Good day, ladies and gentlemen. Thank you for standing by. Welcome to the Xperi Fourth 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 open for questions. This call is being recorded today, Wednesday, February 20, 2019.

I would now like to turn the call over to Geri Weinfeld, Vice President of Investor Relations for Xperi. Please go ahead, ma’am..

Good afternoon, everyone. Thanks for joining us, as we report our fourth 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 discussions contain 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 forms 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, stock-based compensation expense, interest income associated with ASC 606 and unrealized gains or losses on equity securities.

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. 2018 was a good year for Xperi. Total billings grew 6% year-over-year, driven by both our product licensing and IP licensing businesses. We made meaningful investments in new technology that we believe will impact our growth over the next three to five years.

We generated $135 million in operating cash flow and returned $81 million to shareholders through dividends and share repurchases. Importantly, we continued to deliver on our strategic vision and accomplished several important milestones within each of our markets.

In our automotive business, HD Radio penetration reached 52% of new cars sold in North America. We signed a significant partnership with IMAX that strengthens our content footprint and will help drive future codec penetration in the home and beyond.

In mobile, we completed development and released our 3D facial recognition technology to a mobile partner and expect to see the product launch in a new smartphone this quarter. And in December, we reached a significant settlement with Samsung in our IP licensing business.

Our outlook, our current outlook for 2019 reflects a degree of caution as we enter a period of macroeconomic and trade uncertainty. Additionally, given forecast challenges with regard to timing and amount, our outlook does not include any significant new IP licensing agreements, except for one Invensas-driven license agreement.

And while we expected product licensing billings to grow mid-single digits in 2019, due to a mobile customer contract interpretation issue that recently emerged, we now anticipate product licensing to be flat plus or minus a few points. We will continue to work this issue toward resolution in 2019.

Perhaps most important is that during 2019, we expect to see material progress toward the launches of our new technology solutions, such as connected radio, DMS, and 3D face recognition, which we expect will accelerate growth, as we get into 2020 and beyond. Overall, the markets we operate in are highly dynamic.

So as we work to execute against our plans, our outlook may improve over time. Importantly though, our diversified base of licensing billings helps provide stability even as we move through various cycles. Entering 2019, we are focused on four priorities that will help us achieve our long term targets.

In automotive, we will continue to support the development and commercialization of connected radio and DMS. Connected radio is expected to launch in early 2020 and DMS in passenger vehicles in 2021. Notably, DMS is expected to be in nearly 60% of cars by 2025.

In mobile, our 3D facial recognition technology solution, FaceSafe, will launch in Q1, which is the first 3D FR solution shipping on a smartphone based on time of light sensors. FaceSafe offers mobile OEMs more cost efficient sensor solutions, while delivering best-in-class 3D facial recognition and face unlock functionality.

In home, we will continue to build out the IMAX ecosystem with a goal of creating a top brand in the living room. In IP licensing, we remain focused on adding to our pipeline of opportunities, negotiating new license agreements, and continuing to accelerate the adoption of our DBI and ZiBond technologies in the memory space.

Our focus on each of these areas, certain strategic investments in machine learning are key to accelerating growth as we look ahead in 2020 and beyond. Now on to our Q4 results. Please note that the billings data I will provide excludes the impact of audit recoveries. Q4 product licensing billings were $54.1 million, up slightly from last year.

For the year, product licensing billings were $219.7 million, up 4% year-over-year. Our Q4 product licensing billings fell slightly short of our expectations due to a few late customer reports that we received shortly after year-end. Those billings will now be recognized in Q1.

Audit recoveries, which vary considerably in size and timing were $264,000 for the quarter, down from 1 million last year. Audit recoveries were $1.3 million for the year, down from 5.1 million last year.

Automotive billings in Q4 were $19.9 million, down 1% year-over-year, mainly due to a previously mentioned late customer report, which will now be recognized in Q1. HD Radio exited the year at 52% penetration in new cars sold in North America. For the year, automotive billings were up 8%.

