Xperi Holding Corporation

of approximately $350 million starting in 2021. We will provide more details on the license and what it means for Xperia later in this call. For today's call, all year-over-year comparisons will refer to past periods on a fully combined basis for Xperia and TiVo. On to the quarter. We made significant progress on various strategic initiatives during the quarter and delivered financial results in line with our original second half expectations. Revenue in Q3 was $202.8 million, down 6.2% year over year. Operating cash flow for the quarter was $62.2 million, up from $45.1 million last year. Importantly, Adjusted free cash flow was $66.4 million versus $46.5 million a year ago. During the quarter, we bought back 2.8 million shares at an average price of $12.39, or just over 2.5% of our shares outstanding. Our employees continue to navigate through the ongoing pandemic extremely well, and I'm exceptionally proud of the Xperia team for their commitment towards our overarching goal to invent, develop, and deliver technologies that enable extraordinary experiences in the home, on the go, and in the car. Our end markets are beginning to show signs of recovery, and while we are assuming some improvement in Q4, we remain cautious on the pace of recovery in 2021. We are now at the five-month mark since Xperi merged with TiVo, and we've made substantial progress executing on our integration plans, as well as the expected key revenue and cost synergies. We have already completed a full-scale organizational redesign, aligned our major employee programs, including compensation, benefits, and training, and completed the architecture and high-level design requirements for an optimized set of business applications and infrastructure. By the end of the third quarter, which is our first full quarter as a combined company, we've already realized on a run rate basis about two-thirds of the 50 million in annualized synergies we committed to achieve by the end of 2021. We remain highly confident in our ability to meet the synergy targets we outlined and will look for further efficiencies beyond those targets. On the revenue synergy side, we are now augmenting DTS's connected radio product with TiVo's metadata and personalized content discovery. and are in early discussions with TVOEMs with regards to the TiVo Stream implementation. Moving to the IP licensing business. IP licensing revenue in Q3 was $80.3 million, down 9% year-over-year. As expected, the decline was due to lower semiconductor revenue. To be clear, the third quarter numbers we will be discussing do not include any impact from our license agreement with Comcast that was announced today. as that agreement was concluded after the end of the quarter. Given the importance of this resolution to our go-forward IP business, I want to walk you through the license agreement and what we believe should be the key takeaways. First, this agreement resolves all of the outstanding disputes between the companies and underscores the relevance and value of our patent portfolio. Second, the terms of the agreement are consistent with our well-established licensing program for the pay TV market. The overall length of the agreement extends for a total of 15 years, dating back to the expiration of our prior agreement with Comcast in early 2016. Providing coverage through early 2031, this license agreement supports our core pay TV licensing program revenue through the next decade. Third, we are pleased to have resolved our dispute with Comcast so soon after the completion of our merger. This agreement underscores our commitment to successfully licensing the leading companies in our core markets, even if complex and protracted litigation becomes necessary to protect the value of our IP and to achieve long-term value for our shareholders. Finally, concluding this agreement with Comcast illustrates our ability to execute key renewals with our largest customers as the video market continues to experience significant technological and business evolution. Importantly, we believe that resolving Comcast will have a positive impact on our ability to reach successful licensing outcomes across our business going forward. In summary, our IP business is better positioned than ever, supported by long-term agreements with leading companies that generate significant recurring cash flows well into the future. Moving to our product business. Total product revenue for the quarter was $122.5 million. down 4.2% versus $127.9 million last year. As a reminder, we break out our product business down into three categories, consumer experience, connected car, and PTV. In the consumer experience category, revenue was $49 million, up 2% year over year. The growth was driven by sales of the TiVo Stream 4K, which offset declines in other parts of the home business. Regarding the TiVo Stream 4K, during the quarter we grew a retail presence through Walmart and Amazon, as well as adding broadband partner distribution through RCN. TiVo Plus content expanded to include Pluto TV, Tubi, Zumo, and Locast, and now delivers 144 core channels and up to 200 channels in major markets based on local availability. To date, consumer engagement has been strong, and the product is delivering industry-leading search and discovery metrics for consumer satisfaction in time from search to watching content. On the IMAX Enhanced front, we continue to expand the ecosystem with strong momentum in China. Leading streaming services Tencent and iQiyi are expanding IMAX Enhanced content offerings, and Chinese TV manufacturer Hisense just announced the first domestic IMAX