Adeia Inc. (ADEA) Q2 2023 Earnings Report, Transcript and Summary

Good day, everyone. Thank you for standing by. Welcome to Adeia's Second Quarter 2023 Earnings Conference Call. [Operator Instructions] I would like to now turn the call over to Chris Chaney, Vice President of Investor Relations for Adeia. Chris, please go ahead.

Good afternoon, everyone. Thank you for joining us as we share with you details of our second quarter 2023 financial results. With me on the call today are Paul Davis, our President and CEO; and Keith Jones, our CFO. Paul will share with you some general observations during our second quarter and then Keith will give further details on our financial results and guidance. We will then conclude with a question-and-answer period. In addition to today's earnings release, there is an earnings presentation which you can access, along with the webcast in the IR portion of our website. Before turning the call over to Paul, I would like to provide a few reminders. First, today's discussion contains forward-looking statements that are predictions, projections or other statements about future events which are based on management's current expectations and beliefs and therefore, subject to risks, uncertainties and changes in circumstances. For more information on the risks and uncertainties that could cause our actual results to differ materially from what we discussed today, please refer to the Risk Factors section in our SEC filings, including our annual report on Form 10-K and our quarterly report on Form 10-Q. Please note that the company does not intend to update or alter these forward-looking statements to reflect events or circumstances arising after this call. To enhance investors' understanding of our ongoing economic performance, we will discuss non-GAAP information during this call. We use non-GAAP financial measures internally to evaluate and manage our operations. We have, therefore, chosen to provide this information to enable you to perform comparisons of our operating results as we do internally. We have provided reconciliations of these non-GAAP measures to the most directly comparable GAAP measures in the earnings release, the earnings presentation and on the Investor Relations section of our website. A recording of this conference call will be available on the Investor Relations website at adeia.com. Now, I'd like to turn the call over to our CEO, Paul Davis.

Thank you, Chris and thank you, everyone, for joining us today. During the second quarter, our deal momentum continued as we signed 9 agreements with a diverse group of Pay-TV, OTT, Consumer Electronics, in Semiconductor customers in both domestic and international markets. We delivered another quarter of strong financial results with revenue of $83.2 million and adjusted EBITDA of $51.7 million. We paid down approximately $20 million of debt in the second quarter, bringing our debt pay down since separation to over $114 million. In addition, we are on track to expand our patent portfolios by 10% this year. I am also excited to announce that we have expanded our Board with the addition of Adam Rymer. Adam is a well-respected executive with over 20 years of experience in the technology, media and entertainment industries and he has hands-on experience leading organizations in gaming, TV, film, music and live streaming. With his impressive track record of driving innovation at a wide variety of organizations, I am confident Adam will be a valued addition to our Board. Turning back to the quarter. Our deal momentum continued. Of the 9 deals we signed in Q2, 8 were in media and 1 was in semiconductor. Within media, we signed a significant long-term license renewal with Cox Communications. With the Cox renewal, we have now signed 3 multiyear renewals with the top 10 U.S. Pay-TV providers in the first half of the year. These renewals continue to validate the strength of our media portfolio in this market. Additionally, we signed an important new license agreement with DAZN, a leading OTT provider of global sports programming. This is an exciting deal in an emerging market for us and OTT will be a catalyst for our future growth as we continue to expand our customers in this market. Other deals we signed in the quarter included multiyear renewals with Enseo, a domestic provider of technology services to the hospitality industry; Freeview Australia, a free digital TV service provider; TechniSat, a German provider of digital video consumer electronics products; and Massillon Cable, a domestic Pay-TV operator. These deals illustrate the breadth of our portfolio and applicability to customers in multiple jurisdictions and markets. Our commitment to innovation drives deals with new customers in our high renewal rate which has averaged over 90% the past several years. We grow our patent portfolios primarily through investment in internal R&D, where we strategically invest in new technologies we anticipate emerging in our core markets and beyond. Growing our IP portfolio is important for several reasons. First, it allows us to retain our current customers and thus, maintains the pre-existing revenue base. Our customers benefit because they can utilize not only the patents existing in our portfolio when they initiated their license agreements but they also typically get access to new IP we add during the term of those agreements. Second, expanding our portfolio also attracts new customers as they find value in our innovations which enable them to differentiate their products and services in their markets. We take great pride in our long history of being pioneers and innovators in both the media and semiconductor markets. That history of success is based on being a visionary of emerging trends that drive the evolution of technology. Our R&D teams are always focused on the future and what technologies will be adopted in our customers' upcoming products. Our focus on advanced R&D and IP development have positioned us particularly well in both our media and semiconductor businesses to capitalize on the recent explosion of generative AI. In our media business, we have been investing in AI-enabling technologies such as computer vision, machine learning and natural language processing for years. Today, our portfolio contains significant coverage in these areas and this has helped drive license agreements in multiple verticals of our media business. And we believe these and other innovations will enable us to expand our customer base in new media verticals, such as adtech and e-commerce. Generative AI also requires high-performance computing and advancements in semiconductor technologies. The demand for emerging logic nodes, next-generation high-bandwidth memory and advanced system packaging is increasing to meet those needs. Our advanced processing node portfolio and our investment in hybrid bonding have established us as a recognized pioneer in enabling technologies that will drive tomorrow's AI. Before I turn the call over to Keith to further discuss our financials, I would like to briefly provide an update on our measures of success. I am very pleased with the progress we have made to date in each of these key areas. Future revenue growth will be primarily driven by opportunities in OTT, such as our recent deal with DAZN, in addition to adjacent market opportunities such as ad tech, automotive, e-commerce, gaming, music streaming and sports gambling. Importantly, these adjacent markets are entirely greenfield opportunities and we believe they can be significant revenue contributors in the future. We continue to make progress in OTT in our adjacent markets and customer engagements are at various stages. We also remain very excited about our hybrid bonding and advanced processing node portfolio's applicability in the logic market for our semiconductor business as we see these technologies being a catalyst for leading-edge logic devices. Our pipeline of deals remains diverse and robust and we believe our deal momentum will continue for the rest of the year. Lastly, as noted earlier, we remain on track to grow our patent portfolios 10% this year. With that, let me turn the call over to Keith to cover our second quarter financial results and our guidance for 2023.

