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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
 _______________________________________________________________
FORM 10-Q
______________________________________________________________
(Mark One)
x     QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2018
OR
 
o    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number: 001-37956
 _______________________________________________________________

 XPERI CORPORATION
(Exact Name of Registrant as Specified in Its Charter)
 _______________________________________________________________
 
Delaware
 
81-4465732
(State or Other Jurisdiction of
Incorporation or Organization)
 
(I.R.S. Employer
Identification No.)
 
 
3025 Orchard Parkway, San Jose, California
 
95134
(Address of Principal Executive Offices)
 
(Zip Code)
(408) 321-6000
(Registrant’s Telephone Number, Including Area Code)
 _______________________________________________________________
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
 
Name of each exchange on which registered
Common stock, par value $0.001 per share
 
The NASDAQ Global Select Market
Securities registered pursuant to Section 12(g) of the Act:    None
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer ý Accelerated filer ¨ Non-accelerated filer ¨ (Do not check if a smaller reporting company) Smaller reporting company ¨ Emerging growth company ¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No ý
The number of shares outstanding of the registrant’s common stock as of July 31, 2018 was 49,097,002.




Table of Contents

XPERI CORPORATION
FORM 10-Q — QUARTERLY REPORT
FOR THE QUARTER ENDED JUNE 30, 2018
TABLE OF CONTENTS
 

  
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


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XPERI CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
 
 
Six Months Ended
 
June 30, 2018
 
June 30, 2017
Cash flows from operating activities:
 
 
 
Net loss
$
(61,273
)
 
$
(50,086
)
Adjustments to reconcile net loss to net cash from operating activities:
 
 
 
Depreciation of property and equipment
3,437

 
3,614

Amortization of intangible assets
54,365

 
56,706

Stock-based compensation expense
14,627

 
15,585

Deferred income tax
(14,590
)
 
(16,676
)
Amortization of debt issuance costs and other
1,720

 
1,402

Changes in operating assets and liabilities:
 
 
 
Accounts receivable
(3,201
)
 
(16,740
)
Unbilled contracts receivable, net
66,891

 
32,430

Other assets
424

 
11,282

Accounts payable
(1,443
)
 
(951
)
Accrued legal fees
20

 
(1,341
)
Accrued and other liabilities
(23,945
)
 
7,504

Deferred revenue
2,203

 
3,073

Net cash from operating activities
39,235

 
45,802

Cash flows from investing activities:
 
 
 
Purchases of property and equipment
(2,024
)
 
(1,938
)
Acquisition, net of cash acquired
(500
)
 

Purchases of intangible assets
(350
)
 

Purchases of short-term investments

 
(11,975
)
Proceeds from sales of short-term investments
8,540

 
1,035

Proceeds from maturities of short-term investments
14,200

 
4,650

Net cash from investing activities
19,866

 
(8,228
)
Cash flows from financing activities:
 
 
 
Dividend paid
(19,689
)
 
(19,740
)
Repayment of debt
(100,000
)
 
(3,000
)
Proceeds from exercise of stock options
8,000

 
4,680

Proceeds from employee stock purchase program
3,402

 
1,155

Repurchase of common stock
(33,270
)
 
(3,411
)
Net cash from financing activities
(141,557
)
 
(20,316
)
Net increase (decrease) in cash, cash equivalents and restricted cash
(82,456
)
 
17,258

Cash and cash equivalents at beginning of period
138,260

 
65,626

Cash, cash equivalents and restricted cash at end of period
$
55,804

 
$
82,884

 
 
 
 
Supplemental disclosure of cash flow information:
 
 
 
Interest paid
$
11,227

 
$
14,493

Income taxes paid, net of refunds
$
8,306

 
$
7,209


The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.


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XPERI CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except for par value)
 (unaudited)
 
June 30, 2018
 
December 31, 2017
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
55,804

 
$
138,260

Short-term investments
39,449

 
62,432

Accounts receivable, net
19,245

 
17,010

Unbilled contracts receivable
175,315

 
10,866

Other current assets
16,422

 
16,949

Total current assets
306,235

 
245,517

Long-term unbilled contracts receivable
65,013

 
2,930

Property and equipment, net
32,984

 
34,442

Intangible assets, net
378,055

 
431,789

Goodwill
385,784

 
385,574

Other assets
4,959

 
9,772

Total assets
$
1,173,030

 
$
1,110,024

LIABILITIES AND STOCKHOLDERS' EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
2,790

 
$
4,233

Accrued legal fees
7,503

 
7,483

Accrued liabilities
24,254

 
47,969

Current portion of long-term debt

 
34,451

Deferred revenue
4,106

 
2,686

Total current liabilities
38,653

 
96,822

Long-term deferred tax liabilities
64,545

 
15,085

Long-term debt, net
480,952

 
545,211

Other long-term liabilities
17,532

 
17,330

Commitments and contingencies (Note 13)


 


Stockholders’ equity:
 
 
 
Preferred stock: $0.001 par value; 10,000 shares authorized and no shares issued and outstanding

 

Common stock: $0.001 par value; 150,000 shares authorized; 61,994 and 60,608 shares issued, respectively, and 48,962 and 49,103 shares outstanding, respectively
62

 
60

Additional paid-in capital
712,687

 
686,660

Treasury stock at cost: 13,032 and 11,505 shares of common stock at each period end, respectively
(352,667
)
 
(319,397
)
Accumulated other comprehensive loss
(456
)
 
(303
)
Retained earnings
211,722

 
68,556

Total stockholders’ equity
571,348

 
435,576

Total liabilities and stockholders’ equity
$
1,173,030

 
$
1,110,024

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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XPERI CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
 (unaudited)

 
Three Months Ended
 
Six Months Ended
 
June 30, 2018
 
June 30, 2017
 
June 30, 2018
 
June 30, 2017
Revenue:
 
 
 
 
 
 
 
Royalty and license fees
$
63,954

 
$
91,322

 
$
129,486

 
$
158,577

Total revenue
63,954

 
91,322

 
129,486

 
158,577

Operating expenses:
 
 
 
 
 
 
 
Cost of revenue
2,080

 
1,303

 
4,404

 
2,703

Research, development and other related costs
25,170

 
26,313

 
51,685

 
52,325

Selling, general and administrative
30,476

 
33,003

 
65,178

 
74,208

Amortization expense
27,199

 
28,151

 
54,365

 
56,706

Litigation expense
6,635

 
8,226

 
13,951

 
18,204

Total operating expenses
91,560

 
96,996

 
189,583

 
204,146

Operating loss
(27,606
)
 
(5,674
)
 
(60,097
)
 
(45,569
)
Interest expense
(6,200
)
 
(7,046
)
 
(12,518
)
 
(13,505
)
Other income and expense, net
2,229

 
220

 
5,383

 
266

Loss before taxes
(31,577
)
 
(12,500
)
 
(67,232
)
 
(58,808
)
Provision for (benefit from) income taxes
(3,321
)
 
26,557

 
(5,959
)
 
(8,722
)
Net loss
$
(28,256
)
 
$
(39,057
)
 
$
(61,273
)
 
$
(50,086
)
Basic and diluted net loss per share:
 
 
 
 
 
 
 
Basic
$
(0.58
)
 
$
(0.79
)
 
$
(1.25
)
 
$
(1.02
)
Diluted
$
(0.58
)
 
$
(0.79
)
 
$
(1.25
)
 
$
(1.02
)
Cash dividends declared per share
$
0.20

 
$
0.20

 
$
0.40

 
$
0.40

Weighted average number of shares used in per share calculations-basic
49,060

 
49,475

 
49,110

 
49,261

Weighted average number of shares used in per share calculations-diluted
49,060

 
49,475

 
49,110

 
49,261

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.


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XPERI CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(in thousands)
 (unaudited)

 
Three Months Ended
 
Six Months Ended
 
June 30, 2018
 
June 30, 2017
 
June 30, 2018
 
June 30, 2017
Net loss
$
(28,256
)
 
$
(39,057
)
 
$
(61,273
)
 
$
(50,086
)
Other comprehensive income (loss):
 
 
 
 
 
 
 
Net unrealized gains (losses) on available-for-sale securities, net of tax
64

 
16

 
(153
)
 
54

Other comprehensive income (loss)
64

 
16

 
(153
)
 
54

Comprehensive loss
$
(28,192
)
 
$
(39,041
)
 
$
(61,426
)
 
$
(50,032
)

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.


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XPERI CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
NOTE 1 – THE COMPANY AND BASIS OF PRESENTATION

Xperi Corporation (the “Company”) completed the acquisition of DTS, Inc. ("DTS"), a publicly-traded developer of sound-based technologies, in December 2016. At the time of the acquisition, Tessera Technologies, Inc. and DTS were combined under the newly-formed Tessera Holding Corporation. During the first quarter of 2017, the Company introduced its new corporate name, “Xperi Corporation”, stock ticker, “XPER”, and launched a new corporate logo.

Xperi Corporation licenses its innovative products, technologies and inventions to global electronics companies which, in turn, integrate the technologies into their own consumer electronics and semiconductor products. The Company's technologies and inventions are widely adopted and used every day by millions of people. The Company's audio technologies have shipped in billions of devices for the home, mobile and automotive markets. The Company's imaging technologies are embedded in more than 25% of smartphones on the market today. The Company's semiconductor packaging and interconnect technologies have been licensed to more than 100 customers and have shipped in over 100 billion semiconductor chips.
The accompanying interim unaudited condensed consolidated financial statements as of June 30, 2018 and 2017, and for the three and six months then ended, have been prepared by the Company in accordance with generally accepted accounting principles (“GAAP”) in the United States (“U.S.”) for interim financial information. The amounts as of December 31, 2017 have been derived from the Company’s annual audited financial statements. Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted in accordance with such rules and regulations. In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments necessary (consisting of normal recurring adjustments) to state fairly the financial position of the Company and its results of operations and cash flows as of and for the periods presented. These financial statements should be read in conjunction with the annual audited financial statements and notes thereto as of and for the year ended December 31, 2017, included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017, filed on February 23, 2018 (the “Form 10-K”).
The results of operations for the three and six months ended June 30, 2018 are not necessarily indicative of the results that may be expected for the full year ended December 31, 2018 or any future period and the Company makes no representations related thereto.
Reclassification
Certain reclassifications have been made to prior period balances in order to conform to the current period’s presentation.
NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The Company’s significant accounting policies are detailed in "Note 2 - Summary of Significant Accounting Policies" in its Form 10-K for the year ended December 31, 2017. Significant changes to its accounting policies as a result of adopting Topic 606 are discussed in Note 3 - Revenue.
Recently Adopted Accounting Pronouncements
In August 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2016-15, “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments.” This ASU addresses the classification of certain specific cash flow issues including debt prepayment or extinguishment costs, settlement of certain debt instruments, contingent consideration payments made after a business combination, proceeds from the settlement of certain insurance claims and distributions received from equity method investees. This ASU is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years, with early adoption permitted. The Company adopted this standard as of January 1, 2018. The adoption of this standard did not have a material impact on the Company's consolidated financial statements.
In October 2016, the FASB issued ASU No. 2016-16, "Intra-Entity Transfers of Assets Other Than Inventory." This ASU requires entities to recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. For public entities, this ASU is effective for annual reporting periods beginning after December 15, 2017, including interim reporting periods within those annual reporting periods. The Company adopted this standard as of January 1,

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2018 on a prospective basis. The adoption of this standard did not have a material impact on the Company's consolidated financial statements.

