InterDigital, Inc. — Q3 2018 Form 10-Q
Business context and period. InterDigital licenses patents and provides technology solutions. This unaudited report covers the quarter and nine months ended September 30, 2018. The company adopted ASC 606 on January 1, 2018 using the modified retrospective method; prior-year results were not restated, limiting direct comparability.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $75.1m | $97.3m | $232.1m | $327.6m |
| Operating income | $12.9m | $40.9m | $58.8m | $155.8m |
| Operating margin | 17.2% | 42.0% | 25.3% | 47.6% |
| Net income attributable to InterDigital | $21.4m | $35.5m | $62.0m | $121.8m |
| Diluted EPS | $0.60 | $1.00 | $1.74 | $3.40 |
| Operating cash flow | Not separately stated | Not separately stated | $176.6m | $98.3m |
Q3 income before taxes was a $1.0m loss, offset by a $21.1m income tax benefit. The nine-month effective tax rate was a 74.4% benefit, including discrete benefits; without those discrete items, management reported a 19.7% benefit rate.
At September 30, cash and cash equivalents were $508.8m, short-term investments $549.5m, and restricted cash $15.9m, totaling $1,074.3m. Long-term debt was $313.5m; current liabilities were $293.6m and total liabilities $773.0m. The company reported total equity of $1,015.0m. Nine-month investing cash flow was a $2.8m outflow and financing cash flow an $82.1m outflow.
Changes and comparability
- Reported revenue fell 23% in Q3 and 29% for the first nine months. ASC 606 adoption accounted for $16.3m of the Q3 and $54.8m of the nine-month reported revenue decrease. On the company’s ASC 605 comparison basis, 2018 revenue would have been $91.3m for Q3 and $286.9m for nine months; operational revenue declines were about 6% and 12%, respectively.
- Operational pressure included lower variable royalties, reflecting expired contracts and lower licensee shipments, and lower technology-solutions revenue after agreements expired. New dynamic fixed-fee agreements, including LG’s, partly offset the declines. Prior-period past-patent royalties, including Huawei and Microsoft-related amounts, also contributed to comparisons.
- Operating expenses rose 10% in Q3, largely due to Technicolor acquisition costs and acquired-business expenses; nine-month expenses increased 1%. Other expense increased, including an $8.4m loss on a strategic-investment sale and impairment and ASC 606-related financing-component interest expense.
- ASC 606 adoption added $161.3m to opening retained earnings. It changes recognition timing for static fixed-fee agreements and per-unit royalties; management said cash flows were not affected by adoption.
Liquidity, capital allocation, and outlook
- InterDigital acquired Technicolor’s patent licensing business on July 30 for $143.0m net of cash acquired. The transaction added about 18,000 patents and applications, including about 3,000 video-coding assets. Technicolor received a 42.5% share of future net cash receipts from specified new consumer-electronics licensing efforts; mobile licensing receipts are excluded.
- The acquisition contributed $1.9m revenue and $4.6m pretax loss through September 30. The company recorded $9.2m of nine-month transaction-related costs and expects about $16.4m of additional annualized patent amortization.
- Management said available liquidity and operating cash generation should cover operations, capital needs, debt obligations, repurchases, and dividends for the next 12 months. It expected to continue quarterly dividends comparable to $0.35 per share, subject to board review and financial conditions.
- As of September 30, management expected to recognize contracted dynamic fixed-fee revenue of $60.3m for the remainder of 2018, $237.3m in 2019, $236.1m in 2020, $169.0m in 2021, and $85.2m in 2022. These are contract-based expectations, not broad earnings guidance.
- The company repurchased 0.5m shares for $43.5m in the first nine months; approximately $135.1m remained under its authorization. Dividends declared were $1.05 per share for the period.
Risks, contingencies, and unusual items
- The company expected a total tax refund of about $97.4m, including interest, under a U.S.-Korea competent-authority agreement; a portion had been received. It also recorded a $15.7m Q3 tax benefit related primarily to anticipated amended tax returns. Final tax effects and timing remain subject to uncertainty.
- In the Asus litigation, the company recorded no loss accrual. It stated a material loss was reasonably possible but it could not estimate a range. Asus’s expert claimed $75.9m in damages, before additional interest, fees, and potential treble damages; summary-judgment motions remained pending.
- ZTE’s Chinese FRAND case was dismissed without prejudice on September 28; its Chinese antimonopoly case was dismissed without prejudice on October 26, 2018. Other patent proceedings remained pending, including a Huawei Chinese proceeding and U.S. litigation involving ZTE.
- Management identified integration and realization-of-benefits risks for Technicolor, including portfolio and systems integration, employee retention, licensing execution, costs, and potential undiscovered patent or other liabilities. The disclosure-controls evaluation excluded controls relating to the newly acquired business.
- InterDigital’s 1.50% convertible notes have $316.0m principal and mature in 2020. Their conversion price was about $71.74 per share; the company stated its intent to settle conversions using cash for principal and shares for any excess value.
Key facts for investors to verify
- How much of reported revenue and earnings trends reflects ASC 606 timing changes versus underlying licensing activity; review both reported and ASC 605 comparison figures.
- Whether contracted fixed-fee revenue converts to cash as expected, and whether licensee shipment trends, contract expirations, and customer concentration affect royalties.
- Progress integrating Technicolor, realization of consumer-electronics licensing opportunities, related costs, and the contingent revenue-sharing obligations.
- Receipt and accounting treatment of the expected tax refunds, including any remaining procedural or estimation uncertainty.
- Developments in Asus and other patent disputes, including potential loss exposure that the company says cannot currently be estimated.
- Ability to sustain dividends and repurchases while meeting debt obligations and funding the business; confirm the effect of convertible-note settlement terms and share-price movements.