Jul 25, 2013
Executives
Patrick Van de Wille – VP, Communications and IR Rich Brezski – CFO Bill Merritt – President and CEO
Analysts
Anil Doralda – William Blair & Company Charlie Anderson – Dougherty & Company
Operator
Good day and welcome to the InterDigital Second Quarter Earnings Conference Call. Today’s conference is being recorded.
At this time, I would like to turn the conference over to Mr. Patrick Van de Wille.
Please go ahead, sir.
Patrick Van de Wille
Thanks, Erica. Good morning everybody and welcome to InterDigital’s Second Quarter 2013 Earnings Conference Call.
With me this morning are Bill Merritt, our President and CEO, and Rich Brezski our CFO. Consistent with last quarter’s call, we will offer some insights about the quarter and the company and then we’ll 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 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 set forth in our earnings release published this morning as well as those detailed in our Annual Report on Form 10-K for the year ended December 31, 2012, and from time to time in our other filings with the Securities and Exchange Commission.
These forward-looking statements are made only as of the date hereof and except as required by law, we undertake no obligation to update or revise any of them, whether as a result of new information, future events or otherwise. In addition, today’s presentation contains references to free cashflow, a non-GAAP financial measure.
A schedule setting out a reconciliation of free cashflow to net cash provided by operating activities, the most directly comparable GAAP financial measure will be included at the back of our earnings release issued today, which has also been posted in the Investor section of our website at www.interdigitial.com. And with that taken care of, I’ll turn the call over to Rich Brezski.
Rich Brezski
Thank you, Patrick. We are pleased to report strong free cashflow of approximately $133 million for the second quarter of 2013, and $204 million for the first half of 2013.
Our second quarter free cashflow which is driven by approximately $187 million in cash received including prepayments totaling $135 million from existing licensees and nearly $24 million related to the Pegatron arbitration award. The remaining $6 million we received from Pegatron was classified as interest income and therefore was not included within our free cashflow.
With $770 million of cash in short-term investments at the end of June, we are well-positioned to continue to drive our business forward. That includes both investing in the development of advanced wireless technologies and funding any litigation that may be necessary to achieve our licensing goals.
We recorded a second quarter revenue of $67.7 million which was in line with our guidance, and net income of $9.2 million or $0.22 per share. As we previously communicated, our second quarter revenue included $23.5 million related to our arbitration with Pegatron while we recorded another $6.2 million from Pegatron as interest income.
On the expense side, halfway through the year, we’re on track to deliver exactly what we guided towards at the end of 2012. Our second quarter 2013 operating expenses, not including litigation and repositioning, were $37.5 million, down $2.7 million sequentially from first quarter 2013.
This increase was primarily due to seasonal items that elevated first quarter expenses including higher fringe rates, vacation accrual and [inaudible] cost. Last year, we indicated that we expected our internally funded research and development cost pretty roughly $50 million.
With an additional potential, $10 million to $15 million based on external funding including our Convida Wireless doing ventures. Halfway through 2013, our development expenses in total are $30 million, in line with that guided range.
In addition, we realized significant savings from our voluntary early retirement program and reinvested a portion of that savings toward augmenting our patent portfolio, investing in patent department resources and strengthening our management team. Our litigation expenses in second quarter was somewhat lower than first quarter when the most recent ITC file took place.
Nonetheless, we expect litigation expenses to remain at high levels and possibly increase sequentially in third quarter as we move toward our scheduled December trial date in the ITC action we filed at the beginning of the year. Our second quarter effective tax rate remains high at roughly 45%.
Due to our second quarter income partly offsetting our first quarter loss, our effective tax rate for the first half of the year is actually higher than for either the first or second quarter. As we discussed last quarter, our effective tax rate is currently high due to the mix of income included in our tax projections for the year.
We continue to expect that our effective tax rate will return to levels we experienced in recent years once we sufficiently expand our revenue from patent licensed royalties. Finally, we are just beginning to receive our royalty reports from our customer second quarter sales which contribute to our third quarter revenue.
As a reminder, the $23.5 million of revenue we recognized in Q2 related to the recent arbitration award represent the past royalties determined under that award and covered the period through June 30 of 2012. We expect our third quarter revenues will benefit from additional royalties from Pegatron as they begin to report and pay royalties related to the arbitration award on current basis.
