InterDigital, Inc.

Good day, and thank you for standing by. Welcome to the InterDigital Incorporated Third Quarter Earnings Call 2022. At this time, all participants are in listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1 1 on your telephone. You will then hear an automated message advising your hand is raised. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Richard Boyd. Please go ahead.

Good morning to everyone, and welcome to InterDigital's third quarter 2022 earnings conference call. I am Richard Boyd, communications director, and with me in today's call are Lauren Chen, our president and CEO, and Rich Breske, our CFO. Consistent with last quarter's call, We will offer some highlights about the quarter and the company, and then open the call up for questions. Before we begin our remarks, I need to remind you that in this call, we will make forward-looking statements regarding our current beliefs, plans, and expectations, which are not guarantees of future performance and are made only as of the date hereof. Forward-looking statements are subject to risk and uncertainties that could cause actual results and events to differ materially from results and events contemplated by such forward-looking statements. These risks and uncertainties include those described in the risk factors sections of our 2021 Annual Report on Form 10-K and in our other SEC filings. In addition, today's presentation may contain references to non-GAAP financial measures Reconciliations of these non-GAAP financial measures to the most directly comparable GAAP financial measures are included in our financial metrics tracker, which is available on the investor relations section of our website. With that taken care of, I will turn the call over to Liram.

Thank you, Richard, and good morning, everyone. In the third quarter, we once again demonstrated how our innovation is becoming more valuable in an increasingly connected world. We grew our innovation pipeline with a record quarter for new inventions, strengthened our recurring revenue base with an 8% growth year over year, increased recurring revenue in consumer electronics, IoT, and automobile for the sixth consecutive quarter, and entered into a new seven-year license agreement with Apple that goes all the way to 2029. Our new deal with Apple is a huge validation of both the quality of our innovation and the strength of our patent portfolio. Under the term of the deal, InterDigital will recognize around $134 million annually for seven years, which represents a 15% increase over our previous Apple deal. Apple is one of our longest licensee dating back to before the first iPhone went on sale. And I'm delighted that we are able to agree to a new, mutually beneficial deal before our previous agreement came to an end. I would also add that Apple is a clear leader in the rollout of 5G, particularly in the premium tier of the smartphone market. So this deal serves as a resounding endorsement of the strength of our portfolio which now consists of more than 10,000 cellular standard essential patent assets, over 6,000 video-related patents, and a significant number of highly valuable implementation patents for 5G multimode handsets. The Apple license also came at a time of increasing momentum in our licensing programs. Over the last 18 months, we have signed new agreements and renewals with an aggregate value of more than $1.5 billion, including 16 direct agreements and additional agreements executed through partner licensing platforms. While we still see plenty of growth in our core smartphone business, we have built considerable traction in the consumer electronics and IoT automobile markets. In the first three quarters of this year, we have seen a 37% increase year-over-year in our CE, IoT, auto total revenue, and a 66% year-over-year increase in recurring revenue in these markets. Together, those verticals are on track to deliver annual revenue of almost $100 million by end of the year. This is excellent progress and underlines our belief that our innovations are only becoming more critical across a growing number of industries. In the third quarter, automobile was particularly strong with several manufacturers, including Toyota, Honda, and Nissan. All took a license to our portfolio of 3G and 4G patents through our licensing partner. This agreement means that more than 100 million connected vehicles are now licensed to our 3G and 4G technology, with another 30 to 40 million forecasted to be licensed in the next year. With the industry analysis projecting double-digit growth in connected cars through 2026, and 5G projected to ramp up by much of the auto industry, we expect automobile to remain a sector with significant upside for the foreseeable future. I should emphasize, however, that we are only at the beginning of our licensing journey in the broader IoT market, and I'm excited by the potential use cases that we are yet to see for 5G innovation. As I have emphasized in the past, closing a licensing deal without litigation is always our preference, but we remain committed to enforce our IP rights when necessary. With 1.5 billion of new contract revenue, including Apple deal, reinforcing the strength of our balance sheet, we remain in excellent position to renew aspiring smartphone contracts and license new sectors, while at the same time ensuring that we keep on making investment to grow our innovation footprint. Thanks to the outstanding effort of our engineers, this footprint continues to grow. Recently, we announced a new partnership with Philips to work on more immersive video technology that will benefit XR-driven experiences. We continue to see considerable upside from our strengths in video technology, such as VVC, and our work related to more immersive experience should ensure that our video innovation pipeline remains strong for years to come. Overall, our innovation engine is more robust than it has ever been. In Q3, we generated the highest number of new inventions in a quarter in our company history. During the first three quarters of 2022, our total number of new patent family filed was about 10% higher than the whole year of 2021. As an innovation business, we rely on our ability to invest in cutting-edge horizontal technologies, translate them into high-quality patents, and make our innovation available by licensing it to a growing universe of device manufacturers across multiple verticals. Our Apple agreement is yet another endorsement of how this cycle continues to deliver significant financial results and our success in consumer electronics and IoT autos demonstrate that exciting opportunity we have in device outside smartphones. We also see a growing number of opportunity among service providers who are implanting our innovation, which offers another area of growth. Overall, I'm delighted with how we continue to execute against our goals across the company. On the litigation front, we are still waiting for the decision from the UK High Court in our French file against Lenovo, and we remain confident in the strength of our case. Before I hand it over to Rich, I want to mention that this month at InterDigital, we are celebrating our 50th anniversary. And I want to offer my personal thanks to current and former employees, our shareholders, our licenses and partners, and all those who have supported our journey to become a leading innovator in connected technologies. With that, I'll let Rich give you more detail on our financial performance.