In May 2017, the FASB issued ASU No. 2017-09, “Compensation-Stock Compensation (Topic 718) Scope of Modification Accounting.” ASU 2017-09 provides guidance about which changes to the terms or conditions of a share-based payment awarded require an entity to apply modification accounting. The standard is effective for interim and annual reporting periods beginning after December 15, 2017, with early adoption permitted. The Company adopted the standard as of January 1, 2018 on a prospective basis. The adoption of this standard did not have a material impact on the Company's consolidated financial statements.
In May 2014, the FASB issued ASU No. 2014-09 (Topic 606) "Revenue from Contracts with Customers." Topic 606 supersedes the revenue recognition requirements in Topic 605 “Revenue Recognition” (Topic 605), and requires entities to recognize revenue when control of goods or services is transferred to customers at an amount that reflects the consideration to which the entity expects to be entitled in exchange for the goods or services. Under the prior standard, licensing companies generally reported revenue from per-unit royalty based arrangements one quarter in arrears. Under the new guidance, the Company estimates per-unit royalty-based revenue prior to receiving customer royalty reports. The Company also expects the standard to have a significant impact on the timing of revenue recognition associated with its fixed fee and minimum guarantee arrangements, as a majority of such revenue which had previously been recognized over the license term is expected to be recognized at the inception of the license term. On January 1, 2018, the Company adopted the new standard using the modified retrospective method, under which the Company recorded a $224 million cumulative net of tax adjustment to the opening balance of retained earnings on January 1, 2018. The adjustment was determined by measuring the impact of the new standard on existing contracts that were not completed as of December 31, 2017. Prior period comparative information has not been restated and continues to be reported under Topic 605 in effect for those periods. This new standard had a material impact on the Company’s revenue and its consolidated statement of operations and balance sheet as of and for the three and six months ended June 30, 2018, and is expected to have a material impact on an ongoing basis, with no impact on the timing of customer billings or on cash flows. See “Note 3 - Revenue" for further discussion.
The cumulative effect of the changes made to the Company's condensed consolidated balance sheet for the adoption of Topic 606 was as follows (in thousands):
BALANCE SHEET
Balance at December 31, 2017
 
Adjustments due to Topic 606
 
Balance at January 1, 2018
Assets
 
 
 
 
 
Unbilled contracts receivable
$
10,866

 
$
188,760

 
$
199,626

Other current assets
16,949

 
(2,000
)
 
14,949

Long-term unbilled contracts receivable
2,930

 
103,983

 
106,913

Other assets
9,772

 
(2,446
)
 
7,326

Liabilities
 
 
 
 
 
Accrued liabilities
47,969

 
432

 
48,401

Deferred revenue
2,686

 
(783
)
 
1,903

Long-term deferred tax liabilities
15,085

 
64,520

 
79,605

 


 


 


Equity
 
 
 
 


Retained earnings
68,556

 
224,128

 
292,684

The most significant impact from adopting Topic 606 was a substantial increase in unbilled contracts receivable, long-term deferred tax liabilities and retained earnings, which was driven primarily by applying the standard on fixed fee and minimum guarantee contracts that were not completed as of December 31, 2017, and secondarily by recording to retained earnings those royalties from customer shipments completed in the fourth quarter of 2017 and reported to the Company in the first quarter of 2018. The adjustments noted above had no impact on the Company's Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2018.
Adoption of the new revenue standard had the following impact on the Company's condensed consolidated financial statements as compared to the comparable data under the previous accounting standards (in thousands, except per share amounts):

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Three months ended June 30, 2018
 
Six months ended June 30, 2018
STATEMENT OF OPERATIONS
As Reported
 
Amounts under Topic 605
 
Effect of Change Higher/(lower)
 
As Reported
 
Amounts under Topic 605
 
Effect of Change Higher/(lower)
 
 
 
 
 
 
 
 
 
 
 
 
Royalty and license fees
$
63,954

 
$
96,716

 
$
(32,762
)
 
$
129,486

 
$
192,876

 
$
(63,390
)
Cost of revenue
2,080

 
2,230

 
(150
)
 
4,404

 
4,329

 
75

Operating income (loss)
(27,606
)
 
5,006

 
(32,612
)
 
(60,097
)
 
3,368

 
(63,465
)
Other income and expense, net
2,229

 
81

 
2,148

 
5,383

 
1,084

 
4,299

Loss before taxes
(31,577
)
 
(1,112
)
 
(30,465
)
 
(67,232
)
 
(8,065
)
 
(59,167
)
Provision for (benefit from) income taxes
(3,321
)
 
2,458

 
(5,779
)
 
(5,959
)
 
4,708

 
(10,667
)
Net loss
(28,256
)
 
(3,570
)
 
(24,686
)
 
(61,273
)
 
(12,773
)
 
(48,500
)
 
 
 
 
 
 
 
 
 
 
 
 
Basic net loss per share
$
(0.58
)
 
$
(0.07
)
 
$
(0.51
)
 
$
(1.25
)
 
$
(0.26
)
 
$
(0.99
)

 
As of June 30, 2018
BALANCE SHEET
As Reported
 
Amounts under Topic 605
 
Effect of Change Higher/(lower)
Assets
 
 
 
 
 
Unbilled contracts receivable
$
175,315

 
$
5,568

 
$
169,747

Other current assets
16,422

 
17,922

 
(1,500
)
Long-term unbilled contracts receivable
65,013

 
2,091

 
62,922

Other assets
4,959

 
6,609

 
(1,650
)
Liabilities
 
 
 
 


Accrued liabilities
24,254

 
25,019

 
(765
)
Deferred revenue
4,106

 
4,838

 
(732
)
Long-term deferred tax liabilities
64,545

 
9,225

 
55,320

Equity
 
 
 
 


Retained earnings
211,722

 
36,026

 
175,696


Recent Accounting Pronouncements
In February 2016, the FASB issued ASU No. 2016-02, "Leases" (Topic 842) (ASU 2016-02), which generally requires companies to recognize operating and financing lease liabilities and corresponding right-of-use assets on the balance sheet. This guidance will be effective for the Company in the first quarter of 2019, and early adoption is permitted. The Company will adopt the new standard effective January 1, 2019. While the Company continues to evaluate the effect of adopting this guidance on its consolidated financial statements and related disclosures, it is expected the Company's operating leases, as disclosed in Note 13 - "Commitments and Contingencies," will be subject to the new standard. In the second quarter of 2018, the Company established an implementation team to develop a multi-phase plan to assess the Company’s leasing arrangements, as well as any changes to accounting policies, processes or systems necessary to adopt the requirements of the new standard. The Company is evaluating the full impact this guidance will have on its consolidated financial statements, and expects that adoption will result in increases in lease-related Right-of-Use assets and liabilities on its consolidated balance sheet.
In September 2016, the FASB issued ASU No. 2016-13, “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments” (“ASU 2016-13”), which introduces an approach based on expected losses to estimate credit losses on certain types of financial instruments. It also modifies the impairment model for available-for-sale debt securities and provides for a simplified accounting model for purchased financial assets with credit deterioration since their origination. ASU 2016-13 is effective for the Company in the first quarter of the year ending December 31, 2020. The Company is in the process of evaluating the impact of the adoption of this new standard on its consolidated financial statements.
NOTE 3 – REVENUE

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As discussed in Note 2, on January 1, 2018, the Company adopted Topic 606 using the modified retrospective method. Results for reporting periods beginning January 1, 2018 are presented under Topic 606, while prior period amounts are not restated and continue to be reported in accordance with the historic accounting under Topic 605.

Revenue Recognition
The Company derives its revenue primarily from royalty and license fees for rights to use the Company’s intellectual property and technologies (“IP”). Revenue is recognized upon transfer of control of promised products, services or IP rights to customers in an amount that reflects the consideration the Company expects to receive in exchange for those products, services or licensing of the IP rights.
Certain licensees have entered into fixed fee or minimum guarantee arrangements, whereby licensees pay a fixed fee for the right to incorporate the Company's technology in the licensee's products over the license term. In arrangements with a minimum guarantee, the fixed fee component corresponds to a minimum number of units or dollars that the customer must produce or pay, with additional per-unit fees for any units or dollars exceeding the minimum. In most cases, the customer pays the fixed license fee in specified installments over the license term. For these agreements, the Company recognizes the full fixed fee as revenue at the beginning of the license term, when the licensee has the right to use the IP and begins to benefit from the license.
If the contract term of a fixed fee or minimum guarantee arrangement is longer than one year, the Company also considers the scheduled payment arrangements to determine whether a significant financing component exists. In general, if the payment arrangements extend beyond the initial twelve months of the contract, the Company treats a portion of the payments as a significant financing component. When the payments are expected to be received within one year or less, the Company does not adjust the promised amount of consideration for the effects of a financing component. The discount rate used for each arrangement reflects the rate that would be used in a separate financing transaction between the Company and the licensee at contract inception, and takes into account the credit characteristics of the licensee and market interest rates as of the date of the agreement. As such, the amount of fixed fee revenue recognized at the beginning of the license term will be reduced by the calculated financing component. As payments are received from the licensee, the Company recognizes a portion of the financing component as interest income, reported as other income and expense in the Consolidated Statements of Operations.
For certain licensees, royalty revenues are generated based on a licensee's production or shipment of licensed products incorporating the Company’s IP, technologies or software. Licensees with a per-unit arrangement pay a per-unit royalty for each product manufactured or sold, as set forth in its license agreement. Licensees generally report manufacturing or sales information in the quarter subsequent to when the shipment activity takes place. The Company estimates the royalties earned each quarter based on its forecast of manufacturing and sales activity incurred by its licensees in that quarter. Any differences between actual royalties owed by a licensee and the Company’s quarterly estimate are recognized in the following quarter, when the licensee’s royalty report is received. Estimating licensees’ quarterly royalties prior to receiving the royalty reports requires the Company to make significant assumptions and judgments that could have a material impact on the amount of revenue it reports on a quarterly basis.
The Company actively monitors and enforces its IP, including seeking appropriate compensation from customers that have under-reported royalties owed under a license agreement and from third parties that utilize the Company’s intellectual property without a license. As a result of these activities, the Company may, from time to time, recognize revenue from payments resulting from periodic compliance audits of licensees for underreporting royalties incurred in prior periods, as part of a settlement of a patent infringement dispute, or legal judgments from a license dispute. These recoveries and settlements may cause revenue to be higher than expected during a particular reporting period and such recoveries may not occur in subsequent periods. The Company recognizes revenue from recoveries when a binding agreement has been executed and the Company concludes collection under that agreement is likely.
In some instances, the Company may enter into license agreements that contain multiple performance obligations that include engineering services in addition to a technology or software license. For such arrangements where all components are capable of being distinct and accounted for as separate performance obligations, the Company allocates revenue to each performance obligation based on its relative standalone selling price. The Company generally determines standalone selling prices based on the prices ordinarily charged to customers, or in some cases by applying a reasonable cost-plus margin. The consideration for engineering services is recognized as the underlying performance obligations are satisfied. Generally, the Company satisfies performance obligations over time and therefore recognizes revenue over time by measuring the progress toward completion of the performance obligation at each reporting period.