Importantly, we made progress in each of the growth drivers in this market. The continued penetration of HD Radio and the development and licensing of our connected radio and DMS solutions, both of which tap into a larger global market opportunity.

During the quarter, HD Radio launched in several new car models, including the Ford Ranger, Lincoln Nautilus, Mitsubishi Motors Eclipse Cross, Lexus UX and Audi Q8. For connected radio, we executed a development agreement with Commercial Radio Australia and launched a countrywide Alexa skill for selecting radio stations across that country.

We also completed direct service integration with Global Radio, the largest commercial radio group in the UK. All of these milestones are integral to our effort to build out a broadcast ecosystem for connected radio. In advanced driver assistance systems, we continue to work closely with our partners on the launch of our DMS solution.

At CES, we showcased our core DMS features, facial detection and eye gaze and introduced a motion detection from facial expressions. One unique feature of our DMS system is the ability to support a wide range of camera configurations, which allows for easy integration across car manufacturers with different requirements. Turning to the mobile market.

For the quarter, mobile billings were $10.5 million, essentially flat year-over-year. This market remains challenging as market softness, customer consolidation and hyper competition combine to create headwinds.

In the short run, our outlook reflects a few issues including the timing of the phase out of certain older technologies, the adoption rate of new technologies and the recent emergence of a contract interpretation issue with a large mobile customer, which could take some time to resolve.

Plus, absent a resolution of the contract issue, our 2019 outlook for mobile currently reflects a 25% to 30% decline.

Over the next three to five years, our solution to realizing our growth targets in this market is tied to licensing some disruptive and very innovative solutions, such as our new product FaceSafe, an advanced 3D facial recognition technology, which will be launched next week at Mobile World Congress.

During Q4, we saw some pockets of growth, including, we continued to maintain our solid foothold in the gaming headset business where billings grew 28% year-over-year. Note that Microsoft recently announced support for TTS in Windows 10, which provides a new avenue to build on our solid position in gaming headsets and PCs.

We signed a license agreement with Socionext to enhance their next generation of chips with our imaging -- image processing unit for hybrid computer vision, which allows for ultra-low-power facial and people analytics.

And we executed an agreement with iQiyi, a leading Chinese streaming service to deploy our audio solutions to create an immersive experience on their 4K VR headset. Turning to the home market, Q4 billings were $23 million, up 1% year-over-year driven by growth in TVs and soundbars, offset by lower game console and wireless speaker volumes.

For the year, the home category was up 4% driven by growth in the penetration of our DTS:X and Virtual:X technologies in AVRs, TVs and soundbars. This category was also impacted by a late report from a customer that will be reflected in Q1.

During the quarter, we signed nine additional licenses for DTS:X and DTS Virtual:X for TVs, soundbars and AV receivers. We also announced our first DTS Stereo Plus design win with Tencent's AI Display Smart Speaker in China.

DTS Stereo Plus is a premium audio post processing solution that delivers wider, deeper sound from stereo speakers placed within a single enclosure. Lastly, we further developed our smart home offerings, leveraging our sight, sound and machine learning technologies.

We demonstrated some of these products for the first time at CES in January and are working to bring these to market in the 2019-2020 time frame. On the content front, we continue to expand the IMAX enhanced program with newly signed licensees and streaming service partners, including Tencent Video, FandangoNOW, Privilege 4K and Rakuten TV.

New device partners and brands were also added to the ecosystem including TCL, Arcam, Elite, Integra, Lexicon, Onkyo, Pioneer and Trinnov. We also announced the first IMAX enhanced titles to be released on streaming platforms and Ultra HD Blu-ray Disc.

Moving to our IP Licensing business, billings for the fourth quarter were $87.4 million, up 16% year-over-year, driven mainly by the settlement we reached with Samsung in December. Most importantly, the settlement is another sign of validation of our IP portfolio and we look forward to resolving other licensing matters under discussion.

During the quarter, we continued to add new licensing opportunities to our pipeline. As we look ahead, we are very pleased to have the Samsung litigation behind us and we remain engaged in multiple conversations on new IP licensing matters. Moving to our Invensas business.