Thanks, Liren. As Liren described, this past quarter, we made two very important steps toward our stated goal of achieving $650 million or more in annual recurring revenue from device licensing. First, we renewed Apple to a seven-year agreement valued at more than $930 million. Since we have no variable cost under this agreement, this is essentially 100% gross margin, making the Apple renewal the most valuable contract we have ever signed in our 50-year history. As Liren noted, beginning in Q4, we expect to recognize about $134 million a year under this renewal, which represents a 15% increase over the average annual recurring revenue from our prior agreement with Apple. Second, we reported our sixth consecutive quarter of growth in recurring revenue from the consumer electronics and IoT automotive markets. During that time, we have signed license agreements with Vizio, Sony, and Amazon, among others, and through our participation in an automotive licensing platform, we now have approximately 80% of the connected 3G, 4G car market under license. Our aggregate annual recurring revenue for consumer electronics and IoT auto has grown approximately 140% from $23 million in first quarter 2021 to over $54 million in the third quarter of this year. When you include catch-up payments from past infringement, we have reported approximately $75 million of total revenue from these markets in just the last nine months. We have updated our revenue tables and our 10-Q press release and financial metrics to clearly break out recurring revenue from each of these two important vectors for growth in device licensing. Moving on to expenses, our operating expenses came in lower than our expectations, driven by our final tallies for litigation and also aided by the strong U.S. dollar. Overall, the combination of our revenue growth and cost management resulted in almost $190 million of adjusted EBITDA through nine months. at a healthy 56% adjusted EBITDA margin. With continued progress toward our annual recurring revenue goal from device licensing of $650 million or more and continued cost management, we believe we can increase our adjusted EBITDA margin to about 60% or more, achieving both our revenue and margin target would equate to roughly $400 million of adjusted EBITDA on an annual basis. We believe adjusted EBITDA is a great metric for us as we essentially have a subscription business. We tend to sign long-term contracts, oftentimes five years or more, and we tend to recognize revenue smoothly over the terms of those contracts. Adjusted EBITDA adjusts for the timing of payments and better depicts the ongoing cash generation power of the business. For example, you can see our accounts receivable increased to over $400 million at the end of Q3 due to the partly front-loaded payment structure of one of our recent agreements. We expect the collection of this receivable in the fourth quarter will drive record-free cash flows in the quarter, but will be moderated in our fourth quarter adjusted even up. With that, I'll turn it back to Richard.

