InterDigital, Inc. — FY 2019 Form 10-K
Reporting period: Fiscal year ended December 31, 2019. This is an annual filing; fourth-quarter figures are also presented. InterDigital develops wireless, video, display and related technologies and primarily earns revenue by licensing its patent portfolio.
Financial performance and liquidity
| Metric | FY 2019 | FY 2018 | Change |
|---|---|---|---|
| Total revenue | $318.9 million | $307.4 million | Up 4% |
| Recurring revenue | $298.2 million | $280.3 million | Up $17.8 million |
| Operating income | $37.8 million | $62.6 million | Down 40% |
| Operating margin | 11.9% | 20.4% | Calculated from reported figures |
| Net income attributable to InterDigital common shareholders | $20.9 million; $0.66 diluted EPS | $65.0 million; $1.84 diluted EPS | Down 68% in income |
| Cash provided by operating activities | $89.4 million | $146.8 million | Down $57.4 million |
| Cash, restricted cash and short-term investments | $936.3 million | $959.5 million | Down $23.2 million |
| Working capital | $710.8 million | $844.9 million | Down $134.1 million |
| Debt | $444.8 million carrying value; approximately $516.0 million principal indebtedness including Technicolor-related debt | $317.4 million carrying value | Higher following refinancing |
Revenue was mainly patent royalties: $307.4 million, including $287.6 million of current patent royalties and $19.8 million of non-current royalties. Fixed-fee royalty revenue rose 7% to $257.2 million; variable royalties declined 16% to $30.4 million. The filing does not provide a conventional gross-margin measure. Fourth-quarter 2019 revenue was $102.2 million and net income attributable to common shareholders was $13.8 million.
Material changes and unusual items
- Operating expenses increased 15% to $281.1 million, including $63.0 million attributable to the Technicolor acquisitions, higher patent amortization and increased enforcement and litigation costs. Enforcement costs rose to $25.4 million from $17.6 million.
- Operating income declined despite higher revenue. Net income was affected by a $10.991 million income-tax provision, compared with a $27.417 million tax benefit in 2018; 2018 included benefits from FDII and the Korea tax proceeding.
- Non-operating income included a $14.2 million net gain associated with the R&I acquisition and an $8.5 million gain on the sale of Hillcrest’s product business. These were partly offset by a $5.5 million loss on extinguishment of debt and investment losses.
- The R&I acquisition closed May 31, 2019 with no cash consideration. The Hillcrest product business was sold in July; InterDigital retained substantially all related patent assets.
- Revenue comparisons reflect different accounting bases: ASC 606 applies in 2019 and 2018, while 2017 remains under ASC 605. The filing attributes a substantial portion of the 2018-versus-2017 revenue decrease to this accounting change.
Debt, cash flow and capital allocation
- InterDigital issued $400 million of 2.00% convertible notes due 2024 and used proceeds in part to repurchase $221.1 million principal amount of 1.50% notes due 2020. At year-end, $94.9 million principal of the 2020 notes remained, with $400 million principal due in 2024.
- Management stated that available funds and expected operating cash flow should be sufficient for operations, debt obligations, repurchases and dividends over the next 12 months. The filing does not give formal earnings or revenue guidance.
- Cash from operations fell mainly because of lower patent royalty receipts, timing of fixed-fee collections and higher cash operating expenses. Investing cash flow benefited from net sales of short-term investments; financing uses included $196.3 million of repurchases and $44.6 million of dividends paid.
- The company declared $1.40 per share in dividends for 2019 and said it expected to continue a quarterly $0.35 dividend, subject to Board approval and financial, contractual and other conditions.
Outlook, risks and contingencies
- Management’s strategy is to invest in wireless, video, IoT and AI research, grow licensing revenue and commercialize technology solutions. The portfolio comprised approximately 32,000 patents and applications at year-end.
- Revenue concentration is significant: Apple, Samsung and LG represented approximately 35%, 25% and 10% of 2019 revenue, respectively. Apple’s license permits termination of certain rights after September 30, 2021; LG’s agreement expires December 31, 2020; Samsung’s term runs through December 31, 2022.
- Key risks include renewal or collection of major licenses, dependence on a small number of licensees, potential reductions in royalty rates, patent validity and enforcement outcomes, FRAND and antitrust challenges, and uncertainty in developing new commercial markets. The company also cited U.S.-China relations and market and public-health uncertainty as risks to licensing activity.
- InterDigital reported litigation involving Huawei and Lenovo, including U.K. patent proceedings and related U.S. proceedings. Huawei also brought a China action seeking FRAND licensing terms. The filing states that ordinary-course disputes did not meet the thresholds for accrual or disclosure of a potential loss range; it does not provide a clear quantified loss estimate for the principal proceedings.
- Other commitments include up to $25 million of potential Madison Arrangement shortfall funding through 2020; no such funding had been contributed by year-end. The filing also discloses tax uncertainties and $4.5 million of unrecognized tax benefits that could affect the effective tax rate if resolved.
Important facts for investors to verify
- Progress and terms of renewals for LG and other 2020-expiring licenses, and the post-September 2021 status of Apple’s agreement.
- Whether operating cash flow and recurring licensing receipts support debt repayment, dividends and repurchases, particularly given the remaining 2020 notes and 2024 maturity.
- Developments and potential financial effects of Huawei and Lenovo litigation, FRAND proceedings and patent challenges.
- The assumptions and judgments used to value dynamic fixed-fee licenses and patent consideration; the auditor identified these as a critical audit matter.
- Execution and returns from the Technicolor acquisitions, video and consumer-electronics licensing, and IoT and AI initiatives.
PricewaterhouseCoopers issued an unqualified opinion on the consolidated financial statements and stated that internal control over financial reporting was effective as of December 31, 2019.