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Revenue is recognized gross of withholding taxes that are remitted directly by the Company's licensees directly to a local tax authority.

For additional detail on the Company's revenue disaggregated by geographic location, refer to Note 14 - "Segment and Geographic Information."
Contract Balances
Unbilled Contracts Receivable
Timing of revenue recognition may differ significantly from the timing of invoicing to customers. Accounts receivable, net, include amounts billed and currently due from customers. Unbilled contracts receivable represent unbilled amounts expected to be received from customers in future periods, where the revenue recognized to date (or cumulative adjustments to retained earnings in the initial period of adopting Topic 606) exceeds the amount billed, and right to payment is subject to the underlying contractual terms. Unbilled contracts receivable amounts may not exceed their net realizable value and are classified as long-term assets if the payments are expected to be received more than one year from the reporting date.
Deferred Revenue
Deferred revenue includes payments made by licensees for which the corresponding performance obligations have not yet been fully satisfied by the Company and typically arises where performance obligations are satisfied over time.
The following table presents additional revenue and contract disclosures (in thousands):
 
Three months ended June 30,
 
Six months ended June 30,
 
2018
 
2017
 
2018
 
2017
Revenue recognized in the period from:
 
 
 
 
 
 
 
Amounts included in deferred revenue at the beginning of the period
$
1,642

 
$
1,369

 
$
1,995

 
$
1,605

Performance obligations satisfied in previous periods (true ups)
54

 

 
54

 


Remaining revenue under contracts with performance obligations represents the aggregate amount of the transaction price allocated to the performance obligations that are unsatisfied (or partially unsatisfied) under the Company’s engineering services contracts. The Company's remaining revenue under contracts with performance obligations was as follows (in thousands):
 
As of
 
June 30, 2018
 
December 31, 2017
Revenue from contracts with performance obligations expected to be satisfied in:
 
 
 
   One year or less
$
6,373

 
$
2,440

   More than one year but less than two years
437

 
149

   More than two years
118

 
240

Total
$
6,928

 
$
2,829

Practical Expedients
The Company expenses sales commissions when incurred because the amortization period generally would have been one year or less. In addition, sales commissions have historically not been a significant expense and are not contemplated to be significant in the future. Sales commissions are recorded in selling, general and administrative expenses in the consolidated statement of operations.
NOTE 4 – COMPOSITION OF CERTAIN FINANCIAL STATEMENT CAPTIONS
Other current assets consisted of the following (in thousands):

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Table of Contents

 
June 30, 2018
 
December 31, 2017
Prepaid income taxes
$
6,777

 
$
6,713

Prepaid expenses
6,599

 
6,655

Other
3,046

 
3,581

 
$
16,422

 
$
16,949


Property and equipment, net consisted of the following (in thousands):
 
June 30, 2018
 
December 31, 2017
Equipment, furniture and other
$
27,964

 
$
26,029

Building and improvements
18,258

 
18,222

Land
5,300

 
5,300

Leasehold improvements
6,437

 
6,469

 
57,959

 
56,020

Less: accumulated depreciation and amortization
(24,975
)
 
(21,578
)
 
$
32,984

 
$
34,442


Depreciation and amortization expense for the three months ended June 30, 2018 and 2017 amounted to $1.7 million and $1.8 million, respectively.

Depreciation and amortization expense for the six months ended June 30, 2018 and 2017 amounted to $3.4 million and $3.6 million, respectively.
Accrued liabilities consisted of the following (in thousands):
 
June 30, 2018
 
December 31, 2017
Employee compensation and benefits
$
15,327

 
$
37,056

Other
8,927

 
10,913

 
$
24,254

 
$
47,969

Accumulated other comprehensive loss consisted of the following (in thousands):
 
June 30, 2018
 
December 31, 2017
Unrealized loss on available-for-sale securities, net of tax
$
(456
)
 
$
(303
)
 
$
(456
)
 
$
(303
)
Other income and expense, net, consisted of the following (in thousands):
 
For the three months ended,
 
For the six months ended,
 
June 30, 2018
 
June 30, 2017
 
June 30, 2018
 
June 30, 2017
Interest income from significant financing components under Topic 606

$
2,148

 
$

 
$
4,299

 
$

Interest income from investments
214

 
249

 
464

 
463

Other income (losses)
(133
)
 
(29
)
 
620

 
(197
)
 
$
2,229

 
$
220

 
$
5,383

 
$
266


NOTE 5 – FINANCIAL INSTRUMENTS
The following is a summary of marketable securities at June 30, 2018 and December 31, 2017 (in thousands):
 

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June 30, 2018
 
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair
Values
Available-for-sale securities
 
 
 
 
 
 
 
Corporate bonds and notes
$
33,905

 
$

 
$
(377
)
 
$
33,528

Treasury and agency notes and bills
6,000

 

 
(79
)
 
5,921

Money market funds
8,781

 

 

 
8,781

Total available-for-sale securities
$
48,686

 
$

 
$
(456
)
 
$
48,230

Reported in:
 
 
 
 
 
 
 
Cash and cash equivalents
 
 
 
 
 
 
$
8,781

Short-term investments
 
 
 
 
 
 
39,449

Total marketable securities
 
 
 
 
 
 
$
48,230

 
December 31, 2017
 
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair
Values
Available-for-sale securities
 
 
 
 
 
 
 
Corporate bonds and notes
$
45,803

 
$

 
$
(230
)
 
$
45,573

Commercial paper
2,392

 

 
(2
)
 
2,390

Treasury and agency notes and bills
6,000

 

 
(71
)
 
5,929

Certificates of deposit
8,540

 

 

 
8,540

Money market funds
40,413

 

 

 
40,413

Total available-for-sale securities
$
103,148

 
$

 
$
(303
)
 
$
102,845

Reported in:
 
 
 
 
 
 
 
Cash and cash equivalents
 
 
 
 
 
 
$
40,413

Short-term investments
 
 
 
 
 
 
62,432

Total marketable securities
 
 
 
 
 
 
$
102,845

At June 30, 2018 and December 31, 2017, the Company had $95.3 million and $200.7 million, respectively, in cash, cash equivalents and short-term investments. These balances include $47.0 million and $97.8 million in cash held in operating accounts not included in the tables above at June 30, 2018 and December 31, 2017, respectively.
The gross realized gains and losses on sales of marketable securities were not significant during the three and six months ended June 30, 2018 and 2017.
Unrealized losses were $0.5 million and $0.3 million, net of tax, as of June 30, 2018 and December 31, 2017, respectively. These amounts were related to temporary fluctuations in value of the remaining available-for-sale securities and were due primarily to changes in interest rates and market and credit conditions of the underlying securities. Certain investments with a temporary decline in value are not considered to be other-than-temporarily impaired as of June 30, 2018 because the Company has the intent and ability to hold these investments to allow for recovery, does not anticipate having to sell these securities with unrealized losses and continues to receive interest at the maximum contractual rate. For the three and six months ended June 30, 2018 and 2017, respectively, the Company did not record any impairment charges related to its marketable securities.
The following table summarizes the fair value and gross unrealized losses related to individual available-for-sale securities at June 30, 2018 and December 31, 2017, which have been in a continuous unrealized loss position, aggregated by investment category and length of time (in thousands): 

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Table of Contents

June 30, 2018
Less Than 12 Months
 
12 Months or More
 
Total
 
Fair Value
 
Gross
Unrealized
Losses
 
Fair Value
 
Gross
Unrealized
Losses
 
Fair Value
 
Gross
Unrealized
Losses
Corporate bonds and notes
$
24,340

 
$
(325
)
 
$
9,188

 
$
(52
)
 
$
33,528

 
$
(377
)
Treasury and agency notes and bills

 

 
5,921

 
(79
)
 
5,921

 
(79
)
Total
$
24,340

 
$
(325
)
 
$
15,109

 
$
(131
)
 
$
39,449

 
$
(456
)
 
December 31, 2017
Less Than 12 Months
 
12 Months or More
 
Total
 
Fair Value
 
Gross
Unrealized
Losses
 
Fair
Value
 
Gross
Unrealized
Losses
 
Fair Value
 
Gross
Unrealized
Losses
Corporate bonds and notes
$
30,811

 
$
(189
)
 
$
14,762

 
$
(41
)
 
$
45,573

 
$
(230
)
Commercial paper
2,390

 
(2
)
 

 

 
2,390

 
(2
)
Treasury and agency notes and bills

 

 
5,929

 
(71
)
 
5,929

 
(71
)
Total
$
33,201

 
$
(191
)
 
$
20,691

 
$
(112
)
 
$
53,892

 
$
(303
)

The estimated fair value of marketable securities by contractual maturity at June 30, 2018 is shown below (in thousands). Actual maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations without call or prepayment penalties. 
 
