Xperi Inc. (XPER) Q2 2018 Earnings Report, Transcript and Summary

Thank you for standing by. Welcome to the Xperi Second Quarter Fiscal Year 2018 Earnings Conference Call. During today’s presentation all parties will be in a listen-only mode. Following the presentation the call will be open for questions. [Operator Instructions] I would now like to turn the call over to Geri Weinfeld, Senior Director of Investor Relations for Xperi. Geri, please go ahead.

Good afternoon, everyone. Thanks for joining us, as we report our second quarter fiscal year 2018 financial results. With me on the call today are Jon Kirchner, CEO; and Robert Andersen, CFO. Before we begin, I would like to provide two 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. Please refer to the Risk Factors section in our SEC filings, including our most recent Form 10-K and 10-Q, for more information on the risks and uncertainties that could cause our actual results to differ materially from what we discuss today. 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. Second, we refer to certain non-GAAP financial measures, which exclude restructuring and other exit costs, acquisition and related expenses, acquired intangible asset amortization, charges for acquired in process research and development and stock-based compensation expense. We've provided reconciliations of these non-GAAP measures to the most directly comparable GAAP measures in the earnings release and on the Investor Relations section of our website. The recording of this conference call will be available on our Investor Relations website at www.xperi.com. I'll now turn the call over to Jon Kirchner.

Thanks, Geri, and thanks, everyone, for joining us. Let me begin today's call with a few financial highlights. Billings in Q2 were approximately $101 million, in line with our outlook for the quarter. Importantly, expenses for the quarter were lower than expected, placing us meaningfully higher than our profitability outlook. Consequently, we generated nearly $35 million in operating cash flow, putting us on track to hit our target range for the year of $120 million to $145 million. In addition, we remain confident in our business and bought back $15 million in shares during the quarter. For today’s I’ll provide an update on each of our markets and the progress we've made towards the long-term targets we provided in February. Robert will then provide more in-depth discussion of our Q2 financials and our outlook for the third quarter. Let's start with a product licensing business. During the quarter, we made progress on key growth drivers in each of our markets: automotive, mobile and home. As expected, total product licensing billings during the quarter were $51 million, down 7% year-over-year excluding audit recoveries. Growth during the quarter from HD Radio penetration was offset by declines in game consoles, Blu-ray players and PCs. Additionally, we had a sizable NRE payment in automotive last year that did not recur this year. As a reminder, we expect our product licensing business to grow at a CAGR of 12% to 14% through 2022. But given the dynamic nature of the markets we operate in and the way ecosystems naturally develop, we expect our growth to be non-linear and to accelerate, over time, particularly as new solutions begin to ship into the mobile and automotive markets in 2020 and beyond. Turning to auto. The automotive market delivered $20.8 million in billings, a decrease of 5% year-over-year, largely due to the NRE payment received in Q2 last year. Excluding the NRE payment, our automotive business grew 7% year-over-year. We've made significant progress on our three key growth drivers in this market. First, we increased penetration of our HD Radio technology. In Q2, the Cadillac XT4, Jeep Wrangler, Jaguar I-Pace and Subaru Ascent, all announced launches with HD Radio technology. Second, we announced the commercial launch of DTS Connected Radio with a global automotive brand in 2019. Lastly, on the DMS front. In May, DENSO announced the new safety monitoring system for commercial vehicles. This aftermarket product for trucks is the first commercial use of our facial recognition and neural network technologies in DMS. The product is available today in the Japanese market. Moving to the mobile market. Billings were $9 million, down 13% year-over-year as anticipated, primarily due to soft PC-related unit volumes for legacy audio products. Importantly, we continue to make progress on all three of the mobile-related long-term growth drivers we laid out in February. First, we continue to work with our mobile partners to deliver more immersive audio and imaging solutions on our higher-end smartphones and gaming headsets. We added several new customers on both the audio and imaging side, including signing and another top 10 mobile OEM. The Vivo Nex phone launched in June with DTS Ultra, which includes our latest version of Headphone:X. Through Vivo, we worked with Netease to introduce the multichannel version of their most popular game, Knives Out. This enhanced the immersive version of Knives Out will only be available on the Vivo Nex. Second, market interest in 3D facial recognition solutions continues to grow, and we are advancing our engineering work around this key application. Our focus is to deliver a face recognition solution that are sensor agnostic to capture a large addressable market and facilitate easier adoption. Our 3D facial recognition solution is currently under evaluation by a number of key customers. We currently expect to see this solution on products in Q1 of 2019. Third, on the AR/VR front. Interest is growing in the Xperi value proposition for AR/VR devices from an imaging biometrics and audio processing perspective. We currently expect to see at least one partner product in the market by early next year. As this market develops, we believe there is significant long-term opportunity for our solutions. Moving on to the home market. In Q2, we delivered billings of $19.2 million, down slightly versus last year on Blu-ray-related softness. We made solid progress towards our long-term targets in this market. First, we increased our AVR sound bar and TV customer penetration through greater adoption of our newest technology solutions, Virtual:X and DTS:X. Skyworth launched the first DTS Virtual:X TVs in China. The Skyworth Nex TV is Skyworth's high-end smart TV line integrated with AI capability. Skyworth is expected to continue to integrate DTS audio technologies in future products as part of a multiyear partnership. Yamaha expanded its line of DTS Virtual:X-based sound bars with the new YAS-108. We announced the launch of DTS sound and Alibaba's new Tmall Genie C1 smart speaker. Alibaba is China's largest AI speaker provider. This design win brings the DTS brand additional market visibility and paves the way for the licensing of additional technologies. Second, as we look to expand the amount of content supporting our licensing business, we made significant progress and some strategic initiatives that will result in the development of new ecosystem opportunities. We expect to announce more details on the initiatives later in the quarter. Lastly, we continued some exciting development efforts the machine learning front that we believe will drive new opportunities in smart home. Moving to our IP licensing and semiconductor packaging business. Billings were $49.7 million, down 5% year-over-year, primarily driven by the expiration of a fixed fee license agreement that was billed annually, partially offset by quarterly billings related to the Broadcom license agreement. Looking ahead, there are a few key things to note. First, we have seen several of our license discussions progress positively over the past quarter. We believe we are well positioned to resolve at least 1 IP licensing matter prior to the end of the year. During the quarter, we added new licensing opportunities to our pipeline as we continue to work to maximize the value of our portfolio. Additionally, in our open Toshiba matter, a hearing has now been scheduled for mid-October at the Ninth Circuit Court of Appeals. And lastly, while our ITC case against Samsung was terminated on procedural grounds and will now move to an arbitration panel, we have four district court cases that are scheduled to go to trial in 2018, the first one beginning in February. We continue to believe our position is strong. Turning to Invensas. We recently announced the strategic partnership with UMC, the third largest semiconductor foundry in the world, to support the growing demand for our ZiBond and DBI technologies. In addition, we will collaborate on the further development and optimization of DBI in a die-to-wafer configuration. Over time, the use of DBI and a die-to-wafer configuration opens up sizable new market licensing opportunities, including DRAM, RF, GPUs, CPUs, FPGAs and ASICs. The partnership with UMC is an important milestone for the company as it further expands the availability of high-volume manufacturing infrastructure for our customers. As we hit the midpoint in the year, the business continues to be on track, and we continue to progress a number of exciting opportunities for both the second half and our long -term pipeline. With that, I'll turn the call over to Robert to discuss our financials.

