UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------------
FORM 10-Q
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1996
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to _________
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Commission File Number 1-11152
INTERDIGITAL COMMUNICATIONS CORPORATION
(Exact name of registrant as specified in its charter)
PENNSYLVANIA 23-1882087
------------ ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
781 Third Avenue, King of Prussia, PA 19406
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(Address of principal executive offices and zip code)
Registrant's telephone number, including area code (610) 878-7800
--------------
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 x No _____
-----
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Common Stock, par value $.01 per share 48,023,324 shares
- -------------------------------------- -------------------------------
Class Outstanding at October 24, 1996
INTERDIGITAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
- --------------------------------------------------------
INDEX
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PAGES
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Part I - Financial Information:
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets - 3
December 31, 1995 and September 30, 1996 (unaudited)
Consolidated Statements of Operations 4
Three and Nine Months Ended September 30, 1995 and 1996 (unaudited)
Consolidated Statements of Cash Flows - 5
Nine Months Ended September 30, 1995 and 1996 (unaudited)
Notes to Consolidated Financial Statements 6-11
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 12-22
Part II - Other Information:
Item 6. Exhibits and Reports on Form 8-K 23
INTERDIGITAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands)
DECEMBER 31, SEPTEMBER 30,
ASSETS 1995 1996
- ------ ------------ -------------
(UNAUDITED)
CURRENT ASSETS:
Cash and cash equivalents, including restricted
cash of $1,200 and $542 respectively $ 9,427 $ 16,011
Short term investments 55,060 51,421
License fees receivable 400 702
Accounts receivable, net of allowance for
uncollectable accounts of $340 and $389, respectively 2,757 11,946
Inventories 4,853 8,581
Other current assets 1,474 4,037
--------- ---------
Total current assets 73,971 92,698
--------- ---------
Property, plant and equipment, net of accumulated
depreciation of $5,969 and $7,474, respectively 4,452 10,794
Patents, net of accumulated amortization of
$3,456 and $3,843, respectively 2,405 9,622
Other 2,339 4,235
--------- ---------
$ 83,167 $ 117,349
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long term debt $ 430 $ 589
Accounts payable 4,313 9,320
Accrued compensation and related expenses 4,335 3,326
Purchase commitment reserve 855 447
Distributor commission 196 1,043
Accrued warranty 625 1,251
Deferred revenue 1,597 6,622
Income and foreign withholding taxes payable 653 571
Other accrued expenses 1,959 1,732
--------- ---------
Total current liabilities 14,963 24,901
--------- ---------
LONG TERM DEBT 631 3,126
--------- ---------
LONG TERM PORTION OF DEFERRED REVENUE -- 8,362
--------- ---------
OTHER LONG TERM LIABILITIES 1,323 758
--------- ---------
MINORITY INTEREST 3,810 --
--------- ---------
COMMITMENTS AND CONTINGENCIES (Note 3)
SHAREHOLDERS' EQUITY:
Preferred Stock, $ .10 par value, 14,399 shares authorized,
$2.50 Convertible Preferred, 113 shares and 103 shares
issued and outstanding 11 10
Common Stock, $.01 par value, 75,000 shares authorized,
44,424 shares and 47,985 shares issued and
outstanding 444 480
Additional paid-in capital 212,310 233,798
Accumulated deficit (150,325) (154,086)
--------- ---------
Total shareholders' equity 62,440 80,202
--------- ---------
$ 83,167 $ 117,349
========= =========
The accompanying notes are an integral part of these statements.
3
INTERDIGITAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
----------------------- ----------------------
1995 1996 1995 1996
-------- -------- -------- -------
REVENUES:
UltraPhone $ 1,629 $ 7,522 $ 13,085 14,356
Licensing and Alliance 4,000 1,868 66,093 26,575
Contract Services 212 -- 657 --
-------- -------- -------- -------
5,841 9,390 79,835 40,931
-------- -------- -------- -------
OPERATING EXPENSES:
Cost of UltraPhone revenues 3,794 8,755 15,523 16,652
Contract service costs 242 -- 754 --
Sales and marketing 723 1,216 2,791 3,132
General and administrative 2,575 2,627 11,144 8,080
Product development costs 2,532 5,888 6,386 15,054
-------- -------- -------- -------
9,866 18,486 36,598 42,918
-------- -------- -------- -------
Income (loss) from operations (4,025) (9,096) 43,237 (1,987)
OTHER INCOME (EXPENSE):
Interest income 916 892 2,140 2,963
Interest and financing expenses (14) (55) (623) (132)
-------- -------- -------- -------
Income (loss) before income taxes and
minority interest (3,123) (8,259) 44,754 844
INCOME TAX PROVISION 113 (14) (3,195) (3,519)
-------- -------- -------- -------
Income (loss) before minority interest (3,010) (8,273) 41,559 (2,675)
MINORITY INTEREST (246) 1 (4,022) (890)
-------- -------- -------- -------
Net income (loss) (3,256) (8,271) 37,537 (3,565)
PREFERRED STOCK DIVIDENDS (66) (64) (200) (196)
-------- -------- -------- -------
NET INCOME (LOSS) APPLICABLE TO COMMON
SHAREHOLDERS $ (3,322) $ (8,336) $ 37,337 (3,761)
======== ======== ======== =======
NET INCOME (LOSS) PER COMMON SHARE $ (0.07) $ (0.18) $ 0.81 (0.08)
======== ======== ======== =======
WEIGHTED AVERAGE NUMBER OF COMMON
SHARES OUTSTANDING 44,287 46,709 46,333 45,922
======== ======== ======== =======
The accompanying notes are an integral part of these statements.
4
INTERDIGITAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
For the nine months ended September 30,
---------------------------------------
1995 1996
-------- ------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 37,537 $ (3,565)
Adjustments to reconcile net income (loss) to net
cash provided by operating activities-
Minority interest in subsidiary 4,063 890
Depreciation and amortization 1,304 2,179
Other (57) (145)
Decrease (increase) in assets-
Receivables 20,442 (9,491)
Inventories 601 (3,728)
Other current assets (207) (2,563)
Increase (decrease) in liabilities-
Accounts payable (6,645) 5,007
Due to Hughes Network Systems, Inc (7,003) --
Accrued compensation 1,775 (1,009)
Deferred revenue 2,856 12,822
Other accrued expenses (1,497) 756
-------- ---------
Net cash provided by operating activities $ 53,169 $ 1,153
-------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Decrease (increase) in short-term investments $(57,660) $ 3,639
Additions to property and equipment, net of non-cash additions
of $100 and $3,106, respectively (1,156) (4,746)
Additions to patents (331) (429)
Other non-current assets (1,029) (2,178)
-------- ---------
Net cash used for investing activities (60,176) (3,714)
-------- ---------
NET CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from sales of Common Stock
and exercises of stock options and warrants 12,810 9,597
Payments on long-term debt, including capital lease obligations (178) (452)
-------- ---------
Net cash provided by financing activities 12,632 9,145
-------- ---------
NET INCREASE IN CASH AND CASH EQUIVALENTS 5,625 6,584
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 11,889 9,427
-------- ---------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 17,514 $ 16,011
======== =========
SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid $ 16 $ 128
======== =========
Income taxes paid, excluding foreign witholding taxes $ 1,850 $ 389
======== =========
The accompanying notes are an integral part of these statements.