During 2018, we made significant strides in our development and efforts to support customer-driven evaluations of our DBI technology for both 3D NAND and stacked DRAM. During the quarter, we completed a license agreement with a partner focused on a range of imaging applications.

Additionally, we work to process customer provided functional silicon to demonstrate the compelling benefits of our DBI technology in the memory market. As a result of these efforts and other commercial activities under way, we anticipate 2019 will be an important year for the adoption of our hybrid bonding technology.

With that, I'll turn the call over to Robert to discuss our financials..

Thank you, Jon. Before I begin, let me once again remind everyone that due to revenue accounting standard that we adopted at the beginning of last year, known as ASC 606, we'll be discussing billings instead of revenue as we feel it's an important measure of our financial progress.

For additional information on the impact of the new accounting standard on Xperi, please refer to the presentation on ASC 606 we gave back in January of last year which can be found on our website in the Investor Relations section.

For today's discussion, I'll provide details on our fourth quarter results and then a preview of our expectations for 2019. Total billings for the fourth quarter were $141.8 million, up from $130.2 million in Q4 2017. Total billings for the full year were $447.3 million, up from $422.5 million last year.

GAAP operating expense including cost of revenue was $100.4 million compared with $102.7 million for the fourth quarter of 2017. Non-GAAP operating expense including cost of revenue was $64.6 million compared with 61.2 million for the fourth quarter of 2017.

Cost of revenue increased by $1.9 million compared to the fourth quarter of 2017, due to IMAX program costs that are taken upfront while the actual cash payments and associated billings occur over multiple periods.

Non-GAAP R&D expense increased by $4.6 million due primarily to higher development spending on certain machine learning programs and accrued compensation. Non-GAAP SG&A expense increased by $1.5 million due to higher accrued compensation. Litigation expense decreased by $4.6 million on a year-over-year basis due to lower litigation activity this year.

Interest expense was $6.8 million and we paid $10.9 million in net cash taxes during the quarter, primarily for foreign withholding taxes. Moving to the balance sheet. We finished the year with $154.4 million in cash, cash equivalents and investments, and our outstanding debt balance was $494 million.

We expect to pay down some of our outstanding debt balance early this year. Operating cash flow for the fourth quarter of 2018 was $66.5 million, an increase of $5 million compared to the fourth quarter of 2017. Q4 2018 operating cash flow was negatively impacted by the delay in receipt of a tax refund and timing of collections.

For the full year, operating cash flow was $135 million compared with $147 million in 2017.

Even though billings increased in 2018, the year-over-year decline in operating cash flow is primarily attributable to the payment during 2018 of $18 million for onetime retention payments for the DTS acquisition, higher cash taxes and a year-over-year increase in accounts receivable.

But for the non-recurring retention payments, cash flow would have been up year-over-year. During the quarter, we bought back $4.2 million in shares and have approximately $101 million remaining on our authorized share repurchase program. Moving to our outlook for 2019.

For the full year 2019, we expect billings between 395 million and 415 million, non-GAAP operating expense between 225 million and 240 million, stock-based compensation of approximately 31 million, amortization expense of approximately 101 million, non-GAAP interest income, excluding the interest recorded in connection with ASC 606 of approximately 1.5 million, interest expense and debt amortization costs of approximately 26 million and cash tax payments between 22 million and 26 million.

Please refer to our 2019 outlook slide in our updated investor presentation to find additional detail on the breakout of functional expenses.

For the first quarter of 2019, we expect billings between $102 million and $106 million, non-GAAP operating expense is expected to be between $56 million and $59 million, stock-based compensation of approximately 8 million, amortization expense of 25.5 million, non-GAAP interest income of approximately 0.4 million, interest expense and debt amortization costs of approximately 7 million and cash tax payments between 6 million and 7 million.

That concludes our prepared remarks. We'll now open the call for your questions..

[Operator Instructions] Our first question comes from Eric Wold with B. Riley FBR..

I guess, first of all, just kind of housekeeping. I want to make sure I can affirm the adjusted EPS that's kind of implied in the results in the guidance.