Thank you, Jon, and good afternoon, everyone. As a reminder, due to the new revenue accounting standard, ASC 606 will be discussing billings instead of revenue, as we feel, it's an important measure of our financial progress. The presentation we gave on ASC 606, which can be found on our Investor Relations website, outlines the impact of the new accounting standard on Xperi, and conclude the customer billings and operating cash flow will become key metrics for measuring our business. Now on to the numbers. Total billings for the quarter were $100.7 million, in line with our expectations for the quarter. GAAP operating expense including cost of revenue was $91.6 million compared with $97 million for the second quarter of 2017. Non-GAAP operating expense including cost of revenue was $56.1 million compared with $56.8 million for the second quarter of 2017 essentially flat year-over-year. Non-GAAP R&D expense for the second quarter was $21.8 million, in line with the second quarter of 2017. And non-GAAP SG&A expense for the second quarter was $25.6 million essentially flat compared to last year. Litigation expense for the second quarter was $6.6 million, a decrease of $1.6 million from the prior year timing of case activity. Interest expense was $6.2 million and we paid $4.3 million in cash taxes during the quarter. Moving to the balance sheet. We finished the quarter with $95.3 million in cash, cash equivalents and investments and our outstanding debt balance was $494 million. Operating cash flow for the second quarter of 2018 was $34.6 million, an increase of $7.8 million compared to the second quarter of 2017. Despite being higher than last year, the Q2 2018 operating cash flow was negatively impacted by the payment of the remaining $9 million of retention bonus relating to the DTS transaction. As Jon mentioned, we returned $15 million to shareholders through the repurchase of 726,000 shares during the quarter. We have approximately $113 million remaining on our authorized share repurchase program. On June 14, 2018, the Company paid $9.9 million to stockholders of record on May 24, 2018 for the quarterly cash dividend of $0.20 per share of common stock. Additionally, on July 19, 2018, the Board of Directors approved a quarterly dividend of $0.20 per share of common stock, payable on September 6, 2018 to stockholders of record on August 16, 2018. Moving to our outlook for the third quarter, we expect billings to be between $97 million and $102 million. GAAP operating expense is expected to be between $94 million and $96 million. Non-GAAP operating expense is expected to be between $59 million and $61 million. We remain comfortable with our full year outlook on both billing and expenses, but we currently expect to finish on the lower end of our expense range. We expect billings in Q4 to ramp significantly relative to Q3, driven by several factors, including the timing of certain contract billings that occur in Q4; expected product licensing seasonality of approximately 10% between Q3 and Q4, a modest amount of IP licensing and the resolution of certain customer audits. Overall, we are pleased with the second quarter operating performance and are very focused on the range of opportunities in our pipeline for the second half of 2018. We look forward to updating you on our progress over the coming months. That concludes our prepared remarks. We will now open the call for questions. Operator?