5
INTERDIGITAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1996
(UNAUDITED)
1. BACKGROUND:
InterDigital Communications Corporation ("IDC"), a public corporation
incorporated in the state of Pennsylvania, and its subsidiaries (collectively
with IDC, "InterDigital" or the "Company"), develop and market advanced digital
wireless telecommunications systems and technology. The Company's objective is
to become a significant global supplier of digital wireless communications
technology and systems based on its proprietary Time Division Multiple Access
("TDMA") and Broadband Code Division Multiple Access ("B-CDMA(TM)")
technologies.
To achieve that objective, the Company has developed an alliance program
under which it intends to align itself with key entities in the
telecommunications industry. Two of the three key objectives of the Company's
alliance program, if fully and successfully implemented, are to generate
licensing revenues as well as to improve the Company's UltraPhone product
business by (i) making the Company and its UltraPhone products more credible
competitors in large scale telecommunications infrastructure programs, (ii)
expanding the depth and coverage of UltraPhone product marketing efforts around
the world, (iii) facilitating greater focus in the Company's direct sale
activities, and (iv) funding and facilitating engineering changes and
alternative supply and production sources to attempt to significantly reduce
costs and expand product capabilities.
The third objective of the alliance program is to bolster the Company's
on-going efforts to develop its B-CDMA air interface technology and to spread
the commercialization of B-CDMA-based wireless local loop applications and start
the development of B-CDMA-based wireless Personal Communications Service ("PCS")
applications which the Company intends to promote as True PCS(TM). To date, the
Company has formed two such broad business alliances, with Siemens
Aktiengesellschaft ("Siemens") and Samsung Electronics Co., Ltd. ("Samsung").
(See Notes 5 and 6.)
Historically, the Company's principal product has been the UltraPhone
system, a radio telephone system providing business and households access to
basic telephone service through a wireless local loop. Since 1987, the Company
has sold over 270 UltraPhone systems worldwide, with aggregate UltraPhone
telephone system revenues totaling over $151 million. UltraPhone product
revenues accounted for approximately 20% of the total revenues of the Company
during 1995 and approximately 35% of revenues for the nine month period ended
September 30, 1996.
In addition to its UltraPhone telephone system business, the Company,
through InterDigital Technology Corporation ("ITC"), is seeking to capitalize
upon the revenue potential of its extensive TDMA and CDMA patent portfolio. ITC
implemented a strategy during 1993 of negotiation and litigation with certain
entities which it believed were infringing the Company's patents. These efforts
have resulted in patent license agreements with twelve entities as of October
24, 1996, the recognition of $28.7 million, $67.7 million and $26.6 million of
licensing and alliance revenue in fiscal 1994, 1995 and the nine month period
ended September 30, 1996, respectively, and the initiation of litigation with
major telecommunications companies.
Operations of the Company are subject to certain risks and uncertainties,
including, but not limited to, the achievement of its goals and objectives,
uncertainties related to intellectual property rights, the acceptance by
customers of the Company's technology, the development and commercialization of
new products, uncertainty and volatility of future profitability and access to
capital and dependence on alliance arrangements and key personnel.
6
2. BASIS OF PRESENTATION:
In the opinion of management, the accompanying unaudited consolidated
financial statements contain all adjustments (consisting only of normal,
recurring adjustments) necessary to present fairly the Company's financial
position as of September 30, 1996 and the results of their operations for the
three and nine month periods ended September 30, 1995 and 1996 and cash flows
for the nine month periods ended September 30, 1995 and 1996. The accompanying
unaudited consolidated financial statements have been prepared in accordance
with the instructions for Form 10-Q and accordingly do not include all of the
detailed schedules, information and notes necessary for a fair presentation of
financial condition, results of operations and cash flows in conformity with
generally accepted accounting principles. Therefore, these financial statements
should be read in conjunction with the financial statements and notes thereto
contained in the Company's latest annual report on Form 10-K filed with the
Securities and Exchange Commission. The results of operations for interim
periods are not necessarily indicative of the results to be expected for the
entire year.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities as of the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
The Statement of Cash Flows for the nine months ended September 30, 1995
has been restated to conform with current period presentation.
3. CONTINGENCIES:
IDC and ITC are variously parties to certain patent-related litigation in
which ITC is asserting that certain third parties infringe ITC's patents. ITC
generally is seeking injunctive relief and monetary damages. The alleged
infringers generally seek declarations that their products do not infringe ITC's
patents. In one such action involving Motorola Inc., ITC has received an adverse
jury verdict and is in the post-trial appeal process. In another action, the
Court has stayed the proceeding, at the request of the parties, pending a
decision by the appeals court on the Motorola case. ITC is also involved in
administrative proceedings in which various parties have challenged the validity
of ITC's patents.
In addition to litigation associated with patent enforcement and licensing
activities and the other litigation described above, the Company is a party to
certain legal actions arising in the ordinary course of its business. Based upon
information presently available to the Company, the Company believes that the
ultimate outcome of these other actions will not materially affect the Company.
7
4. CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS:
The Company considers investments purchased with an original maturity of
three months or less to be cash equivalents for purposes of the statements of
cash flows. The Company invests its excess cash in various time deposits and
marketable securities, which are included in cash and cash equivalents, as
follows (in thousands):
December 31, September 30,
1995 1996
------- -------
Money market funds and demand deposits $ 2,096 $ 7,975
Certificates of deposit 966 751
Repurchase agreements 3,955 1,313
Commercial paper 2,380 5,972
------- -------
$ 9,427 $16,011
======= =======
The repurchase agreements are fully collateralized by United States
Government securities and are stated at cost which approximates fair market
value.
Short-term investments available for sale as of December 31, 1995 consisted
of $40.5 million in government-issued discount notes, $2.5 million in municipal
securities and $12.1 million in corporate debt securities. Short-term
investments available for sale as of September 30, 1996 consisted of $43.4
million in government-issued discount notes and $8.0 million in corporate debt
securities.
5. SIEMENS AGREEMENTS:
On December 16, 1994, the Company entered into a Master Agreement and a
series of four related agreements as elements of an integrated transaction
establishing a broad based marketing and technology alliance with Siemens. These
agreements were amended in February 1996 in connection with the Samsung
alliance. (See Note 6.)
As partial consideration for the rights and licenses granted by the
Company, Siemens agreed to pay $20 million, of which $14.8 million was paid as
of December 31, 1995. In connection with the Samsung alliance, the Company and
Siemens deferred the remaining payments and, in July 1996, offset the majority
of such payments against payments due to Siemens from InterDigital in
conjunction with the Samsung alliance. (See Note 6.)
In accordance with accounting requirements, the Company will recognize the
$20 million of revenue over the contract performance period due to the combined
nature of the contracts. In 1995 the Company recognized $13.6 million of the
revenue under this agreement based on the progress of the completed work. The
remaining $6.4 million of revenue is expected to be recognized through June
1997, the expected date of completion of functional testing at the system
component level.