Estimated
Fair Value
Due in one year or less
$
23,954

Due in one to two years
22,315

Due in two to three years
1,961

Total
$
48,230

NOTE 6 – FAIR VALUE

The Company follows the authoritative guidance for fair value measurement and the fair value option for financial assets and financial liabilities. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability, or an exit price, in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The established fair value hierarchy requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. There are three levels of inputs that may be used to measure fair value:
Level 1
 
Quoted prices in active markets for identical assets.
Level 2
 
Observable market-based inputs or unobservable inputs that are corroborated by market data.
Level 3
 
Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.
When applying fair value principles in the valuation of assets, the Company is required to maximize the use of quoted market prices and minimize the use of unobservable inputs. The Company calculates the fair value of its Level 1 and Level 2 instruments based on the exchange traded price of similar or identical instruments, where available, or based on other observable inputs. There were no significant transfers into or out of Level 1 or Level 2 that occurred between December 31, 2017 and June 30, 2018.
The following is a list of the Company’s assets required to be measured at fair value on a recurring basis and where they were classified within the hierarchy as of June 30, 2018 (in thousands):
 

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Table of Contents

 
Fair Value
 
Quoted
Prices in
Active Markets
for Identical
Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
Assets
 
 
 
 
 
 
 
Marketable securities
 
 
 
 
 
 
 
Money market funds (1)
$
8,781

 
$
8,781

 
$

 
$

Corporate bonds and notes (2)
33,528

 

 
33,528

 

Treasury and agency notes and bills (2)
5,921

 

 
5,921

 

Total Assets
$
48,230

 
$
8,781

 
$
39,449

 
$

The following footnotes indicate where the noted items were recorded in the Condensed Consolidated Balance Sheet at June 30, 2018:
(1)
Reported as cash and cash equivalents.
(2)
Reported as short-term investments.

The following is a list of the Company’s assets required to be measured at fair value on a recurring basis and where they were classified within the hierarchy as of December 31, 2017 (in thousands): 
 
Fair Value
 
Quoted
Prices in
Active Markets
for Identical
Assets
(Level  1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
Assets
 
 
 
 
 
 
 
Marketable securities
 
 
 
 
 
 
 
Money market funds (1)
$
40,413

 
$
40,413

 
$

 
$

Certificates of deposit (2)
8,540

 

 
8,540

 

Corporate bonds and notes (2)
45,573

 

 
45,573

 

Treasury and agency notes and bills (2)
5,929

 

 
5,929

 

Commercial paper (2)
2,390

 

 
2,390

 

Total Assets
$
102,845

 
$
40,413

 
$
62,432

 
$

 
The following footnotes indicate where the noted items were recorded in the Consolidated Balance Sheet at December 31, 2017:
(1)
Reported as cash and cash equivalents.
(2)
Reported as short-term investments.

The Company also has outstanding debt at June 30, 2018 and December 31, 2017 that is considered a level 2 liability and is measured at fair value on a recurring basis. See “Note 8 - Debt” for additional information. At June 30, 2018 and December 31, 2017, the fair value of the Company's debt was not materially different than the outstanding principal amount.
NOTE 7 – GOODWILL AND IDENTIFIED INTANGIBLE ASSETS
The changes to the carrying value of goodwill from January 1, 2018 through June 30, 2018 are reflected below (in thousands):
December 31, 2017
$
385,574

 
Goodwill acquired through a business acquisition (1)
210

 
June 30, 2018
$
385,784

(2
)



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Table of Contents

(1) Related to the acquisition of an emerging technology company in May 2018.
(2) Of this amount, approximately $378.1 million was allocated to the Product Licensing segment and approximately $7.7 million was allocated to the Semiconductor and IP Licensing segment.
Identified intangible assets consisted of the following (in thousands):
 
 
 
June 30, 2018
 
December 31, 2017
 
Average
Life
(Years)
 
Gross
Assets
 
Accumulated
Amortization
 
Net
 
Gross
Assets
 
Accumulated
Amortization
 
Net
Acquired patents / core technology
3-15
 
$
142,934

 
$
(121,275
)
 
$
21,659

 
$
142,584

 
$
(113,349
)
 
$
29,235

Existing technology
5-10
 
206,879

 
(78,689
)
 
128,190

 
204,394

 
(61,518
)
 
142,876

Customer contracts and related relationships
3-9
 
291,769

 
(95,049
)
 
196,720

 
291,769

 
(68,267
)
 
223,502

Trademarks/trade name
4-10
 
40,083

 
(8,597
)
 
31,486

 
40,083

 
(6,111
)
 
33,972

Non-competition agreements
1
 
2,231

 
(2,231
)
 

 
2,231

 
(2,231
)
 

Total amortizable intangible assets
 
 
683,896

 
(305,841
)
 
378,055

 
681,061

 
(251,476
)
 
429,585

In-process research and development
 
 

 

 

 
2,204

 

 
2,204

Total intangible assets
 
 
$
683,896

 
$
(305,841
)
 
$
378,055

 
$
683,265

 
$
(251,476
)
 
$
431,789

Amortization expense for the three months ended June 30, 2018 and 2017 amounted to $27.2 million and $28.2 million, respectively.
Amortization expense for the six months ended June 30, 2018 and 2017 amounted to $54.4 million and $56.7 million, respectively.
As of June 30, 2018, the estimated future amortization expense of total intangible assets was as follows (in thousands):
2018 (remaining 6 months)
$
53,921

2019
99,383

2020
87,668

2021
80,006

2022
31,614

Thereafter
25,463

 
$
378,055

NOTE 8 - DEBT
On December 1, 2016, in connection with the consummation of the acquisition of DTS, the Company entered into a Credit Agreement (the “Credit Agreement”) by and among the Company, Royal Bank of Canada, as administrative agent and collateral agent, and the lenders party thereto. The Credit Agreement provided for a $600.0 million seven-year term B loan facility (the “Term B Loan Facility”) which matures on November 30, 2023. Upon the closing of the Credit Agreement, the Company borrowed $600.0 million under the Term B Loan facility. Net proceeds were used on December 1, 2016, together with cash and cash equivalents, to finance the acquisition of DTS.
On January 23, 2018, the Company and the loan parties entered into an amendment to the Credit Agreement (the “Amendment”). In connection with the Amendment, the Company made a voluntary prepayment of $100.0 million of the term loan outstanding under the Credit Agreement using cash on hand. The Amendment provided for, among other things, (i) a replacement of the outstanding initial term loan with the new tranche term B-1 loan (the “Amended Term B Loan”) in a principal amount of $494.0 million, (ii) a reduction of the interest rate margin applicable to such loan to (x) in the case of Eurodollar loans, 2.50% per annum and (y) in the case of base rate loans, 1.50% per annum, (iii) a prepayment premium of 1.00% in connection with any repricing transaction with respect to the Amended Term B Loan within six months of the closing

16


Table of Contents

date of the Amendment, and (iv) certain amendments to provide the Company with additional flexibility under the covenant governing restricted payments.
The Company’s obligations under the Credit Agreement, as amended by the Amendment, continue to be guaranteed by substantially all of the Company’s subsidiaries, and secured by substantially all of the assets of the Company and its subsidiaries. The Credit Agreement contains customary events of default, upon the occurrence of which, after any applicable grace period, the lenders will have the ability to accelerate all outstanding loans thereunder. The Credit Agreement contains customary representations and warranties and affirmative and negative covenants that, among other things, restrict the ability of the Company to create or incur certain liens, incur or guarantee additional indebtedness, merge or consolidate with other companies, transfer or sell assets and make restricted payments. The Company was in compliance with all requirements during the three and six months ended June 30, 2018.
All lenders of the Term B Loan Facility participated in the Amendment and the changes in terms were not considered substantial. Accordingly, the repricing event was accounted for as a debt modification. The Company elected to continue to defer the unamortized debt issuance costs related to the partial pay-down of the debt as the prepayment was factored into the terms agreed to on the debt.
At June 30, 2018, $494.0 million was outstanding with an interest rate, including the amortization of debt issuance costs, of 5.0%. Interest is payable monthly. There were also $13.0 million of unamortized debt issuance costs recorded as a reduction of the long-term portion of the debt. Interest expense was $6.2 million and $12.5 million for the three and six months ended June 30, 2018, respectively. Interest expense was $7.0 million and $13.5 million for the three and six months ended June 30, 2017, respectively. Amortized debt issuance costs, which were included in interest expense, amounted to $0.6 million and $1.3 million for the three and six months ended June 30, 2018, respectively, and $0.6 million and $1.2 million for the three and six months ended June 30, 2017, respectively. Other than the voluntary prepayment of $100.0 million in January 2018, there were no other debt principal payments in the first two quarters of 2018 as the prepayment exceeded the minimum principal payment requirements. There were debt principal payments of $1.5 million and $3.0 million during the three and six months ended June 30, 2017, respectively.
As of June 30, 2018, future minimum principal payments for long-term debt are summarized as follows (in thousands):
2018 (remaining 6 months)
$

2019

2020

2021

2022

Thereafter
494,000

Total
$
494,000

NOTE 9 – NET LOSS PER SHARE
The Company has a share-based compensation plan under which employees may be granted share-based awards including shares of restricted stock and restricted stock units ("RSUs"). Non-forfeitable dividends are paid on unvested shares of restricted stock. No dividends are accrued or paid on unvested RSUs. As such, shares of restricted stock are considered participating securities under the two-class method of calculating earnings per share. The two-class method of calculating earnings per share did not have a material impact on the Company’s loss per share calculation for the three and six months ended June 30, 2018 and 2017.