Thank you, Paul. I am very pleased to be speaking with you today to share details of our second quarter 2023 financial results. Our second quarter results were very much in line with the guidance provided during our last call. Revenue for the second quarter was $83.2 million, a decrease of 29% from the prior quarter. Last quarter, when we gave color on the revenue trends we expected to see during the course of the year, we noted that the second quarter would be the low point due to certain renewals we anticipated closing in the second half of the year. And we also noted that we expected the first half of the year and the second half of the year to be evenly split relative to the midpoint of the annual guidance we provided. In the first half of the year, we delivered revenue of $200.5 million. This is exactly in line with what we laid out in last quarter's call. And with our strong pipeline, we remain on track to reach our full year revenue guidance. We generated revenue from the execution of 9 license agreements in the quarter, including a significant renewal with Cox Communications and a new license agreement with OTT sports program provider, DAZN. 7 of the 9 license agreements we signed in the second quarter were renewals. Our renewal rate remains very strong at greater than 90%. As Paul discussed, this is driven by our ongoing dedication to growing and evolving our IP portfolios which are fueled by our continued investments in R&D. Now I'd like to discuss our operating expenses for which I will be referring to non-GAAP numbers only. For the second quarter, operating expenses were $31.9 million, flat compared to the prior quarter. Research and development expenses were relatively consistent as we remain committed to growing our IP portfolios. Selling, general and administrative expenses increased $377,000 or 2%, primarily due to higher expenses related to personnel costs as we continue to build out our sales and administrative teams. Litigation expense was $2.3 million, a decrease of $288,000 from the prior quarter, due to the timing of expenses related to various legal matters. Interest expense during the second quarter was $15.5 million, down $398,000 from the prior quarter due to the continued debt repayments. Our current effective interest rate which includes amortization of debt issuance cost, remains at approximately 9.5%. Effective July 1, the variable component of our interest rate will be based on the secured overnight financing rate, or SOFR, due to the discontinuation of LIBOR going forward. This change will not have an impact on our interest expense as both rates mirror each other. Other income was $1.6 million and was primarily related to interest income recognized on revenue agreements with long-term billing structures under ASC 606 and due to interest earned on our cash and investment portfolio. Our adjusted EBITDA for the second quarter was $51.7 million, reflecting an adjusted EBITDA margin of 62%. Depreciation expense for the quarter was approximately $385,000. Our non-GAAP income tax rate remained constant at 23% for the quarter. Our income tax expense consists primarily of federal and state domestic taxes as well as Korean withholding taxes. Now for a few details on the balance sheet. We ended the second quarter with $84.3 million in cash, cash equivalents and marketable securities. During the quarter, we generated $28.7 million of cash from operations. Additionally, we made $20.1 million in principal payments on our debt. As a result, we ended the quarter with a term loan balance of $645.5 million. Also during the second quarter, we paid a cash dividend of $0.05 per share of common stock. Additionally, our Board approved the payment of another $0.05 per share dividend to be paid on September 18 to shareholders of record as of August 28. Now I will go over our guidance for the full year 2023. Our progress is in line with what we communicated during our last earnings call and we remain on track for achieving the full year annual guidance we set forth then. With that, we reiterate our full year 2023 guidance with our revenue expectation of $385 million to $415 million. As a reminder, our quarterly revenue can be lumpy from quarter-to-quarter as we tend to do a somewhat small number of large agreements that can impact the timing of revenue from quarter-to-quarter. We expect operating expenses to be in the range of $135 million to $145 million. We expect interest expense to be in the range of $64 million to $67 million and we expect other income to be in the range of $2.5 million to $3 million. We expect a resulting adjusted EBITDA margin of 66%. Additionally, we expect cash flows from operations to be in the range of $185 million to $215 million. We expect the non-GAAP tax rate to remain consistent at roughly 23% for the full year. We have also updated our guidance for the GAAP tax rate as it has been impacted by foreign currency remeasurements associated with the Korean withholding taxes which we expect to receive a refund for in future years. As this is merely a remeasurement, it does not affect our cash taxes paid nor our non-GAAP tax rate. We also continue to expect capital expenditures to be approximately $5 million for the full year. The first half of 2023 has progressed as we have planned. With 9 deals signed in the second quarter, our deal momentum has remained strong and I am very optimistic our funnel of deals for the second half of the year positions us well to achieve our full year goals. Our strong performance further reinforces our current baseline revenue of $375 million. And with the strength of our pipeline, we are excited about the future growth opportunities that will allow our baseline revenue to grow. That brings an end to our prepared remarks. And with that, I'd like to turn the call over to the operator to begin our question-and-answer session. Operator?