8
6. SAMSUNG AGREEMENTS:
On February 9, 1996, the Company entered into a series of agreements with
Samsung and amended its agreements with Siemens as a second major step in
implementing its alliance strategy. Under the various agreements, Samsung made
upfront payments to the Company in excess of $35 million (of which approximately
one-half constituted royalty prepayments), less applicable withholding taxes.
All payments from Samsung were received by June 30, 1996. In July 1996, the
Company made, via offset (see Note 5) certain payments to Siemens, which in
turn, committed to provide additional technical assistance. The net upfront
amount received by the Company, after giving effect to the receipt of certain
exemptions from Korean Service Withholding Tax granted by the Korean Ministry of
Information and Communications, was approximately $29 million. Samsung is also
obligated to provide engineering manpower for the development of the Company's
B-CDMA technology.
Samsung has received from InterDigital royalty-bearing licenses covering
InterDigital's TDMA and B-CDMA patent portfolio, its UltraPhone and B-CDMA
technologies and is licensed to use certain InterDigital trademarks.
InterDigital and Samsung anticipate that Samsung may manufacture and sell
privately labeled UltraPhone systems and may become a significant UltraPhone
equipment supplier to InterDigital, which would allow InterDigital to take
advantage of Samsung's expertise in low cost, high quality manufacturing.
The Company recognized $14 million as revenue during the first quarter of
1996 representing the non-refundable upfront patent licensing portion of the
agreements. The Company recognized $6 million in the second quarter of 1996
representing the consideration due for the UltraPhone equipment technology
transfer and manufacturing rights portions of the agreements. Also, during the
second and third quarters, the Company recognized approximately $1.5 million of
the net amount retained by the Company relating to the B-CDMA development
portion of the agreement. The balance of the revenue is expected to be
recognized through fiscal 1999, the expected date of completion of the
applicable development effort.
7. MAJOR CUSTOMERS AND GEOGRAPHIC DATA:
UltraPhone Equipment Revenue:
In fiscal 1995, the Company's Indonesian and Russian customers represented
37% and 20%, of UltraPhone product revenues, respectively. During the third
quarter of 1995, the Company's Myanmarian customer and Mexican distributor
accounted for 42% and 12% of UltraPhone product revenues, respectively. During
the third quarter of 1996, the Company's Philippine and Puerto Rican customer
accounted for 77% of UltraPhone product revenues. For the nine months ended
September 30, 1995, the Company's Indonesian and Russian customers accounted for
43% and 25% of UltraPhone product revenues, respectively. For the nine months
ended September 30, 1996, the Company's Philippine and Puerto Rican customers
accounted for 66% and 10% of UltraPhone product revenues, respectively.
UltraPhone product revenues by geographic area are as follows (in
thousands):
Three Months Nine Months
Ended Ended
September 30, September 30,
1995 1996 1995 1996
---- ---- ---- ----
Domestic $ 479 $ 581 $ 1,829 $ 1,521
Foreign 1,150 6,941 11,256 12,835
------ ------- ------- -------
$1,629 $ 7,522 $13,085 $14,356
====== ======= ======= =======
9
Licensing and Alliance Revenue:
ITC has granted non-exclusive, non-transferable, perpetual, worldwide,
royalty-bearing licenses to use certain TDMA patents (and in certain instances,
technology) to Hughes Network Systems, AT&T, Siemens (see Note 5), Matsushita,
Sanyo, Pacific Communications Systems, Mitsubishi, Hitachi, Kokusai, OKI
Electric Industry Company, and Samsung (see Note 6). The licenses typically
contain "most favored nations" provisions, applied on a going forward basis
only, and other provisions which could, in certain events, cause the licensee's
obligation to pay royalties to the Company to be suspended for an indefinite
period, with or without the accrual of the royalty obligation.
The Licensing and Alliance revenues for the nine months ended September 30,
1996 include $22.3 million from Samsung and $4.0 million from Siemens. During
the nine months ended September 30, 1995, ITC entered into royalty-bearing
license agreements with Pacific Communication Sciences, Sanyo, Mitsubishi,
Hitachi, together with its affiliate Kokusai, and NEC covering patents relating
to the manufacture, use and sale of TDMA-based subscriber units, in certain
instances, and infrastructure equipment. Each of these agreements contains
advance payment obligations pursuant to which ITC received an aggregate of
approximately $54.1 million, which was recognized as revenue during the nine
months ended September 30, 1995. An additional $12.0 million of revenue was
recognized for the nine months ended September 30, 1995 pursuant to the Siemens
agreements.
8. NET INCOME PER COMMON SHARE:
The net income per share is based upon the weighted average common shares
outstanding during the period adjusted for cumulative dividends on $2.50
Preferred Stock. Stock options and warrants have been considered as common stock
equivalents and have been included in the computation for the nine month period
for 1995 since their effect is dilutive. (See Item 6, Exhibit 11 - Computation
of Net Income Per Share.)
9. INVENTORIES:
December 31, September 30,
1995 1996
---- ----
(In thousands)
Component parts and work-in-progress $4,341 $8,097
Finished goods 512 484
------ ------
$4,853 $8,581
====== ======
Inventories are stated net of valuation reserves of $6.9 million and $7.1
million as of December 31, 1995 and September 30, 1996, respectively. In
addition, inventory purchase commitment reserves were $855,000 and
$447,000 as of December 31, 1995 and September 30, 1996, respectively.
10. LONG-TERM DEBT:
During the second quarter of 1996, the Company purchased its King of
Prussia facility for $3.7 million. The Company paid cash of $930,000 and
arranged a 16 year mortgage of $2.8 million with interest payable at a rate of
8.28% per annum. The entire cost of the land and buildings purchased, as well as
the improvements made to the building, have been classified as Land, Building
and Improvements within the property section of the balance sheet. The mortgage
has been classified as long-term debt on the balance sheet, with $88,000
classified as current portion of Long-term Debt.
10
11. PATENTS CORP. MERGER:
During September 1996, InterDigital completed a merger (the "Merger") of IP
Acquisition Corp., a wholly owned subsidiary of the Company, with and into
Patents Corp., an approximately 94% owned subsidiary of the Company. Immediately
before the merger, IP Acquisition Corp. purchased the shares of Patents Corp.
not owned by the Company (approximately 1,600,000 shares) in exchange for shares
of InterDigital Communications Corp. stock (approximately 1,500,000 shares, with
a then current market value of approximately $12 million). As a result of the
Merger, Patents Corp. became a wholly owned subsidiary of InterDigital,
eliminating the minority shareholder interest.
In conjunction with the Merger, the excess of the fair market value of the
consideration paid over the recorded book value of the minority interest of
approximately $7 million was recorded as a write up of the value of its patents.
This increase in value of the patents will be amortized over the remaining
useful life of the patents.
12. INCOME TAXES:
Effective January 1, 1991, the Company adopted the provisions of Statement
of Financial Accounting Standards No. 109, "Accounting for Income Taxes".