Thank you. [Operator Instructions] We will take our first question from Eric Wold with B. Riley.

A couple of question, if I may. One, kind of walking through the non-GAAP numbers in the quarter as well as the guidance. One, if you can help confirm kind of the non-GAAP EPS in the quarter. If I used the bookings and the non-GAAP OpEx, it is expensing cash taxes, I'd get to about $0.66 for the quarter. And then using the guidance range and assuming kind of same levels of interest expense and taxes, that gets around $0.52 to $0.58 for Q3. Are those in the ballpark?

Yes. That sounds correct to me. I can confirm that.

And then just on the – looking at the guidance between Q2 and Q3, you came in below expectations on non-GAAP operating expense guidance or numbers in the quarter. And it's ramping up, at least your guidance for Q3. What is the main driver of that ramp? And is any of that timing kind of what you expect in Q2 just shifted into Q3?

Yes, there's a bit of that in the numbers. So Q2 was under for several reasons. But one of them was lower litigation expense than we're expecting due to the ITC case. So that's roughly $2 million. And then we have some increase during Q3 for litigation expenses. We prepare for the trials in 2019. We also have some expenses pushed from Q2 to Q3, so that makes up a big piece of the difference.

Perfect. My final question, kind of a broader one and kind of away from the numbers. Kind of looking at the announcements you made this morning around DTS Connected Radio. How should we think about the integration timetable for that product versus HD Radio here in the U.S. in terms of ability to get it into models earlier than what may be required here, if that's the case? And then our discussions internationally, at least right now, are they focused more on higher-end cars? Or is this something that can be pushed more sooner towards or more earlier towards medium to low-end brands or models?

Eric, I think it depends on who the automaker is, much like HD Radio is in both higher-end and mid-end as well as lower-end models. In general, I would say that the path to market adoption for Connected Radio is far quicker, in part because we're not having to build new broadcast system. We're really leveraging existing broadcast systems around the world and putting a middleware product, if you will, on the vehicle that can accept the signals, whether they be AM/FM, HD Radio, DAB, DAB plus. So I would expect the rate of adoption to move quicker than what perhaps was originally the case with HD Radio because the market, to a large extent, already exists. We're just kind of selling in. And we are deep in discussions with both European as well as U.S. and other automakers around adopting the product. And the feedback and the testing has been going very, very well.

Perfect. Thanks Jon.

You are welcome.

Thank you. We will take our next question from Gary Mobley with Benchmark.

Good afternoon, everybody. Thanks for taking the question.

Hi Gary.

I wanted to start out asking about the maintenance of your full-year 2018 billings guidance of $415 million to $445 million. As you mentioned in your prepared remarks, Robert, you do expect the seasonal uptick in the fourth quarter revenue, and maybe even a substantial uptick maybe even 10%, I think, you mentioned because of seasonality. But even with that seasonal uptick, you're still struggling to get to the midpoint of the guidance range. And now we're sitting in eighth month of the year. Why did you not lower the high end of the guidance range? And some reason behind it, maybe you can share with us, with sort of bluebirds that might kind of – and factor into that high end of the guidance range?

Gary, it’s a fair question because I'm always aware that when I give Q3 guidance, it's sort of implicit to giving Q4 guidance since we're giving annual number. The items that I outlined and the reason for an uptick between Q3 and Q4, some we have very good visibility, obviously, to the timing of certain contracts, billings the occur in Q4 that don't occur in Q3, in addition to the seasonal uptick that you mentioned. I think that the overall range is still book-ended by IP some IP licensing. As I mentioned, we have a modest amount in for Q4. But if we – it really depends on which counterparties we reach an agreement with. That can be a bit higher or it can be near what we're forecasting. So I'm very comfortable with the range for the remainder of the year that we've outlined.

