InterDigital, Inc. — Q3 2013 Form 10-Q
Reporting period: Three and nine months ended September 30, 2013. Unaudited consolidated results; dollar figures below are in millions unless stated otherwise.
Business context
InterDigital develops and licenses wireless technology and patents, and provides technology solutions. Its reported revenue and earnings are notably affected by patent-license timing, arbitration outcomes, patent sales and royalty prepayments. The company has one reportable segment.
Financial performance and position
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Revenue | $110.6 | $434.0 | $225.7 | $575.2 |
| Operating income | $49.1 | $363.2 | $46.8 | $400.2 |
| Net income attributable to InterDigital | $26.7 | $235.7 | $23.6 | $256.3 |
| Diluted EPS | $0.64 | $5.56 | $0.57 | $5.81 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $218.7 | $300.4 |
- Q3 2013 operating margin was approximately 44%; nine-month margin was approximately 21%. These comparisons are heavily affected by the unusually large 2012 patent-sale revenue.
- Q3 revenue included $51.6 million recognized after resolution of a technology-solutions arbitration and approximately $12.5 million of past-sale royalties, primarily related to Pegatron. Q3 operating expenses included a $4.3 million increase in incentive-compensation accruals.
- Cash, cash equivalents and short-term investments totaled $756.8 million at September 30, 2013, up $179.6 million from year-end 2012. Cash and cash equivalents were $555.5 million.
- Current assets were $879.3 million and current liabilities $126.5 million. Total liabilities were $582.3 million; convertible-note debt had a $206.6 million carrying value and $230.0 million principal amount.
- The 2.50% senior convertible notes mature in 2016. Their disclosed fair value was $240.9 million at September 30, 2013.
- Combined current and long-term deferred revenue was approximately $320.2 million, up $52.1 million since December 31, 2012. Management said it has no material obligations associated with deferred revenue.
- The company declared dividends of $0.10 per share each quarter. It reported no share repurchases during Q3; it repurchased 48,000 shares for $1.7 million from October 1 through October 30, 2013.
Changes versus comparable periods
- Revenue fell 75% in Q3 and 61% for the first nine months, principally because 2012 included $375.0 million of Q3 patent-sale revenue and $384.0 million for the nine-month period. The 2013 nine-month period had no patent-sale revenue.
- Patent-licensing royalties declined 5% in Q3 and 10% year to date. Lower fixed-fee royalty amortization, including the expiration of the 3G portion of Samsung’s license at the end of 2012, was partly offset by past-sales royalties.
- Technology-solutions revenue rose to $54.9 million in Q3 and $55.8 million year to date, mainly due to the $51.6 million arbitration-related recognition. Patent administration and licensing expense declined in Q3 but increased for the nine-month period, including higher intellectual-property enforcement and patent amortization costs.
- Nine-month operating cash flow decreased $81.7 million year over year. The 2013 period included $218.7 million of operating cash flow, while 2012 included substantial patent-sale receipts. Cash flow also benefited from $242.4 million of royalty prepayments in 2013.
- The effective tax rate was approximately 43.5% in Q3 2013 versus 34.6% in Q3 2012, and 41.4% for the first nine months versus 34.7%. Management attributed the increase mainly to forecast state tax expense and the revenue mix.
Outlook, risks and unusual items
- Management said available funds and expected operating cash flow should be sufficient for operations, capital needs, debt obligations, the existing repurchase program and dividends for the next 12 months. It expects future quarterly dividends comparable to $0.10 per share, subject to board discretion and other factors.
- Following a separate arbitration award received in early Q4, the company expected to recognize approximately $27 million of past-sales revenue in Q4 2013. This was an expectation, not formal earnings guidance.
- InterDigital accrued $3.2 million related to the Huawei China proceedings. Chinese courts affirmed rulings finding violations of China’s Anti-Monopoly Law and setting a maximum royalty rate of 0.019% of Huawei product sales for specified Chinese essential patents. InterDigital said it intended to appeal to China’s Supreme People’s Court.
- China’s National Development and Reform Commission opened a formal investigation into licensing practices involving standards-essential patents. Potential consequences described in the filing include cease-and-desist orders, fines and disgorgement of alleged illegal gains.
- Major U.S. patent disputes remain unresolved. In the 2011 USITC matter, the ALJ initially found no violation; the Commission was reviewing that determination, with a final decision then targeted for December 19, 2013. A separate 2013 USITC investigation involving Samsung, Nokia, Huawei and ZTE was scheduled for a 2014 hearing and determination.
- Four licensees accounted for 94% of net accounts receivable. Q3 revenue concentration was also substantial: Intel Mobile Communications GmbH represented 49% and Pegatron 14% of revenue.
- The company recorded a $6.7 million investment impairment in the first quarter and reported an investment carrying value of $15.1 million at September 30; it said it would continue monitoring the investment.
Key facts for investors to verify
- How much recurring royalty revenue and cash generation can replace 2012 patent-sale revenue and the 2013 arbitration-related recognitions?
- Whether the expected $27 million Q4 past-sales revenue was recognized, and whether subsequent royalty receipts support the deferred-revenue and prepayment balances.
- Developments and financial exposure in the Huawei China appeals, the NDRC investigation and the pending U.S. patent proceedings.
- Licensee concentration, especially the dependence on a small number of customers for receivables and revenue.
- The company’s liquidity and capital allocation relative to its $230 million convertible-note principal, dividend expectations and repurchase program.