The income tax provision for the three months ended September 30, 1996
consists of a current state tax provision of $14,000. The income tax
provision for the three months ended September 30, 1995 consisted of a current
foreign withholding tax benefit of $53,000, a current state tax
benefit of $21,000 and a Federal Alternative Minimum Tax benefit of
$39,000. The income tax provision for the nine months ended September 30,
1996, consists of a current foreign withholding tax provision of $3.3 million,
a current state tax provision of $133,000 and a Federal
Alternative Minimum Tax provision of $87,000. The income tax provision for
the nine months ended September 30, 1995 includes a current foreign
withholding tax provision of $2.4 million, a current state provision of $79,000
and a Federal Alternative Minimum Tax provision of $820,000. At December 31,
1995, the Company had net operating loss carryforwards of approximately $102
million. Since realization of the tax benefits associated with these
carryforwards is not assured, a valuation allowance of 100% of the potential tax
benefit is recorded as of September 30, 1996.
Pursuant to the Tax Reform Act of 1986, annual use of the Company's net
operating loss and credit carryforwards may be limited if a cumulative change in
ownership of more than 50% occurs within a three-year period. The annual
limitation is generally equal to the product of (x) the aggregate fair market
value of the Company's stock immediately before the ownership change times (y)
the "long-term tax exempt rate" (within the meaning of Section 382(f) of the
Code) in effect at that time. The Company believes that no ownership change for
purposes of Section 382 occurred up to and including September 30, 1996. The
Company's calculations reflect the adoption of new Treasury Regulations which
became effective on November 4, 1992 and which have beneficial effects regarding
the treatment of options and other aspects of the ownership change calculation.
11
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
The following discussion should be read in conjunction with the Selected
Consolidated Financial Data, and the Consolidated Financial Statements and notes
thereto, contained elsewhere in this document.
InterDigital commenced operations in 1972 and until 1987 was primarily
engaged in research and development activities related to its TDMA wireless
digital communications technology. In 1986, the Company introduced the
UltraPhone system, a fixed digital wireless local loop telephone system
employing its patented and proprietary TDMA technology, which it began
installing in 1987. The Company's operations from 1987 through 1992 were
characterized by increasing revenues accompanied by significant operating
losses. During this period, significant costs were incurred related to the
commercialization and continued development of the UltraPhone system,
development of production sources and capacity, and the implementation of a
broad-based sales and marketing effort designed to promote regulatory and market
acceptance of the UltraPhone system. During 1993, 1994 and 1995, UltraPhone
system revenues were significantly lower than in 1992; losses increased
significantly in 1993 and 1994 as a result of the decline in UltraPhone product
revenues and gross margins and other increases in costs, such as the increased
investment in B-CDMA technology research and development, engineering of product
redesigns and enhancements, the increase in litigation costs and the costs
associated with enforcement of ITC's intellectual property rights. During 1994,
the Company began to realize positive results from its efforts to capitalize
upon the revenue potential of its TDMA and CDMA patent portfolio and recognized
$28.7 million of licensing revenue, representing over 57% of total revenues for
1994. During 1995, the Company recognized $67.7 million of licensing and
alliance revenue enabling the Company to report its first profitable fiscal year
since its inception. The Company was profitable in the first and second quarters
of 1995 and unprofitable in the third and fourth quarters of 1995. The
variability of 1995 quarterly operating results was due to the revenue
recognition accorded to the non-refundable payments associated with the license
agreements. Such variability has continued during 1996 and the Company expects
that such variability will continue to 1997 and beyond.
The Company's objective is to become a significant global supplier of
digital wireless communications technology and systems based on its proprietary
TDMA and B-CDMA technologies. To achieve that objective, the Company has
developed an alliance program under which it intends to align itself with key
entities in the telecommunications industry. Two of the three key objectives of
the Company's alliance program, if fully and successfully implemented, are to
generate licensing revenues as well as to improve the Company's UltraPhone
product business by (i) making the Company and its UltraPhone products more
credible competitors in large scale telecommunications infrastructure programs,
(ii) expanding the depth and coverage of UltraPhone product marketing efforts
around the world, (iii) facilitating greater focus in the Company's direct sale
activities, and (iv) funding and facilitating engineering changes and
alternative supply and production sources to attempt to significantly reduce
costs and expand product capabilities.
The third objective of the alliance program is to bolster the Company's
on-going efforts to develop its B-CDMA air interface technology and to spread
the commercialization of B-CDMA-based wireless local loop applications and start
the development of B-CDMA-based wireless Personal Communications Service ("PCS")
applications. The successful commercial development and deployment of such
products is dependent upon technological achievement, including the continued
validation of the theories upon which the new technology is being designed, the
continued availability of debt, equity or alliance partner funding sufficient to
support an increasing level of efforts over several years and, ultimately,
market acceptance of the resultant product.
In December 1994, the Company completed the initial implementation of the
alliance program by entering into an integrated series of agreements with
Siemens Aktiengesellschaft ("Siemens") covering UltraPhone product marketing and
product development, B-CDMA technology development, patent licensing and other
areas of cooperation (See Note 5 to "Notes to Consolidated Financial
Statements"). The Company continued its implementation of the alliance program
when it signed a series of agreements
12
with Samsung Electronics Co., Ltd ("Samsung") in February 1996. The agreements
cover B-CDMA technology development, patent licensing, product development,
technology transfer and other areas of cooperation.
To augment its efforts to achieve its goals, the Company has retained
investment banking and other outside resources to investigate acquisition and
other strategies designed to strengthen its competitive position.
ITC, a wholly-owned subsidiary, and the Company, together, offer
non-exclusive, royalty-bearing patent, technology and know-how licenses to
telecommunications manufacturers that manufacture, use or sell, or intend to
manufacture, use or sell, equipment that utilizes their extensive portfolio of
TDMA and CDMA patented technologies. The Company believes that, through ITC's
patent portfolio, and the Company's TDMA and B-CDMA technology research and
development capabilities and resultant know-how, both it and ITC are positioned
to take advantage of the present evolution in wireless telecommunications to
digital technology from analog technology, which represents a substantial
portion of the worldwide installed base. ITC implemented a strategy during 1993
of negotiation and litigation with certain entities which it believed were
representative of the broader number of entities infringing ITC's patents. These
efforts have resulted in patent license agreements with a total of twelve
entities as of October 24, 1996.
Historically through 1994, InterDigital's primary source of revenue was
derived from sales of the UltraPhone digital wireless local loop telephone
system. In recent years, foreign sales have represented a majority of the sales
of UltraPhone systems, and it is anticipated that foreign sales will represent a
majority of UltraPhone system sales for the foreseeable future. UltraPhone
system sales have, on a historical basis, varied significantly from quarter to
quarter due to the concentration of revenues from the Company's largest
customers over a few fiscal quarters. See Note 7 to "Notes to Consolidated
Financial Statements". Additionally, the Company expects that it may continue to
experience significant fluctuations in quarterly and annual revenues and
operating results due to variations in the amount and timing of license and
alliance-related revenue. Accordingly, the Company's cash flow may be expected
to fluctuate significantly for the foreseeable future.