We’ll provide revenue guidance for the third quarter once we have received and reviewed the applicable royalty reports. And now, I’ll turn the call over to Bill.
Bill Merritt
Thank you, Rich, and good morning to everyone. As Rich described, we delivered a very solid quarter with strong profitability and positive cashflow.
That success was driven by the fundamental strength of our patent portfolio and licensing business. So while we can have wins and losses in litigations that happened this quarter, and we can have ups and downs in the regulatory environment, but the business performs well.
It also is once again [inaudible] not about nearly one litigation, instead it has happened to the depths of the patent portfolio, the breadth of our licensee base, the numerous opportunities to extend that base and the other ways in which we can make money off of our significant inventive capacity. In the end, we believe solid, market-oriented innovation is worth a lot of money.
And that is what we do. Because we just had a call a few weeks ago, I’ll be very brief in my remarks today.
First, on the ITC litigation, we have filed our petition for review with the full commission and feel very confident in our arguments. As a reminder to everyone, there were four primary avenues that we felt were open to review.
We chose to just focus on three claims instruction issues and need to win on only one. The sooner we do that and all else remain the same, we should win the case.
As we mentioned in the call, on the ITC decision, we believe each of our arguments is very strong. Second, we continue to execute well on our strategy to expand our patent-related revenue as well as the revenue on opportunities from InterDigital Solutions.
I did mention that our Investors Day in New York about two months ago, the company value is based almost entirely on a single aspect of its broad pattern portfolio not related to cellular terminals. Our patent portfolio is far more diverse than that as well as the market opportunities for licensing.
We’re getting off the store from strength innovation, the strength of our licensing teams and our relationships in the industry. We remain very confident in our ability to drive new and meaningful cashflow from other portions of our portfolio.
Some assets of the portfolio are fully ready, most notably the infrastructure portfolio. And we are moving to conclude deals in the short term.
Other portions of the portfolio are also strong, but they benefit from additional scale. As a result, we have taken advantage of a buyers’ market for patents and have acquired some key assets to bolt onto these portfolios.
Since the start of 2012, we have acquired almost 1,000 patents from patent applications in key spaces such as device design, positioning, technology, the video and audio delivery, and [inaudible]. And we continue to grow these portfolios through innovation occurring in our labs.
All in, we remain confident in our ability to drive substantial value both from our core channel of unit programs and from new licensing programs and initiatives leveraging other portions of our portfolio, our innovation labs, and our acquisition team. As I mentioned, I thought I’d keep it short today.
Again, a solid quarter with continued hopes, high hopes for the business and for the year. Now, I’ll turn the call back over to Patrick.
Patrick Van de Wille
Thank you very much, Bill. And if your remarks are concluded, we’ll open the call for questions.
Operator
Certainly. (Operator Instructions) And we’ll take our first question from Anil Doralda from William Blair.
Please go ahead.
Anil Doralda – William Blair & Company
Thank you, guys. Thanks for taking my question.
Bill, I know you guys are thinking of exact numbers on the royalty for the next quarter. But would it be fair to say directionally, you expect the royalty business to be sequentially down?
And I have a follow up.
Bill Merritt
So it was still like assembling the report. And also, we have the contributions coming in from Pegatron as well.
And I think we’re probably better off just waiting until we actually get the reports in and we’ll put out the – give you a more accurate estimate of where we expect to land.
Anil Doralda – William Blair & Company
And then you talked about a buyer’s market in the patent, a world – can you give us a little bit more color about some initiatives you’re taking, a little bit more specific initiatives or potential deals? I mean, I would love to hear how you’re thinking on that side.
Bill Merritt
Sure. So, there’s a couple of different avenues for how to monetize [inaudible].
One of this – like we do today, run licensing programs. Second is to sell a patent as we did with Intel.
Third is to partner with folks to run licensing programs or you can sell a patent and secure an earn out based upon the success of that new licensing program. I think the sale market as we mentioned before is a little softer than we’ve seen it before.
So we’ve taken advantage of that on the buy side and secured some assets that we think are very good pricing. So, we’re looking more today in terms of establishing licensing programs around these new assets and those could be established either inside or outside the company and there’s benefits to both.
