InterDigital, Inc. — Q2 2011 Form 10-Q
Business context and period: Unaudited results for the quarter and six months ended June 30, 2011, compared with the same 2010 periods. InterDigital operates as one reportable segment, principally licensing wireless patents and providing technology solutions.
Financial performance and position
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Revenue | $69.9 million | $91.2 million | $148.3 million | $207.3 million |
| Operating income | $29.8 million | $53.1 million | $67.1 million | $127.8 million |
| Net income | $17.2 million | $35.0 million | $40.5 million | $83.8 million |
| Diluted EPS | $0.37 | $0.78 | $0.88 | $1.88 |
| Operating margin | 42.7% | 58.2% | 45.2% | 61.6% |
| Net margin | 24.5% | 38.4% | 27.3% | 40.4% |
Margins are calculated from reported revenue and income. The six-month effective tax rate was approximately 35.5%, versus 35.2% in 2010.
- Cash flow: Six-month operating cash flow was negative $31.3 million, compared with positive $81.5 million in 2010. Investing activities used $10.1 million; financing provided $205.5 million, including the convertible-note issuance. Cash and cash equivalents increased $164.1 million to $379.6 million.
- Liquidity: Cash, cash equivalents and short-term investments totaled $701.1 million at June 30, 2011, up from $541.7 million at year-end 2010. Current assets were $793.5 million and current liabilities $164.8 million. Management said available funds and expected operating cash generation should cover operations, capital requirements, debt obligations and existing repurchase and dividend programs for the next 12 months.
- Debt: In April, the company issued $230.0 million of 2.50% senior convertible notes due 2016. The balance-sheet carrying amount was $188.8 million after an unamortized discount; reported fair value was $240.6 million. The notes are senior unsecured obligations and have conversion and fundamental-change repurchase provisions.
- Deferred revenue: Current and long-term deferred revenue totaled approximately $383.5 million, down $83.5 million from December 31, 2010. The company expected $133.0 million of fixed-fee amortization over the following 12 months; further reductions depend on reported per-unit royalties and technology-services work.
- Dividends: The company declared $0.10 per share for each of the first two quarters of 2011; $0.20 per share was declared in the six-month period. It had not repurchased shares in the first half.
Material changes versus prior comparable periods
- Q2 revenue declined 23%; first-half revenue declined 28%. The principal causes were lower fixed-fee amortization after expiration of the 3G portion of LG’s license at year-end 2010, fewer past-sales receipts, and lower technology-solutions revenue. Per-unit royalties rose, supported by sales from customers with smartphone concentrations.
- First-half past-sales revenue fell $38.0 million, mainly reflecting prior-period license and audit-related items. First-half per-unit royalties increased $12.9 million, but did not offset declines in other revenue categories.
- Operating expenses increased 5% in Q2 and 2% in the first half. Q2 increases included personnel and intellectual-property enforcement costs; lower compensation, consulting and sublicense costs partly offset them.
- Other expense was $3.4 million in Q2, versus other income of $0.9 million in Q2 2010, largely because of $3.6 million in note-related interest expense and a $0.3 million investment impairment. First-half other expense included $1.6 million of investment impairment.
- Operating cash flow swung to a use of cash, in part because 2010 included a $100 million Samsung license installment. First-half 2011 receipts from patent-license and technology-solutions agreements were approximately $68.5 million, versus $180.8 million in first-half 2010.
Outlook, commentary and risks
- On July 19, 2011, the Board announced a review of strategic alternatives, potentially including a sale or other transaction. There is no assurance of a transaction or stated timetable. The company warned of potential business disruption, customer and employee uncertainty, share-price volatility and review-related costs.
- On July 26, 2011, subsidiaries filed a USITC complaint and a parallel Delaware action against Nokia, Huawei and ZTE alleging infringement of seven U.S. patents by specified 3G devices. The actions seek trade restrictions and court relief; the USITC had not yet decided whether to institute an investigation as of the filing’s description.
- Technology-solutions royalties were affected by an ongoing arbitration over whether royalties are owed on certain product classes. The company reported $18.7 million of related deferred revenue at June 30, 2011.
- In a separate Nokia matter, a district court ruled on July 14 that InterDigital was entitled to recover a $500,000 injunction bond; Nokia appealed on July 26. No amount was recorded in Q2 financial statements, and any recovery would be recognized when received.
- Revenue and receivables are concentrated: Samsung represented 37% of Q2 revenue and 35% of first-half revenue; three customers accounted for 91% of net receivables at June 30. The filing also identifies litigation outcomes, customer royalty reporting, tax matters and the strategic review as uncertainties.
- No specific financial guidance was provided. Management’s 12-month liquidity assessment is a forward-looking belief, not a guarantee. The company reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Key facts for investors to verify
- Whether the strategic-alternatives review produces a transaction, and its costs, timing and effect on operations.
- Progress and outcomes of the USITC and court cases, including the new Nokia, Huawei and ZTE complaints and Nokia’s appeal concerning the $500,000 bond.
- Customer royalty trends, especially Samsung and Japanese per-unit royalties, and the degree to which concentrated customers affect revenue and collections.
- Whether operating cash flow improves as deferred revenue is recognized and prepaid royalties are exhausted; distinguish accounting revenue from cash receipts.
- Convertible-note terms, dilution and cash obligations, alongside the company’s large investment balance and reported note fair value above carrying value.