The Company began to experience a significant decline in UltraPhone system
order volume during 1992. Beginning in 1992, competition for sales of wireless
telephone systems intensified as providers of both analog and digital cellular
systems, many of which have significantly greater resources than the Company,
more actively promoted their products for fixed site installations in the
Company's target markets. The Company sought to counter these competitive
pressures by emphasizing the advantages which it believes the UltraPhone system
offers over fixed cellular and other wireless systems, by lowering UltraPhone
system prices, and by offering the UltraPhone system through or in conjunction
with alliance partners. In addition, the Company is continuing to restructure
its sales and marketing efforts to focus on multi-year, large-scale
telecommunications infrastructure programs in which the UltraPhone product would
be positioned as a fundamental component in the rural and near-urban telephone
networks of such programs.
In order to support the flexible pricing generally required in multi-year
programs, the Company introduced a redesigned central office terminal which
expanded base station capacity by over 50% and a significantly lower-priced
cluster unit during the last half of 1994 and introduced a more fully-featured
subscriber unit during the first half of 1996. Reductions in product costs would
be most fully realized in cluster systems and, to a lesser degree, in other
non-cluster configurations in which there is a high ratio of subscriber units to
base stations. The Company has experienced and may continue to experience
engineering and production delays in the introduction of its new subscriber
units and/or other new enhancements or features.
The Company anticipates that it will continuously need to reduce prices and
expand product features due to industry demands which will result in continued
pressure upon gross profit margins until such time as the Company is able to
reduce product costs commensurate with price reductions. More specifically, the
Company has accepted major orders for 1996 and 1997 delivery (see "Backlog"),
and is actively marketing the UltraPhone system in certain opportunities, at
sales prices which are expected to generate little, if any, margin based on the
current cost characteristics of the system configurations being proposed. In
these
13
situations, and in any additional situations where the Company elects to accept
similarly margined orders, it would do so because of collateral profit
potential, as next enumerated, or because of other strategic positioning
considerations. The Company believes that any profit potential would primarily
relate to design engineering to reduce product costs, the expected positive
effects on vendor pricing of the increased production volume, change orders
(including post contract systems reconfiguration), post contract add-ons and
systems expansions and servicing, as well as follow on orders. Given the
possibility of engineering delays and difficulties, and the continuing inability
to sell UltraPhone systems with a high cluster utilization, the Company can give
no assurance that it will be able to achieve sufficient product cost reductions
or otherwise achieve satisfactory gross profit margins. In addition, there can
be no assurance that the development costs necessary to achieve such potential
product cost reductions will be acceptable to the Company.
The inability to competitively approach the aggressive pricing from fixed
cellular and other competitors, the significant additional complexities of, and
time required in, competing for large scale programs, as well as the
restructuring of the sales force, have all adversely impacted order volume and
revenues since 1993. Delays in introduction of the new subscriber unit may
further adversely affect order volume and timing of revenue recognition,
including timing of revenue recognition from the two major orders currently in
backlog (see "Backlog"). The Company is continuing to adjust its sales and
marketing strategies by focusing its direct efforts, improving its UltraPhone
system distribution network and pursuing various additional alliance partners.
In addition to the effects of varying selling prices and product materials
costs, the Company's gross profit margin ratios are ordinarily affected by the
relative proportions of direct and distributor sales, by the average number of
subscribers per system sold, by its ability to absorb manufacturing overhead
costs through generation of sufficient production volume, and by the field
service costs for installation, warranty, training and post-sale support.
Consistent with industry practices, distributor commissions have been included
in both revenues and cost of sales. Historically, the Company's gross profit
margin from UltraPhone system sales has been inadequate to support its operating
and other expenses. The low sales volumes experienced in recent years have
resulted in production volumes which were inadequate to fully absorb fixed
production overhead costs, producing negative gross margins.
On March 29, 1995, a trial involving ITC and Motorola, Inc. ended with the
jury's verdict that ITC's patent claims at issue in the case, involving four of
ITC's patents, are not infringed by the Motorola products involved in the case.
On June 17, 1996, the U.S. District Court Judge for the District of Delaware
affirmed that portion of the jury's verdict. The judge further sustained the
jury's invalidity finding as to 21 of the 24 patent claims at issue, but
reversed the jury's invalidity determination as to the three other claims,
finding no support in the record for the jury's determination. Both parties have
appealed the decision. While the Company believes that substantial grounds exist
to overturn the verdict, the ultimate resolution of this matter will likely
occur in the intermediate to long-term. Until there is a final judicial
determination the verdict may adversely affect the Company's level of revenue
and potential cash flow from ITC's patent portfolio and may impair generally the
Company's ability to raise additional funds for general corporate purposes. The
outcome of the jury trial may also temporarily or permanently adversely affect
ITC's pending U.S. litigation against Ericsson and its ability to realize
running royalties or specified installment payments under certain of its license
agreements. In addition, an adverse ruling (as to ITC) on Motorola's appeal on
its motion for attorneys' fees (which motion the U.S. District Court judge
denied) could adversely affect the Company's cash position.
FINANCIAL POSITION, LIQUIDITY AND CAPITAL REQUIREMENTS
The Company had working capital of $67.8 million at September 30, 1996
compared to working capital of $59.0 million at December 31, 1995. The increase
in working capital since December is due primarily to the recognition of license
and alliance revenue from Samsung of $22.3 million and receipt of $9.4 million
from stock option and warrant exercises, offset by operating cash needs of the
Company. The Company had, prior to 1995, experienced liquidity problems due to
its lack of profits sufficient to generate cash at a level necessary to fund its
investment in additional equipment, its UltraPhone technology development, its
patent activities, its B-CDMA technology research and development activities,
and its
14
operating losses. Since the fourth quarter of 1994, the Company has
substantially strengthened its cash position due its alliance and licensing
transactions.
Demands on working capital in 1996 and beyond are expected to increase. The
Company expects to significantly increase its B-CDMA technology development
expenditures to commercialize its technology as soon as possible. As the
development effort nears first stage completion, currently anticipated in early
1997, additional expenditures are expected to be incurred for marketing and
other activities and subsequent, substantial additional expenditures will be
required to support later stage development. Engineering efforts required to
support the UltraPhone product are also expected to increase significantly as
the Company continues its efforts to reduce the cost of the UltraPhone product
and increase its market share. Marketing and administrative, and other costs are
expected to increase as well as the Company seeks to more effectively support
its alliance program.
Certain emerging trends associated with product sales could also negatively
impact future working capital, should they occur. The Company has not offered
vendor financing to prospective customers, instead relying on its efforts to
assist prospective customers in obtaining financing from other sources. Should
the Company engage in a vendor financing program (it has no current plans to do
so), such a program would have a material impact on working capital needs. Many
current and prospective customers have required increasingly significant
delivery and performance guarantees of various types, including delay damage
clauses, performance bonds and performance guarantees. The working capital
required to provide such guarantees could be significant for large orders, and
the costs that might be incurred if any such guarantee were called upon could
have a material adverse impact on working capital. In addition, the Company
obtains some component parts from single sources, while other components are
available from multiple sources; changing sources of supply would likely cause a
disruption in supply. Any interruption in the supply of quality components could
have an adverse impact on working capital.
