IDCC
#Good morning, everyone.
Thank you for joining us on the call today.
As you saw from the press release this morning, the company delivered yet another very strong quarter and equally strong year, driven by our broad base of licensees.
The strong results on our top line, combined with the continued efforts to control our costs, resulted in strong profitability and cash flow as well.
Rich will go into the numbers in more detail in his remarks.
I wanted to do a quick review of the year from a strategic perspective and then talk about our objectives for 2018.
As you all know by now, our strategy is very straightforward, focused on growing the value of our core terminal unit licensing business.
To do that, we continue to develop the critical wireless technologies that are so key to our customers.
We also seek to develop and acquire deep new competencies in other pervasive technologies that are also important to our handset customers.
Next, we need to bring these technologies to our customers in a manner that produces stickier, more valuable customer relationships, finally meaning to do all of this respecting our cost structure and operating leverage.
Let me start by talking about the status of our 5G activities.
The first release of the 5G standard was frozen in December 2017.
During this initial standards process, InterDigital made over 1,000 contributions, chaired and vice-chaired important working groups and filled other key roles in shepherding the process along.
The result was not only a fantastic start for the industry in 5G, but also a continuation of our leadership and innovation success.
We also made significant strides in 2017, expanding our technology footprint.
Internally, our video team continues to have great success in developing new technology solutions for adoption into next-generation standards.
We also continued our efforts on security technologies, WiFi and the like.
2017 also saw us complete the integration of our first significant acquisition, Hillcrest Labs.
Hillcrest is a pioneer of sensor fusion technology, with a rich portfolio of invention for a technology that will be pervasive in mobile devices.
During the year, we mined and matured their patent portfolio, identifying innovation relevant to smartphones that are shipping today.
This allowed us to very rapidly bring these innovations into the discussions with our customers.
Second, early this year, we fully integrated the Hillcrest research team into InterDigital Labs, providing the strength and stability of that broader research organization, and perhaps more importantly, providing the opportunity to cross-pollinate innovation across sensors, security and other key technologies being worked on at the company.
Third, we repositioned Hillcrest product effort away from commodity markets to areas where significant new innovation will be necessary.
These product areas are more aligned with developing innovation that can be used in our core business and also allows us to have informative customer engagements that can help guide the direction of our research.
2017 was also a year that saw us do better than ever in terms of bringing all the company has to offer to customers.
For example, our LG agreement included the involvement of our Hillcrest team, which has had a long and productive relationship with LG around smart TVs.
Other licensee conversations are also engaging groups from around the company.
The result was a different type of dialogue with our customers.
Going into 2018, we had matured a number of discussions around more comprehensive relationships and are working to close on those deals this year.
We did all this respecting our expense structure.
The incredible value of InterDigital's core business is in its operating leverage.
We create the greatest value when any added revenue comes with only nominal cost.
In that instance, a 10% increase on the revenue line can yield 2 or 3x that increase in our profit.
That is a remarkable value to shareholders.
We demonstrated that in 2017 as even with the Hillcrest acquisition as an example, our operating expense stayed relatively flat despite having new innovation, products and research to show to customers.
For 2018, our strategic objectives will be largely the same, continue to drive 5 research, deepen our technology position on selected area of innovation like sensors and explore through M&A other opportunities to bring deep and respected technology positions into the mix.
All of these assets will come together with the customer, where we expect to drive valuable and closer customer relationships.
As part of that effort in 2018, we will also have the opportunity to reshape the management team to have a broader set of technology skills and an even greater knowledge of our customer.
The opportunity comes as 3 of my most trusted colleagues, Larry Shay, Scott McQuilkin and B.
K.
Yi, have chosen to retire.
All 3 have had long and distinguished careers with the company and had driven incredible results.
For example, Larry was integral in many of our key negotiations, successfully concluding them and driving our revenue platform to new heights.
Scott reshaped our innovation engine, making it more nimble, more cost effective and more diverse in both the technologies we sought but also from where we secure them.
And B.
took our wireless research to a deeper level, driving fundamental innovation that has become critical to our strong performance in the 5G standard-setting process.
While their departures are hard, the company being as strong as it's ever been, can take the opportunity to broaden its talent base, consistent with our strategy to know our customers even better, deliver to them a wider range of technologies and do so creatively.
We have already announced the promotion of Tim Berghuis to lead the licensing team.
Tim has been at InterDigital for 16 years, and his time in the licensing team under Larry as well as his engineering and business background at Motorola, making the perfect fit for the role going forward.