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Table of Contents

The following table sets forth the computation of basic and diluted shares (in thousands):
 
Three Months Ended
 
Six Months Ended
 
June 30, 2018
 
June 30, 2017
 
June 30, 2018
 
June 30, 2017
Denominator:
 
 
 
 
 
 
 
     Weighted average common shares outstanding
49,060

 
49,477

 
49,110

 
49,264

      Less: shares of restricted stock subject to repurchase

 
(2
)
 

 
(3
)
Total common shares-basic
49,060

 
49,475

 
49,110

 
49,261

Effect of dilutive securities:
 
 
 
 
 
 
 
     Options

 

 

 

     Restricted stock awards and units

 

 

 

Total common shares-diluted
49,060


49,475

 
49,110

 
49,261

Basic net income (loss) per share is computed using the weighted average number of common shares outstanding during the period, excluding any unvested restricted stock awards that are subject to repurchase. Diluted net income (loss) per share is computed using the treasury stock method to calculate the weighted average number of common shares and, if dilutive, potential common shares outstanding during the period. Potential dilutive common shares include unvested restricted stock awards and units and incremental common shares issuable upon the exercise of stock options, less shares from assumed proceeds. The assumed proceeds calculation includes actual proceeds to be received from the employee upon exercise and the average unrecognized stock compensation cost during the period.
For the three and six months ended June 30, 2018, there was no difference in the weighted average number of common shares used for the calculation of basic and diluted loss per share as the effect of all potentially dilutive shares outstanding was anti-dilutive. A total of 2.9 million and 2.9 million shares subject to stock options and restricted stock awards and units were excluded from the computation of diluted net loss per share for the three and six months ended June 30, 2018, respectively, because including them would have been anti-dilutive.
For the three and six months ended June 30, 2017, there was no difference in the weighted average number of common shares used for the calculation of basic and diluted loss per share as the effect of all potentially dilutive shares outstanding was anti-dilutive. A total 0.7 million and 1.1 million shares subject to stock options and restricted stock awards and units were excluded from the computation of diluted net loss per share for the three and six months ended June 30, 2017, respectively, because including them would have been anti-dilutive.
NOTE 10 – STOCKHOLDERS’ EQUITY
Stock Repurchase Programs
In August 2007, the Company’s Board of Directors (“the Board”) authorized a plan to repurchase the Company’s outstanding shares of common stock dependent on market conditions, share price and other factors. As of June 30, 2018, the Company has repurchased a total of approximately 12,513,000 shares of common stock, since inception of the plan, at an average price of $26.94 per share for a total cost of $337.1 million. As of December 31, 2017, the Company had repurchased a total of approximately 11,142,000 shares of common stock, since inception of the plan, at an average price of $27.57 per share for a total cost of $307.2 million. The shares repurchased are recorded as treasury stock and are accounted for under the cost method. No expiration date has been specified for this plan. As of June 30, 2018, the total remaining amount available for repurchase was $112.9 million. The Company plans to continue to execute authorized repurchases from time to time under the plan.

Stock Option Plans
The 2003 Plan
As of June 30, 2018, there were approximately 3.6 million shares reserved for future grant under the Company’s 2003 Equity Incentive Plan (the “2003 Plan”).
A summary of the stock option activity is presented below (in thousands, except per share amounts):

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Table of Contents

 
Options Outstanding
 
Number of
Shares Subject to Options
 
Weighted
Average
Exercise
Price Per
Share
Balance at December 31, 2017
1,172

 
$24.06
Options granted

 
Options exercised
(426
)
 
$18.76
Options canceled / forfeited / expired
(59
)
 
$35.21
Balance at June 30, 2018
687

 
$26.39
 
 
 
 

Restricted Stock Awards and Units
Information with respect to outstanding restricted stock awards and units as of June 30, 2018 is as follows (in thousands, except per share amounts):
 
Restricted Stock and Restricted Stock Units
 
Number of Shares
Subject to Time-
based Vesting
 
Number of Shares
Subject to
Performance-
based Vesting
 
Total Number
of Shares
 
Weighted Average
Grant Date Fair
Value Per Share
Balance at December 31, 2017
2,014

 
1,119

 
3,133

 
$
33.35

Awards and units granted
1,013

 
45

 
1,058

 
$
22.29

Awards and units vested / earned
(604
)
 
(176
)
 
(780
)
 
$
35.00

Awards and units canceled / forfeited
(128
)
 
(228
)
 
(356
)
 
$
29.48

Balance at June 30, 2018
2,295

 
760

 
3,055

 
$
29.55


Performance Awards and Units
Performance awards and units may be granted to employees or consultants based upon, among other things, the contributions, responsibilities and other compensation of the particular employee or consultant. The value and the vesting of such performance awards and units are generally linked to one or more performance goals or other specific performance goals determined by the Company, in each case on a specified date or dates or over any period or periods determined by the Company, and range from zero to 100 percent of the grant.
Employee Stock Purchase Plans
As of June 30, 2018, there were approximately 1,265,000 shares reserved for grant under the Company’s 2003 Employee Stock Purchase Plan (the “ESPP”) and the International Employee Stock Purchase Plan (the “International ESPP”), collectively.
NOTE 11 – STOCK-BASED COMPENSATION EXPENSE
The effect of recording stock-based compensation expense for the three and six months ended June 30, 2018 and 2017 is as follows (in thousands):
 
Three Months Ended
 
Six Months Ended
 
June 30, 2018
 
June 30, 2017
 
June 30, 2018
 
June 30, 2017
Research, development and other related costs
$
3,344

 
$
3,437

 
$
6,438

 
$
6,134

Selling, general and administrative
3,875

 
5,087

 
8,189

 
9,451

Total stock-based compensation expense
7,219

 
8,524

 
14,627

 
15,585

Tax effect on stock-based compensation expense
(1,159
)
 
(2,359
)
 
(2,415
)
 
(4,379
)
Net effect on net income (loss)
$
6,060

 
$
6,165

 
$
12,212

 
$
11,206



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Table of Contents

Stock-based compensation expense categorized by various equity components for the three and six months ended June 30, 2018 and 2017 is summarized in the table below (in thousands):
 
Three Months Ended
 
Six Months Ended
 
June 30, 2018
 
June 30, 2017
 
June 30, 2018
 
June 30, 2017
Employee stock options
$
106

 
$
586

 
$
283

 
$
1,231

Restricted stock awards and units
6,379

 
7,301

 
12,810

 
13,287

Employee stock purchase plan
734

 
637

 
1,534

 
1,067

Total stock-based compensation expense
$
7,219

 
$
8,524

 
$
14,627

 
$
15,585

There were no options granted in the three and six months ended June 30, 2018 and 2017.
ESPP grants occur in February and August. The following assumptions were used to value the ESPP shares for these grants:
 
 
February 2018
 
February 2017
 
Expected life (years)
 
2.0

 
2.0

 
Risk-free interest rate
 
2.2
%
 
1.2
%
 
Dividend yield
 
3.6
%
 
2.0
%
 
Expected volatility
 
39.4
%
 
28.3
%
 

NOTE 12 – INCOME TAXES
For the three months ended June 30, 2018, the Company recorded an income tax benefit of $3.3 million on a pretax loss of $31.6 million and for the six months ended June 30, 2018, the Company recorded an income tax benefit of $6.0 million on a pretax loss of $67.2 million, which resulted in an effective tax rate year to date of 8.9%. The income tax benefit for the three and six months ended June 30, 2018 was primarily related to tax benefit from losses and credits generated from operations offset by foreign withholding taxes, certain book-to-tax permanent differences, valuation allowance recorded against the Company’s unutilized tax credits generated in the current year, and shortfalls from stock-based compensation. For the three months ended June 30, 2017, the Company recorded an income tax provision of $26.6 million, and for the six months ended June 30, 2017, the Company recorded an income tax benefit of $8.7 million, which resulted in an effective tax rate year to date of 14.8%.
The income tax provision of $26.6 million for the three months ended June 30, 2017 was primarily related to a decrease in the Company’s estimated annual effective tax rate applied to actual year-to-date losses incurred that resulted in a reduction of actual tax benefit as compared to the prior quarter. The income tax benefit of $8.7 million for the six months ended June 30, 2017 was primarily related to losses generated in the U.S. and foreign operations offset by foreign withholding tax liability. The Company's provision for income taxes is based on its worldwide estimated annualized effective tax rate, except for jurisdictions for which a loss is expected for the year and no benefit can be realized for those losses, and the tax effect of discrete items occurring during the period. The tax for jurisdictions for which a loss is expected and no benefit can be realized for the year is based on actual taxes and tax reserves for the quarter. The decrease in income tax benefit for the six months ended June 30, 2018 as compared to the income tax benefit during the same period in the prior year is largely attributable to valuation allowance recorded against the Company’s tax credits.
As of June 30, 2018, unrecognized tax benefits were $34.1 million (which is included in long-term deferred tax and other liabilities on the Condensed Consolidated Balance Sheet), of which $22.2 million would affect the effective tax rate if recognized. As of June 30, 2017, unrecognized tax benefits were $30.5 million (which was included in long-term deferred tax and other liabilities on the Condensed Consolidated Balance Sheet), of which $24.0 million would affect the effective tax rate if recognized. The Company is unable to reasonably estimate the timing of the long-term payments or the amount by which the liability will increase or decrease.
It is the Company's policy to classify accrued interest and penalties related to unrecognized tax benefits in the provision for income taxes. For the six months ended June 30, 2018 and June 30, 2017, the Company recognized an insignificant amount of interest and penalties related to unrecognized tax benefits. Accrued interest and penalties were $0.7 million and $0.6 million as of June 30, 2018 and December 31, 2017, respectively.
At June 30, 2018, the Company's 2013 through 2017 tax years were open and subject to potential examination in one or more jurisdictions. In addition, in the U.S., any net operating losses or credits that were generated in prior years but not yet fully