The Company's working capital requirements will depend on numerous
additional factors, including but not limited to the success of the Siemens and
Samsung relationships and the broader alliance strategy, the level of demand and
related margins for the UltraPhone system, the ability to generate license fees
and royalties, and the need to expend funds in connection with its patent
enforcement activities. In addition, when the Company builds to specification to
complete an order, it traditionally experiences negative cash flows from
inception of its production ordering through customer payment at the time of, or
increasingly subsequent to, order shipment. If the Company were to experience
additional sudden and significant increases in orders to be built to
specification, it would intensify the need for significant short to intermediate
term financing arrangements.
Accordingly, the Company may, at some future date subsequent to 1996,
require additional debt or equity capitalization to fully support its technical
and product development and marketing activities and to fund its patent
enforcement activities. The Company does not presently maintain bank lines of
credit and may therefore, in such event, seek to meet such needs through the
sale of debt or equity securities. There can be no assurances that the Company
will be able to sell any such securities, or, if it can, that it can do so on
terms acceptable to the Company.
In August 1996, the Company acquired a fifty (50) percent interest in an
office building located on Long Island, New York for possible use as its primary
location for B-CDMA development. The Company affected the acquisition of the
building through the creation of a New York Limited Liability Company, 60
Crossways, L.L.C., in which the Company holds a 50% interest. A local commercial
real estate owner, developer and building contractor holds the remaining
interest. The limited liability company purchased the building for approximately
$2.0 million. The Company and its partner have agreed to share equally the
acquisition and ownership costs of the limited liability company. The Company is
currently evaluating its short and long term space requirements and reviewing
various options for accommodating such needs.
The Company believes that its investment in inventories and non-current assets
are stated on its December 31, 1995 and September 30, 1996 balance sheets at
realizable values based on expected selling price and order volumes. Property
and equipment are currently being utilized in the Company's on-going business
activities, and the Company believes that no additional write-downs are required
at this time due to lack of
15
use or technological obsolescence. With respect to other assets, the Company
believes that the value of its patents is at least equal to the value included
in the December 31, 1995 and September 30, 1996 balance sheets.
Backlog
At September 30, 1996, the Company's backlog of orders for UltraPhone telephone
equipment and services was $92.1 million, which includes the Company's first
order from its Pakistanian customer of $42.9 million, the balance of one order
from the Company's Philippine customer of $8.3 million and another order
from its Indonesian customer for $36.8 million. The Pakistan order is subject to
final commitment of financing and the Indonesian order is subject to completion
of financing documents. Over $15 million of the backlog is expected to be
delivered during the fourth quarter of fiscal year 1996, with the
balance expected to be delivered during fiscal 1997 and the first half of fiscal
1998. At September 30, 1995, the Company's backlog of orders for UltraPhone
telephone equipment and services was $2.3 million.
Changes in Cash Flows and Financial Condition
The Company has experienced positive cash flows from operations during the
nine months ended September 30, 1996. The positive cash flows from operations
are primarily due to the receipt of funds from the Samsung agreement offset by
expenses incurred for UltraPhone production and marketing, B-CDMA technology
development and the Company's general and administrative activities. Licensing
and Alliance revenue for Samsung of $22.3 million was recognized as revenue in
the nine month period ended September 30, 1996. (See Note 6 of the "Notes to
Consolidated Financial Statements".)
Net cash flows from investing activities were negative for the nine months
ended September 30, 1996 due primarily to the Company's purchase of its King of
Prussia, PA. and Long Island, N.Y. facilities, the payment of $2.6 million in
support of the Company's bonding requirements and its investment in property and
equipment. Notwithstanding the above, the amount of cash used in investing
activities has, historically, been low relative to cash used in operations.
During the nine month period ended September 30, 1996, the Company
generated $8.9 million from financing activities. The funds were primarily from
the exercise of stock options and warrants.
Cash, cash equivalents and short-term investments of $67.4 million as of
September 30, 1996 includes $1.1 million of restricted cash. The UltraPhone
accounts receivable of $12.4 million at September 30, 1996 reflect amounts due
from normal trade receivables, including non-domestic open accounts, as well as
funds to be remitted under letters of credit. Of the outstanding trade
receivables as of September 30, 1996, $4.0 million has been collected through
October 24, 1996.
Inventory levels at September 30, 1996 of $8.2 million have increased as
compared to $4.9 million as of December 31, 1995, reflecting the build-up of
inventory for the Indonesian order and the remaining Philippine shipments.
Inventories at December 31, 1995 and September 30, 1996 are both stated net of
valuation reserves of $6.9 million and $7.1 million, respectively.
Included in other accrued expenses at September 30, 1996 are professional
fees, consulting and other accruals as well as sales taxes payable.
16
Results of Operations - Third Quarter of 1996 Compared to the Third Quarter of
1995
Total Revenues. Total revenues in the third quarter ended September 30, 1996
increased to $9.4 million from $5.8 million in the third quarter ended
September 30, 1996 primarily due to the increase in UltraPhone product sales.
UltraPhone product sales increased 362% in the third quarter of 1996 to $7.5
million from $1.6 million in the comparable quarter of 1995.
During the third quarter of 1996, the Company recognized $754,000 of
Samsung revenue that related to the UltraPhone B-CDMA technology development
portion of the agreement. The Company also recognized $314,000 of recurring
royalty revenue during the third quarter of 1996 from one of its licensees.
Additionally, the Company recognized revenue of $800,000 as part of the Siemens
series of agreements. During the third quarter of 1995, ITC entered into
royalty-bearing license agreements with one licensee under its patent portfolio
for the manufacture, use and sale of TDMA based subscriber units and
infrastructure equipment. The Company recognized $4.0 million as part of the
Siemens series of agreements during the third quarter of 1995.
The Company had contract revenue of $212,000 related to its U.S. Federal
government and other services contracts for the third quarter in 1995 as
compared to no revenue during the 1996 period. The decrease in revenue is due to
the completion of the remaining contracts for which the Company was obligated.
During the third quarter of 1994, the Company began withdrawing from the
contract services market in order to focus on its other core business
activities.
Cost of UltraPhone Sales. The cost of UltraPhone sales for the third quarter of
1996 increased 131% to $8.8 million from $3.8 million for the third quarter of
1995. The Company had approximately 16% negative gross margin on UltraPhone
system sales for the three months ended September 30, 1996 as compared to a
negative gross margin of 133% for the three month period ended September 30,
1995. Included in cost of UltraPhone system sales are costs of product assembly,
integration and testing, distributor commissions, freight and tariffs, and
expenses associated with installation, support and warranty services related to
the UltraPhone systems. Also included in the cost of sales are the overhead
expenses the Company has incurred in maintaining its production resources that
were not absorbed into inventory due to the low volume of production during the
quarter.
Contract Services Costs. Contract services costs were $242,000 in the three
month period ended September 30, 1995. The Company completed the shutdown of the
facilities and the termination of employees related to the contract services
segment of the business during 1995.
Other Operating Expenses. Other operating expenses include sales and marketing
expenses, general and administrative expenses and research and development
expenses.
Sales and marketing expenses increased 70% to $1.2 million during the third
quarter of 1996 as compared to $723,000 during the third quarter of 1995. The
increase is primarily due to increased staff and activity levels, and included
an increase in commission expense due to the increase in UltraPhone product
revenues in the three month period of 1996.