And we look forward to announcing equally exciting talent joining the management team.
InterDigital remains an exciting and invigorating business with great opportunity.
For that reason, I expect 2018 to be another banner year for the company.
With that, let me turn it over to Rich.
Thanks, Bill.
Once again, we delivered a strong fourth quarter, capping off another strong year.
Our fourth quarter revenues topped $200 million, including $106 million of past sales.
A large portion of this past sales amount was expected in connection with the recognition of a nonrefundable prepayment balance upon the expiration of an agreement at the end of 2017.
The balance of the past sales were driven by our fourth quarter patent license agreement with LG.
2017 is the fourth year out of the last 5 that we've recognized over $100 million in past sales, a tremendous driver of value for the company that has contributed nearly $800 million over that period.
More importantly, our new agreement with LG drove our recurring revenue in the quarter to nearly $100 million, our highest level since the first quarter of 2016.
As we discussed previously, on January 1, we adopted ASC 606, the new accounting standard governing revenue recognition.
This morning, we announced that with the adoption of ASC 606, we expect first quarter revenue to be between $66 million and $71 million.
This translates to $90 million to $95 million on a pre-606 basis, which will be roughly in line with our recurring run rate in 2017.
That guidance reflects the stability in our business as our new agreement with LG has roughly offset the expiration of a few agreements at the end of 2017.
And of course, we hope to build on that stable base by adding new license agreements and renewals during 2018.
As previously discussed, we expect that any new fixed fee agreements we sign or renew are likely to qualify for overtime recognition under the new revenue recognition standard.
As a result, we have not changed our $500 million to $600 million target revenue platform for the business, even after accounting for the revenue recognition standard.
As a final note on the new accounting standard, I want to make everyone aware that in our 10-K, which we filed this morning, we have also previewed our detailed expectations for the impact of adopting ASC 606 on our opening balance sheet accounts, including deferred revenue and retained earnings.
Moving on to expenses.
We continue to manage our expense profile with nearly flat overall operating expenses.
As Bill mentioned and we have long discussed, we believe we can achieve our revenue goals without incurring significant additional expense.
This operating leverage has proven to be very beneficial to our shareholders as we have been able to generate substantial pretax profits and cash flows in recent years.
Given that, we are excited about the recent tax reform legislation, which I'd like to discuss.
We recorded a $43 million tax charge in Q4 to revalue our net deferred tax assets under the new statutory rate of 21%.
This charge is a necessary counterpart to the significant reduction in the go-forward effective tax rate we expect to enjoy.
In fact, there is a provision in the new law that taxes the foreign licensing of intellectual property at 13.1% through 2025, at which point the relevant rate increases to 16.4%.
While the detailed IRS regulations necessary to fully implement the new tax law have not yet been published, on a go-forward basis, we currently expect a significant portion of our income will qualify for this low rate.
We expect to communicate a specific estimated effective tax rate in connection with our first quarter results.
With that, I'll turn it back over to <UNK>.
Yes, <UNK>, that's right.
I think you nailed it.
And adding to that, we think it's a significant portion that's taxed at the lower rate.
Yes, that's correct.
And it's not even that we'd avoid it.
I think that the conditions or circumstances that led to us signing the static fixed-fee agreements in the past were somewhat unique, and in our view, not likely to repeat.
So we certainly expect that any new deals or even renewals would be signed on the dynamic terms.
So a couple of things, right.
In terms of the negotiations of licenses today, so that's part of the discussion since 5G is now real.
I mean, the first standard drop is done.
It's done.
While the ---+ I think a lot of the analysis around who's got what patent position will continue over the next months and years.
I think our showing has been pretty good and the people that have been observing the standards processes have seen InterDigital with another good round of contributions there.
In terms of how the economics of that would play out, right, so most ---+ for most of our agreements to date, they have ---+ many of them have not included 5G.
So when the renewal discussion comes up, that will now be included in the discussion.
I think, to some extent, it's what you said, there's obviously older technology that's going away and 5G is replacing that.
That said, 5G has got some pretty ---+ has got broader use cases, and so I think the TAM, to that extent, increases.
And as you also note, the selling price of 5G devices will go up as they have in prior versions.
So when you think about running royalties, even at the same royalty, you would get a higher return.
And then that said, we would still rule for a slightly higher royalty with respect to 5G, reflecting the fact that the company has had a strong position there as well as the underlying technologies.
