InterDigital, Inc.

Good morning and thank you for standing by. Welcome to InterDigital's second quarter 2023 earnings call. At this time, all participants are in a 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 11 on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star 1-1 again. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Rayford Garabrant, Head of Investor Relations. Please go ahead.

Good morning to everyone and welcome to InterDigital's second quarter 2023 earnings conference call. I am Rayford Garabrant, Head of Investor Relations for InterDigital. With me on today's call are Liren 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 risks 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 factor section of our 2022 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 Liren.

Thank you, Reefer. Good morning, everyone. Thanks for joining us today. This was another strong quarter for the business. We added to our recent momentum once again demonstrated our ability to deliver stable recurring revenue and strong profitability and continued our excellent track record of returning capital to shareholders. Let me start with a status update on licensing. We continue to make solid progress in the smartphone space where we added a new licensee in Q2. In addition, we closed a new licensing agreement with Alpine a specialist system and technology provider in the IoT and auto sector. In the first half of the year, our recurring revenue from the consumer electronics and IoT, including auto, increased by almost 20% year-over-year, once again highlighting how we are capitalizing the opportunities in multiple verticals. In addition, early in third quarter, we added another new licensee from the consumer electronics sector. We also continue to advance our case in our arbitration with Samsung. The three arbitrators who will hear the case has now been confirmed. And a case management conference is being held today. As a reminder, Samsung has already agreed to take a license to our portfolio, effective January 1st of 2023, where the arbitration process will decide the monetary terms. We remain confident that our new license with Samsung will reflect the value of portfolio and continue our long-term relations with Samsung that started more than 25 years ago. Next, I want to give you an update on our litigation with Lenovo. Recently, we received another good decision from the UK High Court, which increased the amount Lenovo must pay us for a license to our 3G, 4G, and 5G patents to just under $185 million. which we already received from Lenovo, which will explain the revenue recognition topic in his remarks. This is a very positive development for us, and adds to the Court's previous ruling that Lenovo must pay us in full for the past sales going back to 2027. As Court noted, this is intended to be a powerful way of discouraging licenses from holding out on taking off-rent license. I want to remind you that the $185 million judgment is for our license to only our cellular patents until the end of 2023. It does not include our valuable portfolio of video, Wi-Fi, and implementation patents, and we remain committed to receive a full and fair return on our technology that Lenovo uses in its devices each day. One aspect of our dispute, which I'm particularly pleased with, is that when we assert our patent in three separate technical trials against Lenovo, each patent were found to be valid, essential, and infringed. Because they are all standard essential patents, this not only places us in a strong position on Lenovo case, but also in our future negotiations and litigation with other prospective licenses. We are, in our heart, a research innovation business The technology we developed and the patent that we filed each year are in many ways the product that we bring to the market. The high quality of our portfolio is directly connected to our ability to remain at the cutting edge of foundational research in wireless video and increasingly in AI. This year has already included many examples of how we excel as an innovation business. Our engineers produce a record number of new invention findings in the first half across both 5G and video spaces. As we continue our work in 5G, including what will be the first release of 5G Advanced, we are also deepening our research for 6G. In Q2, we announced a new research partnership with the University of Surrey in the UK to focus on specific technologies that we think will become a part of the 6G standard. Our ongoing wireless work, including the use of AI to improve the efficiency and reliability of mobile networks, is an excellent example of how central AI has become so much of our innovation. Our CTO Rajesh Pankaj is a well-known leading expert in AI and has been working in the space for years. Many of our other engineers are becoming noted experts, and like Rajesh, several have emerged as leaders in the field. For example, in Q2, one of our senior engineers were elected as the vice chair of an industry group within the standard body, ETSI, which is focused on creating standards to preserve and improve the security of AI. Staying on our innovation success, We were recently named by LexisNexis as one of the top 100 companies in innovation that advances sustainability. We strongly believe that our innovation is only becoming more valuable in an increasingly connected world, and I'm delighted that we are also playing our part in steering us towards a more sustainable future. Before I hand it over to Rich, I want to thank all our employees for the hard work in putting us in a strong position and deliver superb value to our shareholders. Our financial strength combined with our innovation leadership and the growing importance of our technology for different use cases means that we remain ideally placed to build on our recent success. And with that, I hand it over to Rich.