I get to -- using your inputs, I get to $1.16 for Q4, $0.63 to $0.65 for Q1 and $2.35 [ph] to $2.37 for the year?.

For Q4, 2018, I'm getting $1.19, it's actually $1.186, so $1.19 rounded up. And then, I think, yes, $0.64 to $0.66 probably this is the correct range for Q1 '19.

And did you give a number for the full year as well?.

$2.35 to $2.37, my prior opinion, so light on that then..

Yeah, I think if you take everything at the midpoint for 2019, it's roughly $2.40..

Perfect. On the billings, on the recognition of the product licensing billings, there were delays from Q4 to Q1.

I'm assuming that because you have to give an estimate at year-end regardless of you knowing what was received now that gets pushed into Q1 and then, if that's the case, if you could give us a sense of how large that was, the delay?.

Sure. It was roughly 3 million to 4 million in terms of the size of the delayed billings and we need to receive a customer’s report prior to sending a billing. So if the report comes in just at the beginning of the next year in this case, it will be a billing for Q1. So it's just a -- strictly need to have the report in hand..

Got it.

And then couple more quick ones on -- sorry, maybe help us understand the issue around the contract interpretation on the mobile side as best you can, in terms of what the disagreement is? And should we assume kind of by your commentary that you've assumed kind of a -- or included kind of a worst-case scenario in the guidance for this year and if that's resolved to the positive, that would be added to that guidance?.

Yeah, from a guidance perspective, that's correct. We've assumed that we're not going to resolve that during the year, though that's not necessarily how it will play out. I think Jon can probably give a little more color..

Yeah.

Eric, it's -- because of the nature of the agreement and the confidentiality provisions, we really can't say too much except, what I can tell you is this relates to a customer that is continuing to pay ongoing royalties, but sometimes you get into contract interpretation issues that have to do with technology or classes of technology and how it gets deployed and what the resulting licensing obligations are.

And so in that context, that's what's going on, not the first time we've seen something like this, but as I said at the top of the call and safe for this issue, we would have been right in line with kind of our expectations going into 2019 for product licensing, in terms of seeing growth in kind of the mid-single digits.

So we're starting from a place of being conservative about it and obviously we'll work with the customer to work through it..

Perfect. And then final question if I may. Obviously now that you've got Broadcom and Samsung under license, I know -- I think it was in the Q2 call last year, you talked about at least one new license signed by year-end, obviously the major one came through.

Maybe give us an idea kind of how those two signings and settlements have helped the discussions and maybe kind of adjunct to that, what should we expect in terms of litigation expense improvements this year versus last year?.

Well, let me -- I'll let Robert address the guidance question. As it relates to ongoing discussions, as we said last year, we're in a number of discussions. That situation remains the same.

I think as we've talked about repeatedly, timing of when these things resolve and the amount is obviously the hard part, which is why we've substantially removed any such risk out of the guidance for 2019, related to new license agreement. So obviously as we get them done, we'll report -- obviously report that out and be very pleased to do so.

But I think you should conclude from the statements made last year and kind of as we continue to move forward in 2019 that there are multiple things at play and we're working to bring them to conclusion..

And just to address the guidance number, so we've given a range for litigation of $10 million to $15 million for 2019. It is a very difficult thing to forecast litigation. We finished the year, as Jon mentioned in his remarks, with no active litigation.

And so we'll do some analysis work and that's typical for us to do that, but it's, I think that's a decent range for this point in the year and we'll update you on that if things change..

Just one clarification. One active -- no active IT litigation, yeah, because there is one pending matter we have, that we're continuing to work through with Toshiba..

That's correct, yes..

Thank you. Our next question comes from Matthew Galinko with National Securities..

Hey, thanks for taking my question. I might have missed it in the script, I had some technical issues. But I believe this is the first time you're reporting since the Samsung license was signed.

I think -- I guess necessarily you're sort of limited in what you could say when that came out that we have the benefit of sort of seeing the, I guess, reporting under ASC 606 on the revenue line and sort of the contribution.

