InterDigital, Inc. — Q3 2015 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2015; unaudited. InterDigital develops and licenses wireless technology patents and reports one operating segment.
Financial results and position
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Revenue | $100.4 million | $77.6 million | $329.3 million | $329.7 million |
| Operating income | $45.4 million | $15.3 million | $155.2 million | $143.7 million |
| Net income attributable to InterDigital | $24.5 million | $13.5 million | $86.2 million | $90.6 million |
| Diluted EPS | $0.68 | $0.34 | $2.35 | $2.23 |
| Operating cash flow | Not presented for quarter | Not presented for quarter | $27.7 million | $186.0 million |
- Q3 patent licensing royalties were $98.9 million, including $21.8 million of past royalties recognized under the new Sony agreement. Recurring revenue was $78.6 million. Technology solutions revenue was $1.5 million; no patent sales were recorded.
- For the first nine months, patent licensing royalties were $324.5 million. Current patent royalties rose to $275.4 million from $196.6 million, while past patent royalties fell to $49.1 million from $123.2 million.
- Operating expenses declined 12% in Q3 to $55.0 million and 6% for nine months to $174.1 million. Q3 included a $2.2 million increase in performance-based incentive compensation accruals; management identifies this and Sony past royalties as items to consider when comparing Q3 results.
- Other expense was $8.1 million in Q3 and $21.1 million for nine months, primarily reflecting higher interest expense after the 2020 notes issuance. The nine-month effective tax rate was 37.3%, versus 33.7%.
- At September 30, cash and cash equivalents were $477.6 million and short-term investments were $389.8 million, totaling $867.4 million. Total assets were $1.45 billion; shareholders’ equity was $491.6 million.
- Convertible debt principal totaled $546.0 million, with a $480.9 million carrying value: $230 million of 2.50% notes due March 2016 and $316 million of 1.50% notes due March 2020. The 2016 notes are classified as current. Nine-month interest expense was $22.0 million.
- Cash from operations fell $158.3 million year over year, mainly because 2014 included larger fixed-fee royalty receipts tied to the timing of a Samsung agreement. Cash receipts were $243.1 million versus $432.1 million; current royalty receipts increased, but fixed-fee royalty payments declined. Investing activities used $167.1 million; financing activities provided $188.4 million.
- Working capital was $679.7 million; management’s adjusted working capital measure was negative $71.4 million, chiefly reflecting reclassification of the 2016 notes to current liabilities. Deferred revenue totaled approximately $406.5 million.
Material changes and notable developments
- Q3 revenue increased 29% year over year, mainly due to Sony past royalties and higher current royalties. Sony, Pegatron and Samsung represented 32%, 23% and 17% of Q3 revenue, respectively.
- Nine-month revenue was essentially flat. Higher current royalties, led by per-unit royalties from Pegatron and other Taiwan-based licensees, were largely offset by lower past royalties compared with 2014.
- In September, InterDigital signed a three-year Sony patent license beginning December 1, 2015, covering future sales and specified prior periods. Future license revenue is to be recognized straight-line over the term; part of the consideration was patents.
- InterDigital issued $316 million of 2020 convertible notes in March and repurchased $89.1 million of shares during the first nine months. It declared $0.20 per share in each of the first three quarters and had $158.3 million remaining under its $400 million repurchase authorization at September 30.
Outlook, risks and contingencies
- Management believed available cash, investments and operating cash generation would fund operations, capital needs, debt obligations—including repayment of the $230 million 2016 notes—share repurchases and dividends for the next 12 months. It expected to continue dividends comparable to $0.20 per share quarterly, subject to financial and other factors.
- Management’s estimates allocating Sony agreement consideration involve judgment. A 5% change in the estimated allocation between past and future royalties would change Q3 revenue and pretax income by approximately $3.9 million; a 5% change in estimated patent value would change them by approximately $0.3 million.
- Patent enforcement and licensing disputes remain significant uncertainties. A Delaware jury found certain InterDigital patents valid and infringed by ZTE, but related damages and FRAND issues remained pending; a separate ZTE verdict found no infringement of the ’151 patent. The USPTO found a number of claims of the ’244 patent unpatentable as obvious, and the Nokia/MMO case was stayed pending IPR proceedings. Other USITC proceedings ended with no violation findings.
- Huawei had made no payments under a confidential arbitration award; InterDigital sought confirmation in New York while Huawei sought annulment in Paris. Huawei and ZTE also pursued Chinese proceedings concerning FRAND rates and competition law. The ZTE competition-law damages claim had been increased to RMB 99.8 million, approximately $15.7 million.
- Pegatron’s Taiwan suit seeking at least $52 million was withdrawn without prejudice after InterDigital obtained a temporary injunction; Pegatron filed counterclaims in California, and InterDigital sought arbitration. Microsoft separately sued alleging monopolization and seeking, among other relief, treble damages and court-set FRAND licensing terms.
- The company stated that none of the described legal matters met the requirements for accrual as of September 30, 2015. Litigation outcomes, licensee shipments and collections, royalty estimates, and customer concentration may affect results and cash flows. Four licensees represented 98% of net accounts receivable.
Important facts for investors to verify
- Whether the Sony agreement’s future royalties and allocated consideration translate into expected cash receipts, and how its accounting estimates develop.
- Collection timing and customer concentration, particularly for Pegatron, Sony and Samsung, and the extent to which per-unit royalties depend on licensee shipments.
- Cash generation after the unusually low nine-month operating cash flow, including working-capital movements and the timing of fixed-fee receipts.
- Repayment, conversion or refinancing plans for the $230 million notes due March 2016, alongside the continued share repurchase and dividend commitments.
- Developments in the Huawei arbitration and China proceedings, the ZTE and Pegatron disputes, Microsoft’s suit, and the ’244 patent IPR proceedings; assess potential effects on licensing economics and enforcement rights.