I think there are some pretty good options for us driven off of the value of the assets that we have currently at the company and particularly the infrastructure asset. So, they are, as I’ve mentioned before, a bit more complicated to put together, but very manageable at the end of the day.
And we’ve been talking all year about getting something done. And I think it’s been mentioned in the script today, we think we can get something done in the short-term.
Anil Doralda – William Blair & Company
Great. And finally, Bill, I know some of the big audience have been trying to litigate against InterDigital by taking it on a per patent basis across different countries rather than and old encompassing patent settlement.
What’s the sentiment right now on that front? Do you still feel that the key folks that you’re litigating against still have that attitude or do you think they’ve come back from that position?
Bill Merritt
Well, I think the decision in the Samsung-Apple ITC case is important here. And so, that issue was raised in terms of whether someone needs to offer license under a single patent or whether they can instead include it in a bundle of patents.
And the commission came down on the side of [inaudible] okay. It’s also what the industry has historically done for lots of really, really good reasons.
It’s also a practice that’s been endorsed previously by other agencies in the U.S. government.
So, I can feel pretty good about that part of the business now in terms of our ability to continue to do the right thing which is to offer fair terms for our portfolio of patents, not to say of other folks, but we’ll continue to try to make that argument to try to piecemeal discussions or negotiations. But I think at least right now, the trend is in our favor.
Anil Doralda – William Blair & Company
Okay, thanks a lot.
Operator
And we’ll go next to the site of Charlie Anderson from Dougherty & Company. Please go ahead.
Charlie Anderson – Dougherty & Company
Good morning, thanks for taking my questions. Just a couple of housekeeping, I wonder if you guys had 10% customers you can disclose in the quarter.
Bill Merritt
We do and they’ll be disclosed in our 10-Q which we’ll be filing either today or tomorrow.
Charlie Anderson – Dougherty & Company
And on the $24.2 million that was passed that was Pegatron, did you get any running royalties from Pegatron in the quarter or did that start in Q3?
Bill Merritt
We did not record any running royalties from Pegatron in the quarter. This was associated with the arbitration work.
Charlie Anderson – Dougherty & Company
Yes, so you go from zero to something, Q2 to Q3, correct?
Bill Merritt
Yes, as we indicated in the script, we look forward to recording additional royalties based on the award in the third quarter.
Charlie Anderson – Dougherty & Company
Perfect. And I noticed you had a pretty big quarter for capitalized patent cost.
And I mean you guys obviously had a headcount reduction last year to the early buyouts. This is one of the biggest capitalized patents quarters I’ve seen in a few years indicating that a high level of sort of patent-filing activity.
Are you guys filing more patents than you were a year ago despite a smaller staff?
Bill Merritt
I think part of that – well, our activity remains high. Part of it is a bit related to timing as well.
If you go back and look at the first quarter, I think the numbers were relatively low. So, some of it is just when these things come up.
But certainly, we continue to have a high level of innovation.
Charlie Anderson – Dougherty & Company
And on the development expense, I think I heard you say $50 million was sort of the goal for the EBIT then you have the extra from the selling arrangements. Can you remind me sort of what the extra is in terms of where we’re going to shake out for development for the sort of annual expense?
Bill Merritt
Yes. So, the selling arrangement, I’ll remind you that the funding that we get is from the joint venture.
Because we actually consolidate the joint venture, we don’t record any additional revenue from it. But in fact, we do receive funding.
And basically, if you look at our goal of $50 million per internal funding plus external funding of $10 million to $15 million, but being the scope of our R&D activity, we’re in line with that. And year-to-date, that’s $30 million.
Charlie Anderson – Dougherty & Company
Got it, okay. So Bill, thanks.
Bill Merritt
Thanks, Charlie.
Operator
(Operator Instructions). Okay, if – we have no further questions, I’ll send it back over to Mr.
Patrick.
Patrick Van de Wille
Thank you very much and thank you to all our investors and analysts for joining us this morning. I appreciate it.
It was a short call, but we’ve had many opportunities to update the market recently. Looking forward to talking to you soon.
Thanks very much.
Operator
This concludes your conference call for today. Have a wonderful evening or afternoon.