Okay. Perhaps related to that topic. You mentioned specifically in the press release and in your prepared remarks the likelihood of reaching a resolution on at least one of the matters on the legal front or trying to get a greenfield across the end zone, so to speak. Why mention that in the press release? I'm sure you've got lots of opportunities in the hopper. And just curious to know why you chose to mention, given one of these, across the line.

Gary, I think there's constant questions as to whether in a world where visibility, obviously, outside is different than it is inside as to whether things are progressing. And I think, similar to some of our past discussions, we can't naturally predict exactly when some of these fairly complex and long discussions come to fruition. However, what we can occasionally comment on, so I think it's a goal of trying to provide helpful color when we have it, which is when we believe we're getting close to the end zone. And in this case, we have multiple discussions that are ongoing that we feel pretty good, at least one of them will land completed prior to the end of the year. And so we're well positioned to do that. And for that reason, we're providing that bit of color.

Okay. And I know it's your long-term goal to grow product billings to the tune of 12% and 14%. In the first half of the year, it looks like it's trending about flattish on a year-over-year basis. And so I guess the question is, do you think you can actually grow product billings this year with the stronger second half? And if so what sort of factors you might play into it?

The short answer is, yes. We believe there's a number of things happening in the back half that we have visibility to, that will help ensure we see an uptick. So it's kind of playing out as we expected. I think as we also have said, while we have a long-term goal of product and technology licensing growth in that low teens kind of range, seeing things in the mid upper digits this year is kind of consistent with also our expectations. So in general, we feel good about where we sit and the number of things that are in motion for the back half of the year in product and technology licensing.

Okay. That’s helpful. Appreciate it. Thank you. I’ll hop in queue.

Thank you. We’ll take our next question from Amit Daryanani with RBC Capital Markets.

Thanks guys. This is Irvin Liu, dialing in for Amit. Two quarters ago, you guys outlined long-term billings CAGR of 5% to 8% and an operating cash flow CAGR of 9% to 15%. Can you just talk about whether your current IP asset portfolio, as it stands today, will be enough to sustain this trajectory? Or would you need to expand your portfolio via M&A or other asset, IP asset purchases? And assuming you guys were in the market for other IP assets, what type of adjacent product areas would make most sense for you guys?

I can take it. This is Robert. So we remain confident in the guidance we've given in terms of the longer-range outlook for the IP licensing portfolio. That being said, we – I think we've taken many judicious view in terms of that outlook. We do buy IP from time-to-time. That's been part of our business model, in addition to doing a great deal of development internally. We've tended to focus our IP purchasing efforts around packaging and other circuitry, some process primarily around semiconductor packaging and continue to do so. So our longer-term outlook doesn't take into account significant purchases of IP and basically working from the portfolio that we have, and now we would continue to do some smaller purchases. I believe that gets to the heart of your question.

Thanks. And then moving on to the Samsung side, I know that arbitration is needed for you to proceed with the Samsung dispute. Can you walk us through what the timeline needed to reach an outcome with Samsung could look like? And also, just any comments on whether a lengthier legal process could impact linearity of your litigation expenses?

Well, certainly, the longer you're active in litigation in different venues, the higher your average legal expense is going to be. Although, it would ebb and flow based on the exact timing of when cases are to be heard and when there's a whole lot of activity and preparation, such as market hearings and other discovery work. So it's somewhat case specific when you think about the case calendar. In terms of Samsung, the arbitration process, I think as we said last quarter, will essentially take somewhere in the neighborhood of a year, plus or minus, a few months. As a result, that arbitration hearing is, perhaps, less gating in terms of a time line than the fact that we have four cases that are pending in 2019. And the first one is to be heard in February and then we have a series of cases, three of which are heard in the first half of the year. And then I think all of these individual events provide milestones and discussion opportunities with Samsung to reevaluate the gap and perhaps, our perspective about the value of our IP portfolio and its relevance to the business. And we continue to be in discussions with Samsung. We have been, for some time. And I think you – the more dialogue you have, generally speaking, and particularly where you have the benefit of a third-party process, it tends to help progress discussions Now when and where those discussions come to conclusion is an unknown. It takes two parties to ultimately reach an agreement. But I think our belief is, is that things are progressing well there as it relates to our legal case, and we'll continue to work regularly with them until we can reach a sensible resolution that fairly values the portfolio as we now move forward and ultimately have to think about licensing a number of other players in the semi space.

Got it. Thanks for the update. That’s all I had.

Great, thank you. End of Q&A

Thank you. We have no further questions. I'll turn it back to Jon Kirchner for closing remarks.

Thanks, operator. Thank you for joining us on the call today. We look forward to updating you during the quarter on our progress. Have a great day.