InterDigital, Inc. — Q3 2020 Form 10-Q
Business context and period: InterDigital licenses its technology and patent portfolio and provides technology solutions. This unaudited report covers the three and nine months ended September 30, 2020; comparisons are with the same periods in 2019. The company has one reportable segment.
Financial performance
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Revenue | $87.5 million | $72.5 million | $268.2 million | $216.8 million |
| Operating income | $15.4 million | $3.8 million | $52.0 million | $12.5 million |
| Net income attributable to InterDigital | $23.8 million | $2.2 million | $46.2 million | $7.2 million |
| Diluted EPS | $0.76 | $0.07 | $1.49 | $0.22 |
| Operating margin | 17.6% | 5.2% | 19.4% | 5.8% |
Operating margins are calculated from reported revenue and operating income. Patent royalties were $85.2 million in Q3, up 25%; total Q3 revenue increased 21%. For the first nine months, patent royalties rose 25% and total revenue rose 24%.
- Revenue mix and drivers: Q3 fixed-fee royalties were $77.3 million, variable royalties $7.4 million, and technology solutions $2.3 million. Management attributed growth chiefly to eight new patent license agreements signed over the preceding 12 months, including Huawei and ZTE. Nine-month variable royalties declined 21%, while fixed-fee royalties increased 16%.
- Expenses and other items: Q3 operating expenses increased 5% to $72.1 million, including higher Madison Arrangement revenue sharing, patent maintenance and enforcement costs; lower SG&A reflected reduced travel, personnel costs and acquisition-related costs. Nine-month operating expenses increased 6% to $216.2 million. Nine-month non-operating income was lower year over year, partly because 2019 included gains from the Technicolor R&I acquisition and Hillcrest business sale.
- Tax: Q3 included an $18.5 million discrete tax benefit, primarily tied to an expected prior-year return amendment and reversal of a tax reserve. The nine-month effective tax rate was negative 16.8%, versus 50.1% in 2019. This benefit materially boosted reported net income; it should not be assumed recurring.
Cash, liquidity and debt
- At September 30, cash and cash equivalents were $746.6 million, short-term investments $172.8 million, and restricted cash $5.5 million. Cash, cash equivalents, restricted cash and short-term investments totaled $924.9 million, down $11.4 million from year-end 2019.
- Nine-month operating cash flow was $144.2 million, compared with $72.0 million in 2019, primarily reflecting higher royalty receipts and their timing. Investing activities used $22.0 million; financing activities used $127.3 million, including repayment of $94.9 million of 2020 Notes and $32.3 million of dividends.
- Total deferred revenue was approximately $356.7 million, up $86.4 million from year-end, primarily due to the timing of fixed-fee royalty receipts, including Huawei. The company expects $248.1 million of this balance to amortize over the next 12 months.
- Long-term debt was $363.5 million, with no current debt portion, versus $444.8 million of current and long-term debt at December 31, 2019. The $400 million 2.00% convertible notes due 2024 had a $340.2 million carrying value; the remaining debt primarily relates to the Technicolor patent acquisition and is contingent on future Madison Arrangement royalties.
- Management stated available liquidity and expected operating cash generation should fund operations, capital needs, debt obligations, and existing dividend and repurchase programs for at least the next 12 months. Quarterly dividends were $0.35 per share; no shares were repurchased during Q3.
Outlook, risks and contingencies
- As of September 30, contracted Dynamic Fixed-Fee Agreement payments were expected to contribute $77.8 million for the remainder of 2020, $271.6 million in 2021, $235.7 million in 2022 and $43.9 million in 2023. These are contract-based expected revenues, not broad company revenue guidance.
- Management reported limited operational and financial impact from COVID-19 through the first nine months, citing the prevalence of fixed-fee royalties and continued remote operations. It cautioned that future effects remain uncertain, including possible customer payment delays, economic disruption, shipment fluctuations, cybersecurity exposure and control risks from extended remote work.
- Revenue is concentrated: Apple and Samsung represented 32% and 22% of Q3 revenue, respectively; Huawei represented 13%. Seven licensees accounted for 74% of net accounts receivable at quarter-end.
- Material legal matters include ongoing U.K. and U.S. patent proceedings involving Lenovo, Lenovo’s U.S. antitrust and FRAND claims, Lenovo’s China FRAND-rate case, and litigation with Xiaomi in India and China. A Chinese court issued an anti-suit injunction affecting InterDigital’s Xiaomi enforcement actions; related challenges and proceedings were pending. The company said other ordinary-course disputes were not expected to have a material adverse effect; it had not accrued amounts or disclosed a reasonably estimable loss range for the described matters.
- The company disclosed possible tax exposure from changing tax laws and interpretations. It also reported a $1.1 million impairment of a leased property in Q1 and a $5.5 million gain from an observable price change in a strategic investment. No material COVID-19-related change to significant estimates was identified as of quarter-end.
Most important facts for investors to verify
- How much earnings improvement reflects recurring licensing economics versus the discrete $18.5 million Q3 tax benefit and other non-operating items.
- Whether fixed-fee contracted revenue is recognized and collected on schedule, and how customer concentration affects receipts and receivables.
- Developments and potential financial consequences in the Lenovo and Xiaomi FRAND, antitrust and patent disputes, including the China anti-suit injunction.
- The sustainability of operating cash flow, the planned dividend and repurchase capacity, and the 2024 convertible notes’ dilution and repayment implications.
- Any further COVID-19 effects on licensee payments, device shipments, remote-work security and business controls.