Enhanced 4K OLED TVs. In addition, Philips announced the first IMAX Enhanced soundbar, bringing the total number of brands in the ecosystem to 19. As a reminder, key long-term growth drivers in the consumer experience category include sales and penetration of TiVo Stream and the monetization of that platform, growth of our IMAX Enhanced program, and the launch of Perceived's Ergo chip and follow-on chips in future products. Moving to the connected car category, revenue was $18.5 million, down 5.8% year over year. As expected, the decline was driven by lower car production year over year due to the impact of COVID-19. On the HD radio front, the FCC approved all digital AM broadcasting. This is significant in that it builds on the existing broadcast standard for our technology, and further encourages receiver manufacturers to incorporate HD radio. During the quarter, HD radio launched in North America on 14 new 2020 car models. We are seeing signs that the automotive market is starting to recover. We expect to see a recovery of our HD radio shipments in line with the market trends. The latest car sales projections released this month predict around a 9% recovery in 2021. On the connected radio front, we reached a significant milestone this quarter with the official launch of connected radio with Daimler AG. Connected radio launched in the Mercedes-Benz S-Class new state-of-the-art Mercedes-Benz user experience multimedia system, which is redefining the in-dash radio listening experience. We expect Daimler to roll the platform out more broadly across their product line. This is the first of many OEMs that we expect to implement our connected radio platform. The team has developed and delivered the most advanced next-generation radio platform for automotive manufacturers. Connected Radio's global platform is available in 24,000 cities, 48 countries, and 14 languages, with content sourced from 76,000 radio stations. all aggregated, curated, and personalized to create a rich in-vehicle radio listening experience for its users. Importantly, by 2025, according to recent market forecasts, we expect the total addressable market for our automotive connected media platform will reach approximately 75 million units worldwide. Lastly, for in-cabin monitoring, we remain on track to deliver the first occupant monitoring solution to a major European brand in the second half of 2021. To capture the opportunity in this market, we continue to add new features to our OMS, which includes advanced computer vision features such as generic object detection and body and gesture analytics. Our current addressable market is roughly half of the 100 million new cars sold each year globally, with a focus on those countries and regions that have been early adopters of improved safety standards. such as Japan, North America, and Europe. Moving to the last category in our product business, our pay TV revenue was $55.6 million, down 6% sequentially. During the quarter, certain customers, including Liberty Latin America, Nutco, Metronet, and RCN, launched next-gen TiVo IPTV platforms. Our new IPTV platform provides an upgraded user experience and greater monetization potential than previous older generation pay TV solutions. However, due to COVID-19 related restrictions, the pace of household conversion to IPTV has been slower than originally expected. Lastly, in our perceived startup, we continue to engage with our lead customers, and the interest level is increasing across potential PC, mobile, and enterprise customers, several of which are evaluating our platform. The ERGO chip received favorable media coverage during the quarter. In September, perceived CEO Steve Teig presented ERGO at the Embedded Vision Summit, where a session was among the highest rated and attended at the conference. With that, I'll turn the call over to Robert to discuss our financials. Robert? Thanks, John. Let me begin with financial results for the third quarter. As noted earlier, in order to provide more meaningful comparisons and discussing both non-GAAP and cash flow-based numbers, our periods are presented on a fully combined basis for the merged companies. The compared third quarter revenue was $202.8 million, which is on track with our original second half 2020 guidance. GAAP operating expense, including the cost of goods sold, was $221.8 million. GAAP operating expense is significantly higher than the third quarter of last year due to our merger with TiVo. On a non-GAAP basis, our total operating expense, including COGS, was $153.1 million, down from $164 million a year ago on a fully combined basis. Cost of goods sold was $33.8 million and increased by $5.5 million year-over-year due to increased hardware expense from the rollout of the Kino Stream 4K. Excluding COGS, non-GAAP operating expense for the corridor was $119.3 million, down by 16.5 million or 12% year-over-year due to lower personnel expense, reduced litigation costs, and lower outside spend. From a synergy perspective, as of the end of the quarter, we'd already realized approximately two-thirds of the targeted annualized savings of $50 million is targeted by the end of 2021. So not all of those savings will be reflected in this year's financial results. Cash taxes paid in the quarter were $16.9 million. This quarter's cash tax was unusually high since it included $5.8 million of TiVo's withholding and BEAT taxes that were accrued prior to the merger, yet paid in Q3. Given the total cash tax number for the third quarter, non-GAAP earnings per share was 19 cents. The form excludes the $5.8 million of cash tax related to prior period TBO