at this time moving on to taxes, our effective tax rate return closer to historical levels in the quarter after being abnormally high last year. As we previously discussed, the high effective rate in the prior year was driven by the large amount of technology solutions revenue resulting from the 2013 arbitration award. Having said that, we expect a higher effective tax rate next quarter due to an anticipated $2.5 million charge associated with the tax settlement we reached in April. We are also investigating whether research and development credits may once again be available to us and if so whether these credits could benefit our way in the future, but I expect it will take another quarter to support such a conclusion.
The net effect of these and other items was a small net loss that represented roughly breakeven performance for the quarter. We have a business that has been, and we believe will continue to be very profitable. We fully acknowledge there’s work to be done, but the business is on very solid financial footing and well positioned to realize maximum benefits from future successes. From our breakeven position, we can expect a drop about $0.65 to the bottom line from every dollar we earn from new licensing deals. As Bill mentioned, if the legal and political environment holds the patent holders and product manufacturers to similar standards of conduct, we like our chances of success.
With that, I’ll turn the call back over to Patrick.
Patrick Van de Wille - Vice President, Communications & Investor Relations
Thanks very much, Rich. Before I open the call to questions, Bill, let me ask you to address the topic that wasn’t covered in your comments. One thing that shareholders have been asking about is the signal trust and our infrastructure licensing efforts. Could I ask you for an update on that?
William J. Merritt - President and Chief Executive Officer
Sure. So just as a reminder to people on the call, we kept the signal trust a while back as a vehicle for licensing our infrastructure portfolio. It was set up as a – basically it’s a separate entity that we do not control, signal trust, and allowed us to basically monetize what we thought was pretty valuable portfolio. So they are up in line. I’d say two of the objectives was, one was to monetize the portfolio, the other one was to create some incentives to our folks during a period of time when Signal Trust was formed, but didn’t – but we still retained some rights on the portfolio that was the success with Fujitsu.
So we got down the license up during that period. So, we’re in the normal licensing cycle now reaching out to customers and that cycle, it’s not a one-month sales cycles. It takes time, but we’re encouraged by having in line, and we’ve always encouraged by buying the assets that went into the Trust.
Patrick Van de Wille - Vice President, Communications & Investor Relations
Fantastic. Thanks very much. Steve, with that we’ll open the call to questions.
Question-and-Answer Session
Operator
(Operator Instructions) Our first question is from Tim Quillin. Your line is open.
Timothy J. Quillin - Stephens Investments
Hey, good morning. Thank you for taking my question. I just want to ask you about your discussions with major potential licensees including Samsung, Nokia and Apple. Right now those awaiting the initial determination on 868 or is even possible to have some kind of agreement in place before that decision, and is arbitration a possibility with any of those big three licensees?
Richard J. Brezski - Chief Financial Officer
Okay. So I’ll go with your last question. I think arbitration is becoming more standard offer from that, and so that is an option with respect to any of the folks that you’ve talked about, and one that we would be happy to do. I think that what happened with the upcoming decision is people are mindful of it, they don’t necessarily wait for it. It just becomes a question of the creating up incentive on the part of both parties to get something done ahead of it. It does, great. If it doesn’t, then we’ll have some more facts, both decisions to deal with. I’d also tell you that the environment that I talked about in the script in terms of the legal system evolving to incenting reasonable behavior on both sides is definitely having its effect we think in the market.
So the question is we’ll have a sufficient effect? We’ll see. And whether the pending decision in 868 also creates sufficient incentive we will see as well. But right now, certainly from those environments standpoint, we probably feel better about the environment than we have in a while.
Timothy J. Quillin - Stephens Investments
Okay, great. And then on Fujitsu, which revealed to give us a sense of the estimated ongoing level of royalties and is it a per unit customer? And then also if you fear for the bracket up what the past sale impact might be in 2Q 2014, that will be great?
Richard J. Brezski - Chief Financial Officer
Yeah. Unfortunately, Tim, I can’t provide any other details about Fujitsu at this time. We are working through the finalization of the accounting. And at some point, we’ll be issuing guidance for the next quarter. Whether or not it’s available at that time, we’ll probably update before too long to include the impact of Fujitsu.