General and administrative expenses for the third quarter of 1996 increased
2% to $2.63 million from $2.57 million for the third quarter of 1995. The
increase is primarily due to an increase in expenses related to the investment
banking and marketing activities.
Research and development expenses for the third quarter of 1996 increased
132% to $5.9 million as compared to $2.5 million during the third quarter of
1995. Staff and activity levels devoted to the development of the B-CDMA
technology and the development of the Company's fourth generation UltraPhone
product have increased significantly.
Other Income and Expense. Interest income for the third quarter of 1996 was
$892,000 as compared to $916,000 for the third quarter of 1995. The Company had
similar average invested cash balances in both periods. Interest expense for the
three month period ended September 30, 1996 was $55,000 as compared
17
to $14,000 for the three month period ended September 30, 1995. The increase is
due primarily to the mortgage interest related to the Company's purchase of its
King of Prussia facilities in the second quarter of 1996.
Minority Interest. In December 1992, the Company sold 5.76% of the common shares
of InterDigital Patents Corporation ("Patents Corp."), which had, prior thereto,
been a wholly-owned subsidiary of the Company. The Company recorded no change in
minority interest in the third quarter of 1996. During the comparable 1995
period, the Company recorded an increase of $246,000 in minority interest
representing the minority interest's portion of the net income of Patents Corp.
for the third quarter of 1995. In September 1996, the Company acquired the
shares of Patents Corp. that it did not currently own and as a result, Patents
Corp. became a wholly-owned subsidiary of InterDigital (See Note 11 to "Notes to
the Consolidated Financial Statements").
Results of Operations - Nine Months Ended September 30, 1996 Compared to Nine
Months Ended September 30, 1995
Total Revenues. Total revenues for the nine months ended September 30, 1996
decreased 49% to $40.9 million from $80.0 million for the nine months ended
September 30, 1995 primarily due to a decrease in the amount of License and
Alliance revenues recognized offset by a small increase in UltraPhone equipment
revenues. License and Alliance revenues for the nine months ended September 30,
1996 includes $22.3 million as part of the Samsung Agreements (see Note 6 of the
Notes to Consolidated Financial Statements) and $4.0 million as part of the
Siemens Agreements (see Note 5 of the Notes to Consolidated Financial
Statements). During the first half of 1995, ITC entered into royalty-bearing
license agreements with Pacific Communication Sciences, Inc., a subsidiary of
Cirrus Logic, Inc., Sanyo Electric Company, Ltd., Mitsubishi Electric
Corporation, Hitachi Ltd. together with its affiliate Kokusai Electric Co., Ltd,
and NEC Corporation under its patent portfolio for the manufacture, use and sale
of TDMA based subscriber units and infrastructure equipment. These agreements
contain advance payment obligations pursuant to which ITC received an aggregate
of approximately $54.1 million, which was recognized as revenue during the first
half of 1995. Additionally, the Company recognized revenue of $12.0 million as
part of the Siemens series of agreements during the 1995 period. UltraPhone
equipment sales increased 10% during the nine months ended September 30, 1996 to
$14.4 million from $13.1 million in the comparable period of 1995.
During the nine months ended September 30, 1995, the Company had $657,000
of contract revenue related to its U.S. Federal government and other services
contracts as compared to no contract services revenue recognized in the 1996
period due to the completion of the remaining contracts for which the Company
was obligated during 1995.
Cost of UltraPhone Sales. The cost of UltraPhone equipment sales for the nine
months ended September 30, 1996 increased 7% to $16.7 million from $15.5 million
for the nine months ended September 30, 1995. The Company incurred a negative
gross margin on UltraPhone equipment sales of 16% for the nine months ended
September 30, 1996 as compared to a negative gross margin of 19% for the nine
month period ended September 30, 1995. Included in cost of UltraPhone equipment
sales are costs of product assembly, integration and testing, distributor
commissions, freight and tariffs, and expenses associated with installation,
support and warranty services related to the UltraPhone systems, as well as the
overhead expenses the Company has incurred in maintaining its production
resources that were not absorbed into inventory due to the low volume of
production. At low production levels, such as those experienced in the first
three quarters of 1996, the Company incurs substantial negative gross profit
margins because production costs are spread over only a limited number of units
of production.
Contract Services Costs. Contract services costs were $754,000 in the nine month
period ended September 30, 1995. There were no contract service costs incurred
during the nine months ended September 30, 1996 as the Company has withdrawn
from this line of business and has completed its obligations on any remaining
contracts.
18
Other Operating Expenses. Other operating expenses include sales and marketing
expenses, general and administrative expenses and research and development
expenses.
Sales and marketing expenses increased 13% to $3.1 million during the nine
months ended September 30, 1996 compared to $2.8 million during the nine months
ended September 30, 1995. The increase is primarily due to increased commissions
expense, commensurate with the increase in UltraPhone system revenues.
General and administrative expenses for the nine months ended September 30,
1996 decreased 27% to $8.1 million from $11.1 million for the nine months ended
September 30, 1995. The reduction in general and administrative expense is due
primarily to a decrease in the Company's patent infringement and enforcement
costs of $3.9 million offset partially by higher activity levels. The 1995
period included costs for the Motorola suit as described in the Company's Annual
Report on Form 10-K for 1995.
Research and development expenses increased 136% for the nine months ended
September 30, 1996 to $15.1 million from $6.4 million for the nine months ended
September 30, 1995. The increase over the prior year period is due primarily to
increased staff and activity levels devoted to the development of the B-CDMA
technology and the development of the Company's fourth generation UltraPhone
product released during the first half of 1996.
Other Income and Expense. Interest income for the nine months ended September
30, 1996 was $3.0 million as compared to $2.1 million for the nine months ended
September 30, 1995. The increase is due primarily to greater average invested
cash and investment balances in 1996 compared to 1995. Interest expense for the
nine month period ended September 30, 1996 was $132,000 as compared to $623,000
for the nine month period ended September 30, 1995. The decrease is due
primarily to the settlement of the HNS obligation during the second quarter of
1995, partially offset by increased interest expense related to the King of
Prussia mortgage. Remaining interest is incurred on the Company's capital lease
obligations.
Minority Interest. In December 1992, the Company sold 5.76% of the common shares
of Patents Corp., which had, prior thereto, been a wholly-owned subsidiary of
the Company. The Company recorded $890,000 as an increase in minority interest
in the nine months ended September 30, 1996 representing the minority interest's
portion of the net income of Patents Corp. for the nine months ended September
30, 1996. During the comparable 1995 period, the Company recorded an increase of
$4.0 million in minority interest representing the minority interest's portion
of the net income of Patents Corp. for the nine months ended September 30, 1995.
19
Statement Pursuant to The Private Securities Litigation Reform Act of 1995
The foregoing Management's Discussion and Analysis and discussion of the
Company's business contains various statements which are forward-looking
statements. Such forward-looking statements are made pursuant to the "safe
harbor" provisions of Section 21E of the Securities Exchange Act of 1934, as
amended, which were enacted as part of the Private Securities Litigation Reform
Act of 1995.
