InterDigital, Inc. — Q2 2014 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2014. Unaudited consolidated results; one reportable segment. Unless noted, amounts are in millions of dollars.
Key financial results
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Revenue | $194.2 | $67.7 | $252.1 | $115.1 |
| Operating income (loss) | $128.4 | $12.7 | $128.3 | $(2.4) |
| Net income (loss) attributable to InterDigital | $78.9 | $9.2 | $77.0 | $(3.0) |
| Diluted EPS | $1.93 | $0.22 | $1.90 | $(0.07) |
| Operating cash flow | Not provided quarterly | Not provided quarterly | $30.3 | $219.8 |
- Revenue mix and one-time items: Q2 patent royalties were $192.1; technology solutions revenue was $2.1. Q2 included $119.9 of past sales, primarily from three new patent license agreements. Of that, Samsung contributed $103.5, including $86.2 of past royalties; two other agreements contributed $37.5 in total.
- Expenses and taxes: Q2 operating expenses were $65.9, up 20% year over year, mainly due to higher performance-based compensation, partly offset by lower intellectual-property enforcement and litigation costs. The Q2 effective tax rate was approximately 37.4%, versus 44.8%.
- Cash and liquidity: At June 30, cash and equivalents were $383.0 and short-term investments were $289.9, totaling $672.9, down $25.5 from year-end. Current assets were $1,117.1 and current liabilities $245.4. Management said available funds and expected operating cash flow should cover operations, capital needs, debt, repurchases and dividends for the next 12 months.
- Cash flow and investment: First-half operating cash flow fell $189.5 year over year to $30.3, principally reflecting lower cash receipts and a $268.5 increase in receivables. Investing used $132.5, including patent investment and net purchases of short-term investments. Cash decreased $114.7 during the half.
- Debt: The company had $213.2 of net carrying-value long-term debt ($230.0 principal), consisting of 2.50% senior convertible notes due 2016. The notes’ estimated fair value was $253.9.
- Deferred revenue and receivables: Current and long-term deferred revenue totaled approximately $490.8, up $186.8 from year-end; $127.5 is expected to amortize over the next 12 months. Receivables were $346.3, versus $92.8 at year-end; two licensees represented 92% of the balance.
Material changes and business developments
- Revenue increased 187% in Q2 and 119% in the first half year over year. Growth reflected new licenses and past royalties, higher fixed-fee revenue, and higher Pegatron per-unit royalties. First-half per-unit revenue also faced an $18.5 decline from certain other licensees.
- Samsung accounted for 53% of Q2 revenue and 41% of first-half revenue. Its multi-year license covers 3G, 4G and certain future-generation products, resolved pending litigation, and may extend for ten years including 2013. Samsung may terminate certain rights and obligations after 2017. Of $270.0 in Samsung receivables at quarter-end, $200.0 was collected after quarter-end; $70.0 remained due within 12 months.
- The fixed-fee Apple license expired at the end of June 2014; Apple became unlicensed for products covered by that agreement.
- A new $300.0 share-repurchase program was authorized in June; $8.5 had been repurchased under it in the first half. The quarterly dividend was doubled to $0.20 per share. Management expected comparable future dividends, subject to financial and other conditions.
Outlook, risks and unusual items
- No specific revenue or earnings guidance was provided. Management highlighted the impact of past-sales recognition on Q2 comparability and expects $127.5 of fixed-fee deferred revenue to be recognized over the next 12 months.
- Revenue allocation for the three new agreements involves significant management judgment. A 5% change in the estimated allocation to past royalties would have changed Q2 revenue by $5.7. Patents received in some transactions were valued at $64.3 in total using income and market approaches.
- In a separate fixed-fee license, deterioration in a licensee’s financial condition led the company to reverse $15.0 of accounts receivable and deferred revenue; recognition may resume if the agreement again meets revenue-recognition criteria.
- Litigation and regulatory matters: In the 2013 USITC matter, the initial determination found no infringement by Nokia or ZTE and found one patent claim indefinite; InterDigital sought Commission review. Samsung settled and its related actions were dismissed. InterDigital’s appeal of an earlier USITC decision involving Nokia and ZTE remained pending. The NDRC suspended its China investigation after InterDigital made licensing commitments, including FRAND-related terms and an arbitration option before seeking exclusionary or injunctive relief; the latter commitment runs through May 22, 2019.
- ZTE filed two China proceedings alleging FRAND and antitrust violations; the company had recorded no loss accrual because the matter was at a preliminary stage. Separately, Chinese courts had upheld a Huawei-related ruling that set a 0.019% royalty ceiling for certain Chinese essential patents; InterDigital petitioned China’s Supreme People’s Court for retrial. A worldwide Huawei arbitration was expected to conclude by early 2015.
- After quarter-end, an arbitration panel awarded InterDigital approximately $23.6 for the Arima dispute. The company said it would recognize related revenue only when collectibility is reasonably assured. The filing also describes ongoing LG arbitration and other patent disputes.
- The company was evaluating the new revenue-recognition standard, effective for periods beginning after December 15, 2016, and did not expect the discontinued-operations standard to have a material impact.
Important facts for investors to verify
- Whether Q2’s large past-sales contribution is replaced by recurring royalties after the Samsung and other license ramps, and how Apple’s license expiry affects subsequent revenue.
- Collection of the remaining $70.0 Samsung receivable, the concentration and credit quality of licensee receivables, and the deferred-revenue recognition schedule.
- Outcomes and timing of USITC, Federal Circuit, Delaware court, China, Huawei arbitration and LG matters, including potential effects on licensing terms or enforcement rights.
- Whether the $23.6 Arima award is collected and when it qualifies for revenue recognition; also monitor the $15.0 licensee-related revenue deferral.
- Use of the $300.0 repurchase authorization and sustainability of the $0.20 quarterly dividend alongside patent acquisition spending and 2016 convertible-note obligations.