Timothy J. Quillin - Stephens Investments
Okay. Thank you. And then, could you just – mean was normal seasonality is in your per unit customers, is it that both this first quarter and fourth quarter the stronger quarters?
William J. Merritt - President and Chief Executive Officer
Yeah. We’ve looked at seasonality over the years and had not found any consistent effect there in part, because it’s – our customers as in the market as a whole has traditionally been growing. So that kind of throws you off given the high growth rate in the industry and particularly in the 3G and 4G space.
By that – what I will clarify for you or remind you of which I’m sure you’re aware of, Ken, on a per unit customers, they report to us for instance, in the first quarter, their fourth quarter sales and that becomes the basis for our first quarter revenue.
Timothy J. Quillin - Stephens Investments
Right, right. Okay. And on the notion of dropping $0.65 to income on each licensing – additional licensing dollar. I guess, first of all, it’s added a pre-tax income and if so, why wouldn’t it be a higher number?
William J. Merritt - President and Chief Executive Officer
No, no, that after tax…
Timothy J. Quillin - Stephens Investments
Okay.
William J. Merritt - President and Chief Executive Officer
And really what we’re accounting for is the federal rate there.
Timothy J. Quillin - Stephens Investments
Okay.
William J. Merritt - President and Chief Executive Officer
Variable cost.
Timothy J. Quillin - Stephens Investments
That makes a lot more sense, thank you. And then just lastly, I wasn’t quite sure how to interpret the language around the development expenses. I do understand that you don’t expect to grow those over time, but should we expect with greater efficiency around that process for those costs to decline?
William J. Merritt - President and Chief Executive Officer
I think that’s a possibility. I think that’s working through that now, part of the reason for separating out the research from the development of taxes that put more of a spotlight on that development spending as well as on the research spending and it happened here before. I think it’s going to happen with even higher degree of figure is – very solid business plans particularly around the development side to make sure that at the richest point that the return we are getting on that investment is very good, very strong.
So one hand, if all the projects that we’re working on look really, really, really solid and it looks like it’s the right thing to do. Then I think on the spend pace we’re on that we said, you know at some of these still make sense. Then we would make a shift, but as I said, the idea is – it certainly doesn’t go up, it either stays flat or it goes down.
Timothy J. Quillin - Stephens Investments
Okay, great. Thank you very much.
Operator
(Operator Instructions) Our next question is from Charlie Anderson from Dougherty & Co. Your line is open.
Charlie Anderson - Dougherty & Co
Yeah, good morning. Thanks for taking my questions. Yeah, as it relates to future guidance, I think Rich you guys were through May 16th as when you put it out last year, so if I hear you right are you saying you’re kind of stay on that schedule and if you have Fujitsu result by than you’ll say what it is, and if you don’t, you’ll say, this excludes Fujitsu. Is that the way to kind of think about it.
William J. Merritt - President and Chief Executive Officer
Yeah, I’d say that’s typically around that time period that we released and sometimes even we’re earlier depending on when reports come in. I would say that we will probably stick to that timeframe. Potentially, we could see an end to the resolution to the Fujitsu accounting and if that’s going to be a week away, maybe we delay just a short period of time to include it.
Charlie Anderson - Dougherty & Co
Okay, fair enough. And then in terms of the expenses that you’re very specific about development. So I wonder if you could just talk to us, are you implying that – Q1 level we kind of flat at that level the rest of the year or are you taking more about year-over-year basis.
William J. Merritt - President and Chief Executive Officer
Yeah, I would have focused on, totally on Q1 I rather the levels that we’ve been running at and I acknowledge that there are some quarter-to-quarter fluctuations just depending on project cycles in the timing of some of those efforts.
Charlie Anderson - Dougherty & Co
Got it and then use of cash. Did you guys have any share repurchase in the quarter and kind of where you stand on that? And also want to ask about the dividend, I think you first put that in a few years ago and then you also did the special dividend. Just kind of where you are on dividend policy in those things to be seen to be sort of trending upward in your business?