Thank you, Rich, and thank you, Liren. Operator, now open it up for questions.

Good day, and thank you for standing by. At this time, we'll conduct the question and answer session. As a reminder, to ask a question, you will need to press star 1 1 on your telephone and wait for your name to be announced. Please stand by while we compile the Q&A roster.

Thank you. We're now ready for the first question.

Our first question comes from the line of Scott Serrell from Roth Capital Partners.

Your line is now open. Hey, good morning. Thanks for taking the questions. Hey, morning, Loren. Just to quickly dive in, historically, you've reported the revenue figures a little bit differently. I was wondering if you could recalibrate us on that front in terms of fixed fee in the third quarter. And also trying to get my hands around the operating expense structure. I know this is a particularly active time period from a legal and litigation standpoint with Apple just concluded, potentially Samsung, what you have going on with Chinese OEMs and Lenovo. I'm wondering if you could help us understand what a more normalized kind of operating expense structure would look like. I know you gave guidance for the fourth quarter, but as we get out into 2023, how should we be thinking about what that structure looks like? And then I had a couple of follow-up questions.

Yeah. Hey, Scott, I'll take those questions. Starting with the first part on the way that we're reporting revenue. You know, we're just been talking about for some time and the breakout between fixed and variable just doesn't seem as useful. We still provide that information in the metrics that you can access on our investor relations section of our website. So it's available to folks, but for a long time, we've been around 90% or a little bit more of fixed revenue. And, you know, we see just a lot of growth outside of smartphones in the consumer electronics IoT auto sector. And I think we mentioned it's our sixth consecutive quarter of growth there, 140%, you know, compared to first quarter of 2021. And we think it's important to show that, you know, we're growing both within smartphones as well in these other areas. The second part of the question on OPEX, I think the important thing to look at there, and you can, again, see this in our financial metrics, is looking at our overall operating expense. We did note that, you know, with success this quarter, we had some adjustment in some of our performance compensation accruals, so it's a little bit elevated, and we've guided for that to come back down in Q4 closer to the levels we originally guided for Q3. And that does include a healthy amount of litigation You can see right on our financial metrics where we've been running there at, you know, about $11 million in Q3. So, I think, you know, excluding litigation, you know, without putting too fine a point on it, we're generally in the zip code. You know, we're going to continue to invest in the business. And then the bigger, you know, more volatile thing is where litigation goes. As we continue to you know, operate in our litigations with Lenovo and Oppo. And then, you know, we still have important renewables coming up.

Gotcha. That's helpful. Liren, if I could jump in on the IoT and auto segment, been having some success now, starting to see some momentum building behind that. And I think you mentioned that 80% of connected vehicles are now under the Avanci licensing partnership. That's around 3G and 4G. I'm wondering how you're thinking about 5G. Is that going to be contributed to a larger industry patent pool? Are you guys going to go it alone? How do you approach that market going forward? Yeah.

Hey, Scott. Good morning. Yes, you're absolutely correct. We've seen a lot of momentum in the IoT, which includes the overall auto market. sector here, and you also tried to start the 3G, 4G coverage under the licensing partnership with Avante. For 5G, we are actually ready for either approach. We are absolutely ready for direct licensing, but we see a lot of incremental value of 5G-enabled connected cars on top of the 3G, 4G. But in the meantime, we are also open for exploration with potential partners in those areas. So regardless with either approach, as I said in my prepared material, we see a lot of growth in the space because the Connecticut car overall will grow in terms of market adoption and 5G just on top of it regarding the value added.