Is there anything more you could share with us around the duration of the contract, structure of the contract or are we still kind of left to our own devices to figure that out?.

Unfortunately the nature of the agreement confidentiality provisions are pretty severe. I think it's fair to say that there are license fees paid over time. Obviously, we're receiving license payments from Samsung during the course of this year as we've said. Beyond that, there's really not a whole lot we can say.

Although over time as these things come up in a longer trajectory, I think we'll naturally see how we can put some shape around it as we can, at that point, but initially the disclosures in the 10-K are what they are and we're really limited to be able to say much more..

Okay, thank you. Maybe just generally speaking, given that these laser sync cycles do come up from time to time. Anything in place that would make the mix to go around with Samsung easier.

Can you speak to that at all? I think if we look back in Tessera's history, there was maybe a hope a few years ago that you’d be able to get more licensing done without litigation and it hasn't necessarily played out with Broadcom and Samsung here, but just curious if anything set to be a little bit more collaborative and to sort of get past these -- the lumpiness of the IP business fundamentally?.

Sure. I think one of the things that transpired in the course of some of our conversations with them was clearly a desire to move collectively toward more collaboratively licensing technology and kind of in a more traditional sense where we're providing solutions that are valuable to them, et cetera. So I think that mutual interest is there.

Secondly, I would say that the deal was concluded incredibly professionally on both sides with, I would say with a certain amount of -- well not -- with plenty of positive intent on both sides in terms of getting it done and viewing it as important to move past it for both of us. So with that, we'll continue to work it.

As you know, we do a fair amount of business with Samsung more broadly and we look to continue to do so. And it's up to us over time to try to avoid having to be back at the table in ways that are more contentious but rather can support each other's businesses for mutual growth..

Got it. Thank you.

And I guess last one from me on the contract dispute, I think you specified that's in mobile product licensing, did you say whether that's an imaging the FotoNation or DTS customer?.

It's imaging related..

Thank you. Our next question comes from Richard Shannon with Craig-Hallum..

Hi, Jon and Robert. Thanks for taking my question as well. I apologize, I jumped in a little bit late, I had a bit of technical issues here, so I'm not sure if you covered this in your prepared remarks, but maybe just like to understand what's implied for product licensing growth this year.

I recognize that there is -- the mobile contract interpretation is impacting that, but I guess what's embedded in the numbers you've given us, what kind of growth is there?.

From a guidance perspective, we mentioned this in the remarks earlier as Jon did, which is product licensing is expected to be flat plus or minus a few points. And that's really for 2019 as we move towards some of it -- launching some of the new technologies, connected radio, DMS and 3D face recognition in the next year or two.

It's a challenge for us, these are very dynamic markets that we operate in. I think for the year, we have -- I think what's important is a diversified base that helps us provide stability as we move through the various cycles. And so we're pretty optimistic about the next few years. But for this year, it's flat to up or down..

But for the contract issue, we would have landed pretty much exactly where we thought we would be in '19, which is kind of mid-single digits..

That's right..

Okay. And just to follow up on that. I can't probably do the math fast enough of my head to -- with an accurate answer, but I would imagine that you're expecting both auto and home to be modestly -- nicely positive growth offsetting the -- I think you said something like 25% decline in mobile assuming the contract interpretation issue..

Correct. And just keep in mind that both the mobile -- both the automotive and home businesses are meaningfully larger than the mobile business for us. So when they're up, it offsets the decline the other way..

Okay, that's helpful. Just another question on your 3D facial recognition discussion, you said you expect to be the -- on the first device that uses time-of-flight for 3D sensing in the phone to be introduced this quarter.

Did I catch that correctly?.

Correct..

So we've been hearing about a number of Android-based phones with that sort of technology, introducing throughout this year. How do you expect your share position to be in this supporting those, are they -- do you have a line of sight into other introductions this year? Maybe Jon, if you could discuss what you're seeing there, please..

We're in a range of discussions, the one that I'm privy to talk about is the phone that we know that will be launched next week at MWC. But we've gotten -- let me step back for half a second.