William J. Merritt - President and Chief Executive Officer
Yes. So as far as the share repurchases, we didn’t have any activity during the quarter. Your number, we had a bit of activity back in Q4. And with regard to the dividend – and frankly our management of cash in general, it’s something that we’re always looking at. So we haven’t announced any change to our dividend policy. We’ve held the ten tenth dividends, clearly dividends since we put in place. I want to say it will handles about three years ago, but it’s something that we’ll continually evaluate.
Charlie Anderson - Dougherty & Co
Got it. And then, Bill, I just wondered if you could update us on Huawei arbitration, how that’s tracking? Is it still at the end of the year a good decision you think.
William J. Merritt - President and Chief Executive Officer
Yeah, I think authorization is there and I think year-end or beginning of the year, the first quarter next year is I think the – the timeframe to some extent it’s now within the control, the arbitrators and while they will adhere to parties desired schedule. They do have a little bit of freedom in this also. So I think it’s generally within timeframe we reasonably put out though that leveled not much.
Charlie Anderson - Dougherty & Co
Got it. Thank you so much.
Operator
Our next question is from Eugene Fox from Cardinal Capital. Your line is open.
Eugene Fox - Cardinal Capital Management LLC.
Just a couple of housekeeping. Could I get what D&A and share-based compensation were in the quarter, please?
William J. Merritt - President and Chief Executive Officer
I’m sorry, DNA?
Eugene Fox - Cardinal Capital Management LLC.
Right, depreciation and amortization as well as stock-based comp.
William J. Merritt - President and Chief Executive Officer
Yeah, sure. So what I can tell you, if you look at our financial metrics schedule which is posted, you can get the patent amortization there. You also will be able to get when we file our two depreciation and amortization of the cash flow, but we haven’t announced that yet. The two will be filed, if not today, then probably tomorrow. And then stock-based compensation will be in the cash flow schedule as well.
Eugene Fox - Cardinal Capital Management LLC.
Okay. Last question. You had a – about a $50 million increase in deferred revenues, but it didn’t seem like you signed any new customers. Can you just give us a sense for where that’s coming from?
William J. Merritt - President and Chief Executive Officer
Yes. So we have – our policy is to recognize accounts receivables that are due within 12 months. So sometimes on longer term fixed price deals, we’ll recognize accounts receivable as the rolling forward 12-month period moves, and that can have an impact on deferred revenue.
Eugene Fox - Cardinal Capital Management LLC.
Okay. Last question. Bill, any further thoughts on – or change in your views on the upcoming Apple expiration?
William J. Merritt - President and Chief Executive Officer
No, I think it’s the same. I mean, as we talked about before, there is not a lot of revenue we’re recognizing under that contract. So the expiration has a little impact on the top lines as far as revenue going away. It can have the opposite effect because of the relationship we have with Pegatron, so to the extent that there is products that are licensed under the Apple agreement, which become unlicensed on July 1, and Pegatron have some other licensees which shipping those products, the result can actually be an increase in revenue from this. So it’s a little bit different in our typical contract expiration. And again, as we’ve talked about the Apple environment, we think we’ve got a very good position with respect to Apple. And I think again the on regulatory climate, people needing to be reasonable is also going to be helpful there.
Eugene Fox - Cardinal Capital Management LLC.
Okay. Nice job, gentleman. Look forward to hearing positive news on Samsung. Thank you.
William J. Merritt - President and Chief Executive Officer
Thanks.
Operator
And there are no further questions at this time. I would now like to turn the call back over to Mr. Patrick Van de Wille for any closing remarks.
Patrick Van de Wille - Vice President, Communications & Investor Relations
Thank you, Steve and thanks to our investors and analysts for joining us today. And just a remind you on Rich Brezski, as mentioned this little moment ago. Last quarter we produced a financial metrics document, which we made available under the events tab of the Investor section of the websit, near the link where you obtain login information for the conference call.
So we’ve updated the document today with a rolling nine quarters of financial metrics. So, the latest quarter can be compared with three different financial years. And you can access them at same location. So, once again if you go to the investors section, click on fundamentals, and then quarterly results near the top, you can find the financial metrics schedule. Thanks again to everyone and have a great day.
Operator
This does conclude today’s program. You may now disconnect and have a wonderful day.
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