Okay. And lastly, if I could, just on the video front, you started to talk a little bit about streaming opportunities. I'm wondering if you could flush that out a little bit, what your latest thoughts are in terms of the opportunity to monetize your video patents into other, I'll call them non-traditional areas, and maybe throw on top of that as well, look, I know you've got a lot on your plate right now, but inorganic opportunities, are they starting to crop up for you as well, or there's enough going on in terms of driving a growing recurring revenue stream in IoT, CE, and auto that that's really not part of the near-term focus? Thanks.

So for the video space, through our inter-digital development as well as our acquisition with Technicolor, we actually have one of the strongest R&D pipelines as well as one of the strongest video patent portfolio in the industry. Our main focus has been and will continue to be monetizing the device licensing, which we are projecting at $650 million of near to mid-term opportunity here. But it's very clearly shown in the industry. Our technology with our patent portfolio is very much relevant for the service delivery by a number of, you know, very successful service providers in the industry. It's a large industry. It's a green industry. So we have done a lot of work, you know, designing our licensing program in that space. We are optimistic about the opportunity, but it will take time to grow. Regarding the acquisition in organic growth of organic growth, as I said earlier, we have an incredible, strong innovation engine that, frankly, creating innovation faster than we ever have been demonstrated in our latest quarter patent findings. We are happy with where we are, but we always look at third-party opportunities. If there's any portfolio, any business opportunity available, we definitely look at all those.

Great. Thank you. Thanks, Scott. Thank you. I'll ready up our next question. Thanks, Operator.

We can take the second question now.

There we go. I was just getting them ready in the queue. Thank you, Richard. Thank you. Our next question comes from the line of Anya Soderstrom from Sedoti. Your line is now open.

Hi, and thank you for taking my questions. So I'm just... I want to reconfirm that for the consumer electronics, you have been going after the smaller contracts, and we should see that growth maybe accelerate as you're targeting the larger opportunities within that, or how should we think about that growth?

Yeah, certainly, when you think about consumer electronics, which is part of that line, consumer electronics, IoT, and auto, The biggest opportunity there is televisions, and then within televisions, the number one and number two players, Samsung and LG, respectively, are unlicensed. So, there's still, you know, a lot of room for growth there, you know, across, you know, a lot of different segments, but especially television and especially within the top players in the market.

Okay, thank you. And for Samsung with the renewal there, does this discussion include the CE or is that running parallel to the smartphone conversation?

Yeah. Hey, Anya, this is Learn. So far, since our negotiation, we have been negotiating mobile opportunity renewal as well as consumer electronics, primarily TV side in parallel. This is primarily due to our CE program is a partnership with Sony. So this negotiation historically has been done separately.

Okay, got it. And that's for the Apple renewal, and congratulations on that. Was that just for the smartphones, or is that also for the other consumer electronics-oriented products?

Yeah, Hanya, now this learned. So due to confidentialities, we won't be able to get into the scope of the license with Apple beyond what we have already disclosed in the 8K fighting. But the right way to think about our relationship with Apple is it's a long-term relationship that, frankly, both parties are very happy with the overall results that we feel are mutually beneficial.

Okay, thank you. And just, Ricky, if you could talk about capital allocation priorities in terms of buybacks and dividends and so forth.

Yeah, Anya, happy to. You know, I think the first thing I'll note is, as I, alluded to on the prepared remarks, we do expect a large payment coming in in Q4. So, you know, it's always a big topic for us and will remain so. But, you know, our priorities remain to, you know, keep a strong balance sheet. You know, with, you know, the large payment coming in, it will only get stronger. And with Apple now renewed, you know, it's at least comparatively, you know, less a necessity, but still, still a priority for us to maintain a strong balance sheet. And then we want to make sure we can invest in, you know, organic opportunities. We already talked about the growth that we have in R&D, and, you know, we've demonstrated the success in, you know, deploying that in the market and getting paid for it. And, you know, to the extent that we're choosing, but to the extent there are inorganic opportunities, we'll consider them as well. And then finally, you know, we want to make sure we're returning capital to shareholders as appropriate. And, you know, we always feel like we do a good job with that over any appropriately length of time.

Okay. Thank you. That was all for me.