liabilities. Non-GAAP earnings per share would have been $0.24. We ended the quarter with 107.5 million basic shares outstanding. During the quarter, we bought back 2.8 million shares of common stock at an average price of $12.39 for a total of $35 million. As of the end of the quarter, we had $100 million of share repurchase authorization remaining. Moving to the balance sheet, we finished the quarter with $203 million in cash and investments, up by $3 million from the second quarter. We paid down $13.1 million of our debt during the quarter and expect to make a significant pay down on our debt as a result of the Comcast license. Operating cash flow for the quarter was $62.2 million, up from $45.1 million a year ago on a fully combined basis due to reduced operating spend and lower interest expense. Our adjusted free cash flow for the quarter was $66.4 million. Adjusted free cash flow reflects operating cash flow adjusted for $1.1 million of property plant and equipment spend and $5.3 million of merger and separation related costs. During the quarter, Xperia paid a cash dividend of $0.05 per share of common stock. Let me now provide an update on our second half outlook. For the second half of 2020, we now expect revenue to be between $625 and $645 million. Importantly, with Comcast now resolved, the new baseline revenue for our IP business beginning in 2021 will increase to approximately $350 million a year compared to figures discussed on our second quarter call of approximately $300 million per year. Notably, we continue to believe there is meaningful upside for our IP business from the three areas we discussed last quarter, including increased penetration in new media and OTT, the remaining unlicensed traditional pay TV subscribers in North America, and new semiconductor business. We now expect cost of goods sold for the second half to be between $73 and $76 million. GAAP operating expense for the second half of the year is now expected to be between $421 and $431 million. The non-GAAP operating expense is expected to be between $275 and $285 million. The expense increase from prior guidance is primarily due to true up of variable compensation expense accruals from an improved outlook year end. Please refer to our earnings release for reconciliation between GAAP and non-GAAP expenses. We expect interest expense to remain between $26 and $27 million. Other income to increase to approximately $3 million and cash taxes to move between $33 and $35 million. Also, due to recent share buybacks, we now expect our basic share number of shares outstanding in the second half to be 106 million and fully deleted shares on a non-GAAP basis to be 112 million. Using the midpoints of the updated guidance ranges, we would expect non-GAAP earnings per share in the second half of 2020 to be approximately $2. Additionally, we expect to generate between $335 and $355 million of adjusted free cash flow in the second half, which includes payments to be received in the fourth quarter relating to prior periods covered in the Comcast agreement. That concludes our prepared remarks. Let's now open the call to your questions.

Thank you. If you'd like to ask a question on today's call, once again, that is star 1 on your telephone keypad. A voice prompt on the phone line will indicate when your line is open. Please state your name and company before posing your question. We'll take our first question. Caller, please go ahead.

Thank you. Hey, it's Eric Wolfe from BeWise Securities. Can you guys hear me now? Yes. Perfect. So I guess a couple of questions on the guidance. Obviously, congrats on getting Comcast done. It's been a slug for a number of years. I guess when you talk about the consistent baseline IP revenue going up from $300 million to $350 million after that license was signed, should we assume that $50 million increase is on a fixed basis, or is there potential variability in that number around those subscribers? The terms of the agreement itself are confidential, so I can't really describe the structure and how it's going to occur going forward. I'm afraid I just can't get into the specifics of the contract. I think, you know, the increase I think will give you a feel for what we're looking at on an annual basis, so the difference between the $300 and the $350. Okay. That's fair. I was just going to say, Eric, the only thing I'd add is just that the license was, you know, I think concluded on consistent terms with our broader USPATV licensing program. Okay. So with the new $300 million base, is there anything, and you talk about this license, you're helping other licensing discussions and renewals. Are there any significant renewals in that 350 number over the next, call it two to three years? I think I can take a pass at that, which is, you know, we have renewals every year. We've been very successful in actually achieving those renewals. So certainly there is some degree of that. I'm not aware of any significant licenses that may be renewed during the period of time that you mentioned. And then just final one for me. Obviously, along with that license, assuming there's going to be a significant amount of savings on litigation spend, what is the current plan with that litigation saving? Is it to be recycled into other pursuits on the litigation end, or is that also going to represent a nice EBITDA boost in addition to the upward move in license revenue? Yeah, it's always tricky trying to forecast litigation spend. But I think to the extent that we don't spend on litigation, that will flow down. So we're not going to use it elsewhere. Very helpful. Thank you, guys. You're welcome.