So I think that, as I already said, 5G is really going to do 2 things for the company ultimately, right.
So it's going to sustain and grow the core business, which has been the licensing of handsets and terminals, but it's also going to enable some other markets, but in particular, the IoT market because it's really a necessary component for the proliferation of connected devices out there and that will be a new and larger revenue stream for the company.
So I think it's a very positive event for those discussions, right.
One, it employed another flexible structure by the company, which says that there's a variety of ways in which we can bring value to folks and also how we can get paid under a license.
It provides visibility for the unlicensed folks into what somebody else is paying and so that they can see what we are asking from them is no different than we've already secured from LG.
So ---+ and LG is another one of those groups that has a very well-respected IP group and so they obviously take these negotiations very seriously.
So having secured a license with them is also a strong indication of the value of the portfolio.
So it's certainly a very positive thing when we go out to the unlicensed folks to have LG now as, again, as a licensee for the company.
So in the K, you guys did disclose that Huawei expires at the end of this year.
So wondered if you could maybe give us a little bit of color on why we're expiring in '18.
It's a little bit shorter deal than some of the other deals that you've signed in the past couple of years.
And then maybe just your confidence level in renewing it, some of the factors that are going to be applied there.
And then I think there were ---+ there was a discussion of one of their $18.5 million deal or $18.5 million contributor in '17.
So similar question there in terms of confidence level and renewing that.
Then I've got a couple of follow-ups.
Sure.
So Huawei, if you recall, there was a process by which the agreement get put in place, and then there was an arbitration process and the resolution.
So actually, if you look at that entire stretch of time, that was actually consistent with our license agreements.
In terms of how the renewal discussions will go, there's a lot of positive things in play, right.
So one, you have the previously determined arbitration rate is still part of the record here with respect to those folks.
I think there's also a good relationship that's developed between the companies since the license agreement.
There's a lot of engagement at the standards bodies, only because it's typical with standards bodies that you need to create alliances and other things.
And so we've been working with them on a number of issues there.
And just as we work with others, I think that they respect what we do in that context.
There's also opportunities with other things that we've developed at the company that will add to the discussions with Huawei, including things that we've done around video.
The Hillcrest assets will be very useful in that discussion.
I think following up on <UNK>'s point before, the fact that we have LG done as well is also useful in that discussion because it's a ---+ that's a ---+ it's a recent benchmark that Huawei can use.
I also would say that Huawei itself has turned up its efforts around its patents, obviously, using them in China with respect to Samsung.
So their respect levels for patents, I think, has been reasonably good.
It continues to be good.
I think we can reflect that in our discussions as well.
So we've got a good amount of time this year to get that renewal in place.
I think we're well positioned to do that, and that's what we intend to do.
And Charlie, if I could just add one point to your comment.
Each of the agreements that you referenced, the Huawei and the second agreement, while they expire at the end of 2018, they both met the description of static agreements.
And therefore, when you look at our revenue guidance for the first quarter, neither of those agreements is included in that revenue guidance.
So while the agreements still run over the balance of the year, the rev rec is out, beginning with our first quarter guidance.
Yes.
No, that's a definite positive.
So just real quick, though, to follow up on the $18.5 million one.
I know you guys had talked previously about some M2M stuff that was rolling off.
Is that in that category.
Or is this a classic terminal licensee and same applies in terms of ability to renew that in terms of how you talked about Huawei.
Yes.
No, that falls into the latter category.
And I think that's also a situation where we have a very strong relationship, and I think most of Bill's comments apply there as well.
Okay, okay, excellent.
I wanted to ask about M&A.
Bill, you did mention in your comments about you still believe you want to develop and acquire some adjacent technology here that'll help you with your conversations.
Just kind of wonder where things stand as far as that's concerned.
How did the landscape look to you.
And then maybe a follow-on question to that for Rich in terms of just the capacity in terms of size of deal that you guys believe you can do.
How should I be looking about where you are in terms of your ratios right now, in terms of borrowing capacity and kind of roughly how much do you have.
So in terms of the opportunity and our feelings around M&A, I think the ---+ a couple of things, right.
The Hillcrest acquisition was very instructive for us.
It was instructive in terms of how licensees reacted to that type of thing and the reaction was very positive.
I think that was reflected in our LG discussions.
It was very instructive in terms of how we can take asset or companies like that and reposition them into the company in a very effective way.
There's nothing better than actually doing it to see how it all works out and how, as an example, as I said in my script, how the research teams can begin to blend, how the product positions can be put in place that will really drive new innovation.