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utilized in a year that is closed under the statute of limitations may also be subject to examination. The Company is currently under examination by the Internal Revenue Service for tax year 2014 and cannot estimate the financial outcome of the examination. The Company is not currently under foreign income tax examination.
On December 22, 2017, the Tax Cut and Jobs Act (“Tax Act”) was signed into law. The Tax Act introduced a broad range of tax reform measures that significantly change the federal income tax laws. As of December 31, 2017, the Company recorded a provisional tax expense in the Statement of Operations of approximately $5.6 million, comprised of approximately $13.5 million tax expense from recording additional valuation allowance against federal tax credits due to certain provisions of the Tax Act, offset by approximately $7.9 million of tax benefit from the remeasurement of U.S. deferred taxes using the relevant tax rate at which the Company expects them to reverse in the future. The estimated one-time transition tax on post-1986 foreign unremitted earnings is not anticipated to have a material impact to the Company's effective tax rate. As of June 30, 2018, the Company has not recorded any adjustments to the provisional tax expense. The Company continues to monitor supplemental legislation and technical interpretations of the tax law that may cause the final impact from the Tax Act to differ from the provisionally recorded amounts. The Company expects to complete its analysis within the measurement period allowed by Staff Accounting Bulletin (“SAB”) No.118, no later than the fourth quarter of 2018.
NOTE 13 – COMMITMENTS AND CONTINGENCIES
Lease Commitments
The Company leases office and research facilities and office equipment under operating leases which expire at various dates through 2029. Under lease agreements that contain escalating rent provisions, lease expense is recorded on a straight-line basis over the lease term. There were no material changes to our future minimum lease payments during the three and six months ended June 30, 2018. Rent expense for the three months ended June 30, 2018 and 2017 amounted to $1.8 million and $1.5 million, respectively. Rent expense for the six months ended June 30, 2018 and 2017 amounted to $3.6 million and $3.1 million, respectively.
Contingencies
At each reporting period, the Company evaluates whether or not a potential loss amount or a potential range of loss is probable and reasonably estimable under the provisions of the authoritative guidance that addresses accounting for contingencies. The Company is currently unable to predict the final outcome of lawsuits to which it is a party and therefore cannot determine the likelihood of loss nor estimate a range of possible loss. An adverse decision in any of these proceedings could significantly harm the Company’s business and consolidated financial position, results of operations or cash flows.
Tessera, Inc. v. Toshiba Corporation, Civil Action No. 5:15-cv-02543-BLF (N.D. Cal.)
On May 12, 2015, Tessera, Inc. filed a complaint against Toshiba Corporation (“Toshiba”) in California Superior Court. Tessera, Inc.’s complaint alleges causes of action for breach of contract, breach of the implied covenant of good faith and fair dealing, and declaratory relief, generally alleging that Toshiba underpaid royalties and failed to cooperate with audits conducted pursuant to the parties’ license agreement.
On June 8, 2015, Toshiba removed the action to the U.S. District Court for the Northern District of California. On June 18, 2015, Toshiba filed its answer, affirmative defenses, and counterclaims to Tessera, Inc.’s complaint. Toshiba alleges counterclaims for declaratory judgment and breach of the implied warranty of good faith and fair dealing. The counterclaims seek, among other things, judicial determinations about the interpretation of the parties’ agreement, termination of the agreement, an accounting of the amount of alleged overpayments by Toshiba, restitution, and damages. On July 10, 2015, Tessera, Inc. filed its answer and affirmative defenses to Toshiba’s counterclaims. On March 17, 2016, Tessera, Inc. filed an amended complaint adding a claim for declaratory relief regarding a February 12, 2016 letter sent by Toshiba to Tessera, Inc. purporting to terminate the parties’ license agreement. On March 18, 2016, Toshiba filed its amended answer, affirmative defenses, and counterclaims. On April 4, 2016, Tessera, Inc. filed an answer to Toshiba’s amended counterclaims.
An initial summary judgment hearing on contract issues took place on September 22, 2016. On November 7, 2016, the Court entered an order granting Toshiba’s motion regarding the definition of “TCC,” and denying summary judgment on the other issues raised by the parties’ cross-motions. On December 6, 2016, Tessera, Inc. filed a motion pursuant to Federal Rule of Civil Procedure 54(b) seeking authorization to appeal the order and for a stay. On March 6, 2017, the Court granted the Rule 54(b) motion. The Court subsequently vacated the trial date and stayed the remainder of the district court proceedings.

On April 4, 2017, Tessera, Inc. filed a notice of appeal to the U.S. Court of Appeals for the Ninth Circuit. The parties completed briefing on November 2, 2017. A hearing for oral argument has been scheduled for October 15, 2018.


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Samsung Electronics Co., Ltd. v. Panasonic Corporation (f/k/a Matsushita Electric Industrial Co.), Ltd., Pannova Semic, LLC, and Tessera Advanced Technologies, Inc. (International Chamber of Commerce)

On May 18, 2018, Samsung Electronics Co., Ltd. (“Samsung”) filed a Request for Arbitration against Tessera Advanced Technologies, Inc. (“Tessera”), Panasonic Corporation (f/k/a Matsushita Electric Industrial Co.) (“Panasonic”) and Pannova Semic, LLC (“Pannova”) with the International Chamber of Commerce. The Request seeks declaratory judgments that Samsung has a license to practice U.S. Patent Nos. 6,954,001, 6,784,557, 6,512,298, and 6,852,616 (“Patents-in-Suit”); damages of at least $15 million for alleged breach of contract; and a declaratory judgment that Panasonic’s assignment of the Patents-in-Suit is null and void. The Request further seeks an order requiring reimbursement to Samsung of all expenses, including attorneys’ fees, incurred in defending against lawsuits that Tessera or its affiliates filed in various jurisdictions. On June 25, 2018, Tessera and Pannova filed a Response to the Request for Arbitration, objecting to the jurisdiction of the Tribunal and denying the merits of Samsung’s claims.

Other Litigation Matters
The Company and its subsidiaries are involved in litigation matters and claims in the normal course of business. In the past, the Company and its subsidiaries have litigated to enforce their respective patents and other intellectual property rights, to enforce the terms of license agreements, to protect trade secrets, to determine the validity and scope of the proprietary rights of others and to defend itself or its customers against claims of infringement or invalidity. The Company expects it or its subsidiaries will be involved in similar legal proceedings in the future, including proceedings regarding infringement of its patents, and proceedings to ensure proper and full payment of royalties by licensees under the terms of its license agreements.
The existing and any future legal actions may harm the Company’s business. For example, legal actions could cause an existing licensee or strategic partner to cease making royalty or other payments to the Company, or to challenge the validity and enforceability of patents owned by the Company’s subsidiaries or the scope of license agreements with the Company’s subsidiaries, and could significantly damage the Company’s relationship with such licensee or strategic partner and, as a result, prevent the adoption of the Company’s other technologies by such licensee or strategic partner. Litigation could also severely disrupt or shut down the business operations of licensees or strategic partners of the Company’s subsidiaries, which in turn would significantly harm ongoing relations with them and cause the Company to lose royalty revenue.

The costs associated with legal proceedings are typically high, relatively unpredictable, and not completely within the Company’s control. These costs may be materially higher than expected, which could adversely affect the Company’s operating results and lead to volatility in the price of its common stock. Whether or not determined in the Company’s favor or ultimately settled, litigation diverts managerial, technical, legal, and financial resources from the Company’s business operations. Furthermore, an adverse decision in any of these legal actions could result in a loss of the Company’s proprietary rights, subject the Company to significant liabilities, require the Company to seek licenses from others, limit the value of the Company’s licensed technology or otherwise negatively impact the Company’s stock price or its business and consolidated financial position, results of operations or cash flows.
NOTE 14 – SEGMENT AND GEOGRAPHIC INFORMATION
The Company reports its financial results within two reportable segments: (1) Product Licensing and (2) Semiconductor and IP Licensing. There are certain corporate overhead costs that are not allocated to these reportable segments because these operating amounts are not considered in evaluating the operating performance of the Company’s business segments.
The Chief Executive Officer is also the Chief Operating Decision Maker (“CODM”) as defined by the authoritative guidance on segment reporting.
The Product Licensing segment, including the Company's DTS and FotoNation subsidiaries, licenses its technologies and intellectual property related to audio, digital radio and imaging solutions under the brands DTS, HD Radio and FotoNation. The Product Licensing solutions typically include the delivery of software or hardware-based solutions, combined with various other intellectual property, including know how, patents, trademarks, and copyrights. Product Licensing represents revenue derived primarily from the consumer electronics market and related applications servicing the home, automotive and mobile markets.

The Semiconductor and IP Licensing segment develops and licenses semiconductor technologies and IP to manufacturers, foundries, subcontract assemblers and others. The segment includes revenue generated from the technology and IP portfolios of Tessera, Inc., Invensas and Invensas Bonding Technologies, Inc. (formally Ziptronix, Inc.). Tessera, Inc. pioneered chip-scale packaging solutions. Invensas develops advanced semiconductor packaging and 3D interconnect solutions, including wafer

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bonding solutions, for applications such as smartphones, tablets, laptops, PCs, data centers and automobiles. The Company expands its technology and IP offerings in this segment through a combination of internal R&D and acquisitions. The Company also provides engineering services to customers in the form of technology demonstrations and technology transfers to assist their evaluation and adoption of the Company's technologies. Through the Company’s technology transfer service, the Company provides detailed documentation outlining design guidelines, process specifications, recommended equipment and process parameters as well as hands-on engineering support to assist its licensees in bringing up and qualifying its technologies at their facilities. This service allows licensees to readily leverage the Company’s years of experience and expertise in direct and hybrid bonding.

The Company does not identify or allocate assets by reportable segment, nor does the CODM evaluate reportable segments using discrete asset information. Reportable segments do not record inter-segment revenue and accordingly there are none to report. The Company does not allocate other income and expense to reportable segments. Although the CODM uses operating income to evaluate reportable segments, operating costs included in one segment may benefit other segments.
The following table sets forth the Company’s segment revenue, operating expenses and operating income (loss) for the three and six months ended June 30, 2018 and 2017 (in thousands):

 
Three Months Ended,
 
Six Months Ended
 
June 30, 2018
 
June 30, 2017
 
June 30, 2018
 
June 30, 2017
Revenue:
 
 
 
 
 
 
 
Product licensing segment
$
51,161

 
$
46,362

 
$
104,377

 
$
74,063

Semiconductor and IP licensing segment
12,793

 
44,960

 
25,109

 
84,514

Total revenue
63,954

 
91,322

 
129,486

 
158,577

Operating expenses:
 
 
 
 
 
 
 
Product licensing segment
42,142

 
42,619

 
86,036

 
85,801

Semiconductor and IP licensing segment
18,942

 
21,374

 
38,369

 
44,137

Unallocated operating expenses (1)
30,476

 
39,829

 
65,178

 
87,447

Total operating expenses
91,560

 
103,822

 
189,583

 
217,385

Operating income (loss):

 
 
 
 
 
 
Product licensing segment
9,019

 
3,743

 
18,341

 
(11,738
)
Semiconductor and IP licensing segment
(6,149
)
 
23,586

 
(13,260
)
 
40,377

Unallocated operating expenses (1)
(30,476
)
 
(39,829
)
 
(65,178
)
 
(87,447
)
Total operating loss
$
(27,606
)
 
$
(12,500
)
 
$
(60,097
)
 
$
(58,808
)

(1) Unallocated operating expenses consist primarily of general and administrative expenses, such as administration, human resources, finance, information technology, corporation development and procurement. These expenses are not allocated because these amounts are not considered in evaluating the operating performance of the Company’s business segments.
A significant portion of the Company’s revenue is derived from licensees headquartered outside of the U.S., principally in Asia, and it is expected that this revenue will continue to account for a significant portion of total revenue in future periods. The table below lists the geographic revenue for the periods indicated (in thousands): 
 
Three Months Ended,
 
Six Months Ended,
 
June 30, 2018
 
June 30, 2017
 
June 30, 2018
 
June 30, 2017
Japan
$
18,199

 
29
%
 
$
20,169

 
22
%
 
$
37,543

 
29
%
 
$
34,059

 
22
%
Korea
17,459

 
27

 
14,103

 
15

 
31,887

 
25

 
20,990

 
13

U.S.
13,952

 
22

 
33,680

 
37

 
25,579

 
20

 
67,086

 
42

Europe and Middle East
10,925

 
17

 
5,070

 
6

 
16,134

 
12

 
6,790

 
4

China
1,491

 
2

 
3,599

 
4

 
15,635

 
12

 
6,653

 
4

Other
1,928

 
3

 
14,701

 
16

 
2,708

 
2

 
22,999

 
15

 
$
63,954

 
100
%
 
$
91,322

 
100
%
 
$
129,486

 
100
%
 
$
158,577

 
100
%

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For the three months ended June 30, 2018 and 2017, there were one and three customers, respectively, that each accounted for 10% or more of total revenue. For the six months ended June 30, 2018 and 2017, there were one and three customers, respectively, that each accounted for 10% or more of total revenue. As of June 30, 2018 and December 31, 2017, there were one and three customers that each accounted for 10% or more of total accounts receivable, respectively.
NOTE 15 - SUBSEQUENT EVENTS
On July 19, 2018, the Board declared a cash dividend of $0.20 per share of common stock, payable on September 6, 2018 for the stockholders of record at the close of business on August 16, 2018.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with the attached unaudited condensed consolidated financial statements and notes thereto, and with our audited financial statements and notes thereto for the year ended December 31, 2017 found in the Form 10-K.