[Operator Instructions] We'll take our first question this afternoon from Hamed Khorsand at BWS Financial.

Just one clarification. You're talking about your patent portfolio expanding. Is that all internal innovation? Or are you looking at acquiring patents in the near term?

Hamed, good question. Yes, we are -- so far, the growth has been almost entirely organic R&D efforts which is what we focus on. We do look for opportunities though to acquire portfolios as well to augment our own internal R&D efforts.

Okay. And then as far as the free cash flow is concerned, do you think it's going to be linear for the rest of the year as far as what you generate? And do you think you're over the hump as far as interest expense rising in this environment as you're paying it down?

In terms of the free cash flow, we actually expect that to kind of go in the same general direction that our revenues, so to the extent that we have a deal being signed and the timing of billings. So we see volatility and we saw that from Q1 to Q2 and we would anticipate seeing a bit of that in Q3, with Q3 kind of being somewhat relatively consistent and then having a little bit more forward momentum as we close out the year. But in terms of the interest rate, we've -- we're still relatively conservative. So we're still baking in some further increases. So with that, we're kind of keeping that guidance the same on interest expense.

Okay. And then Paul, I know in the last couple of quarters, you've talked about music streaming being one of your focuses as being an area to expand on. Is that still the case? Or do you think that you would get new licensees from other end markets first?

Yes. It's still the most likely to be first. I think we're focused on music streaming, adtech and e-commerce as kind of the soonest of the adjacent markets. But music streaming would still be my expectation of what would come in first.

We'll take our next question now from Nick Zangler at Stephens.

So it sounds like performance this quarter was in line with your expectations. And obviously, we saw most of the contracts signed in the quarter, they were renewals and so you did get the new OTT licensee in DAZN. Can you just talk about the full year revenue guide here? It remains unchanged. What has to happen to hit the low end of that guide? And what has to happen to hit the high end of the guide, knowing that we've got a few months left -- 5 months left here, we've got one, I guess, new licensee signed in DAZN as of recently. But maybe you could just talk about those 2 scenarios? And then if you can, just peel back the onion on maybe how many deals you're currently working on and expectations or likelihood that they do get signed by year-end?