As 3DFR solution was popularized in the marketplace with dual cameras in part because it's an easier unlock situation and more reliable than is a fingerprint sensor, we got a lot of interest from people across the handset space in part because we're known for having world-class facial imaging expertise.

At that point, we were working on some solutions, but have since completed the work around a solution and then obviously one of the key issues is that implementing that kind of a solution can be very expensive depending on whether you're using the structure of flight solution or a time-of-flight solution and whether you have multiple cameras or whether ultimately you can do something similar, using less cameras.

And so we have gone forward with a one particular customer who was the earliest that we'll be -- we're launching it here at MWC. And we feel very good about that solution and its performance as well as its cost advantage relative to other means of doing it.

I think our goal is to more broadly commercialize and have that solution penetrate in not only the mobile phone space, but ultimately the PC space and elsewhere anywhere. The advantages of some kind of a secure face unlock feature could be valuable to a user device, and -- so stay tuned.

But we feel very good about where things sit and will play out in the course of 2019..

Okay. And we look forward to hear more about that. I'll ask one last question and jump at the line here. Jon, I think you made some comments on Invensas about -- I don't want to put words in your mouth, it sounds like you're pretty excited about how things are going there. And I certainly got that feeling from what we saw at CES as well.

When you talk about contributions, are we talking about revenues or just making additional progress and seeing the revenues beyond this year? Just wanted to get clear on that one..

I think you're going to see progress on both fronts. But I think the larger economic progress, if you will, will be playing out over the next couple of years, but we are seeing increasing interest across the board, the urgency with which these conversations are being held from multiple parties is I think notable.

And I think over time, it's pretty clear that hybrid bonding is going to be a key feature in enabling performance and greater functionality, not only in memory, but of course in RF and other sensor categories.

So in general, I think it's -- it remains a work in progress, but I think we'll see some material milestones and steps reached this year that kind of set the stage for what happens in 2020 and beyond..

Thank you. [Operator Instructions] Our next question comes from Gary Mobley with Benchmark..

Hi, everyone. Thanks for taking my question. Robert, it looks like, according to your 10-K, the Samsung revenue was about $78 million as applied to ASC 606 GAAP revenue. And I'm assuming all that was in the fourth quarter.

Is that the present value of the contract, the sum of the contract at that unique discount rate?.

No, that's not accurate, but this becomes challenging because as Jon mentioned, we can't share the -- too much in the way of details around the Samsung agreement. And it's -- some of it's reflected on our balance sheet, but not the entirety of it. So it's a difficult thing to communicate to you or to share..

Okay, fair enough. Also disclosed in the K is SK Hynix contribution to your ASC 606 GAAP revenue, looks to be about $48 million, if I'm not mistaken, that's about a 50% increase from the prior two years.

What's sort of the underlying dynamics going on there with SK Hynix?.

Again, we can't share too much around the details of the contract, other than to say that the ASC 606 revenue, sometimes either deflates or inflates the underlying billings related to those contracts. So that -- again trying to read the revenue line even as a contribution from greater than 10% customers is challenging.

So we -- they do remain a very important customer, of course, but I can't get into specifics in terms of the billing side from that for Hynix..

Okay. I also wanted to confirm what is embedded in your fiscal year '19 billings outlook.

I just wanted to confirm, is that exclusive entirely of the roughly $62 million in structured OSAT payments? And I'm assuming none of that is included in the Q1 guidance either, right?.

Yeah, of course, so those OSAT contracts ended at the end of 2018. So there's no PTI nor Amkor in our 2019 guide..

Thank you. And we have no further questions in the queue at this time. I would now like to turn the conference back over to Mr. Jon Kirchner for closing remarks..

Thank you, operator. In closing, while we have work to do in 2019, we feel quite optimistic about our business over the next few years.

I'd like to thank our partners, customers and employees for their significant support and efforts throughout 2018 and we look forward to sharing more news with you over the course of the quarter and the rest of the year. Operator, that concludes today's call..

Ladies and gentlemen, this concludes today's presentation. You may now disconnect..