Thanks, Liren. I'm pleased to share that in Q2, we delivered diluted earnings per share, and adjusted EBITDA above the high end of our guidance range. This was driven primarily by revenue in line with expectations coupled with continued expense management. It's worth highlighting that when we received the initial Lenovo judgment in Q1, we recognized a large amount of catch-up revenue and a smaller amount of recurring revenue. In Q2, the UK High Court increased the value of the award, but in Q2, we recognized the same conservative level of recurring revenue from Lenovo as in Q1. Furthermore, we expect to continue to recognize revenue on that same basis throughout the balance of the year or until the related appeal process progresses. As such, we are deferring recognition for about 40% of the updated award. This is rooted in the conservatism inherent in the generally accepted accounting principles applicable to this situation since some of the award is still contingent on appeal. Even with the deferral, our revenue continued to drive strong profitability as we posted adjusted EBITDA of $54 million at a 53% adjusted EBITDA margin. Notably, we have delivered an adjusted EBITDA margin over 50% in seven out of the last eight quarters. Our adjusted EBITDA margin shows the power of our business model, as even in a quarter with only a small amount of catch-up sales, we converted over half our revenue to adjusted EBITDA. This is driven by the operating leverage inherent in our model combined with the discipline to ensure we maximize the conversion of revenue to profit and cash flow. As discussed on the last few calls, we believe adjusted EBITDA is a great metric to measure the ability of our business to generate cash over time because it adjusts for timing differences in cash collections under our fixed fee agreements. For example, this year, we used cash in the first half of the year, but expect customer receipts, including Lenovo, will drive well more than $200 million of free cash flow in Q3. And we continue to return excess cash to shareholders. As previously discussed, in the first quarter of this year, we repurchased 2.7 million shares through a $200 million Dutch tender. Since then, we have repurchased over 700,000 additional shares for almost $60 million. That brings the year-to-date totals to over a quarter billion dollars of share repurchases, a reduction of 12% of the outstanding shares since the beginning of the year. Looking forward to Q3, I'll remind you that our Q3 revenue guidance is based off of contracts signed to date, since the timing of new license agreements is inherently uncertain. We expect Q3 recurring revenues will once again be around $99 million. We expect operating expenses to be similar to Q2. We expect an adjusted EBITDA margin of about 50%. We expect to continue to repurchase stock. And finally, we expect GAAP diluted earnings per share of 60 to 70 cents. Since both of our converts are in the money now, the diluted share count in our guidance includes an estimated 1.2 million shares of accounting dilution. It's important to note that while the converts are dilutive from a GAAP standpoint, they are not economically dilutive below $106 due to hedges we have in place. Longer term, our goal remains to achieve and sustain a 60% adjusted EBITDA margin on $650 million of annual recurring revenue from device licenses with additional upside from licensing new products and services. With that, I'll turn it back to Rayford.

Thanks, Rich. At this point, Michelle, we are ready to take questions.

As a reminder, to ask a question, please press star 11 on your telephone and wait for your name to be announced. To withdraw your question, please press star 11 again. Please limit to one question and one follow-up question, and you may get back into the queue if you have additional questions. Thank you. Please stand by for our first question. The first question comes from Anya Soderstrom with Sedota. Your line is open.

Hi, and thank you for taking my question, and congratulations on the solid execution. I have a question on the Lenovo case. So the resolution you've got now, the 185 million, is just in regards to license for the cellular. Are you running the other technologies parallel, or is that something you will, when do you think that's going to be resolved as well, or how is that progressing?