This Quarterly Report contains forward-looking statements, which are subject to the safe harbor provisions created by the Private Securities Litigation Reform Act of 1995. Words such as “expects,” “anticipates,” “plans,” “believes,” “seeks,” “estimates,” “could,” “would,” “may,” “intends,” “targets” and similar expressions or variations of such words are intended to identify forward-looking statements, but are not the exclusive means of identifying forward-looking statements in this Quarterly Report. The identification of certain statements as “forward-looking” is not intended to mean that other statements not specifically identified are not forward-looking. All statements other than statements about historical facts are statements that could be deemed forward-looking statements, including, but not limited to, statements that relate to our future revenue, product development, demand, acceptance and market share, growth rate, competitiveness, gross margins, levels of research, development and other related costs, expenditures, the outcome or effects of and expenses related to litigation and administrative proceedings related to our patents, our intent to enforce our intellectual property, our ability to license our intellectual property, tax expenses, cash flows, our ability to liquidate and recover the carrying value of our investments, our management's plans and objectives for our current and future operations, our plans for quarterly dividends and stock repurchases, the levels of customer spending or research and development activities, general economic conditions, and the sufficiency of financial resources to support future operations and capital expenditures.

Although forward-looking statements in this Quarterly Report reflect the good faith judgment of our management, such statements can only be based on facts and factors currently known by us. Consequently, forward-looking statements are inherently subject to risks, uncertainties, and changes in condition, significance, value and effect, including those discussed below under the heading “Risk Factors” within Part II, Item 1A of this Quarterly Report and other documents we file from time to time with the Securities and Exchange Commission (the “SEC”), such as our annual reports on Form 10-K, our quarterly reports on Form 10-Q and our current reports on Form 8-K. Such risks, uncertainties and changes in condition, significance, value and effect could cause our actual results to differ materially from those expressed herein and in ways not readily foreseeable. Readers are urged not to place undue reliance on these forward-looking statements, which speak only as of the date of this Quarterly Report and are based on information currently and reasonably known to us. We undertake no obligation to revise or update any forward-looking statements in order to reflect any event or circumstance that may arise after the date of this Quarterly Report. Readers are urged to carefully review and consider the various disclosures made in this Quarterly Report, which attempt to advise interested parties of the risks and factors that may affect our business, financial condition, results of operations and prospects.

Corporate Information

Our principal executive offices are located at 3025 Orchard Parkway, San Jose, California 95134. Our telephone number is (408) 321-6000. We maintain a website at www.xperi.com. The reference to our website address does not constitute incorporation by reference of the information contained on this website.

Xperi, the Xperi logo, Tessera, the Tessera logo, DTS, the DTS logo, FotoNation, the FotoNation logo, Invensas, the Invensas logo, DigitalAperture, FacePower, FotoSavvy, FotoMagic, BVA, ZiBond, DBI, DTS‑HD, DTS Sound, DTS Studio Sound, DTS Headphone:X, DTS Play‑Fi, DTS:X and HD Radio are trademarks or registered trademarks of Xperi Corporation or its affiliated companies in the U.S. and other countries. All other company, brand and product names may be trademarks or registered trademarks of their respective companies.


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In this Quarterly Report, the “Company,” “we,” “us” and “our” refer to Xperi Corporation, which operates its business through its subsidiaries. Unless specified otherwise, the financial results in this Quarterly Report are those of the Company and its subsidiaries on a consolidated basis.
Business Overview

Xperi is a publicly-traded technology company with headquarters in Silicon Valley and operations around the world. Through its operating subsidiaries, Xperi creates, develops and licenses innovative audio, imaging, semiconductor packaging and interconnect technologies. We have approximately 700 employees and over 25 years of operating experience.

We license our innovative products, technologies and inventions to global electronics companies which, in turn, integrate the technologies into their own consumer electronics and semiconductor products. Our technologies and inventions are widely adopted and used every day by millions of people. Our audio technologies have shipped in billions of devices for the home, mobile and automotive markets. Our imaging technologies are embedded in more than 25% of the current smartphones. Our semiconductor packaging and interconnect technologies have been licensed to more than 100 customers and have shipped in over 100 billion semiconductor chips.

We completed the acquisition of DTS in December 2016. At the time of the acquisition, Tessera Technologies, Inc. and DTS were combined under the newly-formed Tessera Holding Corporation. During the first quarter of 2017, we introduced our new corporate name, Xperi Corporation, launched a new corporate logo, and began trading under a new ticker symbol XPER.
Results of Operations
Under generally accepted accounting principles regarding business combinations, we were unable to record $3.7 million and $9.1 million in revenue in the three and six months ended June 30, 2018, respectively, and $7.3 million and $38.6 million in revenue in the three and six months ended June 30, 2017, respectively, which would have been recognized by DTS under Topic 605 if not for the acquisition. If allowed, this revenue would have had a significant impact on the operating results as described below.
We adopted the new accounting standard, ASU No. 2014-09 (Topic 606) "Revenue from Contracts with Customers" effective January 1, 2018, which had a material impact on the financial reporting of our operating results as described below. Under the modified retrospective transition method, the comparative information has not been restated and continues to be reported under the accounting standards in effect for those periods. Refer to “Note 2 - Summary of Significant Accounting Policies" and “Note 3 - Revenue" in the Notes to Condensed Consolidated Financial Statements (Part I, Item 1 of this Form 10-Q) for detailed information.

This accounting change does not impact billings or the cash flow from our contracts with customers. We expect to experience greater variability in quarterly revenue as a result of Topic 606 being applied to minimum guarantee and fixed fee licensing contracts. We plan to place greater emphasis on billings and operating cash flows rather than revenue and net operating results to internally evaluate our financial performance in current and future periods.
Revenue
Our revenue is generated primarily from royalty and license fees. Revenue is recognized upon transfer of control of promised products, services or intellectual property and technologies (“IP”) rights to customers in an amount that reflects the consideration that we expect to receive in exchange for those products, services or licensing of the IP rights.
Certain licensees have entered into fixed fee or minimum guarantee arrangements, whereby licensees pay a fixed fee for the right to incorporate our technology in the licensee's products over the license term. In arrangements with a minimum guarantee, the fixed fee component corresponds to a minimum number of units or dollars that the customer must produce or pay, with additional per-unit fees for any units or dollars exceeding the minimum. For these agreements, we recognize the full fixed fee as revenue at the beginning of the license term, when the licensee has the right to use the IP and begins to benefit from the license.
If the contract term of a fixed fee or minimum guarantee arrangement is longer than one year, we also consider the scheduled payment arrangements to determine whether a financing component exists. In general, if the payment arrangements extend beyond the initial twelve months of the contract, we treat a portion of the payments as a financing component. The discount rate used for each arrangement reflects the rate that would be used in a separate financing transaction between us and the licensee at contract inception, and takes into account the credit characteristics of the licensee and market interest rates as of the

25


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date of the agreement. As such, the amount of fixed fee revenue recognized at the beginning of the license term will be reduced by the calculated financing component. As payments are received from the licensee, we recognize a portion of the financing component through interest income.
For certain licensees, royalty revenue is generated based on a licensee's production or shipment of licensed products incorporating our IP, technologies or software. Licensees with a per-unit arrangement pay a per-unit royalty for each product manufactured or sold, as set forth in its license agreement. Licensees generally report manufacturing or sales information in the quarter subsequent to when such activity takes place. Under Topic 606, we estimate the royalties earned each quarter based on our forecast of manufacturing and sales activity incurred by our licensees in that quarter. Any differences between actual royalties owed by a licensee and our quarterly estimates are recognized in the following quarter, when the licensee’s royalty report is received. Estimating licensees’ quarterly royalties prior to receiving the royalty reports requires us to make significant assumptions and judgments that could have a material impact on the amount of revenue we report on a quarterly basis.
The timing of revenue recognition and the amount of revenue actually recognized for each type of revenue depends upon a variety of factors, including the specific terms of each arrangement, our ability to determine and allocate the transaction price to each separate performance obligation and the nature of our deliverables and obligations. In addition, our royalty revenue will fluctuate based on a number of factors such as: (a) the rate of adoption and incorporation of our technology by licensees; (b) the demand for products incorporating semiconductors that use our licensed technology; (c) the cyclicality of supply and demand for products using our licensed technology; (d) volume incentive pricing terms in licensing agreements that may result in significant variability in quarterly revenue recognition from customers and (e) the impact of economic downturns.
From time to time we enter into license agreements that have fixed expiration dates. Upon expiration of such agreements, we need to renew or replace these agreements in order to maintain our revenue base. We may not be able to continue licensing customers on terms favorable to us, under the existing terms or at all, which would in turn harm our results of operations.
In the past, we have engaged in litigation and arbitration proceedings to directly or indirectly enforce our intellectual property rights and the terms of our license agreements, including proceedings to ensure proper and full payment of royalties by our current licensees and by third parties whose products incorporate our intellectual property rights.
The following table presents our historical operating results for the periods indicated as a percentage of revenue:
 