So we were very encouraged by what we saw with respect to that opportunity.
I think that the scale of the company is one that makes it attractive for us to seek out things like that because, as I mentioned in the call, we're able to take on things and really do so with very little impact on our cost structure, which means when we go to a licensee, we're actually going to seek almost a lower royalty than they would be charged by a stand-alone company, who's got to cover all of their fixed cost and other cost with respect to that licensing opportunity.
So there's a benefit to consolidation in the industry and so some people see that.
I think that also having more capability at the organization in terms of research and other things is proving to be very valuable in license discussions.
I'll give you an example.
One of the things that's been very useful for us in license discussions is actually to offer up a component of our 5G research as a deliverable in license agreements, people really value that.
And to the extent we can do more than that research capability to other things, that's going to be really valuable.
So we're very encouraged by what we've seen from M&A.
We're very encouraged by the opportunities that are out there for us.
And we are firm believers in the value that, that M&A can drive because, ultimately, the deals that we would look at in terms of investment in the core business are really going to respect that operating leverage.
And the design at the end of the day will be, can we bring in deals, restructure that asset in our business in a way that the added revenue really does drop to the bottom line as close it can net of taxes.
We believe we can do that, and if we can, that is extraordinarily valuable.
And as to the second part of your question, Charlie, the constraint, or the criteria is the better word, is really creating value for the shareholders.
At the end of the year, we had over $1 billion of cash, almost $900 million of net cash.
So just with cash on the balance sheet, we have a significant amount of flexibility there.
Certainly, the amount of cash flow that we've historically generated suggest that we have ample financing capability.
Just in the last 2 years, it's something like $600 million of free cash flow.
So we think that we're well resourced to kind of if we see the right opportunity to go after it.
But at the end of the day, the real measuring stick is what, at the end of the day, do we believe that does for our shareholders.
It's really the full range of customers, right.
So that's going to be people that we're having discussions for the first time with because there's new entrants to the market.
It's people that we're in renewal discussions with.
And it's also folks that may currently be licensee because one of the things that we've been very adamant about in the organization is just because we signed a license agreement with somebody, doesn't mean you stop the conversation.
That conversation needs to keep going.
It can happen at different levels.
So our CTOs are engaged ---+ our CTO will engage with their CTO.
Standards groups will engage.
Product groups will engage.
And we'll kind of keep track of all those engagements so that when it comes time for renewal, we have a better sense of what that customer needs, not only in terms of the license, but also technology and other assets that we have that we can bring to bear.
So it's a very purposeful, committed effort by the company to really know its customers much better and to use that knowledge in a way that creates value for both parties.
I'd say it's more of the latter and that this has been an initiative by the company for a few years to more broadly touch our customers.
Certainly, having more assets makes that easier.
So as an example, with Hillcrest, we have now a relatively straightforward conversation with folks within Samsung around certain of their products because Hillcrest delivers hardware to Samsung.
And so I think there's, to some extent, a limit to what the company can do only because it's sort of limited by the asset it has.
We have great assets and so we can have great conversations around research.
We can have conversations around the Hillcrest solution.
We have that conversations with respect to the Chordant IoT solution.
But I'd love to have a few more things and those can come in a couple of ways.
They can come through M&A, of course, but not everything has to be an acquisition.
They can also come through partnerships.
So we can find companies that we could partner with and be a channel for their software in China, as an example, because we have greater strength and breadth than that company may have, and in fact, that was one of the things I was doing at CES this year, was spending a lot of time with smaller companies, chatting with them about partnering and some of that.
And again, our goal is to create a large fabric of solutions for our handset customers and allow us to really create individualized deals for each of them, with the emphasis on doing it while all along respecting our cost structure, which we understand the value of that.
Yes.
So the primary change there with respect to the guidance is on the per-unit side because now that ---+ where in the past our Q1 guidance, we'd be sitting here in late February providing guidance for the first quarter with the fourth quarter royalty reports in hand, and that becomes the basis under the old rules for the first quarter revenue.
Now we're basically projecting or estimating on the per-unit side where those royalties will come in, and that's how we guide.
And ultimately, at the end of the day, it's 14% of our revenue when you look at 2017, with 86% being fixed.
So it's actually a pretty small portion of our revenue these days.
That is of the per-unit nature.
You'll lose some of that fixed-fee revenue in 606, so that proportion maybe changes a little bit, but it's still not something that we're especially concerned about.