Yes. Hey, Anyang, good morning. This is Learn. So as I mentioned in the prepared remark, our current $185 million reward from the UK judge only captures 3G, 4G, 5G cellular technology, but it also only captures the use of those technology until end of this year. So therefore, there's really three elements for additional value. One is we have other patents, That's Wi-Fi, HEVC, and implementation patterns that their devices are using. We also have patents rating other non-cellular devices, including their PC and their laptop, which are not part of the judge's decision. In addition, after end of the year, going forward, they are unlicensed, even for the cellular devices. So regarding us capture the value, we currently already have ongoing litigation against them, for example, in Germany. where we are asserting our HCBC patterns against both their laptop, but their mobile devices, their cell phones. And the trial is actually coming up in next month. So we definitely working on those and we expect, as I said in the prepared remarks, to be paid fully for our technology that they are using.

OK, thank you. And in terms of capital allocation with all this cash coming in, what's your sort of priorities?

Yeah, so, Anya, you know, our priorities are to be responsible stewards of our cash. You know, we've returned, as I noted in my comments, quite a bit of cash so far this year. But we have $142 million remaining on the authorization. And as I indicated, you know, we certainly plan to continue to repurchase shares into Q3. So that's, as always, an ongoing discussion with us.

Okay, thank you. That was all for me.

As a reminder to ask a question, please press star 1 1 on your telephone. Please stand by for our next question. The next question comes from Brian Chen with Jefferies. Your line is open.

Hi, thanks for taking the question. Just on the targets that you've outlined, you know, 500 million for wireless and 150 million for IoT revenues, could you please give an update on, you know, reaching those targets? You know, how should we think about levers that you still need to pull, you know, perhaps upside from the ongoing cases to reach that 500 million wireless target?

Yeah. Hi, Brian. This is Learn. So on the target for $500 million for mobile, we are proceeding very well. Obviously, the Lenovo case is part of the step towards that decision. But the three largest unlicensed, including also OPPO and Weibo, which frankly, size-wise, are bigger than Lenovo regarding their annual device sales. We currently have cases against OPPO pending in multiple jurisdictions. One of the things I mentioned in my prepared remark is the decision in UK for the three patent trials. It's actually a very helpful decision even for the OPPO case. Because they are standard essential patents, all our patents have been found, the three patents have been found to be valid, infringed, and accurate to the standard, which allows us to fast track that case in UK against OPPO. And there's an Acquia important hearing coming up in October of this year. It's a willingness trial, and then followed by a friend redetermination next February. So those are, frankly, the OPO timeline. It's quite good. And regarding Weibo, we are continuing active dialogue with them. So we feel confident about our $500 million target for the mobile side. Regarding the CE and IoT space, the $150 million That's something we are making progress. And frankly, if you look at our program here, our IoT CE growth rate is faster than our mobile. We have been achieving double-digit year-over-year growth for the IoT space for the last couple years already. And first half of this year, we are growth about 20% year-over-year. So we like to keep on building on that momentum.

Okay, perfect. And I just had one follow-up. So on you guys have started articulating potential monetization of services. Could you perhaps provide an update on potential size of opportunity and timing of this? And if you could provide any color on the process and strategy in building out this platform, that'd be great.

Yes. Again, look, Brad needs to learn. So if you look at So what the kind of technology those online services are using by online services have been, you know, the distribution of video, either, you know, one direction interactively. It's beyond any reasonable doubt that they're using and benefiting a lot from our connectivity as well from our video technology. So the real question is really how do we launch a licensing program in there, which we have been working on for quite a bit now. If you look at the market size, the online video space is projected to be growing to about $500 billion in 2027, which, interestingly enough, is the same size as today's smartphone market size. So we are working on that quite diligently. Currently, we don't have enough specifications to provide a precise estimate on how big a licensing opportunity this is with us, because we really would prefer to sign up at least one or more licenses before we put a specific number to it. So we'll keep you informed, and we have been working quite diligently on that space. Okay, great. Thank you.

To ask a question, please press star 1-1 on your telephone. Again, to ask a question, please press star 11 on your telephone. I am showing no other questions in the queue at this time. I would now like to turn the call back to Rayford for closing remarks.

Thank you, Michelle. I'll now turn it back to Liren for his closing remarks.

Hey, thank you everyone who joined today's call, and we look forward to updating you on our progress next quarter.

This concludes today's conference call. Thank you for participating. You may now disconnect.