Three Months Ended
 
Six Months Ended
 
June 30, 2018
 
June 30, 2017
 
June 30, 2018
 
June 30, 2017
Revenue:
 
 
 
 
 
 
 
Royalty and license fees
100
 %
 
100
 %
 
100
 %
 
100
 %
Total revenue
100

 
100

 
100

 
100

Operating expenses:
 
 
 
 
 
 
 
Cost of revenue
3

 
1

 
3

 
2

Research, development and other related costs
39

 
29

 
40

 
33

Selling, general and administrative
48

 
36

 
50

 
47

Amortization expense
43

 
31

 
42

 
36

Litigation expense
10

 
9

 
11

 
11

Total operating expenses
143

 
106

 
146

 
129

Operating loss
(43
)
 
(6
)
 
(46
)
 
(29
)
Interest expense
9

 
8

 
10

 
9

Other income and expense, net
(3
)
 

 
(4
)
 

Loss before taxes
(49
)
 
(14
)
 
(52
)
 
(38
)
Provision for (benefit from) income taxes
(5
)
 
29

 
(5
)
 
(6
)
Net loss
(44
)%
 
(43
)%
 
(47
)%
 
(32
)%
Our royalty and license fees were as follows (in thousands, except for percentages):

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Three Months Ended
 
 
 
 
 
June 30, 2018
 
June 30, 2017
 
Increase/
(Decrease)
 
%
Change
Royalty and license fees
$
63,954

 
$
91,322

 
$
(27,368
)
 
(30
)%

The $27.4 million or 30% decrease in revenue was due principally to our inability to record billings as revenue in the second quarter of 2018 from minimum guarantee and fixed fee licensing contracts in place prior to the start of 2018 as a result of adopting ASC Topic 606. Partially offsetting year on year changes was the purchase accounting impact on revenue in the second quarter of 2017 totaling $7.3 million, an amount that would have been recognized as revenue by DTS if not for the acquisition. Had we not implemented Topic 606, our revenue in the second quarter of 2018 under legacy GAAP would have been $96.7 million. Refer to “Note 2 - Summary of Significant Accounting Policies" in the Notes to Condensed Consolidated Financial Statements for further detail.
 
Six Months Ended
 
 
 
 
 
June 30, 2018
 
June 30, 2017
 
Increase/
(Decrease)
 
%
Change
Royalty and license fees
$
129,486

 
$
158,577

 
$
(29,091
)
 
(18
)%

The $29.1 million or 18% decrease in revenue was due principally to our inability to record billings as revenue in the first two quarters of 2018 from minimum guarantee and fixed fee licensing contracts in place prior to the start of 2018 as a result of adopting ASC Topic 606. Significantly offsetting year on year changes was the purchase accounting impact on revenue in the first quarter of 2017 totaling $38.6 million, an amount that would have been recognized as revenue by DTS if not for the acquisition. Had we not implemented Topic 606, our revenue in the six months of 2018 under legacy GAAP would have been $192.9 million. Refer to “Note 2 - Summary of Significant Accounting Policies" in the Notes to Condensed Consolidated Financial Statements for further detail.
Our billings were as follows (in thousands, except for percentages):
 
Three Months Ended
 
 
 
 
 
June 30, 2018
 
June 30, 2017
 
Increase/
(Decrease)
 
%
Change
Total billings
$
100,694

 
$
107,287

 
$
(6,593
)
 
(6
)%

Total billings were $100.7 million in the three months ended June 30, 2018, as compared to $107.3 million in the three months ended June 30, 2017, a decrease of $6.6 million. The decrease was primarily driven by expiration of a fixed fee licensing contract in 2017 and by a one-time audit settlement we recorded in the second quarter of 2017, partially offset by billings from new fixed fee contracts.
 
Six Months Ended
 
 
 
 
 
June 30, 2018
 
June 30, 2017
 
Increase/
(Decrease)
 
%
Change
Total billings
$
204,963

 
$
206,959

 
$
(1,996
)
 
(1
)%

Total billings were $205.0 million in the six months ended June 30, 2018, as compared to $207.0 million in the six months ended June 30, 2017, a decrease of $2.0 million. The decrease was primarily driven by expiration of a fixed fee licensing contract in 2017 and by a one-time audit settlement we recorded in the second quarter of 2017, partially offset by billings from new fixed fee contracts.

With changes in revenue recognition due to the adoption of Topic 606 in 2018, we anticipate our revenue for 2018 will be significantly lower than that for 2017 due principally to our inability to record future billings as revenue in 2018 and later periods from minimum guarantee and fixed fee licensing contracts in place prior to adoption of ASC 606 on January 1, 2018. This accounting change will not impact billings or the cash flow from these contracts. Furthermore, we may experience greater variability in quarterly and annual revenue in future periods as a result of the revenue accounting treatment applied to future minimum guarantee and fixed fee licensing contracts. Management plans to place greater emphasis on billings and cash flows rather than revenue and net operating results to internally evaluate our financial performance in future periods.
Cost of Revenue

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Cost of revenue consists of royalties paid to third parties and direct compensation and related expenses to provide non-recurring engineering ("NRE") services.
Cost of revenue for the three months ended June 30, 2018 was $2.1 million, as compared to $1.3 million for the three months ended June 30, 2017. Cost of revenue for the six months ended June 30, 2018 was $4.4 million, as compared to $2.7 million for the six months ended June 30, 2017. The increases were due to higher costs on NRE contracts, which are generally reclassified from research and development as we satisfy the underlying performance obligations, as well as royalties paid to a third party in connection with a Product Licensing segment contract.
We anticipate these expenses will continue to increase when compared to 2017 due to expected higher NRE in 2018 and royalties paid to third parties in connection with Product Licensing segment contracts.
Research, Development and Other Related Costs
Research and development is conducted primarily in-house and targets development of audio and image enhancement technologies, chip-scale, multi-chip and wafer level packaging, circuitry 3D-IC architectures, wafer and die bonding technologies and machine learning. Research, development and other related costs include expenses associated with applications engineering necessary to port and integrate our technologies and products on third party silicon and into end devices. These costs consist primarily of compensation and related costs for personnel, engineering consulting expenses associated with new product and technology development, product commercialization, quality assurance and testing costs, as well as costs related to patent applications and examinations, product "tear downs" and reverse engineering, materials, supplies and equipment depreciation. All research, development and other related costs are expensed as incurred.
Research, development and other related costs for the three months ended June 30, 2018 were $25.2 million, as compared to $26.3 million for the three months ended June 30, 2017, a decrease of $1.1 million or 4%. The decrease was primarily related to a $0.6 million decrease in personnel related expenses and a $0.3 million decrease in outside services.
Research, development and other related costs for the six months ended June 30, 2018 were $51.7 million, as compared to $52.3 million for the six months ended June 30, 2017, a decrease of $0.6 million or 1%. The decrease was primarily related to a $0.5 million decrease in outside services.
We believe that a significant level of research and development expenses will be required for us to remain competitive in the future.
Selling, General and Administrative
Selling expenses consist primarily of compensation and related costs for sales and marketing personnel engaged in sales and licensee support, reverse engineering personnel and services, marketing programs, public relations, promotional materials, travel, trade show expenses, and stock-based compensation expense. General and administrative expenses consist primarily of compensation and related costs for general management, information technology, finance personnel, legal fees and expenses, facilities costs, stock-based compensation expense, and professional services. Our general and administrative expenses, other than facilities related expenses, are not allocated to other expense line items.
Selling, general and administrative expenses for the three months ended June 30, 2018 were $30.5 million, as compared to $33.0 million for the three months ended June 30, 2017, a decrease of $2.5 million or 8%. The decrease was due to a $1.3 million decrease in personnel related expenses, driven primarily by post-acquisition retention bonus in the second quarter of 2017, and a $1.2 million decrease in stock-based compensation.
Selling, general and administrative expenses for the six months ended June 30, 2018 were $65.2 million, as compared to $74.2 million for the six months ended June 30, 2017, a decrease of $9.0 million or 12%. The decrease was due to a $3.6 million decrease in personnel related expenses, driven primarily by lower acquisition related severance and retention bonus, a $2.7 million decrease in outside services which were associated with acquisition transaction costs in 2017, a $1.5 million decrease in marketing and branding expense, and a $1.2 million decrease in stock-based compensation.
Amortization Expense
Amortization expense for the three months ended June 30, 2018 was $27.2 million, as compared to $28.2 million for the three months ended June 30, 2017, a decrease of $1.0 million. Amortization expense for the six months ended June 30, 2018 was $54.4 million, as compared to $56.7 million for the six months ended June 30, 2017, a decrease of $2.3 million. The decreases were primarily attributable to certain intangible assets becoming fully amortized over the past twelve months.


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With the acquisition of DTS, we anticipate that amortization expenses will continue to be a significant expense since we acquired approximately $479 million in intangible assets which will be amortized over the next several years. See “Note 7 - Goodwill and Identified Intangible Assets" in the Notes to Condensed Consolidated Financial Statements for additional information.
Litigation Expense
Litigation expense for the three months ended June 30, 2018 was $6.6 million, as compared to $8.2 million for the three months ended June 30, 2017, a decrease of $1.6 million. Litigation expense for the six months ended June 30, 2018 was $14.0 million, as compared to $18.2 million for the six months ended June 30, 2017, a decrease of $4.2 million. The decreases were primarily related to concluding litigation activity against Broadcom, partially offset by increases in Samsung related litigation expenditure during the periods. As previously announced, we reached a settlement with Broadcom in the fourth quarter of 2017.
We expect that litigation expense may continue to be a material portion of our operating expenses in future periods, and may fluctuate between periods, because of planned or ongoing litigation, as described in Part II, Item 1 – Legal Proceedings, and because of litigation planned for or initiated from time to time in the future in order to enforce and protect our intellectual property and contract rights.
Upon expiration of our customers’ licenses, if those licenses are not renewed, litigation may become necessary to secure payment of reasonable royalties for the use of our patented technology. If we plan for or initiate such litigation, our future litigation expenses may increase.
Stock-based Compensation Expense
The following table sets forth our stock-based compensation expense for the three and six months ended June 30, 2018 and 2017 (in thousands): 
 
Three Months Ended,
Six Months Ended,
 
June 30, 2018
 
June 30, 2017
 
June 30, 2018
 
June 30, 2017
Research, development and other related costs
$
3,344

 
$
3,437

 
$
6,438

 
$
6,134

Selling, general and administrative
3,875

 
5,087