InterDigital, Inc. — Q2 2017 Form 10-Q
Business context and period. InterDigital develops and licenses wireless technology and patents, with additional technology-solutions revenue. This unaudited filing covers the quarter and six months ended June 30, 2017; comparisons are with the corresponding 2016 periods. Dollar amounts below are in millions unless stated otherwise.
Financial performance and position
| Metric | Q2 2017 | Q2 2016 | First half 2017 | First half 2016 |
|---|---|---|---|---|
| Revenue | $135.8 | $75.9 | $230.3 | $183.7 |
| Operating income | $80.9 | $23.1 | $114.9 | $71.4 |
| Net income attributable to InterDigital | $52.5 | $40.0 | $86.3 | $68.1 |
| Diluted EPS | $1.46 | $1.14 | $2.39 | $1.94 |
| Operating margin | 59.6% | 30.4% | 49.9% | 38.9% |
Q2 net income included an income-tax provision of $27.1 million; Q2 2016 included a $16.7 million tax benefit. First-half 2017’s 23.2% effective tax rate benefited from $12.1 million of discrete share-based-compensation tax benefits; excluding those benefits, the company reported an effective tax rate of 34.3%. First-half 2016 benefited from a $23.7 million prior-year domestic-production-activities tax benefit.
- Revenue mix and change: Q2 revenue increased 79%, including $47.9 million of past patent royalties, primarily related to the May 2017 Microsoft settlement. Fixed-fee amortized royalties rose to $73.1 million from $29.1 million, while per-unit royalties declined to $11.4 million from $44.5 million. For the first half, revenue increased 25%; past patent royalties contributed $47.9 million, while per-unit royalties declined $91.0 million year over year, principally following the Apple fixed-fee license agreement.
- Cash flow: First-half operating cash flow was negative $6.4 million versus positive $211.0 million in 2016, largely reflecting lower cash receipts, especially the absence of comparable Huawei-related fixed-fee collections, and timing of Apple royalty receipts. Receivables increased $170.6 million. Cash and cash equivalents fell $223.1 million to $181.0 million.
- Liquidity: Cash, cash equivalents and short-term investments totaled $885.4 million at June 30, down from $952.8 million at year-end. Current assets were $1,336.0 million and current liabilities $379.7 million. Deferred revenue totaled $653.2 million; the company said it has no material obligations associated with that balance.
- Debt: The 1.50% convertible notes due 2020 had $316.0 million principal and $278.5 million carrying value. The notes are not redeemable before maturity. Total liabilities were $1,033.2 million.
- Capital returns: The quarterly dividend was $0.30 per share; $20.7 million was paid in the first half. The company said it currently expects comparable future quarterly dividends, subject to financial and other conditions. No shares were repurchased in the first half.
Material changes and management commentary
- The Microsoft settlement resolved existing disputes with Microsoft and Nokia-related affiliates in exchange for cash and other commitments, in return for a limited release covering certain past product sales. The filing does not state the settlement’s cash amount.
- Samsung did not exercise its termination right; its patent license agreement now runs through December 31, 2022.
- Four per-unit licensees’ agreements expired at the end of 2016, with their final payments received in Q1 2017. Those licensees collectively represented approximately 3% of 2016 revenue.
- Revenue was concentrated: Microsoft, Apple, Samsung and Huawei represented 35%, 21%, 13% and 12% of Q2 revenue, respectively. Four licensees represented 95% of net receivables at June 30.
- Management stated available funds and expected operating cash generation should be sufficient for operations, capital requirements, debt obligations and planned dividends and repurchases over the next 12 months. No specific revenue or earnings guidance was provided.
Risks, contingencies and unusual items
- The pending Asus-related arbitration and court disputes remain material uncertainties. Asus sought return of excess royalties, which it said totaled close to $63 million as of August 2016, plus interest and other relief. An arbitration decision was expected by early August 2017. InterDigital recorded no loss accrual and said a material loss was reasonably possible but the range could not be estimated.
- ZTE-related China proceedings remain pending. InterDigital recorded no accrual for those matters, stating losses were reasonably possible but not probable. Other patent and licensing disputes, including proceedings involving ZTE, remain unresolved; the filing says several matters do not yet meet the requirements for accrual or estimating a loss range.
- InterDigital’s commitments to Chinese manufacturers under a suspended Chinese antitrust investigation include FRAND-related licensing commitments; the commitment concerning arbitration before seeking exclusionary relief expires May 22, 2019.
- Adoption of new revenue-recognition guidance is expected to change timing. The company expects most or all revenue from static fixed-fee agreements to be recognized when signed, while dynamic fixed-fee revenue generally remains recognized over the license term. Per-unit royalties are expected to be accrued in the period of underlying sales using estimates, with later true-ups. The company had not finalized its transition method.
- First-half results included $12.1 million of share-based-compensation tax benefits. Q2 2016 included a $3.4 million gain on sale of the former King of Prussia facility, affecting year-over-year comparisons of other income.
Important facts for investors to verify
- Subsequent disclosures on the Microsoft settlement’s cash proceeds, commitments and any resulting licensing or collaboration arrangements.
- Outcomes and potential financial exposure from the Asus arbitration and remaining ZTE, Huawei, Pegatron and regulatory matters.
- Collection of the sharply higher receivables and the effect of licensee concentration on cash flow.
- Actual revenue-recognition transition choices and their impact on timing, estimates and reported results.
- Whether the expected $0.30 quarterly dividend continues and whether liquidity remains adequate as the 2020 notes approach maturity.