Great. Thanks, Anya.

Yeah. Thank you, Anya.

Our next question comes from the line of Tal Liani. Your line is now open. Hey, can you hear me? We can. Yep.

Your line is now open. Hey, awesome.

Hey, this is John from Bank of America. Thanks, guys. Apologies in advance. I've been on a couple earnings calls this morning, but just in general, obviously, we heard from one of your licensing peers last night on worsening smartphone market demand and general channel inventories. Obviously, you're situation is a little different not being on the volume side of licensing, but I'm kind of curious how that really impacts you guys and what the, I guess, way to navigate that if there's a need for that is for you.

Yeah. Hey, John. Good morning. This is Learn. So, regarding our license agreement, as Rich just commented here, 80 or 90% of our license agreement comes from fixed fee agreement. So in that context here, we are actually better situated than most in our industry to be able to weather, you know, certain amount of downward storms in this area. Having said that, though, there's still, you know, we are not completely immune when we have renegotiations for renewals. And so we are obviously very carefully managing those dynamics. But it's worthwhile mentioning a few things here. One is when we negotiate those agreements, those are long-term agreements, as Rich commented earlier. They are five years or longer. So we are really looking at long-term projection for welding over this period of time. So very often, these will ride out the bombs and batteries, if you would, in the welding. Second thing, more applicable to us than some of our peers, is we currently, as we discussed in prior calls, we have roughly 55% of the market covered. So we are working really hard to get to about 80% to 85% by signing up some on licensed customers that are using our technology. So as we, you know, expand our share here, we see plenty of growth in those space. And lastly, as we, you know, starting this quarter, we are, you know, separating our consumer electronics, IoT, and auto industry opportunity. And we have done a really good job growing that, you know, segment in the last year and a half. So we feel with all those parameters balancing together, we have a really, really good licensing program here.

Got it. Okay. That's helpful. On the, I guess, because you mentioned the 55% penetration, on, I guess, going after new deals, obviously, the current environment is not, hopefully, not a long-term consideration. But have you seen that impacting any conversations on that end in terms of maybe royalty rates or, I guess, just general sentiment on signing new deals at this point?

John, I mean, signing new deals is always challenging, but we have a really long track running in the industry to negotiate most of the deals, you know, through bilateral negotiation. In particular, though, our largest opportunity that's unlicensed currently is really OPPO, Vivo, and Lenovo, which combined has roughly 25% of the market share here. So OPPO and Lenovo are both in litigation. So in that context here, especially for Lenovo, we are just waiting for the UK judge to issue a frank decision, which could come anytime soon. So in that context here, we don't see, frankly, near-term market up and down impacting those decisions.

Got it. Okay. That makes a lot of sense. And then separately on the recent collaboration deal with Philips for the, on the codec side. Can you just discuss any potential impacts, I guess, on bottom line and kind of just what you see coming from that deal in terms of a flow through to the P&L?

Yes. So our collaboration with Spirit of Space Radio R&D collaboration, where we are working together on the multimedia user experience on immersive user experience. which is XR driven, you know, that's extended virtual reality user experience. So it's frankly still a foundational research we are doing. It's leveraging the strengths we already have in, you know, some of the KUDAC area in terms of VVC and others. Frankly, it's still early stage R&D. And then the XR market adoption, it's still relatively low volume. So we do not see any immediate, you know, P&L impact.

Got it. Okay. That's all for me. Thanks, guys. Thank you.

Yes, thank you. And again, as a reminder, if anyone would like to make or ask a question, you will need to press star 1-1 on your telephone. Please wait while we organize the queue. At this time, I'd like to turn it back to the speakers for any further comments.

Thank you, operator, and I'll hand you back to Lauren for a final message.

Before we sign off, I'd just like to thank our employees and our shareholders for their ongoing support. I also hope all of you enjoy the upcoming holiday time and the rest of the year.

Thank you for your participation in today's conference. This does conclude the program. You may now disconnect.