The Company cautions readers that the following important factors, among others,
in some cases have affected and, in the future, could materially adversely
affect the Company's actual results and cause the Company's actual results to
differ materially from the results expressed in any forward-looking statements
made by, or on behalf of, the Company:
General and specific economic conditions of the Company's customers,
potential customers and the wireless communications industry; reversal of
or slow-down in anticipated TELCO infrastructure spending, thereby
decreasing overall product demand below present forecasts; implementation
delay in the conversion from analog cellular technology to digital cellular
technology, whether caused by continuing sufficiency of capacity, new
methods for increasing analog capacity or customer funding, unwillingness
of TELCOs to fund infrastructure replacement or for other reasons.
The effects of, and changes in, foreign trade, monetary and fiscal
policies, laws and regulations, other activities of foreign governments,
agencies and similar organizations, and foreign social and economic
conditions, such as trade restrictions or prohibitions, inflation and
monetary fluctuations, import and other charges or taxes, the ability or
inability of the Company to obtain or hedge against foreign currency,
foreign exchange rates and fluctuations in those rates, adverse foreign tax
consequences, general delays in remittance and difficulties of collection
of foreign payments, efforts to nationalize foreign owned operations,
unstable governments and legal systems, and inter-governmental disputes, as
well as foreign governmental actions affecting frequency, use and
availability, type acceptance, spectrum authorizations and licensing.
Failure to enter additional sufficient strategic alliances necessary to
achieve the Company's business objectives; failure to fully and
successfully implement the alliance program; inadequacy or inability of
alliance partners to meet Company expectations; failure of alliance
partners to meet contractual obligations to the Company.
Lack of existing lines of credit to draw on to support technical and
product development and to fund patent enforcement activities, requiring
the possible sale of debt or equity securities.
The growth in the amount of, and the rate of increase of, the Company's
selling, general and administrative expenses.
Difficulties in the Company's business related to the market acceptance of
its products and/or technologies and any difficulties experienced by
current or future customers using the Company's products and/or
technologies.
Inability to retain existing, and/or hire new, appropriately qualified
administrative, sales and marketing personnel.
Increased and/or more aggressive marketing of competitive wireless
communications systems, in many cases by much larger and better financed
organizations.
Announcements of new products or technologies by the Company's competitors;
the ability of competitive products to achieve a perceived, absolute or
relative overall value advantage when compared to the Company's products or
technologies on the basis of features, quality and pricing;
20
the inability of the Company to keep pace with technological developments
and/or respond in a timely manner to changes in customers' needs.
Increased pressure to engage in a vendor financing program.
Adverse trends in the equipment acquisition and replacement pattern of the
Company's customers.
Loss of customers.
Fluctuating demand for the Company's products; additional sudden and
significant increases in product orders requiring short term and
intermediate term financing.
Inability of the Company or its customers to secure acceptable financing
related to purchase and installation of the Company's products.
Lack of timely availability of the Company's products and the ability and
willingness of purchasers, in such circumstances, to acquire alternative
products.
Imposition of government or industry standards or competitive technological
developments which render any of the Company's technologies and/or products
obsolete or non-competitive.
Lack of frequency or bandwidth allocations within the technical
specifications of the Company's products or technology; engineering
problems in implementing new frequencies or operating with non-standard
bandwidths.
Manufacturing-related problems, including quality, cost or delivery
problems with vendors and component suppliers; unavailability of
alternative sources for component parts of the Company's products or
unavailability of components at competitive prices; longer than desirable
development time arising from the necessity to use alternative sources.
Unanticipated cash flow restrictions, continued or increased pressure to
lower the selling prices of the Company's products; failure to realize
revenues from orders on backlog; failure to increase future orders for and
revenue from UltraPhone products; failure to improve margins; failure to
achieve or maintain technical compliance with terms of customer contracts.
Difficulties or delays in the development, production, testing and
marketing of products or underlying communications technologies, including,
but not limited to (i) the failure to commercialize new products when
anticipated and the failure of manufacturing economies to develop when
planned, (ii) loss of the Company's key personnel, or inability to hire
sufficient number of qualified engineers to achieve technology development
objectives, (iii) the lack of availability or insufficiency of operating,
debt, equity or alliance related funds for research necessary to
effectively and timely complete product and technology development, or lack
of availability on terms acceptable to the Company, and (iv) increased
project engineering costs for future and current projects.
Substantial increased or continuing burdensome impact of the costs and
other effects of legal and administrative cases and proceedings (whether
civil, such as intellectual property and product-related matters, or
criminal), settlements and investigations, claims and changes in those
items, developments or assertions by or against the Company relating to
intellectual property rights and intellectual property licenses, including
but not limited to assertions that others infringe the Company's or ITC's
proprietary rights or that the Company's products infringe proprietary
rights of others.
Failure of the Company to successfully negotiate licensing agreements for
the Company's patents and other intellectual property; inability to enforce
patents against third parties; inability to enforce, or inadequacy of,
non-competition and non-disclosure agreements relating to Company's
21
proprietary rights; adverse decision in the Company's outstanding or any
future intellectual property rights litigation, including but not limited
to declaration of invalidity of ITC patents.
Suspension of royalty revenues under existing or future license agreements,
with or without the accrual of royalty obligations.
Adverse effects from the Motorola judgment, including but not limited to
(i) adverse impacts on the level of revenue and potential cash flow from
ITC's patent portfolio (ii) the impairment of the Company's ability to
raise funds for general corporate purposes, and (iii) the temporary or
permanent impairment of ITC's pending U.S. litigation against Ericsson.
The failure of the appeals courts to reverse, vacate and/or remand the
Motorola judgment, recognizing that, notwithstanding the Company's belief
that substantial grounds exist for reversal, vacation and/or remand, the
Company carries the burden on appeal and, more often than not, jury
determinations are upheld.
An adverse decision in U.S. and foreign patenting forums regarding the
validity of ITC's patents, which could materially impact ITC patent
licensing opportunities, the Company's ability to realize licensing
revenue, and pending patent litigation. Such decision could include, but is
not limited to, the rejection of a patent in whole or in part, or the
material alteration or limitation of patent claims.
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Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) The following is a list of exhibits filed as part of the Form 10-Q.
Exhibit 3.1 -- Restated Articles of Incorporation
Exhibit 3.2 -- Bylaws of Amended on October 6, 1996
Exhibit 10.25 -- Amended 1995 Stock Option Plan
Exhibit 11 -- Computation of Net Income Per Share
Exhibit 27 -- Financial Data Schedule
(b) Reports on Form 8-K
The Company filed a Current Report on Form 8-K dated August 16, 1996
under Item 5 - Other Events, relating to the Company's Agreement and
Plan of Merger with its 94% owned subsidiary, InterDigital Patents
Corporation. No financial statements were filed with this report. A
Registration Statement on Form S-4 to register the shares of
InterDigital's common stock was filed with and declared effective by the
Securities and Exchange Commission and contains consolidated financial
statements for both InterDigital Communications Corporation and
InterDigital Patents Corporation.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
INTERDIGITAL COMMUNICATIONS CORPORATION
Date: November 8, 1996 /s/ William A. Doyle
---------------------------
William A. Doyle, President
Date: November 8, 1996 /s/ James W. Garrison
---------------------------
James W. Garrison,
Vice President -- Finance, Chief
Financial Officer and Treasurer
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