Well, Nick, one of the things I love about my job is going into sales meetings and looking at our pipeline. It's absolutely exciting to me. And for us and when we grow and thinking about how we're going to get to the next level and then kind of maximize our opportunities. It's just a matter of timing. And it's a matter of timing in light of the economics that we're trying to reach in these deals. So frankly, we could close out a lot more deals and we could have some slightly different inflection points for our revenue but to us, that would be sacrificing long-term benefit to the company. So really what I'm getting at is that the pipeline is there. There's nothing in it that's fleeting. It's really going to come down that have we reached the economic terms that we like at that point in time? And to the extent that we don't, we'll let things play out a little bit more. So that's really entirely the difference between us being at the low end of the range or the high end range.

Yes. I would just add, Nick, that what Keith mentioned last quarter and we said earlier on this call is we had a few renewals that we fully anticipated being in the second half of the year and that's still our current expectation. And that's really the fluctuation you see in that quarter-to-quarter but we still have high confidence in our guidance range.

Got it. And I guess with that said and I know you guys don't provide quarterly guidance but how would you recommend the Street model, I guess, 3Q relative to 4Q? Any way to kind of frame that split between what 3Q and 4Q look like given the full year guide?

It's a great question. Really, because of that volatility that we talked about, we're really just focused on the back half in total, is that relative to the midpoint of $400 million and we said it's being evenly split, that's what we're focused in. So there could be a little bit of volatility from one quarter to next, Q3 to Q4. But in any event, that $200 million relative to the midpoint of the guidance, we remain confident.

Got it. All right. Last one. I'm glad you guys talked about it. Everyone has to these days, artificial intelligence. Can you just expand on the ways in which Adeia does support the proliferation of AI? And if there's any way you could either tie your current revenue base or maybe your patent portfolio to AI use cases at least just to gauge your current exposure or how you think about exposure currently.

Sure, Nick. Happy to expand on that. And I'd really look at it both from the media and the semiconductor part of our business differently. But starting with media, we've always been an innovator using AI, like natural language processing, machine learning technology. That is part of our current portfolio. It's been part of our innovations that have actually helped drive current license agreements that we have. We're also today focused on AI technologies, primarily around kind of VR, AR, mixed reality use cases as we see those developing in the marketplace. Going forward, though, what excites me in media is really the AI economy broadly as there's a proliferation of more content out there that's using AI and how we can capitalize on that development as well. So for us, this generative AI explosion is very exciting as we look forward in the media space and how much more is going to be out there in terms of our efforts and how our portfolio will continue to apply. So our R&D team led by Serhad Doken is focused on this area. They talk about AI all the time and we've got key inventors that have always been and continue to be looking at ways that they can use AI in our innovation cycle. On the semi side, it's really what has driven the ability -- AI has been around for a while. The current generative AI explosion that you're seeing today is because semiconductors now are able to process so much of this, right? And the next generation of semiconductor chips that are going to continue to be able to process more and more on the edge, in particular, is going to need advancements in semiconductor technologies. And our hybrid bonding and our advanced processing node portfolios fit within that perfectly. And so we're very excited about that development as well and how we can continue to add to the ecosystem that's driving this development.

We go next now to Matthew Galinko. Excuse me, Mr. Davis, Mr. Jones, it looks like we lost Mr. Galinko. [Operator Instructions] And Mr. Davis, it appears we have no further questions today. I'd like to turn the conference back to you for any closing comments.

Thank you, operator. Our second quarter results were in line with our expectations. We continue to make progress executing our strong deal pipeline and we remain on track to meet our goals set out earlier this year. Also, we will be meeting with investors in the next couple of weeks at several events. We will be attending the BWS Conference on August 17, the Rosenblatt Age of AI Conference on August 23 and the Deutsche Bank Technology Conference on August 30. We look forward to discussing our progress at these and other events later in the year. Thank you for joining us today.

Ladies and gentlemen, that will conclude the Adeia Q2 2023 earnings call. We'd like to thank you all so much for joining and wish you all a great day. Goodbye.