InterDigital, Inc. — Q1 2018 Form 10-Q
Business context and period. InterDigital licenses wireless and other technology patents; the vast majority of revenue comes from patent licensing. This unaudited report covers the three months ended March 31, 2018, compared with Q1 2017. Amounts below are in U.S. dollars; financial figures are in millions unless stated otherwise.
Financial performance and position
| Metric | Q1 2018 | Q1 2017 |
|---|---|---|
| Revenue | $87.4 | $94.5 |
| Operating income | $30.2 | $34.0 |
| Net income | $28.7 | $32.8 |
| Net income attributable to InterDigital | $29.9 | $33.8 |
| Diluted EPS | $0.84 | $0.93 |
| Operating cash flow | $(0.6) | $(25.9) |
- Reported operating margin was approximately 34.5%, versus 35.9% a year earlier; reported net margin was approximately 32.9%, versus 34.7%.
- At March 31, cash and cash equivalents were $417.5 million and short-term investments were $699.1 million, totaling $1,116.6 million. Long-term debt had a carrying value of $288.5 million and principal of $316.0 million. The debt consists of 1.50% convertible notes due 2020.
- Total assets were $1,626.2 million; total liabilities were $590.4 million. The combined current and long-term deferred revenue balance was $241.6 million.
- Investing activities provided $11.5 million, chiefly reflecting net short-term investment sales. Financing activities used $26.5 million, including dividends, share repurchases and taxes withheld on restricted-stock vesting.
Material changes and comparability
- InterDigital adopted ASC 606 on January 1, 2018 using the modified retrospective method. Adoption increased opening retained earnings by $161.3 million and materially changed revenue timing and balance-sheet presentation; it did not change reported cash flows.
- Q1 2018 reported revenue was $7.1 million below Q1 2017. The company estimates that ASC 606 reduced Q1 2018 revenue by $17.5 million relative to the former ASC 605 method. On that former-method basis, Q1 2018 revenue would have been $104.9 million, net income $44.9 million and diluted EPS $1.29. These are comparison estimates, not reported results.
- ASC 606 requires estimates of per-unit royalties in the quarter of underlying sales, with later true-ups. Static fixed-fee agreements generally produce revenue at signing; dynamic fixed-fee agreements remain recognized over their terms. Q1 included $20.0 million of non-current patent royalties, including $10.0 million each from agreements involving Kyocera and the Signal Trust.
- Recurring revenue as reported under ASC 606 was $64.1 million. Management said recurring revenue would have been $91.6 million under ASC 605, versus $94.5 million in Q1 2017, with the former-basis decline primarily attributed to expiration of a technology-solutions agreement.
- Operating expenses fell 5% to $57.3 million, mainly due to lower performance-based compensation, commercial-initiative costs and patent maintenance; higher enforcement and consulting costs partly offset the reductions. Net other expense increased to $6.3 million, including $4.7 million of interest expense related to ASC 606 financing components.
Outlook, risks and unusual items
- Management said available funds and expected operating cash generation should cover operations, capital requirements, debt obligations, the repurchase and dividend programs, and the planned Technicolor acquisition for at least the next 12 months. This is management’s assessment, not a guarantee.
- Based on contracts signed and committed dynamic fixed-fee payments at March 31, the company expected to recognize revenue of $173.0 million for the remainder of 2018, $230.7 million in 2019, $230.7 million in 2020, $169.0 million in 2021 and $85.2 million in 2022.
- InterDigital had made a binding offer to acquire Technicolor’s patent-licensing business for $150.0 million cash plus contingent consideration. Technicolor would receive 42.5% of future net cash receipts from new consumer-electronics licensing efforts; mobile licensing receipts would not be shared. Closing was expected in mid-2018, subject to consultation, consents, regulatory approvals and other conditions. The filing identifies failure or delay to close as a risk.
- The Q1 effective tax rate was a benefit of 20.6%, including a forecast $18.8 million net benefit related to income qualifying for FDII and $3.4 million of discrete benefits. The company cautioned that Tax Reform Act estimates were provisional and could change.
- Revenue concentration was significant: Apple contributed 32% of Q1 revenue, Samsung 22%, Kyocera 11% and a Signal Trust customer 11%. Five licensees represented 83% of net receivables at quarter-end.
- Asus’s expert claimed $75.9 million in damages, plus potential interest, costs and attorneys’ fees and, for its antitrust claim, treble damages. InterDigital recorded no accrual; it said a material loss was reasonably possible but could not estimate a range. The ZTE proceedings and other licensing disputes also remain ongoing; the filing reports no accrual for the identified contingent matters where losses were not considered probable.
- The quarterly dividend declared was $0.35 per share. Management expected comparable future dividends, subject to financial condition, capital needs, debt restrictions and other factors. The company repurchased 84,147 shares for $6.0 million in Q1, leaving approximately $172.6 million under its repurchase authorization.
- On April 3, 2018, after quarter-end, the company completed a holding-company reorganization. The business and consolidated assets and liabilities did not change; the successor continued under the InterDigital name and IDCC ticker.
Key investor verification points
- Assess reported results against the ASC 605 comparison figures and the effects of ASC 606 on revenue timing, estimates and future true-ups.
- Track renewal, collection and concentration risks among major licensees, particularly Apple and Samsung, and changes in receivable concentration.
- Verify completion terms, funding and expected economics of the Technicolor transaction, including contingent payments and consumer-electronics revenue sharing.
- Monitor the Asus and ZTE litigation outcomes, potential damages and any changes to the company’s loss assessments or accruals.
- Review the assumptions underlying the FDII tax benefit, contracted-revenue schedule, dividend policy and management’s liquidity assessment.