InterDigital, Inc. — Q3 2014 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2014. Financial statements are unaudited. InterDigital operates in one reportable segment, principally licensing wireless technology patents and providing technology solutions.
Financial performance
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Revenue | $77.6 million | $110.6 million | $329.7 million | $225.7 million |
| Operating income | $15.3 million | $49.1 million | $143.7 million | $46.8 million |
| Operating margin | 19.8% | 44.4% | 43.6% | 20.7% |
| Net income attributable to InterDigital | $13.5 million | $26.7 million | $90.6 million | $23.6 million |
| Diluted EPS | $0.34 | $0.64 | $2.23 | $0.57 |
| Operating cash flow | Not presented quarterly | Not presented quarterly | $186.0 million | $218.7 million |
Revenue mix and changes: Q3 patent licensing royalties were $73.4 million, including $71.0 million of current royalties and $2.4 million of past royalties; patent sales contributed $2.0 million. Q3 revenue fell 30% year over year, mainly because the prior-year quarter included substantial past technology-solutions and arbitration-related revenue. Recurring revenue increased $26.7 million, led by higher fixed-fee and per-unit royalties. Nine-month revenue increased 46%, primarily reflecting higher patent royalties and past sales from agreements signed in Q2.
Q3 operating expenses were $62.3 million, up 1% year over year. Lower intellectual-property enforcement and litigation costs were largely offset by higher patent amortization, consulting, personnel, and commercial initiative costs. The Q3 effective tax rate was approximately 3.8%, including a $5.7 million net benefit from U.S. research and development tax credits; the nine-month rate was approximately 33.7%, versus 41.4% in 2013.
Cash, liquidity and capital allocation
- At September 30, cash and cash equivalents were $368.8 million and short-term investments were $363.9 million, totaling $732.7 million, up $34.2 million from year-end 2013.
- Nine-month operating cash flow was $186.0 million, down from $218.7 million. Cash receipts were $431.5 million; cash taxes paid were approximately $86.0 million. Cash flow benefited from increased deferred revenue, while receivables and other working-capital movements also affected results.
- Investing cash outflow was $216.2 million and financing cash outflow was $98.7 million. Financing included $88.0 million of share repurchases and $16.1 million of dividends paid.
- Long-term debt carrying value was $215.5 million, consisting of 2.50% senior convertible notes due 2016; the notes’ stated principal is $230.0 million. Current liabilities were $217.7 million versus current assets of $960.0 million.
- Combined current and long-term deferred revenue was approximately $460.0 million. The company expects $127.7 million of fixed-fee royalty amortization to reduce that balance over the next 12 months; deferred revenue recognition does not itself provide future cash.
- The company repurchased $88.0 million of shares during the first nine months under a new $300 million authorization. It declared dividends of $0.50 per share for the nine months and said it currently expects comparable quarterly dividends of $0.20 per share, subject to relevant factors and board decisions.
Material developments, outlook and risks
- Q2 2014 license agreements included Samsung and two other licensees. The Samsung agreement covers 3G, 4G and certain future-generation products, may extend for ten years including 2013, and allows Samsung to terminate certain rights and obligations after 2017. Revenue through the earlier of termination or expiration of that right is expected to be recognized straight-line.
- The Apple agreement expired at the end of June 2014; covered products are now unlicensed. A fixed-fee licensee filed for bankruptcy protection in South Korea and the United States in Q3. InterDigital had reduced receivables and deferred revenue by $15.0 million in Q2 and will resume recognition only if revenue-recognition criteria are again met.
- Management stated that available cash, investments and expected operating cash flow should fund operations, capital requirements, debt obligations, the share repurchase program and dividends for the next 12 months. No formal revenue or earnings guidance is provided.
- InterDigital signed commitments with China’s NDRC in May 2014, suspending its investigation. Commitments include FRAND licensing practices and offering qualifying Chinese manufacturers binding arbitration before seeking exclusionary or injunctive relief; the latter commitment expires May 22, 2019.
- Litigation remains a significant uncertainty. The USITC terminated the 2013 investigation with a no-violation finding; InterDigital appealed. Separately, a Delaware jury on October 28, 2014 found three patents valid and infringed by ZTE devices; damages and FRAND-related matters remain for later proceedings, and the ‘151 patent issue requires another trial. A Nokia/MMO trial was scheduled for March 2015.
- Other legal exposures include Chinese FRAND and antitrust proceedings brought by ZTE and Arima, a Taiwan Fair Trade Commission investigation, Huawei arbitration and an appeal concerning Chinese court rulings. The company recorded no loss accrual for the ZTE and Arima China matters, citing their preliminary stages. Outcomes and timing are uncertain.
- Revenue depends on license agreements and royalty activity, with notable customer concentration: two licensees represented 87% of net receivables at quarter-end. Management’s allocation of consideration and valuation of acquired patents involve significant estimates; a 5% change in the allocation to past royalties would have changed nine-month revenue by $5.5 million.
Investor verification priorities
- Verify the timing and recurring contribution of Q2 license agreements, especially Samsung, and the effects of Apple’s expiration and the bankrupt licensee.
- Track cash collection, receivable concentration, deferred-revenue conversion and the sustainability of operating cash flow.
- Assess the 2016 convertible-note maturity and the cash demands of share repurchases and dividends.
- Monitor litigation, arbitration and regulatory outcomes, including the ZTE damages/FRAND phase, Nokia proceedings and China matters, and whether any material contingency accrual becomes necessary.
- Review assumptions used to allocate license consideration and value patent assets, as these affect reported revenue, amortization and earnings.